Banks Able to Weather Economic Stress, but Lending Still Tight: DBRS

After a good beginning in 2010, stress returned to the financial markets in the second quarter. But the credit rating agency ""DBRS"":http://www.dbrs.com says rising market stress is more manageable this time around for U.S. banks.

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Economic stress was manifested in increasing concerns about sovereign credits and their potential impact on financial institutions, as well as growing doubts about the sustainability of the global economic recovery, DBRS explained.

The ratings agency says various economic indicators suggest that the recovery is slowing, including weakness in employment and housing markets across the United States.

Fortunately, this time the stress on U.S. financial markets has been more muted relative to the extreme stress after the collapse of Lehman Brothers in 2008, DBRS said. First

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and foremost, the firm says, U.S. banks are better prepared. Earnings of many banks are recovering, and credit costs appear to be stabilizing.

Banks have bolstered their liquidity through debt issuance, reduced balance sheets, are less reliant on short-term market funding, and they've significantly increased cash holdings, DBRS noted. Based on the agency's analysis, in early July, U.S. commercial banks had about 10.5 percent of their assets in cash, down marginally from a peak of 11.4 percent earlier in 2010, but still vastly above the level prior to the crisis that were typically around 3 percent.

Despite the increase in capital, DBRS says banks are still finding it difficult to grow loans. One inhibiting factor, according to the rating agency's analysts, is that banks remain cautious about extending credit. Another cause is that loan demand remains weak, as borrowers are also being cautious in view of the uneven economic recovery.

DBRS points out that a strengthening in lending is typically a positive driver for bank earnings in a recovery. This cycle, though, such growth has remained elusive.

The Federal Reserve's survey of senior bank lending officers in April 2010 indicates that there is limited easing of still tight loan underwriting standards, with loan demand consistently weak across most types of lending.

DBRS says it bank lending will remain elusive over the near-term, but is likely to strengthen towards the end of 2010, provided that macroeconomic conditions improve as the year progresses.