Big Banks Report Signs of Health

 | May 09, 2013 | 6:20 PM EDT  | Comments
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The quarterly financial status reports that banks file with their regulators, called "call reports," are available now for the first quarter of 2013. In this column I'll summarize broadly what they indicate for the industry and imply for the economy.

The first big takeaway is that bank balance sheets are indeed getting stronger. Trouble on the balance sheets had been largest single negative issue hanging over the banks, specifically the money centers -- JPMorgan (JPM), Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C).

The value of nonperforming residential loans carried by all banks decreased to its lowest level in three years and by the largest amount and percentage of any calendar quarter during that time -- by about $8 billion, from about $171 billion to $163 billion.

This was a big move and an indicator of an increase in the rate at which banks are repairing their balance sheets. This is a leading indicator of banks' potential to become less risk-averse and more willing to lend as this trend continues.

The Federal Housing Finance Agency recently announced that it will allow defaulted residential mortgagors the opportunity to refinance into lower rates and payments if they agree to start making loan payments again. This will also help to remove the cloud of "shadow inventory" of impending foreclosures that has been partially responsible for banks' aversion to lending since the 2008 crisis.

The trend toward stronger balance sheets was evident across all four of the money centers. Nonperforming first-trust residential mortgages being carried by Bank of America, after having increased steadily since the 2008 crisis, have declined in the past two quarters to their lowest level in two years. Reductions were also experienced by Wells Fargo, JPMorgan and Citigroup.

The value of other real estate owned (OREO), the category of bank balance sheets predominantly represented by foreclosed residential properties, declined in aggregate and at each of the money centers.

Recovery rates have rebounded to their highest level since the financial crisis of 2008. The current average recovery of first-trust mortgages is approaching 10%, almost twice what it was just six months ago. This is an indication of banks' ability to sell their portfolio of foreclosed properties at higher prices than was the case a year ago. The trend looks set to continue.

Bank of America's recovery rate has increased from about 3.5% to 10% in the past six months, Wells Fargo's from about 5.5% to 11%, and JPMorgan's from about 3% to 5%. Citigroup has consistently reported a recovery rate of almost 0%. I don't know why, but it is most probably the resulting of an accounting issue.

It's not all rosy, though. Even though the residual balance sheets are showing a clear pattern of strengthening, banks have not yet increased their lending or exhibited a willingness to become less restrictive in lending.

As I've discussed before, banks have stated an increased willingness to lend, but so far that has not resulted in increased lending.

Total loans in aggregate at U.S. banks actually declined in the first quarter from the fourth. The decrease was only by about $43 million in total, but the fact that this occurred in the first quarter following the implementation of QE3 and 4 by the Federal Reserve last year is a disturbing indicator about the health of lending and borrowing.

At JPMorgan, Bank of America and Citigroup, the total value of their loan portfolios declined in the first quarter. At Wells Fargo they increased, but only because of the continuing increase in residential mortgage lending there.

Last year, I discussed the odd fact that commercial and industrial loans (C&I) have continued to mount since the 2008 crisis while evidence of those funds being invested for other than financial purposes remains lacking.

C&I loans is a category that excludes all loans that are real estate related. If you've heard the meme that banks are taking the Fed's monetary infusions and buying stocks rather than lending, this is the evidence of its truth; and it is continuing.

During the first quarter, C&I loans held by banks increased again by about $25 billion, from about $1.508 billion to about $1.533 billion. In the past three years, the percentage of loans held by banks that fall in this category has steadily increased from about 15% to about 20%, and it is still rising.

The bottom line on the first-quarter call reports is that they show clear signs that the legacy issues from the real estate and mortgage crisis are increasingly being resolved. There is still little indication that banks are making productive loans, though, and they appear to be making more loans for financial engineering purposes.     

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