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 Loans Continue to Increase

The largest twenty-five domestically chartered commercial banks in the United States continue to increase lending to businesses (Commercial and Industrial Loans) over the latest four-week period according to the most recent Federal Reserve data.  Over the latest four-weeks ending November 2, large banks experienced a net increase in business loans by almost $11 billion.  Over the latest 13-week period, these loans have risen by almost $28 billion. 

From October 2010 to October 2011, the largest twenty-five banks have increased their portfolios of these business loans by a little more than $75 billion.

Still, one does not have a lot of confidence that these loans are going into areas that will contribute to the growth of the economy.  Larger companies are still accumulating “cash” to buy back stock or to make acquisitions.  Certainly the cost of borrowing is not a hindrance to these companies obtaining for these purposes these days. 

Commercial and Industrial loans have also increased in the rest of the banking system, but by a little more than one billion dollars over the last four weeks, and by just over $9 billion over the past 13 weeks.  It is not altogether clear what these loans are going for at the present time.  Given that this $9 billion increase is spread through about 6,400 banks, the rise in lending at each bank, on average, is not too great.

The interesting thing about the lending in the smaller 6,400 banks is that residential real estate loans have shown some increase over the past 13-week period.  Residential loans have risen by almost $25 billion over the past quarter, over $13 billion in the last four weeks alone.  The indication is that in some places in the United States, residential lending activity has been picking up.  We will have to watch this number closer in the upcoming weeks and months. 

The softest area in lending still remains the commercial real estate area and the weakness is predominantly in the small- to medium-sized banks.  These loans dropped by slightly less than $14 billion over the past 13-weeks, with more than half the decline at the smaller banks.  Over the past 4-weeks the declines in commercial real estate loans have all been outside the largest 25 banks in the country. 

All domestically chartered commercial banks in the United States reduced their holding of cash balance in the past 13-week period.  The largest 25 commercial banks lowered their balances by $185 billion. The other domestically chartered banks reduced their holdings by only $10 billion.  These decreases in cash balances came despite the fact that excess reserves in the banking system stayed relatively constant during this time period. 

In summary, the latest Federal Reserve statistics indicate that the banking system, as a whole, is becoming less conservative.  Business loans have been picking up for most of the last six months, especially at the largest 25 domestically chartered banks in the United States.  The question mark here, however, is the use that borrowers are putting these funds to.  It does not appear as if the loans are being used for productive purposes that would get the economy moving again. 

The commercial real estate area continues to stay week, especially at small- and medium-sized banks.  Here one still has questions about the quality of these loans on the balance sheets of the smaller banks and the implication of these difficulties for the future.   

One further note: Consumer borrowing at all commercial banks continues to remain weak.  Nothing seems to be happening in this area, which, again, has implications for future economic growth.  The consumer seems to be more interested in getting his/her debt under control than to really engage in more spending.  We will see what happens in this area as the holiday season approaches.

Closing note:  The largest 25 commercial banks in the United States, according to the Federal Reserve data, represented 57 percent of the assets in the banking system on November 2, 2011; foreign-related depository institutions represented 14 percent; and the other (roughly) 6,400 domestically chartered banks represented 29 percent.    

Post QE2 Federal Reserve Watch: Part 2

Excess reserves in the commercial banking system did not change much over the past quarter.  The two-week average for the banking week ending September 7, 2011 was $1, 569 billion.  At the start of August the total was $1,602 billion and at the start of June the total was $1,549 billion.  So roughly, excess reserves averaged around $1.6 billion over the past three months.

It’s kind of hard to appreciate the irony of saying excess reserves didn’t vary much over the past three months when in August 2008 the excess reserves in the whole banking system totaled only $2.0 billion. 

QE2 ended June 30.  So, we were not to expect the Federal Reserve to do too much to the banking system after this period of quantitative easing ended.  And, so far the Fed has done little or nothing.

This does not mean things were not happening in the commercial banking system. 

For example, the required reserves in the banking system rose by more than 20 percent from the banking week ending June 1 to the banking week ending September 7.  The rise was from about $76 billion to around $92 billion.  These are the reserves banks must legally keep on reserve to back up transaction and savings account balances.    

Most of the increase came in the last week of August and the first week in September when required reserves increased by more that $10 billion. 

The rise in required reserves came about due to a massive jump in the demand deposits held at commercial banks in August, which require the highest amount of reserves to be held by the banks! 

There also was a surge in savings deposits at commercial banks in August.  

The increases in demand deposits and savings deposits seemingly came about due to a large movement of funds from small savings accounts and institutional money funds. 

It was during this time that the Federal Reserve announced that it was going to keep short-term interest rates at very low levels for the next 24 months.  This announcement seems to have accelerated the movement out of short-term interest bearing assets to bank accounts…transaction accounts and savings accounts.  In a real sense the disintermediation continues. 

The point is that these movements on the part of wealth holders have influenced the money stock figures.  For example the year-over-year growth rate of the M1 money stock, the measure most affected by the shifts in money, the shifts toward demand deposits, has risen from about 12 percent at the end of May to just under 17 percent at the end of August. 

The M2 money stock measure has also risen but its growth rate remains under 50 percent of the growth rate of the M1 money stock.  Its rise has gone from about 5 percent to 8 percent over the same time frame. 

As I have pointed out for about two years now, the money stock measures appear to be growing because people are shifting out of short-term interest bearing assets because of the exceedingly low interest rates and are parking the funds in commercial banks in transaction balances and savings accounts. 

Some of this transfer is also occurring because people who are under-employed or having other financial difficulties want to keep their funds in accounts that can be accessed quickly to meet daily and weekly needs.      

The money stock growth is not occurring because the banking system in gearing up the lending machine and providing the loans needed for a more robust expansion of the economy.

I believe my interpretation of money stock growth is the correct one because this re-allocation of wealth balances from interest earning assets to transaction balances and other short-term bank assets has been taking place for two years or so and this movement has resulted in increasing growth rates for the money stock measures.  Yet, there has not been a real increase in bank lending during this time period and economic growth remains anemic with a stagnant labor market. 

Money stock growth is occurring but, one could say, for the wrong reasons.  The money stock measures are growing because people are protecting themselves and staying liquid while interest rates are so low.  This is not the behavior that drives the economy forward.  The money stock measures are not growing because of the monetary stimulus and this means that one cannot expect much economic growth from it.

The open market operations of the Federal Reserve have basically been operational over the past five weeks.  Federal Agency securities and Mortgage-backed securities continue to run off from the Fed’s portfolio and these run-offs have been replaced by US Treasury securities.  The off-set has been almost one-for-one, dollar-wise.

The interesting action on the Fed’s balance sheet has been a $34 billion increase in Reverse Repurchase Agreements with foreign official and international accounts.  Reverse repos take reserves out of the United States banking system.   In these cases, the Federal Reserve “sells” US Treasury securities under an agreement to buy them back at a later date. Over the past 14 weeks, reverse repos to foreign governments or their agencies rose by $43 billion.  One can only guess that these transactions have to do with the financial crisis that has been taking place in Europe.  More research needs to be done on this.

The net result of all this is that the Fed has done nothing overt since the end of second round of quantitative easing.  Economic activity continues to be stagnant and the under-employment situation does not improve.  Money stock measures continue to grow but for reasons not related to increases in bank lending and improving economic activity.  The question seems to be, where does the Federal Reserve go next?  Answers to this question are all over the board. 

Federal Reserve QE2 Watch: Part 6

The Federal Reserve continues to pursue its Quantitative Easing 2 exercise.  Over the four-week period ending May 4, 2011, the Federal Reserve purchased $84 billion of U. S. Treasury securities.  About $18 billion of the acquisitions went to offset mortgage-backed securities and Federal Agency issues running off.

Since September 1, 2010, the Fed has purchased $656 billion in Treasuries, with $208 billion to offset mortgage-backed and Agency issues maturing.

Mr. Bernanke indicated at the start that the Fed would increase its holdings of the Treasury securities by $600 billion outright and then purchase about $300 billion more Treasury issues to cover the run-off of Agencies and MBS securities. 

In recent weeks, Mr. Bernanke has stated that the Fed will continue QE2 through the end of June.  It seems as if they are right on target 

Reserve balances at the Federal Reserve totaled $1,473 billion on May 4, 2011 up from $1,019 billion on December 29, 2010 and $1,011 billion on September 1, 2010. 

Excess Reserves at commercial banks (from the Fed’s H.3 release) averaged $1,433 for the two weeks ending May 4, 2011 relatively close to the Reserve Balance total. In December 2010 excess reserves averaged $1,007 billion and in August 2010 excess reserves averaged $1,020 billion. 

Cash assets at commercial banks (from the Fed’s H.8 release) averaged about $1,565 billion for the month of April 2011 while the banks averaged $1,043 for the month of December 2010 and $1,185 for the month of August 2010.

Thus, for the commercial banking system, all measures of vault cash and bank deposits at the Federal Reserve and excess reserves are closing aligned. 

The basic result of QE2, therefore, is that the Fed has injected a little more than $450 billion in excess liquidity into the banking system since the beginning of September 2010, most of the injection coming since 2011 began. 

The net effect of this liquidity on the commercial banking system?

The volume of Loans and Leases on the books of commercial banks have declined by about $132 billion from the beginning of September 2010 through the end of April 2011, and have declined by about $78 billion from the beginning of 2011 to the present. 

The volume of Loans and Leases at commercial banks appeared to remain relatively constant throughout the month of April.

This trajectory seemed to be similar for both the largest 25 domestically chartered commercial banks in the United States and the rest of the domestically chartered commercial banks.

Of the cash assets at commercial banks in the United States, Foreign-Related Institutions held about 50 percent of the $1,565 billion cash assets in the banking system in April.  (For my comments on this see http://seekingalpha.com/article/265481-large-foreign-related-banks-now-hold-77.) 

So,

The Federal Reserve’s QE2 efforts have not stopped the decline in bank lending, and,

About one-half of the excess reserves the Fed has injected into the banking system have gone to foreign-related banking offices.

Good job!

Looking at the money stock measures, the growth in the M1 and M2 money stock continue to rise. 

The year-over-year rate of growth of the M2 measure of the money stock has risen from 3.5 percent in December 2010 to 4.6 percent in March 2011 and 5.1 percent in April.

The year-over-year rate of growth of the M1 measure of the money stock has risen from 8.4 percent in December 2010 to 10.4 percent in March 2011 and 16.6 percent in April. 

How is this growth happening if bank loans are decreasing?

Well, economic units are still getting out of assets that are earning very little interest and are not counted in the two measures of the money stock and placing the assets in accounts or cash that can be spent when needed which are included in these measures of the money stock.  In several previous posts I have taken this as a negative sign, a sign that people want to keep their assets ready for spending because they are without jobs or without sufficient income or see other assets being underwater.  They are keeping assets in transaction accounts so that they can spend the money when needed. 

This movement to assets the economic units can transact with is seen in the increase in the holdings of currency, which has gone from a year-over-year rate of expansion of 6.3 percent in December 2010 to 7.7 percent increase in March 2011 and an 8.2 percent rise in April.

The year-over-year rate of growth of demand deposits has risen from 15.7 percent in December 2010 to 20.9 percent in March to 21.8 percent in April. 

Non-M1 portions of the M2 money stock have hardly increased within this time frame.

So, the Federal Reserve continues to push on a string.  The commercial banks aren’t lending.  Economic units aren’t borrowing.  And these latter economic units continue to move their assets from longer-term, less liquid assets to shorter-term, transaction-type assets. 

The evidence here still indicates that the banking system is not fully engaged in economic recovery and the efforts of the Federal Reserve system have accomplished little more than spur on the “carry” trade in international financial and commodity markets.  And, it also indicates that consumers and small businesses, in aggregate, continue to keep their assets where they can spend them through a period when they cannot meet current spending needs with their incomes and cash flows being weak.    

The Small Banks Are Going Nowhere

Over the past six months or so the total assets of the smaller banks in the United States (smaller than the largest 25 banks) have remained relatively constant. Total assets averaged about $3.6 trillion in September 2010 and they averaged just below this number in March 2011.

And, given the Federal Reserve’s QE2 policy which has caused the cash assets of commercial banks in the United States to increase by almost $350 billion over this time period, the cash assets of these smaller banks remained roughly constant.

Over the past 13-week period, total assets at these smaller banks increased a modest $3 billion, but over the last 4-week span of time, total assets dropped by almost $10 billion.

Cash assets (over the past 13 weeks) rose by slightly more than $3 billion at a time when the total cash assets of the whole banking system were increasing by more than $480 billion.

The smaller commercial banking sector seems to be going nowhere.

What about credit extension amongst these banks?

Loans and leases at the smaller banks dropped by more than $8 billion over the last four weeks. The drop over the last thirteen weeks was slightly more than that.

And the largest 25 banks?

Total assets at the largest banks have increased by $60 billion over the past four weeks and by almost $90 billion over the last thirteen weeks. Most of the growth these largest institutions have come in cash assets. However, the increase in cash assets at the largest 25 banks in the United States has been small relative to the increase in the cash assets of foreign-related financial institutions in the United States. (See http://seekingalpha.com/article/262788-fed-s-monetary-policy-cannot-be-conducted-in-isolation.)

And, what about bank loans at these larger banks?

Since the end of 2010, loans and leases at commercial banks in the United States have declined by about $105 billion; and over the last four weeks of the first quarter, loans and leases at large commercial banks have declined by about $11 billion.

Business loans have rallied some over the last thirteen weeks, up a little more than $12 billion, but $10 billion of this increase has come in the last 4-week period.

Real estate loans have plummeted at commercial banks both over the last four weeks and the last thirteen weeks. The declines have come in both residential and commercial real estate loans.

And, what asset class, other than cash assets, has increased the most at the larger financial institutions? The securities portfolio.

So, the update on the banking industry as of the end of the first quarter of 2011?

The smaller banks, as a whole, continue to be in a holding pattern. And, QE2 seems to be doing little or nothing for these institutions. The cash reserves the Fed is pumping into the banking system is going to either the foreign-related financial institutions in the United States or the largest 25 commercial banks in the United States.

The smaller banks are not increasing their loan portfolios.

For the larger banks, QE2 is having some impact as cash reserves at the largest banks are increasing and the securities portfolios of these institutions are also increasing.

However, loans, as a whole, are not increasing…although there seems to have been a little pickup in the area of business loans.

Overall, one sees very little evidence that the Fed’s QE2 is having any impact on bank lending which, of course, does not provide much evidence that economic growth is going to begin accelerating in the near future.

Not very encouraging.

Still No Life in Banking

Over the last two months I have been hoping that the smaller banks in the United States were starting to lend a little bit again. I was even looking for “Green Shoots”. (See http://seekingalpha.com/article/220685-green-shoots-in-smaller-bank-lending.)

My latest review of the commercial banking data released by the Federal Reserve gives little indication that things are picking up through August. Total assets at the smaller domestically chartered banks in the United States (defined as all domestically chartered commercial banks except the largest 25) grew by a little over $11 billion in the last five weeks. However, the cash assets of these banks rose by slightly more than $8 billion of this total. Only about $1 billion went into bank loans.

The total assets at the 25 largest domestically chartered commercial banks fell by about $26 billion during this time period, but the cash assets held by these banks dropped by even more. Cash assets fell by about $41 billion. What asset class rose? The securities held by these banks rose by almost $23 billion.

At these large banks, Treasury and Agency securities increased by about $210 billion over the last year. These banks can acquire funds at interest rates approaching zero percent and purchase securities with no credit risk and earn several hundred basis points spread on the transaction. And, there is little or no interest rate risk because the Federal Reserve has stated that it will keep short term interest rates extremely low for “an extended time.”

One can see this arbitrage situation setting up over the last year as these large commercial banks have changed the way they have financed their assets relying on less expensive sources of funds and substituting cheaper and cheaper liabilities.

No wonder the large commercial banks have been producing a lot of profits while at the same time building up their loan loss reserves!

Why should commercial banks lend when they have a riskless way to make money?

Business loans? Commercial and Industrial loans are down by more than 12% at all banks, from August 2009 through August 2010. At large commercial banks, however, C&I loans are down by even more, dropping at a 14%, year-over-year rate. In just the last 13 weeks, these loans are down by almost $12 billion which is about one-tenth of all the business loan portfolio in the banking system.

Commercial real estate loans are down by more than $140 billion. Of this drop more than half of the decline was registered at the smaller commercial banks. Of course, this is where people are expecting a lot more trouble over the next twelve months or so.

Surveys have indicated that banks are easing up on lending terms. Well, that may be true, but this is still not resulting in any jump in commercial bank lending.

We are told that businesses and consumers are reluctant to borrow. I believe that this is true. There are two reasons for this. First, many businesses, families, and individuals are still reducing the debt load they had built up over the last decade or more. With the economy so weak, it still represents a substantial risk to go further in debt given the uncertainty about future prospects.

In addition, many of the companies that are better off are accumulating large amounts of cash balances. The play here, I feel, is that mergers and acquisitions will pick up over the next year or so. Analysts are still shaking their heads about all the activity that took place on this front in August. My guess is that companies believe that they can achieve better market share and even have a chance to gain sustainable competitive advantages in their markets by building scale through acquisition of financially “weak” companies as opposed to attempting to expand on their own at this time. Keep the cash so that you can move as quickly as possible when the time is right.

Bottom line: it seems as if very few banks want to extend money to businesses at this time; and very few institutions (except for the federal government) want to put on a lot more debt at this time.

There will be no recovery of any strength without a pickup in commercial bank lending. I have written about this earlier: http://seekingalpha.com/article/218027-no-banks-no-recovery. This is one reason why I am skeptical of the spending and tax-cutting proposals presented by President Obama last week. The economy is in a position where debt positions, both in the financial and non-financial industries have to be worked out and this will take time.

I continue to believe that the Federal Reserve will continue to keep short term interest rates at or near their very low current levels until the commercial banking industry stabilizes. The Fed and the FDIC are doing a good job in helping the smaller banks work through their problems. Still, there are a sizeable number of the smaller banks that are still in serious trouble and asset values are still the problem. As mentioned above, there are anticipated difficulties ahead in the commercial real estate area and some investment portfolios are still substantially under-water.

With all these difficulties, why should these smaller banks, in aggregate be expanding their loan portfolios? The main thrust in the commercial banking sector over the next twelve to eighteen months is still survival and consolidation.

My prediction still remains: over the next five years or so the largest 25 domestically chartered banks in the United States will come to control about 75% of banking assets in America, up from about 67% at the present time.

Federal Reserve Exit Watch: Part 13

In the summer of 2009, a great deal of concern was expressed about the Federal Reserve and the excessive amounts of Reserve Bank credit that had been pumped into the banking system. The Federal Reserve stated that it had an “exit” plan to withdraw these reserves from the banking system so as not to create an inflationary or hyper-inflationary environment once the economic recovery began to pick up speed.

Here we are 13 months into the “exit watch” and there has been “no exit” of reserves from the banking system. In fact, Reserve Bank credit is now $331 billion GREATER than it was one year ago; it has grown over the past 365 days by 16.7%, as of August 4, 2010.
The stated reason for this “no exit” performance: the economy has remained stagnant and as long as the economy stays very weak the Federal Reserve will keep its low target interest rates which means that the target Federal Funds rate will remain close to zero for an “extended period”.

As I have reported in my blog posts, my belief is that the Federal Reserve is excessively concerned about the solvency difficulties being experienced by the small banks in this county, a concern that I have recently summarized in my post of August 2, titled “No Banks, No Recovery,” http://seekingalpha.com/article/218027-no-banks-no-recovery. There are many small banks experiencing extreme problems and the Federal Reserve is not going to begin withdrawing reserves from the banking system until there is some indication that this solvency problem is over.

Commercial bank Reserve Balances with Federal Reserve Banks has risen by $334 billion over the past year, an increase of 46.6% since August 5, 2009. Note that Excess Reserves at depository institutions rose from a monthly average of $750 billion in June 2009 to $1,035 billion in June 2010, an increase of 38%.

This is a strange “exit.”

And, as the Federal Reserve has pumped these additional reserves into the banking system, the total assets of the commercial banks in the United States fell by 1.7% from almost $12.0 trillion to about $11.8 trillion from June 2009 through June 2010. Loans and leases at these commercial banks declined by 2.6%. Banks got out of a substantial amount of business loans during this time period, as commercial and industrial loans fell by 16.7%, June-over-June, and commercial real estate loans declined by 7.8%, year-over-year.

The reserves the Fed is pumping into the banking system are not going into “pumping up” the economy. The reserves the Fed is pumping into the banking system are just going into excess reserves!

Looking at a shorter period of time, over the past 13 weeks, the last quarter, Reserve balances with Federal Reserve banks rose by $8.0 billion. The primary swings in the Fed’s balance sheet over this time period were operational in nature. There was a $26 billion decrease in the General Account of the U. S. Treasury, a seasonal increase in currency in circulation of about $9 billion and a $7 billion rise in Foreign Reverse Repos. The offsetting transactions of the Fed to neutralize these changes was an increase in Securities Held Outright by the Fed of about $12 billion, the primary increase coming in the Fed’s purchase of Mortgage-backed securities.

In the past 4 weeks, the U. S. Treasury balance reversed itself, increasing by almost $28 billion and there were modest declines in currency in circulation and Foreign Reverse Repos. The Fed offset a portion of these by letting it holdings of Federal Agencies decline by a little more than $5 billion. The net effect of these operating transactions was a $19 billion decline in Reserve balances held at Federal Reserve banks.

Thus, over the past 4 weeks and over the past 13 weeks, Reserve Bank Credit barely changed. Both periods were dominated by operating transactions within the banking system offset by Federal Reserve balancing transactions.

As a consequence, excess reserves in the banking system stayed relatively constant over the last quarter of the year.

Loans and leases at commercial banks continued to decline over the last 4-week and 13 week periods as did commercial and industrial loans and commercial real estate loans.

In summary, the Exit Watch in the thirteenth month of its existence can report little or no action on the exit front over the past month or the past three months. “Exit” is still on hold until either the general condition of the small banks improves or the economic recovery really becomes an economic recovery…or both.

The Current Performance of Commercial Banks

Commercial bank profits are OK. Commercial bank lending is practically nil.

The prognosis for the future?

If commercial bank lending does not pick up, commercial bank profits will fall.

When will commercial bank lending pick up?

Good question, but the answer is not an easy one. Also, to get an answer, it seems as if we need to go to both sides of the desk: to those that are demanding loans and to those that are supplying loans.

There seems to be four factors that are keeping loan demand from growing. First, of course, is that a lot of people and companies are still trying to climb out of the economic hole in which they have found themselves over the past three years. We still have foreclosures and bankruptcies continuing at a very rapid pace even though below record levels. We still have massive amounts of unemployment as well as underemployment. And, we still have large numbers of the American families and businesses with extremely poor credit records.

Second, there is a great amount of uncertainty about the future of business. And, confidence is not built when the Chairman of the Board of Governors of the Federal Reserve System announces before Congress…and the whole world… that the business outlook is “unusually uncertain.” If Mr. Bernanke believes this to be true, what are the people “in the trenches” expected to believe?

Third, there are a large number of companies, mostly big companies, that are sitting on a large amount of cash. These companies are not ready to commit at the present time, but they are poised to put these funds into play, either in an expansion off-shore, or in purchasing other companies. These big companies have been profitable, much like the big banks, but they are not yet ready to put these funds to a business use. As far as wanting bank loans, that will depend upon the strategies these companies want to pursue and the cheapest way to finance them.

Fourth, consumers that have the income flow or wealth continue to pay down their debt in an effort to re-balance their balance sheets. At a time like this with all the evidence around that too much financial leverage is not “the place to be”, individuals and families are not seeking credit and are even reducing the amount of credit that they do have outstanding.

From the demand side we see the reality that the people that have the income and the cash assets are not real anxious to borrow and the only ones that really want to borrow have neither the cash flow nor the cash assets to get a loan.

This gets us to the supply side. Commercial banks, in recent months, across the board, say that they have not changed their credit standards. I take them at their word. Yet, if one compares current bank lending standards with those that were in place one, two, or three years ago, the bar is set much higher than it was. This tightening of standards was to be expected as credit standards are always raised during an economic down turn. They were raised to current levels due to the severity of the 2008-2009 financial crises and to the pressures that were brought on the banks by the regulatory agencies. Although these standards will not get tougher, they will not be eased appreciably any time soon.

The commercial banks are also hit by the uncertainty of the current economic situation and by the coming imposition of new financial reform legislation. In terms of the economic situation, loan officers have to be skeptical of business projections of future cash flows. Since the economic outlook is “unusually uncertain” banks have to be extremely careful about basing the extension of money to a borrower upon “optimistic” forecasts. Even “prudent” forecasts are suspicious because of the uncertain nature of the business environment right now.

Plus, bankers, in general, and lending officers, in particular, are “debt guys”. (Please excuse the gender specificity here, “guys” refers to all bankers and lending personnel.) “Debt guys” are taught that forecasting just on cash flows is a tricky business and so it is wise, extremely wise, to require a borrower to put up collateral behind the loan. And, if cash flows projections become even more uncertain than in the past, more collateral should be required.

But, in a very uncertain economic environment, another problem rises to the surface. This problem has to do with the “value” of the collateral. In a very uncertain economic climate and uncertain secondary markets, how can you get a good estimate of what the value of “physical” capital might be? Hence, commercial banks extend their requirements for the collateral backing of loans, now requiring financial instruments, bank deposits like CDs, compensating balances, or other cash demands. Banks are getting back to the “good old days” when to qualify for a loan, a potential borrower had to prove to the bank that they did not need the loan in order for the bank to extend the money to them.

There is another uncertainty now in play. The passage of the financial regulation reform bill introduces more unknowns into the banks’ decision making. Just the concern over higher capital requirements causes the commercial banks to become more conservative in their lending practices. Furthermore, it is unclear how other rules and regulations, some of them not even written yet (the regulators have several months to write up some of the new provisions), will affect bank policies and procedures. How can commercial banks be aggressive in their lending practices it they don’t know what the “playing field” is going to look like in the future?

Finally, there are still many commercial banks that have solvency problems. As I continually quote, about one in eight commercial banks is on the list of problem banks put out by the FDIC. This list was as of March 31, 2010. Soon there will be a new list out relating to June 30, 2010. It is anticipated that the number of commercial banks on this new problem list will be greater than was the case at the earlier date.

My estimate that another two or three commercial banks out of eight still have problems pertaining to capital requirements, or, pertaining to major credit problems in the areas of consumer or commercial real estate loans. To me, this latter problem is one of the major reasons why the Federal Reserve is keeping short-term interest rates so low and will continue to do so, as Bernanke reiterated in his testimony yesterday, for “an extended period”. Market estimates for when the Federal Reserve might increase its target rate of interest now go until at least the third quarter of 2011. This says to me that there are still many, many problems in the commercial banking industry and these problems are not going to be resolved for “an extended period.”

This situation can only result in a large consolidation in the commercial banking industry in this country. Right now there are about 8,000 domestically chartered commercial banks in the United States. I remember when this number was 14,000 and this did not include an extensive Savings and Loan industry. One could see a drop by one-half or more in the number of banks in the country. And, this doesn’t even take into account the effects information technology is going to have on the banking industry in the next five to ten years.

This does not bode well for the supply of bank loans. With the changing financial regulations, the uncertain economic environment, and the changing structure of the banking industry itself, commercial banks are going to concentrate on “high quality” loans. And, if the big banks cannot find them in existing markets they will invade the local or regional markets of other banks. In fact, many banks are now talking about how the big banks are becoming more aggressive in their markets. This will not result in an increase in loan supply, but it will contribute to the consolidation in the commercial banking industry.

In short, there doesn’t seem to be much reason to expect a pickup in bank loan volume in the near future.

"Grasping At Straws" in the Banking Data

The commercial banking industry was still contracting through June. Year-over-year, that is from June 2009 to June 2010, total assets in the United States banking sector dropped by a little more than 1.5%, with the assets of large, domestically chartered banks dropping by 3.0% during this time period. The total assets at small, domestically chartered banks rose by slightly more than 1.0%.

Year-over-year, the loans and leases at commercial banks within the United States dropped by 2.5%. The drop at large, domestically chartered banks was 0.2%, at small, domestically chartered banks was about 3.0%, and at foreign-related institutions the drop was 16.0%.

An interesting pattern is showing up in the data, however, and gives us something to look for going forward. The smaller, domestically chartered banks in the United States increased their loan balances a little bit over the four-week period ending in the week of July 7, 2010.

The Federal Reserve System has defined large commercial banks as the largest twenty-five domestically chartered banks in the United States. These banks control about one-third of the banking assets in America, a total of about $6.9 trillion. Small banks are all of the rest of the domestically charted banks in the country and they number slightly more than 8,000 banks.

Over the past four weeks, all loans and leases at the smaller banks rose by almost $3.0 billion. This is the first time in the past 18 months or so that the small banks have posted an increase in total loans and leases. The increase was not large…but, we are looking for any “green shoots” that we can find.

The increase was not “across the board” but Commercial and Industrial (C&I) loans, business loans, rose by slightly more than $2.0 billion and Consumer loans rose by a little more than $6.5 billion. Real Estate loans dropped by $5.5 billion, mostly in the commercial real estate area. It should be noted that both C&I loans and Consumer loans rose for the last 13-week period, although most of the increase came in the last four weeks. For this latter period, Real Estate loans dropped by more than $21.0 billion, again in the commercial area.

We continue to hear that these smaller banks still have lots of problem commercial real estate loans to deal with and may remain reluctant to lend in this area for an extended period of time.

Remember, it is in the smaller banks that most of the problems still exist relating to bank solvency. At the end of March, there were 775 banks on the problem bank list of the FDIC, implying that roughly one out of every eight of these smaller banks were “problems.” Through July 16, the FDIC had closed 91 banks this year, roughly 3.4 banks each and every week. This pace is expected to continue for at least the next 12 months. Later this month the FDIC will release the list of problem banks it has identified as of June 30, 2010. The expectation is that the number of banks on the list will increase above 775!

At the larger commercial, the largest 25 in the country, Loans and Leases continued to decline. In the last 4-week period these large banks experienced a drop of over $16.0 billion in that line item. For the last 13-week period the drop was in excess of $81.0 billion. Declines in the last 13-week period came in all lending areas as C&I loans fell by about $22.0 billion, Real Estate Loans declined by more than $26.0 billion and Consumer Loans dropped by approximately $31.0 billion.

Declines took place in all loan categories at the large commercial banks over the past four weeks, but the drops were not anywhere near as deep as in the previous two months.

Cash assets at the domestically chartered banks finally seem to be falling. Over the past four weeks, cash at large banks dropped by $35.0 billion while the smaller banks saw cash balances decline by a little more than $11.0 billion. Over the past thirteen weeks, cash assets at the larger banks fell by $61.0 billion while they only fell by $6.0 billion at the smaller banks.

This decline in cash assets is consistent with the drop in excess reserves in the banking system over the past several months. (See http://seekingalpha.com/article/214058-federal-reserve-exit-watch-part-12.)

There was an interesting bump in cash assets at foreign-related institutions during this time period. In the past 4-week period, cash asset at foreign-related institutions rose by $16.0 billion; and they rose by $25.0 in the last 13-week period.

Could this jump have anything to do with the “stress tests” being administered to major European commercial banks?

I don’t remember ever having seen an increase like this in foreign-related banks in such a narrow time span.

Business loans at these foreign-related institutions dropped over the past 4-week and 13-week periods while “other” very short-term lending, which could include loans to banking offices not in the United States, experienced a substantial rise.

Could these movements have anything to do with “window-dressing” for the European “stress tests”?

The summary for this month’s review of the state of the banking industry is much the same as in previous months. The two things to keep a watch on are, first, the small increases in business and consumer lending at the small, domestically chartered banks; and second, the drop in cash assets being held in aggregate by all domestically chartered banks in the United States.

The first piece of information raises hopes that the smaller banks are beginning to lend again to businesses, although not on commercial real estate deals, and consumers, again not on real estate. In terms of the latter, the hopes for a recovery in mortgage lending do not seem very promising as some analysts in the real estate industry predict that foreclosures for the year could approach 1.0 million homes. Some analysts are even saying that banks are not foreclosing as rapidly as they could so as to avoid the housing market being too jammed up with foreclosed houses. That is, the banks are “pacing the foreclosures” so that homes can be sold faster. This does not bode well for the future.

The second piece of information raises hopes that commercial banks are feeling more confident about the future and are, therefore, reducing the amount of cash (excess reserves) they hold on their balance sheets. Not only did lending at the smaller banks increase their lending over the last four weeks, the larger banks only experienced modest declines in their loans outstanding.

Many economists have declared that the recession ended in July 2009. So, the economic recovery has been going on for almost twelve months. The major problem with this claim is that the commercial banking system has not been acting like the recession is over. This has also been reflected in the balance sheet of the Federal Reserve System and in the performance of the monetary aggregates. (See my post referenced above for a discussion on these points.)
Thus, we are scratching around trying to find positive signs in the banking statistics. With this report we are grasping at straws. But, we have not even had tiny straws

Federal Reserve Exit Strategy: Part 10

In the last “Exit Strategy” post (http://seekingalpha.com/article/196931-federal-reserve-exit-watch-part-9) I stated that the Fed balance sheet was getting boring. Over the last four weeks the Fed’s actions continue to be boring.

In the current circumstances, boring is good when it is connected with the non-existent loan growth in the banking sector.

The major change in the Fed’s balance sheet over the last four weeks in terms of factors that supply bank reserves was an increase of almost $28 billion in mortgage-backed securities.
I know, the Fed said it wasn’t going to buy anymore mortgage-backed securities after March 31…but it did. Who can you trust anymore?

The changes in all other factors supplying reserves to the banking system were basically a wash.

However, there was some interesting movement on the other side of the statement. Of course, April is tax time and so the Treasury cash management activities impact the reserves in the banking system. And, we did see U. S. Government demand deposits at commercial banks build up through the month of April, averaging a little less than $8 billion in the banking week ending April 19. (Through most of the year these balances will average in the $1.2 to $1.8 billion range.)

The government lets these deposits build up at commercial banks during tax time so that reserves are not drained from the banking system. They will only be drawn down as the Treasury pays out of its General Account at the Fed which puts reserves back into the banking system. Usually, during tax time the General Account is allowed to decline.

But, there was something else going on at this time. The Federal Reserve, together with the Treasury Department, is using another government account at the Fed, the Supplementary Financing Account, to drain reserves from the banking system.

For more on this see my April 19 post, “The Fed’s New Exit Strategy” (http://seekingalpha.com/article/199444-the-fed-s-new-exit-strategy).

Since the new federal debt limit was passed in February 2010 the Treasury has been increasing the balance in the Supplementary Financing Account. As a consequence, it is difficult to tell exactly how the Treasury is managing its tax receipts and the bond receipts that are finding their way into this supplementary account. On April 28, 2010, the balance in this account was just under $200 billion, the amount the Treasury indicated it would keep there.

In the last four banking weeks, this account has increased by $75 billion while the Treasury’s General Account has declined by almost $35 billion. Hence, roughly $40 billion in bank reserves were absorbed using this method during this time period.

This is interesting because excess reserves in the banking system reached all time highs in February 2010 and stayed relatively high in March. They have declined since then by about $50 billion.

The reason for the increase in excess reserves in the February period was the Fed’s purchase of
mortgage-backed securities. Over the past thirteen weeks, the holdings of mortgage-backed securities rose by almost $127 billion. In January and February, the reserves created by these purchases went into excess reserves in the banking system.

The excess reserves only began to be drawn down as the Treasury Department started to increase the funds it held in its Supplementary Financing Account after the debt limit was increased by Congress in late February. After that the Treasury increased this account by $25 billion per week until it reached the $200 billion level. Therefore, excess reserves in the banking system dropped during this time period.

Since the Treasury maintained a minimum of $5 billion in this account until the debt limit was raised, the Supplementary Financing Account rose by $195 billion over the past thirteen weeks. The Treasury’s General Account rose by $70 billion during this time so that the net affect was an $120 billion absorption of bank reserves which roughly offset the Fed’s purchase of mortgage-backed securities. As a consequence, excess reserves in the banking system on April 28, 2010 were roughly the same as they were at the end of January.

So, excess reserves in the banking system backed off from the all time highs that were reached during the first quarter. A new tool, the U. S. Treasury Supplementary Financing Account, was used to bring the banking system off of this peak. Now where do we go?

Well, another Fed tool was introduced last Friday, the “Term Deposit Facility” or TDF. (See the press release: http://www.federalreserve.gov/newsevents/press/monetary/20100430a.htm.) Under this facility the Fed would offer deposits with maturities of up to six months to member banks. Presumably deposits in the TDF would receive market rates of interest for the idea is that these deposits would be a positive alternative to commercial banks lending out their excess reserves to businesses and consumers. And, it would be risk free.

The Fed has lots of room to provide competitive interest rates because it earns interest on the securities that it has purchased outright and pays little or no interest on most of the funds it has on deposit. The evidence is the large amount of “excess returns” that the Fed gives back to the Treasury every year. This is the benefit of being able to “print money”.

This facility is intended to “tie up” some of the excess reserves the Fed has put into the banking system so as to prevent the banks from extending credit too rapidly thereby increasing money stock growth and threatening excessive inflation in the future.

This is just one more tool that the Fed has created to help it through the “Great Undoing.” Another tool the Fed said it would rely on is “Reverse Repurchase Agreements.” Of course, there is still the old reliable tool, outright sales of securities. The Fed hopes to use these in coordination with each other in order to not only drain excess reserves from the banking system but, in other ways to tie up the excess reserves so that they will not be used in bank lending. This is not a problem right now but could be in the future.

The Fed has indicated that it is continuing the target Federal Funds rate stance it has followed since December 2008. And, because of the weak economy and the weak banking system it is planning to continue this policy for “an extended period” into the future.

The Fed remains in a precarious position since it is still trying to balance itself between a weak economy and banking system and the fear that the economy will begin to strengthen and bank lending will explode using all of the excess reserves that it has available to it. All we can do is sit back and watch what the Fed is doing and hope that things will remain quiet and boring.

The Chances for a Double Dip

I believe that the probability that we will have a double dip in the economy, a second recession following on the Great Recession, is relatively small and growing smaller all of the time.

The reason that I would give for this is that economies only change directions when there is some kind of shock to expectations. To use the words of one famous pundit with respect to an uncertain future, we just don’t know when something will change with respect to an “unknown” unknown. Even in the cases of “known” unknowns, we know where a change might occur; we just don’t know the magnitude of the change.

A liquidity crisis occurs when something happens in a market, generally a financial market, and the buyers on the demand side of the market decide it is best if they just go out and play a round of golf until the market settles and they know where prices will stabilize. The job of the central bank is to provide liquidity to the market so as to achieve this stabilization of prices. The length of a liquidity crisis is usually no more than four weeks.

A credit crisis occurs when something happens in a market, generally a financial market, and the holders of assets must significantly write down the value of their assets. Banks and other financial organizations may go out of business during the credit crisis because they don’t have sufficient capital to cover all the write downs that must take place. The job of the central bank is to provide stability to the financial markets so that the financial institutions can take their charge-offs in an orderly fashion so as not to cause multiple bank failures. The length of a credit crisis can extend for several years as the financial institutions work off their problem loans and those organizations that have to close their doors do so with the least disruption to “business-as-usual.”

In both cases, something unexpected happens and expectations about asset prices have to be adjusted. Extreme danger exists as long as bankers and investors persist is retaining the old expectations about prices and fail to make the moves necessary to adjust their thinking to a more realistic assessment of the situation. However, as these bankers and investors adjust to the “new reality”, they become more conservative and risk-averse in their decision making and work hard to get asset prices into line with the new financial and economic environment they have to deal with.

As the adjustment to the “new reality” takes place, things remain precarious, but, as long as no new surprises come along, the process of re-structuring can continue to lessen the problem and even strengthen the recovery. This is the state in which the United States is in right now.

The thing that needs to be avoided is a “new surprise”. What this can be of course is “unknown”…an “unknown” unknown.

In the 1937-1938 depression, there was an “unknown” unknown in the form of a policy change at the Federal Reserve System that is credited with “shocking” the financial and economic system into the second depression of the 1930s. The shock here was an increase in the reserves the banking system was required to hold behind deposits in banks, an increase in reserve requirements. The argument given for the increase was that there were a lot of excess reserves in the banking system and for the Federal Reserve to be effective at all during the time, the excess reserves had to be removed: hence the increase in reserve requirements.

The problem was that the banks wanted the excess reserves and with the increase in reserve requirements the banks became even more conservative causing another massive decrease in the money stock. This, of course, has been given as a reason for the “double-dip” that took place in the 1930s.

There are, as is well known, a lot of excess reserves in the banking system at the present time, almost $1.2 trillion in excess reserves. The Federal Reserve knows that they are going to have to remove these reserves from the banking system at some time. Hence, it has developed an “exit” strategy.

Banks and investors know that the Federal Reserve is going to have to remove these reserves from the banking system at some time. How the Fed is going to accomplish its “undoing” is, of course, the big unknown!

The fact that these reserves are going to be removed from the banking system is a “known” unknown!

But, how and when the reduction in reserves is going to take place, not even the Fed knows. Bernanke and the Fed have worked hard to keep the banking system and the financial markets aware of the “undoing” so that although there are still many unknowns connected with this undoing, the fact that the “undoing” is going to be done is a “known.”

The effort here is to avoid a policy “shock” coming from the central bank as in the 1937-1938 experience.

There are a lot of things going on in other sectors of the economy and the world, but these all seem to fit into the category of “known” unknowns: like the problems in Greece and the other PIIGS, Portugal, Italy, Ireland, and Spain. There are the problems of states, California, New York, New Jersey, and so on, and municipalities, like Philadelphia and others, but these are also “known”.

There are over 700 commercial banks on the problem list of the FDIC. But these are “known” and are being worked off in an orderly and professional way that seems to be the model of the world. (See the article by Gillian Tett, “Practising the last rites for dying banks,” http://www.ft.com/cms/s/0/00b740a2-350e-11df-9cfb-00144feabdc0.html.) The FDIC closed seven banks last Friday bringing the total for the year to 33. This is right on my projection of closing at least 3 banks a week for the next 12 to 18 months.

And, what about the United States deficit? Well, I would contend that this is a “known” unknown as well. The deficits over the next ten years or so are projected to be in the range of $9-$10 trillion. I believe that they will be more around $15-$18 trillion, but that is just a minor difference. But, the deficits are “on-the-table” even if the amounts are not quite certain. The deficits will be large and this will be a problem, but they are not going to be a surprise.

This is one reason, I believe, why the Obama administration made the effort they did to talk about the budget deficits publically, particularly with regards to the health care initiative. They are talking about the budget, whether one agrees with their projections or not.

And, just the passage of the health care legislation, I believe, will change the temper of things. This thing has been done and I think just this fact will change the environment…for the better.

There are always “unknown” unknowns lurking. There could be a blow up in the Middle East leading to a full-scale war…or in the east. There could be a political move to boost the price of oil. There could be a lot of things. But, as far as the economy itself and the financial markets: I believe that things are being worked out and things will continue to improve. Thus, the probability of a Double Dip has lessened.

The Federal Reserve and the Smaller Banks

The Open Market Committee of the Federal Reserve System meets today. No one is expecting that there will be any change to the Fed’s target Federal Funds rate. The reason given is that the economy still remains exceedingly weak with the unemployment rate remaining just below 10 percent and the inflation rate as measured by the consumer price index less food and energy, the Fed’s preferred price measure, hovering between a one percent and a 1 ½ percent, year-over-year rate of increase. This latter fact combined with the information that there is a lot of unused capacity in United States manufacturing is believed to be the primary argument for keeping the target interest rate at such a low level.

I, too, believe that the Open Market Committee will not change the target rate of interest at this time, but I still believe that the Federal Reserve is still very troubled about the condition of small- and medium-sized banks. To repeat the statistics again, the FDIC has more than 700 banks on its problem list with the expectation that over the next 12 to 18 months there will be three to four banks closed, on average, every week. The small- to medium-sized banks in this country do not appear to be in very good shape.

To raise rates at this time and remove reserves from the banking system could make the situation amongst the small- to medium-sized banks much more difficult. Yes, according to Federal Reserve statistics, small domestically chartered commercial banks in the United States make up only about 34% of the banking assets of domestically chartered banks in the United States as of the first week of March 2010. (The largest 25 domestically chartered banks therefore makeup about two-thirds of the assets of domestically chartered banks in the country.) Therefore, about 8,000 banks in the United States hold only one-third of the bank assets in the country. Perhaps this is not sufficient to worry too much about.

However, one could argue that another reason, perhaps the main reason, that the Fed does not want to raise its interest target is the shaky shape of this portion of the banking system.

The smaller banks in the country hold about $320 billion or about 9% of their assets in cash assets in the first week of March. This is up from 6% one year ago!

Furthermore, these banks hold about 12% of their assets in Treasury and Agency securities with another 7% of assets held in other securities. (This total of 19% is up from around 17% one year ago.)

Thus, these banks hold almost 28% of their assets in cash or marketable securities. This is up from about 23% at the same time in 2009.

One keeps looking for “green shoots” amongst these smaller banks. The bigger banks are going to make it now and do not present much of a worry to the Feds. In fact, the bigger banks are raking in the profits, one way or another.

The problem is, that I don’t see much happening in the smaller banks. The total assets of the bank are about the same as one year ago, but as the above figures show these banks have gone 100% risk-averse. It seems as if they are just holding on, hoping to survive the worst.

Total loans and leases at these banks are down a little more than 6% year-over-year. However, these totals are down almost $88 billion over the past 13 weeks, a drop of almost 4% in about three months.

Commercial and Industrial loans are down around 9%, year-over-year, although they have only dropped about $6 in the 13-week period ending March 3. Business loans are down severely and show no sign of picking up. This has got to have an impact on Main Street because the businesses that deal with these banks have few alternative sources of funds.

Another major area of concern to the small- to medium-sized banks is their portfolio of commercial real estate loans. These loans are down by more than 5% year-over-year and down almost $40 billion over the last 13-week period.

This is an area of major concern to these smaller banks and are expected to be the source of extended troubles to the banks over the next 18- to 24-months. This is the area over which Elizabeth Warren, the head of oversight for Congress of the TARP funds, has expressed extreme anxiety.

The fear that one has in this area is that the loan problems of these small- and medium-sized banks have not really been fully worked out. As such, these banks are behaving in a very conservative fashion for a reason. They are building up cash assets and liquid assets in order to provide protection for themselves to weather potential loan charge offs over the next year or so. If interest rates begin to rise and the Fed begins to withdraw reserves from the banking system, these banking organizations could be forced to charge off many of these loans and this could cause severe damage to their capital positions. It is my belief that the Federal Reserve is cognizant of this situation.

Overall, the Federal Reserve is keeping excess reserves in the banking system at record levels. In the two weeks ending March 10, 2010, excess reserves in the banking system average roughly $1.2 trillion.

The banking system as a whole is recording about $1.3 trillion in cash assets in the banking week ending March 3. This is divided up between Large Domestically Chartered banks about $570 billion, Small Domestically Chartered banks about $320 billion, and Foreign-Related institutions about $460 billion. (What is perhaps interesting is this latter figure which was about $230 billion one year ago. Just what is going on with these foreign-related institutions?)

The loan portfolios of the large banks continue to contract as well. Total loans and leases are down about 7% year-over-year, and have dropped $85 billion over the last 13-week period. The two biggest declines registered come in Commercial and Industrial Loans, $31 billion, and Residential loans, also around $31 billion. There does not seem to be much activity in the Commercial Real Estate portfolio, contrary to what seems to be happening in the small- to medium-sized banks.

The conclusion?

No “green shoots” but lots of problems remaining in the smaller banks!

Surveys coming out from the Federal Reserve indicate that fewer banks are tightening up their lending standards. This is promoted as a good sign. Other indicators in housing construction, foreclosures, and bankruptcies are seen as pointing to a turnaround in the banking system.

I don’t see it yet. And, I don’t think that the Federal Reserve really sees it yet.

The banking system must begin lending again if we are to have an economic recovery and job growth. Many companies seem to be tapping the capital markets as debt issues climb. However, these are not Main Street businesses. And, history teaches us, the banking system must be there to underwrite any expansion of business activity because for many, Main Street is the only place they can raise funds.