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.

Another growing problem for community banks is the flatter U.S. Treasury yield curve. See the chart below from the FDIC, which shows the yield curve at the end of June in red, the yield at the end of March in blue, and the June 2011 yield curve in green. It indicates an additional squeeze on both community banks and savers. A flatter yield curve with lower U.S. Treasury yields makes it more difficult for banks with investment portfolios in U.S. Treasuries.

This tightening range has been following the Federal Reserve's "extended period" of the zero to 0.25% federal funds rate, which is likely to be extended to late 2015 at the Sept. 12 FOMC meeting. It forces the banks to lower money market rates and CD rates even further, putting further pressures on savers on Main Street, which is a drag on the U.S. economy.

At ValuEngine, we publish a detailed analysis of the FDIC Quarterly Banking Profile in a report called, "Quarterly FDIC Report." A main feature of this report is the ValuEngine List of Problem Banks, where we list by name all publicly traded FDIC-insured financial institutions that are overexposed to construction and development loans, overall commercial real estates loans, and the loan pipeline.

Today's article sets the stage for a more detailed analysis tomorrow of exposures among money center and regional banks and, on Thursday, among community banks. I will name names.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Suttmeier has an engineering degree from Georgia Tech and a master of science from Brooklyn Poly. He began his career in the financial services industry in 1972 trading U.S. Treasury securities in the primary dealer community. In 1981 he formed the Government Bond Department at LF Rothschild and helped establish that firm as a primary dealer in 1986. Richard began writing market research in 1984 and held positions as market strategist at firms such as Smith Barney, William R Hough, Joseph Stevens, and Rightside Advisors. He joined www.ValuEngine.com in 2008 producing newsletters covering the U.S. capital markets, and a universe of more than 7,000 stocks. Richard employs a "buy and trade" investment strategy and can be reached at RSuttmeier@Gmail.com.

More from Opinion

Attention 60 Minutes: Google Isn't the Only Big-Tech Monopoly

Attention 60 Minutes: Google Isn't the Only Big-Tech Monopoly

Apple Buys Tesla? Amazon Buys Sears? 3 Dream Mergers That Just Make Sense

Apple Buys Tesla? Amazon Buys Sears? 3 Dream Mergers That Just Make Sense

Amazon's Assault on Grocery Stores Will Have a Profound Impact on Many

Amazon's Assault on Grocery Stores Will Have a Profound Impact on Many

It's Dumb to Think There Aren't Already Monopolies in Big Tech

It's Dumb to Think There Aren't Already Monopolies in Big Tech

Google's EU Battles Are Hardly a Reason to Panic

Google's EU Battles Are Hardly a Reason to Panic