FDIC Girds For Bank Failures

Shaky loan portfolios continue to darken the landscape for the nation's banks, as federal regulators prepare for the possibility of an uptick in failures of financial institutions, according to recent government reports.

A record-high $31.3 billion set aside by banks for loan losses, record trading losses and goodwill expenses dragged down fourth-quarter net incomes of insured banks to a 16-year low, according to the Federal Deposit Insurance Corp.'s quarterly banking profile released Tuesday. The cumulative increase to loan-loss provisions was the largest increase in 20 years.

The FDIC report comes on the heels of study from the Government Accountability Office made public last week, which found the FDIC recorded an estimated liability of $124 million at the end of 2007 for the anticipated failure of some insured institutions and also identified potential losses of $1.7 billion should vulnerable insured institutions also fail.

All of this is happening as the FDIC, established during the Great Depression to provide a backstop to depositors during a rash of bank failures, solicits banks' input on ways to accomplish as orderly a wind-down as possible in the event of a major bank's demise. The FDIC sent a notice out to banks requesting their ideas last month.

"The notion that a bank is too big to fail shouldn't be out there," says Jim Marino, of the FDIC's Division of Resolutions and Receiverships.

The grim picture for banks was reiterated by FDIC's report Tuesday. It noted that non-current loans exceeded reserves for first time since 1993. Loans that are 90 days past due, jumped 32.5% to $26.9 billion, the single-largest increase in a quarter in 24 years. The only loan category with an improving picture was farm loans, no doubt aided by soaring commodity prices.

The fourth quarter was notable for several other firsts and record-breaking numbers. Trading losses came to $10.6 billion, making this the first quarter the industry has ever reported a net trading loss. Less than half of the insured banks reported improved earnings for 2007, making this the first time in 23 years that a majority of the banks have not posted earnings increases. It's also the first time since the mid-1970s that non-interest income has declined. On a positive note, domestic deposits rose to $170.6 billion, the largest quarterly increase. But the bad news is that the industry's ratio of deposits to total assets hit an all-time low.

While no major banks have yet failed in the current crisis, some big names have experienced significant troubles. Washington MutualWM is one national bank that has been particularly hard hit by poor mortgage and other loans. WaMu cut its dividend and set aside $1.5 billion in the fourth quarter to cushion against greater delinquencies on subprime mortgages and home-equity loans. A number of regional banks, like National CityNCC and KeyCorpKEY also recently increased loan-loss provisions.

"The problems are in all categories, and given the thin coverage of the banking system for such losses, rising charge-offs and loan loss reserves are likely to bite deeply into earnings," wrote John Hussman in a September market comment for Hussman Funds.

FDIC spokesman David Barr pointed out that even as assets increase, the agency is restricted in its ability to get more income for the Depository Insurance Fund (DIF). The DIF is administered by the FDIC and is funded through investments and payments by insured banks. The payment is calculated both on the balance of deposits as well as on the degree of risk posed to the insurance fund. However, Congress sets the ratio level and even though it was raised last year to 1.25, the current level of reserves to insured deposits is only at 1.22. In 2006, it was 1.32.