Community Banks - Some Will Fail, So Buy With Care

NEW YORK (TheStreet) -- Bank failures have slowed so far in 2012, but the process is not over as five banks were shuddered by the FDIC last Friday.

I have been keeping a scorecard for Bank Failures since 2008 when the FDIC closed 25 banks. The pace picked up with 140 bank failures in 2009 and 157 in 2010. In 2011, the pace of failures slowed to 92 and now there are 22 failures year to date in 2012.

Why has the FDIC slowed down bank closures? First of all, the FDIC would rather keep weak banks as "zombies" than have to drain a depleted Deposit Insurance Fund (DIF), which covers the losses that occur when a bank fails.

In addition, there are 147 community banks that deferred their TARP dividend payments that were due on Feb.15. By closing these banks the FDIC not only bleeds the DIF, but costs the taxpayers money with defaulted outstanding TARP balances.

The amount still owed to TARP fell to $119 billion from $133 billion in January, but there are 351 small banks that have $15 billion in loans. Most of these banks should never been given TARP money as they are overexposed to Construction & Development Loans and Commercial Real Estate Loans.

Back in the fall of 2005, the Federal Reserve, U.S. Treasury and the Federal Deposit Insurance Corporation (FDIC) realized that community banks were loaning funds to the housing and real estate markets at a pace above what these regulators thought as prudent. Guidelines were set and monitored via quarterly filings to the FDIC. These guidelines were formalized by the end of 2006. They included the following stipulations: These guidelines have been ignored by the banking regulators.

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• Overexposure to construction and development loans: The first guideline states that if loans for construction, land development, and other land are 100% or more of total risk capital, the institution is considered to have loans concentrations above prudent risk levels, and should have heightened risk management practices.
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• Overexposure to construction and development loans including loans secured by multifamily and commercial properties: If loans for construction, land development, and other land, and loans secured by multifamily and commercial property are 300% or more of total risk capital, the institution would also be considered to have a CRE concentrations above prudent levels, and should employ heightened risk management practices.

There remain 1,964 (26.7%) of community banks overexposed to Commercial Real Estate loans.

The FDIC touts that their List of Problem Banks has declined the past three quarters. I say it's a major problem as we have had five consecutive quarters with more than 800 institutions listed as "problems." According to industry sources, once a bank gets on the FDIC List of Problem Banks, the "heal rate" is only between 5% and 10%. Thus, there are many candidates for failure.

See my review of five community bank stocks on the next page.

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