BankNotes ...

The FDIC's mission to maintain stability in the U.S. banking system is partially fulfilled by the deposit insurance program. The FDIC collects premiums from banking institutions to fund the deposit insurance; these premiums are calculated as a percentage of each bank's total deposits. Most banks today are paying out insurance premiums of about 5 to 7 cents for every $100 of domestic deposits.   

The premiums, less operating costs, go into the Deposit Insurance Fund (DIF) which is used to cover the deposit losses of failed banks. Since the existence of a viable deposit insurance program is of critical importance in maintaining the public's faith in the banking system, the FDIC is continually assessing the risks of bank failures and projecting potential expenses that may be charged to the DIF.

Rising losses could signal rising fees

This year, the FDIC has been appointed the receiver for ten banks with total assets just over $40 billion. Not all of these assets translate to losses in the DIF however. Part of the FDIC's function as receiver is to sell off the assets of the failed banks, thus recouping losses to the DIF. It is estimated that the losses to the DIF associated with those ten bank failures will amount to $7.5 billion, meaning that more than 80 percent of the total assets should be recovered.

Even so, the FDIC's list of problem banks is growing. As of the end of the second quarter, there were 117 banks on the "problem" list, up from 90 at the end of the first quarter and 61 at the end of the second quarter of 2007. To address the rising number of at-risk banks, the FDIC increased its provisions for insurance losses by $10.2 billion during the second quarter; this was the largest factor behind the $7.6 billion decrease in the fund, which ended the quarter at $45.2 billion (unaudited). Since insured deposits only rose 0.5 percent in the same time period, the reserve ratio fell to 1.01 percent as of June 30, 2008. The reserve ratio has not been this low since 1995, when the combined Bank Insurance Fund (BIF) and Savings Account Insurance Fund (SAIF) was 0.98. The BIF and SAIF were merged in 2006.

When the reserve ratio dips below 1.15 percent, the FDIC is required by the Federal Deposit Insurance Reform Act of 2005 to create a fund restoration plan that will bring the ratio back up to 1.15 percent within five years. FDIC Chairman, Sheila C. Bair, has already stated publicly that the FDIC's restoration plan is likely to incorporate an increase in the premiums the banks pay into the fund. Bair has also indicated that the FDIC will propose changes in the rate structure to shift a greater share of the responsibility onto financial institutions that participate in higher-risk activities. The current credit crisis will likely result in premium increases across the board for all banks.

An increase in FDIC insurance premiums will put more strain on banks that are already grappling with rising credit losses. While this is bad news for existing banks, it is a necessary step in maintaining the public's confidence in the banking system. Should the FDIC develop an assessment system that provides rewards to banks that engage in safer activities, at least these institutions will have the option and incentive to take some of the risk out of their operations. De novo banks may end up with an advantage in this regard, because they can open the doors with a business strategy that complies with FDIC guidelines to keep premiums low and minimize risk going forward. De Novo Banks also open without a legacy portfolio that may have some high-risk loans. Very few de novo banks fail, which is a credit to the bankers and regulators working together in an effort to build a solid foundation for the new financial institution.

For banks with problem loans in its portfolio, the best solution is to get in and meet with the borrowers early (perhaps when the borrower misses the first payment, not the third). The sooner the problems are addressed the greater opportunity for success in recovery or improvement of the loan. This might mean meeting with all borrowers as a ‘check up' on their status. It is far better for the bank to find the problem loans than the examiners.

The bank insurance fund is a critical part of our country's economic engine and is a model for the world. The fund will be stressed during this credit crisis, but we have to maintain the faith in the system that has kept our banking system safe and in good health for the past 75 years.

By Wendell Brock, MBA, ChFC

By Wendell Brock, MBA, ChFC

Years ago when I was backpacking in the High Sierras, my Boy Scout leader taught me that the air temperature was coldest just before dawn. Hopefully, we are experiencing that time now and things will get better as dawn approaches, because this quarter's report is pretty ice cold! Total net income from insured banks is off 87 percent from second quarter last year to $5 billion. "Loss provisions totaled $50.2 billion, more than four times the $11.4 billion quarterly total of a year ago." Provisions drained almost one-third (31.9 percent) of the industry's operating revenue-the highest level since the third quarter of 1989. 

The average return on assets (ROA) was only 0.15 percent; in the same quarter last year, it was 1.21 percent. Larger institutions (over $1 billion in assets) suffered a bit more; their ROA was 0.10 percent. The average ROA for the smaller institutions (less than $1 billion in assets) was 0.57 percent. In the same quarter last year, the ROAs were 1.23 percent and 1.10 percent, respectively. Nearly two of three institutions (62.1 percent) reported a lower ROA this quarter. Almost 18 percent of banks, approximately 1,530 in number, were unprofitable this quarter; in the second quarter of 2007, this percentage was 9.8 percent.

Noninterest income was 10.9 percent lower than in second quarter of 2007, dipping to $60.8 billion. This decline was due in large part to lower trading income, which totaled only $5.5 billion and was down 88.6 percent from last year. A revenue bright spot showed up in net interest income, which increased by $8.2 billion (9.3 percent) over last year, with servicing fee income rising 35.9 percent or $1.9 billion. Bank customers paid more in service charges this quarter by $853 million or 8.6 percent over year-earlier levels.

Net interest margin ticked up slightly to 3.37 percent compared to the first quarter's margin of 3.33 percent. "Improvements and declines were fairly evenly divided among insured institutions, with 46.9 percent reporting lower margins than in the first quarter, and 51.5 percent reporting improved NIMs." The average yields on interest-bearing assets fell 51 basis points, from 6.27 percent to 5.76 percent. During the same quarter, the interest expense dropped 57 basis points from 2.95 percent to 2.38 percent. The industry average has remained steady within a 5-basis-point range over the last six quarters. The margins for community banks have fallen by 21 basis points, and larger institutions have gained only 10 basis points.

Net charge-offs increased sharply to a total of $26.4 billion during the quarter, which is almost three-times the $8.9 billion in the second quarter of 2007. This is the largest quarterly charge-off rate since the fourth quarter of 1991. At large institutions, the charge-off rate was 1.46 percent; at small institutions, the rate was only 0.44 percent. The annualized industry average for the quarter was 1.32 percent, considerably higher than last year's quarterly average of 0.49 percent.

The amount of noncurrent loans and leases has risen for nine consecutive quarters, increasing by $26.7 billion or 19.6 percent. In the second quarter, all major loan categories experienced increases in noncurrent loans. By quarter-end, the industry's total noncurrent loans and leases reached 2.04 percent, the highest level since the third quarter of 1993. Provisions increased for the third straight quarter, nearly doubling the amount of charge-offs. Institutions set aside $23.8 billion in provisions during the quarter and industry reserves rose by 19.1 percent. The total ratio increased from 1.52 percent to 1.80 percent, which is the highest level since mid-1996. At the same time, the coverage ratio slipped slightly from 88.9 cents for every $1.00 of noncurrent loans to 88.5 cents, which is a 15-year low.

Sixty percent of the institutions reported a decline in their total risk-based capital ratios during the quarter. The industry added only $10.6 billion to its regulatory capital during the quarter. Dividend payments were significantly lower during the quarter, totaling $17.7 billion, less than half the $40.9 billion paid a year earlier. Only 45.5 percent of the institutions reported higher retained earnings compared to a year ago. "Despite the slowdown in capital growth and the erosion in capital ratios at many institutions, 98.4 percent of all institutions (accounting for 99.4 percent of total industry assets) met or exceeded the highest regulatory capital requirements at the end of June."

Total assets declined for the first time since the first quarter of 2002 and experienced the largest quarterly decline since the first quarter of 1991. The decline totaled $118.9 billion or 11.8 percent, with nearly 40 percent of banks reported lower assets at the end of June. OREO properties (acquired by foreclosure) increased by $3.5 billion (29.1 percent) during the quarter to $15.6 billion.

Small business and farm loans increased only 3.4 percent or $25.3 billion during the 12 months ending June 30. These loans currently account for 32.7 percent of all business and farm loans to domestic borrowers. Larger business and farm loans increased by $249.4 billion or 18.4 percent during the same period. Total deposits increased only $6.9 billion or 0.1 percent during the second quarter. This was mostly from deposits in foreign offices, which rose by $46.8 billion, while domestic office deposits decreased by $39.6 billion.

Reporting institutions dropped to 8,451, equating to a loss of 43 institutions. Two banks failed during the quarter, ANB Financial in Arkansas and First Integrity in Minnesota. Three mutual banks converted to stock ownership (combined assets of $1.1 billion). The FDIC's problem bank list increased by 27 banks this quarter, from 90 banks in the first quarter to 117. This is an increase of 40 new problem banks for the year. Assets of problem banks increased from $26.3 billion to $78.3 billion. During the quarter there were 24 new charters, which brings the total of de novo banks for the year to 62.

We can only hope this is as cold as it gets before the dawn!

Note: quotes are from the FDIC second quarter 2008 report.

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