Banking System Continues To Restructure

Includes: IYF, XLF
by: John M. Mason


Loan growth is taking place in the commercial banking sector.

The loan growth, however, is helping the economy to restructure.

This restructuring is necessary before real economic growth can take place once again.

My view on the latest banking statistics is about the same as for last month, "Commercial Bank Lending: Still Not Supporting Economic Growth." Bank lending is up for the quarter, but my interpretation of the data remains the same: the lending is doing very little in the way of underwriting faster economic activity.

And, there still is a substantial division in bank business between the largest twenty-five domestically chartered commercial banks in the country, the "smaller" commercial banks and the foreign-related institutions.

For one, the "big" banks continue to see their residential mortgage portfolios decline. This, as will be noted in a future post, shows up in the earnings performance of the early earnings reporters like JPMorgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC) whose earnings have been impacted by a "slow" mortgage market.

The largest domestically chartered commercial banks saw their residential real estate portfolio decline by over $8.0 billion since January 1. But this just continues the yearly trend where these banks saw this portfolio shrink by almost $90.0 billion.

On the other hand, small, domestically chartered banks experienced an increase in residential real estate loans. Over the past thirteen-week period, residential real estate loans increased by $23.0 billion, while over the year, the increase was almost $28.0 billion.

The data for "small" banks reflect the slow January and February period, impacted by the weather, but residential real estate loans jumped up by over $14.0 billion in March. It is not entirely clear whether or not these increases reflect new construction or the refinancing of existing mortgages or new financing on foreclosed properties. I am not totally convinced that the numbers reflect a bounce in new construction.

Commercial real estate lending continues to rise at both the smaller and the larger banks, albeit at a much faster rate at the "smaller" institution. Over the past 52 weeks, this lending category at the smaller banks has risen by almost $85.0 billion. Over the past 13 weeks, commercial real estate loans have increased by almost $23.0 billion, so the pact seems to be relatively constant over the year. This is confirmed by the fact that these loans rose by almost $7.5 billion over the last four weeks.

As readers of this post know, I believe that this increase in commercial real estate loans contains good news and bad news. The good news is that commercial real estate lending is increasing through deals being refinanced with additional monies going into the loans to support the additional cash needs of the projects.

The bad news, in my mind, is that many of these loans are going to projects that could not be completed during the Great Recession or the subsequent "tepid" economic recovery but are being "turned over" into new loans with the additional monies needed to make them "alive" again. Many of the projects I now see underway were on the drawing boards four or five years ago and had received previous financing that had not actually been put to use. The past issue had always been about what would happen to these loans when they matured. We are getting the answer now…they are being rolled over. But, this is not like new projects that are coming off the drawing boards with a clean financial slate behind them. These loans will be something to watch in the future.

Commercial and Industrial loans, business loans, continue to rise, although the growth slowed some in March. The encouraging thing to me is that there seems to be some pick up in business lending at the smaller banks. As far as I can tell, these funds are going to support new business expansion. Again, we shall see how this works out over time.

As far as the largest domestically chartered banks, their business lending actually declined modestly over the last four-week period, although these loans rose by over $26.0 billion in the last quarter. The concern here is that many of these loans are going to hedge funds and private equity funds that are using the funds to support the building of asset-backed or cash-flow backed securities. This behavior has been particularly evident in the residential real estate area.

The good thing about these loans for the banks is that they are to very credit worthy customers. The other side of this as far as economic activity is concerned is that the loans are connected to the restructuring of markets, like the real estate market, and are not connected with a lot of new production that increases output and puts people back to work.

Thus, the larger banks, while not performing that well, are still outperforming much of the banking system. In a recent post, I wrote that a "Wall Street Journal article reports that 21 percent of the smallest banks had quarterly losses in the fourth quarter of 2014 and only 50 percent had earnings growth year-over-year in the fourth quarter of 2014. The return on assets of these smallest banks was 0.63 percent in the fourth quarter and their return on equity was 5.43 percent."

The larger banks may be suffering but they do not seem to be anywhere close to the difficulties being experienced by a large number of the smaller institutions.

Something new took place in the banking industry in March that had not happened for some time. The cash assets in the commercial banking system actually fell by $3.4 billion.

How did this happen while the Federal Reserve was actually buying approximately $65 billion in securities during this past month? Well, to get more of this story you will have to go to my post Federal Reserve Watch: Calm, So Far and read about how the Fed is working with reverse repurchase agreements to get ready for a return to "more normal" times in the financial markets.

Over the past 13-week period, however, cash assets at commercial banks rose by almost $425 billion. This certainly is an indication that the Fed's tapering of security purchases is not representative of a "tight" monetary policy.

Most of these cash assets, more than 80 percent, wound up in the vaults of foreign-related institutions. I have written about this outcome many times, here is the most recent post. The most import thing about these balances is the role they play in dollar assets going "off shore." Over the past thirteen weeks, these foreign-related institutions placed $232 billion in net deposits to foreign offices. This is a substantial flow, although there was a modest decrease in the total in the month of March.

In general, the United States banking system is going to a substantial restructuring. The number of banks in the country is shrinking, the size of banks is getting bigger, and the loan portfolios of the banks are reflecting the restructuring…not the growth…of the economy. In other words, the whole economy is changing, and it is a change that is apparently necessary. When an economy goes through such a change, lots of things are happening, but one of them is not necessarily growth. But, the economy needs to get to the other side of this restructuring before it can become strong again.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.