Smaller Banks Continue to Struggle

Smaller banks continued to struggle, balance sheet-wise, in the fourth quarter of 2009. Data have just been released bringing us through the last banking week of the year, December 30, 2009.

These data come from the H.8 release of the Federal Reserve System and are seasonally adjusted. Although there are some inconsistencies in the data series over time, this is the best comprehensive view we have of the banking system and can give us some idea of what is happening to banks if examined on a regular basis.

Large domestically chartered banks are the largest 25 domestically chartered banks in the United States and possessed about $6.7 trillion in assets on December 30, 2009. Small banks are the banks not included in the largest 25 and possessed about $3.6 trillion in assets on the same date. This difference in size gives you some indication of the relative importance, based on asset-size, of the two categories of banks. And, there are over 8 thousand FDIC insured banks in the United States.

Large banks, as we have heard, are going to report record or near record-level results for the calendar year 2009 and bonuses are expected to approach the levels reached in the peak year of 2007.

There is some indication that the interest-earning assets of large banks are starting to grow again. Over the past 13-week period securities held by these banks increased by about $87 billion and Loans and Leases rose by around $106 billion. Surprisingly, most of the increases in loans came in residential home loans and commercial real estates mortgages, $83 billion and $20 billion, respectively. Commercial and Industrial loans continued to decline over this period, dropping by about $27 billion.

We see similar behavior over the past 4-week period as the securities portfolio rose by about $21 billion and Residential and Commercial loans increased by a combined $12 billion. Business loans dropped this time period by about $7 billion.

Very little money, if any, is going into the business sector.

The improvement in the position of the larger banks has allowed them to reduce their holdings of cash assets by $172 billion over the past 13 weeks, by $26 billion in the last 4 weeks.

On the other hand, small banks really seem to be struggling. Profit-wise, the news is not good for this sector.

Their balance sheet performance is not all that good, either. Over the past 4-week period, the smaller banks have lost $36 billion in assets and have lost a total of $108 billion in assets over the past 13-weelk period.

All of this reduction has come in earning assets other than securities. Over the whole 13 week period the smaller banks have kept their securities portfolio roughly constant. Hence, the reduction in assets has been centered on their loan portfolios.

The biggest drop: commercial real estate mortgages. The smaller banks have seen their holdings of commercial mortgages drop by around $50 billion over the past 13 weeks; the drop has been slightly less than $20 billion for the last 4 weeks.

We have heard over and over again about the problems in commercial real estate and what a serious problem this is for the small- and medium-sized banks in this country. We have seen a decline of more than 10% in portfolio assets in this category over the past 12 months. The forecasts are for an additional decline by at least this amount over the next 12 to 18 months.

This is not a good picture.

The residential mortgage portfolio also continues to decline. We see another $8 billion reduction in this number over the last 13 weeks, the majority of the fall coming in the last four weeks.

The thing to watch here is that as unemployment stays high, as people continue to leave the workforce, and as businesses go more and more to hiring temporary help, the residential mortgage sector is expected to remain on the weak side. Almost everyone seems to predicting more foreclosures and more bankruptcies and the brunt of these difficulties is expected to fall on the small- to medium-sized banks.

Remember that at the end of the third quarter the FDIC had 552 banks, mostly smaller ones, on its list of problem banks. This number is expected to grow this year, even accounting for the number of banks that will actually fail. People are saying that about one-third of this total will fail which will be that 3 to 3.5 banks will fail every week for the next 12 to 18 months.

Are there any good signs or is everything bad?

Well, the big banks seem to be in great shape and are off to the races!

The small- and medium-sized banks seem to be in for some very rough times.

The gap widens further and further between Wall Street and Main Street!

And, as we have said before, thrift institutions seem to be in the same boat as the small- and medium-sized banks.

Today, it seems as if, if you want to be small, you should be a credit union!

Just one comment on regulatory reform: it seems to me that a part of regulatory reform needs to be a total restructuring of the financial services industry. The mumbo-jumbo we have right now is just a residual from the past and bears no rational relationship to anything that makes sense.

Thrift institutions were, at one time, the only financial institutions dedicated to the housing industry. At one time they were useful. They seem totally superfluous at the present time.

Others, particularly in Great Britain, seem intent upon a restructuring that would separate the deposit banking function of financial institutions from the deal making/trading function of financial institutions.

Perhaps before we spend a lot of time developing a regulatory structure of new bandages and splints for the old system, people should put in some serious time thinking about what financial institutions are needed and how functions should be allocated across institutions.