Saturday, September 5, 2009

Banks’ Balance Sheets: Getting Worse

Following up on my previous report (, banks’ balance sheets show no signs of improvements during the Second Quarter of 2009. In fact, key ratios demonstrating bank weaknesses have increased—in some instances they have surpassed all-time highs. All the charts demonstrate an uninterrupted upward trend since 2007. The caveat of my analysis is that the data are backward-looking; that is, we can only extrapolate from the past to give us an adequate assessment of the future. In addition, it takes the St. Louis FED about 6 weeks after the closing of the quarter to publish these figures (this time it took them close to 8). Considering the present condition of commercial real estate, along with the upcoming ARM and Alt-A mortgage resets, there is no light at the end of the tunnel for bankers. Given the information I will present, it is inconceivable that the FED will pull the plug on its intervention in the market any time soon. At the very least, until these figures reverse, all talk about “green shoots” and “economic recovery just around the corner” must be taken with exceeding caution.

Net Loan Charge Offs-to-Total Loans at commercial banks increased to an all-time high of 2.06%, up from 1.76% as of 3/31/09 and up from .96 reported during 4th Quarter 2008. The ratio has more than tripled year-over-year from .64 in 3/31/08. The most recent recorded figure supersedes the prior peak of 1.81% reached in 12/31/91 [see Note 1].

Loan Loss Reserves-to-Total Loans ratio increased to 2.94 from 2.65% reported on 3/31/2009. Year-over-year the recent ratio is up from 1.79% [see Note 2]. In particular to banks whose assets fall between $1 billion to $15 billion, the increase was from 2.10% to the current figure of 2.28% [see Note 3]. For the biggest banks, that is those with assets in excess of $15 billion, the current figure stands at 3.32%, up from 2.96% reported the previous quarter [see Note 4]. Reserves act as a buffer to capital losses resulting from asset deterioration. From a historical perspective, however, reserves at these institutions are low. For example, for the largest banks (assets > $15 billion), reserves reached a high of approximately 4.65% in terms of total loans during the late 1980s. The fact the current trend is up is good news. The bad news is that it’s not growing fast enough.

Considering Net Loan Losses-to-Average Total Loans, there is no evidence of a turnaround in business condition. The most recent figure broke the previous all-time high of 2.03% reported in 1Q2009. Currently, the ratio stands at 2.36%, which is more than doubled on a year-over-year basis [see Note 5]. For banks with average assets of $1 billion to $15 billion, the ratio currently stands at 2.08%, up from 1.63% in the previous quarter. The recent figure is an all-time high, surpassing the mark of about 1.8% in 1991 [see Note 6]. For institutions exceeding the $15 billion average assets threshold, the figures continue to be abysmal: The ratio currently stands at 2.68%, up from 2.35% in the previous quarter. During the last twelve months, this ratio has more than doubled, which indicates a worsening banking condition [see Note 7].

The next key statistic to consider is Non-Performing Loans-to-Total Loans. You may recall that Non-performing loans constitute past-due principal and interest in excess of 90 days. These are bank assets that will most likely turn toxic. The current figure stands at 2.78%, up from 2.20% reported the previous quarter and up from 1.71% reported on 12/31/08 [see Note 8]. At its peak for all commercial banks, the ratio stood at 4.88%, so the trend is evidence that the figures will continue to deteriorate. The same ominous gap is present for all banks exceeding $1 billion in average assets [see Note 9]

As I stated previously, banks’ balance sheets have deteriorated and will continue to get worse. The trend demonstrates that non-performing loans will continue to increase. Many of these loans will be charged-off. Loan loss reserves, which buffer against defaults, are not sufficient to cover the potential losses:

* * * * * * * * * * * * * * * * * * * * * *

(Note 1)

(Note 2)

(Note 3)

(Note 4)

(Note 5)

(Note 6)

(Note 7)

(Note 8)

(Note 9)

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