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.
Seventy-three start-up banks opened their doors in 2008, according to industry data provider SNL Financial. The number compares unfavorably to what happened in years prior: there were 146 start-ups in 2007, 152 in 2006, and 135 in 2005. The drop-off in bank start-up activity has several contributing factors, but a big one is the ever-lengthening approval cycle. FDIC regulators, ever-conscious about squeezing risk out of the banking system and short on manpower, are taking longer and longer to provide final approvals on new bank applications. It appears that each de novo application now has to be sent to Washington DC for final approval.
Two years ago, a start-up bank could set aside about six months to receive an application approval. However, sometime in early-2008, things began to slow down. Now, a bank organizing group can expect twelve months or more to go by as the FDIC ponders the new bank’s worthiness.
Because time is money The added caution on the part of regulators is understandable, but it doesn’t come without a cost. A de novo bank typically brings $10 to $25 million of new private capital into the industry. SNL Financial estimates that new banks last year brought in an average of $18 million apiece, or roughly $1.3 billion in total. But a look at the same numbers in prior years indicates that this figure could have been much higher; the 146 start-ups in 2007, for example, delivered a cumulative $2.67 billion in new funds to the industry.
Manpower constraintsCaution, unfortunately, isn’t the only obstacle new bank applications face. Another issue is lack of manpower. De novo applications are processed in the examination side of the FDIC. But many of those examination employees are now being diverted to the resolution department that manages the closing of banks. A typical bank closure can require the participation of ninety or more FDIC employees—which is a lot of human resources to shuttle away from examining banks and application processing. Last year, the FDIC shut down 25 failed institutions; the count this year has nearly matched that figure. While the FDIC works hard to help banks survive and keep our financial system healthy, they also look for the least costly solution to the insurance fund as they close an institution.
Private capital, ready and willing
At a time when the feds are dumping money into the financial sector to loosen up lending, the banking system could sorely use the extra capital provided by de novo banks. It was just recently that the Congressional Budget Office (CBO) increased the expected 2009 cost of TARP by more than $150 billion. The estimated total cost is now $356 billion. Meanwhile, the Obama administration is also tinkering with the idea of selling bailout bonds to generate private capital that could fund bailout efforts.
Given that start-up banks bring their own capital—along with clean balance sheets, banking expertise and a willingness to lend—now might be the opportune time to fast-track bank applications. Finding a way to do that might be a practical addition to the existing banking recovery programs.
After rumors and delays, the Fed has released the results of the stress tests that were imposed on the 19 TARP fund recipients. The tests, officially called the Supervisory Capital Assessment Program (SCAP), were intended to check the banks’ capital levels under extreme economic conditions.
The headline news from the Fed’s 38-page report is that 10 of those banks could face capital shortfalls if the assumed future conditions become a reality. Moreover, the cumulative capital shortfall among those 10 banks totaled $75 billion.
A break from the traditional The real story, though, is what’s behind that number. Most of the $75 billion shortfall is not attributable to Tier 1 capital deficiencies.
Tier 1 capital is a traditional measure regulators use to assess a financial institution’s health—but the SCAP tests dug deeper to analyze the composition of the banks’ Tier 1 capital. A specific area of focus for the Fed, and the source of the perceived shortfall, was Tier 1 common capital ratio. Although existing regulations don’t require it, the Fed now believes banks should maintain a large component of common equity within Tier 1 capital. As a result, the 10 banks will be asked to raise their common equity—even though their overall Tier 1 capital levels may be within the regulatory standard under the SCAP scenarios.
Regarding the Tier 1 common capital ratio requirement, American Bankers Association President and CEO Edward Yingling said in a press release, “The regulators are, in effect, changing the existing rules and requiring that a higher [common equity] percentage be held within the Tier 1.”
Officially, the common equity shortfall is being called the SCAP buffer, defined as Tier 1 common or contingent common equity.
Fund-raising In most cases, banks will cover the SCAP buffers by selling common shares or converting existing preferred shares into common. Should those efforts fail, the government has said it will convert its preferred shares in the affected banks from TARP’s Capital Purchase Program to the new Capital Assistance Program (CAP). The CAP program securities are TCE, simply because they are convertible preferred shares.
Bank of America, which is deemed to need $33.9 billion in common equity, has already made its plans known: the bank will hoard earnings and sell assets and common shares to comply with the government’s request. In a CNBC interview, CEO Ken Lewis said, “Our game plan is designed to help get the government out of our bank as quickly as possible.”
Some banks better than others The Fed report provides estimated losses and SCAP buffer shortfalls for each of the 19 banks. The banks that are projected to have the largest capital shortfalls include Bank of America at $33.9 billion, Wells Fargo & Company at $13.7 billion, GMAC, LLC at $11.5 billion, and Citigroup at $5.5 billion. These four and six more will have to present the Treasury with a capital plan specifying how they will raise the additional capital.
The nine banks that “passed” the stress tests are Goldman, JPMorgan, Bank of New York Mellon, MetLife Inc., American Express, State Street Corp., BB&T, U.S. Bancorp and Capital One Financial.
Click here (
http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20090507a1.pdf) to access the complete SCAP report.
On May 6, the Senate passed S. 896, Helping Families Save Their Homes Act of 2009. The legislation contains various mortgage and loan modification initiatives, as well as a few measures to improve the FDIC’s and NCUA’s capacity to maintain stability in the banking system. The latter include:
• Sizeable increases to the borrowing authorities of both the FDIC and NCUA
• An extension of the deadline for restoring the Deposit Insurance Fund (DIF); the original allowable restoration period of five years will be increased to eight years
• Revisions to the systemic risk special assessment
• A four-year extension of the FDIC’s $250,000 deposit insurance limit
• An amendment that calls for the establishment of a National Credit Union Share Insurance Fund Restoration Plan if the National Credit Union Share Insurance Fund (NCUSIF) is projected to dip below a designated equity ratio
Promises, promises The Senate bill clearly contains perks for both banks and their depositors. The higher deposit insurance limit is largely a goodwill measure, but it does provide flexibility to high net worth individuals. A hotter topic, though, is the increase to the FDIC’s borrowing authority.
Here’s the background. In February, the FDIC announced a special assessment of 20 basis points to be applied to all domestic deposits as of June 30, 2009 — an action deemed necessary to recapitalize the DIF.
In early-March, the FDIC then indicated that it could reduce that special assessment by as much as 10 basis points, if Congress passed legislation to increase the insurer’s borrowing power to $100 million.
Special assessments cut into banks’ earnings and capital levels, and generally get passed on to bank customers over time. If S. 896 becomes law and the FDIC keeps its promise, banks and their customers will be spared half of that extra expense for the time being.
In a news release, American Bankers Association (ABA) Executive Director Floyd E. Stoner had this to say about the Senate’s passage of the bill:
“During this time of economic uncertainty, bankers recognize the importance of maintaining public confidence in the Federal Deposit Insurance Corporation (FDIC). We also believe that it is important to strike the right balance between maintaining a strong deposit insurance fund without unnecessarily taking money out of the system. S. 896, the Helping Families Save Their Homes Act, helps achieve this delicate balance.”
Incidentally, the Senate’s approved version of the bill did not contain the hotly contested cramdown legislation, which gives bankruptcy judges the right to modify mortgages on primary residences. The cramdown provision was, however, included in the House’s version of the bill, which was passed in March.
The Senate passed the Helping Families Save Their Homes Act of 2009 with a vote of 91-5.
Late last week, executives from the 19 largest domestic banks were briefed on the results of TARP-related stress test, officially called the SCAP. The stress tests are intended to predict bank capital levels under deteriorating economic conditions in 2009 and 2010. Equivalent to a government-imposed pop quiz, the tests were incorporated into TARP after the Obama administration was handed the U.S. political reins in January.
The exact details of the test results are supposed to be kept under wraps until an official announcement can be made on May 4. Bloomberg has reported, however, that six banks failed the tests and will be asked by the Fed to raise additional capital. Analysts believe Bank of America, Citigroup and possibly Fifth Third Bancorp of Cincinnati are among the six.
Test assumptions The stress tests used two scenarios to project the banks’ losses, revenues and reserve needs for 2009 and 2010. The more adverse set of assumptions included:
• Negative 3.3 percent GDP growth in 2009 and 0.5 percent GDP growth in 2010
• Unemployment of 8.9 percent this year, rising to 10.3 percent next year
• Housing price declines of 22 percent this year and 7 percent next year
The value of testing the banks’ capital levels under these particular assumptions has drawn both criticism and praise—some say the assumptions aren’t extreme enough, while others argue that these scenarios will produce results that make banks look worse off than they really are.
Setting aside that argument, the Treasury intends to use the results to determine which institutions need to shore up their capital reserves—to ensure they remain well capitalized in a sharp economic downturn. The exercise is also intended to bolster the public’s confidence that the banking system has the capital to withstand further economic deterioration.
The consequences of failureBanks that fail the stress tests will be required by the Fed to raise more capital, preferably from private sources. It has also been suggested that a quick fix might be to convert the government’s preferred stock into common shares—but that scenario raises questions about how the government should appropriately manage its role as an investor.
There has been no official word on the government’s intention to become a common shareholder in the banking system. Treasury Secretary Timothy Geithner has only said that the Treasury would be able to provide additional convertible preferred shares as “a backstop until private capital becomes available.”
Banks that end up needing additional taxpayer cash will undoubtedly be subject to greater government scrutiny and involvement. It’s a possibility that some industry executives and board members could even suffer the fate of GM Chief Rick Wagoner.