FDIC List Slows, More Banks Go Bust

According to a government report released on Tuesday, the number of banks on the Federal Deposit Insurance Corporation’s (FDIC) list of problem institutions in the second quarter grew to 829 from 775 in the previous quarter and 416 in the year-ago quarter. This is the highest since the savings and loan crisis in the early 1990s.

Banks that feature on the problem list are most likely to fail, though some may still scrape through. As of now, only about 13% of banks on the FDIC’s problem list have actually failed so far. What is interesting is that this percentage is likely to change; though the problem list is growing at a slower pace, bank failures are accelerating.

The How and Why of Bank Failures

There have been 118 bank failures so far this year, compared to 140 in 2009, 25 in 2008 and just 3 in 2007. Increasing loan losses on commercial real estate are expected to cause hundreds more bank failures in the next few years.

While the bigger banks benefited greatly from the various programs launched by the government, many smaller banks are still weak. Tumbling home prices, soaring loan defaults and a high unemployment rate continue to take their toll on such institutions.

As the industry absorbs bad loans made during the credit boom, the trouble in the banking system goes even deeper, increasing the possibility of more bank failures. Economic threats emanating from the European debt crisis, the impact of tighter regulations of the new financial reform law and weak economic growth data released by the U.S. government last Friday further add to the concerns.

FDIC: Mentor Tormented?

The FDIC insures deposits in 7,932 banks and savings associations in the country and promotes the safety and soundness of these institutions. When a bank fails, the FDIC reimburses customers for deposits of up to $250,000 per account. Though the FDIC managed to shore up its deposit insurance fund during the last couple of quarters, the outbreak of bank failures has tested its limits. As of June 30, 2010, the fund remained in the red with a deficit of $15.2 billion.

To further stretch the dwindling FDIC reserves, the amount of assets from the failed banks is expected to be lower as banks have been cleaning up their balance sheets.

On the positive side, the consolidated earnings of the FDIC-insured banks came in at approximately $21.6 billion during the second quarter compared to a loss of $4.4 billion a year ago. This marks the highest in nearly three years.

Increasing loan losses on commercial real estate are expected to precipitate hundreds more bank failures in the next few years. The FDIC expects bank failures to cost about $60 billion over the next four years.

Loans and Margins: The Vicious Cycle

Government efforts in restoring the lending activity at the banks have not succeeded either. Lower lending will continue to hurt margins and the overall economy, though the low interest rate environment should be beneficial to banks with a liability-sensitive balance sheet.

On the other hand, even with near-zero interest rates, many banks have failed to encourage investment. Moreover, the Congress remains reluctant to provide more bailout funds to the banks as the government’s deficit is significantly increasing.
What Price Consolidation?

The failure of Washington Mutual in 2008 was the largest in U.S. banking history. It was acquired by JPMorgan Chase & Co. (JPM). The other major acquirers of failed institutions since 2008 include Fifth Third Bancorp (FITB), U.S. Bancorp (USB), Zions Bancorp (ZION), SunTrust Banks Inc. (STI), PNC Financial Services Group Inc. (PNC), BB&T Corporation (BBT) and Regions Financial Corp. (RF).

If the current pace of consolidation remains intact, we will see only a few large banks survive, exposing the industry to an oligopolistic market, which is not desirable. Does the Obama administration have a solution for this?

JPMORGAN CHASE (JPM): Free Stock Analysis Report
US BANCORP (USB): Free Stock Analysis Report
ZIONS BANCORP (ZION): Free Stock Analysis Report

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