What’s $10 billion between friends? That’s what the FDIC is asking a handful of large banks as the insurance operation attempts to rebuild its balance sheet. Currently, the FDIC is reeling from the losses it has taken as nearly 100 banks have gone belly up this year. As the black list of troubled banks continues to grow, the FDIC is running short on capital used to guarantee deposits.
Now before you go and pull your money out of the bank and put it under a mattress, please understand that the FDIC is not insolvent. Even under the worst case scenario where the coffers turn up completely empty, the US Treasury will extend a credit line to insure the deposits, so we are far from a place which warrants a run on the bank. But since the FDIC wants to make sure that line of credit is never actually used, they are asking four of the largest banks to pre-pay a hefty chunk of fees in order to shore up the balance sheet.
The request comes at a time when banks are struggling to re-build their own balance sheets and instill confidence in their financial soundness. While a fully functioning FDIC is in the best interest of all banks, prepayment is certainly not a pleasant scenario for these large banks. The institutions in question are Bank of America (BAC), Wells Fargo & Co. (WFC), JPMorgan Chase & Co. (JPM) and Citigroup (C). All four of these institutions appear to have pulled back from the brink of disaster, although Citi will still likely post a loss for 2009.
The FDIC is very much an insurance program where banks are charged premiums and in return their depositors are guaranteed against a loss (for deposits up to a maximum limit). The premiums vary by bank and are calculated based on the financial soundness of each institution. While the rates may seem too small to be significant (typically 0.12% to 0.45%), earnings on these deposits are extremely low due to the low interest rates, so the premiums certainly eat into profit. If banks are required to pay 3 years worth of these premiums by the end of 2009, it would be a significant cash-flow issue.
As of the end of the second quarter, the FDIC reserve was down to 10.4 billion. That represents just 0.22% of total deposits insured. By law, the FDIC must rebuild the reserve ratio when it falls below 1.15% so there is obviously a lot of work to be done to beef up these levels. At the same time, regional banks are likely to be hit by a serious wave of commercial mortgage defaults. Many of these regional banks are significant in size and while the FDIC won’t disclose which of these banks are on its problem list, we can see that the list itself continues to grow.
So as investors, it is very important to determine the financial credibility of any financial institution you are invested in. Remember, there is no mandate to be involved in any particular industry and it may be wisest to step back from this risky sector until the financial picture clears up. Citigroup may offer the best chance for returns as investors appear to have a very negative perception of the company despite an improving condition. Still, there is plenty of uncertainty around financial institutions and the best bet may be to step aside.
FD: Author does not have a position in C
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