This Could Blow a Hole in the Recovery

On Tuesday, I indicated that the accelerating pace of small bank failures is the canary in the coal mine with respect to further losses on commercial real estate loans at major banks such as Bank of America (NYSE: BAC  ) , JPMorgan Chase (NYSE: JPM  ) , and Citigroup (NYSE: C  ) . The same day, the FDIC released its quarterly report on the U.S. banking industry; unfortunately, the report's data suggest the sector's difficulties could be a drag on the broader economy for some time yet.

The hits keep on coming
Here are some of the lowlights:

  • Banks' loan loss rate in the fourth quarter was higher than it has been in over two decades.
  • The number of "problem" banks rose to 702 at the end of December -- the highest number since 1993. FDIC Chairman Sheila Bair expects the number of bank failures in 2010 will handily exceed last year's total of 140.
  • In 2009, total outstanding bank loans suffered the most severe decline since 1942.

Even though overall loan demand is weak, even where such demand exists, we can expect supply to remain constrained as the prospect of further losses on existing loans continues to weigh on bankers' appetite to make new loans.

The pain isn't spread equally
That won't be a problem for large-cap names -- U.S. companies took advantage of the bond market rally to issue a record $1.24 trillion in corporate bonds last year. Firms like AT&T (NYSE: T  ) , Procter & Gamble (NYSE: PG  ) , Wal-Mart (NYSE: WMT  ) , and Verizon (NYSE: VZ  ) , the four S&P 500 non-financials with the largest bond maturities in 2010, should have little trouble rolling over that debt.

An investor's interpretation
However, small- and medium-sized businesses can't access the capital markets directly and must rely on bank borrowing to fund their operations and growth. If credit is tight, that will weigh on the economy, which is one of the reasons why I find it difficult to imagine the robust recovery that some are touting. It's also a reason to favor large-cap stocks over small caps, and small caps with a clean balance sheet over those that are leveraged.

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Fool contributor Alex Dumortier loves macro-themed investing; he has no beneficial interest in any of the stocks mentioned in this article. Wal-Mart Stores is a Motley Fool Inside Value choice. Procter & Gamble is a Motley Fool Income Investor pick. The Fool owns shares of Procter & Gamble. Try any of our Foolish newsletters today, free for 30 days. Motley Fool has a disclosure policy.


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  • Report this Comment On February 25, 2010, at 4:16 PM, judithjo wrote:

    Hurray for Alex Dumortier. Unlike so many Motley Fool contributors, he actually wrote a short but relevant and informative article. Others should follow your example.

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