Gulf South Bank Conference

I’m heading down to the Gulf South Bank Conference later in the week. This is an industry-sponsored event that has about 20 or so banks presenting to investors. These aren’t the giant commercial banks that dominate the news, but are smaller community banks that don’t get a lot of publicity. I think the largest bank presenting has a market capitalization of approximately $2 billion. Here is a list of the banks attending:

BancorpSouth, Inc. (BXS)
MidSouth Bancorp, Inc. (MSL)
Bank of Florida Corporation (BOFL)
Peoples Financial Corporation (PFBX)
Bank of the Ozarks, Inc. (OZRK)
Porter Bancorp, Inc. (PBIB)
Capital City Bank Group, Inc. (CCBG)
Renasant Corporation (RNST)
CenterState Banks of Florida, Inc. (CSFL)
Simmons First National Corporation (SFNC)
Encore Bancshares, Inc (EBTX)
Southside Bancshares, Inc. (SBSI)
First Financial Bankshares, Inc (FFIN)
Superior Bancorp (SUPR)
First Security Group (FSGI)
Teche Holding Company (TSH)
Hancock Holding Company (HBHC)
TIB Financial Corporation (TIBB)
Home BancShares, Inc. (HOMB)
Trustmark Corporation (TRMK)
IBERIABANK Corporation (IBKC)

I just found out that Whitney Holding (WTNY) pulled out of the conference several weeks ago because it didn’t want to get any political flack from Congress about spending money on wining and dining investors. I will post my thoughts on the conference when I return.

More TARP Banks

The Treasury released the list of banks getting money from the government as part of the Capital Purchase Plan. The total amount given out was $14.77 billion for 43 banks. Some are household names and others are rather obscure:

Will This Be Citibank on Monday Morning?

An engraving from the run on the Union Trust Company during the Panic of 1873.



Will This Be Citibank on Monday Morning? No, it won't but the market seems just as scared nonetheless.

Bank Death Watch

It's Friday afternoon which means it's time for the Federal Deposit Insurance Corporation (FDIC) to take over another bank. I keep refreshing the page at the FDIC site. I admit it's a little morbid, but what the heck.

FDIC Home Page

Silver State Bank - Postmortem

Here are some final stats on the bank seized Friday by the Federal Deposit Insurance Corporation (FDIC) as of 6/30/08.

Equity capital to assets - 6.87%
Core capital (leverage) ratio - 6.56%
Tier 1 risk-based capital ratio - 7.57%
Total risk-based capital ratio - 8.86%

Noncurrent loans to loans - 15.38% (Total noncurrent loans and leases, Loans and leases 90 days or more past due plus loans in nonaccrual status, as a percent of gross loans and leases.

Time deposits of $100,000 or more - 21.23%

Another One Bites The Dust

Silver State Bank of Henderson, NV was seized early this evening by the Federal Deposit Insurance Corporation (FDIC).

The Nevada State Bank, of Las Vegas, has assumed the insured deposits of Silver State Bank.

Silver State Bank had total assets of $2.0 billion and total deposits of $1.7 billion. Nevada State Bank agreed to purchase the insured deposits for a premium of 1.3%.

From the web site of the seized bank:

Silver State Bancorp, through its wholly-owned subsidiary, Silver State Bank, currently operates thirteen full service branches in southern Nevada and four full service branches in the Phoenix/Scottsdale market area. Silver State Bank also operates loan production offices located in Nevada, California, Washington, Oregon, Utah, Colorado and Florida.

Silver State Bancorp is headquartered in Henderson, Nevada and listed on the Nasdaq Global Market under the symbol SSBX.

Two More Banks Go Down

Last Friday, the Federal Deposit Insurance Corporation (FDIC), issued its usual late afternoon press release announcing the seizure of two more banks. This Friday afternoon watch is starting to become a popular blogging sport for many of us. There is not much to add to this story since it has been well covered, but I will publish the final stats for the banks from 3/31/2008.

First National Bank of Nevada - Reno, NV

Noncurrent assets plus other real estate owned to assets - 4.28%
Percent of loans noncurrent - 8.35%
Total risk-based capital ratio - 9.67%
Tier 1 risk-based capital ratio - 8.40%
Core capital (leverage) ratio - 6.24%
Equity capital to assets - 7.37%

First Heritage Bank - Newport Beach, CA

Noncurrent assets plus other real estate owned to assets - 1.26%
Noncurrent loans to loans - 1.89%
Equity capital to assets - 11.89%
Core capital (leverage) ratio - 12.16%
Tier 1 risk-based capital ratio - 14.40%
Total risk-based capital ratio - 15.66%

This bank has very high capital ratios, and fairly low rates of non current loans, which begs the question of what did them in. The OCC said it closed the bank because it was undercapitalized, which is not reflected in the numbers above so a lot must have happened since the end of March 2008.

Read my post on the failure of Hume Bank and First Integrity Bank

Thrift Industry Quarterly Report

The Office of Thrift Supervision (OTS) released its first quarter report on the 1,276 thrifts that it supervises. The report showed the effects of the deteriorating credit cycle on bank balance sheets. We have written previously on this quarterly report here, and it is important in monitoring the state of the industry.

All data is as of 3/31/2008.

1) Average capital ratios are still strong, some even increased from the end of 2007. There are still outliers on the ratio scale but it is encouraging to see overall strength:

Total Risk Based Capital Ratio - 14.6%
Tier One Risk Based Capital Ratio - 12.5%
Equity Capital Ratio - 9.1%
Tier One Core Capital Ratio - 8.5%

2) The industry has reserved 2.01% of its assets, or $7.6 billion for the coming storm of losses.

3) Troubled assets are now 2.06% of assets. This category includes noncurrent (90 days or more past due), nonaccrual status loans and other real estate owned (OREO). This has not yet peaked and will continue to increase during 2008.

4) The total percent of non current loans continues to rise, reaching 1.78% of assets. The most problems are coming in the category of Construction and Land loans where 6% of all loans are non current. However, this is only 3.5% of all loans held by thrifts. Unfortunately, 1-4 Family loans represent 49.4% of all loans held by thrifts, and delinquencies here are at 2.85% and rising.

5) There are another 1.33 percent of total loans past due by 30 to 89 days. Many of these loans will eventually filter into the non current and OREO categories.

6) Another "bright" spot, if you can use that term, is that the number of banks on the OTS watch list is only at 12. For a bank to qualify for this list it must have a CAMELS rating of 4 or 5. The CAMELS rating is a ratings system that examines capital adequacy, asset quality, management, earnings, liquidity, and sensitivity to market risk. In 1992, the number of banks on this watch list was 203, or 11% of all thrifts.

Read the Full Report by clicking below:

Press Release

Chart Package

Games Banks Play - Number Five

Over the next couple of years, many banks will fail and be taken over by the government or larger institutions. This will be an agonizing process that some banks will try to avoid at any cost. I will explain in a multi part series what to watch out for:

There are strict requirements regarding the sale of OREO by Banks in terms of the cash down payment by the buyer. FASB 66 states that:

"The buyer's initial investment shall include only:

(a) cash paid as a down payment.

(b) the buyer's notes supported by irrevocable letters of credit from an independent established lending institution.

(c) payments by the buyer to third parties to reduce existing indebtedness on the property.

(d) other amounts paid by the buyer that are part of the sales value."

Banks cannot lend money to the buyer to finance the purchase of OREO - or as the Comptroller of the Currency has put it:

"The cash down payment requirement of FAS 66 can be satisfied only with the borrower’s personal funds, funds borrowed from an unrelated source, or an irrevocable letter of credit from a third party. This requirement for a cash down payment generally is not met when a bank provides the borrower with an additional loan for working capital or when the borrower’s down payment is obtained by draws on an unrelated line of credit with the bank."

Part One

Part Two

Part Three

Part Four

Games Banks Play - Number Four

Over the next couple of years, many banks will fail and be taken over by the government or larger institutions. This will be an agonizing process that some banks will try to avoid at any cost. I will explain in a multi part series what to watch out for:

Restructured Loans - banks will work with borrowers to try to restructure loans to change the term or the interest rate. This restructuring may trigger an impairment that must be recognized under accounting rules. Also, just because a loan has been restructured doesn't mean that the loan moves from non accrual to accrual status. The borrower must demonstrate an "ability to comply with the new terms." Up to six months may be required before the loan is moved back to accrual status.

Part One

Part Two

Part Three

Games Banks Play - Number Three

Over the next couple of years, many banks will fail and be taken over by the government or larger institutions. This will be an agonizing process that some banks will try to avoid at any cost. I will explain in a multi part series what to watch out for:

Held for Sale Account - When a bank intends to sell a loan, it puts it into an account called "held for sale." A bank may use this account to stuff poorly performing loans. Accounting rules say a charge to the Allowance for Loan and Lease Losses (ALLL) must be made at the time the loan is transferred if the loss is due to credit factors. If the decline is the result primarily from interest rate fluctuations or changes in foreign exchange rates, known as market factors, it should be recorded as a charge to a noninterest expense account. I suppose an unscrupulous bank management can hide losses by claiming a decline in value due to "market factors" rather than "credit factors."

Part One

Part Two

Games Banks Play - Number Two

Over the next couple of years, many banks will fail and be taken over by the government or larger institutions. This will be an agonizing process that some banks will try to avoid at any cost. I will explain in a multi part series what to watch out for:

Other Real Estate Owned (OREO) - Banks will take title to many properties during this downturn and put them into a category called Other Real Estate Owned (OREO). This real estate must be recorded upon foreclosure at fair value, with the difference between the recorded amount of the loan and the fair value of the property charged to the allowance for loan losses. I suppose that some Banks will fudge on this "fair value" deduction and try to keep the loss as small as possible. Future writedowns of the OREO must be charged against operating income. Therefore, there will be two hits against banks regarding real estate. First, the difference between the loan outstanding and the fair value at the time title is taken, and second, the difference between this fair value at foreclosure and what the property is finally sold at.

I attended a banking conference in February and was told that current offers for OREO by buyers are in the range of 40-50 cents on the dollar, and that at this time, most banks aren't accepting such offers.

Part One

Games Banks Play - Number One

Over the next couple of years, many banks will fail and be taken over by the government or larger institutions. This will be an agonizing process that some banks will try to avoid at any cost. I will explain in a multi part series what to watch out for:

Delaying recognition of non accrual loans - Banks are required to put loans into non accrual status when full repayment of interest and principal is not expected, or when loans become 90 days or more delinquent. Some institutions will convince themselves that repayment of interest and principal is still possible and delay putting these loans into non performing status. Some loans should be put in non accrual much earlier than 90 days based on observations and facts that the banks recognize.

Obviously, it is hard to detect these shenanigans, but one should be aware anyway.

Hume Bank Bites the Dust

The Federal Deposit Insurance Corporation (FDIC) announced very quietly the failure of a bank in Missouri:

Hume Bank Fails

As I have said before, this will be the first of many failures over the next year. The Hume Bank was founded in 1909, and survived the Great Depression, but apparently not the “Great Deleveraging.”

So let’s look at Hume and see where they went wrong. Hume is a small bank and its failure will not directly affect the financial system, except to the extent that it may go down in history as one of the first banks to fail this cycle. All the data is as of 12/31/2007.

Hume had only one branch and $13 million in deposits.

Total loans and leases 90 days or more past due plus loans in nonaccrual status, as a percent of gross loans and leases, was 6.99%.

The bank had total charge offs as a percent of loans at 1.28%.

Hume had total equity capital of $2.7 million.

Hume had total net loans of $13.6 million, with half of them in Real Estate. One interesting point about the loan portfolio is that the bank had $2.5 million in loans for “farmland,” and $ 4 million in “farm loans.” I would assume that these loans would be in great shape due to the bubble prices beginning to form for many agricultural commodities, and the strong increase in prices for farm land the last few years.

Here are the capital ratios for Hume Bank

Equity capital to assets - 14.96%
Core capital (leverage) ratio - 7.63%
Tier 1 risk-based capital ratio - 10.28%
Total risk-based capital ratio - 11.57%

All these ratios are well in excess of regulatory limits for being well capitalized. In fact, the terrifying thing is that Hume had a larger capital cushion than Citicorp, which reported the following ratios at year-end:

Tier 1 Capital - 7.12%
Total Capital (Tier 1 and Tier 2) - 10.70%
Leverage - 4.03%

So what killed Hume Bank? It’s hard to say. The FDIC press release did not go into too much detail. If I had to guess, I would say that it was a large loan that went bad, and may have wiped out much of its capital of $2.7 million. After deducting $1.4 million in good will, Hume only had $1.3 million in tier one capital, not much of a cushion.

On sad fact is that at the time of closing, Hume Bank had approximately $1.1 million in 33 deposit accounts that exceeded the federal deposit insurance limit. Those depositors need to get in line now with other unsecured creditors of the bank.

Community Bank Conference

I attended the Supercommunity Bank Conference earlier this week, and here are some of the things that I learned at the conference:

1) The conference was very "unattended" and somber. This was obviously due to the current investing climate and interest in financial stocks, but more specifically, was caused by a contraction in money flowing into funds that specifically invest only in community banks. Many of these funds have closed recently as the prospects for buyouts, and the premiums therein have disappeared.

2) There were only one or two banks from Georgia at the conference, strange since the conference was held in Atlanta. I later heard that so many Atlanta banks are in trouble that they stayed away from the conference. The average bank in Atlanta, according to the scuttlebutt at the conference, has a 6% of its assets in the non performing category.

3) I learned of the existence of something called an "interest reserve" on the books of banks. When a borrower makes a payment, not all of it hits the income statement. Some of it is put into a "reserve account" so when loans become non performing, it goes against this reserve, thereby delaying the recognition of non performing assets. This may be why there has been a lag between the deteriorating economy and an increase in past due and non performing assets by banks.

Conference Time

I've decided to personally investigate the credit crunch so tomorrow I am heading to Atlanta to attend the Super-Community Bank Conference. This organization holds five regional conferences every year, and the Southeastern event is February 11 and 12. None of the banks are household names, with most having a market capitalization less than a billion. This will make it more interesting as I can get a good read on Main Street credit conditions.

Dugan Speech

John C. Dugan is the Comptroller of the Currency, and yesterday he gave a speech to the Florida Bankers Association. The Office of the Comptroller of the Currency (OCC) is but one of five regulators of banks in the United States. The five are:

The Office of the Comptroller of the Currency (charters, regulates, and supervises all national banks. It also supervises the federal branches and agencies of foreign banks)

Federal Reserve Board (state chartered banks that are members of the Federal Reserve System and bank holding companies)

Federal Deposit Insurance Corporation (insured state banks that are not members of the Federal Reserve System)

Office of Thrift Supervision (savings and loans)

National Credit Union Administration (credit unions)

Dugan mentioned some interesting information regarding banks and the risks they face.

1) The ratio of commercial real estate loans to capital has nearly doubled in the past six years, to 285 percent.

2) Over a third of the nation’s community banks have commercial real estate concentrations exceeding 300 percent of their capital, and almost 30 percent have construction and development loans exceeding 100 percent of capital.

3) Over 60 percent of Florida banks have CRE loans exceeding 300 percent of capital, and more than half have C&D loans exceeding 100 percent of capital.

4) Indeed, during the past year national community banks have experienced a significant increase in nonperforming C&D loans. As of Sept 30, these loans amounted to 1.96 percent of total C&D loans, a rate that was more than twice that of a year earlier.

5) In Florida, that trend is even more pronounced. While nonperforming loans a year ago were 40 basis points less than the national average, the figure has increased to 3.34 percent of total C&D loans. That’s 70 percent greater than the national average and an almost eight-fold increase in one year.

6) Thus far overall nonperforming CRE loans, even in the area of residential construction and development lending, are a long way from approaching historical peaks.

It should be a fun year for the Banking Industry.

The Case for Financials

I want to make the case for starting to put some money to work in Financial stocks. Please don't jump all over me before you read this. Here is the thesis:

1) The Federal Reserve has finally realized the seriousness of the situation and is committed to bringing rates down to stimulate economic growth. The Fed cut rates 75 basis points this morning, and will cut more.

2) Housing, as we all know, is in a deep depression. The latest report on starts show a drop to levels not seen since 1991. The market sold off on this, but this is actually good news as supply must be taken out of the market in order to restore balance.

3) Housing will also be helped during the Fed easing cycle, as the tidal wave of resets on mortgages hits in 2008. Mortgages will reset at lower rates than expected. This will mean less foreclosures than the market expects.

4) President Bush has announced a tax cut to also help the economy. It seems that both parties will work together to come up with some plan to help, despite the election year coming up. The announced plan was for a $150 billion stimulus package, but by the time it becomes law it will be larger than that.

5) The last quarter of reported GDP growth came in very strong at 4.9% for the third quarter of 2007. We all know that the official definition of a recession is two straight quarters of negative GDP growth, but lets assume that one quarter would be enough. The economy would have to contract almost 5% to reach negative growth. That is an extraordinary amount in an economy of our size.

6) The Financials, as measured by the large cap index, the XLF, is at $25.17, after peaking at close to $38. That is a drop of almost 40%, more than a Bear Market. At $25, the index is now at a level last reached in late 2003. It is hard to get a handle on valuation because book values and earnings are in "flux" to put it mildly, but clearly the stock prices are more grounded in reality than before.

7) The banking industry is recapitalizing fairly rapidly, with capital infusions of almost $100 billion from Sovereign Wealth Funds, and other foreign players. The rest of the world does not have an interest in seeing the United States financial system go under. That would be bad for business. After all, there is a reason why 36 countries store Gold reserves in a vault under the Federal Reserve building in Lower Manhattan.

8) Banks have started started to write off bad loans and bad investments from its balance sheets. Although the market sees this as a negative, it is actually the beginning of the end of crisis. Another point that some investors don't realize is that accounting rules forbid banks to "write up" these investments once they are put into the "other than temporary loss" category. This raises the possibility that once the market recovers, these securities will actually have a value despite being valued at nothing on the bank books. So one day, we will have a situation where bank book values are understated on a trailing basis, the opposite of the situation we have today, where bank and other financial book values are overstated on a trailing basis.

9) Newly tightened lending standards means that fewer bad loans are entering the pipeline. Underwriting departments are finally doing its job. Non performing loans, and loan write offs will eventually peak and then turn down. That is how the credit cycle works.

10)Despite all the investment write offs and reserving for credit losses, bank capital ratios are well above minimum regulatory levels.

11) The psychology is correct as well. Everyone thinks that the sky is falling. Panic is setting in, just the time to buy.

The Next Shoe to Drop?

Bank failures are at a historical low, with only three in 2007, and none in 2005 and 2006. The chart below shows bank failures as calculated by the Federal Deposit Insurance Corporation (FDIC) since 1934. I couldn't get the years to appear on the horizontal axis, but the chart starts in 1934 at the right and ends at the far left. I know that it is in reverse order chronologically, but blame Google Docs for that not me.

The large bulge is from the banking crisis in the late 1980's and early 90's, and the smaller bulge is from the Great Depression. many banks failed prior to 1934, but since the FDIC was created in that year, that is all the data they have.

JP Morgan vs. Citigroup

If you take a look at the capital ratios of the these two banks, it speaks volumes about what is going on. These numbers are preliminary but here they are:

Citigroup

Tier 1 Capital Ratio - 7.1%
Total Capital Ratio - 10.9%

JP Morgan

Tier 1 Capital Ratio - 8.4%
Total Capital Ratio - 12.6%

You can look up capital ratios for any bank by going to this web site:

http://www2.fdic.gov/idasp/main.asp

The info is always a quarter behind, but it is useful nonetheless to see the trends.