Wednesday, November 24, 2010

Is there a ticking time bomb in the banking system? (Charts)

Housing market update as of 10:00 AM: New home sales drop 8.1% in October and median home prices dropped 14% to the lowest level since 2003.

No North Korea, TSA or Iran this morning. Today a look at the huge weight still sitting on the US banking system. Will it bend and not break or is another shoe going to drop?

What are these weights? Foreclosures and loans soon to become foreclosures!

Is the price action in major banks such as Bank of America and Citi telling us something? Something about the real health of the banking system and the economy? Different than the story the bank are telling themselves?

It could very well be! Due to be released next week on Tuesday is the FDIC list of banks at risk of failure while a report this week showed major banks still holding huge amounts of bad home loans.

While the "too big to fail" institutions won't be on the list of the banks on life support released next week, it is expected that the number of banks at risk of failing could rise to over 900. This from a number of only 829 at the end of the second quarter.

So, is there a story in the price action of the common stock of major banks, the riskiest asset (for the owner) in the corporate food chain? Is it telling us something about the future health of the banking system and by extension an already floundering economy?

Still huge amounts of bad single-family loan debt on the books, equity prices going nowhere while the broader market has done nothing but rally.

From the charts below it is apparent that while the INDU has rallied sharply, the common stock of banks B of A and Citi have not. It is often said that the stock market is a great predictor of the future (although in many cases it certainly is not).

Data released this week showed that the major banks still hold huge amounts of single-family mortgages either already foreclosed or in the process of foreclosure.

How huge? Consider the numbers below, ponder the problem as you know it, look at the common stock price action and then decide if all of the economic shoes have dropped, or if there are other shoes hiding in the background.

  • B of A, Wells Fargo and JP Morgan each have more than $20 billion of single-family loans in foreclosure or in the process of foreclosure.
  • In the pipeline of mortgages that are more than 30 days past due and therefore in danger of moving into the in-process of foreclosure column, each bank has over $50 billion in exposure (although all past due loans will not go into foreclosure).
  • If the total of current foreclosures plus potential foreclosures of past due loans are combined, the numbers are staggering:
- B of A $74.9 billion
- Wells Fargo $68.6 billion
- JP Morgan $65 billion

This poses potential future risk to bank capital, common stock shareholders, an already fragile and stagnant economy and the banking system itself.

On top of the global risks faced, the domestic economy and financial system is definitely still on the front burner and is no slouch!

Common stock price history of B of A, Citigroup and the Dow Industrials average

Prices as of 10/23 pre-open

Dow Industrials


Bank of America


  1. Mike, The question that I now have is how can we profit from this just as John Paulson has profited from betting against the housing bubble? There has to be a way.

  2. I suppose you can short the broader market that has rallied pretty strongly or there is probably a currency play of some type.

  3. Although the housing market has been struggling as of late, it may be a great time to invest. A turn around has to be imminent, so it could be a good time to invest if you're business is looking to expand or move locations. Check out these great commercial building finance options from Apex to help you fulfill your plans.

  4. Ho Owen:

    I threw you a bond and published your comment although I will usually delete advertisements, but I had to take issue with your comment.

    Why does a turnaround need to be imminent? Why can't we be in store for a double dip or worse? What is your rationale for saying that? Does Apex have a published forecast for the real estate market you can point us to?

    For the people who thought pullbacks at the end of the tech bubble in the early 2000's was a great time to get in because a turnaround had to be coming went broke.