Banks forced to make bad loans
Posted
Nov 04 2008, 05:47 AM
by
Jon Markman
Rating:
Bullish investors were excited this week to learn that there's been a surge in commercial and industrial loans at banks. The effort has been taken to mean that credit is finally thawing out. Yet one independent credit analyst is out this week with analysis that suggests that the surge of loans is actually a huge negative. The reason: They're involuntary, and will lead to cuts in other type of lending.
The analyst, Brian Reynolds, notes that C&I loans surged in a similar manner in mid-2000 and August 2007. And in both cases the effort turned out badly because, like today, it was triggered by a freeze at money markets funds.
Reynolds points out that money market funds have for years been the biggest buyers of commercial paper, which supply working capital to corporations. When investors pulled out of money markets earlier in the fall due to fears they were too risky, companies have had to look elsewhere for credit. So they drew down their standby lines of credit at banks just to remain solvent and pay the bills.
Reynolds reports that these are "horrible, risky, low-profit loans" for banks because they were granted during the bull market when credit was cheap. Banks only took a nominal fee for creating the lines, and their pre-determined terms mean they are being issued at low-margin spreads at a time when loan costs otherwise are massively higher. He says that a bank writing these lines during a bull market is like an investor selling naked puts on stock in a bull market at a time of low volatility: It produces a little income while times are good, but a bear market can be disastrous.
Since banks are not making money on these loans, they are believed to be compensating by reducing other forms of lending just as they did in years past. They will cut back on auto loans, student loans, home equity loans and hedge fund loans.
Now if the big banks' new owners -- the government -- decides to come in and force them to make more loans that are uneconomic just for the sake of political correctness, you can just imagine what will result: Yes, banks could be in more danger next year than they were before the bailout.
