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."

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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

Banks 'Too Big to Fail' Have Grown Even Bigger - washingtonpost.com

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By David Cho
Washington Post Staff Writer
Friday, August 28, 2009

When the credit crisis struck last year, federal regulators pumped tens of billions of dollars into the nation's leading financial institutions because the banks were so big that officials feared their failure would ruin the entire financial system.

Today, the biggest of those banks are even bigger.

The crisis may be turning out very well for many of the behemoths that dominate U.S. finance. A series of federally arranged mergers safely landed troubled banks on the decks of more stable firms. And it allowed the survivors to emerge from the turmoil with strengthened market positions, giving them even greater control over consumer lending and more potential to profit.

J.P. Morgan Chase, an amalgam of some of Wall Street's most storied institutions, now holds more than $1 of every $10 on deposit in this country. So does Bank of America, scarred by its acquisition of Merrill Lynch and partly government-owned as a result of the crisis, as does Wells Fargo, the biggest West Coast bank. Those three banks, plus government-rescued and -owned Citigroup, now issue one of every two mortgages and about two of every three credit cards, federal data show.

A year after the near-collapse of the financial system last September, the federal response has redefined how Americans get mortgages, student loans and other kinds of credit and has made a national spectacle of executive pay. But no consequence of the crisis alarms top regulators more than having banks that were already too big to fail grow even larger and more interconnected.

"It is at the top of the list of things that need to be fixed," said Sheila C. Bair, chairman of the Federal Deposit Insurance Corp. "It fed the crisis, and it has gotten worse because of the crisis."

Regulators' concerns are twofold: that consumers will wind up with fewer choices for services and that big banks will assume they always have the government's backing if things go wrong. That presumed guarantee means large companies could return to the risky behavior that led to the crisis if they figure federal officials will clean up their mess.

This problem, known as "moral hazard," is partly why government officials are keeping a tight rein on bailed-out banks -- monitoring executive pay, reviewing sales of major divisions -- and it is driving the Obama administration's efforts to create a new regulatory system to prevent another crisis. That plan would impose higher capital standards on large institutions and empower the government to take over a wide range of troubled financial firms to wind down their businesses in an orderly way.

"The dominant public policy imperative motivating reform is to address the moral hazard risk created by what we did, what we had to do in the crisis to save the economy," Treasury Secretary Timothy F. Geithner said in an interview.

The worry for consumers is that the bailouts skewed the financial industry in favor of the big and powerful. Fresh data from the FDIC show that big banks have the ability to borrow more cheaply than their peers because creditors assume these large companies are not at risk of failing. That imbalance could eventually squeeze out smaller competitors. Already, consumers are seeing fewer choices and higher prices for financial services, some senior government officials warn.

Those mergers were largely the government's making. Regulators pushed failing mortgage lenders and Wall Street firms into the arms of even bigger banks and handed out billions of dollars to ensure that the deals would go through. They say they reluctantly arranged the marriages. Their aim was to dull the shock caused by collapses and prevent confidence in the U.S. financial system from crumbling.

Officials waived long-standing regulations to make the deals work. J.P. Morgan Chase, Bank of America and Wells Fargo were each allowed to hold more than 10 percent of the nation's deposits despite a rule barring such a practice. In several metropolitan regions, these banks were permitted to take market share beyond what the Department of Justice's antitrust guidelines typically allow, Federal Reserve documents show.

"There's been a significant consolidation among the big banks, and it's kind of hollowing out the banking system," said Mark Zandi, chief economist of Moody's Economy.com. "You'll be left with very large institutions and small ones that fill in the cracks. But it'll be difficult for the mid-tier institutions to thrive."

"The oligopoly has tightened," he added.

Consumer Choice

Federal officials and advocacy groups are just beginning to study the impact of the crisis on consumers, but there is some evidence that the mergers are creating new challenges for ordinary Americans.

In the last quarter, the top four banks raised fees related to deposits by an average of 8 percent, according to research from the Federal Reserve Bank of Dallas. Striving to stay competitive, smaller banks lowered their fees by an average of 12 percent.

"None of us are saying dismember these institutions. But you do want to create a system that allows for others to grow, where no one has an oligopolistic power at the expense of others who might be able to provide financial services to consumers," said Richard Fisher, president of the Federal Reserve Bank of Dallas.

Normally, when faced with price increases, consumers simply switch. But industry officials said that is not so easy when it comes to financial services.

In Santa Cruz, Calif., Wells Fargo, Bank of America and J.P. Morgan Chase hold three-quarters of the deposit market. Each firm was given tens of billions of dollars in bailout funds to help it swallow other banks.

The rest of the market, which consists of a handful of tiny community banks, cannot match the marketing power of the bigger banks. Instead, presidents of the smaller companies said, they must offer more personalized service and adapt to technological changes more quickly to entice customers. Some acknowledged it can be a tough fight.

Wells Fargo is "really, really good at the way they cross-sell and get their tentacles around you," said Richard Hofstetter, president of Lighthouse Bank, whose only branch is in Santa Cruz. "Their customers have multiple areas of their financial life involved with Wells Fargo. If you have a checking account and an ATM and a credit card and a home-equity line and automatic bill payments . . . to change that is a major undertaking."

Wells Fargo, J.P. Morgan and Bank of America declined to comment for this article.

Last October, when the Fed was arranging the merger between Wells Fargo and Wachovia, it identified six other metropolitan regions in which the combined company would either exceed the Justice Department's antitrust guidelines or hold more than a third of an area's deposits. But the central bank thought local competition in each of those places was sufficient to allow the merger to go through, documents show.

Camden Fine, president of the Independent Community Bankers of America, said those comments reveal the government's preferential treatment of big banks. He doubted whether the Fed would approve the merger of community banks if the combined company ended up controlling more a third of the market.

"To favor one class of financial institutions over another class skews the market. You don't have a free market; you have a government-favored market," he said. "We will never have free markets again if you have the government picking winners and losers."

Moral Hazard

Before the crisis, many creditors thought that the big institutions were a relatively safe investment because they were diversified and thus unlikely to fail. If one line of business struggled, each bank had other ventures to keep the franchise afloat. And even if the entire house caught fire, wouldn't the government step in to cover the losses?

With executives comforted by that thinking, risk came unhinged from investment decisions. Wall Street borrowed to make money without having enough in reserves to cover potential losses. The pursuit of profit was put ahead of the regard for safety and soundness.

The federal bailouts only reinforced the thought that government would save big banks, no matter how horrible their decisions.

Today, even with the memory of the crisis fresh in their minds, creditors are granting big institutions more favorable treatment because they know the government is backing them, FDIC officials said.

Large banks with more than $100 billion in assets are borrowing at interest rates 0.34 percentage points lower than the rest of the industry. Back in 2007, that advantage was only 0.08 percentage points, according to the FDIC. Such differences can cause huge variance in borrowing costs given the massive amount of money that flows through banks.

Many of the largest banks reported a surge in profit during the most recent quarter, including J.P. Morgan Chase and Goldman Sachs. They are prospering while many regional and community banks are struggling. Nearly three dozen of the smaller institutions have failed since July 1, including Community Bank of Nevada and Alabama-based Colonial Bank just last week.

If the government continues to back big firms over small, regulators worry that reckless behavior could return to Wall Street.

The administration's regulatory reform plan takes aim at this problem by penalizing banks for being big. It would require large institutions to hold more capital and pay higher regulatory fees, as well as allow the government to liquidate them in an orderly way if they begin to fail. The plan also seeks to bolster nontraditional channels of finance to create competition for large banks. If Congress approves the proposal, Geithner said, it would be clear at launch which financial companies would face these measures.

Economists and officials debate whether these steps would address the too-big-to-fail problem. Some say, for instance, that determining the precise amount of capital big financial companies should hold in their reserves will be difficult.

Geithner acknowledged that difficulty but said the administration would probably lean toward being more strict. Taken together, the combination of reforms would be a powerful counterbalance to big banks, he said.

"Our system is not going to be significantly more concentrated than it is today," Geithner said. "And it's important to remember that even now, our system remains much less concentrated and will continue to provide more choice for consumers and businesses than any other major economy in the world."

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