FDIC List Shrinks, Earnings Soar - Analyst Blog

The number of banks on the Federal Deposit Insurance Corporation's (FDIC) list of problem institutions saw a sharp decline for the second straight quarter to 844 in the July-September period from 865 in the preceding sequential period, federal regulators reported Tuesday. This represents the second quarterly drop since 2006.

Things looked a lot brighter in the third quarter given the drop in the problem list accompanied by the highest level of overall profit earned by FDIC insured banks in more than four years. This also represents profits earned by banks for the ninth straight quarter.

The problem list includes banks that face imminent failure due to low capital support, though some may survive and pull out of the crisis. As of now, only less than a quarter of the banks on FDIC's problem list have actually failed. This ratio may however change if the pace of bank failures increases.

Size of Problem Banks

Most of the problem banks are small institutions. Total assets of these banks decreased to $339 billion at the end of the third quarter from $372 billion at the end of the previous quarter. This nevertheless represents a phenomenal 57-fold jump from $6 billion in assets of 50 problem institutions in 2006.

Pace of Bank Failures

There have been 90 bank failures so far this year, preceded by 157 in 2010, 140 in 2009 and 25 in 2008. On a cautionary note, increasing loan losses on commercial real estate could trigger hundreds of bank failures in the coming years. However, considering the course of failure so far this year, the FDIC does not expect the number of failed banks in 2011 to exceed the 2010 tally.

While the financials of a few large banks have been stabilizing on the back of an economic recovery, the industry is still on shaky ground. Nagging issues like rock-bottom home prices along with still-high loan defaults and unemployment levels continue to trouble such institutions.

Lingering effects of the financial crisis continue to weigh on many banks. The need to absorb bad loans offered during the credit explosion made these banks susceptible to severe problems.

Further, the repeated risk-taking of bailed out banks ultimately resulted in further threats to the system. Risky loans and market uncertainty aggravated the risk of bank failures even further.

Role of FDIC

The FDIC insures deposits at 7,437 banks and savings associations in the nation as well as promotes the safety and soundness of these institutions by addressing risks associated with them. The number is, however, down from 7,513 in the prior quarter. Now the problem banks represent about 11.3% of the total number of institutions covered by the FDIC. When a bank fails, the agency reimburses customers for deposits of up to $250,000 per account.

Financial Health of FDIC

Though the FDIC has managed to shore up its deposit insurance fund over the last few quarters, the ongoing bank failures have kept it under pressure. However, at the end of the third quarter, the fund was in surplus for the second straight quarter. Also, the balance increased to $7.8 billion from $3.9 billion at the end of the prior quarter. The improvement in fund balance was aided by a moderate pace of bank failures and assessment revenue.

Record Profit: A Confidence Booster

Besides the heartening decline in the list of problem institutions, the highest level of profit from FDIC-insured banks significantly impresses us. The consolidated third quarter profit of FDIC-insured banks came in at $35.3 billion, up 22.6% sequentially and 48.3% year over year. The year-over-year rise was primarily driven by improving asset quality and lower loss provisions.

However, in terms of numbers, only a handful of banks, with assets exceeding $10 billion,generated the major portion (more than three-fourth) of the consolidated profit during the quarter. These are primarily the large banks, of the likes of JPMorgan Chase & Co. ( JPM ), Wells Fargo & Co. ( WFC ), The Goldman Sachs Group Inc. ( GS ) and Citigroup Inc. ( C ), which were supported by government bailout money and low borrowing rates. On the other hand, smaller banks not doing too well failed to make any meaningful contribution.

Consolidation to Continue

With repeated bank failures, consolidation has become the industry trend. For almost all of the failed banks, the FDIC enters into purchase agreements with healthy institutions. When Washington Mutual collapsed in 2008 (branded as the largest bank failure in the U.S. history), it was acquired by JPMorgan Chase & Co. The other major acquirers of failed institutions since 2008 include U.S. Bancorp ( USB ) and BB&T Corporation ( BBT ).

We expect the pace of consolidation to more or less replicate the pace of bank failures,making way for an oligopolistic market. Less competition could even put the country's wealth and welfare optimization at stake.

BB&T CORP ( BBT ): Free Stock Analysis Report

CITIGROUP INC ( C ): Free Stock Analysis Report

GOLDMAN SACHS ( GS ): Free Stock Analysis Report

JPMORGAN CHASE ( JPM ): Free Stock Analysis Report

US BANCORP ( USB ): Free Stock Analysis Report

WELLS FARGO-NEW (WFC): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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