Future Banking Industry Losses On Bad Loans Estimated At $268 Billion

September 14, 2010 – Despite the fact that banks have already taken huge losses on bad loans, Moody’s Investor Service estimates that the US banking industry still needs to recognize an additional $268 billion in losses on defaulted loans.

According to Moody’s, banks will write off a total of $744 billion in bad loans through the end of 2011.   To date, the banking industry has recognized losses of $476 billion, leaving $268 billion in additional writeoffs needed for nonperforming loans.  Moody’s estimates that 68% of losses on residential mortgages have been accounted for, but only 49% of eventual losses on commercial real estate have been recognized by the banking industry.

The banking industry has had charge-offs averaging about $50 billion per quarter for the past five quarters, a historic high.  If the Moody’s estimate is correct, an additional $50 billion in charge-offs will be needed for an additional five quarters.  Putting this into perspective, the entire banking industry reported total earnings of only $21.6 billion for the latest quarter ending June 2010.

Quarterly Net Charge Offs - Source: FDIC

The latest FDIC Quarterly Banking Profile showed signs of improvement for the banking industry.  Net charge-offs for the quarter ending June 30, 2010 were lower than the prior year and the first year-over-year decline since the 2006 fourth quarter.

Noncurrent loans (90 days or more past due) declined by 4.8% ($19.6 billion), the first quarterly decline since the beginning of 2006.   Although two thirds of all banks increased their loan-loss reserves in the second quarter, total loan-loss reserves declined by 4.5% due to a number of the largest banks reducing their loss provisions.

Reserve Ratios - Source: FDIC

The biggest uncertainty clouding the outlook for a recovery in the banking industry is the economy, which now appears to be slowing.   The Federal Reserve’s most recently released “beige book”, which tracks economic conditions in the 12 Fed Districts, reported that “Economic growth at a modest pace was the most common characterization of overall conditions.”  Five of the Fed Districts reported “mixed conditions or deceleration in overall economic activity”.

In June the Federal Reserve estimated that by the end of 2011, the unemployment rate would still be in the 8.3% to 8.7% range.

Although the banking industry seems to be on the path to slow recovery, continued economic weakness and high unemployment will lead to further credit problems and additional writeoffs.  Expect banking industry’s profits and lending activity to remain subdued pending an economic recovery.