Wednesday, September 1, 2010

Like Dominoes

[click to enlarge]

Yesterday the Federal Deposit Insurance Corporation
(FDIC) released its Quarterly Banking Profile, evaluating the health of the commercial banking industry. The FDIC oversees over 7,000 banks; as of the end of June, 829 of them were categorized as "problem banks" at risk of failure. That number is up by 127 since the end of 2009 and does not include the 86 banks that were closed from January to June. In July and August 32 more banks have failed, raising the total cost to the Deposit Insurance Fund to almost $19.5 billion in 2010.

Aggregate loans and leases fell by $95.7 billion, or more than one percent, as banks continued to shrink their balance sheets. It was the fifth quarter out of the last six in which banks' assets declined, further evidence that the economy is contracting.

Although the FDIC's press release hailed the improved profitability of the industry, Peter Atwater, President and CEO of Financial Insyghts, remains skeptical. He believes that the $21.6 billion in combined profits for Q2 are largely illusory. Even the FDIC admits that "the primary factor contributing to the year-over-year improvement in quarterly earnings was a reduction in provisions for loan losses." At the end of June, loan-loss reserves totaled 65% of non-current loans.

"Personally," says Atwater, "I think the industry needs something closer to 80% coverage of non-current loans given our high unemployment and underemployment rate and the deflationary environment impact on underlying loan collateral." That would call for another $50 billion in reserves, offsetting reported Q2 profits by a ratio of more than 2:1.

According to the St. Louis Federal Reserve, allowances for loan and lease losses (ALLL) industrywide stand at less than 20% of all nonperforming loans:

Mike Mish Shedlock suspects that the problem is worse than what the FDIC is reporting. In his article "Something's Not Right With Report's Loan Loss Data," he quotes a commercial banker in California as follows:

In my estimation, if every bank had the collateral of all loans accurately appraised and each loan’s loan grading was finely tuned for an expected loss based on financial performance and collateral values, the number of essentially bankrupt banks in this county would increase by a factor of four to five from the current level.

In other words, there is a potential pool of 2,000 to 3,000 banks that would be on the FDIC's radar for getting closed.

The health of the industry is not accurately reported by any means.

Reminder: the MainePERS portfolio is still over-exposed to the banking sector, which means the hits will keep on comin'.

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