Spotting Banks In Danger

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 |  Includes: BKUNA, CORS, DRL, DWNFQ, FED, WMIH
by: David Enke

The SEC is looking to expand investigations into the spread of false rumors that may affect the financial system. Articles at Reuters and Bloomberg mention the recent slide in Freddie Mac (FRE) and Fannie Mae (FNM), as well as Lehman Brothers (LEH), for the increased SEC attention. No word in either article whether a member of Congress will be investigated after the recent collapse of IndyMac, although an LA Times article does mentioned that some federal regulators are looking into the issue.

This all comes just as the International Herald Tribune is reporting how banking analysts are predicting that as many as 150 of the 7,500 banks nationwide (mainly small and mid-size) could fail over the next 12 to 18 months. Others disagree and state that while there will be liquidity issues, many lenders are likely to first either shut branches or seek mergers with stronger banks. The article also notes that the nation's banks are in less danger now than in the late 1980s and early 1990s when over 1,000 institutions failed during the savings-and-loan crisis. Unfortunately, even with fewer bank failures, the $125 billion government bailout that resulted at the time may seem like a good deal if things were to get as messy this time around. Hopefully we can avoid reaching the same levels, but some analysts are not optimistic.

Some perspective is in order. In 1994, the FDIC listed 575 banks that it considered to be troubled, while earlier this year only around 90 banks were listed - but the list is probably growing. Yet given recently developments, more failures are likely beyond the six already reported given that bank failures are a lagging indicator. Of interest is that IndyMac was not on the troubled bank list earlier this year, highlighting the fluidity of the problem. Also, of the $53 billion the FDIC has to reimburse consumers of failed banks, IndyMac is estimated to need between $4-8 billion, putting more pressure on existing banks, and possibly forcing the government to get more involved as it has recently with Freddie and Fannie.

Not unexpectedly, short sellers are jumping into the waters as various regional banks, such as BankUnited Financial Corporation (BKUNA), now trading under a dollar, and the Downey Financial Corporation (NYSE:DSL), trading between $1-2 after reaching a 52 week high of $65.67, have been highlighted as having potential problems.

In order to spot banks in danger, two popular ratios are used. First, when you divide non-performing assets by all outstanding loans, you find that a ratio over 5% signals danger (see CNBC article). Using this ratio you find that other banks, in addition to BankUnited and Downey (BankUnited's ratio is 5.36%, while Downey is at 13.86%) are suspect, including Corus Bankshares (CORS) at a 13.18% ratio, Doral Financial (NYSE:DRL) at 12.82%, and FirstFed Financial (FED) at 6.73%. A second commonly used ratio that compares non-performing assets divided by reserves plus common equity causes Washington Mutual (NYSE:WM), with a ratio of 40.6%, to also become suspect. Any value around 40% is thought to be in the danger zone.