Three Undiscussed Risks That Banks Are Facing Today

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One of the lessons that we learned from this year’s round of stress tests is that, while some banks are incredibly complex and likely therefore hard to manage, US banks are much better capitalized now than they were in the run up to the financial crisis. But just as banks ignored the risks that came along with their reliance on mortgage-backed securities, Rafferty Capital Markets VP of equity research Richard Bove sees three growing risks that banks should be discussing but aren’t.

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“My conversations with bankers in recent days indicate that virtually no thought is being given to the impact of these three loan products on their businesses. It is almost like we are back in 2007 and no one really cares about the basic drivers to the product sales,” Bove writes.

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Falling oil prices could hurt exposed banks

Bove’s first big worry is the banking sector’s exposure to the oil industry. He remembers when oil fell to $10 per barrel in the mid-1980s, wiping out what had been a strong Texas banking industry because of its concentrated exposure to that one sector. But it’s not just struggling oil companies that create problems for banks. The communities that spring up around oil and gas activity can disappear just as quickly, and Bove mentions the Colorado National Bank getting stuck with over 100,000 mobile homes after the shale oil industry shut down as an example of knock on effects that can have a major impact on banks.

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“I know nothing about what drives oil prices and in most likelihood never will. I do know, however, what a sustained period of relatively low oil prices will do to banks,” says Bove, with WTI crude below $80 per barrel and Brent crude not much higher.

Who will buy mortgages now that QE has ended, asks Bove

Regular readers won’t be surprised that Bove is also worried about the mortgage industry. Now that QE is over banks won’t be able to rely on the Fed creating artificial demand, and Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) are supposed to be selling their mortgages, not adding to their portfolio. The GSEs will still securitize mortgages, but they aren’t the final customer.

“Having followed a number of industries over my close to 50 years in this business, I have never found an industry that does not know who the ultimate buyer of its products is. Yet the banks do not know who the ultimate buyer of their mortgage loans is,” writes Bove.

With so much global liquidity, it’s possible that banks won’t get punished for their lax attitude toward who is actually buying mortgages (and not just passing them on), but it means that they can’t accurately gauge whether non-Fed demand will hold.

Finally, the bankers that Bove has spoken to recently tell him that leveraged loans are being made in very low amounts, but if that’s true he wonders why the Federal Reserve has made it so clear that they don’t approve of the practice. If leveraged loans are a bigger portion of earnings then banks have let on, falling asset prices post-QE could be even more dangerous.

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Michael has a Bachelor's Degree in mathematics and physics from Boston University and Master's Degree in physics from University of California, San Diego. He has worked as an editor and writer for several magazines. Prior to his career in journalism, Michael Worked in the Peace Corps teaching math and science in South Africa.
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