Update on the U.S. Credit Situation

by: Erwan Mahe

While everyone remains fixated on European political leaders and their proposals to overcome the Greek debt crisis, today I have instead decided to re-examine the most important macro factors for the next 18 months. Namely, changes in outstanding credit in the United States. Our analysis continues to rely on Minsky whose work has helped us successfully weave through the past six years.

Here are two graphs which speak volumes about the situation today.

Bank bankruptcies in the United States

They are off to an even steeper pace in 2010! (Click to enlarge)

Although investors no longer seem interested in this type of news item, since we apparently can get used to anything (return of resilience, our favorite theme of 2003-2007?). Seven banks went bankrupt last week in the United Estates, including State Bank of Aurora, First Lowndes Bank, Bank of Hiawassee, Appalachian Community Bank, Advanta Bank Corp, Century Security Bank and American National Bank. Assets: $3.32bn in bankruptcies of which the FDIC assumes a cost of $1.28bn, or 38.55%!

This constant rise in bankruptcy costs for the FDIC in relation to the assets of shuttered banks can be clearly seen in the table below:


No. of Failed Banks

Total Assets of Failed Banks

Loss to FDIC's DIF




$113,000,000 ratio Loss/Assets :4.34%




$15,708,200,000 ratio Loss/Assets :4.20%




$36,432,500,000 ratio Loss/Assets :21.32%




$6,189.900,000 ratio Loss/Assets :28.64%

As you can see, the amount of the FDIC's losses in relation to the assets of seized banks has been increasing: At slightly above 4% in 2007 and 2008 (with the $307bn Washington Mutual bankruptcy having a huge impact in February), this proportion has climbed from 21.32% in 2009 to already 28.64% in 2010.

This surge logically represents the poor quality of the regional bank assets, which tried tried to survive banking regulations by booking low provisions on their toxic assets in recent years. The FDIC must update these asset prices upon seizing them.

According to the Congress Oversight Panel (see 190 page report here), nearly 3,000 small- and medium-sized American businesses are now struggling, due to the heavy concentration of commercial real estate loans (CRE) in their portfolios.

Some $1.4 trillion in CRE must be refinanced between now and 2014, while the value of the underlying assets has declined by an average of 40%.

The losses are estimated at between $200bn and $300bn.

Given that holders of Mortgage Backed Securities (MBS) -- residential assets this time, like Fannie Mae (FNM), Freddie Mac (FRE) (Fannie, Freddie Ask Banks to Eat 21 B$ of Soured Mortgages) and the Federal Home Loan Banks (FHLB files $19.1bn complaint against Wall Street) -- are trying to send those MBSs they consider to be fraudulent back to originating banks, it should come as no surprise that we continue to see little chance of a resurgence in credit in the Untied States, as confirmed by the graph below.

Bank credit in the US

This sort of correction is unprecedented and shows no sign of letting up… (Click to enlarge)

As you can see, it is not a pretty picture.

Asset allocation biases:

  • Interest rates: The Greek torment is bolstering the Schatz [Treasury], which is hurting the bets on this part of the yield curve. But we continue to consider that history is on the side of flattening, and our choices in maturities and structures, below, brings an added measure of protection.

  • Equities: Stock markets remain generally murky, which, on the other hand, can be seen in the very low implied volatility levels of Eurostoxx options. We are beginning to see some opportunist switches (long or short) vs long option positions (calls or puts).

Disclosure: Long 20 years OAT and 30 years BTP Zero Coupons, EDF Corp 5 Years 4.5%, Grece 2 Y and 10 Y bonds