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Banking industry faces huge risk in major disasters, insurers tell ABA


NAPLES, Fla.—The U.S. banking sector faces one of the biggest exposures of any industry in the event of a major disaster in an affluent, major metropolitan area, but banks do little to protect themselves from such catastrophes, a reinsurance broker says.

In the event of powerful earthquake in Los Angeles or San Francisco, for example, banks could lose more money than insurers and reinsurers, said David TenHoor, Minneapolis-based executive vp for Willis Re Inc.

While the insurance industry protects itself with exclusions and limits, the banking industry is largely unprepared for the possibility of widespread loan defaults in areas with the most expensive housing prices, he said at the American Bankers Assn. Insurance Risk Management Annual Conference & Meetings for the Financial Services Industry held Jan. 21-24 in Naples, Fla.

"We're surprised you're not doing anything about it," Mr. TenHoor said. "This is the 600-pound gorilla in the living room that nobody wants to talk about."

Various industry studies, including those conducted by Lloyd's of London and Swiss Reinsurance Co., have found that a repeat of the 1906 San Francisco earthquake would cause $74 billion to $400 billion in damage.

A similar earthquake today would likely result in a wave of mortgage defaults, which is a risk that the banking industry disregards with a long list of false assumptions, Mr. TenHoor said.

For example, since most California homeowners do not purchase adequate earthquake insurance, the banking industry relies on emergency state and federal programs that could fall short. Residential loans from the Federal Emergency Management Agency are capped at 200,000--far short of most California home values, he said.

And the costliest disaster in U.S. history, Hurricane Katrina, does not serve as a model for what could happen in the event of an earthquake in one of California's major cities, Mr. TenHoor said.

The fallout from Hurricane Katrina's devastation doesn't compare to what could happen to banks if an earthquake in California causes the same amount of damage, he said.

The risk is seen in the disparity between property values and lending practices: Louisiana, Mississippi and Alabama represent less than 2% of the total U.S. residential mortgage market, with the average home valued between $85,000 and $125,000; the states also represent less than 1% of commercial mortgage backed securities; and the region features a limited use of exotic mortgages.

A Katrina-sized disaster in more expensive areas in the nation could be devastating to the lending industry given the "sheer dollar size of property values," Mr. TenHoor said, adding that California median home prices typically exceed $500,000.

Exotic financing and second mortgages for such needs as repairs are much more common in high priced areas and in some cases homeowners can owe more than their home is worth, he said.

"We (in the insurance industry) see huge amounts of losses for banks," Mr. TenHoor said. "We have capped our coverage. We know the risk and we're shoveling it over to you."