A recent research report out of Moody’s is calling for further write-downs of $470B among U.S. banks. In the report Moody’s says:
“Moody’s states that it expects US rated banks will incur a total of approximately $470 billion (pre-tax) of loan and security losses and write-downs in 2009 and 2010. The lending portion of this estimated loss is $415 billion, or 8% of the industry’s outstanding loans at the end of last year.
Under more adverse conditions, numerous US banks could become insolvent by the end of 2010. More specifically, based on our modeling of such an adverse scenario we calculate that US rated banks could incur a total of approximately $640 billion (pre-tax) of loan and security losses and write-downs in 2009/2010; without additional capital, this means that more than a third would fall below investment grade on a standalone basis …
Additionally, if the US economy worsens beyond expectations US banks would need to raise significant amounts of additional equity capital. For instance, under this adverse scenario we estimate that recapitalizing all rated banks back to a B- financial strength level would require a $112 billion investment.”
Of course, this doesn’t come as a big surprise to regular readers. The banks are very likely to suffer similar cash flows problems that the Japanese banks suffered in the late 90’s as consumers fail to recover quickly, lending standards increase, commercial real estate weakens, arm loans reset and credit card delinquencies continue to surge. In all likelihood, the very worst of the credit crisis is behind us, but the balance sheet problems are as alive as they’ve ever been. We had our opportunity to hold the banks over the fire and force them to take their losses, but we chose to pour more booze down the drunk man’s throat. We are going to let the banks earn their way out of this. Those earnings of course are not sustainable.
While there are clear cut signs that the credit markets are improving banks are still hoarding the massive amount of freshly printed government cash as they buckle down for the potential losses that will come in the next 12 months. As they batten down the hatches it’s likely that lending standards will remain very high and small businesses will continue having trouble getting loans. Throw in the weak consumer and you have the perfect recipe for an inverted square root recovery.
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.