Lending Metrics, Part II: Are Businesses Borrowing?

In Part I of this series of posts on lending metrics, we looked at the use of lending volumes to indicate whether or not banks are lending, arguing it is a poor indicator of current lending. A closer look that breaks down the numbers reveals that banks initiated roughly $1.2 trillion in new loans in 2009 – a remarkable accomplishment in difficult economic times.

Today we’ll look at loan demand – the metric that illustrates whether people and businesses are borrowing. According to the Federal Reserve, banks have been experiencing a deep fall off in loan demand (see the chart below) – no surprise during this, or previous recessions. High levels of unemployment clearly are affecting consumer loan demands; businesses as well either do not want to take on additional debt or are not in a position to do so, given the falloff in their customer base.

The decline in loan demand continues, but there are fewer banks reporting a falloff of demand. And some positive signs are beginning to appear, as more small businesses are returning to test the market for loans, even though they may not wish to borrow at the moment. It will take time for this renewed interest to be translated into new loans made, however. In fact, our research shows that it typically takes 13 months after the recession for business confidence to return and credit to return to pre-recession levels.



Also see Lending Metrics, Part I: Are Banks Lending?
And Lending Metrics, Part III: Are Businesses Using Available Credit?

Lending Metrics, Part I: Are Banks Lending?

Often repeated – yet rarely investigated – in Washington and in the media is that banks are not lending. Critics of the banking industry point to a simple metric to support their conclusion – lending volume at the beginning of the year versus at the end of the year. At the end of 2009, lending volume was $600 billion less than at the beginning of 2009. But the factors that determine the ultimate level of lending are complex and cannot be captured in a simple comparison of volumes. A look at the chart below illustrates some of these factors and shows that, in fact, banks initiated roughly $1.2 trillion in new lending in 2009.

At the start of the year, total loans across all business lines on the books of banks totaled $7.9 trillion. Over the course of the year, banks set aside $248 billion in provisions for anticipated loan losses. This can be seen in the red bar in the center of the chart. In addition, a rough estimate is that at least $1.6 trillion of loans matured or were paid off, visible in the blue box. If banks had initiated no new lending, the year-end loan volume would have been $6.1 trillion.

Just to stay even with last year, banks would have to originate over $1.8 trillion of new loans. In normal times of economic growth and low loan losses, this is possible, but it’s impossible today with the many economic challenges, such as:

• 61,000 business failures,
• 4.7 million jobs lost, and
• 10 percent reduction in business inventories.

It is remarkable, in this context, that banks were able to originate about $1.2 trillion in new loans, for a total of $7.3 trillion at year-end.



Also see Lending Metrics, Part II: Are Businesses Borrowing?
And Lending Metrics, Part III: Are Businesses Using Available Credit?

End of Fed's Balance Sheet Growth Approaching

In what will likely mark the beginning of the end of the Federal Reserve’s balance sheet expansion, the central bank is scheduled to purchase the last installment of its pledged $1.25 trillion in mortgage-backed securities (MBS) next week.

The Fed’s balance sheet has grown from $890 billion in January 2008 to $2.26 trillion in March 2010. Initially, the increase in its balance sheet was due to numerous liquidity programs aimed to address frozen credit markets in the fall of 2008. As the credit markets healed over 2009 allowing the Fed to unwind many of the programs, the outstanding balances of the liquidity programs declined.

As the liquidity crisis passed, the Fed shifted its focus to revive the morbid housing market. The Fed will have purchased all of its $1.25 trillion in MBS by March 31, 2010. As a result, the Fed’s balance sheet is expected to peak later this Spring, as it finalizes and books all of its securities purchases.

Prior to this balance sheet growth, Treasury holdings, used for conducting monetary policy, comprised about 80 percent of its balance sheet. As of March 2010, U.S. Treasury debt, at $776 billion, was 34 percent of the balance sheet, while MBS comprised 52 percent, and liquidity programs were 13 percent, near their January 2008 share of 17 percent yet $141 billion larger in dollar terms.

Why Should We Care About Greece’s Fiscal Problem?

Excerpt from March 22, 2010 Speech by Dennis Lockhart, President and CEO of Federal Reserve Bank of Atlanta

What do fiscal problems in Greece have to do with my economic outlook for the United States?

I see three ways the Greek crisis might directly affect the U.S. economy. First, adjustment across the EU to fiscal problems could dampen euro area growth and constrain U.S. exports to that region. The European Union as a whole is this nation's largest export market. Second, related to this, safe haven currency flows from the euro into dollar assets could cause appreciation of the dollar and hurt U.S. export competitiveness. Third is the possibility that the Greek fiscal crisis could lead to a broad shock to financial markets. This could play out in the banking system or in the form of a general retreat from sovereign debt.

10.03.22 (Source: Federal Reserve Bank of Atlanta)

Long-term Unemployment Jumps

As of February, 6.13 million of the 15 million unemployed men and women have been without a job for over 26 weeks. The sharp increase could signal structural unemployment – jobs being permanently eliminated and a mismatch between job requirements and the skills of potential workers. If structural, a reduction in unemployment will likely be slow.

Prior to this cycle, long-term unemployment, the red portion of the graph below, averaged 13% of the total unemployment count. As of February, long-term unemployment accounted for 41% of the total jobless count, the highest share since available records dating to 1950.

Household Financial Position Strengthening

The financial position of the household sector is getting stronger.

Two measures of financial health, the debt service ratio and the financial obligations ratio, have steadily improved over the last several quarters. The household debt service ratio (DSR) is an estimate of the ratio of debt payments to disposable personal income. Debt payments consist of the estimated required payments on outstanding mortgage and consumer debt. The financial obligations ratio (FOR) adds automobile lease payments, rental payments on tenant-occupied property, homeowners' insurance, and property tax payments to the debt service ratio.

According to the Federal Reserve, the FOR is at 17.76 percent – its lowest level since the first quarter of 2001 when it was 17.72 percent. The DSR at the end of the third quarter was 12.85 percent. The last time it was this low was nine years ago, when it was 12.73 percent.

The household sector still faces formidable headwinds in a weak job market. But these recent improvements with respect to servicing debts and other financial obligations – coupled with the news that household net worth is increasing – makes us more hopeful that consumers will step up their spending in the coming months.

Unemployment Jumps Most for Less Educated

Unemployment rates for all education levels have increased, but most significantly for segments of the labor force with limited education. As of February, the unemployment rate for those without a high school diploma was 10.6 percentage points above that of those with college degrees. The gap hit 10.8 percentage points in October 2009, the largest spread on record.

While the severity of the gap is alarming, the general trend is somewhat expected, since there have been declines in segments have high concentrations of lower-wage labor that generally do not require higher education credentials. These segments include new home and commercial real estate construction, some manufacturing, and auto production.

Headwinds to Labor Market Recovery Part III: Permanent Layoffs

In the first post in this series, we examined how slower job creation in this recession is slowing the recover. Then we looked at how employers are limiting workweeks in order to avoid laying off some employees. A third headwind which will impact the speed of labor market recovery, is the historically low level of those temporarily unemployed. In previous recessions, firms temporarily laid off employees knowing that they would quickly rehire them once the economy rebounded. However, during the current recession, businesses have been more inclined to permanently reduce staff, an indicator that, even as the recovery proceeds, firms are not expecting to quickly re-staff previous positions.

During the six previous recessions, the share of those temporarily unemployed averaged 33.6 percent of total unemployment. In this recession, businesses have opted to make permanent layoffs, pushing the share of temporary layoffs to a record low of 15.5 percent in November 2009.

Those permanently laid off will either have to acquire new skills before re-entering the labor market or relocate to other areas where their current skills are in demand. Neither solution offers immediate relief to the persistently high unemployment rate.

There is some positive news, however. In late 2009, businesses’ use of temporary staffing increased, which in past recessions was a harbinger for future permanent hiring. But businesses still have significant slack in their current employees’ work week, which will need to be utilized before hiring new staff.



Other posts in the series Headwinds to Labor Market Recovery
Part I: Slower Job Creation
Part II: Excessive Slack in Work Week

Delinquency Improvements Due to Jobs and Housing; More Work to be Done

The second consecutive quarter of broad-based decline in consumer delinquencies is very positive news. It shows that consumers are managing their finances better and that banks are exercising a very prudent approach in realizing losses and extending sound credit. It’s also a strong indication that the economy is on an upswing.

Consumers are doing better. They’re taking on less debt, they’re saving more, and they’re building up a little buffer, which is extremely important in these uncertain economic times. Consumers are being sensitive to the debt that they’ve taken on and they’re trying to lower that debt as best they can.

There are a couple of factors that have played prominently in this report. Jobs are the most critical factor in determining consumer credit delinquencies, and we’ve had a horrible string of job losses over the last 18 months. We’ve finally started to see some improvement in new jobs created, but it won’t be until we see a steady increase in jobs that we’ll see delinquencies come down from the levels we’ve had over the last year or so.

Housing continues to struggle, and we did see home equity loans with a fixed repayment increase to record levels. The very good news, though, is that home equity lines of credit fell quite dramatically. This is the first sign of spring in a horrible winter for the housing market.

Headwinds to Labor Market Recovery Part II: Excessive Slack in Work Week

A second headwind to the labor market recovery is excessive slack in current employees’ work schedules. In effort to retain valued employees while balancing lowered consumer demand, employers have reduced work schedules, dropping the average weekly hours worked.

Prior to the onset of the recession, the average work week was 33.8 hours, but as employers began reacting to the decline in consumer demand during the recession, the work week fell to a record low of 33.0 hours in October 2009. Recently there has been a slight improvement in the average work week, which stood at 33.3 hours in March 2010.

However, as the recovery continues in the manufacturing sector and spreads to the service sector, employers have ample flexibility to increase work weeks of existing employees before hiring new staff. To return to the average work week for the six years prior to the recession, employers would have to increase work weeks 1.5%, adding 62.9 million work hours per week for those currently employed.

Other posts in the series Headwinds to Labor Market Recovery
Part I: Slower Job Creation
Part III: Permanent Layoffs
Part IV: Housing Markets

Headwinds to Labor Market Recovery Part I: Slower Job Creation

A recovery like we saw following the 1981 recession is unlikely coming out of this recession. After the 1981 recession – the worst in recent memory – the economy rebounded to recover all jobs lost during the recession in the 12 months after the recession ended. 2.82 million jobs were lost in 16 months. In the 12 months after the recession, the economy rebounded robustly and created 3.08 million jobs. Despite the quick rebound, the economy still took 76 months to arrive at a 5% unemployment rate.

In the current recession, the economy has shed 8.3 million jobs. Even if our economy grew at its fastest pace in the last decade, when 2.5 million jobs were added in 2005, it would take over 3 years of job creation to recover all the lost jobs and this does not address new entrants to the labor force.

The administration is forecasting that only around 1.1 million jobs will be created in 2010, equating to about 104,000 jobs each month for the rest of the year. This pace is indicative of neither a steep reduction in unemployment nor a robust recovery. A March 16 Treasury press release stated, “It typically takes employment growth of somewhat over 100,000 per month to bring the unemployment rate down. Because we do not expect job growth substantially over 100,000 per month over the remainder of the year, we do not expect substantial further declines in unemployment this year.”

So when will unemployment decline? Job growth is expected to accelerate in 2011, which will reduce the unemployment rate gradually. The Administration projects unemployment of 8.9 percent in the fourth quarter of 2011 and 7.9 percent in the fourth quarter of 2012. A recovery of this pace would put unemployment on track for more normal levels in late 2016 to mid 2017.



Other posts in the series Headwinds to Labor Market Recovery
Part II: Excessive Slack in Work Week
Part III: Permanent Layoffs
Part IV: Housing Markets

Condition of the FDIC

Two years of major losses dropped the FDIC insurance fund from an all-time high of $52.4 billion going into 2008 to a deficit of $20.9 billion at the end of last year. The decline was despite $17.8 billion of premiums, including a $5.6 billion “special assessment.”

The large deficit is the result of nearly $100 billion of provisioning for insurance expenses. The FDIC predicts that bank failures will cost this much over 2009-2013 – most of this by the end of 2010. Noting the continued rise in the “Problem Bank List” mostly due to commercial real estate troubles –FDIC Chairman Sheila Bair recently forecast that there will be more bank failures this year than last (140).

However, Chairman Bair also forecasted that bank failures will peak this year, and that the insurance fund will reach a nadir in mid-year (see below). Premium assessment rates rose significantly last year and the assessment schedule will rise by three basis points again starting next year. The good news is that Chairman Bair indicated that the insurance fund is expected to recapitalize on the timeline established last September – without additional hikes of the assessment schedule or “special assessments.”

Why is lending not increasing if the recession is over?

Previous recessions have shown that it typically takes 13 months after the recession for business confidence to return and credit to return to pre-recession levels. This is because the risk of lending in the current economic environment is much greater today than several years ago when the economy was much stronger. Banks are actively looking for lending opportunities. Business confidence is down, however, and many businesses either do not want to take on additional debt or are not in a position to do so given weak sales. Consequently, loan demand has fallen dramatically since the start of the recession.

Because of the increased risks, credit terms are different in this environment, with higher downpayments required. In addition, loans tend to be smaller, which is consistent with diminished collateral values. These are prudent business practices and ones bank regulators expect. But it means that some projects that might have been funded when the economy was stronger may not find funding today. The NFIB recognized this, stating, “[T]he continued poor earnings and sales performance has weakened the credit worthiness of many potential borrowers. This has resulted in tougher terms and higher loan rejection rates (even with no change in lending standards).” [NFIB Small Business Economic Trends, November 2009. National Federation of Independent Business.]

Lending Metrics, Part III: Are Businesses Using Available Credit?

Loan demand, as we discussed in the last post, has declined dramatically at banks as the economy slipped into a recession. One concrete demonstration of this slowdown in demand is just how much people and businesses are actually using their outstanding lines of credit. The fact that banks have been reducing the maximum lines of credit to help manage risk exposure in a weak economy has sometimes been (mis)interpreted as an unwillingness on the part of banks to lend. Like the bank lending volume measure we discussed in the first post, such an interpretation misses the mark.

In fact, even with the cutbacks in lines of credit, there is $6 trillion in unused commitments made available by FDIC-insured banks. Moreover, the utilization rates have declined for business lending, reflecting the decreased demand. Credit card utilization rates have risen somewhat, but the rate remains low overall at 18.7 percent, and demonstrates that there is a considerable amount of credit available for card holders. Just as businesses are more cautious in taking on new debt, so are consumers, which is the major reason why revolving debt outstanding has declined consistently for the last 16 months.





Also see Lending Metrics, Part I: Are Banks Lending?
And Lending Metrics, Part II: Are Businesses Borrowing?

Case-Schiller Trends Show Winners, Losers, and Cities to Watch

Yesterday the Case-Shiller Housing Index reported its 9th consecutive monthly increase; home prices rose 0.3% from December to January. The increase in this widely-reported composite index masks the recovery – or lack thereof – in individual cities. The recovery in most markets peaked in late summer of last year. From this point forward the recovery has varied depending on the region.

Markets with the biggest bubbles – which were the first to enter steep price declines – are continuing to recover, as deal-seekers create upward price pressure in these markets. Those with little to no bubble are also continuing to recover. However, a number of urban areas have lost steam since the late summer appreciation and have returned to price declines. Growth in a third group of cities has weakened considerably over the past months; these cities may experience declines in the near future. Miami is an exception; declines have weakened and growth is expected in the near future.

All numbers are seasonally adjusted month-over-month percent changes.

Winners – Markets with Large Bubble or No Bubble Continue to Recover
Los Angeles	posted its strongest increase (1.8%) since October 2005.
San Diego	has reported growth near or above 1% for the past seven months.
Las Vegas	after 32 months of decline, the city has posted three months of modest gains, with a 0.3% increase in January.
Phoenix	reported eight straight months of increases, seven of which were near or above 1%.
Tampa	after four months of weakening declines, the market posted a gain of 0.5% in January.
Minneapolis	after five months of weakening increases, growth jumped from 0.3% in December to 0.7% in January.
Cleveland	after declines in four of the five previous months, the market posted 0.7% growth in January.
Losers – Some Urban Areas Are Losing Steam
Atlanta	growth has been flat or negative for the past five months. -0.5% in January was the largest decline since March 2009.
Chicago	declines of around 1% for the past four months.
New York City	after a short-lived four-month recovery last summer (following 25 months of declines) the market has posted declines over the past five months.
Charlotte	after a year of declines mostly under 1%, the market posted 3 months of essentially flat growth. The index turned negative again in January at -0.1%.
Portland	modest increase in six of last seven months, but turned negative again in January at -0.5%.
Seattle	after three months of small growth (0.2% to 0.3%), the market fell 0.6% in January.
Watch List – Markets in Transition Show Questionable Growth
San Francisco	still posting gains, but at an increasingly weaker pace since July 2009.
Denver	growth has slowed to 0.0% and 0.1% in the past two months from as high as 1% in August and June.
Washington DC	growth has weakened from 1.3% - 1.5% from June through August to 0.2% in January.
Boston	after two months of declines, prices increased 0.6% in November but growth has since diminished to 0.3% in January.
Dallas	after a 0.9% growth in November and 0.2% growth in December, the index declined 0.3% in January, its first decline since September.
Detroit	after solid growth of around 1% from August through October, the market posted a decline then near flat growth the past three months.
Miami	declines have weakened over the past three months from -0.5% in October to -0.1% in January as the market trends toward increases in coming months.

Obama Proposals Destroy $50 Billion in Shareholder Value

Over the last week, we described in detail why the new tax proposal is a bad idea. New analysis today reveals that the $90 billion Financial Crisis Responsibility Tax combined with the proposal to introduce restrictions that limit both the scope and size of the largest financial institutions have destroyed $50 billion in combined shareholder value of six firms – Bank of America, JP Morgan Chase, Morgan Stanley, Goldman Sachs, Citigroup, and Wells Fargo.

On January 21, investors reacted negatively to the news that the Administration would seek legislation to limit the scale and scope of their operations. These financial institutions experienced a 4.4% decline in the value of their stocks. Almost $29 billion in shareholder wealth was destroyed in the large financial institutions that were directly targeted by the Administration. Even after adjusting for the decline in the value of the stock market, these institutions experienced a market adjusted return of -3.72% in a single day. Over the eleven-day period from January 11 to January 21, the losses experienced by the shareholders of these six firms, fully wiped out gains these firms had made in the first three weeks of 2010.

New Bank Tax Part IV: The Markets Don't Like It

In this last post in a four-part series on the new $90 billion tax on banks proposed by the Obama Administration, we show that the markets hate this idea. If our arguments about this tax increasing the cost of credit, slowing lending, and hitting community banks haven't convinced you, then consider this:

When the news of the tax was reported in the financial press, the KBW bank stock index fell by 1.70 percent on that day. On a market adjusted basis, the index declined by 0.76 percent.*

For the 24 large cap banks in the index, twenty posted a negative daily return on January 12, as shareholder wealth declined by $16.44 billion. Including both Goldman Sachs and Morgan Stanley, the Administration’s proposed fee destroyed almost $20 billion in shareholder value in one day.

Also see:

• Part I: Increases the Cost of Credit
  
• Part II: Reducing Capital Hinders Lending
• Part III: Community Banks Not Immune

* Market adjusted return subtracts the daily return of the S&P 500 from the daily return of a company’s stock or index.

New Bank Tax Part III: Community Banks Not Immune

In this series of posts on the new bank tax the Obama Administration has proposed, we have reviewed how:

• the new tax will increase the cost of credit
  
• the new tax will cause banks to reduce lending as the tax reduces bank capital

Today we see that, although community banks will not be paying the tax directly, since their assets are less than the $50 billion threshold, community banks will still feel the effects of this tax.

Since this tax is imposed on non-insured liabilities, impacted banks will shift their funding mix away from these sources and rely more heavily on insured deposits. The increased competition for insured deposits will pinch net interest margins at community banks as they compete with larger banks for deposits. Not only will this tax reduce profits for community banks, but also impede their ability to build capital and slow lending across the country.

Also see:

• Part I: Increases the Cost of Credit
  
• Part II: Reducing Capital Hinders Lending
• Part IV: The Markets Don't Like It

New Bank Tax Part II: Reducing Capital Hinders Lending

Yesterday, we discussed the new tax the Obama Administration proposed to pay for losses of non-bank TARP programs. This tax would be levied on financial firms with at least $50 billion in assets, and would certainly increase the cost of credit, as some portion would be passed along to borrowers.

In addition, the new tax will cause banks to reduce lending as it potentially reduces bank capital. One dollar in capital supports roughly seven dollars in loans. Thus, the incidence of this tax could reduce lending by $630 billion, enough to fund 3.75 million small business loans over the next decade.

Moreover, some banks that are approaching the $50 billion threshold may decide to slow their growth to avoid being hit by this tax. This further limits lending and economic growth over the duration that the tax is in place.

Also see:

• Part I: Increases the Cost of Credit
  
• Part III: Community Banks Not Immune
• Part IV: The Markets Don't Like It

New Bank Tax Part I

The Obama Administration has proposed a Financial Crisis Responsibility Tax on financial firms with at least $50 billion in assets to pay for losses of non-bank TARP programs. The proposed tax will adversely impact bank earnings, raise the cost of credit, reduce lending, increase deposit competition, and slow the economic recovery.

The proposal imposes a tax of 15 basis points on non-insured liabilities for at least the ten years. The Obama Administration projects that this fee will raise $90 billion over this period. This tax will act as a drag on bank earnings, reducing normalized earnings by an estimated 5 percent over the next 10 years. This tax has many other consequences.

Over the next few days, we're going to be reviewing this tax and the negative implications it holds for borrowers, the economic recovery, and community banks.

The $90 Billion Tax on Banks Increases the Cost of Credit
The proposed tax will cause the cost of loans to increase as simple economics suggests that some of the tax will be passed through to borrowers. This will increase interest rates by up to 15 basis points. In the current interest rate environment, this would amount to a 2 percent increase in the cost of credit, further impairing the ability for consumers and small businesses to borrow.

Also see:

• Part II: Reducing Capital Hinders Lending
• Part III: Community Banks Not Immune
• Part IV: The Markets Don't Like It