The Federal Reserve released its 2007 data on aggregate US bank lending, and the results will surprise many. Despite the hand-wringing over perceived dried-up liquidity, US bank lending grew throughout the year. Simply, this is an impossible outcome if a liquidity crisis truly existed.
2007 bank lending rose a stellar 10.8% from 2006—the fourth consecutive year of double-digit lending growth. The fourth quarter (the peak of the so-called liquidity crunch) resulted in 3.2% lending growth from the third quarter. This is a powerful demonstration of strength of US banks in the face of turmoil.
Just as impressive, all categories of US bank loans experienced an increase in 2007. The strongest segment was Commercial and Industrial lending at +21% from a year earlier, while the weakest was Revolving Home Equity (no surprise). And even that still managed to post a +3.2%.
But let's take it a step further:
Excluding mark-to-market asset write-downs, Financials' operating earnings were strong all year. This is of paramount importance because operating earnings are often a better indication of a company's ability to earn on an ongoing basis than bottom line earnings-per-share. That's because operating earnings do not count non-recurring items, only recurring revenue and expenses tied to a firm's core business.
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To really get this concept, let's look at a few specifics. Citigroup, a company which took a $10 billion net loss in the fourth quarter and more than $22 billion in asset write-downs (non-recurring items) for the year still managed to earn $3.6 billion in 2007. That implies operating earnings somewhere in at least the $25 billion dollar range. That's a mondo impressive number. Or, as economist Robert E. Litan recently put it, "Strip out the losses and Citi could make close to $10 billion a quarter." It's a similar story for many of the big US banks and financiers.
This isn't to say Citi's or any of the Financials' asset write-downs don't count. Of course they do. But it's key to recognize those losses will not continue in perpetuity, rather, the underlying capital markets business, which is ongoing, remains healthy and thriving.
And there's a subtler and just as interesting feature to all of this. While many have compared today's US banking sector to Japan's Financials sector woes of the late 90s, we see stark and important differences. We quote from the above article:
"During the 1990s, former Federal Reserve Chairman Alan Greenspan and other Fed officials advised Japanese regulators to push the banks to write off their bad loans, recapitalize themselves and get back to business. That didn't happen for years, and after it did—and Japanese corporations also cleaned up their balance sheets—economic growth resumed.
"So instead of just moaning about how much some institutions have lost, everyone also should be applauding that the potential losses are being recognized and new capital is being raised."
Banks had a choice to either shrink their balance sheets by reining in lending or attracting equity capital to continue operations in the face of recent credit market turbulence. Most chose the latter via sovereign wealth fund investments, preferred share offerings, hitting up the Fed's discount window, and so on.
Already, the big banks have gotten their acts together, taken their lumps, and still have balance sheets flush with cash and in good shape. This is precisely the opposite of Japanese Financials' precarious position ten years ago, and yet another demonstration of more fully developed, well-functioning capital markets today. (And anyway, Japanese banking problems ten years ago weren't enough to bring global markets down for the year in the first place!)
What's more likely taking place today is a reallocation of capital rather than a liquidity crisis. In recent years, a lot of credit financing capital went to high yield bonds (or, junk bonds). What we're seeing today is a reallocation of capital away from junk and toward investment grade (or, less risky) borrowers. It's cheaper today for investment grade companies to borrow than it was last summer. That's not a crisis at all, that's just a shift in who gets access to the money. What's more, the vast majority of dollars lent each year is investment grade debt. That means the overall corporate lending environment has actually improved over the last months in spite of erosion in the high yield markets.
On top of all that, credit default rates—even for junk bonds—remain near historic lows:
Junk Bonds and Green Skies, 1/9/2008
In sum, this is compelling evidence today's Financial and economic world is much healthier than most folks imagine. Sentiment can only hold a market down for so long. Those in debt disbelief at today's positive numbers will find it more and more difficult to justify a negative outlook for stocks looking ahead.
Source: The Federal Reserve
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.