Seven Deadly Sins of Banking: take home notes
Higher Structural Risk
- The seven deadly sins of banking include greedy loan growth, gluttony of real estate, lust for high yields, sloth-like risk management, pride of low capital, envy of exotic fees, and anger of regulators.
- To a degree, each reflects a way that banks tried to compensate for lower natural rates of growth by taking more risk.
- The effect was to front-load earnings only to have back-ended costs, the brunt which is getting felt today. The consequences of this risk, while not new, seem only midstream and have more to go.
- We expect loan losses to increase from 2% to 3.5% by year-end 2010 given ongoing problems in mortgage and an acceleration in cards, consumer credit, construction, commercial real estate and industrial.
- Pre-tax, pre-provision profits should get hurt more than in the past given a greater portion of market sensitive fees, higher deposit insurance, and fall-out from a higher risk securities portfolio, as well as a historically high starting level of consumer debt.
- Most of our estimates are below consensus.
Government actions are a Catch-22
- The government can go easy on the banks but, if so, would leave many of the toxic assets on balance sheet (at least as it relates to loans vs. securities).
- Alternatively, overly tough actions will trigger the need for large capital raises by the banks.
- Relaxation of mark-to-market accounting rules impacts balance sheets by only one-quarter to one-third or less and, where it could impact, reflects a potential artificial accounting-induced capital injection that does not change the economics.
The crux of the problem according to Mayo: 5.5% projected cumulative losses on loans. On a $7 trillion base, this implies $250-$400 billion annual losses, or $650-$1 trillion over three years. This should be no surprise to our readers. Also as a reference point: Mayo estimates loans are marked down to only 98 cents on the dollar on average (compared to low-mid 90s per Goldman). We reference readers to our post from two weeks ago discussing this very issue. (click on chart to enlarge)