By Jon Markman | 8 September 2008
In the coming year, tens of thousands of Americans could fall victim to bank failures. Yes, this could include you. You can ignore the risk— or move your money now.
Ten U.S. banks have gone belly-up so far this year, yet the concept still seems vaguely distant. Unless you had money in the five-branch Integrity Bank of Alpharetta, Ga., or the nine-branch Columbian Bank of Topeka, Kan., or the eight other institutions in small towns with as much as $1 billion in deposits each, the announcements likely have slipped under your radar this summer. Yet this is not something you should ignore, as if it is happening to some other poor fool. The banking system today is so interconnected— and so many more banks are vulnerable— that tens of thousands of Americans are likely to become victims of bank failures over the next year.
The list of troubled banks will likely reach into the hundreds and lead to half a trillion dollars in government and insurer costs, according to research by Chris Whalen, a veteran bank analyst at Institutional Risk Analytics, an independent firm. And all that money will come from taxpayers, customers at stronger banks, and foreign buyers of U.S. debt, who aren't likely to continue to be so compliant that they hand it over without protest or a demand for something extra in return.
David Kotok, the head of institutional firm Cumberland Advisors, agreed with that assessment in an analysis for clients this week, concluding that "stock market complacency about the financials hitting a bottom in mid-July is about to be sorely tested as we enter autumn." There are plenty of ways to lose here, including two biggies: either by losing a portion of your own deposits or by investing in the banks themselves. In a moment, I'll give you suggestions on how to cope, including a short list of banks expected to be much safer than most.
But first let me note that it's impossible to know exactly how many banks will fail because the U.S. Office of Thrift Supervision and the Federal Deposit Insurance Corp., which are responsible for closing and rescuing insolvent banks, have been so secretive. The FDIC regularly announces how many troubled banks it is watching, but to avoid a panic, it won't reveal their names. Yet even that list is misleading. For example, IndyMac Bancorp (IDMC) in Southern California wasn't on the FDIC list of 90 problem banks in the first quarter, even though it was ultimately a $32 billion failure. So in three months it went from being a nonproblem to being the second-largest bank failure in history.
The trouble at banks stems from losses in real-estate, auto and credit card lending that are worsening every day as U.S. job losses mount, inflation rises and income levels shrink amid a widening recession. Realized loan losses at banks nationwide have risen to the stunning level of 1.3% of assets so far, but analyst Whalen's research suggests we're on target for at least a 2% annualized loss rate nationwide— which was the level in the early 1990s, when more than 800 regional banks and thrifts went under because of bad real-estate loans.
Big institutions such as National City (NCC, news, msgs), based in Cleveland, and Washington Mutual (WM, news, msgs) in Seattle are already at 3% losses, and the examples of greater-than-expected losses continue to pile up. On Tuesday, First Horizon National (FHN, news, msgs) of Tennessee announced that its write-offs would be $100 million, or 20%, larger than the $485 million loss it had previously estimated. The company blamed more-extensive loan reviews and statistical analyses for the difference, as well as deteriorating collateral values of land and lots. "Economic conditions continue to stress certain borrower segments," the company said in a news release.
Because the threat of widespread bank failures is no longer just a staple of wacko doomsday theoriists, it behooves all depositors to do everything they can to avoid becoming victims. And that is much more possible than you might think, particularly if your bank is a heavy borrower from the Federal Home Loan Bank system. Banks that borrow more than 15% of their total assets from Home Loan Banks, which are quasi-governmental organizations that are used as a lender of last resort for mortgages, are believed to be at higher risk of failure than their peers. So far, all of the failed banks have been in this category.
One key problem is that obligations to Home Loan Banks are first in line when commercial banks go under, and they must first be paid back "at par," or in full. That leaves less for depositors who have more than the insured limit of $100,000 at the banks, who become unsecured creditors of the institution in an insolvency. Although it may seem odd to most of us for someone to have more than $100,000 at a single bank, it's common for small businesses to have hundreds of thousands of dollars in cash in a demand account for payroll purposes, and even for wealthy families that require a lot of liquidity.
There are ways to use joint accounts, retirement accounts and child beneficiaries to boost the insurable limit up to $250,000 or even $400,000. But most people don't know that these options are available, and banks don't make a practice of letting them know. (Who can blame them, since it's the banking equivalent of that scary moment on airliners when the crew tells you how to survive a crash.)
As bank failures mount and fear rises, the result will be a rush away from smaller banks toward ones that the government deems too big to fail. But since that will be a crowded trek, I checked in with analyst Whalen for a list of banks he considers the most stable and best of breed. His favorites:
Northern Trust (NTRS), based in Chicago, has one of the best fundamental performance records in the business. Its profits are one standard deviation above those of its peers through June 30, and its loan default rate in the second quarter this year was just 0.03%. The main reason is that its noninterest income is four times greater than its net interest income, meaning that it doesn't depend on loans to make a profit. Whalen believes its performance margin compared with those of its peers will widen over the next few quarters as banks with more credit exposure take a beating.
US Bancorp (USB), based in Minneapolis, still has a return on equity of 22% and has a high proportion of its income coming from nonloan services. It has charged off 1% of its total loans and is adding to loan-loss reserves at a 2-1 ratio without cutting dividends, which speaks well for management. Whalen says it is very unlikely that US Bancorp, "one of the best-performing commercial banks in the world," will ever need to obtain additional capital or sell itself to outsiders.
Washington Federal (WFSL), a thrift based in Seattle, reported a 10.1% return on equity through the second quarter, compared with a negative 4% for peers. Returns have tracked a full standard deviation above those of its rivals. Its main operating unit reported just 0.21% of loan defaults versus 1.26% for its peers. It has received advances from the Federal Home Loan Bank system equal to 16% of its assets, but its strong capital position and profitability still make it a top choice for cash deposits.
Charles Schwab Bank (SCHW), based in San Francisco and the thrift subsidiary of a discount brokerage, has an "eye-popping" return on equity of 27%, which is 1.26 standard deviations above those of its peers, making it almost countercyclical. With virtually no credit losses in the second quarter, Whalen calls the thrift subsidiary of Schwab a "pretty safe place to stash your loot" and says it deserves kudos for its success in a declining credit market.
Bank of Hawaii (BOH), based in Honolulu, sports a return on equity of 26% and is a full standard deviation above its peers in funding its loans. With just a 0.46% charge-off rate and high average maturity of its loans, Whalen thinks it has done a beautiful job in a tough environment.
In summary, there may be a lot of banks facing the executioner for their mortal sins, and you should steer clear of them— not just as investments but with your cash. But others are holding their own and then some, and it's probably worth the trouble to move your funds there just to be safe.
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Normxxx
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