Non Performing Loans at US Banks

Despite concerns about the fiscal cliff, it should be encouraging to investors that bank stocks have held up quite well over the last couple of months.  It seems that sentiment may have finally turned for the group, especially for Bank of America, which regained the $10 level yesterday yet still trades for a little over 50% of book value.

The banking system has healed a lot since 2008 and profitability has almost returned to old highs.  However, non-performing loans remain piled on US banks' books and probably will stay there for years to come.  According to recent FDIC data, non performing loans (NPL) as a percentage of all loans at FDIC insured banks are still higher than they were at the peak of the S&L crisis.  

While it's an interesting data-point, this isn't necessarily cause for alarm because NPLs are supposed to be written down to fair value when they go to non-accrual status.  This means that as long as housing prices remain stable, these loans probably wont have to be written down any more.  Also, just because a loan is marked as NPL doesn't mean that it's not still paying.  In fact, many of these loans are probably still generating cash flow for the banks that hold them.

How Does Housing Compare to the Tech Cycle?

Even though Bank of America is trading lower, today's quarterly release capped off what was a surprisingly good quarter for major US Banks.  In general, loans and deposits both showed growth, capital levels are extremely high and credit quality is significantly improved from where it was during the crisis.  Similarly, the housing sector has had some healthy reports as well recently (see previous post).

Seeing as how housing and banking were at the epicenter of the previous crisis, what does the fact that the two sectors are recovering say about where we are in the current economic cycle?  To try to help discern how this cycle compares to previous cycles, below is a chart comparing the performance of housing (ITB) and Financials (XLF) in this cycle to Technology (XLK) in the last one.  The chart shows relative performance of ITB, XLF and XLK compared to the S&P 500.  ITB and XLF are shown from 2006 and 2012 and XLK is shown between 2000 and 2007.

After the sharp collapse of technology stocks relative to the S&P from 2000-2002, XLK languished on a relative basis for the next four years before finally starting to outperform in 2006.  Similarly, both XLF and ITB showed steep drops and have continued to be losers since.  Now, years later, they may finally be starting to show signs of a turn.  XLK continued to steadily outperform the S&P 500 through 2012.  However, by the time XLK turned in 2006, the general economy only had one year left before it began to contract.

How Long Will It Be Until XLF Makes a New All Time High?

XLV may be making new all time highs, but its cousin, XLF is far from the point where it could make new highs of its own.  Thanks to the heavy dilution that the financial sector incurred during the financial crisis, the companies that make up the XLF were among the few large companies that sustained permanent losses of capital since 2008.  XLF made an all time high of $38.15 in 2007, but today sells for just $14.76.  

Given the extreme destruction of capital it will be a long time before the financial sector makes back its losses per share, but eventually it should get there.  XLF had a book value of $15.07 as of the end of 2011.  If the ETF trades in line with book value and grows book value per share by 8% per year, XLF will reach a new peak around 12 years from today, 2024.