As we review credit quality trends in this report, we think it is critical to look back at the Financial Crisis years and study Banks’ percentage of Loan losses. A key point to remind investors and other industry observers is that many of the Bad Actors were removed via FDIC failures and closings which changes the loss data for those surviving financial institutions operating today. But, for capital markets players today, these Banks are the most appropriate to examine and assess future risk.
Therefore, we reviewed all available FDIC charter information and calculated gross charge-offs from 2007 to 2012 and calculated a Cumulative Loss Rate for each institution based on their maximum loan balance from the end of 2006 through the end of 2009 (i.e., most institutions were shrinking their balance sheets after 2009, if not before, so we judge losses based on the “max Loans outstanding” to see a true picture). The average loss rate for Banks between $30 Billion and $200 Million was 4.8% with 73% of these institutions operating below a 5.0% cum loss rate. While a healthy 27% of the Banks had losses above 5%, 16% of the 27% fell between 5.0% to 8.0%. Importantly, we calculate Tier 1 Capital-to-Assets at 6-30-2015 and then again after applying a 5.0% loss rate on today’s strong capital levels. We make the point that 9% of these FDIC charters would experience a Tier 1 ratio below 8% if 5.0% cum losses occurred in future years. A more onerous 8% loss rate increases the percentage of Banks with less than an 8.0% Tier 1 ratio to 20% (yes, this is significant deterioration, but we feel this risk is more than acceptable). In our view, the Banking industry has substantial capacity to weather a large credit storm every bit as fierce as the 2007 to 2012 Crisis years.