A Trio of Bank Ratios
Lest anyone think we missed it, on August 31st the FDIC put out its Quarterly Banking Profile for the second quarter of 2010. The headline was glowing: “Quarterly Earnings Are Highest in Almost Three Years.” The insured institutions reported aggregate net income of $21.6 billion in the quarter, impressive when compared to the previous year’s loss of $4.4 billion. Before getting into how the banks reported this relatively impressive figure, we will update our favorite Quarterly Banking Profile graph, which hints at the answer:
The coverage ratio, reserves against losses divided by noncurrent loans and leases (90+ days delinquent and nonaccruals), only managed to stay flat at roughly 65%, despite a decline in nonperforming assets (the first in 17 straight quarters). The $19.6 billion drop in NPAs was offset by the $11.8 billion drop in reserves, the first drop in 14 quarters. The $11.2 billion fall in provisions helped prop up net income significantly. However, these improvements don’t seem to be very robust across the entire banking sector. Despite the 40.2% decline in aggregate provisions since the year ago quarter, only about 41% of individual banks reported a year-over-year reduction. Our math skills tell us that nearly 60% of insured banks and thrifts actually increased their loan loss provisions over last year. “Reductions were more prevalent among larger institutions,” to quote the FDIC. A similar story took place behind the decline in loan loss reserves: despite the decline in aggregate reserves, nearly 2 of 3 insured banks actually increased their reserves in the quarter. It seems that it is the best of times, and the worst of times, depending on the size of your bank. Corroborating the FDIC report, a Washington Post article from Monday highlighted a Treasury report showing that more than 120 banks (most of them small) missed their TARP dividend payments. Five banks who received TARP money have already failed.
It is in this light that we read reports of the new Basel III requirements as they leak out. So far, the new rules are focusing on capital requirements, and leaving for later issues of liquidity. The FDIC reports an aggregate Tier 1 capital ratio for insured institutions, which is painting a more cheery picture than does the coverage ratio.
The coverage ratio looks at how well the banks have reserved for nonperforming assets, but doesn’t take into account capital available to take losses. The Tier 1 capital ratio addresses this capital (equity, reserves, and some “equity-like” capital), but doesn’t look at the credit performance of the assets. To bridge the gap between these two concepts, we have been looking to the Texas Ratio: nonperforming assets as a percentage of tangible common equity (TCE) and reserves. In the chart below, we’ve included the components of this ratio.
Though elevated, the Texas Ratio moved in the right direction as nonperforming assets declined and increased securities prices helped the capital/reserve cushion to rise. We expect that this ratio is also bifurcated, with the larger banks looking much more healthy than some of the smaller banks. The changes in the “problem” bank list seems to confirm this hunch: the number of banks on the list rose by 54 to 829 banks, while the total assets of the problem banks actually fell from $431 billion to $403 billion.
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