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Undercapitalized Banks Fall To Lowest Level In 17 Quarters

By Nathan Stovall and Robert Clark
SNL Financial

The number of undercapitalized banks fell to the lowest level in 17 quarters at the end of the first quarter, with more banks escaping undercapitalized territory through positive means.

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 is less than 3.0%.

Thirty-eight banks and thrifts were undercapitalized, based on the criteria of having Tier 1 ratios below 4%, at March 31, compared to 42 institutions at the end of the fourth quarter and 61 institutions a year ago, according to SNL data, representing linked-quarter and year-over-year decreases of 9.5% and 37.7%, respectively. The number of undercapitalized institutions has fallen to the lowest level since the fourth quarter of 2008, when 30 banks were considered undercapitalized.

The number of undercapitalized banks in the industry has steadily declined for the last 10 quarters, with failures - rather than banks finding their way out of trouble through other means - accounting for the bulk of the decline. The trend was consistent through 2012, when the number of undercapitalized banks decreased by 26 to 44 institutions. During that period, a number of banks joined the ranks of the undercapitalized and 51 banks failed, while just 15 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 the first quarter of 2013, though, when eight banks found their way out of undercapitalized territory without failing.

The number of undercapitalized institutions has declined at a faster rate than the decrease seen in the number of banks on the FDIC's "problem list" over the past few years. However, the number of institutions on the problem bank list has declined more quickly in the last two quarters.

The number of institutions on the problem list fell to 612 at the end of the first quarter, compared to 651 institutions in the fourth quarter and 772 a year ago, a 6.0% drop from the linked quarter and down 20.7% from a year ago. The number of problem institutions stood at 888 two years ago but totaled 702 at the end of 2009 and just 252 at end of 2008.

Most problem and undercapitalized institutions continue to be in areas that suffered from stress during the cycle. Florida, where 68 banks have failed this cycle, had five operating banks falling below the 4% Tier 1 risk-based capital threshold at March 31. Tennessee also had five operating, undercapitalized institutions as of March 31. Tennessee has not seen nearly as many bank failures as Florida, with just three banks failing in Tennessee this credit cycle.

Nevada and Georgia, which together have produced 99 bank failures this cycle, each had three operating undercapitalized institutions at the end of the first quarter.

The overall pace of resolutions has slowed dramatically in the last two years. Ninety-two banks failed in 2011 after 157 saw their doors closed in 2010. The pace of failures slowed considerably in 2012, with 51 banks failing last year.

One institution that has remained on the verge of failing has distorted the amount of undercapitalized institutions in the banking industry for some time. Capitol Bancorp Ltd. has struggled for a while and had eight of its banking subsidiaries among the list of undercapitalized banks for more than two years. In the first quarter though, five Capitol Bancorp subsidiaries previously deemed undercapitalized found their way out of those ranks, but three of those institutions failed.

In total, 10 banks previously deemed undercapitalized have failed since SNL last published the list of undercapitalized banks in the industry. When excluding the banks that have failed or sold since the end of the first quarter, SNL data shows that 27 banks were undercapitalized based on March 31 data, compared to 38 banks at the last publication of the list of undercapitalized banks.

Three Capitol Bancorp subsidiaries remain in undercapitalized territory. Capitol Bancorp said in a Chapter 11 liquidation plan proposed May 16 that it would seek to sell its interests in some or all of its remaining subsidiary banks. Excluding the Capitol subsidiary banks deemed undercapitalized, the number of operating undercapitalized institutions stood at 24 at May 30.

Seven banks, including two banks with more than $1 billion in assets, joined the ranks of the undercapitalized during the first quarter. Some of these banks had Tier 1 ratios below 4% at the end of the fourth quarter, but their financials were not current at the time of the SNL's last publication of undercapitalized banks. Edinburg, Texas-based First National Bank is among those joining the ranks and is the largest with $3.19 billion in assets. First Security Group Inc. unit FSGBank NA, which has $1.04 billion in assets, was also deemed undercapitalized at the end of the first quarter. However, First Security recently recapitalized and down streamed $65 million in capital to FSBBank, boosting the capital ratios of the bank significantly.

Eighteen banks in all escaped undercapitalized territory during the first quarter, which represents a far greater number than in past periods, but again failures were responsible for the bulk of the decline. Raising much-needed capital has proved very difficult for struggling institutions seeking new funds for defensive purposes, but a handful of banks have enjoyed greater success raising funds this year.

For instance, a few banks previously deemed undercapitalized escaped that territory by raising capital. New Dominion Bank raised in excess of $10 million after spending close to a year on the transaction. And Patterson Bankshares Inc.'s Patterson Bank recapitalized through an unorthodox capital raise where investors injected capital directly into the bank subsidiary.

A few other banks managed to build their capital levels modestly while delivering their balance sheets. And one bank, First National Bank of Baldwin County, found a lifeline selling to First Bancshares Inc. through Section 363 of the U.S. Bankruptcy Code. Under the structure of 363 sales, a bank holding company files for Chapter 11 bankruptcy protection while another entity recapitalizes and purchases the bank subsidiary. The buyer in turn avoids acquiring liability and adverse claims associated with the holding company.

Those transactions have increased in the last year but still are not commonplace. Failures, meanwhile, have slowed considerably and troubled banks seem to have more time to work through issues before facing a closure by their regulators. Just 14 banks have failed this year, and only 41 banks have closed in the last 12 months.