Wednesday, September 17, 2008

Evaluating the Soundness of Banks

Now that WaMu stock is trading at penny-stock prices, my friend closed his account yesterday at the bank because he was worried about its imminent collapse. He told me that there were 20 people ahead of him withdrawing significant amounts of money, clearly due to the same concerns.

I referred my friend to this article from the Los Angeles Times that discusses ways we can evaluate (or at least get a better idea) of a bank's solvency.

The Federal Deposit Insurance Corp.’s website lists 11 firms that rate banks and thrifts and provide reports online, by mail or even over the phone.

The articles states:

"Some of these services are expensive and oriented toward financial professionals. But and BauerFinancial Inc. give free access to their ratings on all 17,000 U.S. banks, savings and loans and credit unions. Most institutions get three or four stars, with five best.

Veribanc issues twin ratings: one on the institution's current condition, plus a forecast of its prospects. The ratings for one bank or credit union cost $10; additional institutions are $5 apiece.

The rating experts take pains to caution that a low rating does not signal that collapse is likely. Even the worst-off banks -- those on the FDIC's secret list of troubled institutions -- have failed only 13% of the time, the agency says. Most worked their way back to health." (Italics mine.)

The best advice given in this article is to NOT trust bank employees' assurances or opinions about what's covered and what's not. Greg McBride, senior analyst at Bankrate asked, "Do you really want to have as your financial advisor someone making $10/hour on the other side of the teller window?" McBride instead advises looking at 2 calculators that estimate your deposits' insurance coverage: 1.) FDIC's EDIE calculator and 2.) NCUA's credit union share estimator.

If you want to do more than to rely upon Bankrate or Bauer Financial's rating system, also offers free access to selected financial data for each institution.

The link in the article points out things to look for:

"Ratio of nonperforming assets to total assets, an indicator of the scale of a bank's problem with bad loans. A ratio of less than 1% was traditionally the badge of a healthy bank, but the housing bust and mortgage meltdown have catapulted many institutions far beyond that threshold these days.

Equity-to-assets ratio. This is a bank's equity -- also known as its capital or net worth -- relative to its loans and other investments. The ratio is a measure of the bank's cushion against losses. IndyMac's ratio was 5.8% on March 31, its last public report. That compared with 8.2% at Bank of America, 8.9% at Beverly Hills-based City National Bank and 19.9% at Long Beach's Farmers & Merchants Bank.

Total risk-based capital ratio. This is a bank's capital adjusted for the riskiness of its loans and other investments. Look for 11% or better, advises Anaheim banking consultant Gary S. Findley. Although 10% meets the definition of "well-capitalized," Findley said, a ratio that low these days "raises regulatory concerns -- a lot of banks want to be 14%-plus."

Other data. The ratio of non-interest-bearing deposits to total deposits is essentially how much of the money a bank "borrows" from its depositors is interest-free. Higher is better. By contrast, the lower the ratio of loans to deposits, the stronger the bank will tend to be, at least from a depositor's perspective. A lower ratio of jumbo CDs and borrowings to assets is also a plus.

If you're especially intrepid, or suffer from insomnia, you can plunge into the quarterly reports banks and thrifts are required to file with federal regulators. These highly technical filings, known as call reports, contain a large amount of financial data. They are available online at FFIEC's website. There you can check out:

Past due and nonaccrual loans as a percentage of total loans and as a percentage of capital. These are loans on which borrowers are behind in their payments or have stopped paying altogether. If such loans exceed 5% of total loans or 50% of capital, that's a red flag and should be looked into, Findley said.

Brokered deposits. These are deposits placed by intermediaries on behalf of savers looking for the best rates they can get on substantial nest eggs. Less is better. "Too many brokered deposits raises potential liquidity issues," Findley said."

Additionally, when I looked up WaMu on Bankrate, I found 2 choices: (1) Washinton Mutual Bank, Nevada and (2)Washington Mutual Bank FSB, Utah. Which one do I choose?

This other link in the article explains that the FDIC's online directory helps you sort this out. Bauer Financial lets you search for ratings using a unit's unique FDIC certificate number, which you can get at your branch or the FDIC insitution directory.

Since the most common sense advice we are given with respect to our investments is to diversify, why would this be different with where we keep our money? I have my money split between 4 banks and 1 credit union. All have varying degrees of accessibility and I'm sure, solvency. But since I haven't kept all my eggs in one basket, I feel very comfortable knowing that I'll won't lose access (even temporarily) of all of my liquid assets.