Banks Wrestle With Weak Loans Despite Gains

Even as bank stocks climb this year, fewer companies are earning strong ratings for credit quality, profits and capital strength, according to TheStreet.
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NEW YORK (TheStreet) -- Bank stocks are climbing this year, with the S&P 500 Financials Index doubling the return of the S&P 500 Index. But loan quality has yet to improve across the industry.

Based on fourth-quarter financial reports, 962 U.S. banks and savings-and-loan institutions have been assigned "recommended" ratings of B-plus or higher by

TheStreet Ratings

, down from 1,035 in the previous quarter. Banks with ratings of at least A-minus, or "excellent," totaled 509, down from 555 the previous quarter. Out of roughly 8,000 banks and thrifts, 27 received the highest rating of A-plus, unchanged from last quarter. The ratings are based on capital strength, credit quality and earnings.

JPMorgan Chase's

(JPM) - Get Report

profit quadrupled in the fourth quarter while

Wells Fargo

(WFC) - Get Report

reported a $2.8 billion profit after a year-earlier loss. While major banks are stabilizing, 41 small banks have failed this year, almost a third of the 140 banks that closed in 2009.

The institutions rated A-plus had capital ratios that exceeded the 5% tier 1 leverage ratio and 10% total risk-based capital ratio required for most banks and thrifts to be considered "well-capitalized" under

regulatory capital guidelines

. Most were so strongly capitalized that their ratios doubled the thresholds for well-capitalized institutions.

Privately owned community banks dominate the A-plus list, but a bank held by a publicly traded holding company joined the list last quarter:

OptumHealth Bank

of Salt Lake City is a subsidiary of

UnitedHealth Group

(UNH) - Get Report

. The bank's rating was upgraded to A-plus, reflecting its strong profitability. The company's has had a return on equity of about 30% for the past three years. OptumHealth provides health savings accounts. The bank is not in the lending business and has maintained strong capital levels despite rapid expansion during recent years.

Close to Turning The Corner

The Federal Deposit Insurance Corp.'s list of "problem banks" based on fourth quarter results grew to 702 from 552 in the previous quarter, even after 45 institutions failed.

The banking industry reported a combined profit of $914 million for the fourth quarter, as banks continued building loan loss reserves. Nonperforming loans continued to increase, but at a slower pace than previous quarters.

The FDIC said the industry's 3.12% ratio of loan loss reserves to total loans was the highest on record. Combined banks and thrifts set aside $61 billion for reserves during the fourth quarter, which was a very high level, but the smallest provision for loan losses since the third quarter of 2008, another sign that the industry is probably turning a corner.

The fourth quarter ratio of net charge-offs (actual loan losses) to total loans for the industry was an annualized 2.89%, compared to 2.71% in the third quarter and 1.92% a year earlier.

Once the charge-off figures begin to decline, the bank rebound should strengthen. Many institutions have reserved more than necessary. When potential loan losses are more than covered, banks' quarterly loan-loss provisions will decline, boosting earnings.

Capital ratios have also risen significantly. As lending activity slowed, banks expanded less aggressively and dividends were lowered or suspended by many institutions. As the industry settles down and lending activity resumes, the excess capital will be deployed through acquisitions, stock buybacks and dividends.

The industry's net interest margin -- the difference between the average rate earned on loans and securities investments and the average cost of funds -- declined to 3.49% from 3.51% in the previous quarter. With short-term rates near zero, banks will face margin compression when rates begin to rise.

Deposit Insurance

The FDIC's decision to boost the individual deposit insurance limit to $250,000 from $100,000 has been extended through 2013.

The FDIC's Transaction Account Guarantee Program is a temporary waiver of deposit insurance limits on non-interest-bearing transaction accounts. This program has been an important part of the agency's efforts to ease fears during the crisis and lower the potential for sudden withdrawals by worried customers. The program was originally scheduled to end in December but was extended until June 30.

Earlier this month, FDIC Chairman Sheila Bair said the agency was considering another extension to the waiver of deposit insurance limits for business checking accounts. This suggests the plan will be extended again.

Once business checking accounts return to the $100,000 deposit insurance limit, community banks will face a greater risk of deposit flight.

Free Financial Strength Ratings

TheStreet Ratings issues independent, conservative financial strength ratings on the nation's 8,500 banks and savings and loans. They are available at the

Banks & Thrifts Screener

.

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Reported by Philip van Doorn in Jupiter Fla.

Philip W. van Doorn joined TheStreet.com Ratings., Inc., in February 2007. He is the senior analyst responsible for assigning financial strength ratings to banks and savings and loan institutions. He also comments on industry and regulatory trends. Mr. van Doorn has fifteen years experience, having served as a loan operations officer at Riverside National Bank in Fort Pierce, Florida, and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a Bachelor of Science in business administration from Long Island University.