What's to Like About the United States Banking System?

I really don’t see much to like in the United States banking system. 

With interest rates so low across the board, commercial banks have very little interest rate spread to work with.

With Congress and the regulators so screwed up and yet so anxious to pass laws and regulate, the “regulatory risk” and the “complexity risk” facing the industry is enormous.

There is still plenty of evidence that commercial banks have a lot of unrecognized overvalued assets on their balance sheets. (http://seekingalpha.com/article/320370-bank-stress-tests-a-substitute-for-mark-to-market-accounting)

There seems to be growing interest in suing banks that are alleged of “making misleading public statements as the property market crumbled in 2007 to hide internal downgrades of loans from investors” (http://professional.wsj.com/article/SB10001424052970203735304577169360314402158.html?mod=ITP_moneyandinvesting_2&mg=reno-secaucus-wsj) or for other reasons that banks failed to appropriately disclose their financial condition.  There are also other settlements coming related to bank lending practices in the 2000s.

Bank earnings are a mixed bag, at best.  The larger banks are not performing well because trading profits and profits on many non-traditional banking operations are off.  (See JPMorgan and Citigroup)  The returns to trust banks (BNY Mellon, State Street Corp. and Northern Trust Corp.) are sagging because these institutions have taken a “defensive position” with respect to the financial markets and shifted a substantial amount of funds into cash and ultra-safe assets. (http://www.ft.com/intl/cms/s/0/140b9e70-41da-11e1-a586-00144feab49a.html#axzz1jqA4rKTp)

Only the banks that have stayed pretty much as traditional banks (like Wells Fargo, U. S. Bankcorp, and PNC Financial Services Group) have held up, profit-wise, in recent periods. This performance seems to be connected with some minor pickup in loan growth. 

Even in the case of loan growth, analysts are relatively pessimistic about the future.  “It appears that much of the commercial loan growth we have seen at the large cap banks is coming from large corporate syndicated lending.  Not all banks are players in this market.” This from Christopher Mutascio at Stifel, Nicolaus & Co.  Note that Mutascio is expecting “total loan growth and commercial loan growth” to slow in 2012.  No bounce here. (http://professional.wsj.com/article/SB10001424052970204555904577168510658669178.html?mod=ITP_moneyandinvesting_2&mg=reno-secaucus-wsj)

In my most recent blog I discussed the effort of BankUnited, a Florida-based bank, to sell itself because of the condition of the banking industry, especially in Florida.  BankUnited wanted to grow and yet could find no other banks to acquire…and they had looked at about 50 banks in the Florida region and elsewhere.  Because of the state of the banks available to acquire, BankUnited decided to sell.

Well, yesterday, BankUnited pulled itself “off the market”.  The bank had attempted to set up an auction for itself but only Toronto-Dominion Bank and BB&T Corp. submitted preliminary offers.  These offers did not come up to the price of that BankUnited received when it went public last year.  Thus, the bank withdrew its offer to sell. (http://professional.wsj.com/article/SB10001424052970203735304577169400198108514.html?mod=ITP_moneyandinvesting_1&mg=reno-secaucus-wsj)

Some of the banking statistics reflect the stagnant nature of the banking system as a whole.  For example, total commercial banking assets in the United States rose by about $700 billion last year. 

Note, however, that cash assets at commercial banks rose by about $515 billion!  That is, almost 75 percent of the growth in bank assets came from an increase in the cash holdings of the banks. 

Also, note that about 80 percent of this increase in cash assets at commercial banks in the United States occurred at foreign-related financial institutions. 

Furthermore, these foreign-related financial institutions increased their commitment to Net Deposits Due to Foreign-related offices by almost $650 billion.  Thus, these foreign related institutions took U. S. dollars and shipped them off-shore!  Thank you Federal Reserve System!

In all, the share of United States banking assets going to foreign-related financial institutions rose from about 11 percent to almost 15 percent from December 2010 to December 2012.  The largest twenty-five domestically chartered banks in the United States continue to account for almost 60 percent of the banking assets in the country.  The smallest domestically chartered banks (about 6,300 of them) continue to shrink as a proportion of banking assets. 

The American banking system is welcoming more foreign-related financial institutions to the ownership of its assets…note that one of the two bidders for BankUnited was Toronto-Dominion Bank…and is also seeing more and more of its assets being held by larger banks.

Right now, the commercial banking system seems to be going nowhere, just restructuring. 

This is just a very, very tough time for the banking system.  It is a time of transition.  The whole industry is changing. (http://seekingalpha.com/article/319449-the-banks-they-are-a-changing) But, then, the whole world seems to be going through a period of transition.  

United States Loses 355 Banks in 2010

One December 31, 2010, the FDIC reported that there were 7,657 insured depository institutions in the United States. This was 355 less than the 8,012 institutions that were in existence on December 31, 2009. (157 banks were officially closed by the FDIC in calendar 2010.)

This is up from the 293 institutions that dropped out of the industry in 2009.

In the fourth quarter of 2010, the number of insured depository institutions in the United States dropped by 104 depository institutions.

The number of banks on the FDIC’s list of problem banks rose from 860 to 884 at the end of the year.

The FDIC does not list how many of these problem banks went out of business in the fourth quarter of 2010 or were acquired by or merged into other institutions during this period. But, the picture is not quite as rosy as New York Times columnist Eric Dash reports this morning: “And only 24 lenders were added to the government’s list of troubled banks, the smallest increase since the financial crisis erupted in late
2007.” (http://dealbook.nytimes.com/2011/02/23/banking-shows-signs-of-a-turnaround/?ref=business)

Most of the banks leaving the banking industry were on the smaller size.

Furthermore, the list of problem banks does not include many other banks that are facing serious problems but have not yet qualified to be put on the FDICs list of problem banks. Need I mention the name of Wilmington Trust Bank, a bank that was considered by almost everyone as a bank that was doing OK. Then came the news of its sale last November. (http://seekingalpha.com/article/234027-wilmington-trust-sold-at-45-discount)

The problem list is a proxy for the number of institutions that are severely stressed, but does not include all that are still experiencing questionable futures. These latter banks have just not crossed the statistical threshold to be considered “problem banks.” Still 12% of the banking system is on the problem list.

I have been arguing for more than a year now that the actions of the Federal Reserve have been aimed at keeping things calm in the banking industry so that the FDIC can close or arrange acquisitions for troubled banks in an “orderly” fashion. This, I believe, has been one of the reasons that the Fed’s target interest rates have been kept near zero for such a long time. It is also part of the reason for the Fed’s second round of spaghetti tossing, or, quantitative easing (QE2).

The FDIC has needed the calmest environment possible to oversee a dramatic reduction in the number of banks in the banking system. As reported above, the banking system has almost 650 fewer banks in existence now than were in the banking system on January 1, 2009. That is a reduction of almost 8% of the banking institutions that existed at that time.

The other fact that does not bode well for the smaller banks in the country was just reported by the Associated Press: the profits of the big banks represented 95% of all bank profits in the fourth quarter of 2010. The big banks earned $20.6 billion of the $21.7 billion in profits earned by the banking industry as a whole. That is, only about 1.4% of the 7,657 banks noted above with assets of more than $10 billion saw these earnings.

And, bank lending. Bank lending continues to drag. I reported in my post of February 21, 2011:

“bank lending was abysmal over the past 6-week period and the last 14-week period.

Since the end of the year, loans and leases at the largest 25 domestically chartered banks in the United States dropped dramatically by about $50 billion, much of this coming in consumer lending although loan amounts were down across the board. Loans and leases held roughly constant in the eight weeks that preceded December 29 at these large banks.

In the rest of the banking system, the declines in the loan portfolio came primarily before the end of the year. After falling by about $60 billion in November and December, loans at these institutions rose slightly in the first six weeks of 2011. Notable decreases came in both residential lending and in commercial real estate loans, each declining by a little more than $20 billion over the last 14-week period.” (http://seekingalpha.com/article/254004-why-is-most-of-the-fed-s-qe2-cash-going-to-foreign-related-banking-institutions)

My question still remains, “why should the commercial banks be lending?” A large number of the banks have balance sheets that are not in very good shape, interest rates are abysmally low, and there are still quite a few sectors of the economy, housing, commercial real estate, consumer loans, state and local governments, that are experiencing serve financial difficulties themselves.

Having $1.2 trillion of excess reserves in the banking system is not justification for the banks to be lending…especially the smaller banks.

If the banks don’t lend right now it avoids the possibility of putting another bad loan on their balance sheets. In that way they can focus on their existing bad loans.
Some people looking for “green shoots” in the banking industry claim that they have found them. Unfortunately, I have not yet found a lot to raise my spirits.

The Number of Problem Banks Rise in the Third Quarter

The number of problem banks, as listed by the FDIC, continued to rise in the third quarter of 2010. The number went from 829 at the end of the second quarter to 860 in the third quarter.

Forty-one banks failed in the third quarter, an average of about 3.2 banks per week. A total of 149 banks have been closed through the first three quarters of 2010, an average of 3.8 per week. Thus, the pace of bank closings has been relatively steady throughout the year, somewhere between 3 and 4 banks per week.

The total number of FDIC-insured commercial banks in the system was 7,760 at the end of the third quarter. This is down from 7,830 at the end of the second quarter and 8,195 at the end of the second quarter of 2009. So, the number of banks in the system dropped by 70 banks in the third quarter. Since June 30, 2009, the number of banks in the system has fallen by 435.

The decline in the number of banks in the banking system is not all failures as some banks are merged into other banks before the bank is closed by the FDIC. For example, in the third quarter of 2010, 30 mergers took place.

So, the industry is shrinking by bank failings and by the consolidation of healthy banks with banks that are not in very good shape. From June 30, 2009 to June 30, 2010, the number of banks in the banking system dropped by 365 banks, an average of 7 banks per week. In the third quarter of 2010 the number of banks dropped by 70 banks, an average of about 5.5 banks per week.

This fact raises concerns not only about those banks that are listed on the problem list, but what about those banks that are in serious trouble but do not “qualify” to be on the FDIC’s problem list?

How many surprises are out there?

Wilmington Trust, in Wilmington, Delaware, was considered to be doing OK. Then, the bombshell hit. Wilmington Trust ended up being sold at a 45% discount. (See http://seekingalpha.com/article/234027-wilmington-trust-sold-at-45-discount.)

How many more banks in the system are facing the same fate as Wilmington Trust?

Earlier this year Elizabeth Warren told Congress that as many as 3,000 commercial banks were facing real problems over the next 18 months.

My prediction is that the total number of banks in the banking system will drop to 4,000 or so over the next five years. This is down from 7,760 at the end of the third quarter of 2010, a reduction in the number of banks of 3,760 banks or of approximately 750 banks per year for the next five years.

There is good news:
“Banks and savings institutions earned $14.5 billion in the third quarter, $12.5 billion more than the industry’s $2 billion profit a year ago, the FDIC said yesterday. The third-quarter income was below the $17.7 billion and $21.4 billion reported in this year’s first and second quarters, but agency officials said the shortfall was attributable to a huge goodwill impairment charge at one institution.

A reduction in loan-loss provisions was the primary factor contributing to third-quarter earnings…. While third-quarter loan-loss provisions were still high, at $34.3 billion, they were $28 billion -- or 44.5 percent -- lower than a year earlier. Net interest income was $8.1 billion -- or 8.1 percent-- higher than a year ago, and realized gains on securities and other assets improved by $7.3 billion, officials said.”

This was from the American Bankers Association release, “Newsbytes”.

But, the good news was not for all sectors of the banking industry. As I have been reporting in my posts, the largest twenty-five banks continue to prosper at the expense of the smaller banks. One must report that the “good news” presented above is for the industry as a whole. For the largest twenty-five banks, the news is “good”. For the other 7, 735 banks…the results are really “not-so-good”.

And this is why the worry is focused on the smaller banks.

We keep getting bits of news like that reported in the NYTimes this morning, “Large Banks Still Have a Financing Advantage” (http://www.nytimes.com/2010/11/24/business/24views.html?ref=todayspaper):

“What happened to ending ‘too big to fail?’ That was one objective of the financial overhaul bill, the Dodd-Frank Act, that was passed this year. Central to the legislation were rules intended to make big banks less exciting and safer. It also created an authority meant to smoothly wind down even the largest institutions without greatly disrupting the financial system.

Five months after the bill’s passage, big banks should have lost at least some of their financing advantage over smaller rivals. But as the latest quarterly report from the FDIC shows, too big to fail is still very much alive and well.”

The point being made is that the average “cost of funding earning assets” for commercial banks in excess of $10 billion (109 banks out of the 7,760 banks in the system) was 0.80 percent. The average cost of the 7,651 smaller banks was an average of 1.29 percent so that the bigger banks had a 49 basis point advantage over the smaller banks. (Note that the gap was 69 basis points a year ago.)

The average cost of funding earning assets was even lower for the largest 25 banks in the country!

It seems like everything the policy makers are doing is benefitting the largest banks in the country.

And, what is being done for the smaller banks…the other 7,735 banks?

The Federal Reserve is pumping plenty of liquidity into the banking system so that the FDIC can reduce the number of banks in the banking system as smoothly as possible. (See my post “The Real Reason for Fed Easing”: http://seekingalpha.com/article/237834-the-real-reason-for-fed-easing-debasement-inflation.)

In reducing the number of banks in the banking system we don’t want disruptions and we don’t want panic. If this is the goal of the Federal Reserve and the FDIC, then they are doing a good job. The bank closure situation has, so far, neither resulted in major disruptions to the financial system or the economy or panic over the state of the banking industry.

The dismantling of the former United States banking system is going quite smoothly, thank you.

The future United States banking system is going to look entirely different. What might that banking system look like? Try the Canadian banking system or the banking system in Great Britain…a few very large banks dominate these systems. Is that what the United States system is going to look like?