Interest Rate Roundup

Wednesday, August 22, 2007

Q2 banking stats out ... and they don't look good

The FDIC just released data on the banking industry for Q2 2007. Suffice it to say the numbers don't look good. You can read the full "Quarterly Banking Profile" document at this PDF link. But let me excerpt some of the main points, highlight a few things in bold, and then comment on them ...

* There were 824 institutions reporting net losses for the quarter, compared to 600 unprofitable institutions a year earlier. This is the largest year-over-year increase in unprofitable institutions since the third quarter of 1996. The increase in unprofitable institutions was greatest among institutions with less than $1 billion in assets, and among institutions with high levels of residential real estate and commercial loan exposures. The proportion of unprofitable institutions — 9.6 percent of all insured institutions — was the highest level for a second quarter since 1991.

* Insured institutions added $11.4 billion in provisions for loan losses to their reserves during the second quarter, the largest quarterly loss provision for the industry since the fourth quarter of 2002. This was $4.9 billion (75.3 percent) more than they set aside in the second quarter of 2006.

* Net charge-offs totaled $9.2 billion in the second quarter, the highest quarterly total since the fourth quarter of 2005, and $3.1 billion (51.2 percent) more than in the second quarter of 2006. The loan categories with the largest increases in net charge-offs included consumer loans other than credit cards (up $757 million, or 60.9 percent), commercial and industrial (C&I) loans (up $577 million, or 71.4 percent), residential mortgage loans (up $422 million, or 144.3 percent), and credit card loans (up $393 million, or 12.1 percent). All of the major loan categories posted both increased net charge-offs and higher net charge-off rates.

* The amount of loans and leases that were noncurrent (loans 90 days or more past due or in nonaccrual status) grew by $6.4 billion (10.6 percent) during the quarter. This is the largest quarterly increase in noncurrent loans since the fourth quarter of 1990, and marks the fifth consecutive quarter that the industry’s inventory of noncurrent loans has grown. Almost half of the increase (48.1 percent) consisted of residential mortgage loans. Noncurrent mortgages increased by $3.1 billion (12.6 percent) during the quarter. Real estate construction and development loans accounted for more than a third (34.2 percent) of the increase in noncurrent loans. Noncurrent construction loans increased by $2.2 billion (39.5 percent) during the quarter. The amount of home equity lines of credit that were noncurrent increased by $407 million (16.6 percent) during the quarter. The industry’s noncurrent loan rate, which was at an alltime low of 0.70 percent at the end of the second quarter of 2006, rose from 0.83 percent to 0.90 percent during the second quarter. This is the highest noncurrent rate for the industry in three years.

* Banks and thrifts grew their loss reserves by $2.6 billion (3.2 percent) during the quarter, as loss provisions of $11.4 billion surpassed net charge-offs of $9.2 billion. The $2.6-billion rise in loss reserves was the largest quarterly increase since the first quarter of 2002, but it barely kept pace with growth in the industry’s loans and leases. The ratio of reserves to total loans increased from 1.08 percent to 1.09 percent during the quarter, but remains near the 32-year low of 1.07 percent reached at the end of 2006. For the fifth quarter in a row, reserves failed to keep pace with the increase in noncurrent loans. As a result, the industry’s "coverage ratio" of reserves to noncurrent loans fell from $1.30 in reserves for every $1.00 of noncurrent loans to $1.21 during the quarter. This is the lowest level for the coverage ratio since the third quarter of 2002. Reserves increased at 60 percent of institutions during the quarter.

The FDIC’s latest figures show a banking industry that’s clearly suffering from the housing and mortgage slump. We’re seeing charge-offs, loan loss provisions, and noncurrent loans all rise sharply. That’s likely to continue as long as home sales remain weak and home prices continue to slump.

There’s plenty of turmoil in the non-bank mortgage market, too. Many lenders are failing, while others are tightening their lending standards. In just the past few days, for instance, Capital One announced it would wind down its GreenPoint Mortgage unit and First Magnus Financial filed for bankruptcy. Combined, the two lenders originated around $66 billion in mortgages last year. American home Mortgage, a $59 billion lender in 2006, also recently went broke. That doesn’t bode well for housing demand.

The key question for the health of the banking industry going forward is, "What happens to the economy outside of housing?" We have dodged recession so far. But layoffs are rising fast. The financial sector alone has announced about 88,000 job cuts this year, 75% more than in 2006, according to Challenger, Gray & Christmas. If we see cutbacks spread to other industries, and consumer spending slip, the economy will slump further. That would cause credit quality to deteriorate in other loan categories. And that would lead to more earnings hits, more loan losses, and potential bank failures down the road.


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