Big Banks Get Bigger While the Smaller Banks Disappear

The FDIC released data on the state of the banking industry last week.  And, we see that the size and number of the bigger banks increase while the size and number of the smaller banks continue to decline.

Let’s look at the number of banks in the United States first.  The number of banks in the United States dropped by 61 from June 30 to November 30 leaving only 6,352 banks still in existence.  Note that the FDIC closed only 26 banks in the third quarter of 2011.

Over the past 12 months, the number of banks in the banking system dropped by 271 banks. 

Obviously, if we focus on just the number of banks that the FDIC closed, we are not getting the whole picture as many unhealthy banks that might eventually be closed are being acquired.

The number of banks on the FDIC’s list of problem banks dropped to 844 on September 30, down from 865 on June 30.  So, the number of banks on the problem list dropped by 21, the number of failed banks was 26, and the number of banks leaving the banking system was 61.  Seems like more banks went on the problem list than left it in the third quarter of the year.  Maybe the statistics on problem banks is not as "jolly" as indicated. 

Over the past 12 months, however, the largest bank classification, banks with assets in excess of one billion dollars rose by 10.  Banks with less that $100 million in assets declined by 176 over the past year and banks with assets between $100 million and $1.0 billion dropped by 105.

Whereas the average size of banks in these last two categories remained about the same over the past year, the average size of banks over $1.0 billion in rose by $1.5 billion to $22.0 billion.

At the end of September 2011, there were 2,208 banks that were less than $100 million in asset size and these banks represented about 1.0 percent of the assets in the banking industry.  On the same date, there were 3,626 banks with assets ranging from $100 million to 1.0 billion, and all of these banks just controlled slightly more than 8.0 percent of the assets in the banking industry.

There were 518 banks in the United States that had assets in excess of $1.0 billion, and these 518 banks controlled 91.0 percent of the assets in the banking industry.

In terms of loans, Net Loans and Leases at the smaller commercial banks declined by almost $8.0 million over the past year, by $2.5 million over the past quarter.  The Net Loans and Leases at the middle range of banks dropped by a little less that $50.0 million over the past year and by about $4.0 million over the past quarter.

In the larger banks, Net Loans and Leases increased by more than $70.0 million over the past year and by about $36 million over the past quarter. 

The bottom line is that commercial banks with assets totaling less than $1.0 billion continue to produce statistics that cause one to question the health of this segment of the banking industry.  In addition, given the decline in total assets in these banks, the sector has not observed a consistent reduction in noncurrent assets (past due loans).  That is, there has only been a modest reduction in the average amount of noncurrent assets to total assets over this time period. 

Consequently, the larger banks are getting larger and becoming more dominant all the time.  And, if one looks at Federal Reserve statistics, the largest 25 domestically chartered banks in the country control about two-thirds of all the assets held by domestically chartered banks.  Thus, if the largest 518 banks in the country control 91.0 percent of the banking assets, this means that 493 banks that are larger than $1.0 billion in asset size but are not among the 25 largest, control about 24 percent of the assets. 

All the statistics show that the small- to medium-sized banks are really becoming insignificant in the United States banking industry and, given the troubles that many of these banks still face, will become even less significant in the future. 

An article in the Monday edition of the Wall Street Journal presents research showing that the health of the banking industry is being questioned by the stock markets.  Andrew Atkeson and William Simon write that “The recent volatility in bank stocks is a signal that U. S. banks, large and small, are not as healthy as many analysts assume.” (http://professional.wsj.com/article/SB10001424052970204531404577052493270860130.html?mod=ITP_opinion_0&mg=reno-secaucus-wsj)

“The dynamic has played out twice before over the past 85 years—in the Great Depression and the panic of 2008-09—with devastating consequences for the broader economy.  Over the past three months, investor uncertainty about the soundness of bank balance sheets, manifested in the daily volatility of stock prices is back up to levels seen historically only in advance of these two great crises.”

“This extraordinary volatility is not limited to the stocks of large banks but extend to small and midsize banks as well.”

So much has been written about the condition of the banking industry in Europe.  Very little has really been written about the condition of the banking industry in the United States.  Investors in the stock market seem to have picked up this concern.

And, I have argued for more than two years now that the major reason that the Federal Reserve has pumped so much money into the banking system is that the United States banking industry has severe problems.  And, the fact that banks have held onto these funds as excess reserves and have not loaned them out is an indication of the fact that many of the banks are still not solvent.  However, the fact that the Fed has provided so many excess reserves to the banking system has allowed the FDIC to either close banks or approve acquisitions of weak banks as smoothly as possible.  The Fed and the FDIC have, so far, prevented any panic from occurring. 

However, problems remain. 

Business Lending is Increasing, Especially at the Largest US Banks

Business lending continues to accelerate in US commercial banking system according to the latest data released by the Federal Reserve System.  Although overall lending has not increased by much in the commercial banks, only about $27 billion year-over-year at all domestic and foreign-related institutions, business loans (commercial and industrial loans) rose by more than $95 billion. 

True, many of these loans have gone to support acquisitions and other uses that are not directly related to expanding economic expansion.  Still, it is good to see more life in this particular area of bank lending.

Most of the increase in business lending came from the largest twenty-five banks in the country and foreign-related financial institutions.  Business loans did increase modestly at the small- and medium-sized banks, but not by much.

Commercial banks continued to allow their real estate and consumer loans to run off, the largest declines coming in the commercial real estate area.  All real estate loans at commercial banks decreased by almost $160 billion, year-over-year, with $86 billion of the decline coming at the largest twenty-five commercial banks and almost $70 billion coming in the rest of the domestically chartered banks.  The largest proportion of these declines came in the commercial real estate area. 

Consumer loans declined by about $41 billion in the whole banking system, year-over-year, with $38 billion of the decline coming in the largest 25 banks.

On another note, one can still see how the Federal Reserve is helping to finance banks in the eurozone.  Cash assets in the whole commercial banking system rose by almost $620 billion, year-over-year, with the rise at the foreign-related financial institutions absorbing almost $490 billion of the total.  At the same time the net deposits to foreign offices at these foreign-related financial institutions rose by more than $590 billion.  The average increase in these net deposits to foreign offices over the past month was another $50 billion. 

The Federal Reserve has done what it can to supply liquidity to European-related financial institutions to help them through the recent financial crisis.

I still have substantial concern about the smaller commercial banks in the United States.  The statistics still do not look good to me.  The total assets at the “smaller” banks rose by about $58 billion over the last year, but over $39 billion of that increase came in the cash assets of these institutions.  Although business loans at these institutions rose modestly, as mentioned above, total loans at these “smaller” banks dropped by almost $60 billion.  These “smaller” banks are just not growing.

A very large number of these smaller banks are just “sitting on their hands” hoping to survive.  These banks are doing everything they can to work out their loan portfolios and to become more liquid.  The reserves for bad assets have declined, but these declines are coming at the healthier banks.  And, given the low interest rates that can be earned on securities, the profits of many of these smaller banks are not sufficient to help them recover from the bad assets that are still on their balance sheets.  It is just amazing the numbers related to bad commercial real estate loans that are on these balance sheets. 

One could say that the good news is still related to the fact that there are not major disruptions occurring in the commercial banking sector.  This “peace and quiet” allows the FDIC to close as many banks as need to be closed without a big fuss.  This year 85 banks have been closed, just under 2 per week.  This figure, however, does not include the decline in the number of banks still open due to acquisitions.  I am still expecting some 2,000 or so commercial banks to drop out of the banking system over the next five years or so. 

It is hard to imagine that bank lending will grow much in the future given all the vacant residential real estate and commercial real estate that is around and all the foreclosures that are still to come.  An examination of the commercial banking sector does not give us much hope about the possibility of a more rapid expansion of the economy. 

The Banking Mess: It's Not Over Until It's Over

Credit inflation impacts asset values.  In a credit inflation, the expansion of credit takes place at a faster rate of growth than does the rate of increase in the production of the underlying assets.  Credit inflation can create bubbles. This occurred, as we know, in the dot.com bubble of the 1990s and the housing bubble of the 2000s.

The Federal Reserve is desperate to get credit inflation going again. This was the whole point behind the Fed’s QE2 operations.  Now, we have a version of “Operation Twist” an effort to lower longer-term interest rates relative to shorter-term interest rates.   

At present, the only bubbles the Federal Reserve has created have been in foreign assets like commodities and the stocks in emerging markets.

So far, the policy of the Federal Reserve has not been very successful in the way of domestic assets.  Credit expansion in the United States remains moribund.  And, as a consequence, asset prices seem to be remaining level.

Housing prices continue to fall, or, at best, stay relatively constant.  The stock market has gone nowhere.  Year-over-year, the Dow-Jones Average is up just 0.8 percent.  Since the same time in 2007, around the start of the recent recession, the Dow-Jones Average is still down 21.6 percent.

The only major borrowers of any consequence seem to be the largest companies and they seem to be either holding onto the cash or using the cash to repurchase their own stock.  Where once it was felt that these funds would be used for the acquisition of other companies, so far the number of acquisitions taking place have fallen below expectations as the future remains listless and uncertain.

We still have to look at the banking system for any sign of a recovery in credit and the credit inflation cycle.  And, in looking at the banking system, the signs of expansion still are absent.

A start up of bank lending is going to depend upon the status of the banks themselves…and this picture is mixed, at best.

The good news is that the FDIC is closing two of its three temporary offices.  Due to a decline in the amount of bank problems and the severity of those problems, the FDIC has decided that it can handle problem banks primarily out of its permanent offices.  The period of the ramping up of staff and the sending of staff all over the country, seven days of week, seems to be over.

Also, only 74 commercial banks have been closed this year through Friday, September 30.  In 2010 the total number of banks that failed were 157 with 30 closings coming in the fourth quarter of the year.  In 2009 a total of 140 banks failed.   Bank failures are on the wane.

Note that the number of bank failures does not include the decline in the number of banks in business.  For example, since December 31, 2007, 396 commercial banks have failed.  Yet, the number of banks in the banking system declined by 871.  This left the commercial banking system with 6,41 banks in existence. 

Likewise, about 1,000 banks and savings institutions have disappeared since the end of 2007, leaving only 7,513 FDIC insured institutions in existence on June 30, 2011.

And, still there are 865 banks on the FDIC’s list of problem banks at the end of June, down only slightly from a total of 884 at the end of March 2011.

“Camden Fine, president of the Independent Community Bankers of America, a trade group, predicted another 1,000 to 1,500 banks will vanish between now and the end of 2015.” (http://professional.wsj.com/article/SB10001424052970204138204576603130578559172.html?mod=ITP_moneyandinvesting_2&mg=reno-wsj)

My prediction has been more in the range of a further decline of 2,000 to 2,500 banks.  This will put the total number of commercial banks in the United States below 4,000.  And, I believe that the total number of FDIC insured institutions will drop below 5,000. 

The way that credit inflation works is through the rate of increase in asset prices.  In essence, if asset prices are increasing rapidly, the “real” value of the credit goes down making it much easier for the debtor to handle the increased leverage on his/her balance sheet.  This is, of course, what happened over the last fifty-year period of credit inflation. 

But, credit inflation is a cumulative process.  As people begin to borrow more, asset prices begin to rise.  And, as asset prices rise, borrowing, in real terms, becomes cheaper and so more borrowing takes place.  But, this causes asset prices to rise further, and so on and so forth.

Right now, people and businesses are not borrowing.  They are trying to reduce their debt loads because asset prices are remaining relatively constant or are declining.  The Fed is trying to get to the first stage of the cumulative process…to get people to begin borrowing again.  The commercial banks, especially the small- to medium-sized ones are not contributing to this cycle, either because the people aren’t borrowing or because the banks, because they are in trouble, are not lending. 

And, on top of this the commercial banks face two other problems.

First, the banks are facing a tougher regulatory environment that is resulting in increased costs of doing business.  Either they have to absorb the increased costs…or they have to pass them along to customers.  The debit card fees announced by Bank of America and others are just one result of this.  There is more, a lot more, coming.

Second, the banks are facing further interest margin squeezes due to the Fed’s “Operation Twist.”  Balance sheet arbitrage is dependent upon the ability of the banks to “borrow short” and “lend long.”  If these margins are narrowed because of what the Fed is doing, more pressure will be put on the banks to raise fees in order to survive.  The small- and medium-sized banks will suffer more because of this.

I believe that we need to keep a close eye on the banking system to determine whether or not the economy is going to pick up.  The banking system is still in a troubled state.  If either Camden Fine, of the Independent Community Bankers of America, or myself is correct about the continued decline in the number of banks in the United States, the commercial banking sector has a lot of adjustment to go through over the next four years or so and the focus of the industry will not be on lending. 

On the other side, the Federal Reserve is acting relentless in its efforts to start up credit inflation once again.  And, given the political climate in Washington, D. C. I don’t see any change in this attitude.

The question then becomes, when do we reach the tipping point?  When does the unwillingness of the banks to lend and the unwillingness of families and businesses to borrow lose out to the efforts of the Fed to create the credit inflation it so badly wants?  The problem is that once a tipping point is reached, the cumulative credit cycle buildup begins and I don’t really see how the Fed can prevent this from happening. However, there is no indication that another bout of credit inflation will produce more robust economic growth and job creation.   Still, keep your eye on the banks.

Struggling With A Great Contraction

Martin Wolf of the Financial Times recently returned from vacation.   It is interesting to see where this “top” economic commentator stands after taking off from his weekly writing for a full month. 

His view on his return: The major economies of the world are “Struggling with a great contraction.” (http://www.ft.com/intl/cms/s/0/079ff1c6-d2f0-11e0-9aae-00144feab49a.html#axzz1Wbu6HxQ0) His concern is not with the possibility of a “double dip” recession, but with something more sustained.  He asks, “How much deeper and longer this recession or ‘contraction’ might become.  The point is that, by the second quarter of 2011, none of the six largest high-income economies had surpassed output levels reached before the crisis hit, in 2008.”  Hence, the great contraction.

The turmoil in financial markets that was seen in August, he contends, tells us, first, that “the debt-encumbered economies of the high income-countries remain extremely fragile”; second, “investors have next to no confidence in the ability of policymakers to resolve the difficulties”; and third, “in a time of high anxiety, investors prefer what are seen as the least risky assets, namely, the bonds of the most highly-rated governments, regardless of their defects, together with gold.”

A pretty succinct summary…what?

There is too much debt around which means that all the efforts that governments are making to get the economy moving again face the up-hill battle of over-coming the efforts people, businesses, and local and regional governments are making to reduce their debts. (http://seekingalpha.com/article/285172-when-debt-loads-become-too-large)

While national governments deal with their own excessive debt loads and deficits, their central banks have responded with undifferentiated policies to flood banks and financial markets with sufficient liquidity in order to provide time for banks, consumers, businesses, and local and regional governments to “work out” their positions as smoothly as possible. (http://seekingalpha.com/article/290416-quantitative-easing-theory-need-not-apply)

The hope seems to be that “time will heal all things.”

Whereas there is too much deb around, there is too little leadership.  I will quote Wolf on this: “In neither the US nor the eurozone, does the politician supposedly in charge—Barack Obama, the US president, and Angela Merkel, Germany’s chancellor—appear to be much more than a bystander of unfolding events.” (http://seekingalpha.com/article/285658-if-the-economy-is-a-football-game-we-need-new-strategies)

If there are no leaders, then policy decisions tend to be postponed as long possible, and then, when a result is finally forthcoming, the outcome is more like a camel, something that appears to be an inconsistent piecing together of incompatible parts.

And, this is supposed to produce confidence?  To quote Mr. Wolf again: “Those who fear deflation buy bonds; those that fear inflation buy gold; those who cannot decide buy both.” 

The point being that it is not a time to commit to the future, to invest in real assets or investments.  Hence, the economies of the “high-income” nations stagnate, unemployment remains excessive, and public confidence continues to be depressed.   

Such a general condition argues for a continuance of the economic malaise and not a more robust recovery any time soon.  Hence, the great contraction.

Mr. Wolf still has hope: “Yet all is not lost.  In particular the US and German governments retain substantial fiscal room for manoeuvre…the central banks have not used up their ammunition.”  

But, this hope is based on the existence that leadership in these governments will arise.  Policy makers will come to their senses: “The key, surely, is not to approach a situation as dangerous as this one within the boundaries of conventional thinking.”  

Therein lies the problem.  Mr. Wolf is looking for the hero to ride in on her/his white stallion and provide the leadership necessary to clean up the mess and get things going forward on the right path. 

He has just argued, however, that that leadership does not seem to exist.  So, where is the leadership going to come from?

With all the debt loads outstanding, just how much can be done to overcome the drag on the spending and the economy coming from the efforts of many to de-leverage. 

The Federal Reserve and the European Central Bank have flooded the world with liquidity.  Their effort here is to give banks, consumers, businesses, and governments time to work out their bad debts.  This also provides time for banks and others to fail, consolidate, and/or raise capital without causing major disruptions to the whole financial system. Banks in the United States continue to fail, banks in the US and Europe continue to consolidate, and banks in the US and Europe continue to raise capital. 

Since debt seems to be the major problem here, the only other major suggestion that has been made that could relieve the credit crisis is to relieve debtors of some of their debt burden.  This would mean that some parts of the debt would need to be written off.  Whereas many have suggested such a program, the difficulty of creating such a problem is in the details and no one seems to have come up with any acceptable details of such a program.  Some have suggested that inventing such a workable and just program of debt reduction is nearly impossible.

So, we are back to square one…there are no “good” options.  And, when there are no “good” options, potential leaders tend to disappear into the woodwork.  It is easy to “lead” when you can create credit without end and encourage everyone to own a house and attempt to guarantee people jobs for their lifetime.  But, real leaders are the ones that can stand up and lead when there are no good options.

It is just that few want to be “out front” when none of the options are nice and comfortable.      

The Number of Banks in US Banking System Continues to Decline

There were 40 fewer banks at the end of the second quarter than there were at the end of the first quarter according to data just released by the FDIC.  On June 30, 2011, there were 117 fewer banks in the banking system than at December 31, 2010.

The commercial banking system continues to shrink.

The good news?

The number of institutions on the FDIC's "Problem List" fell for the first time in 15 quarters. The number of "problem" institutions declined from 888 to 865. This is the first time since the third quarter of 2006 that the number of "problem" banks fell.

The FDIC closed only 20 banks in the third quarter of 2011.  The average number of FDIC closings per week for the year 2. 

So, the pace at which the banking system is declining appears to be slowing. 

The smaller banks continue to bear the burden of the decline.  Since the end of 2010, about 3 percent of the banks with assets of less than $100 million have fallen out of the banking system.  The total number of these banks that dropped out of the banking system was 64.

Note that these smaller banks makes up only about 1 percent of the total assets in the banking system.

The number of banks with assets between $100 million and $1 billion declined by 61 banks, but this represented only about 2 percent of the number of banks in this category.

Note that this category of bank makes up only about 8 percent of the total assets of the banking system.

The largest banks, those with assets of more than $1, actually increased by 8 in the first half of 2011.  Note that these banks make up 91 percent of the total assets in the banking system.

Remember, from the Federal Reserve statistics, the largest 25 commercial banks in the United States make up about 60 percent of the total banking assets in the country. 

The vast majority of the banks on the FDIC’s list of problem banks fall in the less than $100 million in asset class.  The middle class of banks ranked by asset size make up the next largest portion of the problem list. 

So, it seems as if we need to say good-bye to the smallest banks and farewell to many of those in the middle category of banks.  Even if these smaller institutions are not closed, they will be acquired by the larger banks and so the average size of bank in the United States will continue to rise.

My forecast for the past two years is that the number of banks in the banking system will drop to under 4,000 over the next four-to-five years.  Not only will this decline occur due to the weeding out of the problem banks, but the smaller banks will just not be able to compete in the new world of banking that is so dependent upon the new information technology spreading throughout the financial world. 

And, the larger banks?

Again, I see that the largest twenty-five domestically chartered banks in the United States will control close to 70 percent of the total assets in the banking system over the next four-to-five years.  Foreign-related financial institutions will move up to the 10- to 15-percent range. 

So, the 3,950 or so smaller banks will have only 15- to 20-percent of the total assets in the banking system.  This will mean that we will still have a lot of smaller banks around…or, my estimate that there will still be around 4,000 banks in the banking system is optimistic.

The banking system in the United States is changing.  We are not a country based on agriculture that needs a lot of local banks.  That went out with the 1930s.  We are not a country anymore that is based on manufacturing that needs a lot of sizeable regional banks.  That went out with the 1980s.  We are a country that is in the midst of the information age and the predominant financial institution in such an age will be large and will have a sizeable international presence.   

So, the decline in the number of banks in existence is not surprising.  The fact that the decline will continue is also not surprising.  And, a continuing decline will take place even if the economy picks up strength. 

Debt Deflation and the Selling of Small Businesses

The Wall Street Journal carries the story, “Sales of Small Firms Are Up”. (http://professional.wsj.com/article/SB10001424052702303406104576444062140022104.html?mod=ITP_marketplace_4&mg=reno-secaucus-wsj)  “Sales of businesses with roughly $350,000 in annual revenue rose 8% from a year earlier…”

“The main driving force is the acceptance among owners that their businesses are no longer worth what they once were.  Many sellers cut their asking prices and agreed to finance a significant portion of the deals themselves.

This is the other side of the last fifty years of credit inflation.  People are in debt, business is not good, and valuations have dropped substantially. 

How do you like the story of the individual who bought a 200-seat casual restaurant in 2002 for $200,000 and “is finally selling it for just $75,000, and he is lending the buyer 25% of the selling price”?

More and more information is now coming out on the situation in the world of small- and medium-sized businesses. 

But, this has been the case in the residential housing market.  People are in debt, unemployed, facing lower incomes, and property values have plummeted.

This is also the situation in the banking industry among the small- to medium-sized commercial banks.

The FDIC has only closed 51 commercial banks through July 8 of this year, but this figure does not include banks that were acquired by other institutions.  Through March 31, 2011, there were 77 fewer insured banks in the banking system than there were on December 31, 2010.  (In all of 2010, there was a net decline in the banks in existence of 290 even though the FDIC closed only 157.)  With 888 commercial banks on the problem list the likelihood that there will be 300 or so fewer banks in existence at the end of this year is highly probable. 

My point is that this is a part of the debt deflation process going on in the economy and it is a natural progression from the fifty years of credit inflation that preceded it. (“Credit Inflation or Debt Deflation,” http://seekingalpha.com/article/279283-credit-inflation-or-debt-deflation) 

Of course, the Federal Government is doing all it can to offset the forces of debt deflation by continuing to pump more and more debt into the economy.  Yesterday, Fed Chairman Bernanke, in Congressional testimony, argued that the Federal Governments needed to get its “act together” on the federal budget.  Bernanke followed this up by saying that the Fed will “do what it has to do” if the economy remains weak.

This was immediately interpreted by the “market” that the Fed will throw QE3 on the fire if it believes it is necessary.   Gold prices rose to a new record.

Today, Bernanke backed off and said the Fed was not “prepping” for a new edition of quantitative easing.   Gold prices dropped.

The problem with the effort of the federal government to offset the debt deflation going on in the economy by more and more rounds of credit inflation is that much of the liquidity the government is pumping into the system is going offshore…that is, it is going into world financial and commodity markets! (See “Federal Reserve Money Continues to Go Offshore,” http://seekingalpha.com/article/276909-federal-reserve-money-continues-to-go-offshore.)  This is doing little or nothing to stimulate the American economy and is doing lots to inflate world commodity markets. 

And, in this condition of debt deflation we see one of the real confusing issues connected with credit inflation and debt deflation. 

To take a specific example, in the 2000s there was a terrific increase in the price of houses and the value of small- and medium-sized businesses, in asset values.  Yet, price inflation, which is measured in terms of flow price…rents and business cash flows…did not increase at the same rate.  Hence, it looked as if consumer price inflation was being kept quite low.

Now, we see just the opposite happening.  Price inflation seems to be picking up, yet the value of assets like homes and small- and medium-sized businesses are declining, sometimes quite precipitously. 

In a period of credit inflation, asset prices tend to increase more rapidly than “flow” prices and this dis-connect must ultimately be corrected.

In a period of debt deflation, asset prices tend to decrease more rapidly than “flow” prices and this tends to continue until they are brought back more nearly into line (or over adjust).

The actions of the federal government and the Fed seem to be having little or no effect on asset prices.  Owners of businesses (and houses) are forced to accept “that their businesses (and homes) are no longer worth what they once were.” 

Further rounds of credit inflation may moderate the downside of this move…but, continuation of aggressive credit inflation will only just postpone the adjustment that is needed in the economy until a later time.    

Commercial Banks Closures in 2011

The Federal Deposit Insurance Corporation oversaw the closing of six banks on Friday, April 15.  This brings the total for 2011 up to 34 banks, a pace of about 2.3 banks per week. 

In 2010, 157 banks were closed, a pace of about 3.0 banks per week.

The problem bank list published by the FDIC every quarter rested at just under 900 banks (out of 6,529 banks in the banking system) on December 31, 2010.  We are waiting for the release of this number for the March 31, 2011 date.

The other number that is important in this respect is the number of banks that were acquired or merged into other banks.  Last year there were 153 banks dropping out of the industry due to such consolidations. 

Thus, the number of banks in the commercial banking system declined by 310 units last year or at a rate of approximately 6.0 banks leaving the system per week.

Most of the banks dropping out of the banking system are smaller institutions.  However, last week a $3.0 billion bank was closed so it is not all just the very smallest banks that are leaving the system.  Still, it not the largest 25 commercial banks in the banking system, the banks that control almost 60% of the total assets of the industry, that are departing.

The question still remains about the health of this industry.  Is the number of problem banks in the industry going to remain around 900 institutions?  Are bank departures going to continue to run off at the rate of 5 to 6 banks a week?  Will these rates lessen this year?  Or, will they increase?

Supposedly, the condition of the smaller banks is getting better.  But, as we saw with Bank of America last week, the overhang of bad mortgage loans still plagues some institutions.  Right now, I believe that the drop off in foreclosures on residential mortgages is misleading because the whole foreclosure issue has become so political that we probably won’t really have a good idea about the situation in the housing industry and in loan writeoffs for some time. 

We do know, however, that there are a lot of commercial real estate loans coming due over the next twelve months and the word I hear about the refinancing of these loans is not good.  Vacancies in commercial properties remain high and cash flows have not picked up significantly.  Furthermore, as more and more political entities downsize, more and more office properties used by these state and local governments are being vacated.  This was not expected a year ago.

In addition, I am also hearing that more small- and medium-sized businesses have exhausted their efforts to re-structure and just cannot go on much further.  As their loans come due, they are informing their banks that they are not going to be able to pay off their loans and must re-finance.

Thus, the banks have to make a decision about whether or not they roll over the loans for another period of time.  Or, do they “bite the bullet” and say they just cannot keep the loan going with no real sign that things are going to get better.

Then there are the examiners looking closely over the shoulders of these bankers.  The regulators are still running scared and, given all the restructuring of the regulatory institutions, don’t want to have the people in the new regulatory alignment holding them accountable for being too easy on these “failing” banks.  There is enough finger-pointing going on with respect to the “lax” regulatory environment that existed in the past. 

Bankers, especially from the smaller banks, feel caught in the middle of this exercise.  They want to do what they can to help their customers survive.  Yet, they are being pressed by the regulators, who also feel they are under excessive pressure, to not show overly-optimistic hopes about the ability of these businesses to repay.   In fact, the result may be that a too pessimistic approach is taken toward the quality of the bank loans. 

As a consequence, we will probably see the list of problem banks remain somewhere around their current highs and we will probably see business loans and commercial real estate loans continue to decline on the balance sheets of the banking industry. 

And we will continue to experience a decline in the number of banking institutions in the United States. 

The crucial element of this decline is that it is that the decline takes place in an orderly fashion. 

I believe that the Federal Reserve has contributed greatly to the achievement of this orderly reduction in the number of commercial bans in the banking industry.  Keeping short-term interest rates so low and pumping so much liquidity into the banking industry has reduced what could have been a very chaotic evacuation into a relatively peaceful exodus. 

Of course, there are other consequences to the Fed’s policy and we will have to deal with those in the future.  For now, the Federal Reserve has kept the banking system open.

Until the history of the recent financial collapse is fully understood and written up, most of us will probably not know how serious the banking crisis has been.  We get bits and pieces of this seriousness, but government officials have not really believed that the depth of the problem should be presented to the rest of the world.

For example, buried in the column Global Insight by Tony Barber in the Financial Times this morning is this observation: “For the truth about the eurozone’s crisis…is that the rescues of Greece, Ireland and Portugal are at heart rescues of European banks…Restructuring these countries debts would involve losses for German banks…” (http://www.ft.com/cms/s/0/4ed1d54a-6915-11e0-9040-00144feab49a.html#axzz1JsjXsOj5).   But this is not what is expressed in most governmental commentary. 

It appears as if the credit inflation of the past fifty years in America, and in Europe, seriously infected the banks and the cure for this infection is taking a very long period of time to achieve and is creating, in the process, economic and financial dislocations that we may not fully recognize for many years. 

For now, however, we can only hope that the cure takes place in an orderly fashion. 

FDIC Bill for Loan Losses at Failed Banks to Reach $30 Billion

The good news is that the FDIC payments to those organizations and institutions buying failed banks during the present crisis are smaller than the regulatory officials anticipated. The FDIC has paid out $8.89 billion to “cover losses” at 165 banking institutions that have failed during the recent financial crisis. (See Wall Street Journal article: http://professional.wsj.com/article/SB10001424052748704396504576204752754667840.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj.)

The reason for this good news, I believe, is the monetary policy followed by the Federal Reserve over the past three years, now captured in the quaint symbol QE2. Excess reserves pumped into the banking system by the Fed now total around $1.3 trillion.

I have argued for at least a year-and-a-half now, that the Federal Reserve is pumping all these reserves into the banking system to help the FDIC close banks in an orderly manner. The basic premise is that if the Fed can provide sufficient “liquidity” to the financial markets in order to maintain the value of financial assets it wil give the FDIC breathing room to close banks as rapidly as they can without causing major disruptions to the many other troubled banks in the system.

The Federal Reserve has argued that it has pumped all these reserves into the banking system to help stimulate the economy. The economic recovery has almost reached its two-year anniversary, although there is general dissatisfaction with the speed of the recovery, and looks likely to extend beyond this milestone.

However, the recovery seems to have taken place without the Fed’s help except for the argument that there have not been further disruptions to the recovery due to major cumulative banking failures. Certainly, one cannot argue that the Fed’s actions have provided banks with the incentives to increase their lending activity for they have not. Commercial banks are still sitting on the money.

This is exactly my point! The policy of the Federal Reserve has been to support the FDIC and allow the FDIC to close insolvent banks in an orderly manner.

Thus, the monetary policy followed by the Federal Reserve over the past three years has succeeded.

Added evidence that the policy of the Federal Reserve has been successful is that reported above: the FDIC payments to those acquiring banks have been “smaller than FDIC officials anticipated.” Without the market liquidity, results would have been much worse.

The Wall Street Journal even reports: “Some executives at U. S. banks that bought failed institutions using the FDIC lifeline agreed that losses on the troubled loans aren’t piling up as high or as fast as they previously anticipated.”

The bad news?

“FDIC officials expect to make an additional $21.5 billion in payments from 2011 to 2014. More than half of that total is predicted for this year, followed by an estimated $6 billion in loss-share reimbursements in 2012, according to the agency.”

According to my calculations, $21.5 billion is almost two-and-one-half times the $8.89 billion the FDIC has already paid out during this cycle of bank failures!

This would bring the total of FDIC payments up to more than $30 billion!

It also seems to mean that we have a lot of bank failures that still have to be resolved!

The banking system now has less than 8,000 banks in it. Over the past year or so, I have argued that this number will drop to less than 4,000 by 2015.

I see nothing inconsistent between my forecast about the number of banks that will be in the banking system and the estimates made by the FDIC, itself, concerning the amount of payments it will need to make to those that acquire banks to cover loan losses.

Bottom line: there are still a massive amount of bad loans that still reside on the balance sheets of commercial banks!

Consequently, there are still a lot of commercial banks that need to be closed!

And, what does this mean for the Fed and QE2? The Fed claimed on Tuesday that the economic recovery is picking up. However, QE2 will need to continue, as planned, through June. Also, the Fed will maintain its interest rate targets at current levels for “an extended period”. NO CHANGE IN MONETARY POLICY!

If I am correct the Fed will only change its monetary policy when it…and the FDIC…believe that problems connected with bank closings have receded sufficiently so that more normal operations can be resumed.

Since the Fed…and the FDIC…have never claimed that the excessively loose monetary policy over the past few years has been to assist the regulatory closing of commercial banks, any statements about changing policy will not be worded in a way that ties the policy with the closing of banks.

Maybe it has been just as well for us…that we have not really known how bad off the banking system has been. But, so much for openness and transparency.

What to Watch For in Early 2011

There are four situations in the financial area that require special attention in, at least, the early part of 2011. These situations pertain to the European debt problem, both sovereign and corporate, the problems being experienced by state and municipal governments in the United States, the problems connected with the rolling over of commercial real estate loans, and the consolidation that is taking place in the United States banking system.

The European situation seems to be the first out-of-the-box for the new year. Although most of the attention on Europe has been focused on the sovereign debt problem, the potential for problems to arise in the corporate sector should not be overlooked.

Europe cannot put its debt problems behind it because its leaders are not really facing up to the real problem. The real problem relates to the fiscal integration of the countries within the European Union.

As I have stated many times over the past year, a region cannot have just one currency if capital flows within the region are not restricted and if the political entities within the union continue to conduct their fiscal policies independently of one another. The European Union cannot be successful over time if it tries to maintain all three of these objectives.

Simon Johnson in “The Baseline Scenario” states that “Most experienced watchers of the eurozone are expecting another serious crisis to break out in early 2011. This projected crisis is tied to the rollover funding needs of weaker eurozone governments…” A solution will not be reached until the leaders of the European Union really face the fundamental facts of their crisis.

But, the sovereign debt of Europe is not the only concern. Although the corporate sector has been relatively successful in staying out of the limelight, concern is rising over what might happen here in 2011 if there are spillover effects coming from the “sovereign” sector. Especially worrisome is the amount of speculative-grade bonds maturing in the future and the potential number of defaults connected with the roll-overs. (See “Gearing up for 2011,” http://www.ft.com/cms/s/3/4b13a710-1363-11e0-a367-00144feabdc0.html#axzz19ypGKK7a.)

The second uncomfortable situation that is looming over 2011 is the fiscal soundness of many states and municipalities in the United States. Almost daily, new information comes out about the condition of our state and municipal governments, the cutbacks in police, firemen, educators, and social workers, the un-funded pension funds, and the labor unrest that is stirring because of the changes being proposed.

Bankruptcy is an issue. In some states, the bankruptcy of a municipality is unrecognized. For example, the situation in Hamtramck, Michigan is extremely bad, yet, the state of Michigan will not let the city declare bankruptcy. (See http://www.freep.com/article/20101205/NEWS02/12050500/Hamtramck-can-t-declare-bankruptcy-state-says.) Harrisburg, Pennsylvania and a host of other municipalities are just plugging holes attempting to avoid the worst.

But, many states are not doing much better.

And, the unrest in these areas continues to grow. However, this unrest is not just associated with the citizens losing services, the unrest is connected with the workers and the unions that are losing jobs and benefits. More than 50% of the union workers in the United States are in state and local governments so the potential conflicts with budget needs can be substantial. But, the times may be changing: “In California, New York, Michigan, and New Jersey, states where public unions wield much power and the culture historically tends to be pro-labor, even longtime liberal political leaders have demanded concessions—wage freezes, benefit cuts and tougher work rules.” (See http://www.nytimes.com/2011/01/02/business/02showdown.html?_r=1&scp=1&sq=public%20workers%20facing%20outrate%20in%20budget%20crisis&st=cse.)

Commercial real estate is another potential disaster area. For twelve months or more, commercial real estate loans have been on the list of major looming problems, in Europe as well as the United States. Yet, a crisis never seems to occur. One reason is that “banks on both sides of the Atlantic have been ‘ever-greening’ loans—or essentially extending the maturities, and practicing forbearance to avoid recognizing losses.” (See Gillian Tett, “Commercial Property Loans Pose New Threat”, http://www.ft.com/cms/s/0/c23e885e-1422-11e0-a21b-00144feabdc0.html#axzz19yRTp3ed.)

“Banks and borrowers have been able to conduct such ever-greening because interest rates have been rock-bottom low. But if rates rise, this ever-greening will be harder to maintain.”

Tett concludes with something we all need to keep in mind: “while a sense of peace might have returned to parts of the financial system in the past two years, this has only been achieved by virtue of government aid—and rock-bottom interest rates.”

As I have said over and over again, Federal Reserve policy has been aimed at achieving “a sense of peace” so that banks and others could work out of their debt problems: so that the FDIC could close banks in as quiet an environment as possible. And, some participants believe that the reduction in the size of the banking system will still be in the 1,000s over the next four or five years.

The question remains: has deleveraging taken place by a significant enough amount so that we can declare the bank crisis over?

The first three situations described above indicate that the deleveraging still has a ways to go and that as this deleveraging takes place the banks, in both the United States and Europe, could face further stress. There is certainly concern “out there” that the problems in the banking sector are not over. See, for example “Banks Pushed Together in a Wave of Deals,” http://professional.wsj.com/article/SB10001424052748704774604576035732836200772.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj, and “Bailed-Out Banks Slip Toward Failure,” http://professional.wsj.com/article/SB10001424052970203568004576044014219791114.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj.

In terms of closing banks in an orderly fashion, another problem has existed: the FDIC has just not had the resources to act as quickly as needed to fully deal with those banks that are seriously facing financial difficulties. Thus, even in troubled banks, “ever-greening” is a methodology for keeping the doors open because this buys time and “who knows what might happen” if a bank can keep open. “There’s just not enough manpower and coordination to catch all these failing institutions at once.” For more on this see “Hard Call for FDIC: When to Shut Bank,” http://professional.wsj.com/article/SB10001424052970204685004576045912789516274.html.


I am not saying that it is a sure thing that we will face eruptions in these four areas in 2011. And, I am not saying that these four situations are the only ones to be looking at during the year. It is just that the problems that exist in these four areas have not been resolved and will have to be resolved at some time in the future for the economic recovery to really pick up steam. The interesting times are not over.