Banking Industry Performance

and Financial Stabilization Policies

Fourth Quarter 2008

Richard
Ri h d A.
A Brown
B Richmond
Ri h d Association
A i ti
Chief Economist, FDIC for Business Economics
May 19, 2009
 Agenda

• Self-Reinforcing
S lf R i f i C Cycles
l
p
• Credit Market Lockup
• Economic Fallout
• Banking Industry Performance
• Federal Policy Remedies
• Outlook
Self-Reinforcing Cycles
 Futures prices suggest that we are 76 percent of the way
through the ultimate decline in average U.S.
U S home prices.
prices

S&P Case-Shiller Composite 10-City Index; Futures Prices on Index

250
Composite Index Futures Prices

200 192% Futures prices imply

further 14.4% decline
increase over 31.0%
31 0% through May 2010
10 years to decline
150 peak from peak
(so far)
Futures
F t prices
i
100 imply subsequent
rebound of 19.8%
over next 4 years
50
Total implied peak-to-trough decline:
40.9% over 4 years.
0
1996 1998 2000 2002 2004 2006 2008 2010 2012
Source: S&P Case-Shiller (Haver Analytics, Bloomberg)
 The rapid rise in mortgage credit distress is now being observed
in Alt-A and prime loans.

Conventional Loans Past Due 90+ Days Conventional Loans In Foreclosure

12 25

10
Subprime ARMs Only 20

8 Subprime ARMs Only

15
6 All
All
10
4
ARMs 5
2 Only Prime
Prime ARMs Only
All All
0 0
2000 2002 2004 2006 2008 2000 2002 2004 2006 2008

Source: Mortgage Bankers Association

With the end of the housing boom has come a steep rise in
residential foreclosures.
Estimated Annual Number of Foreclosures, in Millions
2.50
2 28
2.28

2.00

1 54
1.54
1.50

0.94
1 00
1.00 0 80
0.80 0.80
0.73

0.50

-
2003 2004 2005 2006 2007 2008
Source: FDIC estimates
S ti t based
b d on d
data
t ffrom the
th Mortgage
M t Bankers
B k Association
A i ti and
d th
the American
A i H
Housing
i
Survey (HUD)
Issuance of Private-Label Residential Mortgage-Backed Securities (RMBS)
($ Billions)
300
Subprime

250

200

150 Prime/Alt-A

100

50

0
1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08
Source: Inside Mortgage Finance
Credit Market Lockup
Spikes in the credit risk premium reflect periods of intense
financial market distress
distress.
Credit Spread (BAA yield less AAA yield) 2008
Percent Credit
4.0 Severe U.S. Market
recession Lockup
Oil price
3.5 Failures of
and inflation
Enron,
30
3.0 spike
WorldCom,
1974 oil etc.
2.5 LTCM,
embargo Gulf War I
20
2.0 Russian
fallout
bond default
1.5

1.0

0.5

0.0
1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
Source: Federal Reserve
Key Libor spreads have steadied somewhat since the severe
disruption of the interbank market in Sept. and Oct. 2008

Three Month Spreads (%)

5
Peak TED Spread (Oct. 10)
Libor-OIS Spread
464 bps
4
Libor-T bill ((TED)) Spread
p Wachovia Assistance
Transaction (Sept. 29)
3
Washington Mutual
Failure (Sept. 25)
2 IndyMac Failure (July 11)

1
Lehman Brothers Bankruptcy (Sept. 15)
AIG Bailout (Sept. 16)
0
Feb 08
Feb-08 Apr 08
Apr-08 Jun 08
Jun-08 Aug 08
Aug-08 Oct 08
Oct-08 Dec 08
Dec-08 Feb 09
Feb-09 Apr 09
Apr-09

Source: Bloomberg
Net Percentage of Banks Reporting Tighter Lending Standards
((Percent))
100

80 Credit Card Loans

60
Commercial and Industrial Loans

40
Residential Mortgage Loans
20

-20
4 1 2 3 4 1 2 3 4 1 2 3 4 1 2
2006 2007 2008 2009

Source: Federal Reserve Senion Loan Officer Opinion Survey/Haver Analytics

Economic Fallout
 Real Gross Domestic Product
% Change - Annual Rate SAAR, Bil.Chn.2000$

7.5 7.5

5.0 5.0

25
2.5 25
2.5

0.0 0.0

-2.5 10 year avg = 2.1% -2.5

4Q 2008 = -6.3%
6 3%
-5.0 1Q 2009 = -6.1% -5.0

-7.5 -7.5
98 99 00 01 02 03 04 05 06 07 08
Source: Bureau of Economic Analysis /Haver Analytics
The 6.1 percent first-quarter contraction in real GDP was led by
large declines in business investment
investment.
Contribution to real net GDP growth (percentage points)
8.0
6.0
4.0 Consumer Decrease in
spending
p g +1.5 imports +6.1
20
2.0
Fed. govt. -.30
0.0
Residential State/loc govt -.5 Decrease in
-2.0
construction -1.4
1.4 exports -4.1
-4.0
Equipment &
-6.0 Non-residential
software -2.6
construction -2.1
-8.0 Inventories -2.8
2.8
-10.0
Personal Business Government Net Exports
Consumption Investment
Expenditures
Source: Bureau of Economic Analysis
Banking
B ki IIndustry
d t
Performance
The Industry Has Its First Quarterly Loss in 18 Years
($ Billions)
50
Securities and Other Gains/Losses, Net
Net Operating Income
40 36.9 38.0 38.1 36.8
35.3 35.6
33 2 34
34 0 33.2
34.0 34.7
7 32.6
31.8 31.2 32.5 31.0
30 28.7

20 19.3

10
4.8 1.0
0.6
0

-10

-20

-30 -32.1
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

2004 2005 2006 2007 2008

Loss Provisions Were More Than Twice the Level of a Year Ago
4th Quarter 2008 vs. 4th Quarter 2007
($ Billions)
40
37.3
35

30
Positive Negative
25
Factor Factors
20

15

10
6.8
4.5
5

-5
-4.5
-6.1
-10
Increase in Net Increase in Loan Decrease in Increase in Increase in
Interest Income Loss Provisions Noninterest Realized Losses Noninterest
Income on Securities Expense
Troubled Loans Continue to Rise
Percent
4.0

3.5

3.0

25
2.5 Noncurrent Loan Rate

Quarterly Net Charge-off Rate

2.0

1.5

1.0

0.5

0.0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
 Earnings have unraveled fastest at larger institutions.

Pre-Tax Return on Average Assets, Annualized

3.00%
2.50%
2.00%
1.50%
1.00%
0 50%
0.50%
0.00%
-0.50%2001 2002 2003 2004 2005 2006 2007 2008
All Insured Banks & Thrifts Assets < $100MM
-1.00%
Assets $100MM - $1B Assets $1 - $10B
-1.50% Assets > $10B
-2.00%
Source: FDIC
 Credit losses have risen fastest for larger institutions.

All Insured Banks & Thrifts

Net Loan Chargeoffs to Average Loans, Annualized
A
Assets
t < $100MM
2.50%
Assets $100MM - $1B
Assets $1 - $10B
2.00% Assets > $10B

1.50%

1.00%

0.50%

0.00%
2001 2002 2003 2004 2005 2006 2007 2008
Source: FDIC
 There is still little relief from margin pressure except at the
l
largest institutions.
i i i

Net Interest Margin, Annualized

4.5%

4.0%

3.5%

3.0% All Insured Banks & Thrifts

Assets < $100MM
Assets $100MM - $1B
2.5%
Assets $1 - $10B
Assets > $10B
2.0%
2001 2002 2003 2004 2005 2006 2007 2008
Source: FDIC
Federal Policy Remedies
 The American Recovery and Reinvestment Act of 2009
totals some $787 billion in spending and tax cuts.
Expressed in billions of dollars
Agriculture,
broadband and
welfare, $26
Other - defense, govt. Payroll tax credit &
infrastructure, $90 othe r taxes, $166

Unemployment Alternative Minimum

Benefits, $82 tax $70
tax,

Business tax cuts, $5

Transportation &
Clean Energy,
Energy $112 Modernizing
Healthcare , $21

Employment Training Aid to States-

& Education, $71 Stabilizati on & Relief,
$1 44

Source: Financial Times and Wall Street Journal

 Goals of Financial Stabilization
P li i
Policies
• Restore liquidity to financial markets in the
short term
• Sort out the difficult valuation issues that arise
from complex assets and an uncertain economic
and financial environment
• Solidify the capital base and funding of the
industry
• Provide
P id a sound dbbasis
i ffor th
the availability
il bilit off
credit that will be needed to finance an
economic recoveryy
 Federal Reserve Liquidity Programs
• Term Auction Facility
y (TAF)
( ) - December 2007
• Reciprocal Currency Agreements – December 2007
• Term Securities Lending Facility (TSLF) - March 2008
• Pi
Primary D
Dealer
l C Credit
dit F
Facility
ilit (PDCF) – March
M h 2008
• Asset Backed CP Money Mkt Fund Liquid. Facility (AMLF) – Sept 2008
• p Funding
The Commercial Paper g Facility
y ((CPFF)) – October 2008
• The Money Market Investor Funding Facility (MMIFF) – October 2008
• Term Asset-Backed Securities Loan Facility (TALF) – November 2008
• Mortgage Backed Securities
S Program (MBS)
( S) – November 2008
Troubled Assets Relief Program (TARP)
• $700 billion total authorized funding, in two tranches
• Authorizes Treasuryy to “purchase
p or insure” troubled assets
• MBS and whole loan purchase programs
• As of February 2009, about $376.9 billion has been distributed through
seven programs:
– C it l Purchase
Capital P h Program
P
• $198.4 billion distributed to 440 depository institutions and bank holding companies
– Systemically Significant Failing Institution Program
• $69.8 preferred equity stake in AIG
– Targeted Investment Program
• $40 billion preferred equity stake each in Citigroup and Bank of America
– Asset Guarantee Program
• $5 billion in loan guarantees for Citigroup
– Automotive Industry Financing Program
• $24.8 billion was used to assist the automotive industry
– Consumer & Business Lending Initiative
• $20 billion was invested in TALF
– Home Affordable Modification Program
• $13.9 billion invested in 11 institutions for home loan modifications
 FDIC Temporary Liquidity
G
Guarantee Program
P
• Authorized by FDIC Board in October 2008 under systemic risk finding
• Two components:
1. Guarantee of senior unsecured debt issued by insured depository
institutions and most depository institution holding companies
2 Guarantee
2. G t off noninterest
i t t bearing
b i transaction
t ti deposit
d it accounts
t in
i excess off
deposit insurance limits.
• Participation:
– Debt guarantee program -- 7,100
7 100 banks
banks, thrifts and holding companies
– Transaction account guarantee program -- 7,000 banks and thrifts
• Fees
– D
Debt
bt guarantee
t program – 10 tto 50 bbasis
i points
i t ffor iindividual
di id l ddepository
it
institutions and other entities depending on debt type and maturity
– Transactions accounts – 10 basis points of amount greater than $250,000
• $328 5 billion in FDIC-guaranteed
$328.5 FDIC guaranteed debt outstanding as of April 22
 FDIC Temporary Liquidity
G
Guarantee Program
P
(T + bps) 3 to 3
3.5 Y
Year T
TLGP
GP and
d Agency
A Debt
D b Spreads
S d Over
O Treasuries
T i
140

120

100

80

60

40

20

0
3/30/09 3/31/09 4/1/09 4/2/09 4/3/09 4/6/09 4/7/09 4/8/09 4/9/09 4/10/09 4/13/09 4/14/09 4/15/09 4/16/09 4/17/09

C GE HSBC JPM MS NYCB RF WFC BAC GS FNMA FHLMC

 Financial Stability Plan
• Capital Assistance Program
– Determine capital needs – stress test
– Purchase convertible preferred stock
• Public-Private Investment Fund
–$
$500 billion to $
$1 trillion in g
gov’t funding
g
– Attract private capital, generate pricing
• Consumer and Business Lending Initiative
– Expand TALF to $1 trillion
– Expand
E d eligible
li ibl ABS
 Homeowner Affordability and
S bili Pl
Stability Plan
• Allow conforming borrowers to refinance at historically
low rates with the GSEs even when loan-to-value
exceeds 80%
• Provide up to $75 billion in financial incentives and
subsidies to servicers to modify unaffordable mortgages
to lower monthly payment
• Also:
– Increase funding commitment to GSEs
– Streamline Hope for Homeowners
– Support
S t judicial
j di i l modifications
difi ti
Outlook
Consensus forecasts of GDP growth currently track between
"b
"baseline"
li " and
d "adverse"
" d " stress
t test
t t scenarios.
i
Annualized Growth in Real GDP

6 0%
6.0% A t l = +2.0%
Actual 2 0% A t l = +1.1%
Actual 1 1% F
Forecast
t = -2.8%
2 8% Forecast = +1.9%
+1 9%

4.0%
"Average Baseline"
+2.1%
Scenario
2 0%
2.0%

0.0%
+0.5%
-2.0%
-2 0%
-2.0%

-4.0% -3.3% "Alternative More

Adverse" Scenario
-6
6.0%
0%
2007 2008 2009 2010
-8.0%
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4
Source: BLS (Haver Analytics); Blue Chip Economic Indicators , May 2009; FRB "The
Supervisory Capital Assessment Program: Design and Implementation," April 24, 2009
Consensus forecasts of unemployment exceed both the
"b
"baseline"
li " and
d "adverse"
" d " stress
t test
t t scenarios
i for
f 2009.
2009
Unemployment Rate, Quarterly
Actual = 4.6% Actual = 5.8% Forecast = 9.1% Forecast = 9.7%
12 0%
12.0%
"Alternative More
10.3%
Adverse" Scenario
10.0%
8.9%
8.8%
8.0% 8.4%
"Average Baseline"
Scenario
6.0%

4.0%

2.0%
2007 2008 2009 2010
0.0%
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

Source: BLS (Haver Analytics); Blue Chip Economic Indicators , May 2009; FRB "The
The
Supervisory Capital Assessment Program: Design and Implementation," April 24, 2009
Consensus forecasts of house price growth currently track
b t
between "baseline"
"b li " and
d "adverse"
" d " stress
t test
t t scenarios.
i
Growth in House Prices (quarter over the year ago quarter)

10 0%
10.0% A t l = -8.3%
Actual 8 3% A t l = -19.2%
Actual 19 2% F
Forecast
t =-15.7
15 7 % F
Forecast
t = 6.2%
6 2%

5.0%

0 0%
0.0%
-4%
-5.0%
"Average baseline"
10 0%
-10.0% scenario -7%
7%
-14%
"Alternative More
-15.0%
Adverse" Scenario

20 0%
-20.0% -22%
22%
2007 2008 2009 2010
-25.0%
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4
Source: S&P Case Shiller (Haver Analytics and Bloomberg). Forecast based on 5/11/09 futures
prices.
Discussion