Banks Charging Off Debt at a Higher Rate than in Great Depression

Bank charge-offs are continuing to grow and are likely to do so for at least the next few months, even though the government and most economists say that the recession is over.

“Charge-offs are a lagging indicator,” said Dan North, said Dan North chief economist at Euler Hermes ACI a trade credit insurance firm. “I think we’re getting near the peak. The charge-offs are on loans that were made in the past.”

Moody’s Investors Service reported earlier this week that bank charge-offs had reached $116 billion year to date, or 2.9 percent of outstanding loans on an annualized basis. According the report, the rate is higher than the charge off rate during the Great Depression.

“While the latest reports of net charge-offs to banks are alarming and unprecedented, the credit economy during the Great Depression and the one we have now are very different from each other,” cautioned Dana Wiklund, research director for Financial Insights’ Risk Management Advisory Service. “There is no comparison between the diversity and terms of products or the levels of borrowing. Taken as a percentage comparison, the numbers are alarming, but one needs to look beyond charge-off numbers to make economic comparisons.”

“They were still awarding too much credit when they should have been cutting back. Banks are now able to make good loans going forward,” North said.

“The economy we have today is much more diversified and has many stabilization features not available during the Great Depression.” Wiklund added. “Monetary policy makers also have tools, mechanisms and authorities that were not available to their counterparts 77 years ago.”

So while charge-offs will continue to grow, at least for a while, neither North nor Wiklund expects the fall out to be as bad as it was during the Depression.

“Economic growth over the past several years has in part been based on a consumer and commercial credit bubble that has burst, we are now charging off the fall out,” Wiklund added. “Moving forward financial institutions will have to balance drivers of economic growth with the necessary increased accountability of a consumer or a business’s willingness and more importantly, ability to pay."

While the economy is improving, banks are still very hesitant to lend until they see more evidence of improvement, according to North.

“Many U.S. banks justified a smaller loan loss reserve build in the third quarter compared to previous quarters in 2009 because of both the slower rate of increase in charge-offs and the early signs of moderating delinquency trends,” Moody’s said.

The rating agency estimates loan loss provisions for rated U.S. banks in the quarter at $55 billion, or approximately 120 percent of charge-offs or just less than five quarters coverage.

The excess of provisions over charge-offs represents a $10 billion allowance for loan loss build in the quarter down from $21 billion in the first quarter of 2009 and $16 billion in the second quarter of 2009, according to the ratings agency.

“We continue to believe it’s premature for banks to lower their reserve build since problem loans and net charge-offs continue to show an upward trend even though some, but not all, consumer delinquencies showed improvement,” Moody’s said.