FDIC's Quarterly Banking Report Indicates More Trouble Ahead

Includes: SKF, XLF
by: Managing Money

The FDIC on Tuesday issued a report showing that the number of financial institutions on its so-called problem list rose to 117 from 90 which were reported at the end of the first quarter.

That's an increase of 30% in three months, and things look to get worse before they get better. The number of banks on the list is the most visible thing to consumers, but the amount of assets held by those problem institutions is more troubling still. The total assets of institutions on the problem list tripled. That means some pretty big players are in the additions.

While the FDIC doesn't give out the names of troubled banks on its list for fear of hurting them even more, we do know that Indymac Bank which failed in July was on the list. That bank alone had assets of $32 billion, so by deduction that's almost certainly the largest single bank on the list.

For investors, of course, the prospect of bank closings should be scary. When a bank is taken over by the FDIC, all available assets are first used to repay depositors. If anything is left, once all the debts are paid, it is divvied up among shareholders. It's almost always a small part of the pre-closure value of the bank's shares. Usually the risk of a bank failure gets factored into the stock price over time. Freddie Mac (NYSE: FRE) and Fannie Mae (NYSE: FNM) are two examples right now. While both institutions still claim they will not need a bail out, some important industry analysts are saying otherwise. Consequently the stock prices of both have fallen tremendously in recent months.

If you're an investor looking at or holding shares in financial institutions, it's buyer beware. Look closely at the balance sheets. Look also at loss reserves, most of the difficulty these banks are facing stems from unrecoverable loans, if sufficient loss reserves are not already in place, then adjustments can turn a positive quarter into negative very quickly. Loans to businesses as well as consumer loans are seeing a default rates that are increasing at a tremendous clip, according to the report. Banks are also tightening restrictions on new loans.

While that's smart and would have prevented most of the current problems had those restrictions been in place long ago, it does mean less new business coming into the banks at a time when they need it most.

So we'll end this entry the way we began it. The FDIC Quarterly Banking Report is out and things are definitely going to get worse before they get better for the financial sector.

Disclosure: none