Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Credit Quality and the Suffering Banks

By

Given that human nature goes through all aspects of denial, fear, depression and panic, declines in credit quality take much longer to play out than most market participants anticipate.

PrintPRINT
The following is the latest missive from Minyan Peter, author of popular articles like the Bank Earnings series.


First, credit quality is getting worse, not better. In fact, one could easily argue that the pace of decline has accelerated during the third quarter. For example, in early September, Washington Mutual (WM) estimated that its full year credit loss provision would be $2.2 billion. As of last night's press release, that number is now estimated to be $2.7-$2.9 billion. (And again, as a point of perspective, WaMu forecast a $1.5-1.7 billion figure in July.)

Second, historical recovery assumptions on mortgages and home equity loans are now in question. With the accelerating decline in home prices, not only is the number of defaulting loans rising, but the severity of loan losses ($ loss per loan) is accelerating. This is likely to result is greater and greater provisioning for the same notional amount of non-performing loans.

Third, comments on indirect lending activities have been universally negative – whether mortgages, home equity loans or automobile loans. I raise this because, up until recently, most of these loans had been packaged by banks and resold into the secondary market. As the banks represent "deep pockets" we should expect to see more and more secondary market investors claiming foul and seeking recourse.

Fourth, in its prepared remarks last night, WaMu specifically added credit card loans to the list of deteriorating assets - suggesting both higher future delinquencies and lower recovery rates for these assets.

Finally, a word of caution. From my perspective, there are two distinct elements to a down hill credit cycle which I believe most people combine into one. The first is the repricing of risk. To me this best resembles a car being shifted from "drive" to "reverse" at 100 mph. This is what we saw in August, and arguably what we are seeing right now. Here, the market tends to extrapolate both down (August) and up (September) future credit quality; and, as a result, mark-to-market pricing moves wildly in both directions. It is also why financial stocks become such "value traps".

Under the surface, however, is a much more steady, albeit accelerating, decline in credit quality. Given that human nature goes through all aspects of denial, fear, depression and panic, declines in credit quality take much longer to play out than most market participants anticipate.

As a consequence, and as we have already seen to a limited extend, the collapsing of our credit balloon is much more likely to resemble a series of waterfalls, versus a one-time October 1987 like stock drop. (Remember too, that one of the critical roles of the Federal Reserve is to slow the pace of decline. And in fact, Mr. Bernanke all but admitted that in his most recent speech to the NY Economics Group.) Also, don't forget, that if you look at bank stocks they continued to drop from 1987 through 1990.

This is not to say that there won't be panics along the way. There will be. And many of them will be severe, particularly given the magnitude of the credit contraction underway. But I believe both traders and investors would be wise to ignore any notion of a "one and done" credit market correction.
< Previous
  • 1
Next >
Position in SKF
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
PrintPRINT
 
Featured Videos

WHAT'S POPULAR IN THE VILLE