More Bank Failures – I Told You So

An article published on “Market Watch” on February 23, 2010 stated (emphasis mine):

The number of distressed banks in the U.S. rose to 702 in the fourth quarter, the highest level in sixteen years, according to a report released by the Federal Deposit Insurance Corp. Tuesday. That number is up from 552 at the end of September and 416 at the end of June. This is the largest number of banks on its “problem list” since June 1993. Banks insured by the FDIC dropped to a total quarterly profit of $914 million in the fourth quarter, compared with $2.8 billion in the third quarter. However, the result was significantly better than the $37.8 billion loss for insured institutions during the fourth quarter of 2008. Insured deposits reported full-year net income of $12.5 billion. The FDIC reported that its’ Deposit Insurance Fund dropped further into negative territory, reporting a $20.9 billion loss in the fourth quarter, worse than its $8.2 billion loss in the third quarter. The agency hopes to make up that loss through advance payments by banks of $45 billion in fees.

Let’s do some math.

The number of distressed banks in the US is up 27% from the third quarter of last year when looking at fourth quarter numbers. The number of distressed banks during the 3^rd quarter was up 32% from the second quarter. When comparing the number of distressed banks from the second quarter to the fourth quarter the increase was almost 60%! This is in spite of the fact that mark-to-market rules were suspended last year. If you’re not familiar with mark-to-market rules, these rules require that a bank report assets on its balance sheet at current market value rather than face value. These rules were suspended last year as I’ve reported in prior blog entries. And, even though these rules have been suspended, the number of distressed banks has continued to rise to levels not seen in many years.

Why?

Simple. While mark-to-market provides some benefit to banks when reporting asset values, allowing them to report values higher than what the assets are really worth, the reality is that many assets currently on the books of banks are not worth the amount reported on the books of the bank. Many of these assets are worth only a fraction of the reported value, resulting in even more potential bank failures.

The math above doesn’t lie.

I’ve discussed this in many prior blog entries and the very fact that the number of distressed banks has increased by almost 60% in just 6 months proves that the underlying health of many banks is suspect at best.

Wait until the commercial real estate and the second phase of the rate reset mortgage kicks in. The numbers will likely get worse.

In my view, smart investors have incorporated exit strategies into their investment portfolio. Exit strategies are designed to lock in a profit or prevent a significant loss by determining at what predetermined point an investment will be sold. Although having a particular investment strategy does not ensure a profit or guarantee against loss, the use of exit strategies in volatile markets may be beneficial.

And, from where I sit, there may not be much time to do so.

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This information is education in nature and, therefore, is not intended to constitute investment advice and should not be interpreted as a recommendation to purchase, sell or hold a particular security. Prior to making any investment decision, the services of an appropriate professional should be sought as investment related recommendations are dependent upon the personal situation of each individual investor. Investing in market related securities involves a risk of principal loss