Friday, September 25, 2009

"Shadow Banks" Lousy Underwriters

The FT reports that the US financial sector's losses on large loans exploded over the past year, exceeding the combined losses since 2001. Regulators' annual review of "shared national credits" - loans larger than $20 million shared by three or more federally regulated institutions - reveal that one in three dollars lent by non-bank institutions (i.e hedge funds, securitization vehicles and pension funds) went sour compared with 11.5% for US banks. Furthermore, non-bank institutions were responsible for 47% of problem loans in spite of only accounting for 21.2% of the total loan pool.

Overall, the US financial sector's losses on loans in early 2009 reached a record of $53 billion, almost triple the previous high in 2002, and nearly 15% of the $2.9 trillion in the SNC portfolio was classified as "substandard." The review is conducted each year by the Fed, FDIC, OCC and OTS. They made the astonishing discovery that underwriting standards had improved last year, but that the loans originated before mid-2007 had continued to drag down the portfolio's performance. Could it be that underwriting standards have improved because many of the non-bank lenders have since gone bust and all financial institutions virtually ceased lending after the credit crisis hit? Nice to know our regulators are discovering such ground-breaking information three years after it actually matters.

If you were wondering what on earth the OCC and OTS actually did with their time, the answer is here: run reviews of loan portfolios made during a credit boom that they slept through and say things like "wow! you guys really originated a bunch of crappy loans!" If there's a silver lining in any of this, it's that the non-bank institutions made our banking institutions look like prudent lenders. Even in the business of lending, everything is relative.