"But, logic, like whiskey, loses its beneficial effect when taken in too large quantities"
Edward John Moreton

Time for another economic update in graphs- today's it's focused primarily on financials- once again I think things are not "all clear" yet as many assume- I'll let the graphs do the talking though...

Let's start with an introduction- banking sector's health seems to be quite different depending on the state. The list should not surprise anyone- right column is heavy on states where housing prices are collapsing- but there are also few states that don't quite come to mind when one is thinking about the housing crisis like Virginia, Maryland and New Hampshire...

Source: FDIC

Net Interest Margin in smaller banks (<1B in assets) is contracting rapidly despite the fact that yield curve now is very beneficial for banks, which again supports my hypothesis that a number of smaller regional banks are having trouble attracting lower cost deposits and that many might collapse later this year...

Source: FDIC

Reserve coverage ratio has been declining since 2005 and now stands at only 120%- this might mean higher loan loss provisions in the next few quarters.

Source: FDIC

Now here is the punch line- I think all the pundits claiming that the Financials are "dirt cheap" are pretty much basing their case on the assumption that since the commercial loans (CRE and C&I) side of the business has held up so far, it won't deteriorate in the future- I think this logic is flawed, what's more it could be outright dangerous- because CRE and C&I loans are by definition much larger in size; and thus outlook for a smaller bank that has high commercial real estate exposure on the asset side and does not have real diversified funding base on the liability side (like DDAs (checking accounts) or other lower cost sources) could change literally overnight...

I think the graph above is an indicator that regardless of all the noise in the media- we aren't yet close to the bottom of the credit cycle in financials- closer to start than to finish...

Expect the commercial side to look similar to the residential side before it's over...

In my opinion, we could very well see the volume of bank failures explode in the next few quarters- (so far only 4 this year)... They are likely to be concentrated in smaller regional banks that have heavy exposure to CRE and C&I loans and no diversified deposit base. Larger banks are also likely going to write off a lot more commercial loans and thus real earnings probably won't improve much until 2009, which in turn means there are still a bunch of good shorts in the financial sector...

Stay safe, Vad skepticalcapitalist@gmail.com