2014: The Year Big Banks Returned To Trouble

Six years. That’s how long it takes financial institutions to start forgetting the scars and nightmares of the credit crisis that came out in full force in September 2008 and extended throughout much of 2009.

Wells Fargo, the strongest of the “Big Four” banks in the United States, has re-entered the market of subprime lending:

A less-than-perfect credit score is no longer an obstacle to buying a single-family home or townhouse in Southern Nevada.

Following a recent decline in demand for refinancings, Wells Fargo &Co., the nation’s largest mortgage lender, is easing some mortgage loan qualifications to boost lending.

Wells Fargo will drop its minimum credit score for loans backed by the Federal Housing Administration to 600 from 640. The change applies only to purchase loans, not refinances, taken out through its retail business.

“We are giving access to credit for the first time to low- and middle-income homebuyers,” Wells Fargo Home Mortgage spokesman Tom Goyda said. “This decision is consistent with our responsible lending principles.”

Goyda disputed media reports saying the bank was getting back into the subprime housing market. Technically, though, Wells Fargo is extending loans to borrowers with subprime credit, so they could be called subprime mortgages.

The other banks, principally Citigroup and Bank of America, are still federally prohibited from easing their mortgage requirements. When we study banking history in the 2030s, I think we will look back upon 2013, 2014, and 2015 as the years at the top of the bell curve representing borrower quality.

Right now, the banks are well capitalized and the loans are of very high quality. That’s why you’re going to see JP Morgan, Citigroup, Bank of America, and Wells Fargo likely paying out much higher dividends in 2018 than 2014. But the consequence is that the quality of the loans is going to start to slide here in the coming years—it wouldn’t surprise me if we see Bank of America and Citigroup play a game of “follow the leader” in the next eighteen months and re-enter the subprime lending game as well.

The capital ratios are still high at the “Big Four” banks (this includes JP Morgan in addition to the three mentioned above). There is a huge gap between their earnings power and the dividends they are currently paying out, meaning that dividend growth at all four firms should be quite nice over the next five or so years. But still, that little birdie should be showing up on your shoulder to deliver a message. Banks tend to blow up every generation or so, and this might be the moment of conception for the next bank crisis. It might take twenty years before we see any real, harmful effects, but the lowering of credit standards is the first step of many in the return to trouble.