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Some Banks Still Moving Into Undercapitalized Territory

SNL Financial Exclusive
By Hina Nawaz and Nathan Stovall

While the number of undercapitalized banks continued to decline in the first quarter, more than a handful of institutions entered the dreaded ranks in the period.

In 2013, the number of undercapitalized banks decreased steadily and not necessarily through failures as was the case during 2011 and 2012. Although true success stories were not commonplace, more banks found their ways out of trouble through positive means in 2013 than in years past. A few banks escaped undercapitalized territory in the first quarter of 2014, and the ultimate number of undercapitalized institutions declined notably. However, even at this late stage in the credit cycle, more than one-third of the operating banks that are undercapitalized only just moved into that territory in the first quarter.

The FDIC defines undercapitalized banks as those with a total risk-based capital ratio below 8.0%, a Tier 1 risk-based capital ratio below 4.0% or a Tier 1 leverage capital ratio below 4.0%, unless the bank is a CAMELS one-rated institution. In that case, a bank would be undercapitalized if its leverage ratio was less than 3.0%.

At the end of the first quarter, 19 banks and thrifts were undercapitalized, based on the criteria of having Tier 1 ratios below 4%, compared to 24 institutions at the end of the fourth quarter of 2013 and 38 institutions a year ago, according to SNL data. The drop in the first quarter represented the largest decrease in undercapitalized institutions in some time. Declines in undercapitalized institutions had moderated over much of 2013 as the sheer number of banks still reporting low capital ratios fell to pre-crisis levels.

The current number of undercapitalized institutions stands in stark contrast to the levels seen three years ago, when 83 banks were considered undercapitalized. Failures were the main contributor to the decrease in undercapitalized institutions in 2011 and 2012. The trend was consistent through those two years, when the number of undercapitalized banks decreased by 49 to 44 institutions. During that period, a number of banks joined the ranks of the undercapitalized and 143, while 36 banks found their way out of trouble through recapitalizations, mergers or balance sheet shrinkage and de-risking, coupled with modest earnings in some cases.

The trend was more positive in 2013, when 16 banks, including five in the fourth quarter, found their way out of undercapitalized territory without failing or closing their doors. Just 24 banks failed in 2013 - only two banks failed in the fourth quarter.

Two banks previously deemed undercapitalized have failed since SNL last published the list of undercapitalized banks in the industry. When excluding banks that have failed or merged since the end of the first quarter, SNL data shows that, as of June 6, 15 banks were undercapitalized based on March 31 data, compared to 17 banks at the last publication of the list of undercapitalized banks.

The 15 undercapitalized banks reported a median Tier 1 ratio of 2.80% at the end of the first quarter, and the group reported median linked-quarter declines in their capital ratio of 21 basis points.

A total of four banks escaped undercapitalized territory during the first quarter, compared to six banks in the fourth quarter of 2013.
Two institutions escaped undercapitalized territory by receiving capital infusions in the period, while two banks failed in the first quarter.
One institution that was undercapitalized at the end of first quarter has since come under new ownership. FirstSecure Bank and Trust Co.'s parent company, Community Holdings Corp., changed ownership in May, when a private investor infused about $7.2 million into the institution.

Fort Lauderdale, Fla.-based Valley Bank, which reported a Tier 1 risk-based ratio of 0.87% at the end of the first quarter, nearly found a lifeline of its own when the Seminole Tribe of Florida applied to acquire the institution. Shortly thereafter, the tribe ultimately decided not to move forward with its application to purchase the bank.

Other banks made moves in the opposite direction in the first quarter, joining the undercapitalized ranks in the period. Six banks, all of which had less than $500 million in assets, gained undercapitalized status during the first quarter. The banking industry as a whole, though, finds itself on the mend, with credit quality having improved considerably from the depths of the crisis.

Commercial banks' adjusted nonaccrual loans fell to $86.20 billion in the first quarter, from $89.93 billion in the prior quarter and $115.23 billion a year earlier, while net charge-offs declined to just 0.52% of average loans, from 0.61% in the linked quarter and 0.85% one year ago, according to SNL data.

With the improvements, the number of banks on the FDIC's "problem list" continues to decline, building on the success in 2013, when problem banks declined at an even faster rate than the decrease in undercapitalized institutions. The number of institutions on the problem list dropped notably again in the first quarter, falling to 411 institutions from 467 institutions in the 2013 fourth quarter and 612 a year ago, a 12.0% drop from the linked quarter and down 32.8% from the year prior. The number of problem institutions stood at 772 two years ago and 888 three years ago.

Banks that continue to grapple with issues and remain on the problem bank list and in undercapitalized territory are largely in areas that suffered from stress during the cycle. The Southeast remains home to more undercapitalized banks than any other region.

Florida, where 70 banks have failed this cycle, had three operating banks falling below the 4% Tier 1 risk-based capital threshold at March 31. Georgia and Illinois also had three operating, undercapitalized institutions as of June 6, using March 31 data. Eighty-eight banks have failed in Georgia this cycle, while 58 banks have failed in Illinois.

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Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.