Bill Cassill's  Instablog

Has anyone seen the latest press releases from the FDIC on bank failures on July 2nd?

If you haven't seen it yet, you can catch it here.  Calculated Risk also has a nice announcement on it as well.  Those who have read previous posts of mine know that I like to do time series forecasting of future financial events.  Well, bank failures are no different.

I actually created this forecast back in May using ARIMA.  We can see that the forecast of 28 bank failures came in pretty close to the actual number of 24 for Q2.  However, what is really disturbing is that we already have 7 new bank failures in the first 3 days of Q3.  I'm predicting that we will have around 35 failures this quarter although at this rate, the actual number of failures may actually exceed forecast.  I'm looking for around 125 failures for this year in total with another 230 banks going under next year.  While this is a small number compared to the 8300 institutions chartered by the FDIC, the numbers are astronomically large when compared to the relative lack of failures in years past (usually much less than 10 in any given year from 2000 to 2007 with the exception of 2002 which had 11 failures).

If you are a U.S. based banking consumer, my recommendation is to keep your money under the FDIC insurance limit of $250K per individual in any one bank This number is different if you have a joint account with a spouse.  You can check out the amount of insurance coverage you have by going HERE.  Anyhow, be vigiliant and your money should be safe.

Disclosure: no positions

Everyone is talking about the smart boys at Goldman Sachs and J.P. Morgan Chase 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.

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 occassionally with financial services companies of whom Bank of America has been a client.  He currently has no positions.

Since March, the Wall Street talking heads have been having a pep rally.  “Rah! Rah! Rah!”  Shake the pom pom’s.  Have you popped the bubbly yet?  Don’t bother.  I looked at the S&P 500 index a little closer today just to see what was going on.  If we follow the index back to 1990 we see we have had 2 large bull markets.

Both bull markets were strong multi-month advances in equities.  But what of the current rally everyone is talking about?  What I am about to cover may be a bit technical for a general business audience, but it underpins several measures as used in technical analysis of stocks (particularly the MACD measure).  If we look at the 100 day and 200 exponential moving average plotted over the same index, an interesting pattern emerges.

For every single long term rally going back the last 19 years the 100 day EMA (i.e. exponential moving average) exceeds the 200 day EMA.  When the market has topped and started a long decline, the 100 day EMA crosses and then slips below the 200 day EMA.  This has been the pattern for almost 20 years.  So what of the current “rally”?  Well, let’s look at the chart.  We can see where the S&P topped out around mid 2007 and then started its long decline.  At the same time, particularly starting from late last year, the 100 day EMA has been far below the 200 day EMA.  As of yet, the 100 day EMA has yet to converge on the 200 day EMA which indicates from a technical analysis perspective that a real rally is not in the works.  At least not yet.  Two additional points deserve mention.  Compared to the long market decline from the tech bubble in 2000/2001, this market decline has been more of a collapse particularly from October 2008 to March 2009.  Second, the economic fundamentals are simply not there to support a real recovery.  Banks are just now starting a 2 year or longer process of realizing credit losses from credit cards, HELOCs, and CRE.  Unemployment will continue to rise for at least the next year and may exceed 12% (based on my forecasts) by year’s end.  And no one is lending in this current environment (and rightfully so).  So, what does all this mean?  I think what we have on our hands is a typical bear market rally.  But you don’t have to take my word for it.  Just ask why executives have been dumping their shares at the fastest pace in two years (courtesy of Bloomberg).  Obviously, it seems that these guys know something we don’t.  My advice is this: don’t be a sucker in a sucker’s rally.  You stick your money into the market at your own peril.

Disclosure: no positions