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Don't be Fooled: U.S. Banks Aren't as Strong as They Look

U.S. banks are seeing positive trends in several measures of their health.

That's the good news.

Unfortunately, U.S. banks continue to struggle with some much-more-deeply entrenched problems. Those problems pose a major threat to banking-system health.

And they could even cause the U.S. economy to stumble.

Investors who have been heavily and successfully invested in emerging markets, commodities and precious metals have started to repatriate capital back into the U.S. market in anticipation of domestic growth.

However, to really gauge whether that's the correct move to be making right now, those investors would be wise to keep an eye on U.S. banking trends.

The message here is clear: Don't be fooled by the "official" outlook for U.S. banks – the superficial statistics and their in-depth counterparts tell two very different tales.

Good News for U.S. Banks?

It's important to understand that bank-performance statistics are a compilation of the finances of all reporting U.S. banks. Most of this information comes from statistics provided by the U.S. Federal Reserve and the Federal Deposit Insurance Corp. (FDIC). But, as we'll see shortly, the Top 10 U.S. banks hold more than half of the industry's assets, meaning any of the trend numbers are very likely to be skewed – and in a big way.

The good news for banks – particularly the "too-big-to-fail" giants – is that they are experiencing some real improvements … at least, by some important measures.

First-quarter profits totaled $29 billion, a 67% profit over the same quarter last year and the seventh-consecutive quarter of bottom-line improvements, the FDIC said.

Total net charge-offs in the first quarter of 2011 totaled $33 billion, a 37% decline that also included a hefty 39% drop in credit-card charge-offs.

Non-current loans fell 4.7%. And in the area of money that's "reserved" against possible future loan losses, banks set aside a full $31 billion less in this year's first quarter than they did a year ago.

The big banks have already turned in several quarters of profit improvements – based mostly on such declines in loan-loss reserves. And now those institutions are flaunting some highly positive trends in asset quality, which they say will result in lower-loan-loss provisions in the future.

Finally, as a result of such strong capital improvements at the biggest of banks, average capital ratios reached an all-time high.

But, the bigger picture isn't as bright as might be indicated by some of these good trends.

And here we must understand how some of these apparently upbeat numbers and trends can fool us.

Don't Be Fooled

There are 7,575 banks that hold an aggregate $7.2 trillion that's insured by the FDIC. But the 10 largest U.S. banks hold more than half of the assets held by the entire banking industry.

The bottom line: Those 10 banks can skew the sector averages, hiding any trends, developments or problems at the smaller institutions that make up the rest of the industry.

Although the FDIC blithely reported that only four banks were added to its "problem list" in the current year's quarter.

Here, too, a broader context is required.

For one thing, that "problem list" – which identifies banks that don't have enough capital to protect them against risk – stands at 888. That means that nearly one in every nine (888 of the 7,575 FDIC-insured banks) U.S. banks is in trouble.

Those 888 banks have total assets of more than $397 billion.

And even though only four banks joined that list in the fourth quarter, the grand total of 888 is the most in 18 years.

Here's the really scary part: Back in 2006 – we're talking five short years ago – that list only had 50 banks on it.

There were 26 bank failures in the first quarter of 2011. That comes after last year's total of 157 – which was the highest amount since 1992.

On its face, that seems to be an improving trend. But with 888 banks identified as "problems," that's a trend that could turn very quickly.

Here are two other disturbing trends – these, too, masked by the big-bank skew:

  • First, while big banks continue to report earnings improvements, thanks to the ongoing reduction in loan-loss reserves, the FDIC says that banks with less than $1 billion in assets are doing just the opposite – and are continuing to add to their loan-loss-reserve pools.
  • And, second, while overall profits were higher, this was yet another bit of big-bank sleight-of-hand: The profit improvement was driven by the decline in loan-loss-reserve set-asides; bank revenue for the first quarter of this year was actually down $5.5 billion, or 3.2%, on a year-over-year basis.

While that doesn't sound like much, and it isn't terribly bad, it is only the second time in the 27 years that the FDIC has been keeping such statistics that quarterly revenue actually fell. The only other time was the fourth quarter of 2008 – during the depth of the global credit crisis and the Great Recession.

Six of the 10 biggest banks over the period reported lower non-interest revenue, which fell 3.7% to $58.6 billion for the entire industry. Eight of the 10 largest banks reported lower net-interest income, which was down 3% to $106 billion on an industry-wide basis.

And banks reported tighter margins and a 17% drop in revenue from "service" charges and "fees," which include such items as overdraft charges and late-fee charges on credit cards.

Total loan and lease balances for the quarter were down 1.7% from a year ago. Again, while that doesn't sound so bad, it is actually the fifth-largest drop in loan book balances in the FDIC's 27 years of keeping such records. Worse, loan balances have been falling for two straight years.

Beware of the Economic Fallout

It's no secret that the U.S. economy is highly consumer driven. So while many of our multinational corporations are in great shape – thanks to strong overseas demand – domestic growth has been sluggish, partly as a result of weak loan demand, which is being increasingly reflected in banks' metrics.

If we actually remove the nation's 10 biggest banks from our field of vision, the domestic picture based on the rest of the banking industry looks anemic, at best. I say that based on the fact that big banks are making most of their net new loans to one or both of two places – to overseas borrowers, or to foreign banks. And that means the contribution they've made to the domestic economy has been much less than is needed to foster real growth.

Banks are facing increased U.S. regulatory oversight (which is a good thing in the long run) at the same time they're facing heightened international standards based on pending Basel III requirements that will have to be met. But it's not the addition of regulatory constraints that banks are suffering from (most of them under the Dodd-Frank Wall Street Reform and Consumer Protection Act have yet to be written and the Basel III requirements are to be phased in over several years yet to come), it's sluggish loan demand partly resulting from their own more-stringent standards.

Going forward, investors must take special care to watch and see if banks are growing – and, if they are, how are they getting that growth?

If domestic loan demand improves, that's a good sign that banks are getting back on track. If, however, loan books expand as a result of lowered standards, well, look out below. (The one particular scenario to beware of here goes like this: The market for the already-well-served, and highly creditworthy borrowers becomes even more saturated due to intense competition. Banks, in search of more growth, see no option but to chase after "subprime" borrowers who are once again viewed as viable customers. It happened once before…)

When it comes to U.S. banks, revenue, interest margins, fee revenue, loan-loss reserves, charge-offs and customer profiles are all important metrics to track, and to scrutinize, in order to gauge the health of the banking industry – and the outlook for U.S. gross-domestic-product (GDP) growth. But don't let yourself be fooled by the-more superficial figures.

After all, with U.S. banks, we've now demonstrated just what to look for.

[Editor's Note: In the shadowy world of Wall Street, Money Morning Contributing Editor Shah Gilani is a rare commodity.

As a retired hedge fund manager who's willing to share the secrets of what goes on behind Wall Street's "velvet rope," Gilani is able to spot the stock market's hottest profit opportunities.

And since he's no longer part of the Wall Street power structure, Gilani is also willing to show you how to capitalize.

Gilani recently helped develop a strategy for individual investors to bring in the big money Wall Street tries to keep for itself.

And we're willing to share that secret strategy with you.

To find out more about this strategy – and more about our worldwide team of global-investing experts – please just click here for a report from our monthly affiliate, The Money Map Report. You'll never regret it.]

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About the Author

Shah Gilani is the Event Trading Specialist for Money Map Press. He provides specific trading recommendations in Capital Wave Forecast, where he predicts gigantic "waves" of money forming and shows you how to play them for the biggest gains. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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  1. Ron Chandler | May 27, 2011

    Your observations regarding Federal regulation and oversight are naive and understated. In the past two weeks I have attended meetings with regional banks who are all telling me that federal regulators are squeezing them out of the lending business entirely. This is the real goal of Dodd-Frank, consolidate the Banking Industry into just 10 mega banks that can be controlled as quasi-government agencies just as the utility companies are today. Socialists know that it is much easier to control a few large organizations than many small ones. This is all part of the "hope and change" that has come to Washington and players on both sides of the aisle are involved.

  2. Clay Clark | May 27, 2011


    Is there a blog or forum where Money Morning users chat?



  3. William Patalon III | May 27, 2011

    Dear Clay:

    Thanks for the note.

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    William (Bill) Patalon III
    Executive Editor
    Money Morning

  4. Casey Schein | May 27, 2011

    I would like to subscribe to the newsletter!

  5. CanadaNorth | May 27, 2011

    Ron Chandler may be right about squeezing out the small banks and consolidating into fewer but larger entities that are at least partially controlled by the government. The working model is already in place and has been working very well north of the border. Canada has faired much better under this model than the states.

  6. James | May 27, 2011

    You state that the U.S. economy is consumer driven. Many consumers borrow and save at federal credit unions. They are perceived as a safer place to park your money and borrow. What is their status?

    Most or all the 888 regional banks that are in trouble are the ones that got caught in the real estate bubble making loans that are currently under water. Let them pay for their own transgressions like home borrowers with under water loans who are losing their homes. Let them fight for their own survival or be swallowed up by other stronger regional banks or as you say, by the big banks, if they wish to play with small time stuff.

    The big banks would rather play the bigger game in the global economy. That is where their money is going and not to the domestic economy as attested by the chronically high 9 percent unemployment rate.

    Who needs big banks? … not the U.S. consumer who is not being served. In fact, the Federal Reserve, by trying to save the big banks by the "too big to fail" mantra (probably created by the big banks themselves to save their own skin), is saddling U.S. consumers with huge deficits not of their own making.

    The banking mess is in the global economy instigated partially by our own greedy, money grubbing big banks and businesses like AIG. Like cancer, they infected the European regions and their creepy tantacles are spreading and reaching out to Asian countries.

    Let's hope the "increased U. S. regulatory oversight" and Basel III requirements will lead to corrections to a flawed banking system, both domestically and globally.

  7. fred | May 31, 2011

    The opinion that banks will be forced to turn to subprime borrowers flies in the face of several previous articles which explain that banks DON'T WANT TO LOAN anything, they borrow from the Fed at near zero interest and invest in stock market at high rate of return.

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