FDIC member institutions' earnings improved this quarter to a modest $2.8 billion, which is significant over last quarter's net loss of $4.3 billion and third quarter of 2008 of $879 million. Loan loss provision continued to affect the profitability of the industry as banks continued to cover their bad assets. Growth in securities and operating income helped the industry realize the profit, with 43 percent of the institutions reporting higher profits this quarter over the same quarter last year. Just over one in four banks reported losses this quarter of 26.4 percent, which is slightly up from 24.6 percent a year ago.
Net Interest Margin, ALLL
Net interest was higher this quarter, rising to a four-year high of 4.6 billion. The average net interest margin (NIM) was 3.51 percent, slightly higher than last quarter. Most banks, 62.1 percent, reported higher NIM than last quarter; however only 42.2 percent had an NIM increase year over year. Provisions for loan and lease losses increased and total set aside, remained over $60 billion for the fourth straight quarter, rising to $62.5 billion. While the quarterly amount banks set aside was only 11.3 billion, $4.2 billion less than the second quarter, it was 22.2 percent higher than last year. Almost two out of three institutions, 62.6 percent, increased their loan loss provisions.
Net Charge Offs Remain High
Loan losses continued to mount, as banks suffered year over year increases for 11 straight quarters. Insured institutions charged off a net of $50.2 billion this quarter, a $22.6 billion increase or an 80.5 percent increase compared to third quarter of 2008. This is the highest annual charge off rate since banks began reporting this information in 1984. All major categories of loans saw significant increases in charge offs this quarter, but losses were largest amongst commercial and industrial (C&I) borrowers. While noncurrent loans continued to increase, the rate of increase slowed; noncurrent loans and leases increased $34.7 billion or 10.5 percent to $366.6 billion, which is 4.94 percent of all loans and leases. This is the highest level of noncurrent loans and leases in 26 years. The increase of noncurrent loans was the smallest in the past four quarters.
The reserve ratio increased as noncurrent loans increased, however the spread continued to widen. While the industry set aside 9.2 billion, 4.4 percent in reserves, which increased the reserve level from 2.77 percent to 2.97 percent. This increase was not enough to slow the slide - it was the smallest quarterly increase in the past four quarters and the growth in reserves lagged the growth of noncurrent loans, which caused the 14th consecutive quarterly decline in this ratio from 63.6 percent to 60.1 percent.
Loan Balances Decline Deposits Are Up
Loan and lease balances saw the largest quarterly decline since the industry started keeping track of these numbers in 1984; they fell by $210.4 billion or 2.8 percent. Total assets fell for the third straight quarter; assets at insured institutions fell by $54.3 billion, which follows a decline of $237.9 billion in the second quarter and a $303.2 billion decline in the first quarter. Deposits increased $79.8 billion or 0.4 percent during the third quarter, allowing banks to fund more loans with deposits rather than other liabilities. At the end of the quarter deposits funded bank assets was 68.7 percent, the highest level since second quarter 1997.
Troubled Banks Increase
The number of reporting insured institutions at the end of the quarter was down to 8,099 from 8,195; there were fifty bank failures and forty-seven bank mergers. This is the largest number of banks to fail since fourth quarter of 1992, when 55 banks failed. The number of banks on the FDIC's problem list increased from 416 to 552 at the end of the second quarter.
During the quarter, the number of new banks chartered was three. This is the lowest level since World War II. This begs the question on what is the best way to get new capital into the banking industry. Should we recapitalize the existing banks including those in trouble? Or, should we start fresh with a new bank that can build a new, clean loan portfolio?
CREED - a 501(c)3 nonprofit has started a Crowdfunding project/contest to help a small business - Look at the opportunity to be a part of something truly great! We will follow this closely as we are strong supporters of CREED.
In the beginning of 2009, the media was pushing the idea that this would be the year for the community bank. Many smaller banks had not weighted down their balance sheets with subprime loans, asset-backed securities and complex derivatives. In theory, they had the stability to pick up loan customers that had been turned away by larger institutions. Columbus Business First published an article entitled, "Larger competitors' retrenchment may give smaller banks opening." And Business Week said, "As big banks struggle, community banks are stepping in to offer loans and lines of credit to small business customers."
Getting in to the banking industry during a power shift from big banks to small ones would appear to be an attractive opportunity for bank executives and community leaders who wish to be bank investors. But the predictions of a few publications don't sufficiently address the risk involved in buying a bank. Bank investors need to have some framework for separating the good targets from the bad ones.
Characteristics of at-risk community banks
In a speech made last July, San Francisco Fed President Janet Yellen summarized the characteristics of at-risk community banks. She cited:
- High concentrations of construction loans for speculative housing projects
- Concentrations of land acquisition and development loans
- Poor appraisal systems
- Weak risk-monitoring systems
Looking ahead, Yellen also identified "income-producing office, warehouse, and retail commercial property" as an area of potential risk. She cited rising vacancies and poor rent dynamics, which are putting negative pressures on property values. These value declines can be particularly problematic for maturing loans that need to be refinanced. Community banks that maintain large portfolios of commercial property loans should be proactively managing these risks. Bank acquisition groups should verify that target banks are updating property appraisals, recognizing impairments early, and negotiating work-outs with borrowers when appropriate.
Tim Coffey, Research Analyst for FIG Partners, LLC, agrees that commercial real estate is the next area of risk for banks. In an interview, Coffey said,
I think the residential portion of this correction has been dealt with and recognized by bankers and market participants alike. The next shoe to drop is going to be commercial real estate. I don't think there is really any kind of argument about that. How messy it's going to be compared to the residential part remains to be seen.
Coffey's comment was included in a report by The Wall Street Transcript that also quoted commentary from other banking analysts. The consensus among them was that some community banks are still facing potentially disastrous problems ahead.
Separating the good acquisition targets from the bad ones, then, requires careful analysis of the balance sheet, loan portfolio and the bank's current risk management practices. If the bank isn't managing risk proactively, there could be unknown problems brewing within the loan portfolio. Buying a bank with known problem assets is a manageable challenge-but buying a bank with unknown problem assets is something else entirely.
SNL recently published an article discussing the FDIC's new policy change on de novo banks. In "Extending Bank's Adolescence," author Christina M. Mitchell writes, the "change effectively extends adolescence for young banks, lengthening the period of increased regulatory supervision required for de novo institutions in a move that industry observers say will heighten the already considerable barriers to opening new banks." Over the past few years, the regulators have nearly shut down the flow of de novo bank openings with a drastic increase in regulatory scrutiny. As the regulatory approval timeline continues to increase, the capital requirements and start-up expenses of opening a bank have climbed significantly. These challenges are keeping many potential investors on the sidelines, and too few of them are looking for other opportunities to enter the banking industry, such as Buying a Bank.
To read Ms. Mitchell's full article click on the link: Extending Bank's Adolescence
The FDIC has announced its intention to extend the de novo period for certain new banking institutions. The previous de novo period was three years; the new one will be seven years. This change is significant because newly insured institutions are subject to more scrutiny and higher minimum capital ratios during that de novo period. Along with extending the de novo period, the FDIC will also subject de novos to more risk management examinations and require prior approval for any de novo business plan changes.
Heightened risk for seven years
Regulators say the supervisory updates are needed because de novos pose a heightened risk to the banking system. According to the FDIC, too many of the actual failures that occurred in 2008 and 2009 were banks that had been open for fewer than seven years. On top of that, a good number of those failures were banks that had been operating between four and seven years-banks that, under current policy, were not subject to the heightened de novo regulations.
According to data compiled by FinCriAdvisor (http://www.fincriadvisor.com/2009-09-07/FDICdenovopolicy), twenty-three, or 19.6 percent, of the 109 bank failures occurring between January 1, 2008 and August 21, 2009 were de novos. Of those twenty-three, six were within the three-year de novo period; the rest, 74 percent, failed between their fourth and seventh years of operation.
The extended de novo period will apply to existing newly insured institutions as well as banks for which charters have not yet been issued. Since the number of new charters awarded by the FDIC in recent months is relatively minimal, the changes affect existing banks far more than would-be banks. The only de novos that won't be subject to the extension and heightened scrutiny are those that are subsidiaries of eligible holding companies.
Eligible holding companies must have consolidated assets of $150 million or more. Bank holding companies are required to have BOPEC ratings of at least 2; thrift holding companies must have an A rating.
Capital requirement. A primary change implied by the extension of the de novo period is an increased capital requirement. De novos are currently required to maintain a Tier 1 leverage ratio of at least 8 percent during the de novo period. A longer de novo period means that young institutions will have to maintain this higher ratio for seven years instead of three.
Examination frequency. Along with extending the de novo period, the FDIC will also increase the frequency of risk management exams for de novo banks. Periodic risk management exams, which begin after the institution's first birthday, will occur once annually rather than once every eighteen months. De novos will have to budget for the extra costs associated with the additional examinations.
The first year examination requirements for de novos will be as follows:
- Limited risk management exam during first six months of operation
- Full risk management exam during first twelve months of operation
- Compliance exams during first twelve months of operation
- CRA evaluation during first twelve months of operation
Thereafter, under the new policy, a risk management exam will be conducted every twelve months until the expiration of the de novo period. Compliance exams and CRA evaluations "will alternate on an annual basis."
Business plan changes. The new policy also requires de novos to get FDIC approval prior to implementing any material changes to the institution's business plan during the seven-year de novo period. Previously, newly insured institutions had to provide the FDIC with a written notice of proposed business plan changes within the three-year de novo period.
The FDIC argues that experience shows the necessity of this requirement; when newly insured institutions deviate from their original business plans, those deviations can often lead them into areas of business where they do not have adequate risk management expertise or resources. "Significant deviations from approved business plans" was one of several common elements the FDIC identified among troubled institutions that have not yet completed their seventh year of operation.
Change requests will be reviewed to ensure that:
- There is a defensible business reason for the change.
- The de novo has the resources-financial and human-to manage any risks created by the change.
While this requirement keeps de novos from jumping into risky lines of business without adequate forethought, it also limits the de novo's ability to adapt quickly to changing circumstances. Should the bank implement changes or deviate from the original business plan without FDIC approval, fines or other penalties could result.
Financial statement updates. In the third year of operation, de novos must now provide the FDIC with current financial statements along with strategic plans and projected financial statements covering years four through seven. This applies to existing institutions that are less than three years old, as well as newly chartered institutions. The FDIC will want to know specifically about the de novo's expansion plans, product/service strategies and the outlook for capital expenditures and dividend payments.
To read the full Financial Institution Letter explaining and defending the altered supervisory procedures, click here: http://www.fdic.gov/news/news/financial/2009/fil09050.html
In the first quarter of 2009, the banking industry rebounded from a net loss in the prior quarter-an improvement that masked mixed performance. The first quarter cumulative net profit of $7.6 billion, the highpoint of the previous four quarters, was more than 60 percent below 2008's first quarter performance. Further, this year's profitability was largely fueled by strong trading revenues and realized gains on securities at large banks. Nearly one-quarter (21.6 percent) of banks reported a net loss, and a majority of banks reported quarter-over-quarter net income declines.
A $7.6 billion increase in trading revenues boosted noninterest income, with additional contribution coming from increased servicing fees and gains on loan sales. The industry also benefited from an improved net interest margin (NIM), driven primarily by a lower cost of funds. The average NIM of 3.39 percent was slightly higher on a sequential and quarter-over-quarter basis.
Bad loans still a factor
First quarter charge-offs notched a slight sequential decline, but are still outpacing last year's level by almost 100 percent.
C&I loans accounted for most of the year-over-year increase in charge-offs, but credit cards, real estate construction loans and closed end 1-4 family residential real estate loans were also problematic. Net charge-offs in all major categories were higher than a year ago. The total annualized charge-off rate was 1 basis point below the fourth quarter's record-high level.
Noncurrent loans are still on the rise. The percentage of noncurrent loans and leases to total loans and leases rose 81 basis points during the first quarter to 3.76 percent, with the increase being led by real estate loans. Nearly three-fifths (58 percent) of banks indicated that their noncurrent loan balances increased during the first quarter.
Banks added to their reserves again this quarter, pushing the ratio of reserves to total loans up to the record level of 2.5 percent. This reserve building was outpaced by the rise in noncurrent loans, however, such that the ratio of reserves to noncurrent loans declined to 66.5 percent, a 17-year low.
Balance sheets shift
The industry's equity capital rose substantially, partially driven by reduced dividend payments and TARP infusions. The paring down of loan portfolios and trading accounts led to an industry-wide decline in total assets of $302 billion. As a result, the ratio of total deposits to industry assets rose to 66.1 percent, despite a slight decline in total deposits.
Failure rate high, DIF decreasing
At quarter-end, there were 8,246 FDIC-insured commercial banks and savings institutions, down from 8,305 at year-end. Twenty-one banks failed in the first quarter. The problem list grew in number from 252 to 305, while the assets managed by problem banks increased 38 percent to $220 billion.
Loss provisions (for actual and anticipated failures) drove a 24.7 percent in the DIF during the quarter, bringing the balance to about $13 billion. The 21 failures during the first quarter are estimated to have cost the DIF $2.2 billion. At quarter-end, the reserve ratio was 0.27 percent, its lowest level in 16 years.
New charters approved during the first quarter of 2009 numbered 13, the lowest level since the first quarter of 1994. There were 50 bank mergers during the quarter.
As the shake-down in the financial services industry continues, traditional banks may find themselves losing customers to healthcare providers.
Health insurer WellPoint Inc. recently received conditional approval from the FDIC to open ARCUS Bank, which will be a Utah-chartered industrial loan company (ILC). The approval was obtained despite an FDIC moratorium on deposit insurance applications for ILCs that would be operated by firms which participate in non-banking business activities. The underwriting and selling of health plans by WellPoint wasn't the problem; it was the company's retail activities, primarily pharmacy services and disease management operations.
WellPoint appealed to the Federal Reserve Bank to get around the moratorium, arguing that the company is, first and foremost, a financial services provider. The Fed agreed, with the stipulation that WellPoint has to keep its pharmacy and disease management revenues in check-specifically, less than 15 percent of total sales.
WellPoint isn't the only health insurer that's moving into the banking industry. OptumHealthBank, which is part of the UnitedHealth Group (NYSE: UNH), has been providing "health care banking" services since 2005. And last year, a group of Blue Cross and Blue Shield Association member plans chartered Blue Healthcare Bank. Blue Healthcare Bank's mission is to "help participating Blue companies offer their members state-of-the-art healthcare savings and payment options...facilitating members' choice of high-quality, self-directed accounts..."
It is the growing popularity of high-deductible health plans (HDHP) that's driving these health insurers into the banking business. HDHPs generally charge lower premiums in exchange for coverage that doesn't kick in until a very high deductible is met. Having an HDHP gives the insured the right to maintain a tax-advantaged savings account to hold funds that are earmarked for healthcare expenses. So-called health savings accounts (HSAs) share characteristics with IRAs: contributions can be invested in securities and the earnings are tax-free until the money is withdrawn.
The company providing the HSA has the opportunity to collect account fees, management fees, investing fees, etc. OptumHealthBank, Blue Healthcare Bank and Arcus Bank believe that offering HSAs and related financial services is just a natural extension of their current health insurance offerings; they're simply providing another tool to help their customers manage ever-rising healthcare expenses.
The evolution of banking
For the traditional banking industry, this development presents yet another argument for banks to reassess their innovation efforts. Customers need to have a compelling reason to choose one service provider over another. For some, a negative perception of the traditional banking industry may be enough. Traditional banks stand to lose out on HSA-related revenues and, possibly, revenues related to other financial services as well. Now, and for the foreseeable future, the pressure is on banks to develop strategies that will drive innovation, develop new and improved products and services, and enhance efforts to build deep, lasting customer relationships.
By Wendell Brock, MBA, ChFC
Today the FDIC issued the Fourth Quarter 2007 banking profile, which contained very mixed results on a slippery slope. The industry as a whole is struggling through the latest national economic tidal wave of debt problems from the sub-prime termoil to an over leveraged derivative market. So the banks are squeezed between tougher regulation enforcement, higher deposit rates, lower net interest margins, larger loan loss reserves, higher charge off and noncurrent accounts, growth in deposits, etc. The following are some key highlights.
Widespread earnings weakness occurred in more than half the institutions - "51.2% reported lower net income than in the 4th quarter of 2006. One out of four institutions with assets greater than $10 billion reported a net loss for the fourth quarter." During the 4th quarter interest rates fell, which increased downward pressure on Net Interest Margins (NIM), making it the lowest quarterly NIM since 1989.
Total earnings for banks were off by 27.4% for all of 2007, which was a decline of $39.8 billion to $105.5 billion. This is the first time since 1999-2000 that annual net income declined. Only 49.2% of insured institutions reported improved earnings in 2007 - the lowest level in 23 years. Unprofitable institutions reached a 26 year high of 11.6% at the same time the ROA was the lowest in 26 years at 0.86%. This is the first time since the mid 1970's that noninterest income has declined - it fell by 2.9% to $233.4 billion.
2007 fourth quarter net charge offs spiked nearly 100% to $16.2 billion over the same quarter in 2006 which had $8.5 billion. This increase has regulators very worried. In mid 2006 the amount of noncurrent loans (loans which are 90 days past due) began an upward movement, this loan pool continued to swell by $26.9 billion, a increase of 32.5% during the 4th quarter of 2007. "The percentage of loans that were noncurrent at year-end was 1.39%, the highest level since the third quarter of 2002." This has prompted banks to put more away in their Allowance for Loan and Lease Losses (ALLL). The ALLL reserve ratio rose from 1.13% to 1.29% during the quarter; however it was not enough to cover the increase in noncurrent loans. "At year end, one in three institutions had noncurrent loans that exceeded reserves, compared to fewer than one in four institutions a year earlier."
Equity capital increased by $25.1 billion or 1.9%; at the same time the leverage ratio fell to 7.98% down from 8.14%. "In contrast, the industry's total risk-based capital ratio, which includes loss reserves, increased from 12.74% to 12.79%." In the end 99% of all insured institutions, which represents more than 99% of industry assets, met or exceeded the highest regulatory capital requirements. During this same time, banks were lending money - asset growth continued strong - assets increased by $331.8 billion or 2.6% during the quarter. Because of the high increase in noncurrent loans, examiners have been watching closely the concentrations of bank portfolios in commercial real estate. In spite of the construction slow down, the number of banks that have a high concentration of construction lending increased from 2,348 to 2,368. A high concentration of commercial real estate loans in a bank's loan portfolio is defined when that part of the loan portfolio exceeds the bank's total capital.
Deposits grew to record levels during the 4th quarter. Institutions saw an increase of $170.6 billion or 2.5%, the largest quarterly increase ever reported. "The industry's ratio of deposits to total assets, which hit an all time low of 64.4% at the end of the 3rd quarter, rose slightly to 64.5% at year end."
For the year, Trust Assets increased an amazing $2.6 trillion or 13.4% for managed accounts and $68.6 billion or 1.6% for non-managed accounts. "Five institutions accounted for 53% of the industry's net trust income in 2007."
In 2007, there were only three bank failures, this is the most since 2004 - this ended the unprecedented run of no bank failures (there was only one failure in the 4th quarter). The two-year term was the longest in the FDIC's history. During the quarter, there were 50 de novo banks, which brought the total for the year up to 181 new institutions. Mergers in the 4th quarter slowed down to 74 for an annual total of 321 banks merged out of existence. The regulator's problem bank list grew to 76 banks, up from 65 at the close of the 3rd quarter. The total assets of these problem banks are $22.3 billion, up from $18.5 billion at the end of the 3rd quarter. The total FDIC insured institutions ended the year at 8,533 down, slightly from 8,559. For a complete copy of the report see request for a white paper.
Wendell Brock, MBA, ChFC
De Novo Strategy