Are We Looking at a New Savings and Loan Crisis?

Every three months the FDIC issues their “Quarterly Banking Profile.” Most people — even serious investors and Wall Street — have never paid these reports much mind. With the credit crunch, however, people are starting to pay attention. The latest report is chock-full of scary statistics. For starters, insured commercial banks reported net income of only $5 billion for the second quarter of 2008. Take a gander at the chart below, and you will see that second quarter earnings for the banking industry were 87% below the year-earlier numbers. This is the second-lowest quarterly earnings since 1991 (124 banks failed in 1991, none in 2005 & 2006, 9 failures this year including giant IndyMac).

The report sites the primary cause of the low earnings, saying, “Higher loan-loss provisions were the most significant factor in the earnings decline.” What that means is this. If a bank expects a loan to go bad, it is required to place a “loan loss provision” on its books. In other words, banks can’t have bad loans right around the corner and allow their financial statements to look rosy, despite impending losses. Quarterly loss provisions surpassed $50 billion for the second quarter of 2008 — more than four times the quarterly total of one year ago. The report continued, stating, “Second-quarter provisions absorbed almost one-third (31.9 percent) of the industry’s net operating revenue (net interest income plus total noninterest income), the highest proportion since the third quarter of 1989.”

The report also places loan losses at their highest levels since 1991:

The report states: “Net chargeoffs increased year-over-year for all major loan categories.”

• Charge-offs of 1-4 family residential mortgage loans increased by 821.9 percent
• Charge-offs of real estate construction and land development loans rose by 1,226.6 percent
• Net charge-offs of home equity loans were 632.7 percent higher than a year earlier
• Charge-offs of commercial and industrial (C&I) loans were up by 127.5 percent
• Credit card charge-offs increased by 47.4 percent
• Charge-offs of other loans to individuals grew by 70.3 percent

Anyone who thinks that we have a residential mortgage problem is kidding themselves. Banks are writing off loans in all categories, and the large percentage increases are staggering. The percentage of noncurrent loans (at least 90 days past due or no longer accruing interest) stood at 2.04% — the highest level since the third quarter of 1993.

When it comes to banks in trouble, there are more of them every day. The FDIC keeps a “problem list” of banks experiencing financial woes, but it does not make that list public. There were 76 banks on the list at the end of 2007. That number increased to 90 after the first quarter of 2008 and again to 117 at the close of the second quarter of 2008. Perhaps more important, the assets of the banks on the problem list increased from $26 billion to $78 billion — a 200% jump in one quarter. The $78 billion of assets on the “problem list” accounts for about 1.74% of total assets. FDIC Chairman Sheila Blair said, “More banks will come on the list as credit problems worsen … assets of problem institutions also will continue to rise.”

No one knows how accurate the “problem list” is because a cloud of secrecy surrounds the list. The list clearly is not accurate. The first quarter problem list did not contain IndyMac, for example. Either the FDIC made a $32-billion-dollar “oops” by not including IndyMac, or the exclusion was intentional. Either possibility is scary. How did they miss the second biggest bank failure in history? Maybe they didn’t. Some believe that IndyMac was excluded from the “problem list” because the inclusion of its $32 billion in assets would have sent a red flag to Wall Street. If the bank assets on the “problem list” jumped that high in one quarter, there would have been a hunt to find out which big bank was in trouble. The thinking is that the FDIC intentionally left IndyMac off the “problem list” in order to prevent a run on the bank. The question then becomes: can we trust the FDIC? The answer is quite clearly no. They are either incompetent — missing the second largest bank failure in history (the largest was the 1984 failure of Chicago’s $40B Continental Illinois National Bank & Trust Company) — or they tweak their reports whenever it suits their fancy.

As Chairman Blair said, we are going to see more banks in trouble. There is no end in sight yet for the credit crisis. Be wary of banks offering the best interest rate, as that is often a sign of a bank in trouble. Unable to obtain funds elsewhere, troubled banks often appeal to the public to raise funds through tempting interest rate offers. If you hold significant deposits, look into your bank’s rating to avoid having to wait for an FDIC payoff should your bank go under.

The original savings and loan crisis was brought about by a variety of factors, but for certain, they overextended themselves, particularly in the commercial real estate sector. Real estate collapsed in states like Texas, Louisiana and Oklahoma due to falling oil prices. Bad banking policies were at the heart of the collapse. As for our current crisis, the International Monetary Fund has said that total credit losss could reach $1 trillion. NYU economist and professor Nouriel Roubini places potential losses at $2 trillion by the end of 2009. Bloomberg places bank losses at $500 billion thus far — one-quarter of the way towards Professor Roubini’s $2-trillion-dollar prediction. In comparison, the original S&L crisis resulted in a total cost of only $.16 trillion. Some experts say that hundreds of banks will fail. Time will tell.

Wade Young is a Denver mortgage broker.