I recently analyzed the nation's banks by examining their nonperforming assets. Using a somewhat esoteric banking ratio, I used this data to create a list of which financial institutions are most likely to fail. Last Friday the announced the 82nd banking failure of 2010, Washington First International Bank.
It was on my list. (Available here.)
In the course of poring through regulatory data, I noticed another factor that piqued my curiosity. Some banks are utterly dependent on the federal government.
All financial institutions rely on Uncle Sam to guarantee their deposits. This, of course, is the Federal Deposit Insurance Corporation, a New Deal program initiated by Franklin Roosevelt to strengthen public confidence in banks during the Great Depression. Aside from periodic examinations by regulators, which most bankers view as being nibbled to death by ducks, banks don't have much to do with the federal government.
Every banker I know likes it that way.
But the truth of the matter is that I haven't met every banker.
A few bankers -- and I'm going to tell you who they are in a moment -- actually seem to relish the support they get from Uncle Sam. In fact without it, these banks would take serious and perhaps even life-threatening losses to their loan portfolios.
Happily, these banks are the exception. But I have to wonder whether I would sleep very well knowing that my money was being watched over by bankers who were willing to accept corporate welfare to ensure their viability. Why couldn't they just make good loans like the rest of the industry?
Let me explain a little about what the numbers are. Then I'll tell you what they show. Who knows, your bank might be on the list.
1. All banks make a few bad loans. They are a cost of doing business, even in the best of times. These bad loans are deducted from the banks net interest margin. This is called the charge-off rate. In a typical year, a bank will charge off between 30 and 40 cents for every $100 it loans.
These days, however, the charge-off rate is 1.94%. In other words, for every $100 in loans, a bank has to eat $1.94 in losses. Ouch! That's a big chunk of bank's net interest margin, which is currently $3.83 per every $100 lent. ("Net interest margin" is the difference between interest charged and interest collected.) Aggregate bank data from the FDIC shows that the average profit margin banks could earn, before fees, is 1.89%. That's pretty low, and the reason is all the bad loans out there.
2. Loans don't go bad right away. Most loans allow customers a certain grace period. Then they might sit before being marked overdue. After a certain number of days the loan is classified as nonperforming. That means it isn't earning any interest because the customer isn't making any payments.
3. The higher the amount of nonperforming assets, the weaker the bank's revenue stream. In the short term, a lot of banks have the ability to ride out the storm. They might have strong reserves or other capital that can be used. But after a while, if that capital is used up, nonperforming loans will imperil a bank's health.
4. Some loans, typically mortgages, are said to carry "no risk" even though they are past due because they are guaranteed by the federal government. The feds, to keep mortgage lending going during the financial crisis, explicitly guaranteed some mortgages. If they go bad, the feds will pay off the principal balance (and, ostensibly, sell the house to recoup some of the loss, just as a bank would do in foreclosure.)
In the meantime, the loan is a nonperforming asset that isn't making any money. It's actually generating an opportunity loss for the bank, because it doesn't earn the interest that those dollars could have. Think of nonperforming assets as dead weight on the balance sheet. They are footnoted on bank balance sheets.
To find out which financial institutions are most dependent on the federal government, I took all banks and eliminated any with less than 80% of their non-current loans guaranteed by the federal government. For most banks, guaranteed loans are a tiny portion of their nonperforming loans, so I was left with only 55 banks out of about 7,930. I inferred that these were banks that made or bought mortgages that were federally guaranteed.
For most banks, this was a very small percentage of their overall loan portfolio, an average 5.1%, with half the banks sporting less than 1.5%. But for some banks, it was as if they gorged on these ill-fated mortgages, and ended up with a much greater allocation as a percentage of their overall loan portfolio. The most federally dependent banks would lose between 17.5% and 30.8% of their entire loan portfolio if not for Uncle Sam's safety net.
I call this the "Dependence Ratio." And here are the top five most dependent banks in the United States.
|Name||Location||Assets||Total Loans||Classified Loans||Partially Guaranteed||% Partially Guaranteed||Dependence Ratio|
|State Bank and Trust Co.||Macon, GA||$2,569.6||$1,112.2||$343.6||$342.3||99.7%||30.8%|
|BankUnited||Miami Lakes, FL||$11,463.6||$4,431.8||$1,168.7||$1,168.7||100.0%||26.4%|
|MidFirst Bank||Oklahoma City, OK||$12,365.2||$9,535.1||$2,305.0||$1,976.0||85.7%||20.7%|
(all numbers except percentages are in millions)
What is not surprising is that there really are very few banks on this list. Five egregious offenders out of nearly 8,000 does not represent another round of noisome systemic risk.
What is a little surprising, however, is that the worst offenders on this list have the number of assets they do -- all are large institutions with at least $2.5 billion and as much as $12.3 billion in assets. One would presume that larger institutions would have more experienced officers or, at the very least, have more experienced regulators who would frown on the potential downside risk of such a high concentration of risky credits.
A high Dependence Ratio means two things: First, the bank isn't earning money it could be earning because it has tied up its money in nonperforming assets, even if they are guaranteed.
The second thing is that it has no one to blame but itself. Diversity is the key to a strong loan portfolio, as is evidenced by the other banks on the list, most of whom have far less than 5% of their loan portfolios tied up in worthless mortgages good only for their guarantee.
Unlike the Texas Ratio, I can't support and won't make the claim that a high Dependence Ratio has any sort of predictive value for bank failure. One could argue it might have the opposite effect, as Uncle Sam is the most powerful financial force on the planet and when Washington guarantees loans, their principal is guaranteed. These banks might be solvent -- but I wouldn't do business with them.