Variant Perceptions

Month: December, 2011

Banking quick review: asset quality

The last part of bankregdata‘s review of the banks’ third quarter results. His emphasis is on asset quality and I do not think there are going to be many surprises for the readers that have been following the Charting Banking series despite the slightly different angle that Bill uses:

  1. Asset quality is improving fast
  2. Construction and development loans are a pain in the neck

In particular, I like his analysis of the real estate owned (REO) composition and the speed on how banks have been restructuring the most troubled loans (construction and development, and housing mortgages).


This week reviews the Banking Industry 3rd Quarter 2011 performance for Asset Quality, Loans, Restructures and REO.

Using the Texas Ratio as a measure of risk we see that (collectively) banks continue to improve:

A review by Asset Size shows some risk in the largest banks (where GAAP issues mitigate some of the concerns) and mid-size Community Banks between $250 and $999 Million.

Unadjusted Nonperforming Loans continue to drop and are at 4.21% of Total Loans. In terms of dollars, NPLs at $309.67 Billion are now 24.47% below the 2010 Q1 peak:

The Adjusted NPL numbers are dropping slightly quicker – more on that shortly.

Quarter over Quarter Nonperforming Loan Amount by Loan Portfolio:

Of the 13 largest Loan Portfolio types, every one experienced a drop with the exception of Individuals: Auto Loans which rose 1.98%.

A couple of thoughts regarding Construction & Development NPLs:

  • Even with a 10.10% drop in NPLs, Construction & Development loans still have a 14.57% NPL rate.
  • At $254 Billion C&D lending is back to 2003 Q1 levels and $377 Billion (59.69%) off the 2008 Q1 high.
  • In 2003 Q1 C&D made up 4.88% of all loans outstanding – today it is 3.46%.
  • Is this due to a lack of demand or the fact that banks won’t go near Constuction loans?
  • It’s hard to picture an expanding economy without an increase in Construction & Develoment loans.

One concern is that while there is good news with Charge Offs at $31.66 Billion (lowest quarter since 2008 Q3), Adjusted NPLs to Charge Offs has climbed to $7.09. Basically, there are $7.09 of Adjusted NPLs for every $1 of Charge Offs – banks are delaying Charge Offs relative to the NPLs earlier in the cycle.

If you go here you’ll note that it is the small banks struggling with the ratio. Home Equity and 1-4 Family Junior Liens are particularly a problem.

Restructured Debt inexorably climbs higher (and higher):

Restructured Loans to Total Loans is at 2.63%. All reported loan types experienced increases in the rate:

  • 1-4 Family Residential at 4.52%
  • Commercial Real Estate at 2.08%
  • Commercial & Industrial at 0.76%
  • Construction & Development at 5.93%

Once again, Construction & Development loans continue to be a problem area – especially with a 52.96% NPL rate on the restructured portion.

Other Real Estate Owned continues to slowly drop:

OREO is being liquidated and slowly coming down. Collectively, banks took a -$1,135,148,000 hit to Non Interest Income, however, they continue to offset it with Gains from Loan Sales.

OREO levels compared to Peak/Previous High by OREO Type:

And on that cheery note, I’ll end this much-too-long missive and wish you a Merry Christmas. If you have any questions or suggestions feel free to contact me.Ahh, yes, there is that pesky Construction & Development issue once again. Comparatively, the smaller community banks have worked through a higher portion of their Construction NPLs and charged them off to REO. The problem is that they are just sitting on the balance sheet – slightly more difficult to get rid of that partially built apartment building.

Looking at 1-4 Family Residential is a mixed bag. All 1-4 Family Residential has come down 19.38%, however, Foreclosed GNMA is still very high. The bigger problem for Housing is that banks are just not charging it off at the same clip – the inventory is being held out of REO. Once again, we look to the NPL to CO ratio which shows 37.34 for 1-4 Family Residential. That’s $37.34 of NPLs for $1 of Charge Offs – which is an 11 quarter high and the highest since the 46.00 put up in 2008 Q4 when the largest banks delayed charge offs to hit year end numbers.

Bill Moreland


Banking quick review: income statement

As promised, this is BankRegData’s monthly comment follow-up. Some comments at the end.

Pre-Tax Net Operating Income hit $48.82 Billion (1.65%):

The quarter over quarter increase was $6.63 Billion. The $48.82 Billion figure is the highest since 2007 Q2 at $54.97 Billion (2.07%). The peak was $56.88 Billion in 2006 Q2 (2.29%).

Let’s look first at the big part of the pie which is Net Interest Margin:

Net Interest Margin is down $663 Million from last quarter. A couple of points here:

  • The $105.23 Billion represents the 6th straight quarterly decline from the Credit Card inflated peak in 2010 Q1.
  • Funding Costs continue to drop and are now sitting at 0.70%. Banks are clearing another $33 billion per quarter in lower Interest Expense costs compared to 3 years ago.
  • Interest Income (Yield) is dropping faster and sitting at 4.25% which is a historically low number.

So where did the increase in Pre-Tax NOI come from? Trading Gains:

Trading Gains once again made a disproportionate impact with a Q on Q increase of $5.55 Billion. JPM made up $4.55 Billion of the increase.

Other Non Interest Income observations:

  • Banks are once again finding ways to increase Service Charges income.
  • Investment Banking Income at $2.13 Billion is at least a nine year low.
  • Net Servicing Fees got hammered at a number of banks – especially JPM.
  • Income from Loan Sales is once again on the rise.

As an aside, Loans Held For Sale jumped $49.43 Billion Q on Q. Part of this ($8.14 Billion) is due to the conversion of OTS reporters (who did not previously report the item) to the OCC Call Reports. That means $41.28 Billion is newly marked for sale.

If you have any questions or suggestions feel free to contact me.

Bill Moreland


When discussing banks for the Charting Banking series I preferred to focus on the balance sheet (asset quality, capital and reserves). That was the key to assess if banks could manage the stress before regulators pull the plug.

It is about time to address the income statement. And yes, the banks in general are showing profits. Very large profits, even after provisions and write downs. And increasing.

However, Bill rightly notices  some weak spots:

  • NIM under pressure: both in absolute and percentage numbers. Lack of loan generation, pointed out in part 1, and all time low interest rates are starting to make a dent.
  • Large trading gains: that are not sustainable

Even without the jump in trading gains, the net operating income would have shown an increase over last Q ($43.2B adjusted for the increase) so I do not worry about the trading profits sustainability too much.

However, the net interest margin under pressure is very important and is a direct consequence of consumers delevering (fair to say they do not need more debt) and businesses not investing because of lack of demand.

The question is, when is loan demand going to jump start? I have an hypothesis, but for the moment I prefer to keep it to myself. At the same time this is not a life threatening issue with banks trading below tangible book value. Tangible book is a  good estimate of liquidation value so if the worse happens, and banks profits start to decline, the sector would still seem very cheap.

Bronte Capital was very early in noticing this possibility (while thinking it was not going to happen).  A very good example of hoping for the best but planning for the worst.

In fact he was so early that it was one of his first posts. At the time it was radical because everyone was fixed on the bad loans. He says he had only 20 readers. If that is the case I am honored!

Banking quick review: assets and liabilities

First of all, thanks to Bill Moreland from BankRegData that granted us permission to post his latest commentary. Every month, he chooses some graphs from his service to address some critical issue. If you are not subscribed I suggest you doing so.

His latest installment tackles the latest results of the banking system. We will start sharing his view on the balance sheet, leaving the income statement for a follow-up.

I have added a few comments at the end.

This week reviews the Banking Industry 3rd Quarter 2011 performance for Assets, Liabilities and Income/Expense. The next mailing in a couple weeks will cover Asset Quality, Loans, Restructures and REO.

Total Assets industry wide climbed $208.28 Billion over Q2 and are now at $13.84 Trillion. This is the second highest number ever and just shy of the peak of $13.89 Trillion set in 2008 Q4.

Please note the $252 Billion bump in 2010 Q1 up to $13.36 Trillion. The number would have shrunk were it not for the $291 Billion lift from the international Credit Card balances being brought on to the Call Reports. Note the impacts of this on Pre-Tax NOI & NIM in tables coming up shortly

Goodwill and Other Intangibles make up the majority of the drop in the Other Assets category.

The growth in Net Loans & Leases, while considerably lower than Securities, Trading and Fed Funds, does mark the second consecutive quarterly increase. This is the first time that has happened since 2008 Q2.

That said, banks are becoming less and less focused on lending.

The chart above details Net Loans as a percentage of Total Assets. I did a spot check on the FDIC data going back to 1992 and could not find a number lower than this quarter’s 51.70%.

Deposits grew $233 billion Q on Q (2.38%) and surpassed $10 Trillion for the first time. In 3 years, deposits have grown $955.84 Billion, since 2003 Q1 they have grown $4.34 Trillion.

Other notable items from the Liabilities & Equity side of the Balance Sheet:

  • $38.18 Billion increase (12.92% Q on Q) in Trading Liabilities
  • $26.25 Billion increase (7.34% Q on Q) in Other Liabilities
  • $106.85 Billion decrease (-10.87% Q on Q) in Other Borrowed Monies ($17.91 Billion drop (-5.25%) in FHLB Advances)


What do we make of this?

  • What Liquidity Concerns?: the banks are flooded with deposits and what they are lacking is loan demand.
  • Loan Growth Anemic: banks are still hoarding but there are some initial signs that it could be restarting.
  • Goodwill Written Down: improving the asset quality. There has been a lot of focus in tangible assets and equity, but the issue is becoming less important by the day.
  • Franchise Value Increasing: assets are growing, deposits are growing. If the assets are good, the franchise value is also growing

The bad news is that the same large liquidity and lack of loan generation is starting to affect the banks’ net interest margin, but that is an issue we will tackle in the follow-up.