Since almost everyone by now understands that our most recent financial crisis was brought on by poor lending practices at Fannie Mae, Freddie Mac, and the Big Banks, I thought in this third article in my banking series for Business Insider that I would show how those poor lending practices played out within the U.S. banking industry during the crisis.
Exhibit 1 tracks eight years (32 quarters) of the most important loan accounting performance indicators, allowing any layperson to hopefully gain a better understanding of what has taken place over the last several years.
Again, as I have mentioned in my previous articles, all of my information and analysis can be confirmed and duplicated. My data source is the FDIC banking data base open to the public worldwide.
Photo: Jim Boswell
If you really want to track and understand U.S. Banking loan performance throughout our most recent crisis period, Exhibit 1 is about as good as it gets. If you can understand Exhibit 1, you can pretty much understand everything that has taken place in the area of problem loan processing by the U.S. banks since our latest crisis began. You will also understand better where that processing stands today.
Now here are several key things that you should take away as you study the Exhibit.
- The first indicator that a problem is brewing comes from tracking non-performing assets (i.e., loans delinquent more than 90 days, in foreclosure, or that the bank has actually taken over, called Real Estate Owned assets). All of these loans sit on the balance sheet and can be identified and tracked. I will leave it to the reader to determine when he or she might have suspected a loan problem was brewing by looking at the trending Non-Performing Asset line (the dark brown line) on the Exhibit
- The second thing the reader should understand is that when the amount of non-performing loans begins to increase, believe it or not, the banks actually have to start setting money aside to cover potential losses associated with those loans. They do this through a Provision for Losses account which hits their income statement. These Provisions are identified as the dark red line on the above Exhibit.
- Up this point non-performing assets remain on the books and even though the banks have already recognised losses associated with these assets, it is not until the banks actually “write off” these loans as Net Chargeoffs (the dark blue line) that the loans leave the balance sheet. Until the bank actually writes off the loan, the lost income identified as loss provisions, is credited to a contra-asset account on the balance sheet, called Loan Loss Allowances (the dark green line).
- When the actual loss amount associated with a non-performing asset is finally determined (after say, a short sale or otherwise), the bank removes the loan from the balance sheet, and the actual losses associated with the loan are subtracted from the Loan Loss Allowance account. Actual net chargeoffs do not affect the income statement because those losses have already been recognised.
Now with that as a basic 101 loan accounting lesson, here is what you can glean from the above Exhibit:
- By 12/31/2007 (nine months before TARP), U.S. banking non-performing assets had already doubled from pre-crisis steady state levels.
- Since that quarter (or over the last five years) U.S. banks have recognised $779 Billion in loan loss provisions on their income statements. This is essentially the area under the Provisions curve (red line of Exhibit 1) since 12/31/2007.
- The amount of those loss provisions that have actually been written off during the same period is $691 Billion. The difference between the $779 Billion of losses recognised on the income statement as Loan Loss Provisions and the $691 Billion in actual Net Chargeoffs is $88 Billion (the amount the Loan Loss Allowance has increased since 12/31/2007.–$79 Billion to $167 Billion)
- The amount of non-performing assets still on the books of the U.S. Banking industry (the end point of the dark brown NPA curve) is $292 Billion. The amount that has been set aside to cover losses associated with those non-performing loans (the end point of the dark green line) is $167 billion—meaning 57 cents of every dollar of non-performing assets has already been recognised and set aside to cover for losses when they are actually written off..
What you cannot see from Exhibit 1 is that the $292 Billion of current non-performing assets represents 3.85% of the current total amount of U.S. Banking loan assets ($7.6 Trillion). If for some reason this number does not seem high, don’t forget that the banks have “already written off” $691 Billion and thus another 8.36% of their loans (i.e., using the same current loan asset number plus the amount written off as the denominator in the equation).
OK, so what does all of this really mean or what are you trying to tell us, Jim?
Well, from my professional opinion, humble or not, I say the accounting for the latest banking crisis is essentially over. And even though the amount of non-performing assets may still seem high ($292 Billion, 3.85% of total banking loans) and still well above pre-crisis levels, I believe the $167 Billion of loan loss allowances already recognised should be sufficient to cover the actual losses associated with those non-performing assets (especially now that housing prices have stabilised and actually begun to raise again).
In ending, I think it is worth mentioning that not all banks are created equal—nor is their management team. What I have presented today is a composite view of loan performance for the entire U.S. banking industry. Using the FDIC’s data base one can perform the same analysis on each and every one–large or small–of the more than 7,000 operating banks in the United States.
Next week, I intend to provide Business Insider a more detailed breakdown of the above analysis, which will show how the loan performance differed during our crisis between (1) the Big Four banks (i.e., Bank of America, JPMorgan/Chase, Citigroup, and Wells Fargo—all with more than $1 Trillion in assets; (2) the next tier of Thirteen Banks with more than $100 Billion and less than $1 Trillion in assets; and (3) the rest of the 7,000 plus operating banks in the United States.
As I just mentioned, loan performance varied between bank to bank, and I think the reader will find next weeks’ comparative analysis rather interesting.