Honoring a Soothsayer

Chip Shields

Today I was proud to join with a bipartisan group of legislators to introduce HB 2784, which will provide oversight of how state-chartered banks are spending money they've been given through the Troubled Assets Relief Program (TARP).

And while digging through some old files, I came across this Portland Business Journal op-ed by Michelle Rand of Cascade Investment Advisors who had great foresight back in September 2008.

Thanks for the focus on banking and finance in the Aug. 29 Business Journal. However, I must take issue with the article by Dan Hempy, “Measuring bank soundness: Most institutions are healthy.”

He states that recent bank failures are few compared to the S&L crisis of the late ’80s and early ’90s. But he fails to mention that the trends are not good.  We are but one or two years into this credit crunch, whereas the S&L crisis took several years to reach its worst.

For instance, the FDIC’s “problem list” has expanded to 117 banks from 90 just a few weeks ago. Looming resets on poorly underwritten loans will hit all banks for at least the next two to three years, assuring a long tail for loan problems.

Capital ratios, which Hempy points to as an indicator of bank health, are only being maintained for many banks at intensely high cost — whether in dilution for existing shareholders, dividend eliminations, and/or extremely high borrowing costs.

Recent efforts by CitiGroup, American Express and others to raise money in the bond market were met with underwhelming demand, causing a spike in interest rates that these companies must pay to investors.

This fall, billions more in bank debt needs to be refinanced — not a pretty picture. Maintaining capital ratios at a high cost damages current and future profits, a legacy banks will have to live with for a number of years.

The return on asset ratio, another of Hempy’s “health” criteria, is falling like a rock at most banks, even the better ones. Nonperforming assets are surging with each new quarterly earnings report. I noted that the article didn’t give any aggregate statistics for these two criteria; our reading on a bank-by-bank basis shows deterioration ranging from massive to mild, but it’s all deterioration.

There is zero improvement.

Furthermore, we have only just begun to see contagion from residential loan problems to commercial loans and other consumer loans. That shoe has yet to drop and could cause more capital impairments as loan failures increase.

I also disagree with the notion that only unregulated brokers caused the subprime crisis. Regulated, insured banks proved to be ready lenders, with very poor underwriting standards, and they deserve a hefty share of the blame.

 

In short, Hempy’s underlying thesis may prove far too rosy. All is not well — nor is it even getting better — at most banks. Worse yet, not even bank managers have proved to be particularly adept at identifying which loans are about to detonate.

 

While we believe most banks will survive, we cannot agree that this situation is in any way healthy.

 

Michelle Rand is owner of Cascade Investment Advisors Inc.

 

By Chip Shields March 09, 2009