Banks needing capital, and other misleading statistics

Right now, it’s a pretty good idea for investors to get a handle on the balance sheets of key financial institutions — in light of recent bank failures, and a looming spate of further failures ahead, grappling with capital adequacy and even the direction of future earnings is a key question. Philip van Doorn at takes a swing at identifying the ten largest banks and ten smallest banks in need of capital, like right now. Some of the obvious suspects are on the list, like Fremont General Corp., but there are others he identifies. van Doorn makes a good attempt, but we think he’s focusing on a measure isn’t as forward looking as it could be — his list ranks banks using the total risk-based capital ratio. A good stat in theory, but it rolls up capital classifications and is dependent on the risk-weightings banks assign to asset classes. (We’re skeptics at heart here at HW, which means we don’t take at face value a bank’s assessment of the risk on its own books.) Being the mortgage nerds we are, we tend to focus in on a ratio that’s a little cleaner: loan loss reserves against non-performing loans. It’s a quick and easy way to see directionally where a bank’s income statement is going to head in future quarters, and following it the past few quarters has demonstrated a pretty uncanny predictive ability. In general, if a bank hasn’t set aside close to 100 percent of its NPL base, we tend to think they’re going to be upping reserves. The further from 100 percent a bank gets, the larger that provision charge is likely to be. By that measure, and looking at van Doorn’s list of top ten large banks that are “undercapitalized,” Fremont Investment & Loan is clearly in the red — loss reserves comprise just .02 percent of non-performing loans. But others pop out as well. Reno, Nevada-based First National Bank of Nevada, a privately-held bank with $1.6 billion in assets, posted a reserve ratio of 41.74 percent at the end of the first quarter. $4.1 billion PFF Bank & Trust [stock PFB][/stock], based in Pomona, Calif., posted an even more woeful 22.92 percent reserve ratio — and NPAs represent nearly 11 percent of assets. Yet the bank is considered “adequately capitalized” under risk-based capital measurements. We can’t help but wonder what that capital might look like if the bank were required to reserve something closer to 100 percent of current NPLs on its books. Note: authors held no stock in publicly-traded firms mentioned in this BuzzPost.

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