Bad Debt Update

Posted by jeff

Tue Feb 26th, 2008 08:25 AM

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I have been waiting expectantly for the latest Federal Reserve Data on banks' bad debts for Q4 2007...haven't you? Ok, well even if you're not a data geek....it's gettin' kinda interesting to say the least. The Q3 2007 data had already been showing the ugliness in residential lending, where delinquent loans had reached levels as high as the early 1990s real estate debacle (when data first began to be collected). It is possible that these numbers were even higher in the late 1980s, when the S&L crisis was still new. But suffice it to say, as evident from the chart below, things are truly ugggly in residential loan land. Things continue to worsen, but that's not new news.


Courtesy of Guild Partners


Note that the delinquencies are being converted rapidly to charge-offs (write-downs) of the value of these loans, which impacts banks' capital levels and ability to make new loans. Due to the severe declines in the value of residential real estate collateral, I would expect delinquencies to convert to more severe charge-offs in the current crisis.


Courtesy of Guild Partners

I'm not sure what the spike in charge-offs was in late 2001, most likely 9/11 related (I double checked and it is valid data point). What can be said is that we are in an area not reached very often and distinctly "recessionary."

Here's the interesting part of this quarter's data. I commented in my last piece on bank bad debt that commercial real estate data was likely to get worse and wrote about why in my piece The Next Train Wreck?. It's showing up in the data pretty rapidly. While the absolute level is not nearly as high as the early 1990s wipeout, we have recently "broken out" to the upside hitting levels above the last recession and not seen since Q3 1998 and the "Asian contagion" period. I am still on the fence about how bad the commercial real estate downturn will be, but not about whether there will be one. In my mind it seems highly unlikely that the delinquency numbers will get better near term. So this is a data series I - and I'll wager a bunch of bank regulators - will be keeping an eye on.


Courtesy of Guild Partners

The media has also been rife with reports of pressure on the consumer and credit card troubles. As you can see from the chart below, credit card delinquencies have been ticking up, but at 4.67%, they have not exceeded the 5% level that appears to be the "recessionary" level hit in the dot com/9-11 period or the early 1990s.


Courtesy of Guild Partners

The most important numbers are to be found in the table below. This is an aggregation of all bad loans as a percent of loans outstanding. It speaks to how much capital is being burned up by the current bad loan trend and it talks to the ability of banks to make future loans, without raising new capital. Fortunately for banks and the economy, we are nowhere near the crisis levels of the early 1990s. Remember, however, these numbers do not include write-downs of the values of marketable securities. They only include loans banks are planning to hold to maturity (which were probably better underwritten). There are literally tens of billions of losses - a number that seems to rise everyday - that are not included here. Note that these "marked to market" losses are not recognized yet and could reverse if the bad debt trend ends. Clearly, from these numbers, we can tell it's still increasing and, dare I say, accelerating.


Courtesy of Guild Partners

The data presented here is from the Federal Reserve Bank of San Francisco. I have utilized the non-seasonally adjusted numbers, which I hope will give us an un-varnished sense of the very latest data. Note that of course, this being Q4 2007 data, it's stale. But it does give a reality check as to whether debts are going bad with the same rapidity as debt-backed securities are being written down in the marketplace. I would have to say that as far as the residential housing and the CMBS market trends go, they seem to be being borne out in actual bank loan delinquencies. The one area where the media seems to have over-blown the story may be in credit cards, according to this somewhat stale data. Individual reports from credit card securitization trusts, and fresher data collected by market research firms, may be showing more stress than the numbers here do. I have to plead ignorance on this point. As noted above, the total bad debt picture is likely worse than what is being seen in the total bank delinquency numbers due to the marketable securities write-offs, which don't show up in these numbers.