The loan loss reserve percentage chart for major banks has been nosediving since mid 2018. It reached another post crisis record low on April 17. Loans outstanding have been soaring lately, but loss reserves are flat. So the percentage of loan loss reserves keeps falling.
There has been virtually no growth in total loss reserves since Q4, 2016. Apparently, bankers think that there’s no risk in the system. This is bubble mentality. Bank loan officers are living in a fantasy world where nothing ever goes wrong.
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This is a symptom of the steadily building systemic risk inherent in bubble behavior. That behavior has returned with a vengeance since the Fed’s policy aboutface. Imprudence starts with confidence that ultimately overflows into irrationality.
Naturally this isn’t the first time this has happened. And it did not end well the last two times it occurred.
This data is from the 25 largest banks in the US, which comprise 57% of total US bank assets. It includes most of the parent banks of US Primary Dealers. This statistic in the Fed’s weekly H8 gives us a detailed history that covers the last two major market cycles.
The loan loss reserve percentage of total large commercial bank assets has reached the levels reached in 1999-2000 and 2006-2007. It is currently 0.7%. That’s right. Seven tenths of a percent. This level corresponds with levels reached near the 1999-2000 and 2006-07 stock market bubble tops. So perhaps we should be paying attention.
The Fed began compiling this data in 1999. In December 1999 the indicator was at 0.75%. It got as low as 0.71% in January. Stocks topped out in March. The indicator rose as the bear market progressed, exceeding 1% in early 2003. It began steadily falling again after the stock market bottomed in March 2003.
Da Nile Ain’t Just a River in Egypt, The Loan Loss Reserve Percentage is Swimming In It
The next time the loan loss reserve percentage fell below 0.75% was in January 2006 as the housing bubble was topping out. The stock market topped out in July and October of 2007. The lead time between the loan loss reserve percentage falling below 0.75% and the stock market top was approximately 18 months.
The loan loss reserve percentage stayed below 0.75% until January 2008. By then, the stock market was well on its way into that bear market. Denial ain’t just a river in Egypt.
Meanwhile, more recently, the loan loss reserve percentage fell below and persistently stayed below 0.75% in May 2017. It has spent nearly 2 years below that level. It hit a low of 0.693 in January and got close to that in March at 0.697. The low in 2007 was 0.646.
We could roll the dice and bet that the loan loss reserve percentage will get that low again before stocks top out. Or we could look at the 2 year period of being below 0.75% as a warning that the period of “irrational exuberance” has gone on long enough.
No monetary or banking measure is a perfect market timing indicator. All they can do is indicate context. The current indication tells us that being long stocks in this context is playing with fire. For specific timing and trade suggestions, technical analysis is best.
This report is excerpted and expanded from Bank Lending Bubble Still Red Hot