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The Ideas and Analysis Letter: The Sanchez “Take”
December 2010
The Fat Lady is not Singing
The June and July 2010 Sanchez “Takes” analyzed certain aspects of the reported financial information for the 21 top Bank Holding Companies (BHCs) – the entities with the most economic power in banking circles. The data analyzed was for the same 21 BHCs that existed between 12/31/08 and 3/31/10 – five of the most difficult and challenging economic quarters in recent history.
The Sad Situation at 3/31/10
The data analyzed at that time highlighted the following “not so good” balances as a % of total assets activity occurred:
· BHCs were “hoarding” large amounts of cash, although the % was declining slightly over the quarters (from 7.66% to 7.30%) · Investments in “held-to-maturity (HTM)” and “available-for sale (AFS)” securities rose significantly from 13.93% to 17.63% · Loan balances declined dramatically from 43.26% to 39.09% · Federal Funds Sold and Reverse Repos rose significantly from 8.86% to 11.43% · Trading (i.e. “speculative”) assets declined very little from 12.72% to 11.70% · Foreclosed real estate (OREO or “Other Real Estate Owned”) actually declined from 0.22% to 0.17%. · Deposit balances slipped, but not by much (from 45.60% to 44.51%). The slippage was primarily due to declines in interest bearing deposits in foreign offices of the BHCs · Funding by purchasing federal funds and selling securities that are to be repurchased (repos) increased from 10.22% to 12.13% · Borrowed money – principally advances from the Federal Home Loan Banks (FHLB) – declined from 19.06% t0 17.74% · Funding by using debt in the form of Notes and Debentures hardly changed (2.88% to 2.76%) · Total equity improved slightly from 8.05% to 8.66% due principally to significant declines in outstanding preferred stock, significant increases in outstanding common stock, significant declines in retained earnings, and significant reductions in the massive holding losses included in “Other Comprehensive Income (OCI)”
What was Happening – In Plain English
The financial information painted a bleak picture. In plain English, the top companies that control banking (and are considered the engine that drives the economy) have:
· Hoarded cash · Stopped lending · Beefed up investments (which are more speculative and less profitable than loans) · Transferred cash to other banks and investment banks · Continued to dabble in speculative trading assets · Hardly increased foreclosures on real estate collateral · Held steady with cheap customer deposits · Funded their businesses with fed funds purchases and repo security sales and issuance of notes and bonds · Stopped relying on advances from FHLB · Continued to lose money and decrease accumulated earnings
This was not the activity expected of the driving engine in the economy. As stated in the June and July 2010 “Takes,” profitability needed to be restored via lending. That would have made the BHCs healthy and would have pumped money into businesses for growth and for working capital purposes. That would have stimulated economic activity and lead to something other than a “jobless” recovery.
In July, the Take thought it would be wise to keep an eye on the loan-to-deposit ratio at the top 21 BHCs. An improvement (an increase) in that ratio would be an indicator that businesses are receiving more funds from the BHCs, and BHC profitability is being restored. The pathetic decline in the loan-to-deposit ratio from 94.87% to 87.73% between 12/31/08 and 3/31/10 highlighted the sad economic situation we were in at that time.
It was no mistake back then when the “Take” stated “the lenders are not lending.”
What’s Happened Since 3/31/10
Now we find ourselves deep into in what is starting to be called “The Second Great Contraction.” It is natural that we look for signs that show we are headed in the right direction economically. We strive to find the green shoots that tell us the worst is over. A logical place to look is at the financial statements of the 21 largest BHCs.
What has happened to the BHCs since 3/31/10 is shown in the following table. Table 1 Composition of Assets as % of Total Assets
The cash balances are still very large but have shown a significant decline to 5.96%. Unfortunately, the cash that was “freed up” was not “loaned out.” Since 3/31/10, the loan balances declined even further from 39.09% to 38.45% (remember at 12/31/08 they were 43.26%). So, what happened to the cash? The BHCs are investing the cash in securities (a great deal are mortgage-backed securities – one of the problems that started the economic mess in the first place.)
Presumably, banks have expertise in the credit risk area. However, they are not the “champs” when it comes to investment market risk. So, why load up with securities? A good question that regulators should ask! The loosening up of cash can be seen in Table 2.
Table 2 Cash Balances
The failure to distribute the cash in the form of loans is evident in Table 3.
Table 3 Loans
The financial intermediary, flow-through, conduit purpose of BHCs is still not being fulfilled.
The use of funds for investments in HTM and AFS securities is another sad study (Table 4). The BHCs are starting to look like mutual funds. It seems they use deposits and other funds to buy securities at the expense of making loans.
Table 4 Securities (HTM and AFS)
The investment banking activities of using cash to purchase federal funds, using cash to buy ”overnight” securities, and maintaining large trading (speculative) positions continue unabated.
This is clear in Table 5 and Table 6.
Table 5 Federal Funds Sold and Reverse Repos
Table 6 Trading Assets
Observations
From 3/31/10 to quarter-end 9/30/10 many voices have said economic activity is on the “up tick.” A review of the 21 BHCs may indicate otherwise.
There has been no significant return to “normal” banking. Cash is still hoarded. Investing and trading and investment banking (i.e. Wall Street activity) continue to grow and dominate. The loan and deposit ratio tells the real story. See the following Table 7.
Table 7 Loan to Deposits
The 21 huge lenders don’t look like and don’t act like lenders. The situation might seem calmer now than it was before but “real” progress, as always, will be based on lending which will create the “real” profitability that will start the engine of economic growth.
Summary
At this time, I still don’t see significant changes in the banking activities of the top 21 BHCs. The sick economy has not turned around. I believe the economy will not turn around until lending is revitalized.
The banking industry is certainly liquid. However, the key players still rely on the central government’s low cost of funds to limp along and to continue investment banking activities. There are still large unrecognized losses on the balance sheet. If recognized, the banks’ lack of proper capital would be painfully obvious. No “new” loans will be made as long as “old” loans are not written off or not converted to OREO to be sold.
The depressed conditions continue. The failure for BHCs to do what they do best – make loans – continues. The depressed situation “ain’t” over yet, and I don’t hear the fat lady singing!
Paul J. Sanchez CPA, CBA, CFSA Professional Service Associates December 15, 2010 |