Bank Profits

Just a very quick note to draw your attention to the profits being announced this week by many of the big banks: while they appear to be pretty good there are some ugly spots.

Morgan Stanley reported its third straight quarterly loss, and even though its profits rose substantially, Wells Fargo had to raise its provision for future loan losses by a very large amount.

Some of our lesser known regional banks also reported a mixed bag of earnings.

The thread running through all of them was the collapse of commercial real estate. I have been warning about this for months now, and it looks very much as if the start of the tsunami is upon us.

Morgan Stanley had to write down $700 million of loans, out of its $17 billion commercial real estate portfolio, and its CFO warned that much more was to come. His words were that he ‘saw no light at the end of the tunnel’.

Similarly Wells Fargo saw its non-performing commercial real estate loans jump by 69% last quarter from $4.5 billion to $7.6 billion.

This story was repeated on a lesser scale around the country.

So: the next big source of bank losses is steaming straight at us. This probably means that bank profits will be very shaky over the next few quarters. Clearly any talk of the banking crisis being over is premature, because we are now headed into that period of a recessionary cycle where consumer and commercial real estate losses ‘normally’ pick up steam.

We may have survived the first shock, that from the gambling in derivatives and sub-prime mortgages, but that was out of the ordinary. This next wave has been very predictable.

To put this all in some context: commercial real estate accounts for a very large chunk of GDP, around 10%, so its increasing difficulties are going to slow whatever recovery there may be later this year. Why is this happening now and not earlier? Because large projects like commercial real estate typically have long lead times and need to be re-financed periodically. As projects, building, and other forms of real estate come up for re-financing any drop off in value and occupancy reduces the amount a bank is willing to lend against that property. Often this leaves the property owner unable to secure enough financing to stay in business, so they default on the loans and the bank forecloses.

Similarly even in ‘good’ properties a collapse in rental values as the retail and office markets dry up will produce the same effect.

So, stay tuned and buckle up, the next phase of the banking crisis is about to begin in earnest.