Learn if Your Bank is Undercapitalized

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ome undercapitalized banks were nearly wiped out by securities losses springing from the government takeover of Fannie Mae (Stock Quote: FNM) and Freddie Mac (Stock Quote: FRE) in September, which all but eliminated the value of the mortgage giants' preferred stock. There have been indications that the federal government's infusion of capital into 52 bank and savings-and-loan holding companies (at last count) is settling things down. However, Treasury's planned $250 billion in preferred equity investments is mainly going to stronger institutions. Preliminary third-quarter industry data for the nation's banks show that the number of undercapitalized institutions increased considerably from June 30.

To be considered well-capitalized under regulatory guidelines, a bank or S&L needs to maintain a leverage ratio of at least 5% and a risk-based capital ratio of at least 10%. At the end of the second quarter, 127 banks and 12 S&Ls were considered below well-capitalized.

TheStreet.com has preliminary Sept. 30 call-report data for 97% of U.S. banks, but S&L information won't be available for a few weeks.

Looking at the early bank data, 139 banks were below well-capitalized. Of 36 considered undercapitalized, six were significantly undercapitalized and seven critically undercapitalized.

Before listing the 13 banks, it is important to point out:

The list is based on preliminary data. Most banks have filed their call reports, which our data provider, Highline Financial Inc., obtains from the FDIC. The set of data was not yet finalized when downloaded on Nov. 10, and about 3% of banks had not filed yet. The call reports are often updated by banks before they are finalized.

The list includes only banks. The Office of Thrift Supervision doesn't make preliminary data available for the more than 800 S&Ls supervised by the agency.

The data are for the banks themselves, not holding companies.

These banks were considered significantly or critically undercapitalized as of Sept. 30.

Of 13 banks that reported being significantly or critically undercapitalized as of Sept. 30, five have already failed. These institutions are in bold on the table.

Meridian Bank of Elred, Illinois, was shuttered on Oct. 10.

Alpha Bank and Trust was closed by Georgia regulators on Oct. 24.

Freedom Bank of Bradenton, Florida, failed on Halloween, with its branches taken over by Fifth Third Bank of Grand Rapids, Mich. (held by Fifth Third Bancorp.

Franklin Bank, SSB of Houston, and Security Pacific Bank of Los Angeles, were shut down by state regulators last Friday. Franklin's branches were taken over by Prosperity Bank of El Campo, Texas (held by Prosperity Bancshares, and Security Pacific's branches went to Pacific Western Bank of San Diego, a subsidiary of PacWest Bancorp.

Moving on to the eight banks remaining on the list, four posted large securities losses during the quarter, causing them to slip from well-capitalized status. While the call reports don't list the specific issues the banks lost money on, it's clear that most losses sprang from the government takeover of Fannie Mae and Freddie Mac. We confirmed this for two of the institutions, from an earnings release and an executive interview.

TheStreet.com contacted all eight remaining institutions on the list, but only one responded in time for this article.

National Bank of Commerce of Berkeley, Ill., reported $57 million in securities losses during the third quarter, which wiped out most of the $459 million institution's capital. Total equity capital was just $5.7 million as of Sept. 30, down from $41 million at the end of the second quarter. With deductions for deferred tax assets and disallowed goodwill, the bank's tier 1 capital was negative $39 million. National Bank of Commerce's loan quality hasn't been a problem, as the institution reported nonperforming assets comprising 0.95% of total assets as of Sept. 30, with no loan charge-offs year to date.

Oakland Deposit Bank of Oakland, Tenn., reported net loan charge-offs of residential, commercial and consumer loans totaling $7.2 million during the third quarter. To cover the charge-offs and expected future losses, the $126 million institution set aside $8.7 million for loan loss reserves in the quarter, which lowered its total capital to just $1.8 million. Oakland Deposit was considered critically undercapitalized as of Sept. 30, and its leverage and risk-based capital ratios were 1.43% and 3.11%.

Another bank hit hard by the Fannie and Freddie debacle was New York City's Berkshire Bank, held by Berkshire Bancorp. Securities losses during the quarter totaled $94.5 million, leaving the $917 million bank with a net loss of $88.5 million and just $3.8 million in total capital as of Sept. 30. This is another bank that has maintained good loan quality through the crisis, as nonperforming assets comprised 0.83% of total assets as of Sept. 30, and year-to-date charge-offs were close to zero.

Berkshire Bancorp announced on Sept. 16 that Moses Marx, the company's chairman and majority stockholder, would make $60 million in cash available for the company to draw upon to bring Berkshire Bank back to well-capitalized status, subject to regulatory approval. Apparently, this approval was not granted before the end of the third quarter.

One United Bank of Boston was well-capitalized at the end of the second quarter, but slipped to critically undercapitalized, with a leverage ratio of 1.70% and a risk-based capital ratio of 3.67%, as of Sept. 30. The institution reported securities losses of $54.9 million during the third quarter, leading to a net loss of $48.3 million and leaving One United with $11.8 million in tier 1 capital to support $625 million in total assets.

The good news is that the bank has raised about $20 million in additional capital during the fourth quarter. Robert P. Cooper, senior counsel for One United Bank, said the institution is now adequately capitalized per regulatory guidelines and expects to improve to well-capitalized by year-end. "The reduction in capital was solely the result of the government conservatorship of Fannie and Freddie," he said.

One United Bank is a certified Community Development Financial Institution (CDFI), whose main business is lending to low- to moderate-income individuals and businesses in Boston, Miami and Los Angeles. The CDFI Fund is run by the Treasury Department, and allocates monetary awards and tax credits to foster development in distressed areas.

"This is actually a good story," said Cooper, who pointed out that the bank hadn't engaged in "the subprime madness," and was on pace for strong earnings before Fannie and Freddie were taken over. Indeed, One United Bank has maintained decent asset quality in the crisis environment, with a nonperforming assets ratio of 1.51% as of Sept. 30, and more importantly, an annualized net charge-off ratio of just 0.35%.

For the remaining three (surviving) banks on the list, there were no securities losses in the third quarter. The problem is loan quality. Citizens Community Bank of Ridgewood, N.J., fell below well-capitalized in the fourth quarter of 2007 and has continued to drop as losses from the institution's construction and residential loan portfolios threaten to overwhelm its capital. The $45 million bank's annualized ratio of net charge-offs to average loans year-to-date was 11.10%, while loan loss reserves covered just 2.53% of total loans as of Sept. 30. It's hard to see how Citizens Community can survive without raising additional capital.

Corn Belt Bank & Trust Co. of Pittsfield, Ill., has also reported a very high level of charge-offs during 2008. Year-to-date net charge-offs (mostly commercial loans) totaled $13 million, or an annualized 19.69% of average loans. The ratio of nonperforming assets to total assets was 2.25% as of Sept. 30. Corn Belt B&TC hasn't been carrying high levels of nonperforming loans over the past year, meaning the institution quickly charges off bad loans. So there's no way to know if its reserve coverage will be adequate in the future. The bank's leverage ratio was 2.73% and its risk-based capital ratio was 5.09% as of Sept. 30.

Community Bank of Loganville, Ga., reported nonperforming assets of 37.83% of total assets as of Sept. 30. Like so many banks in and around Atlanta, Community Bank had an overconcentration in residential construction loans, which comprised 64% of the $635 million bank's assets as of Sept. 30. After losing $8.7 million in the second quarter, the bank posted a net loss of $18.2 million, as it continued to beef up its loan-loss reserves, which covered 9.11% of total loans as of Sept. 30.

This level of reserve coverage is way ahead of the annualized pace of net charge-offs, which was 2.23% of average loans for the first three quarters. However, with losses on nonperforming construction loans often "approaching 50%," according to one veteran loss mitigation specialist, it's possible that Community Bank's $46 million in loan-loss reserves won't cover losses from the bank's $171 million in nonperforming construction loans.

Hope for regulatory assistance

Sydney Garmong, a partner with Crowe Horwath LLP, a top-10 public-accounting and consulting firm, said the Emergency Economic Stabilization Act of 2008 (also known as the $700 billion bailout) left open the possibility of the Treasury offering assistance to banks and thrifts with less than $1 billion in assets that slipped to undercapitalized because of losses from Fannie and Freddie preferred stock.

This offers hope to National Bank of Commerce, Berkshire Bank, State of Franklin Savings Bank and other undercapitalized institutions that took significant losses on GSE preferred shares. They also must meet other qualifications such as serving "low- and moderate-income populations and other underserved communities."

Bank and thrift ratings

As we see in the third-quarter numbers, loan quality isn't the only threat to banks and thrifts. Many banks that maintained good loan quality were hurt by investments that were previously considered rock-solid. The pace of failures is accelerating, so it's important to keep an eye on the safety of your bank or savings-and-loan institution. TheStreet.com Ratings provides objective, conservative financial strength ratings for all U.S. banks and thrifts.

While the FDIC has temporarily raised deposit insurance limits, it is still a good idea to check out your institution's rating, and ask some questions if the rating is below a C- (Fair Financial Strength).

It is also important to consider that you or someone you know may be affiliated with a business or municipal depositor (such as a school district) that keeps large uninsured balances in a local institution. P/>Financial Strength Ratings on each of the nation's 8,600 banks and savings and loans are available at no charge on the Banks & Thrifts Screener. In addition, the Financial Strength Ratings for 4,000 life, health, annuity, and property/casualty insurers are available on the Insurers & HMOs Screener.

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