Are We Out of the Woods? Future Loan Provisions Taken?

Posted by urbandigs

Mon Apr 13th, 2009 12:39 PM

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A: Yes, everybody knows the banks are having a killer quarter with a zero interest rate policy in place, a refi boom, and backdoor counterparty bailouts from taxpayers to the banks via AIG - how could banks NOT have a monster quarter. Wells kicked off the earnings season with a nice surprise, and I'm sure JPM/BAC/GS will follow suit with monster earnings as the week goes on. The stocks flied on a percentage basis because of the incredible plunge that the sector has dealt with since the beginning of this crisis, and instant clarity is provided for very near term! But is the worst really behind us? Are future loss provisions being set aside for what may lie ahead? Is this a one-time bump or a sustainable recovery in banks earnings? A few questions we must ask ourselves: are defaults starting to decelerate - are defaults spreading to higher quality debt classes - are banks taking the proper loan loss provisions to cushion against future losses ? T2 partners has its latest report out showing us some graphs of what lies ahead; hat tip Rolfe @ OptionARMageddon.

Now, before we look at some of these charts we must put some pieces together that are actually favorable. Mainly, there is a refi boom going on right now that is helping all those with resetting ARM's or other adjustable rate products to lock in at a much lower rate. So, the damage that is priced in for some of these Option ARM's + the refi boom may paint a rosier picture than what these charts suggest. Besides, I'm not worried about the reset, I'm more concerned with the recast of the loan that will bump up minimum monthly payments for those with higher loan principals than from origination; yes, there are many of these out there. So while the lower rate helps, what happens when the recast kicks in? The prime, alt-a issues, HELOCs, jumbo prime, CRE, credit cards, auto loans, etc..that is a different story - this NEVER was just about subprime:



When taken separately, this chart shows you how subprime sparked the credit crisis. Now that the fire has been raging for 18 months, higher quality debt classes are starting to kick in - spreading the fire around:



This is where fed policy can only do so much. The system is being gamed to help the banks (recapitalize & steepen) right now, with the hopes that earnings can help recapitalize balance sheets enough to comfortably absorb future losses. But how does this stop the debt snowball that already rolled down the mountain - it can't! As bank equity prices surge from the euphoria that comes with 'worst is over' speeches, watch out for capital raises! Goldman Sachs already started the trend with an announcement that a shareholder dilutive capital raise is likely to help pay off TARP funds. So while the capital raising is highly dilutive to shareholders, the euphoria of being free from government and free from capital assistance seems to trump the concerns that may still be in the pipeline - the stock may continue to rise w/ their earnings expected to destroy consensus estimates. In fact, as each bank comes out and re-iterates how great the quarter was, all logic as to why the quarter was so great goes out the window and the bull market equity party drinks get passed around (momentum trading, short squeezes, institutional moves all could power a rally much further than most think possible - stocks will move in the direction of least resistance until it doesn't anymore). Who cares why or what may lie ahead, lets PARTY! BABY!!!

Just beware of the kool-aid and the nature of this crisis. Are the banks setting enough provisions aside to account for expected future loan losses? This was the basis for Mayo's report last week that there will be another wave of bank pressure ahead of us as other areas of banks' balance sheets continue to deteriorate. Ask yourself, is the world really all better again? To look at these charts, no, it isn't and we have a few more waves of this credit tsunami still ahead of us. That is NOT to say these charts reflect what is happening now (a refi boom) and that what may look ugly in a chart may not turn out to be so ugly in reality. But clearly we see there is nothing to get too excited about here and caution is in order when predicting sustainable or accelerated future growth prospects.

The MEW (mortgage-equity-withdrawal) powered economy is now behind us. What is left is lower asset values for people's homes and higher debts on consumer balance sheets (shown below). This must be repaired before any sustainable economic growth is to be expected. See for yourself the path we led ourselves on:



This is all part of a larger process where deleveraging/unwinding/writing off of debts reigns king. Its not a fun process, but a necessary one when you take into account where we came from, and the system in place that allowed it to occur. We are not out of the woods yet, and we must wonder how the banks are preparing for future loan losses with the great quarter they seem to be having. Many people have been burned by the banks' 'adequately capitalized' forecasts and 'contained losses' speeches in 2008; now that they are actually making money, we must be a bit creative when we look ahead and see if this is sustainable and the worst is really behind us! I don't think all is well again, yet, as it is just too early to declare anything with certainty for the above noted reasons.