Banks: Long Way to Go Before Things Get Better

Everyone is talking about the smart boys at Goldman Sachs (GS) and J.P. Morgan Chase (JPM) paying back their TARP money early. Everything must be okay, right? Don’t be fooled. The banks are a long, long way from being out of the woods.

The problem is credit losses on the stuff banks have kept on their books. You know, credit cards, home equity lines of credit (a.k.a. the home ATM machine), and commercial real estate. Have we really seen the end of the losses? The problem is that losses are just now beginning to mount.

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Source (FDIC Statistics on Depository Institutions Quarterly Data)

As of the end of 2008, net loan losses for all banks was almost $32 billion - a precipitously sharp increase from the end of 2007. The problem is that losses will only continue to head north. Using single series ARIMA, we can create a forecast of what potential losses would likely look like over the next several quarters.

Forecast in Thousands of Dollars

This forecast was created prior to the release of Q1 2009 data from the FDIC. However, when the data was finally released, total net charge-offs for Q1 totaled $37.8 billion. This was very close to the forecast of $35.4 billion and well within the 95% confidence interval of our forecast estimates. From this forecast, cumulative net loan losses are likely to amount to between $142 billion and $198 billion by year’s end. Total cumulative net loan losses are forecast to be between $315 billion and $511 billion by the end of 2010. For an industry that started out with only a trillion dollars in tier I capital as of the end of 2008, these losses will be catastrophic.

I’ve written before that we have a ways to go before we see the end of the carnage. And these are losses of just the loans retained on the banks’ books. They do not include continued losses that banks will also suffer due to bad investments in derivatives like mortgage backed securities. As we have seen in the last few weeks, there has been plenty of bad news regarding charge-offs and write downs:

Goldman Sees $1.2 Trillion in Credit Losses

Bank of America net falls on credit losses

US credit card chargeoffs break new record – Moody’s

And we could go on and on. Amid this environment, anyone who thinks we are about to turn a corner needs to think again. We have a long way to go before things get better.

Disclosure: Bill consults occasionally with financial service companies of whom Bank of America (BAC) has been a client. He currently has no positions.

Comments

[W Buffett:]

And yet, these stocks would make great investments because their distressed levels already reflect these negative forecasts.

Jun 28 10:20 AM

[Mad Hedge F...:]

They certainly do. I have really been avoiding financials for the last few months after they had their dead cat bounces. However, I had to listen to Midsouth Bank CEO Rusty Cloutier when he spoke on CNBC. His 24 branch bank, with a market cap of only $103 million, is based in Lafayette, LA, one of my old stomping grounds and home of the world’s greatest étouffée and shrimp gumbo. He says that “Unless we break up the big banks and get back to sound banking principles we are going to relive this over and over again….Free enterprise has to have the right to fail….Allan Greenspan and his administration have some problems they have to ‘fess up to.” With the current system of megabanks “they get the gain and we get the pain….I’m regulated now by 13 agencies of the US government and I don’t know that I need a 14th.” There’s no one who can read you a riot act like a Southern regional banker

Jun 28 03:47 PM

[Fitz919:]

5 more little banks failed on Friday, that makes 45 so far this year. At least one of them had no buyer, so the FDIC starts cutting checks and mailing them to depositors on Monday. Oh yeah, the banking sector is just great. I'm holding my short position with TZA.

Jun 28 09:45 PM