August 27, 2009: 2Q 2009 Update on the Banking Industry
This morning, the FDIC released information on the performance of the banking sector during the second quarter of 2009. In aggregate, the industry lost $3.7 billion dollars primarily as a result of provisions for bad loans. Loan quality continued to deteriorate, with loans past due 90 or more days and still accruing interest or in nonaccrual status as a percentage of total loans reaching 4.35%--the highest level in the 26 years that the FDIC has tracked this measure of loan quality,dating back to 1984. This includes virtually the entire banking crisis era of the mid-1980s through early 1990s, when more than a thousand banks were closed. When loans past due 30-89 days and OREO are included, this ratio jumps to 6.65%. As a percent of total assets, this broader measure of nonperforming assets is 3.8%. The volume of noncurrent loans increased by $41.4 billion or 14.3%, led by noncurrent residential mortgages (up 12.7%), construction and development loans (up 16.6%) and non-farm non-residential loans (up 29.2%). Commercial real estate is the next emerging crisis area for the banking industry but also for the CMBS industry.
The number of "problem banks" (those with CAMELS ratings on 3, 4 or 5) increased from 305 to 416--the highest number in 15 years--in spite of the fact that 39 institutions were merged into other institutions and 24 were closed. However, the assets of "problem banks" rose from $220 billion to only $300 billion. This indicates that the FDIC and other bank regulators cling to the fiction that Citibank, Bank of America and Well Fargo should not be classified as "problems."
Until our commercial banking system returns to health, the U.S. economy will continue to flounder. The much-ballyhooed "stress tests" were nothing more than a PR stunt by the Fed and other bank regulators; in fact, the banking industry remains in dire and deteriorating condition. Look for as many as 100 more banks to fail by the end of 2009.
Next year holds new perils for the banking industry. As the New York Times reported in yesterday's edition, there are approximately 600,000 option-ARM mortgages that will be repricing during the next couple of years, primarily during 2010 and 2011. Option ARMs are nasty little products that allow for negative amortization; that's right, your loan balance increases rather than decreases over time. Most borrowers take advantage of the negative amortization option. When the outstanding balance reaches 115% to 125% of the initial loan balance, these mortgages become fully amortizing, meaning that monthly payments double, triple or worse. The aggregate value of these mortgages is in the range of $750 billion, or approximately the same size as the cohorts of subprime mortgages that precipitated the ongoing financial crisis. The value of MBSs and CDSs tied to these option ARMs is largely unknown. Analysts estimate that as many as four out of five of these option ARMs will go into default. So, just at we run out of subprime mortgages that are not already in default, option ARMs will fill the void, inflicting additional and massive losses on lenders.
Green shoots, anyone?
