“Bank Profits Mirage”

There is a great and troubling little post up at Annaly (hat tip reader Scott) which confirms that all is far from well in bank-land. This story is consistent with the negative readings coming from bank maven Chris Whalen, whose latest proprietary stress ratings based on FDIC call reports found that :

the far worse result for our Stress Index survey vs. Q2 suggests that levels of stress in FDIC insured banks are continuing to build, from multiple factors, even as the subsidies that make the large banks look less risky are being withdrawn.

The issue it focuses on is the profits-goosing strategies employed by banks, namely underreserving. Just as retail stores haircut their revenues to allow for returns, so to do banks provide for a loan loss reserve (an expense item) in anticipation of losses. Loan losses are just as much a part of doing business for banks as returns are for retail stores.

Annaly tells us that the FDIC Quarterly Banking Profile show that loan loss reserves, although higher than the level of 3Q 2008, is lower than the levels of 1Q and 2Q 2009. And that is cause for pause:

If we had improving (or at least steady) credit performance, or a banking system that was already adequately reserved, falling provisions wouldn’t be a red flag. But we don’t. The chart below is an old favorite of ours, one you’ve seen before and one you’re likely to see again (click to enlarge).

It confirms that credit performance continues to deteriorate and the coverage ratio is certainly not what we’d call adequate for any scenario other than a rosy one. As non-performing assets and net charge-offs climb unabated, a lower loan loss provision (one that is lower than 2 of the previous 3 quarters) cannot be justified. If banks had held their coverage ratio steady at 63.6%, where it was in the previous quarter, this would have called for an additional provision of $12.9 billion, which more than wipes out the $2.8 billion in “profits” for this quarter. Instead, to produce those headline profits, the coverage ratio drifted further south, to stand at only 60.1%. It’s impossible for outside observers to say what level of reserves is adequate to cover future losses. After all, if a loan is collateralized, losses won’t total 100% of the loan. We can’t say what the “correct” amount of provisioning is, but it isn’t 60%. The average coverage ratio in the nearly 15 years before the crisis began is roughly 140%. The current coverage ratio won’t do, not when credit continues to deteriorate (and not if you want an active and lending banking system).

Extend and pretend…..and this pattern clearly shows that the regulators are enablers.

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  1. Uncle Billy Cunctator

    Well aren’t they elegant on their expensive rug.


    Check out their CBoD/CEO, Farrell’s profile on Forbes. What’s that? He’s not there?


    Here’s one from the trashcache:

    He wouldn’t be trying to hide his old ties to Schroder Wertheim or Rothschild would he?

  2. Cullpepper

    Not to be nihilistic or anything, but a year of reading this blog and I feel unable to trust *anything*. The government? Nah. The regulators? Nope. Banks? Hah!

    So, Yves, what does your standard gen-xer with no assets and mountains of college debt in a job-free society apply himself to?

    Poetry? Goat farming? Target practice?

    Sigh. I should just quit reading the news.

    1. Yves Smith Post author

      A certain amount of Zen detachment and/or black humor is called for at times like these. And failing that, a stiff drink works too.

      It is pretty horrid. I grew up believing in some (not all, mind you, but some) of the conventional crap in my youth. The worst is that the ones who came after me were for the most part far more true believers. That’s why you can see such vitriol in comments. Their fundamental beliefs are under assault, and they’ll shoot the messengers rather than face the ugly facts.

      1. cougar_w

        My greatest fear is a wide spread failure of civil discourse, and an associated rise in violent expression. Hopelessness and injustice create desperation, and desperate people will sometimes do desperate things.


    2. Stanhope

      I’m beyond jaded, and have entered into a kind of permanent skepticism.

      A “financial services adviser” came to hype my small company’s new 401k plan. His pitch was a mix of truths, half-truths, and outright lies. I bit my tongue throughout, but when he praised the suspension of mark-to-market I resolved I would have nothing to do with him.

      I have friends at the same company who ask me, in all innocence, if I’m going to be setting up a private meeting with the adviser. I can hard get started explaining why Everything They Know About Investing May Well Be Wrong without sounding like a crank.

  3. Waldo


    Please excuse me.

    I have a simple question:

    Does the Fed hold gold physical stock for any reason?

    Thank you for your assistance.

  4. Hugh

    I think we all know the books are being cooked. It is posts like this one that shed light on the various ways this is being done.

  5. killben

    “Extend and pretend…..and this pattern clearly shows that the regulators are enablers”

    You have GOT IT WRONG!!

    Regulators, Government et al ARE THE LEADERS .. BANKS are tiny followers in this fantasyland of Extend & Pretend, Hide & Hype …

  6. timbo


    This post ignores the fact that many banks are borrowing via the FED from good-hearted taxpayers at near 0.00% daily, 0.000% monthly, and an ultra-cheap 0.0000% percent annual basis.

    When you take that oft overlooked fact, and then realize that they will be investing these funds in quality assets such as 10 year treasuries at 3.5%, you will quickly realize that things are not as bad as they seem.

    In about 15 years they will be healthy as a horse.

    In speaking of such things – asset quality and credit performance, you show yourself to be a bit of a luddite, and are clearly unschooled in the spohistries of modern banking.

    Whats that? Oh sweet…. more troops to Afghanistan?

    1. cougar_w

      You imply that after 15 years of QE and FED money printing the banks will be healthy. So stay the course. Is that right?

      To summarize the general thinking on this, another 2 years of QE will destroy the country. And that I believe will destroy the banks.

      Healing is great, but if the rate of healing is longer than the time to live you need to do something else.


  7. mg

    I echo cullpeppers sentiments. Nothing is as it seems and all information has a spin. All together a crappy way to live by doubting everything offered for public consumption.

    PS!!! Very disappointed in censoring the archives to exclude Jesse’s personal gold diatribe and the resulting negative populist response. Then allowing his followup to not have public comment??? Following in the form of non democratic process perfected during the Bush admin. Great judgment.

    1. Yves Smith Post author

      I did NOT censor the archives. His post crashed the entire site. My tech guy had to disable it. He was not able to figure out what was wrong. I had this happen once before, and two hours of efforts to debug did not succeed, I had to remove the post that time too.

      1. Anonymous Jones

        It’s the government that crashed the site and corrupted the post! They don’t want the ideas out for public consumption! I’m sure of it! Nefarious bastards!

  8. mmckinl

    Great post Yves.

    This can’t be any great surprise. They’ve threatened FASBY into wholesale concessions. The Housing market is headed into round II of foreclosures as layoffs continue and loans reset and recast. CRE is headed for a nasty crash. Personal and business bankruptcies are skyrocketing. We are one calamity away from a complete meltdown.

    Citi bank is at around $4 … the canary in the coal mine is breathing hard …

  9. Expat

    The major banks have no need for reserves; they have the full confidence and support of the US taxpayer. Why waste money on reserves when you can use it for salaries and bonuses!

    I only wish I were being sarcastic.

  10. Kay4


    Do you think that for those people who were believers in these institutions we have hope in the future and things will change?

  11. Siggy

    If you want some change YOU are going to have to initiate it. When you apprehend that fact, you might also consider attending a revolution. Well, maybe not a guns and bombs one but perhaps a ballot box one, vote the incumbents out. Keep doing that until they get the message.

    As to this post, the banks may, or may not, be booking earnings. Their problem most probably is that they still have a lot of worthless paper that needs to be liquidated. Either write it off, or find some other dummy to buy it. A good place to look for buyers would be the Fed.

    The pretend and extend business is with us because the Feds do not know what to do. Their economic models have no application. They exhibit no understanding of the pernicious effect that the continuous loss in the purchasing power of the currency has had, and is continuing to have, on society. They think that something like a 2% per year rate of inflation is acceptable and, in fact, they consider it to be a good job. Consider that 2% per year and in about 35 years the price of everything doubles.

    There is no painless solution to this problem. Sadly, I see no leadership in the politiccal community, nor the academic community that is offering any form of resolution to the problem. What is most disheartening is the fact that this is a simple problem with mildly complex side issues.

    The problem at hand is too damm much debt that cannot be serviced. The resolution is liquidation. First by repudiation; second, by the liquidation of the debt itself; and third, by sale of other assets. The government, by taking on additional debt is effecting a devaluation of what is already a debased currency.

    The course we have elected to follow is to borrow more money. We would have been much better served to have followed the Swedish model and nationalized the insolvent banks and proceded with their liquidation in a comparable manner. If we continue to borrow more and more, there will not be enough GDP to service the accumulated debt let alone pay it down. A national default is a real possibility. Wait for it, its coming soon to a TV near you!

  12. cougar_w

    The banking system — including several of the largest banks — have been effectively nationalized via FED backstops and the Treasury backstopping the FDIC. As such the banks operate now with the full faith (and taxation capacity) of the US government.

    The US Treasury is entirely their reserves. Equally, the dollar as global reserve currency is their reserve too since Ben can print as many as he needs to on demand.

    Banking in the US has become one huge party. These guys cannot lose. All they can be is eaten, and the larger ones are steadily eating the smaller ones. TBTF will become a national past-time sometime next year.

    I have no idea how we’re going to get free of this awful tangle. Well I can think of one way, but “conflagration” is such an ugly word.


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