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U.S. Banks Weakened in First Quarter

The financial strength of the nation's banks deteriorated in the first quarter amid declining credit quality and low capital levels.

The financial strength of the nation's

banks

deteriorated in the first quarter amid declining credit quality and low capital levels.

Among 8,260

banks

and savings-and-loan institutions, 26% received "weak" financial-strength grades of D-plus or lower from

TheStreet.com Ratings

, based on first-quarter data. That amounts to 2,125 companies, up from 1,835 in the previous quarter and 1,717 a year earlier.

The banking industry's combined profit dropped to $7.6 billion in the first quarter from $19.3 billion a year earlier as companies like

Bank of America

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and

Citigroup

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struggled to regain their footing. While it was an improvement from the industry's $32 billion net loss in the fourth quarter,

banks

and thrifts continued to wrestle with nonperforming loans and rising charge-off rates. Twenty-one banks failed during the first quarter, the most in any quarter since 1992.

TheStreet.com Ratings

assigned "good" ratings of B-plus or above to 1,175 of the reporting institutions, or 14%. That's a decrease from 1,388 in the previous quarter and 1,561 a year earlier. We rated 32 banks or thrifts A-plus, or "excellent, down from 37 in the previous quarter.

Problem institutions and failures

The Federal Deposit Insurance Corp.'s list of "problem institutions" increased to 305 in the first quarter from 252 at the end of 2008, according to its Quarterly Banking Profile.

Loan charge-offs in the first quarter increased twice as fast as a year earlier, but only slightly more than the fourth quarter, when banks rushed to dump as many bad loans as possible from their books. The table below illustrates that point using FDIC data for the past four quarters.

Nonperforming assets rose faster during the first quarter than the previous four quarters. Even though the industry's nonperforming assets ratio of 2.39% as of March 31 was 27% higher than the previous quarter, loan charge-offs were up only slightly.

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Provisions for loan losses during the first quarter totaled $63 billion, down from $69 billion in the fourth quarter, but up 70% from a year earlier.

Bank and Thrift Ratings

Stable capital levels and consistent profits are the most important factors in determining financial-strength ratings. The banks and thrifts that received A-plus ratings had capital ratios that exceeded the 5% tier 1 leverage ratio and 10% total risk-based capital ratio required for most companies to be considered "well-capitalized" under

regulatory guidelines

.

Peoples Community State Bank

of Doniphan, Mo., and

Waukesha State Bank

of Waukesha, Wis., were upgraded to A-plus from A in the previous quarter. These community banks maintained excellent loan quality while achieving returns on average assets above 2% and high returns on average equity.

The strong capital levels at these A-plus banks means lower returns on equity. In contrast, the largest publicly traded bank holding companies have faced pressure to limit excess capital because investors (and directors) prefer bigger returns on equity.

This data suggests that investors and the U.S. government might be better served if major banks were required to hold higher levels of capital. In exchange for lower dividends in the short term, investors could enjoy steadier returns over longer periods if banks had enough capital to ride out market bubbles.

Taxpayers would also benefit if the government could avoid the no-win scenario it faced last year, when it dispatched the Troubled Asset Relief Program to avert a potential meltdown in the financial markets.

In the second quarter, 32 banks and S&Ls failed, including 16 named in

TheStreet.com's

list of 89

undercapitalized banks

, published in May.

TheStreet.com Ratings

issues independent and very conservative financial strength ratings on each of the nation's 8,500 banks and savings and loans. They are available at no charge on the

Banks & Thrifts Screener

. In addition, the Financial Strength Ratings for 4,000 life, health, annuity, and property/casualty insurers are available on the

Insurers & HMOs Screener

.

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.