The FDIC recently released its Q3 banking report, and the headliner sounds like good news. According to the report, the overall industry earned a profit of $2.8 billion this quarter compared to a total industry loss of $4.3 billion for the second quarter of 2009.
However, there are reasons to believe these profits are misleading, especially since other statistics show again that the banking industry is getting worse as opposed to better. The report also revealed the following statistics:
The last statistic is perhaps the most troublesome. As we’ve mentioned in our posts about bank health during Q1 and Q2 of this year, the amount of reserves that banks set aside is a somewhat arbitrary provision because it represents management’s best guess how much they will actually lose from outstanding loans if they go bad.
It is hard to believe that bank managers now feel that they will need fewer reserves to cover losses from loans going bad. The more realistic explanation why banks are becoming increasingly optimistic about potential losses is that they are trying to appear healthier to raise capital or avoid seizure by the FDIC.
But how overly optimistic are banks being? Let’s consider that the amount of non-current loans went up by about $35 billion this quarter. If banks decided to keep last quarter’s ratio of reserves to non-current loans the same at 64%, they would have increased reserves by about $22 billion. Instead, they only increased reserves by about $9 billion, a $13 billion dollar difference.
Had the industry done that, instead of having a $2.8 billion profit this quarter, the industry as a whole would have lost about $10 billion, much worse than its $4.3 billion loss last quarter.
Thus, the industry swinging to a profit is misleading – it’s clear there are still large losses to be realized and the banking industry is far from out of the woods. In fact, there’s evidence that the industry continues to get worse, not better.
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