As the mortgage crisis unfolds, many of the largest banks and thrifts have been making ever-higher provisions for loan-loss reserves.

While some of the largest banks continued making significant quarterly writedowns of mortgage-related securities, the elevated reserving activity in the fourth quarter caused the industry to post its worst quarterly earnings performance since the fourth quarter of 1991.

U.S. banks and savings and loans reported combined net income of $5.1 billion for the fourth quarter of 2007, or an annualized return on average assets of just 0.15%, and a return on average equity of 1.46%. This compares with quarterly net income of $40.3 billion in the fourth quarter of 2006, with average returns on assets and equity of 1.30% and 12.53%.

Many institutions, of course, continued to weather the storm without much ill effects. Still, there's a clear trend in the ratings. Ratings assigned financial strength ratings of B (good financial strength) or above to 51% of institutions, down from 53% a year ago. Institutions receiving D (weak financial strength) ratings or lower comprised 17% of all institutions, compared with 15% a year earlier. (The ratings are based on data from the latest available statutory regulatory filings.)

Another sign of weakness was that 89 banks and thrifts were considered less than well capitalized per regulatory guidelines as of Dec. 31, 2007, compared with 59 institutions at the end of 2006.

We spoke with Philip van Doorn, senior bank analyst for Ratings, about the fourth-quarter results.

Which institutions contributed the most to the earnings fallout?

The elevated provisions for loan losses at the nation's largest banks and thrifts were the primary factor in the paltry earnings results for the industry.

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Looking at the largest 20 institutions, six took losses during the quarter, including Citibank NA, (held by Citigroup ( C - Get Report)) with a loss of $4.5 billion and Washington Mutual Bank (held by Washington Mutual ( WM - Get Report)), with a loss of $1.8 billion. A total of 15 institutions reported lower earnings than in the previous quarter.

Which of the largest 20 concern you the most?

Let's take a look at asset quality and capital exposure for the group.

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Of the largest 20 institutions, the ones with the worst asset quality and greatest exposure of capital and reserves to problem loans were Washington Mutual Bank, National City Bank (held by National City Corp. ( NCC and Countrywide Bank (held by Countrywide Financial Corp. ( CFC).

As we have followed the mortgage crisis over the past year, these three have always stood out among the largest 20 institutions, with major loan quality concerns. All three continued to see their nonperforming loans increase significantly, with Countrywide's problem loans nearly doubling during the quarter. Of course, Countrywide has a deal in place to be acquired by Bank of America Corp. ( BAC - Get Report).

When J.P. Morgan Chase ( JPM - Get Report) announced its initial deal to acquire Bear Stearns ( BSC for a measly $2 a share, some speculated that Bank of America might walk away from its deal to acquire Countrywide. CEO Ken Lewis has repeatedly stated that BofA won't walk away from the deal.

National City Corp. has also been mentioned in various reports as a takeover target.

A fourth institution, World Savings, no longer appears on the list. The thrift's holding company, Wachovia Corporation ( WB - Get Report), changed the institution's name to Wachovia Mortgage FSB during the quarter and shifted some of its assets to other charters.

How about smaller banks and S&Ls?

As always, we are concerned that smaller institutions have sufficient capital to weather storms like this. While only 89 out of 8,613 U.S. banks and thrifts were considered below well capitalized at year-end, this was a 51% increase from a year earlier.

The following table shows the 10 institutions assigned an E-minus (very weak financial strength) rating on the basis of Dec. 31, 2007, financial reports, with the lowest leverage capital ratios. Five of these also reported terrible asset quality.

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Should depositors be concerned about the health of these institutions?

Absolutely, especially if they have deposits exceeding FDIC insurance limits. They should also be concerned if they or someone they know are affiliated with municipalities, most of which have deposits in local banks. School districts, for example, make very large seasonal deposits, most of which are not insured.

Our ratings for banks, S&Ls, insurance companies, stocks and ETFs are available for free, using our Ratings Screener.

OK, enough of the bad news. Which institutions are rated the highest?

The following is a list of the 10 highest-ranking A-plus-rated institutions. All have very strong capital levels and consistent earnings results.

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One institution on the list, Maspeth FS&LA, reported nonperforming assets comprising 1.63% of total assets as of December 31. While this number is rather high for an A+ rated institution, Maspeth also had the highest leverage ratio on the list. It is a strongly capitalized institution with a long history of excellent financial performance.

Last quarter you said you expected layoffs at larger institutions to have a major effect on total industry employment numbers. What happened in the fourth quarter?

Banks and thrifts reported total full-time equivalent employees of 2.219 million as of Dec. 31, which was the lowest level for 2007. This was still higher than the 2.211 million at the end of 2006.

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Mr. van Doorn appreciates your feedback; click here to send him an email.

This article was written by a staff member of Ratings.