Spotting Banks In Danger

The SEC is looking to expand investigations into the spread of false rumors that may affect the financial system. Articles at Reuters and Bloomberg mention the recent slide in Freddie Mac (FRE) and Fannie Mae (FNM), as well as Lehman Brothers (LEH), for the increased SEC attention. No word in either article whether a member of Congress will be investigated after the recent collapse of IndyMac, although an LA Times article does mentioned that some federal regulators are looking into the issue.

This all comes just as the International Herald Tribune is reporting how banking analysts are predicting that as many as 150 of the 7,500 banks nationwide (mainly small and mid-size) could fail over the next 12 to 18 months. Others disagree and state that while there will be liquidity issues, many lenders are likely to first either shut branches or seek mergers with stronger banks. The article also notes that the nation's banks are in less danger now than in the late 1980s and early 1990s when over 1,000 institutions failed during the savings-and-loan crisis. Unfortunately, even with fewer bank failures, the $125 billion government bailout that resulted at the time may seem like a good deal if things were to get as messy this time around. Hopefully we can avoid reaching the same levels, but some analysts are not optimistic.

Some perspective is in order. In 1994, the FDIC listed 575 banks that it considered to be troubled, while earlier this year only around 90 banks were listed - but the list is probably growing. Yet given recently developments, more failures are likely beyond the six already reported given that bank failures are a lagging indicator. Of interest is that IndyMac was not on the troubled bank list earlier this year, highlighting the fluidity of the problem. Also, of the $53 billion the FDIC has to reimburse consumers of failed banks, IndyMac is estimated to need between $4-8 billion, putting more pressure on existing banks, and possibly forcing the government to get more involved as it has recently with Freddie and Fannie.

Not unexpectedly, short sellers are jumping into the waters as various regional banks, such as BankUnited Financial Corporation (BKUNA), now trading under a dollar, and the Downey Financial Corporation (DSL), trading between $1-2 after reaching a 52 week high of $65.67, have been highlighted as having potential problems.

In order to spot banks in danger, two popular ratios are used. First, when you divide non-performing assets by all outstanding loans, you find that a ratio over 5% signals danger (see CNBC article). Using this ratio you find that other banks, in addition to BankUnited and Downey (BankUnited's ratio is 5.36%, while Downey is at 13.86%) are suspect, including Corus Bankshares (CORS) at a 13.18% ratio, Doral Financial (DRL) at 12.82%, and FirstFed Financial (FED) at 6.73%. A second commonly used ratio that compares non-performing assets divided by reserves plus common equity causes Washington Mutual (WM), with a ratio of 40.6%, to also become suspect. Any value around 40% is thought to be in the danger zone.

Comments

[User 126359]

just a quick note - I'm pretty sure that 40.6% number for WM does not include their recent capital raise. When included their Common Equity + Reserves should be about $32B. Non performing assets were $9.3, making the correct number (I think) 29%. Most likely it will be higher than this after Q2 results.

[alexb]

From my reading of the latest Corus Bank 10Q, the percentage of non-performing loans over total loans is approximately 9.3%, not 13.2% - it's clearly stated on page 29 of the 10Q. Furthermore, half their assets are tied up in very safe short-term securities - they hold alot of Freddie & Fannie debt, which is now explicitly guaranteed by the federal government (as of this weekend!). Technically these are loans - but they're loans guaranteed to be repaid. So their real number comes out to be below 5% by my calculations.

Disclosure: I have a long position in CORS stock.

[BxCapricorn]

I thought your article was a great summary of both history and the current state of affairs. The CNBC article used Richard Bove's numbers, from his recent report, and since I cannot access the report, I'd like to thank the commenters for being so specific about the source of their data and information.

[WM fremontinvestor]

Agree with "user 126359". Just checked the Q1 financial report - non-performing assets: $9.18B; total equity: $22.5B, thus the 40.6% number. Including the $7.2B capital raised recently, the # should be lower, although non-performing assets could rise too, but I would still expect the # to be <40%. Will see on the 22nd when Q2 is out

[WM fremontinvestor]

looks like Richard Dove is expecting the current non-performing assets to be $12.B(based on the 3.89% number), in that case, the 40.6% number is current(including the $7.2 new capital), which is close to the level 3 mos ago

[peterthepainter]

IT'S A WONDERFUL LIFE
Up here in the garret we have tv and often especially at yuletide they show this really great old movie with James Stewart and Donna Reed.

Course everyone's seen it dozens of times - old time savings and loan threatened with a run, saved by Stewart and the bell. Bad guy Lionel Barrymore wants to buy it out and close it so ordinary people can't afford to buy their own home but have to rent from him.

Then a 'credit crunch' - 'solvency crisis' or is it fraud - the money has disappeared (lost) (taken away by the bad guy). Stewart is bereft and jumps in the river - he nearly sells out!!

In the end though an angel steps (jumps) in and... well you know the rest - everybody digs deep in their pockets to find the money to bail out the bank!

It's set 60 years ago and nothing like it could happen today. But as we sit here, dreaming up art stuff like paintings and video wheezes, me and Opkins (the mouse) and Spider (the spider) don't feel as secure as we used to . No sirree not quite as secure as we used to.

[gashousegorilla]

Minor quibble here...

Why quote "# of banks" as though that's significant? After nearly 20 years of bank consolidations, "# of banks" is a misleading comparison.

I read elsewhere that Texas banks in the 80's were often independent from one county to the next. Many small banks went under. Rather than quote "# of banks", maybe it's better to quote total cap in absolute terms or perhaps as a % of GDP.

[User 125852]

Where do you find the last figures for non-performing assets, common equity and reserves? On my bloomberg I only have the last 2007 ones apparently. Thanks

[WM fremontinvestor]

to "user 125852" RE: Where do you find the last figures for non-performing assets, common equity and reserves?

biz.yahoo.com/bw/08041...

[EBC]

FDIC "BANK FIND"

www4.fdic.gov/IDASP/ma...

[EBC]

But why just use "non-accrual"... why not 90 days or more, or 30-60 days?

[billddrummer]

To EBC:

Non-accrual assets for banks include loans which for whatever reason have stopped earning interest. There are myriad reasons for loans to cease being earning assets, not just delinquency (though that's a primary cause). Sometimes the borrower files bankruptcy prior to the 90+ day delinquency, and the bank must place the loan on nonaccrual until the bankruptcy is settled; sometimes a borrower disappears (remember the phantom developers during the S & L crisis?). Other things can happen as well--natural disasters, etc., which can cause a loan to cease to perform even if it wasn't past due.

Conversely, some loans will have terms that on face may look risky, but are structured for a specific reason. Classically, construction loans fall into that category. Typical construction loans have maturities longer than one year and no specific repayment schedule except possibly a permanent mortgage at the completion of construction. In this case, the loan structure appears risky, but properly managed, a bank can reduce the risk with effective underwriting techniques.

The non-accrual designation provides a consistent method of determining the relative health of a loan portfolio. Generally speaking, the lower the non-accrual asset percentage, the better managed the portfolio.

[dixie]

Just who are these bank analysts that say 150 out of 7,500 banks will fail within 18 months? That's 2% . . . yawn. Do these represent the largest 2%, smallest 2%? Such figures are merely meaningless guesses.

If one assumes that these statistics may be somewhat correct, then it should not require much diligence to spot the 98% "safe" banks. Even using a dart board to separate the loosers from the pack, I would be correct 98% of the time.

[rnestler]

What happens when a bank goes under to your direct deposits such as pay checks and social security deposits.

[jcrash]

rnestler...the bank keeps on running..the FDIC just manages it. I'd assume someone getting SS wouldn't have over $100k in said account, but if not...they might have issues.

[jjason]

David, I went to the FDIC website and your data for Corus Bank is incorrect. Please review the data and if you are wrong, please write another article and correct the data.

Also, if some data is incorrect it brings into question the source of the data and if any other data in the article is incorrect too.

[CanadianBanker]

Are you kidding me?? Ratio analysis of banks & Savings & Loans? Are you stupid or do you think investors are idiots? Recall GAAP my friends: Banks are allowed to book the negative amortization portion of loan payments as Income. Stop for one minute & THINK!!! Bank's balance sheets are completely & totally over-valued (or over stated). Don't get burned by this crap about looking at ratios. If ratio analysis were that good, we (the investor) wouldn't be sitting here today on worthless paper - i.e. stock certificates. To be sure, Bank's, particularly Savings & Loans are trying to "manage their earnings" (actually their losses) to avoid or defer the inevitable run on their banks. If you have your money deposited in a regional bank, you would be wise to pull it & put it into a larger, national, more well know institution. We are in the middle of a very wide and very deep banking / financial crises. If you live in Southern California, you would be very smart to put your money in Wells Fargo, Bank of The West, or Union Bank (maybe Bank of America). Yes, there is FDIC (but can take up to 8 weeks for a bank to accept a check on a failed bank, or may not take the check at all). Pull your money from S&Ls including First Federal Bank, Downey Saving, Imperial Bank / Comerica and other small local banks. First Federal is trying to convince depositors to keep their money in the their bank - a total hoax and based on, what I believe to be misrepresentations - about the bank's financial stability. Most notably, First Federal is on the watch list of the federal regulators and on Friday (July 25) announced the appointment of a new board member which appears to be a dissidant shareholder (look at their website). However, most alarming is that the bank is departing from its normal practice of announcing its earnings of the last Thursday of the month to this coming weekend (Saturday, August 3rd) in what appears to be their effort to hide / shield their ongoing problems. President Geraldin & CEO Hiembech should be fired!! Should have been fired a long time ago given the stock decline from over $70 to under $7 in about a 12-month period (that represents about 20 years of shareholder value wiped out in 12 months)!!!!. How ironic that Prez Geraldin sold over 50% of his stock holding last Novermber (2007) for over $34 per share & grossing over $1 million (again, look at their website: "Insider Trading"). Talk about a bunch of crooks in my opinion. Stay away!!!