Banks on Sick List Top 400 - WSJ.com

By DAMIAN PALETTA and DAVID ENRICH

The banking industry continues to deteriorate, with federal regulators adding 111 lenders to their list of endangered banks in the latest quarter, even as the economy shows signs of stabilizing.

Data released Thursday painted a gloomy picture of the state of banking.

The government fund that protects consumer deposits fell to its lowest level since 1993. The continuing woes, which come despite trillions of dollars in government rescue financing and a rebounding stock market, raised questions about how quickly the economy can revive.

The Federal Deposit Insurance Corp. said it had 416 banks on its "problem list" at the end of June, equivalent to about 5% of the nation's banks, up from 305 at the end of March and 117 at the end of June 2008. Problem banks had a combined $299.8 billion of assets at the end of June, compared with $78.3 billion a year ago.

Landing on the FDIC's problem list means a bank is at a high risk of insolvency. State and federal regulators have already shut 81 banks this year.

"It's a continuation of the deterioration across the industry," said Gerard Cassidy, a bank analyst with RBC Capital Markets. "We think there are hundreds of failures to come."

The FDIC's insurance fund, which guards $6.2 trillion in U.S. deposits, fell to $10.4 billion at the quarter's end, the lowest since mid-1993.

This is after the agency had provisioned $32 billion to account in anticipated bank failures during the coming 12 months. The agency is backed by the full faith and credit of the U.S. government, and depositors haven't lost a penny of insured deposits since it was created in 1933. Its fund stood at more than $50 billion last year. Bankers and analysts say the FDIC's latest figures boost the odds of the agency having to replenish its fund by imposing a new fee on banks. The fund is typically supplied that way.

The FDIC data provided at least one ray of hope. The percentage of delinquent loans -- that is, borrowers who are 30 to 89 days past due -- declined modestly in the second quarter. That suggests loan defaults might be nearing their peak.

The swelling of the problem list could be a harbinger of further industry consolidation, analysts said. Large, healthy banks, several of which have paid back their government-rescue funds, are "chomping at the bit" to buy failed lenders from the FDIC, and Thursday's report is likely to further whet their appetites, said Ed Najarian, head of bank research at International Strategy & Investment Group Inc. "They're looking at it as more opportunity to acquire banks."

Banks That Went Bust

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Looking Back on the FDIC

Journal articles on the creation of the Federal Deposit Insurance Corp:

• Final Drive For Bank Insurance (June 13, 1933)
• Deposit Insurance Plan: U.S. Policy Is to Admit as Many Non-Member Banks as Possible (Sept. 13, 1933)
• Seek Membership In Deposit Corp: 6,748 State Non-Member Banks Apply ... Examinations Expected To Be Completed By December 15 (Dec. 5, 1933)
• Plan to Boost Deposit Fund (Dec. 6, 1933)

More

• Deal Journal: TARP Scorecard
• Savers Should Manage Accounts Diligently
• Rules Eased on Bank Buyouts

The report also spotlighted a potential risk to the broader economy. Banks are socking away cash and limiting risky business, leaving them less capital to lend and thus constricting credit just as the economy appears poised to revive.

Banks are also facing extra scrutiny from state and federal officials, another reason they are cautious. For example, the FDIC said loans to small firms declined 1.9% in the past year.

"That slows job creation and affects corporate spending" and could prove a hindrance to an economic recovery, said Lou Crandall, chief economist at research firm Wrightson ICAP.

At a news conference Thursday, FDIC Chairman Sheila Bair acknowledged "credit problems will outlast the recession by at least a couple of quarters."

Ms. Bair said FDIC officials were in discussions with the Treasury Department about ways to direct more government capital to smaller, community banks. The Treasury Department's Troubled Asset Relief Program still has $13.6 billion that can be invested in these banks. The Obama administration, in its latest budget forecasts, has indicated it doesn't intend to ask for more funds from Congress.

The banking industry lost $3.7 billion in the second quarter, mostly because banks wrote off $48.9 billion in soured loans and put away $66.9 billion to cover potential future losses. But loans are souring faster than banks are stockpiling cash. The FDIC said the industry's ratio of reserves to bad loans was just 63.5%, the lowest level since 1991, amid the crisis in the savings-and-loan sector.

The FDIC data underscore how the pain continues to spread beyond real-estate loans. In the second quarter, defaults on commercial and industrial loans more than doubled from a year earlier.

Credit-card losses climbed to a record 9.95%. Banks are sitting on $332 billion of loans more than 90 days past due and therefore at high risk of default. That is up by $41 billion at the end of March, and the highest level since the FDIC started collecting data 26 years ago.

Banks are holding more than $34 billion in repossessed real estate, according to a Wall Street Journal analysis of the FDIC data.

Even as banks modify billions of dollars of mortgages, their pools of foreclosed properties keep growing, up 12% from the prior three months and 72% from a year before. They now stand at the highest level since 1993.

With the U.S. jobless rate nearing 10%, even borrowers once deemed low-risk are falling behind on home payments, said Sanjiv Das, head of Citigroup Inc.'s mortgage business. While mortgage defaults had been concentrated largely among subprime borrowers, "now there's a second phenomenon, with prime rising," Mr. Das said.

He said the rise in mortgage delinquencies among these less-risky borrowers is infecting a "substantially larger" pool of loans and is likely to cause more foreclosures. Mr. Das said he worries that the trend could torpedo recent gains in housing prices.

Blunting bank losses are new fees and higher interest rates charged to consumers. In the second quarter, banks pocketed nearly $22 billion from service charges on deposit accounts, according to the Journal analysis, more than double the first quarter and up 5% from last year.

Getty Images

FDIC Chairman Sheila Bair briefs the media on the bank-and-thrift industry earnings for the second quarter of 2009 on Aug. 27.

FDIC officials face a tough decision in the next few months about the dwindling insurance fund.

The FDIC could hit the banking industry with a special fee, the second this year, bringing in a likely $5.6 billion. Or it could tap a pre-existing $100 billion credit line with the Treasury and pay the money back later. The FDIC borrowed from the Treasury during the savings and loan crisis, the last time the fund went into the red.

Ms. Bair said Thursday that she had no plans "at this point" to seek the Treasury's assistance, but added: "Never say 'never.'"

There are pitfalls either way. Executives at big banks say a second fee would amount to healthy institutions being forced to subsidize their weaker rivals. But borrowing money from the Treasury could send the unwanted signal that the FDIC needs its own bailout, fanning fears about the agency's solvency and worrying consumers -- precisely the opposite of what the FDIC is designed to do.

—Maurice Tamman contributed to this article.

Write to Damian Paletta at damian.paletta@wsj.com and David Enrich at david.enrich@wsj.com