BankNotes ...

The Risk Management Association (RMA) just released 2009 Q4 figures showing that the downward slide of bank asset quality is beginning to level off.

The RMA is a nonprofit with 3,000 institutional members whose goal is to implement sound risk principles in the financial sector. Their Risk Analysis Service data report was released in conjunction with Automated Financial Systems, Inc., and is the self-professed only gauge of comprehensive credit risk. The data utilize figures from 17 top-tier banks.

Showing Signs of Recovery

From the press release: "The leveling off of the deterioration of commercial asset quality from the third to fourth quarter is a positive indicator that the economy is showing signs of recovery," said William F. Githens, RMA president and CEO. "However, the business banking sector continues to be a concern and is substantially underperforming the middle market and large corporate lines of business."

But while the rate of decline in asset value for big banks is only beginning to level off, specialty lenders are enjoying quicker successes. AmeriCredit, CapitalSource, Allied Capital Source, and CIT Group all posted 52-week high stock prices (TheStreet).

CIT GROUP

CIT Group, a commercial lender to small and medium-sized businesses, took its first bond to market on February 26 after emerging from a brief, month-long Chapter 11 reorganization in December. The bond, offered at $667.2M, represents a portfolio transition from commercial-paper-backed to equipment leases. Hopefully, this shift will lead the way to longer-term solutions to loan portfolio instability and vulnerability.

CIT's bond is issued through the Federal Reserve's Term Asset-Backed Securities Loan Facility (TALF), also known as "Bailout #2." CIT got in on the Facility just before its rapidly approaching final monthly application deadline of March 4.

It's a start, but CIT needs to secure other, low-cost funding that doesn't come from the government. Their bankruptcy had followed on the heels of nine consecutive losing quarters that totaled over $5B.

Whether CIT Group-and other lenders-will be able to remain solvent after TALF's discontinuation remains to be seen. What we know, though, is that small businesses are counting on the success of CIT and similar lenders.

Word on the Street

A recent CIT report-auspiciously titled "Lessons Learned-A Case for Greater Optimism" -surveyed owners and executives of 220 American small businesses (as defined by annual revenues from $1M to $15M) about the close of 2009 and their views of 2010.

Key findings:

• For 2009, 33% said their revenue "declined," and 26% said it "declined significantly"
• 64% said it was harder today to manage their company's cash flow than it was 12 months ago
• 90% agreed that current stimuli does not help them
• For 2010, a whopping 53% expected their revenues to "grow," and 8% expected their revenues to "grow significantly"
• 80% said they're now smarter about running their businesses
• 70% said the recession made them better leaders

Bankers should look at a systems to stress test their loan portfolios in an effort to better manage the risk. There are systems in the market place that will stratify/custom grade loan portfolios, stress test the portfolio along various key data points (not just interest rate stress), provide the probability of loss a portfolio will incur. These systems offer many other items of information that are essential to managing the loan portfolio and its risk, to both the bankers and the regulators.

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.

Eroding reserves

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 14^th 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?

Another Item

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.

4M5EDCNY9JWB

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.

By:
Wendell Brock, MBA, ChFC
Principal
De Novo Strategy
www.denovostrategy.com