Don't Worry, U.S. Banks Are Lending Again — Just Like Espirito Santo
July 12, 2014 • 10:51AM

American Banker reported July 10 what U.S. bankers themselves are saying—don't take seriously the reports that bank lending is rising back to "a record level". Unlike European banks' plunging lending activity, U.S. banks' lending is rising all right, bankers tell American Banker, but overwhelmingly for: stock buybacks by companies; increased dividends by companies to stockholders; mergers and acquisitions; and leveraged lending to overindebted companies. And what's left, the "actual lending to demand", is in the "energy boom," or fracking. The article is entitled "Bankers warn over increased business lending".

Total outstanding U.S. commercial and industrial (C & I) lending, which excludes consumer or real estate loans, rose to a record $1.7 trillion in May from a nadir of $1.2 trillion in 2009, four years ago, according to data from the Federal Reserve Bank of St Louis.

"Loan growth doesn't seem to be driven by the underpinning of an economic recovery in terms of new warehouses and [capital expenditure]," said one bank executive. And another: "The larger part of the usage in the market right now are loan refinancings where companies are paying dividends back out." He added: "They're requesting increased loans or usage under a lien in order to pay a dividend or equity holders of a company. Traditionally banks have been very cautious of that."

The big bubble is "leveraged loans," defined as loans to a company already overindebted with at least six times its annual earnings in debt. Euromoney Institutional Investor's bond magazine, called IFLR, reports that the explosion of leveraged lending (to $280 billion in 2013) is keyed by new partnerships between banks and BDCs (business development companies). What is a BDC? "A kind of hedge fund without the requirement for qualified investors"! The banks take the senior tranches of these high-risk loans; the BDCs take the junior tranches to get higher yield. And do they then further securitize these tranches? Of course. Subprime CLOs and derivatives by any other names....

Is Banco Espirito Santo the Northern Rock of 2014?

Portugal's Banco de Espirito Santo (BES) is NOT considered a systemic bank by the ECB. However, what does the ECB really understand about the "system?" BES is not the trigger of a collapse; it is the top of the collapse.

BES's dimensions can be compared with those of Northern Rock before the crisis.

Its EU93 billion balance sheet is half of Portugal's nominal GDP. Before the current crisis, its capital was about 5 billion. Already then, a 5% loss on the balance sheet would have wiped out its entire capital. Currently, as share values have dropped 50%, much less would do the trick.

Despite reassurances of an adequate capital buffer by BES managers, there is no way the bank can survive except through a combined bail-out/bail-in process.

London's Financial Times reported Friday, "A banker who has worked closely with BES said the Portuguese bank had a EU2 billion-EU3 billion capital shortfall and the most likely solution was some kind of state-brokered rescue deal, as a private sector solution would take too long. 'There are rumors of an M&A [merger] solution, but no one has the speed to do the necessary due diligence and move fast enough to do a deal,' the banker said. 'This needs a solution now — in the next couple of weeks — and that means a state intervention.'"

This re-opens the Eurozone sovereign debt crisis. Bail-in will be enforced but is not enough. With a 130% government debt, Portugal has no money for a bail-out. They must call in the Troika for an ESM loan.

France's Crédit Agricole, a bank which the ECB considers "systemically relevant," is the second-largest shareholder of Espirito Santo, with 14.6%.