Bank Loan Stats: The Good, The Bad & ........

Posted by jeff

Tue Nov 18th, 2008 04:42 PM

The Federal Reserve's survey of loan quality for U.S. commercial banks is in. Bottom line, it's still all about residential housing delinquencies and charge-offs, which remain ugly and are killing the banks. Surprisingly to some, credit card delinquencies and losses are holding up reasonably well, and while we continue to see some erosion in the commercial real estate market, it is not yet the debacle some have been expecting. Overall, the pain has not ratcheted up to quite the early 1990s level....a time those of us who can remember try not to. So let's dive into the data, but first just a reminder about why we consider these somewhat lagging data (all the banks who give this data to the feds have already reported it publicly when they reported earnings) to be of particular importance in this credit crunch. Remember that these days banks can lend money in two ways: first, they can make old-fashioned loans, which they hold on their books. Some of these go delinquent and if the borrower does not cure their delinquency they eventually default and the loan is charged off. Secondly, they can make loans, bundle them together and sell them off to investors. If they keep any part of the CMBS security they have manufactured for themselves it is held as a marketable security. In some cases they got stuck holding CMBSs they assembled and were about to sell into the market, when the credit crunch hit. In other cases, they bought CMBS securities from other banks to hold as investments. Generally, in these cases the bank is forced to mark the securities to market whenever a trade is reported, the way they would any other stock or bond. If the security trades and a new price is established in the market, the bank's position must be marked to that value. In the case of whole loans held to maturity, the bank does not take a write-down until the borrower goes into delinquency (even then, banks have flexibility with regard to how they value the loan). Even when a loan is charged off as permanently impaired, the bank may still eventually reverse the charge off, if, when it sells the underlying property collateralizing the loan, it gets back all of the money owed to it. Believe it or not this does sometimes happen. In the 1990s, many loans that were charged off eventually brought in greater proceeds when the property was sold and the charge offs were reversed.

One of the biggest debates in this credit debacle has been whether the hellacious markdowns being experienced in the CMBS market accurately reflect the future actual losses that will be realized on the underlying loans and real estate. This is still an open question as the markdowns continue to get worse. By looking at the whole loan books of banks, we can get some insight into just how many borrowers are actually going delinquent on loans of various types. So here we go.


First some good news. As you can see from the chart above, although credit card delinquencies are rising somewhat, and have reached prior recessionary levels, they are by no means skyrocketing. The latest click came in at 4.9% of credit card receivables outstanding. In Q3 of 2001, during the last recession, this figure hit 5.1%, while the high water mark in the recorded data was 5.41% reached in Q3 of 1991. So while you may be reading about American Express and Capital One taking TARP funds, it's not because the consumer is all of a sudden defaulting on their credit cards left and right. The credit card companies saw the economic problems coming 12 months ago like everyone else and they started to reduce borrowers' credit lines, boost interest rates and penalties, etc. They essentially sent the message out that they did not want people running up debt, which they might later have trouble paying off. Since credit card debt is a short-term smaller liability, if you start managing things a year ahead of a recession, you can actually batten down the hatches pretty well. While there is no doubt things will get worse here, it looks to be reasonably well contained and "normal for a recession" so far.

Where American Express has a problem is that it was not a bank and it funded new receivables by selling off existing credit card receivables to investors in the ABS (asset backed securities) market, which has completely seized up. So American Express is buying a bank and taking some TARP funds. Capitol One, in comparison, bought a couple of banks in the last couple of years (the old North Fork in NYC for one) and they are taking TARP funds just to give themselves even more liquidity and flexibility. Frankly, with everyone becoming a bank these days, the fight for deposits used to fund these other businesses is going to get nasty and raise people's costs of funds.


I am pleasantly surprised by the commercial real estate data. Commercial real estate loan delinquencies rose 49 basis points to 4.52%, nothing to cheer about to be sure, but while it's still reasonably ugly, it is not going ballistic at the rate it was two quarters ago. Between Q4 2007 and Q1 2008, delinquencies vaulted 97 basis points. However, delinquencies are back to levels not seen since late 1994. I still believe there are some big shoes to drop here. Right now, however, it's hard to see commercial delinquencies getting to 10 percent plus of commercial real estate loans in this cycle, as they did in the early 90s.


BUTT UGLY! those are the only words I can use (in public) strong enough to describe the chart of residential loan delinquencies above. Residential delinquencies hit 3.64% of all residential loans in Q1 2008, and that was the highest figure for as far as the data go back - Q1 1991. Now remember, these are the residential loans that banks chose to keep on their own, books as opposed to selling into the secondary market. Now for those pups out there who don't remember the last real estate cycle, it included a rolling residential recession that struck Texas, Oklahoma and Colorado after the late 70s/early 80s oil boom went bust. It then went on to strike southern California, in part due to defense industry consolidations, and eventually it hit New England and the Silicon Valley area, following the mid to late 80s tech venture bust. So the high levels of delinquencies experienced in the early 90s were actually sustained throughout much of the late 80s and into the early 90s. However, the firestorm that has raged across the country looks to be of a whole different proportion. Residential delinquencies jumped 47 basis points from 3.64% to 4.11% between Q1 2008 and Q2 2008. In Q3 they leapt another 100 basis points to 5.11% - stratospheric vs. the prior highs. Let's hope the feds figure out some kind of plan here and start working it....cause as Tuco says: "There are two kinds of people in the world, my friend. Those who have a rope around their neck and those who have the job of cutting."

Now I don't have the figures on what percentage of bank loans are residential, versus commercial loans, but my wager is that the former is significantly larger than the latter. I will be investigating this further but if any of you brilliant and good looking Urban Digs readers does know the answer, please save me some work and leave us a comment. In any event, the commercial loan losses that did in the banking system last time around will not likely be matched this cycle. But we have busted out to new highs on residential delinquencies and we are accelerating, it could be just as bad. We can get a little insight from the total delinquencies data, below.


Even with the soaring residential loan losses, the total loan delinquencies as a percentage of all loans has not come anywhere near the levels of the early 1990s. In Q3 2008, total loan delinquencies stood at 3.64% of all loans, up 49 basis points and an acceleration from the 26 basis point rise in Q2. We are at the highest level since Q3 1993, but well below the peak value of 6.33% of all loans seen in Q1 1991, when the banks truly were all busted.


Interestingly, the charge-off data is available all the way back to 1985. Despite the much higher percentage of delinquent loans seen in the early 90s, charge-off levels are already back to the 1.4% plus range seen back then. I suspect that it may be because banks are being more pro-active about charging off bad loans this time around, but I can only speculate. A big question will be what the ultimate recoveries will look like in commercial real estate. I will wager they will be much better. With regard to residential recoveries......well, that could be a problem.