FDIC Reports Positive Banking System Data

NEW YORK (TheStreet) -- The best way to understand how the banking system is performing is to slice and dice the wealth of data found in the FDIC Quarterly Banking Profile. The FDIC released its QBP for Q3 on Tuesday to limited fanfare on Wall Street.

While the FDIC's headlines touted the positive developments, I dug deeper into the data to gauge whether or not the banking system has emerged from the great credit crunch which began at the end of 2007.

My analysis of what I believe are key metrics found in the QBP indicates while progress has been made to unwind the great credit crunch, problem assets remain on the books of our nation's banks.

According to the report, FDIC-insured financial institutions generated $37.6 billion in net income in the third quarter, a sequential increase of 6.6% to the highest level since the third quarter of 2006. However, improved income continues to be buoyed by the reduction of loan loss provisions and rising noninterest income, not by a significant increase in interest income from new loan issuance, as tight credit standards continue.

Below the surface, noncurrent loans continued to decline but the pace slowed to a decline of just $100 million (0.03%), the smallest in the past 10 quarters.

Bank failures fell to the lowest levels since the end of 2008 with only 12 banks shuttered in the quarter. Mergers absorbed another 49 insured institutions. As a result the FDIC's list of problem banks fell from 732 to 694, still quite elevated. In my judgment the FDIC is allowing banks that should be closed to stay open as zombie banks.

The table shows key line items from the FDIC Quarterly Banking Profile comparing data from the end of 2007 versus Q3 2012.

Number of Banks: The number of FDIC-insured financial institutions declined by 1,353 to 7,181 since the end of 2007, down 15.9%. Only 464 of this net reduction (34.3%) was via the bank failure process.

Total Assets: Despite the great credit crunch, total assets in the banking system increased 9.1% to $14.2 trillion since the end of 2007.

Residential Mortgages (1- to 4-Family Homes): These are mortgage loans on the books of the banks. Since the end of 2007 this asset class is down $355.4 billion, or 15.8% to $1.89 trillion.

Nonfarm/Nonresidential Real Estate Loans: This category is a portion of what's known as commercial real estate loans (CRE). This category has not suffered the fate of other real estate loan categories with a rise of 9.3% since the end of 2007 to $1.06 trillion.

Construction and Development Loans: This category has been the Achilles Heel of the banking system. These are loans to developers and home builders where a significant number of loans became noncurrent. With write-downs and asset sales this category is down 66.5% since the end of 2007, but remains elevated at $210.4 billion. Compare this to the crunch of the S&L crisis. At the end of 1988 C&D loans stood at $216.6 billion. At the end of 1992 C&D loans were down 54.7% to $98.1 billion.

Home Equity Loans: The problem in this category is the exposure where the bank holding the line of credit does not hold the first lien mortgage. Home equity loans are down 6.6% since the end of 2007 to $567.3 billion. In recent quarters the decline in this category of loans has been accelerating; 5.3% year over year in Q4 2011, 0.4% year over year in Q1 2012, 5.7% in Q2 2012, and 6.7% in Q3 2012.

Other Real Estate Owned (OREO) : This asset class has been declining since peaking at $53.2 billion in the third quarter of 2010. This is still a source of stress in the banking system because at $41.0 billion it is up 238.0% since the end of 2007.

Notional Amount of Derivative Contracts: Is also a source of continued stress in the banking system. At $229.3 trillion it's up by $63.2 trillion or 38.0% since the end of 2007. Since the end of 2007 the banking system should have de-leveraged, but has not. I still say that time bombs are ticking in this category.

Deposit Insurance Fund (DIF): While the FDIC has been making progress on replenishing the DIF, it's is only funded at 0.35% of insured deposits. By September 2020 this percentage must rise to 1.35%.

Insured Deposits: While the DIF is down 51.9% since the end of 2007 to $25.2 billion, insured deposits are up 68.9% to $7.25 trillion. As deposits grow the size of DIF must increase, which is another source of stress.

Reserves for Losses: The banking system has been reducing reserves for losses since it peaked at $263.1 billion beginning in Q2 2010. Now at $167.0 billion, reserves remain 64.2% above the level of 2007. This shows that there are additional bad assets that need to be unwound.

30-89 Day Past Due: As real estate loans began to default this category peaked at $157.9 billion in Q1 2009. Since the pace of bad loans has slowed this category has slowed to $87.0 billion in Q3 2012, down 21.6% since the end of 2007.

Noncurrent Loans: The peak in this bad loan category was $405.4 billion at the end of Q1 2010. While significantly lower today at $292.1 billion it's up $182.2 billion, or 165.8% since the end of 2007. This is another sign that the banking system continues to experience the effects of the great credit crunch.

In summary, while the banking system has been slowly but surely reducing exposures to bad real estate loans overall stress in the banking system remains. Tomorrow I will update my profiles for several stocks in the money center and regional banking industries.

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.

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