Current strength of banks is an illusion

By DAVID MOON, Moon Capital Management, LLC
October 25, 2009

Since the most recent stock market bottom in March of this year, the S&P Bank Index has increased a whopping 170 percent. Citigroup (34 percent owned by U.S. taxpayers) recently sold its energy-trading unit, just before paying one of its traders $100 million. October 9 marked the first weekend since June 12 that regulators didn’t shut down any banks.

If I didn’t know any better, I might think that good times for the banking industry have returned. But I know better.

Despite this spate of positive news, bank lenders certainly aren’t acting like good times have returned. Total banking lending declined from $7.14 trillion in May to $6.78 trillion in September.

This decline in lending is part of the reason for the illusion of bank strength. Consider First Horizon’s third quarter results as an example. The good news was that First Tennessee Bank’s parent company lost less money than was expected. Nonperforming assets also declined slightly.

What isn’t so obvious, however, is that, like the overall banking industry, First Horizon’s entire loan portfolio shrunk. As a result, nonperforming assets as a percentage of its total assets actually increased from 6.15 percent to 6.38 percent of assets.

The magnitude of the increase isn’t a huge deal, but it’s a move in the wrong direction, for sure.

Thus far, the biggest problems in the banking industry have been with residential real estate loans. For example, 6.6 percent of the residential real estate loans at SunTrust are currently more than 90 days past due. That’s more than 20 times the level five years earlier.

The next shoe to drop in the banking industry is likely to be in commercial loan portfolios. There are 35 banks and thrifts with 161 branches that accept deposits in Knox County. Those banks hold about $3.3 billion worth of single family loans in Knox County, compared to more than $1.5 billion worth of local commercial loans. The commercial loan sector isn’t as large as the mortgage market, but it is significant. And increasing losses are just beginning to be seen in the commercial sector.

Of the banks in Knox County, overall bank exposure to commercial loans ranges from a low of less than two percent (Tennessee State Bancshares) to 28 percent (Fifth Third and CapitalMark.) The average in Knox County is 14.6 percent. Since large banks tend to be more active commercial lenders, it is no surprise that every bank with more than $20 billion in assets has commercial loans comprising greater than 14.6 percent of its total loans outstanding.

Across the nation, thirty-five banks have defaulted on payments owed to the Federal government pursuant to the TARP program. Since January 1, 2008, 124 banks and thrifts have failed. It is no accident that the nation’s largest small-business lender, CIT, is on the edge of bankruptcy.

The worst may be over for the entire banking industry, but I am afraid there are likely more failures and write-offs looming.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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