Recent data has been chock full of mortgage modification news. Bank of America announced a principal forgiveness plan on certain option ARM and hybrid loans, which they believe could help roughly 45,000 borrowers. Next, the Office of the Comptroller of the Currency and the Office of Thrift Supervision jointly released their 4th quarter 2009 Mortgage Metrics report. This report is always full of interesting details, any one of which could make a good headline (or blog post, for that matter):
– Seriously Delinquent Loans Rise to a New High of 7.1%
– Nearly 30% of All Option ARM Loans are Seriously Delinquent or in
– New Home Retention Actions Fall in the 4th Quarter
– Home Retention Actions Still Focus Primarily on Rate Reduction,
– Over Half of All Modified Loans Re-Default Within 9 Months
– Even When Mods Reduce Payments by 20% or More, One Quarter Re-
Default Within 6 Months
Ok, maybe that last one is a little long, but you get the picture. Bank of America’s plan is interesting, if for no other reason than it is a departure from the largely failing actions that have been taken thus far.
Given that mortgage credit is still deteriorating, even laying aside problems in other loan categories, we expect the wave of FDIC bank closures to continue apace. And what a pace it’s been. On March 19th, 2010, the FDIC closed 7 banks (noteworthy fact: that was the one year anniversary of the sale of IndyMac by the FDIC). This took the year-to-date failures to 37. By this time last year, the FDIC had closed 20 banks (of the 140 total that would fail during the year). That currently puts 2010 about 85% ahead of last year’s pace. So, how far into this cycle are we?
An interesting metric that may be able to shed some light on the situation is the Texas Ratio. This ratio looks at a bank’s non-current assets and real estate owned versus its tangible common equity and loan loss reserves. It’s been nicknamed the Texas Ratio because it was originally used to determine the health of Texas banks during the 1980s oil bust. A Texas Ratio of 100% would obviously be worrisome, and an indication that a bank could fail, but some banks fail with a ratio which is several multiples higher. We started wondering what an industry-wide Texas Ratio would look like using FDIC aggregate data, so we took a look. Below is our attempt:
Click Here to Enlarge Chart
Aggressive efforts to grow tangible common equity, dividend cuts and capital raises, have helped keep the Texas Ratio below the late 1980’s peak so far, despite the fact that noncurrent loans and leases as a percentage of total assets are higher now (2.98%) than in the previous peak (2.37% in 1987). This should give some hope that the absolute number of bank failures should be lower than the Savings & Loan crisis total. However, the Texas Ratio doesn’t deal with securities portfolios, which have changed drastically over the period pictured in the chart above. Line items in FDIC reports like “commercial mortgage-backed securities” and “structured financial products” and “asset-backed securities” simply state “N/A” as recently as 2000. As of the 4th quarter of 2009, these items made up nearly 10% of the aggregate securities portfolio of all FDIC-insured banks.
All caveats aside, it’s likely that we won’t see a peak in bank failures until well after a peak in the Texas Ratio; there was a two year lag between the previous Texas Ratio peak in 1987 until the 1989 peak in bank failures. A current “problem bank” list of 702 banks seems to confirm this (150 were added to the list in the 4th quarter alone).
Just add the above chart to the list of FDIC Quarterly Banking Profile charts that we will be watching in anticipation of a return to a healthy banking sector.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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