Monday, December 21, 2009

Failed Banks. The December 18th Group

The FDIC failed seven (7) additional banks on December 18th. Two in California and one each in the states of Illinois, Alabama, Michigan, Florida and Georgia. The jump from an average of four per cycle to seven indicates that the build up of the FDIC's task force for bank closures has reached operational status and we can expect that the pruning of weaker banks from the system will proceed at a brisker pace in 2010.

This is a good thing. Clipping off the low tail of a moribund system serves to eventually bring the overall industry up the quality tree. It's an example of a regulatory agency doing what it's supposed to. Yes I do hear those of you lamenting "if only we could do the same over in the large bank and investment bank segments of the system." True there's a lot more politics involved in arresting the risk shifting gamesmanship at the upper end of the spectrum to actually achieve some productive pruning. I'll take a little larger view though. The remainder of the banking system is being "trained up" by what the FDIC is doing and eventually this higher quality population of competitors will make their mark on the landscape. There may be some "mastodon stew" for these emerging hunter gatherers to feast on yet.

So here's the next installment of what I think will be a weekly forensic report by IRA. Your feedbck is important so let me know if you want to see more of these.

First Federal Bank of California, FSB Santa Monica, CA
Imperial Capital Bank La Jolla, CA
Independent Banker' Bank Springfield, IL
New South Federal Savings Bank Irondale, AL
Citizens State Bank New Baltimore, MI
Peoples First Community Bank Panama City, FL
RockBridge Commercial Bank Atlanta, GA

As you'll see in these forensic tables the IRA Bank Stress Index letter grading methodology picks up on the stresses with a fair bit of warning. More than enough to implement tactical plans to mitigate exposure and shift assets to more stable institutions.

Survey Invitation

IRA is taking a survey of how CFO's, Treasurers, bankers and bank counterparties feel about the current financial landscape. It's a short survey and we invite you to participate. If you'd like to take the survey please email Diana Waters before January 15, 2010.

Monday, December 14, 2009

Failed Banks: What was knowable when?

Bank failures happen at close of business on Fridays. A team of operatives from the FDIC shows up at the door and by the time those doors open again on Monday morning the bank has been inventoried, valued and transferred to a new owner. This story institutional devastation has happened so many times in 2009 that it become a footnote fixture in the weekly wrap up of financial news. Americans don't quite understand how it really works except to take assurance in the fact that the Federal Deposit Insurance Corporation (FDIC) somehow takes care of them even as tumult rages on.

So is it possible to see this kind of trouble heading towards a bank? And if so, how far in advance of disaster do the indications begin to reveal? That's the question that comes across my desk frequently. Everyone wants to know if the IRA Bank Monitor can see it coming. The direct answer is yes. IRA's A+ through F grading system was in fact developed specifically to illustrate these Bank Stress Indices or BSI's so as to begin warning early enough while there might still be time for bank directors and officers to attempt to avoid or mitigate a crisis that could result in regulatory action. But not all banks make it. For some, the fate of failure manifests. It is from these that it's possible to study the "What went wrongs?" so that the clues in the rubble can help others avoid the same fate.

On December 11, 2009 the FDIC closed three banks. The links point to IRA's Failed Bank History Report that shows the prior twelve (12) quarters of stress history for the failed institution. They are presented here as forensic examples.

Solutions Bank
in Overland Park, Kansas

Valley Capital Bank, N.A.
in Mesa, Arizona

Republic Federal Bank, N.A.
in Miami, Florida

I highly encourage serious students of banking and bank risk to study them. Reports on live institutions are available to subscribers at .

Tuesday, December 8, 2009

Industry and Bankers: Chasing Quality

Today we turn to looking at the banking scenarios facing CFO's and Treasurers. As 2009 ends we see the Obama Administration preparing to gear up its job restoration strategy. President Obama and his team, along with pretty much every other financial expert, correctly surmises the importance of bringing US unemployment down and restarting the Main Street economy as critical to maneuvering the economy away from the vortex created by the collapse of the leveraged finance house of cards.

I must say that I personally find the thought of a grassroots approach based on emphasizing small business recovery to be refreshing. The concept that "many hands make light work" makes good sense to me. The best of breed from the old ways will do well regardless. Encouraging and supporting smaller more maneuverable business to fill the needs voids will almost surely result in a revitalized and globally competitive United States of America. It's the kind of thing this country, encompassing all our political and cultural persuasions, is good at. It's certainly a more persuasive use of precious national wealth than continuing to prop up obsolescent "sucking sound" infrastructures. The question is of the new year will be can the Administration steer a course to the correct balance. I wish the President and his team the best in this effort.

The Flight to Quality, A Never Ending Journey

The impact on banks and businesses by what is about to unfold are many but ultimately it boils down to quality. The quality of the commercial and industrial entities that will seek and use business financing in 2010 and the quality of the banking institutions that will serve the new landscape. The banks will need to contend with two things to clear the way serving Main Street again.

First is completing the transition into a new reality that the country has moved into a post real estate boom phase. Shedding exposure is a tactical necessity. This means banks need to tend to their own health particularly with respect to the lingering cancer of losses from distressed real estate still in their bloodstreams. Projected real estate loan losses still to come are massive. The bulk of Option-ARM reset dates are in the still to come in 2010 and 2011 bucket. The reality is that these loans were never meant to survive the reset. Unless an alternative is created, the human pain and loss will be massive. The current loan modification program has an applicant failure rate of over 60% and the actuarial probability is that the remainder might just be a delaying tactic slowing the inevitable. Here's the truth. We have a lot of U.S. homeowners who can only afford to be U.S. renters. Until their relationship with finance and banking is morphed to reflect that truth the cancer will remain in the national bloodstream. Statutory loss reserves and FDIC insurance premiums will continue to suck discretionary capital away from new lending and a credit availability crisis will hamper the President's recovery agenda. Still, looking at the various piecemeal components of proposed solutions to this that have crossed my desk in the last year, I have a degree of belief there is a way to do this. It needs someone to architect it into a cohesive strategy then sell it to what is clearly still a weakened and hesitant hospital patient.

The second challenge to banks is to make the transition back to becoming a competitive marketplace for quality lending. Specifically, for the supporting the President's agenda, quality commercial and industrial lending. C&I loans and lines of credit are the fuel that grows economies. Targeted C&I for small firms may be forthcoming if the Administration follows through turning policy into substance. We should not be surprised if keen competition for the highest quality C&I customers will become all the rage next year. Indeed CFO's and Treasurers of well positioned firms should be insulted if they don't have several bankers knocking on your door courting their business accounts. There's some evidence of that happening already. Expect to see all kinds of spin about why your current bank is a pile of poop and you should become a client of bank X. It'll be all to the good because a competitive Main Street financing market is a sign of an improving economy. Don't believe bank advertising material on it's face though.

CFO's of commercial and industrial companies are well advised to exercise some "Trust No One Agent Mulder" prudence. We've seen a fair few "we're better than your old bank" pitches that turn out to have higher risk and stress ratings than a company's existing banking relationships. When asked we tell companies it's worth the peace of mind to obtain even the basic IRA report on one's bank and any bank pitching you for business. CFO's need an independent eye. Think of it as getting a "CarFax" before signing the papers. Making banks compete in the bright light of day could even sweeten the pot for a CFO particularly when being approached by equally good and competitively motivated banking alternatives. Finally, in these days of SOX compliance, it's also important to prove to the finance committee and to satisfy potential adequacy of internal controls challenges that one did use at least one independent criteria to base one's decision on.

In parallel, Treasurers need to look at their deposits placements and cash management strategies with a keen eye on bank quality. There are 8,500 or so active banks in the U.S. Not all of them are healthy. Some of them are "hazardous" and that's not a term I made up, it's a category they fall into based on business conditions exceeding regulatory criteria thresholds. And just relying on ladders and brokered deposit spreading isn't enough. Treasurers still need to pick one or more primary banking relationships where sizable balances may have to sit as part of enabling the smooth operations of the CFO and COO of the firm. The same reality that hit the Wall Street finance universe applies to industrials. Shifting risk is no substitute for reducing risk.

Sunday, December 6, 2009

Teeter Tot: Third Quarter Stable at the Brink

There's good news of sorts from the third quarter data. The risk distribution of the banking system looks to be in a holding pattern. Life is still full of pain of course. Credit availability remains tight. The prospect for more mortgage losses in 2010 remains looming. Leveraging vehicles for finance are sparse. And the valuation of the real assets underlying capital continues to shrink. But here's the good news. There's a pattern to the pain. The volatility and uncertainty surrounding much of 2009 has morphed to a collection of set piece issues. And that gives me some hope because set piece battles are things we can begin to work on. We Americans tend to be as good at tactical problem solving as we are bad at strategic vision. But this means that overall our problems are moving towards our strenghts rather than our weaknesses.

The risk map at the end of September 2000 was as follows,

IRA Bank Stress Grade Distributions

And asset distributions are,

IRA Bank Assets Stress Distributions
Amounts in $ Billions.

The risk map is roughly identical from 2Q2009 to 3Q2009 give or take a little because of continued but now predictable hemmoraging. So where are America's challenges ahead?

Do we have the political will to do the right thing?

Bringing Wall Street back into the service of Main Street remains elusive. Finance remains a universe separate from the rest of our reality. The excesses of a decade and a half of "financial innovation" have been exposed but the inertia behind the collapse continues to fight on delaying the finance system's reintegration into mainstream society. What else can you say when you witness artifacts such as a stock market that pushes up prices on the arithmetic of expense management paid for by the unemployed and underemployed. Or a derivatives market so steeped in its' habits that it remains hell bent on preventing the kind of transparency that would help ensure the debacle we are living through won't happen again? These are not economic fundamentals, they are social and political risks that this nation cannot afford. The Administration and Congress are by now well aware of these forces and their effects. There is no reason the citizenry should not expect our leaders to do the right thing.

Refocusing industry incentives to make things right.

Just under 2/3rd's of the banking industry's assets lives in the A+/A/B stress range according to our calculations. The remainder have issues clearly requiring some degree of extraordinary administration. But so far, the remediation efforts of the United States remain piecemeal and nearest I can tell, overly focused on a few large entities that fall within the fashionable coverage limit of the major news bureaus. We have so far failed to systemically tap into the single largest source of recovery strength we have, the healthier banks. They are there but they are hamstrung from acting lumped in with the weaker and louder players who's calls for mercy and aid via taxpayer dollars retain our attention. In my job I see and talk to some of these A+/A/B banks and even some really smart C grade banks on the mend that struggle to take advantage of their positional strengths. But what should be a downhill run competitive advantage is an uphill struggle for the best of breed. So here's the challenge to our leadership. Refocus the process from a smattering of narrowly selective aid packages to a tidal of movement to change the nature of the industry so it gets back to an 80 good/ 20 bad ratio. This will involve a much larger shifting of impaired assets to sound foundations. It will undoubtedly manifest as a newsworthty mix of debacles and recombinations. But we need to return to a process of natural selection based on value instead of clout.

Make Main Street the political priority already.

We cannot make lemonade from rotting lemons. You can take comfort deluding yourself looking at day to day economic indicators but the reality is that as of September 2009 the total amount of bank balance sheet real estate loans outstanding by FDIC reporting banks was around $4.5 trillion dollars. That is about the same amount as it was in March 2007. It peaked at a high of $4.8 trillion in March 2008 just as the "crisis" was becoming common knowledge to America.

But here's the thing. In 2007 the annualized default rate on these loans was 11.8 basis points. Today it's 194.3 bp. Main street home ownership is struggling. Let's look at a few more then and now comparisons.
  • In March 2007, 30-89 Day overdue loans was $43.7 billion. Today, it's $100.8 billion.
  • Over 90 Day overdue loans were $11.2 billion in 2Q2007; today that figute is up to $88 billion.
  • Non-Accrual residential real estate loans were $29.2 billion in March 2007; we are at $202 billion now.
  • And bank real estate owned was $6.9 billion in March 2007. Today banks own $37 billion worth of real estate.

The challenge is pretty clear. The degraded real estate portfolio of America's banks massive and does not yet shows no signs of abating. Surrounding this challenging financial scenario is a loan modification program that by best estimates will work for no more than 1/3rd of the problem. An infrastructure solution needs to be found for the balance of the U.S. homeownership problem. Banks saddled with such problems cannot lend and therefore cannot help re-stimulate the economy. In economic terms this is a massive downward accelerating force if not dealt with. Numerous proposals surrounding this subject abound as we reach the end of 2009. None yet cohesive enough to represent anything amounting to a solution. We have a collective choice to focus on it or not.