Credit Corrosion Continues - Delinquencies At Record
Warning: This article contains other shocking images which may disturb those with exposure to U.S. debt or equity instruments.
I just got a chance to wade through the latest Federal Reserve Bank data on asset quality. Apologies, as these figures, which usually come out around the twentieth of the month after a quarter end were actually out November 16 and are now a few weeks stale. I haven't seen much written on these statistics in recent weeks, however and I personally like to track the bad debt debacle using this quarterly data for reasons I have outlined previously, not the least of which is the fact that these are not "mark-to-market" figures. These numbers represent debt at a large cross section of banks that has gone delinquent, i.e., the borrower has stopped paying, rather than write-offs of debt that is expected to go delinquent or has suffered a significant decline in market value. As the recent rally in credit markets has demonstrated, trading values of debt can display significant swings based on factors far removed from the credit worthiness of individual borrowers. You just have to look at what has happened recently with Dubai World's debt which recovered, post the world financial crisis, to above par only to crash to 40 cents on the dollar in a couple of days - to understand how volatile debt values can be in the marketplace.
Let's get right to the punchline. The Q3 bank delinquency data are awful in general. The only positive things that can be said about it are:
1) Delinquency rates, while at historically record levels for various types of bank loans, did not accelerate quarter to quarter across the board as commercial real estate and credit card delinquency increases slowed in basis point terms from the Q1 to Q2 09. However, all delinquent loans as a percentage of all loans at banks regulated by the Federal Reserve reached an all-time record high of 6.87%, eclipsing the prior peak of 6.33% in Q1 of 1991. The overall number did accelerate, increasing 72 basis points from Q2 to Q3, after a 45 basis point rise between Q109 and Q209. Call me Chicken Little, but I am still worried about the U.S. banking system, TARP or no TARP, stress tests or not. Seeing the FDIC run out of money, while these numbers are still getting worse gives me the willies.
2) Charge-offs have moved up much more aggressively in this cycle, versus the late 1980s, (View image) to early 1990s rolling real estate down cycle. This suggests that despite all of the "kick the can" debt restructuring going on, a lot of bad debt is being written-off. Which should bode well for a quicker resolution of the junk clogging up the system. However, it is very possible that banks are modifying loans, keeping owners in properties and taking a smaller charge-off today in hopes of avoiding a bigger one, if they took properties back today, took their lumps and sold them into a distressed buyers' market.
3) Credit card delinquencies look like they may have peaked two quarters ago (View image), which may be taken as a small ray of light indicating improving health for the critical "consumer economy". However, much more restrictive policies by credit card companies have definitely contributed to fewer better loans being made to better borrowers, which should be expected to produce lower loss rates.
On the other side of the coin are some more troubling trends:
1) Commercial & Industrial Loans which turned up late in this credit cycle, as a result of the Lehman induced economic free fall, continued to go delinquent at an accelerating rate (View image). With delinquencies rising 80 basis points quarter to quarter after a 51 basis point rise from Q109 to Q209. This suggests that un-employment trends may not yet be ready to turn the corner as banks may continue to be nervous about extending loans for new business expansion and creation for some time to come. C&I delinquencies have now surpassed the 2000 recession cycle peak of 3.93%, having reached 4.46% of all C&I loans in Q3, although they are still well below the 1990 cycle peak of 6.58%.
2) Residential delinquencies, which remain obnoxiously bad (View image), got worse at an accelerated pace in Q3, increasing 123 basis points quarter to quarter, versus a 44 basis point rise from Q1 to Q2 of 2009. This could have been a result of some catch up in foreclosure activity after a period of bank attempts at forbearance and loan restructuring earlier in the year. Nonetheless, this trend is especially troubling, after the long period of real estate price declines, and an apparent stabilization in the last six months with the help of much government impetus.
Comments (8)
Jeff: I agree with everything your saying. I see the pipeline for MBS deals still very full on a day to day basis. There was not 1 bank who was underwriting loans for over 10% unemployment during the boom under any scenerio. When we would securitize and structure deals, not one of the loss scenerios included this level of losses or unemployment either. I have to say, none of this includes any of the option ARM recast that will be starting to ramp up in the year 2014, without even considering that interest rates will most certainly be higher at that point then they are today. The markets seem to be very fragile and and the "lets kick the can down the road" solution that the govt and banks have taken will come back to bite them. This will effect RE prices, maybe another 10% decline, could be more, and the stagnation period for prices should be longer because of all this artificial influence by the govt.
Posted by Brian23 | November 30, 2009 11:20 AM
Brian23,
Thanks for your informed commentary....as scary as it sounds. It really makes the site better for everyone when guys like you with deep knowledge of a market segment speak up and add expert comment to our articles. We always want to hear your opinions....even if they are 180 degrees different than our own. Thanks again.
Posted by jeff | November 30, 2009 2:31 PM
All this data seems to support further Quantitative Easing by the Fed. Inflation won't remain a concern for the US for a while longer so long as money supply remains depressed through lack of lending.
Think of it this way. If I were a loan officer, would I rather:
a) lend $100k to a struggling restaurant owner at 10% for 5 years and which carries a 25% chance of failure; or
b) lend $100k to my prop desk that can make 10% in 1 day and which carries a 10% chance of failure.
Also, it's worthwhile to consider things from the other side of the coin. Namely the other parties to the dollar carry trade.
The world will continue to face bubbles so long as the US refuses to a) take fiscally sound steps and/or b) East Asian nations refuse to de-peg away from the dollar.
Countries like China can actually stop the formation of liquidity bubbles by raising rates right now and strengthening their currencies.
Since I don't see either a) or b) happening anytime soon, things look like a continuation of buying the dips.
Regarding Dubai, I have the sneaking suspicion that the authorities there are buying their own debt back on the cheap through cut-outs and other intermediaries. I don't have anything concrete to support these allegations; it's just a hunch.
Posted by Anonymous | November 30, 2009 5:00 PM
Anonymous,
I totally agree with you that not only shouldn't banks lend to small business right now...there are few borrowers who are not having difficulties who wantto borrow.
It is interesting that you note the refusal to de-link from the dollar. It does seem that the U.S. is telling China "Sorry about the value of your dollar denominated investments, but if you would like a better return on them....and more fiscal responsibility on our part....you need to let your currency rise and stimulate domestic demand, rather than building more plants to make shwag to sell in the America....thanks and have a nice day." I'm not sure I agree with the buy the dips part except maybe commodities. While macro factors are not a negative, stocks look pretty fully valued based on any kind of recovery scenario including lots more quantitative easing, which will be needed to mop up the continued rising bad debt.
Posted by jeff | November 30, 2009 5:50 PM
No way have the credit card defaults peaked yet: Christmas is the debtor's last hurrah before default.
More importantly, the state/municipal sector hasn't liquidated its workers yet (it's coming) and when that happens, those new job losses will lead to another round of defaults.
Posted by Thisson | November 30, 2009 6:12 PM
I think Thisson makes a good point regarding states and municipalities. In addition, we could see some major muni bond downgrades in 2010, and that could put some fear into the markets.
Posted by mh23 | December 1, 2009 8:21 AM
"a) lend $100k to a struggling restaurant owner at 10% for 5 years and which carries a 25% chance of failure; or
b) lend $100k to my prop desk that can make 10% in 1 day and which carries a 10% chance of failure."
I'm not saying that lending to restaurants is a great business, but lending to prop traders is not a great alternative. At least restaurants can pledge hard assets as collateral. If your prop desk blows up, there's probably not anything left. Also, if you make 10% in one day, you can probably lose as much in a day too. Lenders really participate fully only on the downside and have a limited upside, so it doesn't really help them if you can generate 30% daily if the risk of default is the same. Sounds like very high risk trading if you ask me.
Posted by Anonymous | December 1, 2009 9:47 AM
Dumb and dumber (US and Japan) compete to see who can debase the fastest. In the process they are hastening the carry trade.
TOKYO (Dow Jones)--Japan's central bank unveiled a surprise monetary easing effort Tuesday that could inject up to $115.7 billion into an economy facing deflation and a soaring currency, but it failed to impress financial markets or economists eager for bolder action.
The Bank of Japan's move, which followed increasing political pressure from Japan's new government, underscores the pessimism surrounding the Japanese economy. Japan has posted two straight quarters of economic growth and seen a resurgence in demand for its exports. But declining consumer prices and the yen's strength against the dollar have raised concerns that Japan could slip back into recession.
At an emergency meeting Tuesday, the BOJ adopted a new lending program to provide 10 trillion yen worth of funds for three months at a rock-bottom rate of 0.1%, taking in exchange a wide range of collateral from government bonds to deeds on loans. But the bank stopped short of lowering its key policy rates, also at a low 0.1%.
Posted by In Debt We Trust | December 1, 2009 10:21 AM