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The Banking System's Slow, Stressful Recovery

NEW YORK ( TheStreet) -- Last week, the Federal Deposit Insurance Corp.'s banking profile for the second quarter of 2012 showed a 12th consecutive quarter of year-over-year earnings gains. The banking system earned $34.5 billion during the quarter on the back of lower loan-loss provisions and higher gains on the sale of loans and other assets.

In my opinion, studying this FDIC data is extremely important when evaluating the U.S. economy, as its Quarterly Banking Profile is essentially the balance sheet for GDP.

Today, I discuss the broader stresses within the banking system as a prelude to an examination of specific assets of concern for money center and regional banks and problem-loan exposures among community banks.

Sure, there is gradual steady progress toward recovery, but the levels of "troubled assets" remain high and the FDIC list of problem banks still includes 732 institutions. That's down from 772 in the first quarter, but well above 76 at the end of 2007.

Assets of the problem banks declined to $282 billion from $292 billion, and the FDIC has slowed the process of closing these banks on what I have called "Bank Failure Friday." So far this year, the FDIC has closed 40 banks versus 68 at this time in 2011. Since the end of 2007, a total of 454 banks have failed, approaching my predicted range of 500 to 800.

A potential problem for the banking system is the funding of the Deposit Insurance Fund. The unaudited DIF balance ended the second quarter at $22.7 billion, which is 0.32% of insured deposits, as shown in the chart below from the FDIC.

Insured deposits have increased by $2.79 trillion, or 65.1%, since the end of 2007 to $7.09 trillion, as money flows into the banking system on the back of the rise in deposit insurance to $250,000 per bank per depositor. This will put increasing stress on the DIF.

Under Dodd-Frank, the DIF must be expanded to 1.35% of insured deposits by Sept. 30, 2020. If this rule was in effect today, the DIF would have to be at $95.7 billion. On Sept. 30, 2020, this amount could be significantly higher given the 65.1% growth rate of insured deposits since the end of 2007.

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