Citigroup (C) and other banks showed solid improvement in net interest rates and loan-loss reserves in Q1, but it may not matter much, writes R.C. Whalen with Institutional Risk Analytics in a note to clients this afternoon.
The banking business will deteriorate on declining credit quality the rest of this year, writes Whalen.
For one thing, the adoption of Financial Accounting Standards Board rule 166, during the quarter, largely inflated net interest income.
What’s more, Whalen finds that the off-balance-sheet metrics are more distressing after sifting through Q1 data from the FDIC.
Looking at “Loss Given Default,” Whalen finds that the recovery rate for defaulted loans is a mere 8%, way down from 30% in 2005. That, suggests Whalen, means, “Capital and reserves will need to be higher in the future — even without legislative and regulatory changes already in process.”
The average recovery over the past 20 years was 19%, notes Whalen, while analysts seem to be projecting a most unreasonable 30% to 40% of recovery of par value of loans in future.
Whalen concludes:
The Obama Administration, the Congress, the regulators and the banks all have a vested interest in portraying a US banking industry which is on the mend. Unfortunately, the reality below the surface is considerably more complex and far from stable. We see a definite risk that when the banking industry starts to show evidence of heading down for a second �dip� in terms of credit losses and foreclosures, the markets will be �surprised� and that the resulting downdraft could move the entire sector lower.
When you add the fact of macro risk such as the fiscal problems in the EU and financial reform in the US, the picture for financials becomes even less clear. We continue to believe that our subscribers should use market weakness to accumulate exposure to quality names, but don�t be �surprised� if Q1 2010 turns out to be the best quarter for this year in the US banking sector.
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