Wednesday, November 23, 2011

'Problem Banks' Declining, Failures Still Climbing

The FDIC says the number of U.S. banks in financial distress continues to decline.

At the end of the third quarter there were 844 “problem” institutions on the FDIC's list, down from the 865 at the end of the second quarter, and 888 at the end of the first quarter.

Though this decline is being heralded as good news, we must remember that at the end of the first quarter last year, the number of lenders on the FDIC's "problem banks list" had climbed to 775, which was the highest level since 1992.

This means there are still 69 more banks on this list than there were at the end of the Savings & Loan crisis. That provides some perspective on the magnitude of the current problem.

Martin Gruneberg, acting chief of the FDIC, said that a central concern for the agency is whether banks can generate income from a greater demand for loans, something that is still lacking.

Americans are still overwhelmingly in debt and are doing all they can to deleverage.

“The key issue is going to be can there be a pick up in economic activity and generate demand for loans, Gruenberg said.

Any rational observer knows that the global economy is getting worse, not better. The likelihood of increased economic activity and a higher demand for loans is slim or none, and that won't change for quite some time. We've entered a new economic reality where the limits to growth are finally being recognized.

One-quarter of homes with a mortgage are underwater. Unemployment remains troublingly high. Moreover, wages and incomes remain flat or depressed for the vast majority of Americans. This is not a recipe for increased economic activity or borrowing.

Last year, one-third of American consumers were considered sub-prime and couldn't even qualify for a home loan. When a third of your market is disqualified, that's obviously a very bad sign.

The problems in the European banking system could quickly and easily spill over into the U.S.

While Gruenberg said direct U.S. bank exposures to the European sovereign debt crisis is “relatively” limited, he added that a “key” risk for US institutions as well as for the global economy is the potential contagion effects that would result from a serious financial crisis in Europe.

As a result, Gruenberg said the FDIC is pressing banks to hike capital and improve their liquidity. He said that closer attention is being paid to “potential avenues of contagion” such as each institution’s derivatives exposure. However, he added that banks generally have much stronger levels of capital and liquidity than they did years before.

We can only hope.

Having 844 banks on a "problem" list is clearly an issue of great concern. It's certainly not the mark of stability.

More than 100 banks failed in each of the last two years; a total of 140 banks were shuttered in 2009 and 157 institutions failed in 2010. The trouble is not yet behind us.

A total of 90 U.S. banks have already failed this year. With six weeks to go before 2011 concludes, who really doubts that number won't reach 100 yet again?

Since the creation of the FDIC in 1933, there have been only 12 years in which 100 banks failed in a single year. The last two were among them. We made yet add to that total.

To provide some perspective, a mere three U.S. banks failed in 2007 and just 25 U.S. banks were closed in 2008, which was more than in the previous five years combined.

The banks on the "problem" list are considered the most likely to fail. However, their names are never made public for fear of creating a run on those banks.

Bank failures over the previous two years pushed the number of FDIC institutions to below 8,000 for the first time in the agency's 76-year history. Two decades ago, the FDIC insured more than 16,000 institutions nationwide.

While the number of banks considered at risk for failing may have declined, the problem can only be described as going from really, really bad to really bad.

Keep your eye on Europe's debt crisis and how that affects the banking system there. The fallout could be both catastrophic and contagious.


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