Banking on security of local lenders

By DAVID MOON, Moon Capital Management, LLC
July 20, 2008

When Pasadena-based IndyMac Bank failed with $32 billion in assets and was taken over by the FDIC a week ago, it was the second-largest bank failure in U.S. history. As the banking crisis has worsened over the last several months, many depositors have probably questioned the soundness of the entire banking system, particularly their personal bank.

As we learned watching James Stewart in 'It's a Wonderful Life,' banks don't actually keep all of your cash in the vault. They lend it to folks who pay interest and eventually repay the loan balance to the bank.

Well, that's how it's supposed to work, anyway.

On March 31, 8.65 percent of IndyMac's loans were noncurrent. That means the borrowers were either behind on their payments or simply weren't making payments. If you add the real estate that the bank had foreclosed as a result of defaulted loans, the percentage grows to 11.55 percent.

The average yield on the bank's loans was 6.69 percent.

Seems like it would be hard to stay in business long if you were loaning money at 6.69 percent and more than ten percent of your borrowers didn't pay you back.

Yet the bank wasn't even on the government's official list of troubled banks this spring. Do you have to shoot someone to get on that list?

Using IndyMac as an example of how not to run a bank, how do some local lenders compare?

They're better.

First Tennessee's parent, First Horizon, which replaced its president and CEO last week, has 20 percent of local deposits. Based on its March 31 reporting, 3.25 percent of its loans were noncurrent. It had reserves equal to 90 percent of its nonperforming loans.

For comparison, IndyMac's reserves were only 17 percent of its nonperforming loans.

Like First Tennessee, SunTrust has reserved less than its nonperforming loans, at 76 percent.

On the other end of the scale, Knoxville's Home Federal Bank has reserves exceeding 1,000 percent of its nonperforming loans. At 0.05 percent, Home Federal's nonperforming assets are almost nonexistent.

BB&T and Regions also have each reserved more than their reported nonperforming loans. One reason: First Tennessee and SunTrust have higher percentages of noncurrent loans on their books than either BB&T or Regions.

If a bank hasn't yet reserved an amount equal to its nonperforming loans, perhaps the bank is expecting a significant percentage of its bad loans to start performing again. If not, it will likely either have to increase its reserves in the future or do something even less pleasant, like write off loans or sell them at a discount.

It is possible, of course, that different banks might use different definitions of 'nonperforming,' so this measure can be misleading.

Even the regional bank stocks with significant stock-price declines appear to be much healthier than one of the few banks to be taken over by the FDIC during this recent debacle. Based on the reported figures, the balance sheets aren't even comparable.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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