"The Danish mortgage system has survived since 1795 in large part due to the conservative lending policies of the Danish mortgage providers. Denmark's mortgage market has not offered self-certification loans or subprime lending of any note, as the lenders in Denmark have found this sort of business risky and more conservative lending practices offer a good return on equity. It is also not part of general Danish consumer behaviour to borrow beyond one's means. Danish banks have not been heavily exposed to the toxic bonds to the extent that has plagued banks in other European countries. In addition, throughout the credit crisis, the Danish and, to a greater extent, Scandinavian banks have still been willing to lend to each other. Trust has not evaporated. Spreads have risen somewhat in the interbank market, but the general view among bankers is that there is very little "hidden in the closet" that could surprise you in the future. This continuing liquidity and the ability to still sell Danish covered bonds (which finances the mortgage lending) even at the most illiquid of times has further supported confidence in the market."

Ted Lord
Managing Director and Head of European Covered Bonds
Barclays Capital
Frankfurt, Germany
FT/Letters
August 15, 2008

The Q2 data from the FDIC is now available to subscribers to The IRA Bank Monitor and Bank Report services.

On Tuesday, watching the FDIC press conference results flash across the screen on a television at Langan's in NY, we could not help but notice that everyone in the bar area was paying very close attention to the reporter describe the latest results from the US banking system. Five years ago, the same group was watching soaring prices for dot.com stocks, but now bank solvency is the headline du jour.

Of course, it is normal for people like us to get excited by data releases from the FDIC. We'll always be proud of the time in San Jose when Jon Wisneiski of that agency referred to "the freaks" in the analytics world who actually take the trouble to distill insights from the FDIC's structured financial statement data.  That would be us. 

The unusual level of attention being paid to the US banking sector seemingly confirms the anecdotal evidence we see suggesting rising grass roots concern about bank safety and soundness. Since we launched our IRA Bank Report  service about a week ago, literally hundreds of users have visited the IRA web site to purchase a report on a specific bank. Smaller, rather than larger institutions seem to be the primary focus of attention.

So what's our take on the aggregate data in the FDIC's Quarterly Banking Profile? (Click here to download the report in PDF format.)  Some bullet points:

** Q2 loan loss provisions consumed nearly one third of operating income for the banking industry, the highest proportion of income transferred to loss reserves since 1989. Loss rates increased 30% from Q1 and the shape of the loss curve suggests we are still relatively early in the adjustment cycle. We are sticking with our estimate of Q1 or Q2 2009 as the peak for bank loss rates.

** Q2 charge off rates at 132bp for the industry are at highest rates since Q4 1991. The industry continues to put aside $2 in provisions for future loss for every $1 in current defaults, suggesting that the credit outlook remains negative. Part of the reason: industry loan loss reserve coverage for NPLs at 88.5% is the lowest in 15 years. The banking industry may need to continue diverting significant portions of income to reserves for several more quarters/years.

** The number of problem banks reported by the FDIC increased from 90 to 117 during the quarter. Our list of institutions under stress in terms of lending was over 800 institutions in Q1 2008 and is now considerably higher. Users of The IRA Bank Monitor will get a look at the Q2 results from our credit conditions index next week.

Not all of the names in the group of banks evidencing lending stress are necessarily in danger of failing, but a defensive lending posture often is accompanied by volatility in liabilities and increases in credit spreads. As these stressed banks withdraw credit from the economy, pressure on remaining lenders and obligors increases, creating a feedback loop cycle that makes the credit squeeze worse.

The fact that the banking industry's assets are falling for the first time in years is also an indication of things to come. As we've said afore and will say again, banks come under pressure first and foremost in terms of liabilities, not losses on assets. Whether you are a broker dealer or a bank, the price and availability of funding is the chief concern.

Update: Washington Mutual

A member of the big media called yesterday, for example, asking about the fact that Washington Mutual (NYSE:WM) was advertising a 5% rate for a five-year CD. Was not the fact that WM was paying up for money an indication that the bank is in trouble?

No. In fact, between Q1 and Q2 2008, WM's lead bank actually added core deposits and reduced reliance on FHLB advances, as shown in the profile for WM's lead bank in The IRA Bank Monitor (subscribers click here to load the current Q2 report for WM). But defaults are continuing to climb sharply from the 225bp annual run rate in Q1.

More to the point above about the industry in general, WM and other banks are shrinking assets to manage the growing volatility of their balance sheets. This implies an overall contraction in the amount of primary finance available to the US economy and a much sharper correction in the immediate future for borrowers and lenders alike.

Citigroup: Don't Know Nothing About Continental Illinois

A reader of The IRA reports that during a conference call this week hosted by Citigroup (NYSE:C) to talk about an August 26th report about the risks of GSE debt, "Mortgage Government Sponsored Enterprises Examining The Options,"  a participant asked an impolitic question about the methodology used in the report.

"Why not use Continental Illinois instead of Chrysler, as included in your previous report? Continental is a financial company, and is a more appropriate comp," asked the participant.

"I am not familiar with Continental Illinois, but we will definitely look into it," came the reply from one of the Citibankers, according to the reader.

Q: Should we care about the advice of a financial professional who is not familiar with the FDIC's bailout of Continental Illinois? See our interview with Martin Mayer for a refresher course on one of the most significant US bank failures in the past century ('The Vigorish of OTC: Interview with Martin Mayer' ).

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