So the Fed is going to stress test the 6 biggest U.S. banks, again. For those of us who've been arguing for over a year that the major banks are chronically under-reserved for the sickly reality that is the U.S. real estate market, its a bit of a vindication. After all, anyone who simply followed the (rapidly declining) trend in loan loss provisions at domestic banks over the past 11 quarters (they've fallen 74 percent over the period) could be forgiven for wondering why another round of tests is even necessary, let alone mandatory? Why won't the Fed get off their backs? Haven't banks been signaling an impending "all clear" for credit for a while now? What gives?
Logically, the best evidence of an improvement in credit would be a meaningful increase in loans outstanding. We have yet to see it. According to the FDIC's latest quarterly survey, net loans and leases at U.S. banks are still 8.9% below the level of the third quarter of 2008. Total loans did manage to edge up at a 1.2% annualized rate in the third quarter of 2011, mostly due to a healthy increase in the commercial and industrial category, but real estate loans are still declining. And with good reason. Why would banks lend against property which continues to slide in value, especially when they know the backlog of supply is on the upswing? Remember, the robo-signing scandal has now faded from view enough that the foreclosure engines are cranking up again. A RealtyTrac executive described the situation this way in their October foreclosure report:
"The October foreclosure numbers continue to show strong signs that foreclosure activity is coming out of the rain delay we've been in for the past year as lenders corrected foreclosure paperwork and processing problems," said James Saccacio, chief executive officer of RealtyTrac.
A rain delay. Hmmm. Sounds like home prices might be headed lower. Saccacio goes on:
"However, recent state court rulings and new state laws keep changing the rules of the foreclosure game on the fly, creating more uncertainty in the housing market and threatening to prolong the road to a robust real estate recovery."
Question: Do you suppose bankers are happy or UNhappy with these rule changes? Given the apparent lack of interest in secured real estate lending, I'd say they really don't care. They're just as happy to slow-walk the foreclosures, put their money in Treasuries and (taxpayer-guaranteed) agency bonds and be done with it. And the numbers back me up. Since the panicked third quarter of 2008, security holdings at U.S. banks have increased by a whopping 38%. Again, over the same period loans and leases declined almost 9%, and overall assets rose just 2%. Bottom line: Why bother rushing the foreclosures and taking the political heat when you can get cheap money from the public and wait it out? Sadly for 14 million unemployed Americans, its all very deflationary.
But the endgame may be approaching. Wall Street has become profoundly unhappy with "extend and pretend" as evidenced by shrinking price-to-tangible book multiples for all the major banks. Analysts are busy slashing their long-run estimates of "normalized" return on equity (ROE) for the industry as well. Either the banks get busy writing down their surplus real estate to realistic values, thereby clearing the decks for future loan growth, or they'll find their P/E ratios permanently impaired. And no amount of stress testing by the Fed will fix it.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.