Failure patterns

Notebook: Investment diary

Created: 31-07-2017 11:03 Updated: 04-09-2020 16:48
Author: Anil Tulsiram
Tags: Banking failure

Failure patterns
Author: Anil Tulsiram

Failure patterns

Rapid growth: Some Mania - huge increase in agriculture product price, real estate price , Oil prices and banks
participated madly in it.
No diversification.. high concentration of loans....
wholesale lending in double digits to one sector like infra, power, commercial real estate etc
Even failed banks had high RoA before failure... focus on nature and sources of profits....ANY CONCENTRATION IN
SOURCE OF PROFITS....
Failure rate was high among newly chartered banks compared to old banks...These institutions had strong incentive
to expand loan rapidly to meet shareholders expectations...
~ 30 to 50% of failure of banks due to Fraud and managerial deficiencies
When lending opportunities are reduced some managers might take risky loans....

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lowest PE ratio touched 50% of S&P 500
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Compilation of notes on Banking failure and its causes [All

are compilation from various sources, headlines my
interpretation]
Author: Anil Tulsiram

Same banks get in trouble repeatedly.....

Seven deadly sins.....

Banking failure during 1980-1994

Various regional and sectoral recession was main reason for

many banking failure during 1980s 1) Oil gas boom and bust
2) commercial real estate boom and bust

Huge fluctuation in Fx [some failed banks had FX

borrowing]

Increased competition due to 1) Deregulation on regional

expansion 2) dereguation of deposit rates 3) competition
from corporate bonds
REgulations removed limit on 1) Real estate lending 2) One
borrower limit lead to excessive lending to commercial real
estate

Geographic lending restriction were removed to reduce risk

of geographic concentration...

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Various reasons for banking failures during 1980-1994

REgional and sectoral recession after boom and bust cycle...

Most bank failures happened during recessions...

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Asset based lending relying on collateral valued assuming
future inflation [Just like gold loans finance during 2007-12

Commercial real estate lending inherent risky [more so

when construction done without confirm tenants]

1) no equity at stake by borrower 2) Wrong appraisal of real

estate values 3) Asset based lending rather than cash flow
based lending.....
Leverage not more than 10x maximum, major reason for
failure was RECKLESS LENDING RESULTING IN HIGHER
CREDIT COSTS....

Unlike 2007-09 credit crisis

Before 1 year of failure, few failed banks had RoA. 1%,
underwriting standard more important

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More new banks failed compared to old banks...

Absence of risk based capital requirements...

Emerging markets loans defaults...

FEd came up with promt corrective action rules post 1994...

Washington Mutual, retail bank failure lead by bad credit

costs in subprime lending and low equity to absorb losses....
Hired agents to sell loans. Even if interest payments
delayed, fees will be recorded....

94% of WuMu business comes from retail lending....

Exposure to california market where house prices declined

a lot [but home loans only 16% of assets]
Irresponsible lending practices

Lavish life style and big emp compensation of CEO

Nine chief compliance officer in 7 years....

WuMu had15x leverage under current rules maximum of 10x

was allowed.. its losses were twice equity....
Continental illinois failure lead by 1) high credit losses 2)
Reliance on volatile foreign sources of funds [42%]

Continental illinois RoA was merely 0.5% and leverage 26x...

Be careful of averaging down when decline in share price

lead by decline in quality of assets...

Significant exposure to less developed country loans

1) Little retail banking deposits 2) large dependence of short

term commercial papers 3) once unable to raise domestic
ST funds relied on foreign funds....

NPAs continue to increase, increasing boosted by

extraordinary gains...

Rumor about bankruptcy resulted in run on bank...

Decentralize credit approval without any internal controls..

100% wholesale book

42% of funds from foreign sources.....and volatile funds...

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expenses were very high for a wholesale bank....

Entire continental Peer group of 8 wholesale bank at the

time of its bankruptcy is now PART OF JP MORGAN
CHASE......
Continental bank lot of OIl and gas loans of Penn square
bank most of which went bad after oil prices crashed....

Dhanlaxmi bank analysis mostly based on an article

published in Mind by name " Dhanlaxmi untold story"