What's Going On In The Banking Sector? Nothing Very Good

Includes: IYF, VFH
by: John M. Mason


The banking sector continues to decline in number as the average size of banks become larger and foreign-related institutions take on more US assets.

Commercial real estate loans continue to boom at "smaller" US banks as regular business loans at these banks declined over the last thirteen-week period.

Business loans at the largest 25 domestically chartered banks continued to rise at a decent rate of increase of 10 percent, year-over-year.

Commercial banks grew in total assets by 3.2 percent over the past twelve months. The largest 25 domestically chartered banks grew by only 2.9 percent, while the smallest domestically chartered banks grew at a 7.0 percent rate year over year.

The largest 25 domestically chartered banks represent 56.9 percent of total banking assets in the United States while foreign-related institutions had 14.5 percent. This meant that the rest of the domestically chartered banks in the country held only 28.6 percent of the assets. This latter percentage keeps declining year after year.

One other piece of information on the makeup of the banking industry: in 2015 there were 265 bank mergers and one bank failure, so the number of banks in the country continues to fall. And, of course, most of the decline in numbers is in the less than $100 total asset category.

Bank mergers increased last year over the 238 mergers in 2014 and 203 mergers in 2013. The number of mergers will continue to grow every year, representing, I believe, the basic weaknesses that currently exist in the banking sector.

Over the past twelve-month period, cash assets at commercial banks fell by $271 billion, which was consistent with the decline in excess reserves on the Federal Reserve's balance sheet.

The interesting thing, however, is that of the $271 billion decline, $141 billion of the fall came from foreign-related institutions. The decline at the largest 25 domestically chartered banks was only $133 billion.

Bank loans and leases increased year over year by 8.0 percent, with the largest increase coming in commercial real estate loans at 11.3 percent. This latter increase totaled over $183 billion, with more than half of this increase, $104 billion, coming in the "small" domestically chartered banks.

As readers of my posts know, I have a great concern over what is taking place in the area of commercial real estate lending. Delinquencies have been increasing and there has been trouble in the area of hotel financings and bonds backed by commercial real estate loans.

This is an area that needs to be watched closely and the continued rise in loan volumes, some of which are just being added to existing projects, is not a good sign. Furthermore, since these loans tend to have a longer-term maturity and do not pay off until the end of the loan, they can be carried on the books of the banks as good healthy loans that the bank examiners can easily pass on.

Business loans continue to show a good rate of increase, 10.1 percent year over year, but the major rise in commercial and industrial loans are at the largest 25 domestically chartered banks.

In fact, over the past 13-week period ending March 30, 2016, commercial and industrial loans at the "small" domestically chartered banks have fallen by $15 billion. These business loans rose at the largest 25 domestically chartered banks by more than $58 billion.

The smaller banks are getting tied up more and more in commercial real estate loans and losing market share on regular business loans. This does not seem to me to be a good indicator of how business is progressing across the country.

Another interesting development is the role that foreign-related institutions are playing in the commercial real estate area. Over the past year, commercial real estate loans at foreign-related institutions rose by $16.3 billion.

The shocking thing is that this is a 47 percent increase in the amount of commercial real estate loans that are on the books of these foreign-related institutions.

Residential real estate loans grew by only 2.3 percent year over year, although there seemed to be a pickup in lending over the past thirteen-week period.

As I have written earlier, I am not a big fan of investing in the commercial banking sector. I fear that too many banks have not regained their full health after almost seven years of economic recovery from the Great Recession.

Furthermore, the interest rate scenario is not good. Such a flat interest rate yield curve cannot provided a sufficient net interest margin for the banks to prosper. Furthermore, for the bigger banks, the loss of fees from trading activity is not helping out their performance numbers at all. I am not expecting the earnings results this month to provide any encouragement for investors in banks.

Finally, the upcoming changes in banking resulting from changing information technology and from regulatory adjustments are not going to help the banking industry profit-wise. I expect that bank mergers will continue to run at more than 200 per year for the next five years or so, reducing the number of banks in the industry by close to 1,500 banks.

This is not a very optimistic outlook. It could be worse if we hit another recession along the way.

Disclosure: I/we 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.