Rate Of Bank Charge Offs Surpasses That Set During Great Depression

Even as the cataclysmic events of last year fade into memory and most pundits are convinced that the government alone can push the country into prosperity, if it only wasn't for that pesky unemployment number that just refuses to cooperate, yet another comparison with the Great Depression emerges, one that shows that the current period is in fact even worse than what occurred in the years after 1930. Moody's has released an analysis which shows that the most recent rate of bank charge offs, which hit $45 billion in the past quarter, and have now reached a total of $116 billion, is at 3.4%, which is substantially higher than the 2.25% hit in 1932, before peaking at at 3.4% rate by 1934.

The estimated $45 billion in total charge-offs in the third quarter for rated U.S. banks compares to the $40 billion and $31 billion totals reported in second and first quarters of 2009, respectively.

Yet leave it to Moody's to put a favorable spin on things and to indicate that this will hardly require the rating agency to adjust their bank ratings:

These losses are consistent with our earlier estimate that rated U.S. banks will incur $415 billion of charge-offs in 2009 and 2010 ($299 billion remaining ($415 billion - $116 billion) As such, these losses have been incorporated into our U.S. bank ratings and therefore will not trigger rating actions.

However, based on our estimate, the rate of increase in the absolute dollar value of charge-offs has also slowed significantly in the third quarter of 2009.

How the charge off rate is "slowing significantly" when all factual sign point to the opposite is a bit of a mystery. Perhaps some Moody's analyst can take a walk to Stuy Town when not too busy getting advance info on upcoming LBOs to see what the economy really has in store.

In any case, a graphic representation of the Great Depression comparison is seen on the chart below:

So how does the increasing charge off rate compare to the loan loss reserves taken by US banks? The comparison is presented by the following graphic:

Here is how Moody's explains the flatlining of new charge offs, which, as expected are driven by expectations of an economic improvement:

Many U.S. banks justified a smaller loan loss reserve build in the third quarter compared to previous quarters in 2009 because of both the slower rate of increase in charge-offs and the early signs of moderating delinquency trends.

  • We estimate loan loss provisions for rated U.S. banks in the quarter at $55 billion, or approximately 120% of charge-offs or just less than five quarters coverage.
  • The excess of provisions over charge-offs represents a $10 billion allowance for loan loss build in the quarter down from $21 billion in the first quarter of 2009 and $16 billion in the second quarter of 2009.

We continue to believe it’s premature for banks to lower their reserve build since problem loans and net charge-offs continue to show an upward trend even though some, but not all, consumer delinquencies showed improvement.

So the real question is whether this optimism is justified by actual conditions? While some credit card companies have indeed demonstrated a moderation in weak credit card trends, the overall move is for ever increasing delinquencies and deterioration across the consumer landscape. As for Commercial Real Estate, with numerous vacant office Easter Eggs coming to market soon, once reserves are depleted, the real push for loss recognition may have only just begun.

Lastly, are banks now expected to be able to weather the storm on their own? If historical precedent is any indication, some of the heretofore strong banks may be in for a long-overdue marking to reality of their loan portfolios.

As expected, high credit costs weighed heavily on rated U.S. banks’ third quarter results. For most banks, third quarter earnings were at best modest and in many cases they recorded sizeable losses. As the majority of our estimated credit costs have yet to be taken, we believe earnings prospects for the fourth quarter of 2009 and for 2010 are bleak for many U.S. banks. The graph below displays number of quarterly losses that major U.S. banks have incurred since the credit crisis began in the second quarter of 2009 and through the third quarter 2009.

As charge offs and increasing loss provisions equate with actual losses and declines in capitalization ratios, it is no surprise why banks may still be leery of acknowledging the spectre that CRE is. Then again, the administration still has at least one full year of propping up the market by any means necessary and possible before the inevitable maturity rolls have to take place. And, as has been widely discussed before, absent a resurgence of the securitization market, between CMBS, and the whole loans that are carried on bank balance sheets, this will likely be the most relevant metric to follow into the next 12-18 months to see how many additional write-downs firms will ultimately be forced to recognize.