| Credit Crunch Underway: Can Recession Be Far Behind? Posted: 12 Apr 2015 09:59 PM PDT Credit Crunch UnderwayLast week, Alexander Giryavets of Dynamika Capital L.L.C. pinged me with an article he had written on Recessionary Level in Credit Conditions. His article was based on data from the March Credit Managers' Index by the National Association of Credit Management. The report is pretty damning. First, let's take a look at some NACM snips. Emphasis in italics is mine. Following the NACM snips and some NACM explanations, we will return to a chart from Giryavets. From the March NACM Credit Managers Report: Combined Sectors [Manufacturing and Service]
There is quite obviously some serious financial stress manifesting in the data and this does not bode well for the growth of the economy going forward. These readings are as low as they have been since the recession started and to see everything start to get back on track would take a substantial reversal at this stage. The data from the CMI is not the only place where this distress is showing up, but thus far, it may be the most profound.
The combined score is getting dangerously closer to the contraction zone and has not been this weak in many years (going back to 2010). It is sitting at 51.2 and that is down from the 53.2 noted last month.
The most drastic fall took place with the unfavorable factors that indicate the real distress in the credit market. It has tumbled from 50.5 to 48.5 and that is firmly in the contraction zone—a place this index has not been since the days right after the recession formally ended. The signal this sends is that many companies are not nearly as healthy as it has been assumed and that there is considerably less resilience in the business sector than assumed.
The breakdown of the two index categories proves instructive. The category of sales slid to 57.9 and that is a far cry from the 65.7 that was notched back in October of last year. These numbers have been in the high 5 0s and 60s for the last year and now the slide is accelerating. The new credit applications category actually improved from 54.5 to 57.4, but when one combines this reading with the one for amount of credit extended, you get a n even more miserable story than one would assume. The latter reading went from 52.1 to a very troubling 46.1. There may be more applications for credit, but there is not all that much getting issued and that indicates that much of the new credit being requested is coming from companies that are not in a position to get that credit.
The real damage is showing up in the unfavorable categories. By far the most disturbing is the rejection of credit applications as this has fallen from an already weak 48.1 to 42.9. This is credit crunch territory—unseen since the very start of the recession. Suddenly companies are having a very hard time getting credit. The accounts placed for collection reading slipped below 50 with a fall from 50.8 to 49.8 and that suggests that many companies are beyond slow pay and are faltering badly. The disputes category improved very slightly from 48.8 to 49, but is still below 50. This indicates that more companies are in such distress they are not bothering to dispute; they are just trying to survive. The dollar amount beyond terms slipped even deeper into contraction with a reading of 45.5 after a previous reading of 48.4. The dollar amount of customer deductions slipped out of the 50s as i t went from 51.8 to 48.7. The only semi-bright spot was that filings for bankruptcies stayed almost the same—going from 55.0 to 55.1. This is the one and only category in the unfavorable list that did not fall into contraction territory and that suggests that there are big, big problems as far as the financial security of these companies are concerned.
Manufacturing Sector
The damage this month is pretty widespread and the manufacturing sector took a hit as well as the service sector. The combined index slipped from 53.7 to 51.6 and that is getting uncomfortably close to the contraction zone. The index of favorable factors remains in acceptable territory with a reading of 55.6 after one of 57.9 la st month, but for the bulk of the last year these readings have been in the 60s and trending in a far more positive direction is the case right now. The index of unfavorable factors is where the damage really starts to manifest as the overall score slipped from 50.9 to 48.9 and that marks the first time the combined reading has been this low since 2010, although it must be pointed out that these readings have not been all that high for quite a while — bouncing along in the low 50s for the past couple of years.
The new credit applications category stayed roughly the same as last month with a slight rise from 56.7 to 58.6, but as pointed out in the narrative above, this is not really good news as the amount of credit extended slipped badly from 49.4 to 45.1. The fact is that companies that are not all that creditworthy are trying to get credit and they are not getting much attention.
As stated earlier, the real concerns start to manifest with the unfavorable categories. The rejections of credit applications fell out of the 50s with a resounding thud—going from 50.3 to 43.8. There is most definitely a credit crunch underway and it is now easy to determine what the prime factor is. There are many companies seeking credit that are too weak and there is obviously an abundance of caution showing up in those that issue that credit.
The big news is access to credit. It is suddenly very hard to get and this looks like the situation that existed at the start of the recession in 2008 [2007 actually]. The overall economy didn't look all that bad in late 2008, except that there was a dearth of credit and that soon led to business failures and struggles.
Service Sector
As was the case last month, the majority of the damage was seen in the service sector and this month it is going to be hard to blame it all on the weather or some other seasonal factor. The combined index is teetering right on the edge of contraction as it has slipped from 52.6 to 50.9. The index of favorable factors fell from 56.4 to 55.2 and just as with manufacturing, the big issue was access to credit. The sales category was not affected all that much from last month, but is down from much of the last year. It has fallen from 57.9 to 56.9. Again we see a hike in the new credit applications category as it moved from 52.1 to 56.2 and again this is far from good news given that amount of credit extended slipped from 54.8 to 47.2. The pattern is the same whether one is discussing the manufacturing or service side—too many seeking credit that are not going to get what they are seeking—either because there are doubts as to their credit status or because those issuing credit are in a very cautious mood.
The overall unfavorable reading has been above 50 for several years and in some months, the reading was nearly mid-50s. That is no longer the case as the numbers slipped from 50.1 to 48.0. The details illustrate the problems just as they do for manufacturing. The rejections of credit applications is as miserable as it has been since the depths of the recession—going from 45.9 to 42.0. These are very bad readings and it will take a good long while to climb out of this mess. The accounts placed for collection category is weak as well—going from 49.9 to 48.1, but at least the fall wasn't as dramatic as with some of the other readings. The disputes category fell out of the 50s with a reading of 49.4 following last month's reading of 50.4. The dollar amount beyond terms improved a little but still remained in the 40s—going from 44.7 to 45.1. The dollar amount of customer deductions went from 54.8 to 48.7 and that was a sharp drop. The filings for bankruptcies went from 54.9 to 55.0 and that was one of the very few positive readings this month.
March 2015 versus March 2014
The year-over-year trend remains miserable and seems to be getting worse and thus far nearly all the blame can be laid at the feet of credit access. There is just not a lot of confidence in those that are doing the credit offerings these days. NACM Favorable and Unfavorable Factors click on chart for sharper imageThis is somewhat counterintuitive, but negative unfavorable scores are not a good thing. " When survey respondents report increases in unfavorable factors, the index numbers drop, reflecting worsening conditions." Recessionary Credit ConditionsInquiring minds may wish to read Recessionary Level in Credit Conditions by Alexander Giryavets. The charts in Giryavets' article are in his words "shifted and rescaled" so one can see how much of subcomponent movement can be explained by index movement. Some may find those charts hard to follow, so I asked Giryavets for a simple chart of the overall index, credit extended, rejection of credit, and dollar amount beyond terms. He graciously created that chart for us, shown below. Combined Index, Amount of Credit Extended, Credit Rejected, Dollar Amount Beyond Terms  click on chart for sharper imageStart of recession is denoted by vertical red line, end of recession by vertical green line. Can Recession Be Far Behind?NACM data only goes back to 2002. Also data prior to 2006 is not seasonally adjusted, while data from 2006 and later is seasonally adjusted. In the entire series since 2002, the only other time we have seen deep plunges in amount of credit extended and rejection of credit applications was deep in the middle of the last recession. Those are apples to apples comparisons, both seasonally adjusted. Although comparisons between seasonally adjusted numbers and unseasonably adjusted numbers are technically invalid, if anything that would have led to more volatility between comparisons, not less. This is still more supporting evidence that a recession is on the way. Heck, we may even be in the start of one right now, just as everyone is expecting rate hikes. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot |
| Former Fed Governor Thomas Hoenig Says US Banks Undercapitalized; Unsafe, and Unsound Banks Posted: 12 Apr 2015 12:42 PM PDT In another round of " stress" tests last month, the Fed said Big Banks Pass Muster. Anyone who has been following stress tests in US or Europe knows full well, the tests were in reality " stress free". Confirmation of the undercapitalized state of US banks comes from former Fed Governor Thomas Hoenig. He served as chief executive of the Tenth District Federal Reserve Bank, in Kansas City, for 20 years. Rules limit terms to 20 years. Hoenig is now vice chairman of the Federal Deposit Insurance Corporation. Undercapitalized, Unsafe, and Unsound Hoenig's opinion should carry some weight. And a New York Times Editorial citing Hoenig sounded an alarm today regarding Unsafe and Unsound Banks. After the latest round of bank stress tests last month, the Federal Reserve announced that, by and large, the nation's biggest banks would all be able to withstand another crisis without requiring bailouts.
This month, Thomas Hoenig, vice chairman of the Federal Deposit Insurance Corporation, released data that contradict the Fed's conclusions.
In the face of Mr. Hoenig's challenge, the Fed would do well to recall a chapter from its recent history. Before the financial crisis, when Alan Greenspan, then chairman of the Fed, was insisting all was well with the banks, one Fed governor, the late Edward Gramlich, warned of mounting risks. He was ignored.
At issue this time around is the level of bank capital, which reflects the amount of loss a bank can endure before failing (or, if the bank is "too big to fail," requiring a bailout). According to the Fed's main measure, capital at the eight largest American banks averaged 12.9 percent of assets at the end of 2014, well above required regulatory minimums.
In contrast, Mr. Hoenig's calculations show that capital at those same banks averaged only 4.97 percent at the end of 2014.
In a recent speech, Mr. Hoenig noted that under American accounting rules, derivative holdings add $300 billion to the balance sheets of five top banks — JPMorgan Chase, Citigroup, Bank of America, Goldman Sachs and Morgan Stanley. Under international rules, the holdings would add $4 trillion.
History favors Mr. Hoenig's approach. Gains and losses on derivatives may be offsetting when the economy is stable, but in the financial crisis American taxpayers were forced to hand the banks tens of billions of dollars to make good on derivative bets gone bad. In a healthy system, the banks would hold enough capital to ensure that doesn't happen again. Do they now? Fed officials seem to think so. They should think again. Thomas Hoenig on State of US BanksLet's take a look at April 2 statements by Thomas Hoenig in the FDIC Release of Fourth Quarter 2014 Global Capital Index. For the largest U.S. banking firms, the average tangible equity capital ratio – known inversely as the leverage ratio – is 4.97 percent (column 8). In other words, each dollar of assets is funded with 95 cents of borrowed money.
The largest regional and community banks, shown in the last three rows of column 8, have tangible capital ratios ranging from 7.57 to 8.85 percent. That is, they operate with between 1.5 and 1.7 times more funding from their ownership than G-SIBs do.
"The Global Capital Index illustrates how financial resiliency is still sorely lacking," Vice Chairman Hoenig said. "The sector of the financial industry with the greatest concentration of assets is the least well capitalized. Plainly put, it operates with the largest amount of borrowed, or as we say, leveraged funding, and thus it is the least well prepared to absorb loss. Yet the primary measure of capital – the risk weighted measure (column 3) -- makes the largest firms appear relatively more stable than they really are. The reality is that with too little owner equity funding individual firms, the industry as a whole also is undercapitalized and should one firm fail, the industry continues to be vulnerable to contagion and systemic crisis. It follows that the lack of adequate tangible capital remains among the greatest impediments to successful bankruptcy and resolution."
The ratios of Tier I capital to risk-weighted assets for all banks (column 3), largest to smallest, are above 10 percent and some of the largest have ratios of more than 15 percent. "This higher capital ratio is achieved by reducing on-balance sheet assets by a pre-assigned risk weight and excluding off-balance sheet assets, such as derivatives. This measure is misleading and overstates the strength of these firms' balance sheets. No other industry is allowed to make these kinds of adjustments," Vice Chairman Hoenig said. "The tangible leverage ratio provides a more accurate measure of assets and risks than the balance sheet reported under either GAAP or Basel." Banks Not Well CapitalizedBanks are "well capitalized" in the US only by ignoring derivatives. European banks are "well capitalized" by treating all sovereign debt, including Greece, Spain, Portugal, as if it was risk-free. The reality is banks are undercapitalized globally. And although taxpayers were forced to cover losses, they shouldn't have been. The notion that bondholders should never take losses is absurd. The Fed assumes "derivatives are risk free because they net out". Hoenig doesn't buy that argument and neither do I. A currency crisis awaits. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot. |
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