Can U.S. Banks Dig Themselves Out Of This Hole

If you read this blog regularly you know that late Friday evening I have a regular post called “Friday Failures”. It basically lists the banks that have been seized by the FDIC on Friday, the day they traditionally shutter banks. Based on this information, it looks like there will be plenty of future posts.

The U.S. banking industry during the last three months of 2008 suffered its worst quarter since the middle of the savings-and-loan crisis, as the growing number of bank failures nearly cut the federal safety net for deposits in half.

U.S. banks and thrifts recorded a loss of $26.2 billion for the fourth quarter, the first time since the last three months of 1990 that the industry failed to turn a profit. The pain was widespread: losses at four major banks accounted for half of the losses, but nearly a third of the industry reported a fourth-quarter net loss.

“High expenses for loan-loss provisions, sizable losses in trading accounts and large write-downs of goodwill and other assets all contributed to the industry’s net loss,” the Federal Deposit Insurance Corp. said in its quarterly report on the health of the industry.

The staggering losses were paced by a sizable increase in the number of banks considered high-risk, or “problem” institutions. The FDIC said there were 252 banks or thrifts with assets of $159 billion on its “problem list” at the end of 2008, a 47% increase from the end of the third quarter and more than triple the number of problem banks at the end of 2007.

The odds are pretty good that a fair sized proportion of those 252 banks on the “problem list” are going to end up in receivership. Many simply not large enough to warrant government assistance and with the tides of the economy running against them it’s doubtful that they can survive.

But it gets worse.

Banks and thrifts responded to the ongoing turmoil by setting aside more than $69 billion in loan-loss provisions during the fourth quarter, more than double the $32.1 billion set aside in the final quarter of 2007. The loan-loss provisions represented 50.2% of the industry’s net operating revenue, the highest proportion since the second quarter of 1987.

At the same time, total reserves for the industry increased by $16.5 billion during the quarter as insured institutions added $31.5 billion more in loss provisions to reserves than they took out in charge-offs.

Despite the increased provisioning for losses, however, the FDIC said the reserves did not keep pace with the $44.1 billion increase in loans at least 90 days past due. The result: the banking industry’s ratio of reserves to noncurrent loans fell to 75%, the lowest “coverage ratio” level since the third quarter of 1992.

Other indicators were equally as grim, with some firms reporting large trading losses and goodwill impairment charges. The FDIC said the $9.2 billion net loss in the last three months of last year marked only the second quarter in 25 years where trading revenues were negative. Goodwill impairment and other intangible asset expenses climbed to $15.8 billion, up from $11.5 billion at the end of 2007.

Additionally, the FDIC said net loan and lease charge-offs at insured institutions totaled $37.9 billion in the fourth quarter, up $21.6 billion from the end of 2007. The quarterly net charge-off rate was 1.91%, equaling the highest level in the 25 years that banks have reported the figure.

In essence, the industries’ assets have been deteriorating at a faster pace than their ability to reserve for them. So it comes down to two things. One, have they been reserving honestly or are they behind the curve. Two, is the recession going to debase their assets at a pace that exceeds their ability to keep up. Of course, both of those factors could be in play in which case there is little hope for those in trouble and for which government aid is not in play.

John Hempton who writes Bronte Capital has had a couple of posts that postulate that the industry is making money hand over fist right now and that this may make the situation less grave than many think. He contends that the trend in net interest income is so strong that many banks will be able to earn their way out of the spot they’re in. Not many agree with him but I think he has a valid proposition. 

The question isn’t whether or not there are going to be a lot of failures. There will be. No, it’s really whether or not we are going to see a blood bath. That question depends on the two factors I noted above.

more: here (WSJ) and here (Bronte Capital) 

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