More Profits, More Problems

As an industry, we just made more money than ever before. But it would be wise to see the good news in context.

Late in January, the Federal Deposit Insurance Corp announced that profits at commercial banks and savings institutions collectively reported aggregate net income of $40.3 billion in the fourth quarter of 2013—a record by any measure.  The $5.8 billion recorded marks 16.9 percent spike over the same quarter last year. This is the 17th time in 18 quarters that there have been increased profits. That’s a steady drumbeat of positive numbers since the third quarter of 2009, barely a year a year after the dark days of bank bailouts dominated the headlines. For 2013 overall, the industry took in $155 billion, a 10% jump over 2012 and a lot higher than the $148 billion of 2006, the previous record.

Man Looking at CalendarAnd there’s more. The FDIC insures 6,812 institutions, and more than half of them, 53% had year-over-year growth for the quarter. On the flip side, the 12.2% booking losses is better than the 15% that had a losing quarter in 2012. In fact, the number of banks on the ‘problem list’ was down to 467 at year-end 2013, the lowest number since the financial crisis. In fact, it was 888 in early 2011.

Of course, there is nuance in these numbers. The FDIC notes that a big part of the bottom-line boost can be attributed to an $8.1 billion decline in loan-loss provisions. More specifically, 20% of the profits came from putting away less money to cover future losses—more a sign of accounting maneuvers than good business. On a related note, there was significantly less mortgage activity and lower trading revenue, leading to a year-over-year decline in net operating revenue.

Looking at the big picture, here’s one major takeaway. While lending rose generally, primary mortgage loans fell by $51 billion for the year. That’s a bad sign for economic recovery, and it’s got the critics out: At its annual meeting in January, JPMorgan Chase executives got asked why, since its faring so much better, the company isn’t doing more to help borrowers. In the wake of the FDIC report, expect this question to come up a lot more often, particularly since the mortgage market is expected to fall even faster this year.

To get a (perhaps unfair) sense of the dichotomy, here’s a curious factoid: The FDIC is stepping up its legal efforts against institutions during the financial crisis half a decade ago. Cornerstone Research reports that the agency filed 40 director and officer lawsuits in 2013, the same year that had such stellar results. That’s a 54% jump over the 26 suits filed in 2012.

Much of the litigation revolves around the surge in bank failures in 2009 and 2010. In fact, of the 140 financial institutions that failed in 2009 alone, 64 have settled claims or been taken to court. How all these cases play out could provide an indication of the pressure the industry will face in the days ahead.

Of course, it might be safe to assume that while these banks failed in 2009 and 2010, some of their woes go back further, perhaps to the days when the mortgage market was exploding. Yet here we are again, facing criticism for not giving out enough mortgages.

The news of a boosted bottom line is a good thing, but it’s no more than a start. The financial services industry can never be insulated from the economy at large—it’s too large, too integral and too important. The fact that profits have risen so sharply means there will be more pressure to generate similar cheer for everyone else.

How Do You Rate?: Q&A with VERIBANC President

Mike Heller Veribanc

We recently spoke with VERIBANC, a company that provides bank ratings on all U.S. federally insured financial institutions. Michael Heller, president of the company, told Banking.com about what the VERIBANC does and who they work with.

 

Q: Can you tell us more about VERIBANC?

A: We’ve been in business since 1981 and our bank rating system has helped banks, consumers, business people and government offices manage banking risk and protect their deposits and investments against bank failure and fraud.

Q: How do you develop your bank ratings?

A: The ratings are developed using our existing ‘Beyond CAMELS’ quantitative only methodology. This methodology has been audited and approved by several insurance companies for use with insuring deposits in excess of the FDIC’s limit. No bank or holding company has ever paid us to rate them. We have always published our track record (ratings effectiveness) and not just a few of the good years.

Q: What does your track record look like?

A: We don’t claim to be perfect, just optimally tuned. Our current ratings effectiveness rate is over 99 percent, while our false alarm rate is about 20 percent. Our rating system is unique in that we do not “conservatively adjust” our criteria so that a large part (30 percent or higher) of the banking industry winds up in our lower rating categories – so as to improve or inflate our predictive results. Instead we balance predictability of bank failure with false alarms, so we can provide our customers with true value. We even publish our track record on our website at: http://www.veribanc.com/TrackRecord.php.

Q: What products do you offer to help Banks and Credit Unions meet regulatory standards?

A: Our most popular report for banks is our Regulation F Report. Comparable to this for Credit Unions is our Section 703 Due Diligence Report.

Q: You released your Q4 ratings at the end of 2013. Can you share an excerpt with us?

A: Our Director of Modeling at VERIBANC, Milton Joseph, wrote the following on “Size Equals Strength”

The FDIC’s recently released September 2013 (Quarterly Banking Profile) reveals an overall sound condition and continued financial improvement among the nation’s Insured commercial and savings banks. For the quarter, the sector achieved a nearly 1.0% return on average assets, and, as of September 30th, the industry’s Leverage (Core Capital) Ratio reached 9.4%. Nonperforming Assets-to-Assets fell to 1.8% at that date. At mid-year, comparable percentages were 9.3% and 1.9%, respectively.

Our asset size review indicates that small banks and thrifts, those with assets of less than $100 million, demonstrated particular strength. As of September 30th, that category of institution reported a Leverage Ratio of 11.7% and a Loss Reserve-to-Noncurrent Loan Ratio of 87.4%. Both percentage were the highest among any of the measured asset-size peer groups.

Interestingly, at September 30th, deposits held by FDIC-Insured institutions exceeded $11.0 trillion. Included in that total were deposits of close to $1.6 trillion that were higher than the FDIC’s $250 thousand Insurance limit. Nearly all of the $1.6 trillion of Un-Insured deposits (91.6%) were held at large institutions with total assets greater than $10 billion. One might conclude that size does continue to equate to strength 

 

To learn more you can go to www.veribanc.com.

The Volcker Rule, Then and Now

Paul Volcker has long been regarded as a giant in the financial services industry, and with good reason. He was likely most influential during his tenure as Chairman of the Federal Reserve during both the Carter and Reagan administrations, when he played a leading role in bringing down the rampant levels of inflation at the time. A generation later, he returned to the spotlight as chair of the Economic Recovery Advisory Board, a post he retained until early in 2011. His storied history also includes stints with the New York Fed and the Treasury Department, along with senior posts in the private sector at institutions such as what was then Chase Manhattan and investment banking firm Wolfensohn & Co.

In 2014, his name will probably be in the headlines again quite a bit, even if he personally doesn’t say much. That’s because right before Christmas, the American Bankers Association (ABA) announced plans to file a lawsuit challenging key portions of what is generally known as the Volcker Rule, a set of regulations that prevents many banks from speculatively trading with their deposits.

There are many interesting aspects to this developing imbroglio, not the least of which is that the ABA is leading the fight on behalf of smaller institutions, which it says are already concerned over possible repercussions. The harm to these vulnerable companies is described as “real, imminent, and irreparable.”

Of course, no one expects the challenge to end there. Some of the issues covered by the Volcker Rule, such as collateralized debt obligations (CDOs)—which are widely blamed for helping stoke the financial crisis of the last decade—are deeply embedded in the business practices of much larger corporations. If the new rules are not amended, it’s easy to see how many of these Fortune 100 conglomerates might throw themselves into the legal fray.

For the record, it’s far from clear exactly how these regulations will affect the industry, and it’s a matter of interpretation whether the Volcker Rule even prohibits banks from holding CDOs. However, many observers insist that it does exactly that, and some auditors are saying that without further guidance from the Fed (along with the FDIC and the Office of the Comptroller of the Currency, both of which are also named in the potential lawsuit), banks would be well advised write down CDOs, even if it means taking a hit to the balance sheet.

The regulations and potential lawsuits, while new, are in no way a surprise. There’s been intense lobbying behind the scenes for a long time now, but it was only in December that five federal agencies approved the final rule. That’s still left plenty of room for loopholes, hence the ongoing concerns and legal challenges. Besides, banks still have a solid six months to drop the questionable assets from their portfolios, and can subsequently apply for an extension. In other words, these are early skirmishes that help set the stage for more sustained assaults.

There’s also a broader question here that deserves attention. To many, Volcker represents a different breed of financial services veteran, a point he demonstrated during his appearance before a British parliamentary commission a year ago. “The economic and social value of much of the trading and innovative financial engineering is questionable,” he stated forcefully, adding that without regulation banks will inevitably intertwine trades for their own accounts with their retail businesses—a toxic brew by any definition. In this and other appearances, Mr. Volcker has voiced criticism of new financial instruments that disrupted long-held industry processes and practices.

As we noted on this blog at the time, those are exactly the characteristics that sustain and nourish the technology industry. Is there are way for the disruptive innovation of the tech world to be balanced with the stability required in financial services? As these legal challenges play out, we might get some interesting answers to that question.

Community Service: Making Room For Smaller Banks

It was always known that from the moment she was awarded a spot on the Senate Banking Committee, freshman Sen. Elizabeth Warren would be making waves. In the few months since her swearing-in, she’s certainly lived up to her billing: She’s hammered bankers, lobbyists and regulators alike on issues such as home foreclosures, announced an active review of the settlement the government reached with big banks, and called for major changes to gender equity laws. And that’s all in just the past few weeks.

Another recent query, however, may have even greater consequences for the banking industry. During a hearing with the Senate Committee on Banking, Housing and Urban Affairs, she asked a direct question that has perhaps been on many others’ minds: “Are we reaching a point where we should have a two-tiered regulatory system?”

By any definition, this is at least a valid question. Specific subtleties aside, the entire industry is essentially subject to the same set of regulations. However, as the Federal Deposit Insurance Corp. has reported, community banks represented a staggering 95% of all banking organizations in 2011, yet retained only 14% of all banking assets. Incidentally, that figure represents a steep drop—in 1984, the same industry segment held 38% of all U.S. banking assets.

There are other serious discrepancies, too. Despite the dominance of larger banks in this domain, the FDIC revealed that community banks hold the majority of banking deposits in U.S. rural and ‘micropolitan’ counties. In fact, almost 20% of all counties in the United States have no physical banking offices other than community banks. This represents a sharp urban-rural divide, ensuring that any change to the system could have major ramifications.

There’s another variable here that may be even more significant: These community banks, which technically have such a small footprint in the industry overall, currently hold 46% of all small loans to businesses.

If this is seen as a problem, is a two-tiered banking system the solution? It’s an interesting question that deserves extended discussion.

First, as the FDIC makes clear, community banks often succeed or fail for the same reasons as their larger industry counterparts (or even other businesses). The three main factors are distressingly familiar: too-rapid growth, an unjustified focus on commercial real estate lending and volatile funding practices. In effect, some banks made bad decisions and paid the price.

However, it should also be noted that the banking environment in 1984 (the ominous date cited in the FDIC report) was entirely different, one without online banking or mobile apps. As discussed in this blog frequently, many consumers no longer feel the need to go the neighborhood bank, since a basic smartphone can take them anywhere. Does this hurt community banks, or does it give them the ability to take on larger competitors more aggressively?

Moreover, does a two-tiered regulatory system imply that community banks will face fewer regulatory restrictions? Sen. Warren makes the case that small banks are subject to too many mandates that were written for their larger brethren, creating a fundamental unfairness that hurts some competitors.

Larger institutions could argue, however, that more regulations in effect penalize larger corporations for their success. After all, short of monopolistic concerns, shouldn’t everyone have to play by the same rules?

There are perhaps no easy answers here. But in the weeks and months ahead, as the economy continues to heal, the housing crisis works itself out and new technologies continue to emerge and stoke competition, it will be interesting to see how this debate plays out.

Markers of Change

Some of the most significant news in the Federal Deposit Insurance Corp.’s Quarterly Banking Profile ranks dead last in the lengthy list of news nuggets highlighted in the introduction. It has to do with bank failures.

It’s not a surprise that the subject typically ranks low in the report, since there’s plenty of good news to tout upfront. As the media will surely promote, net income rose by more than a third over the year-ago quarter, non-interest income rebounded, large-denomination deposit balances surged, loan losses improved across all loan categories and, in big picture terms, full-year earnings turned out to be the second-highest ever. For the record, it’s not all rosy—there’s been a reduction in equity capital, which can be attributed to the decline in securities value. It as economic reports go, it seems positive overall.

This is why the news of banks going under needs to be seen in context. According to the report, which analyses the last quarter of 2012, eight insured institutions failed during this period. That’s the smallest number of failures in a quarter since the second quarter of 2008.

That’s fully four and a half years ago, but it’s significant for another reason. As the Business Cycle Dating Committee of the National Bureau of Economic Research pointed out late that year, this was around the time the recession took hold.

There’s other news related to this area: The new FDIC reports states that the number of insured commercial banks and savings institutions reporting financial results actually fell from 7,181 to 7,083 and 88 institutions were merged into other banks. The number of institutions on the FDIC’s “Problem List” fell for the seventh consecutive quarter, this time from 694 to 651, and the assets in them declined from $262 billion to $233 billion

But then there’s this nugget: The year 2012 also marks the first in FDIC history in which absolutely no new reporting institutions were added.

It’s easy to attribute too much importance to a single report; three months from now the news might be very different either way. In fact, as this blog noted at the time, the FDIC report from two quarters ago fit into the narrative of ‘cautious optimism.’

As this new snapshot in time reveals, we still have reason to be cautiously optimistic. There is no question that for many different reasons—economic contraction and (hopefully) expansion, changing consumer and other market expectations, the evolving role played by technology in everything from the back end infrastructure to custom mobile applications—we’re in a time of transition, and we’re going to stay that way.

The banking industry has long been associated with gradual change, and that seems like an anachronism in a time of technology-fueled rapid upgrades and instant gratification. It’ll be interesting to see how many failures and other trends might be in the FDIC quarterly profile a year from now. Any predictions?

 

When Moderate Is Good

The Federal Deposit Insurance Corporation (FDIC) isn’t supposed to make news. It’s the safety net beneath the high-flying trapeze act that the financial world can sometimes be—unquestionably vital but decidedly unglamorous. Since its launch almost 80 years ago, not a single depositor has lost money through a bank failure, yet no one seems to talk about it much.

Still, its role as the consumer safeguard at some 8,000 institutions nationwide gives the agency a ringside view into the industry a whole. That’s why its reports, such as its recent announcement on the second quarter of 2012, deserve attention.

The topline items fit nicely into the current narrative around the economy, which typically goes by the cliché ‘cautious optimism.’ The numbers are clearly up: Commercial banks and savings institutions insured by the FDIC collectively reported aggregate net income of $34.5 billion for the period. That’s a significant jump of $5.9 billion over the $28.5 billion in profits the industry reported in the second quarter of last year.

The gradual progress is also evident in that this is the 12th straight quarter in which earnings have registered a year-to-year increase. In other good news, the money is flowing out too, with an uptick in consumer loans in most categories, the fourth time in the last five quarters that this has happened.

However, there might be even better news in the bad news (you read that right). It’s hard to discount the nearly $6 billion in losses incurred by JPMorgan Chase this year through a bet that went awry. However, the reality is that without that single blow, this industry-wide report would look a lot healthier.

The news that 40 banks have failed so far this year is sobering, yet that represents a steep decline from recent times—92 went under last year and 157 in 2010 (the highest since the S&L debacle of 1992). That trend should hold for a while. The list of ‘problem’ banks (it’s surely not fun to be on any list with this tag) continues to shrink, to 732 from 772 in the first quarter of this year.

This has in turn helped replenish the insurance fund’s own coffers. After turning from red to black at this time last year, the Deposit Insurance Fund (DIF) has had a balance of $22.7 billion as of June 30, compared with $15.3 billion at the end of March.

It’s not that all the news is good: total revenue 0.8 percent over the second quarter last year. Still, the rise is the profitability measure—average return on assets, or ROA—spiked from 0.85% in the year-ago quarter to 0.99% this year. That’s a very decent increase.

“Most institutions are profitable and are improving their profitability,” said FDIC Acting Chairman Martin J. Gruenberg. “All of these trends are consistent with the moderate pace of economic growth.”

After the past couple of years, that almost sounds like cheerleading.

FDIC Outlines Top 10 Online Resources for Consumers

This week, theFederal Deposit Insurance Corporation (FDIC) honored National Consumer Protection Week by sharing 10 online resources to keep consumers safe while managing their finances. In an era where “Googling” reliable information is standard, the FDIC wants to ensure that consumers are getting practical and dependable tips to help avoid fraud while managing their bank accounts.

A few of the resources offered by the FDIC include:

  • Bank Find: Our online directory that consumers can use to locate an FDIC-insured institution, learn what happened to a bank that changed names or no longer exists, and more.
  • Small Business Web Page: Useful information for small businesses, especially regarding access to loans, plus an online form to ask the FDIC a question or register a concern.
  • Foreclosure Prevention Toolkit: A Web page that provides easy access to helpful information for homeowners on avoiding foreclosure and foreclosure “rescue” scams.

To read the remainder of the tips, visit the FDIC.

What does your FI do to inform customers about the danger of online fraud? Let us know in the comments section below.