Developments in the Banking Sector: Large Amounts of Funds Still Going to Foreign Institutions

There seem to be three major stories in commercial banking these days: first, the cash going to foreign-related institutions; second, the pickup in non-real estate business lending; and three, the continued weakness in consumer borrowing.

Excess reserves at depository institutions in the United States averaged $1,509 billion in the two weeks ending January 25, 2012.  Cash assets at commercial banks in the United States were $1,597 billion in the week ending January 25, 2012.

In December 2010, excess reserves were $1,007 billion and cash assets $1,082 billion. 

Both excess reserves and cash assets rose by about 50 percent during this time period.

In recent years excess reserves at depository institutions and cash assets held by commercial banks have moved closely together.  The reserves the Fed has injected into the financial system have gone primarily into cash assets. 

It is interesting to note that of the $590 billion increase in cash assets at commercial banks, $403 billion went onto the balance sheets of foreign-related institutions in the United States.

For the week ending January 25, 2012, roughly 47 percent of all the cash assets held in commercial banks in the United States were held on the books of foreign-related institutions.  This is up from about 32 percent in December 2010. 

Note: These foreign-related institutions hold only 14.5 percent of the total assets in the United States banking system (up from about 11 percent a year earlier) so they are now holding a disproportionate share of the cash assets in the banking system.   

 

On the liability side of these foreign-related institutions there was a net increase in “net (deposits) due to foreign offices of $625 billion and a decrease in US held deposits (large time and other deposits) of $185 billion.  Thus, the right side of the balance sheets of these foreign related institutions rose by a net amount of $440 billion related to movements of funds “offshore”, i.e., primarily to Europe.

The Federal Reserve has not only supplied liquidity to the European continent through dollar swaps with foreign central bank, it has supplied funds to international financial markets through its open market operation.

It is not expected that many of the funds going to these foreign-related financial institutions will go into loans in the United States market as these institutions only hold about 8 to 9 percent of all commercial loans in the United States.

Therefore, when we look at what the Federal Reserve has done, we have to realize that only about fifty percent of the funds the Fed has injected into the banking system has gone to domestically chartered banks.  It is only this domestic portion of the Fed’s injection of funds that can have the greatest possibility of impact on business lending and hence economic growth.

Cash assets did increase at domestically chartered commercial banks during this time period: the increase was about $112 billion as total assets grew by $243 billion.  At the largest twenty-five banks in the country, the increase was $75 billion in cash assets and $130 billion in total assets.

The important thing is that business loans (Commercial and Industrial loans) at commercial banks have been increasing, primarily at the largest twenty-five domestically chartered banks in the United States.  From December 2010 to December 2011, C&I loans rose by $123 billion in the commercial banking system, with $94 billion of this increase coming at the largest twenty five banks, a 15 percent year-over-year rate of increase. 

Business loans did increase at the rest of the domestically chartered US banks, but they rose by only about $18 billion or about 5 percent year-over-year.

Over the past thirteen-week period, however, C&I loans at these smaller banks hardly increased at all and actually fell over the last four-week period.

At the largest banks, business loans continued to rise over the past four weeks ($15 billion) and over the past thirteen weeks ($35 billion).  My question about these increases has to do with the uses that the funds are being put to.  The national invome statistics showed that inventories increased in the latter part of last year and these loans could have gone to increase the inventory buildup.  Many economists seem to believe that given the weak consumer behavior (see below) that the inventories will decline in the first quarter of 2012 and this will result in some weakness in business loans.  Alternatively, some of the borrowing could be so that corporations could buildup cash positions for either acquisitions or for stock repurchases.  There does not seem to be any inclination to increase spending on business plant or equipment.

Commercial real estate loans continue to decline at the smaller banks in the country although there has been a pickup in these loans at the largest banks.  All-in-all, lending on commercial real estate continues to go down: and given all the loans that will mature over the next 12 to 18 months, with many of them being unable to re-finance, there is a continued likelihood that these loans will continue to decline in the near future.    

On the other hand, residential mortgage lending rose across the board at commercial banks.  Although residential mortgages fell on the books of the banks from December 2010 to December 2011 by $12 billion, over the past thirteen-week period, these mortgages grew by almost $19 billion, with $11 billion of this increase coming in the last four weeks.  And, the increases came in all sizes of banks.

This line item will be interesting to watch over the upcoming months since housing prices continue to decline and foreclosures and bankruptcies seem continue to occur at a rapid pace.

Just a further note on real estate lending: home equity loans have declined over the last thirteen weeks and held roughly constant over the past four.  

Counter to this increase in residential spending is the decline in the dollar amount of consumer loans on the books of the banks.  Over the past six months consumer lending has dropped by a little more than $6 billion with a major decline of roughly $15 billion coming over the last four weeks.   Most of this decline has come in credit card debt outstanding at the banks. 

This information on consumer lending seems to point to a continued weakness in consumer expenditures. 

In terms of the domestic economy it seems as if there is not much encouragement for a stronger economic recovery in the banking numbers.  There seems to be little demand for any kind of loans in the current environment, but, one also gets the feeling that the banks, especially the smaller ones, are not willing to lend even if there were an increasing demand for loans. 

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.    

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 Smaller Banks Continue to Lose Ground

First, we need to define what the Federal Reserve calls “Small” banks.  The Federal Reserve defines small banks as domestically chartered banks that are not counted among the largest 25 domestically chartered banks in the United States.  Hence, “Large” domestically chartered banks are the largest 25 domestically chartered banks in the United States. 

As of September 7, 2011, the largest 25 domestically chartered commercial banks in the United States account for 56 percent of all the banking assets in the United States.  The smaller banks represent about 28 percent.  Foreign related financial institutions control about 16 percent.    

From August 2010 to August 2011, the total assets held by the small banks in the United States grew by one-half the rate at which the total assets in the largest 25 banks.  The “large” banks grew at a 1.4 percent annual rate while the “small” banks grew by 0.7 percent.

Over the last calendar quarter from the banking week ending June 1 through the banking week ending September 7, the smaller banks actually shrank by almost $20 billion while the larger banks grew by about $165 billion. 

Over this last quarter, “Loans and Leases” at the smaller institutions dropped by almost $70 billion.  At the largest 25 banks, “Loans and Leases” rose by over $130 billion.  At the smaller banks, loans fell in ALL categories. 

From the banking week ending August 3 through the banking week ending September 7, “Loans and Leases” at the smaller banks rose by only $1.5 billion while they rose by more than $30 billion at the 25 largest banks. 

One could say that lending activity is increasing on Wall Street but not on Mail Street.   One could ask questions, however, about the type of loans that the larger banks are initiating.  See my posts from last week: http://seekingalpha.com/article/293657-bankers-expect-weak-profit-performance-in-the-future and http://seekingalpha.com/article/293893-some-banks-are-stretching-for-risk.   

But, business loans are not suffering the most at the smaller banks.  Over the past year, residential real estate loans (home mortgages) at these smaller banks have declined by more than 6 percent, year-over-year.  Over the past quarter these loans have fallen by $12 billion. 

And the smaller banks still are suffering through the commercial real estate decline as these loans declined by almost 7 percent, year-over-year through August.  Commercial real estate loans at these banks declined by more than $40 billion over the last quarter alone. 

The FDIC reports that there were 6,413 commercial banks in the banking system as of June 30, 2011.  Of this number, 865 banks were included on the FDIC’s list of problem banks for this date, more than 13 percent of the banks in insured at that time.  Troubled banks total even more than this, some estimate that more than twice this number are very fragile institutions. 

From these data one can argue that bank lending activity may be picking up, but it is not picking up among many of the smaller banking institutions that still face serious balance sheet troubles.  These organizations are not going to participate in any economic recovery and, in fact, are going to have to be closed or absorbed into the banking system that will remain.  As mentioned above, even though loans may be picking up in the largest 25 banks in the country, the loans may not be going into the physical investment that would cause the economy to grow faster than it is. 

FOREIGN RELATED INSTITUTIONS, QE2, AND THE EUROPEAN BANKING CRISIS

Dollar deposits continue to flow out of the United States into foreign banking offices through domestically located foreign related institutions.  From August 2010 through August 2011, cash assets at these domestically located foreign related institutions rose by about $470 billion!  This increase in cash assets tracks closely the Federal Reserve’s implementation of QE2 and represents about 75 percent of the roughly $630 billion rise in cash assets of the whole United States banking system. 

The interesting thing for our purposes is that the item on the other side of the balance sheet that most closely tracks this increase in the cash assets of foreign related banking institutions is “Net Due to Foreign Offices.”  That is, this money is going off shore. 

From August 2010 through August 2011, this account, “Net Due to Foreign Offices”, rose by almost $540 billion.  In the last quarter it rose by over $160 billion.  In the last month it rose by $112 billion. 

Can the rise in this this account be associated with the sovereign debt crisis in Europe and the recent problems faced by many of the large European banks?

I believe one can make a pretty strong case for this conclusion.  The Fed’s QE2 preceded the agreements that the central banks made last week to provide more US dollars to European banks. 

Of course, this provision of US dollars to the world is not spurring on economic growth although it may be helpful to preventing another Lehman Brothers meltdown.  

Business Loans at Commercial Banks Continue to Rise

Commercial and Industrial loans in the banking system continue to rise.  Over the past thirteen week period business loans at all commercial banks in the United States increased by almost $37 billion.  These loans began a slight uptick last November and have been rising modestly since then.

Over the past four weeks, commercial and industrial loans have risen by about $16 billion. 

Up until recently the increase has been solely in the largest twenty-five banks in the country.  These large banks are still making the largest additions to the growth in business loans, but in the latest four-week period there seems to be some life in this kind of lending in the rest of the banking system. 

Of the $37 billion increase in business loans over the past thirteen weeks, $29 billion has come from the largest banks while $3 billion has come in the smaller banks and almost all of this latter increase came in the past four weeks. 

Real estate loans continue to drop although some leveling out in the larger banks seems to have occurred over the past month.  All real estate loans dropped by $65 billion over the last three months although they dropped by only $6 billion over the last month. 

Again, the largest balance sheet movements in the banking system came in cash assets. 

Over the past thirteen weeks, the cash assets in the banking system rose by about $415 billion while the total assets in the banking system rose by almost $500 billion. 

In the last four weeks, the cash assets in the banking system rose by a little less than $160 billion while the total assets in the banking system rose by about the same amount.

QE2 continues fund the banking system. 

There are some really important differences in the rise in cash assets, however, 

Over the past thirteen-week period, the cash assets at the largest twenty-five domestically chartered commercial banks dropped by $42 billion.  At the smaller domestically chartered banks, cash assets fell by $2 billion.

Cash assets at foreign-related financial institutions rose by almost $460 billion during this same time period! 

Over this past thirteen week period it appears as if all the excess reserves the Federal Reserve pumped into the banking system went directly into foreign-related financial institutions and…and…$44 billion of excess reserves already in the banking system found its way from domestically chartered banks into the hands of the foreign-related financial institutions!

Loans and leases at all domestically chartered commercial banks dropped by a small amount during this period of time. 

The summary: business lending seems to be getting stronger in the United States, but it is the only sign of life in the lending area in the domestically chartered commercial banks. 

The funds the Federal Reserve is pumping into the financial system is going directly into foreign-institutions in the United States and is going off-shore. (http://seekingalpha.com/article/273506-cash-assets-at-foreign-related-financial-institutions-in-the-u-s-approach-1t)

So much for monetary policy stimulus!

Fed Continues to Pump Reserves into Foreign-Reated Institutions in United States

Over the past thirteen week period the Federal Reserve has pumped roughly $350 billion of excess reserves into the banking system. 

From February 2, 2011 to May 4, 2011, cash assets at commercial banks rose by $400 billion.  (Cash assets at commercial banks can serve as a rough proxy for the measure excess reserves.)   

During the same time period, $306 billion of the $400 billion increase in cash assets of commercial banks in the United States went to foreign-related financial institutions.

On May 4, 2011, of the $1,586 billion of cash assets in commercial banks in the United States, 50%, or exactly half of these cash assets, resided on the balance sheets of foreign-related financial institutions.   

The quantitative easing of the Federal Reserve continues to support, in large part, the “carry trade” where funds generated in the United States continue to find their way into foreign markets. 

This is not the first time I have written on this subject: http://seekingalpha.com/article/265481-large-foreign-related-banks-now-hold-776-billion-in-cash-assets.  Actually, this is the third time I have written about the subject: http://seekingalpha.com/article/254004-why-is-most-of-the-fed-s-qe2-cash-going-to-foreign-related-banking-institutions.

Over the past four-week period, cash assets at all commercial banks actually declined by about $9 billion.  However, cash assets at the foreign-related institutions rose by $27 billion during this time period while cash assets at the largest 25 commercial banks in the United States fell by approximately $21 billion and they fell at smaller domestically chartered United States banks by $14 billion.

There is some good news, however!

The good news is that business loans, commercial and industrial loans, at commercial banks really seem to be on the up swing.  Over the past thirteen-week period, C&I loans have increased by $35 billion.  Roughly two-thirds of this increase, or about $23 billion, of the loans came from the largest 25 banks in the country.  However, C&I loans were only up modestly at the smaller commercial banks over this period. 

In the past four-week period business loans were up $10 billion and 60 percent of these, or $6 billion, came from the largest banks.  Again, C&I loans were up at the smaller institutions by a modest amount. 

So, banks, especially the larger banks, seem to be lending again to business, something that is vitally needed if the economic recovery now under way is to really pick up. 

If the goal of the Federal Reserve in conducting QE2 was to get business loans increasing again, then it seems to have succeeded.  Sure, we will have to wait a little longer to get more confirmation of this trend, but this is the first time in this cycle that business loans really do seem to be increasing.

The not-so-good news: the volume of real estate loans on the books of commercial banks continues to tank.  Over the past thirteen-week period, real estate loans at all commercial banks dropped by almost $90 billion.  Over the past four-week period, these loans declined by over $18 billion. 

Almost all of the decline has come at the largest 25 domestically chartered banks in the country.

Over the past thirteen weeks, the major part of the decline came in the area of residential loans ($41 billion), which was closely followed by the fall in commercial real estate loans ($34 billion).  In the past four weeks, the bulk of the decline came in the residential area ($12 billion). 

So, business loans appear to be picking up but the real estate market continues to decline: mixed signals for any sustainable economic recovery.

Maybe, however, this is all the Federal Reserve hoped to achieve at this time.  It seems as if almost everyone believes that it will still be a while before the real estate markets, both residential and commercial, bottom out and start to pick up steam. 

Maybe all the Federal Reserve thinks it can do is to get businesses borrowing again and with that borrowing put some people back to work.  And, it seems that if the Fed can achieve this small win it would think that flooding the rest of the world with United States dollars has been worth it.   

It would be too bad if a substantial part of the uptick in business lending was just going to finance the merger and acquisition activity of large businesses: http://seekingalpha.com/article/269056-the-latest-merger-binge-and-the-economy.   

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. 

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.

Is Bank Lending to Business Starting to Pick Up a Little?

Last month I wrote a post about “Why is most of the Fed’s QE2 Cash Going to Foreign Related Banking Institutions.” ( http://seekingalpha.com/article/254004-why-is-most-of-the-fed-s-qe2-cash-going-to-foreign-related-banking-institutions)

This month the Fed’s “cash” injection has ended up at the largest 25 banking institutions in the United States. Cash assets at the largest domestically chartered banks rose by almost $160 billion over the past four weeks.

The cash assets at foreign-related banking institutions dropped modestly (about $4 billion) over the last four weeks but is still up approximately $125 billion since the end of last year.

According to the Fed’s data on the commercial banking industry, cash assets in commercial banks have risen by about $260 billion over the past nine banking weeks, with around $135 billion going to the largest 25 domestically chartered banks, $125 billion going to foreign related financial institutions and roughly zero going to the other 7,600 domestically chartered small banks.

Other than this fact, the interesting change within the United States banking system itself is that although credit extension at domestically chartered commercial banks declined rather substantially since the end of last year, the loans and leases at the smaller commercial banks actually went up.

Overall, loans and leases on the books of commercial banks declined by about $27 billion over the last four weeks and by $61 billion since the end of 2010.

Interestingly, the smaller banks recorded a $28 billion increase in loans over the last four weeks, with commercial and industrial (C&I) loans rising by $5.5 billion and commercial real estate loans increasing by about $18 billion.

It should be noted that residential mortgages fell by about $11 billion over the same time frame.
Is this a sign that commercial lending is picking up for the smaller banks. This is the first time in the last few years that commercial lending has actually shown any sign of increasing at these smaller institutions, especially in the area of commercial real estate.

C & I loans did pick up at the larger banks over the last four weeks and this dominated the activity in this area during the early part of this year.

However, commercial real estate lending declined at the largest banks by $25 billion, so that this category of loans did decline in total. Also, since the end of last year, commercial real estate loans at these large banks declined by $32 billion so that overall, the commercial real estate sector continued to decline throughout the early part of 2011.

So, the question is, “Is bank lending to businesses starting to pick up a little?”
Really, we only have a little information that it might be picking up. But, it certainly is something to keep our eyes on.

The big mystery still seems to be the placement of the QE2 money being generated by the Federal Reserve system. Reserve balances at Federal Reserve banks have increased by about $280 billion from the end of 2010 to March 2, 2011. This increase in Reserve Balances seems to be roughly divided between the largest 25 domestically chartered commercial banks and foreign-related financial institutions. But, loan at these institutions over this time period have actually gone down. What’s going on?

As for the smaller banks, they do not seem to have participated in this round of quantitative easing. Yet, it has been my belief that one rationale for QE2 has been to provide market liquidity for the smaller banks so that it will ease the strain on those banks that are especially having solvency problems. Given recent data released by the FDIC it seems as if there are still a large number of the smaller banks in the country that are still having major problems staying alive.

Thus, at least part of the purpose of QE2 is to help keep these banks open so that they can be closed by the FDIC in an orderly fashion. Through the first nine weeks of the year the FDIC has closed an average of just under 3 banks per week. This is down slightly from about 3.5 banks a week in 2010.

We continue to wait. Believe it or not, the economic recovery is just about a quarter short of being two years old. There are still areas of the economy that remain of concern like the banking industry, the residential housing market, the commercial real estate market, and state and local finances. And, there still are shocks around the world that threaten to bring everything else down: the unrest in the Middle East and arising oil prices; the earthquake in Japan; and the sovereign debt problem in Europe.

So the bad news is that the economic recovery is just about a quarter short of being two years old and underemployment is so large and manufacturing capacity is so low for this time in the business cycle.

The good news is that the economic recovery is just about a quarter short of being two years old
and the recovery seems to be robust enough to continue to meander along in an upward direction.

It would be nice to have more bank lending to spur the recovery along, but it will be even better if the financial system can continue to function without a disruption to the steady pace of the FDIC closing the banks it needs to close.

The Two Banking Systems in the United States

More and more it appears as if the banking system of the United States is bifurcating into two parts, the largest 25 banks and the rest. These designations, large and small, are used by the Federal Reserve System for the data they release for the whole commercial banking system.

Over the past year, the total assets of the domestically chartered commercial banking system in the United States hardly grew at all. Yet, throughout the year, the smaller banks made their balance sheets much more conservative than did the largest banks.

For one, the smaller commercial banks increased their holdings of cash assets by 10% from December 2009 to December 2010; the largest banks decreased their cash holdings by more than 21%.

Both the large banks and the smaller banks increased their securities portfolios over the year, but the smaller ones increased their securities portfolios by almost 9% while the largest banks increased theirs by only about 3%.

Over the whole year, Commercial and Industrial Loans declined across the board with the larger banks portfolio of C&I loans dropping by almost 5% while in the smaller banks, C&I loans fell by only about 3%. Real Estate loans also fell during the year dropping about 4% and 5% at the largest and the smaller institutions, respectively. Consumer loans were re-defined over the year for this Federal Reserve release so that the data year-over-year growth rates are not meaningful.

The largest declines since December 2009 came in commercial real estate loans. At the largest banks, commercial real estate loans dropped by almost 11%; at the smaller banks they fell by 8%. The troubles in the commercial real estate area show up very clearly in the banking statistics.

The conservative movement in the balance sheets of the smaller banks was continued over the last 13 weeks ending with the banking week finishing on January 5, 2011. Total banks assets fell during this time period, but not by very much. Over this time period, however, the smaller banks increased their holdings of securities by over 7% while their loan portfolios fell by more than 3%.

During this time period, loans making up the loan portfolios of the smaller banks fell across the board: C&I loans dropped by 4%; real estate loans fell by 3%; and consumer loans declined by about 4%.

The loans at the smaller banks also continued to drop through the Christmas season with C&I loans falling by over 2% in the five-week period ending January 5, 2011; real estate loans fell by just 2% during this time period; and consumer loans dropped by almost 5%.

Interestingly enough, there was a front page article in the Saturday Wall Street Journal with the title “Banks Loosen Purse Strings” which reported data from Equifax Inc. and Moody’s Analytics. (http://professional.wsj.com/article/SB10001424052748704637704576082300851916930.html?mod=WSJPRO_hps_LEFTWhatsNews) In this article the claim is made that “In the third quarter (of 2010), lenders made more than 36 million consumer loans, up 3.7% from a year earlier...That is the first year-over-year gain since the crisis began. Consumer-loan originations are expected to climb 5.9% this year, much higher than the slim 1.1% increase in 2010.” The article goes on to say that “The totals include bank-issued and retail credit cards, auto loans, consumer-finance loans, home-equity lending and student loans”. Whoops, these are not all banks are they!

But, the commercial banks do not seem to be opening their purse strings when it comes to consumer lending. Besides the drop of 5% in consumer loans at the smaller commercial banks, the Federal Reserve data also showed that consumer loans fell by 5% at the largest 25 commercial banks over the past 5 weeks.

Again, the largest declining loan class over the last 5 weeks was still the commercial real estate loan area. The decline at the largest banks in the last 5 weeks was a little under 1%, while the decline at the smaller banks in this area was over 2%.

Everywhere, the aggregate banking statistics can be interpreted as showing that the smaller commercial banks continue to “tighten up” their balance sheets. The loan portfolios of these banks experienced further declines while the banks keep building up their cash positions and the size of their securities portfolios. The largest contractions have come in commercial real estate, the area that seems to have the biggest cloud over it for the next year or two.

Generally, the largest 25 domestically chartered banks in the United States seem to be doing well.

Of course, we all heard about the 47% profit jump at J.P.Morgan Chase which was announced on Friday. This week we will get more information on how the other “large” commercial banks are doing. It is expected that the reports coming out this week will show that the bigger banks are pulling ahead.

Of interest is the areas of lending that seem to be picking up at these larger banks. For one, commercial and industrial loans are, indeed, starting to increase. Over the past 13-week period, the largest 25 banks saw their portfolios of C&I loans increase by more than 3%; these loans also showed a gain over the past 5-week period.

The one other lending area that seems to be picking up at these larger banks is the area of residential loans, mortgages. (Note: this does not include equity-line loans.) Over the last 13-week period, residential real estate loans have picked up by slightly more than 3%; these loans also registered a modest increase over the last 5-week period.

So, I still firmly believe what I wrote in my January 3, 2011 post, “Four ‘Uncomfortable Situations’ to Watch in Early 2011,” (http://seekingalpha.com/article/244531-four-uncomfortable-situations-to-watch-in-early-2011). Two of these four “uncomfortable situations” are the health of the commercial real estate area and the solvency of commercial banks that fall into the small- and medium-size category.

The small- and medium-sized banks continue to “pull-in-the-carpet.” That is, these banks continue to shrink their balance sheets and they continue to re-allocate assets to either cash or “safe” Treasury securities. They have been doing this for more than two years and show no signs of acting any differently in the near future. To me, this behavior is a real “red flag” that these institutions are not doing well.

And, these smaller banks seem to be getting commercial real estate loans off their balance sheets as fast as they can just re-confirming the problems that exist in this area.

The Federal Reserve continues to pursue the policy they call “Quantitative Easing.” Perhaps a better name for it would be “Keeping the Smaller Banks Liquid.” The reason, I have argued, for keeping the smaller banks liquid is that this allows many of these smaller banks to keep their doors open in the short run so that the Federal Deposit Insurance Corporation (FDIC) can close as many of these banks as they need to in as orderly a fashion as possible. The data continue to support this conclusion.

"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

Big Banks seem to be doing just fine: Smaller Banks, not so well

Last month it seemed as if there was a glimmer of hope for the smaller banks: lending appeared to be picking up across the board. (See my November 9 post, “A Positive Trend in Small Bank Lending”: http://seekingalpha.com/article/172219-a-positive-trend-in-small-bank-lending.)

Well, the glimmer of hope went away in November. However, lending, and profits, at the larger banks seemed to become more robust as we went deeper into the fall.

Overall, bank liquidity continued to rise as the cash assets in the commercial banking system rose by $290 billion in the latest 13-week period and by $110 billion in the last 4-week period. This increase was, of course, reflected in the aggregate bank data. The Federal Reserve showed that Reserve Balances with Federal Reserve Banks averaged $833 billion in the banking week ending August 26, $1.085 trillion in the banking week ending October 28, and $1.139 trillion in the banking week ending December 2. Excess reserves in the banking system averaged $795 billion, $987 billion, and $1.120 trillion for the two-week periods ending, August 26, October 21, December, respectively. The banking system became more liquid as the fall matured.

Whereas, lending in the smaller banks showed some rise in October, lending was down across the board in the November period and this seemed to drag down the results from the last 13-week period.

The leader in this decline was lending for Commercial Real Estate. Analysts have claimed for some time now that problems were looming in this area for the small- and medium-sized banks. The concern was over timing: when were the problems being experienced by this sector going to show up on the balance sheets of these banking organizations?

Well, they really seem to be showing up now. Commercial Real Estate loans on the balance sheets of “small” domestically chartered commercial banks declined by $33 billion in the 4-week period ending November 25. They dropped by $50 billion in the last 13-week period.

Commercial and Industrial loans also decreased at the smaller banks in the latest 4-week period by $23 billion. (These loans actually had increased in the previous nine weeks.)

Furthermore, as stated in my December 1 post, these small- and medium-sized banks are not doing well profit-wise. The F. D. I. C. reported that commercial banks of $1.0 billion in assets size or less roughly broke even profit-wise in the third quarter of 2009. Banks in the $1.0 billion to $10.0 billion in asset size lost, on average, $3.0 million per bank in the third quarter.

The problem bank list, which consists primarily of small- and medium-sized banks rose to 552 at the end of the third quarter, an increase from a total of 416 at the end of the second quarter, and this is with 50 banks dropping off the list in the third quarter because they failed. (This information is reported in http://seekingalpha.com/article/175958-banking-sector-weakness-the-secret-no-one-wants-to-talk-about.)

The blip upwards in lending at the small- and medium-sized commercial banks reported last month is typical of the information flows we are getting these days. Some months the information that is reported looks good and we get excited about it. The next month…well, the information isn’t so good. The concern with the smaller banks is that the future could really be quite bleak.

With 552 banks on the F. D. I. C. problem list, we could see the banking industry taking a lot of hits in the next 12 months or so. If one-third of these banks fail, which is the estimate going around, this would mean that 184 of these banks would be closed or, in a 12-month period, roughly 3.5 banks per week would be closed. In the third quarter of 2009 three banks a week, on average, were closed. And, this assumes that no other banks come onto the problem bank list.

What about the big banks?

The big banks, except Citigroup, seem to be doing just fine. Even Bank of America is going to pay back the money it received from the federal government and it has raised additional capital.

Evidence that big banks are doing OK is present in the F. D. I. C. data just released. Commercial banks with assets in excess of $10 billion reported profits, on average, of $42 million per bank in the third quarter.

This prosperity seems to be translating itself into the performance of these larger banks. The assets of large commercial banks rose by $202 billion in the last 4-week period, whereas total assets actually dropped in the smaller banks and in foreign-related banking offices.

Loans and leases at the bigger banks surged by $163 billion in the last four weeks. This is the first substantial increase in activity in these banks this year!

Whereas the increase in loan volume was registered in all categories of loans, of particular note was an increase in Real Estate loans of $125 billion. And, the increase was distributed across residential mortgages, $80 billion, commercial real estate loans, $29 billion, and home equity loans, $16 billion. Business loans and consumer loans lagged these totals, but increased by $12 billion and $10 billion, respectively.

The bottom line:

Big banks, in general, seem to be doing very well;

Small- and medium-sized banks, in general, are not doing so good.

This presents quite a dilemma for the Federal Reserve. The bailouts of the big banks have seemingly worked. The big banks were saved from the systemic risk that existed within the financial system (yes, Mr. Goldman Sachs, you too would have failed if we had done nothing—Tim Geithner) and are now doing quite well. The Fed’s policy of keeping short term interest rates close to zero seems to be lining the coffers of these banks in record amounts.

The small- and medium-sized banks are another issue. These organizations, on average, do not seem to be making profits yet. Their loan losses really seem to be piling up and more is going to be asked of them in terms of reserves in anticipation of further losses. External capital does not seem to be readily available to them. And, they have more than 25% of their assets in cash and securities to help them through this period and to be able to pay off their own debt as it matures.

The Federal Reserve must take the condition of these smaller banks into consideration when considering a way to “exit” from its bloated balance sheet. Too quick of an exit could just exacerbate a situation that is already taxing the resources of these institutions.