Market Commentary

When will bank lending resume?
October 26, 2009

When will bank lending resume?  As stated many times and as per the Federal Reserve excess bank reserves are $900 billion versus the historical average of $1.5-$2 billion.  In my view it is not a matter of if but when.  As widely noted there is approximately $160 billion in commercial real estate that must be renewed, paid off in the next 18 months.  Most of this debt is backed by properties that have declined in value thus suggesting this debt is not properly collateralized.

However it is my first hand experience banks will not force the borrower into foreclosure if the project is cashflowing.  Yes banks will demand as much collateral as possible but banks will not push a performing entity over the proverbial edge but instead kick the proverbial can down the road until the next loan renewal believing asset values should by then have recovered.

This approach is not new.  It is widely accepted that during the early 1980s most money center banks were technically insolvent because of Latin and Central American loans.  Government officials permitted banks to carry this debt at face amount as long the debt was cashflowing, only taking charges when the loans went delinquent.

As also noted many times the consistency of this crisis is its inconsistencies and the velocity of change.

Because of the lack of bank lending, partially constrained by real and imagined regulatory over reach, corporate bond issuance is surging including originations of leverage buy out loans which is widely regarded as the most aggressive type of lending.

 Junk bond issuance is at the highest level since 2007 partially the result of the 51% YTD gain in prices.  The spread over treasuries is now around 7.5% as compared to a record 21.8% on December 15, 2008.  Incidentally the average spread is around 500 basis points.  It reached an all time low of 2.4% in June 2007.  [Merrill Lynch]

What does this have to do with bank lending?  Everything.  Six months ago corporate debt issuance, especially for unrated debt, was nonexistent.  Third quarter GDP is released Thursday.  Consensus is estimating a 3.2% growth, the quickest pace since the 3.6% rate experienced in September 2007.  As widely noted growth has declined four consecutive quarters of declining growth, the longest streak since the 1930s. 

An expanding economy should increase the asset values of most entities.  If the data is suggesting momentum is growing, the odds of greater bank lending increase.

As noted last week the sixth month rise in The Index of Leading Economic Indicators was the greatest in 26 years or at the conclusion of the last major recession.  As per the economic consulting firm of Capital Economics, such a rise is consistent with an annual economic growth rate of 8% GDP.  The last time the economy expanded at this annual rate was June 1983-- through March 1984.

While I am not suggesting such growth will occur, I am only stating a case that I think growth will surprise on the upside, partially the result that growth is rebounding off such low levels.  It is this rebound that should permit an increase in bank lending.

Unfortunately only history will judge me correct in this view.

As mentioned above, this week is filled with top tier data including estimates of third quarter GDP, Consumer Confidence, S & P/CaseShiller Price Index, Durable Goods, New Home Sales and various regional manufacturing indices.  All data can impact the direction of the markets.

Commenting briefly on Friday’s market activity, stocks declined because of a drop in oil and questions about the timing of a change in monetary policy.   Earnings have been great.  Approximately 80% of S & P companies that have posted earnings have exceeded expectations, the greatest proportion since the 1993 inception of this data point.  Bloomberg is now estimating 3Q results to decline about 15% versus the October 1 view of a 23% decline.

Bonds were down about a point on better than expected existing home sales, angst about the direction of monetary policy and a record $123 billion of new treasury supply coming to market this week.

Last night the foreign markets were up. London was up 0.20%, Paris up 0.23% and Frankfurt up 0.38%.  Japan was up 0.77% and Hang Sang up 1.71%.

The Dow should open nominally higher on profit reports.  The 10-year is off 3/32 to yield 3.50%.