How Bad Is Banking? And Who Are The FDIC Four?
This guest blog entry by Tristan Yates is a follow-up to “Are America’s banks really insolvent?” and is part of the important effort to understand and evaluate the depth and breadth of the financial crisis. For The Curious Investor’s take and to leave your own thoughts check out this post’s comments thread.
What kind of losses is the banking industry facing? And are all of the banks really insolvent? Although the answers are critical inputs for any economic decisions, it has been far easier to find dire predictions than real analysis and evidence.
But for anyone looking for hard numbers, the FDIC’s Q42008 Quarterly Banking Profile is perhaps the most useful report published to date. Just in the first paragraph, the agency reveals the following:
- The total loss to the insured institutions sector this quarter was $26.2B, the worst on record. Losses were due to high expenses for loan loss provisions, losses in trading accounts, and writedowns of goodwill and other assets
- Earnings problems were widespread, but just four institutions accounted for half of the industry’s total loss. Yet in this difficult quarter, 68% of institutions were profitable and more than a third reported year-over-year increases in RoA.
Both of these findings run counter to conventional wisdom. $26B of total net losses for the quarter isn’t good, but it is light years away from the multi-trillion financial apocalypse that’s being predicted by economics pundits such as Krugman, Roubini, and Grantham. And a concentration of losses in four institutions suggests that perhaps just a handful are in danger rather than the banking system as a whole.
Alas, the identities of the “FDIC four”, i.e. the four institutions that accounted for half the loss, were not provided in the report. But I have access to not only the FDIC’s publicly available data, but a star analyst and my former Director at Price Waterhouse Coopers, Jim Boswell. Jim managed risk for the $600B Ginnie Mae portfolio in the aftermath of the Savings & Loan crisis and wrote their guarantee fee study, and is now a fellow consultant.
Jim forwarded me three spreadsheets that I’ve combined into one (download here -> FDIC Bank Stats). The first shows clearly the deterioration of the banking sector as a whole, with loan loss allowances, loan delinquencies, and chargeoffs all essentially doubling in about the past fifteen months.
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Yet, total non-accrual loans (essentially non-performing loans) are just $158B. Under the assumption that every single one goes to foreclosure – and history says that they won’t – and that the bank can only recover 50% from the sale of the property – and house prices haven’t fallen that far – the losses would only be about $80B.
Thus although we definitely haven’t seen the end of the trendline, one would still have to make extremely dire assumptions about future delinquency and recovery rates just to arrive at a $300B or $400B total loss for a banking sector which still has $1.3T of equity available.
And Jim also pointed out that either lower interest rates or higher inflation could be mitigating factors. Both effects boost the value of the underlying asset (the home) and improve recovery rates. He is an advocate for the 4% mortgage as a recovery tool, and may soon get his wish as rates are falling fast.
The second spreadsheet shows the losses for large institutions and identifies the “FDIC four” as Regions, Merrill Lynch, Indymac, and RBS Citizens. However net losses don’t take into account the amount of existing equity and assets, so it’s not quite accurate to use this as a health measure. Also, IndyMac is old news, a ward of the state taken over by the FDIC in late June and just resold.
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The third spreadsheet is a more detailed ratio analysis of large banks and compares the results to two years ago. While virtually every bank is worse off, the differences are still significant. For example, fully 4.4% of Citi’s loans and 5.1% of Countrywide’s are non-current or REO, as compared to 3.0% for Bank of America, 2.6% for Chase, 2.1% for PNC, and 1.3% for Capital One.
ROE, Net Interest Margin, and Equity to Assets ratios also vary widely, and this helps support the argument that while every institution has been impacted to some extent, not all banks are in trouble and some have been much more successful in anticipating and/or navigating this current environment than others.
Note that just about every institution that has been rescued or shut down recently reports numbers significantly worse than its peers, and this past usefulness gives us some reason to be confident about the data. And of course the FDIC itself has performed well during this crisis.
Let’s be clear where this report and data leaves us. If someone has evidence that this banking crisis is a one or two trillion dollar problem and that most or all of the banks are insolvent, then let’s see it. Better yet, let’s have them testify in front of Congress and show their work. Because this FDIC data & report isn’t that evidence.
While there’s no question that it points to a worsening situation, the cumulative dollar amounts of net losses, non-accrual loans, and net chargeoffs only sum to $220B, as compared to $1.3T of industry equity. And the individual situations vary immensely – some banks will face the guillotine, and others will get away with but a haircut.
Tristan Yates is the author of Enhanced Indexing Strategies
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Comments
This is also a first for me, commenting to a blog, that is. However, since I am the person that did much of the research relating to the FDIC information that Triston mentioned in what I consider to be an excellent article, I would like to just add this.
What is currently going on in the global financial world does not need to turn into “the Next Great Depression.” Globalnomics, my new term for modern economics, portends low inflation on the longer term as Developing Countries continue to develop and Advanced Countries continue to find new and better ways for improved productivity and innovation.
In the United States the current housing problem looks more like the Savings and Loan problem than it does a Great Depression like problem. I have experience here. I was responsible for moniotoring the risk of ginnie mae’s portfolio of mortgage-backed securities during the Savings and Loan crisis a few years back.
Sure housing prices have fallen across the nation which makes the current problem a bit different from the S&L problem, but with the prediction of low inflation in the future (my Globalnomic theory), current long-term mortgage rates can be lowered to 4.0 percent easily (and maybe even lower) in the United States. These lower mortgage rates, in and of themselves, recovers much of the lost equity that has currently been experienced and will make most all home loans hole, if not prosperous, again.
And just wait. All those toxic assets, which a high percentage include the second and third home condos that those wall street guys invested in and built in sunny California, Nevada, Arizona, and Florida. In a few years, when the global economy has recovered and back on its feet, the Baby Boomers will snuff all those toxic assets up and live their golden years in ’sunny blis”.
It reminds me of the days when i used to travel down to Dallas during the S&L crisis and see all the forty story buildings sided with ‘gold’ tint sitting empty. Do you know what happened to those. The Government after taking them over sold them to a bunch of ‘high tech’ companies and turned the Texas economy around to one that was more diversified than the one which was pretty much solely dependent upon ‘oil”. Funny how that happens, isn’t it?
On its face, this is certainly an interesting analysis particularly in light of the fact that it is derived from recent FCIC data. Unfortuntately, most banks don’t just have a portfolio of loans anymore. Many have “diversified” away from originating and holding pieces of tranditional loans and become either originators or investors (or both) in a panoply of securities, many of which are now illiquid and nearly impossible to value other than via internal models. Your analysis does not appear to take into account these potential time bombs inherent on many bank balance sheets, i.e., their holdings of what are now “toxic” securities, such as subprime RMBS, commercial CMBS, other types of asset-baced sucurities, Non-AAA CLO tranches, etc. Factoring in the potential losses on these types of instruments will likely paint a decidedly more dire picture for the health of many institutions.
This is a first for The Curious Investor. I haven’t done a guest blog post before and I don’t know that it will become a regular thing. But, when Tristan contacted me and presented the data he collected from a deep dive that I definitely would not have the time to do myself, I couldn’t help but want to share this with my readers.
I think this article provides tremendous context relative to the doom and gloom we’ve been hearing from various media pundits on the state of our nation’s banks. Too many people regurgitate the “Banks are insolvent. Let them all fail.” rhetoric without any idea as to the real fundamentals that support such a statement.
I don’t think readers should take this article to refute Krugman, Roubini, and Grantham, but use this article to educate their view on their predictions. In the end, Roubini, Krugman, and Grantham are not so much commenting on the true state of the nation’s banks but on an implied over leverage in our economy. The truth, however, is that most banks today are not insolvent and, if given time, Roubini, Krugman, and Grantham’s realities can be mitigated simply by the forces of inflation, cheap money, and time. The question is, is there any monetary or fiscal policy which can buy enough time for banks to straighten up? Or, will market fear and irrationality spur continued forced selling, asset deflation, and the ultimate realization of doomsday scenarios?