Banks are reluctant to lend for various reasons, depending on the individual bank in question. In some cases, the bank doesn’t have enough capital to lend and is too busy dealing with bad loans to lend out incremental capital – they’re trying to deleverage. In others, the bank has plenty of capital to lend but doesn’t see good lending opportunities – they’re concerned about the future.
The aggregate stats that you see are generally from the 50 largest banks in the country as they comprise about 80% of industry assets. From a macro perspective, these 50 banks ARE the industry. I don’t have anything to do with any of these banks or any remotely like them. It’s not my area of expertise.
Having said that, a few observations:
(1) The Big Banks are almost certainly undercapitalized, whether they want to admit it or not;
(2) The Big Banks may or may not be “insolvent” depending on how you want to define the term. As I’ve stated many times, any spread lender, no matter how impaired its balance sheet, can earn its way back to solvency given a long enough time horizon. So, the Big Banks may be technically insolvent today from a liquidation perspective but still have a positive NPV of future cash flows, which is a paradox that doesn’t generally apply to non-spread lenders;
(3) Mish’s “analysis” does not include previous charge-offs against the NPLs, which is a rather important omission. His overall views may be correct, but this would be somewhat accidental because his analysis is incomplete. [File Under: A little knowledge is a dangerous thing (but doesn’t mean you’re necessarily wrong).]
I’ll elaborate a little on this last point. Let’s say you had a loan with a stated balance of $1 million. You had a specific reserve that covered 1.5% of the loan, or $15K. Now the loan’s gone into default and you think fair market value is $700K, so you charge off $300K, and add $20K to the ALLL, so now you’ve got $35K in specific reserves (5% of the written-down principal balance) against the $700K loan. And this is happening in various places within your loan portfolio. So, what’s happening is the ALLL is growing but at a rate slower than NPLs, so it appears that the bank isn’t covering its NPLs as much as it should. But… this doesn’t take into account that the bank has been charging down the principal balance of the loans in the NPL bucket. My point is that you have to take into account not only what the current ALLL is relative to NPLs, but also what’s already been charged off, in order to get an idea – and it’s only an idea – of where the bank’s reserves stand relative to its NPLs. And of course you can apply that to the macro stats as well.
Mish makes several legitimate points. But his analysis is incomplete. There are certain banks for which extend-and-pretend is best for the FDIC Insurance Fund (that is, the hole in their balance sheet can be repaired within a few years if left alone) and there are others for which it might not be best for the Insurance Fund. We hear about a lot of latter each Friday afternoon and there will be a lot more coming. As I’ve said before, the FDIC’s job is to determine which banks are going to take “too long” (whatever that metric is) to make it back to health and shut them down, while leaving open the other banks that just need some breathing room to repair themselves.
Interestingly – and it’s good news for the FDIC – the loss percentages on failed banks have declined substantially over the last 18 months. During the first half of 2009, losses as a percentage of assets for failed banks were averaging almost 30%. Most recently that number’s down to about 12%. This is due to two factors: (1) Bidders are getting more aggressive (there’s a LOT more capital in the industry today), and (2) Bidders believe that the majority of damage in CRE is past. That’s not to say they believe there’s not more pain to come, but rather that they don’t expect to see another 40% decline on top of the 40% decline already witnessed.
