Institutional Risk Analytics
www.institutionalriskanalyics.com
Lord, Whalen LLC
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Phone: 310-676-3300 Fax: 310-943-1570

May 6, 2009

IRA Releases Preliminary Q1 2009 Bank Stress Index Results
Significant Increase in Stress Across the US Banking Industry
Summary

In Q1 2009, the bank safety and soundness ratings calculated by the IRA Bank Monitor using the data from the FDIC indicate a dramatic climb in the stress in the US banking industry. The industry aggregate average Bank Stress Index calculated by IRA was 1.8 at the end of Q4 2008, but in Q1 2009 jumped to a whopping 5.57 or now half an order or magnitude above the 1995 benchmark year which is = 1. The apparent reason for this large increase in stress is the number of banks that delivered negative net incomes in the first quarter of 2009, one thousand five hundred seventy-five (1,575) of them.

Below is a discussion of the Q1 2009 results for the banking industry based on the CALL reports filed with the FDIC so far. IRA’s unique automated system enables us to gather and process CALL reports in real time, as they become available on the FDIC web site. We will be releasing summary data to the public on Thursday. Users of the consumer and professional version of the IRA Bank Monitor will also be able to see the ratings for individual institutions that have filed their CALL reports to date when we enable those new displays next week.

This overview may be attributed to IRA CEO Dennis Santiago, who is the designer of the Bank Monitor and other IRA analytics, and prepared the Q1 2009 preliminary results. Both Dennis and I are available for interview. Dennis is based in Los Angeles and I in New York. Email me to schedule. Thank you.

Chris Whalen
cwhalen@institutionalriskanalytics.com (914) 827 9272

The FDIC’s CDR: Technology Innovation That Actually Works

We admire the Federal Deposit Insurance Corporation for many reasons. This month, we applaud them once again for the fine job they have done to bring the Central Data Repository (CDR) online in a way that serves the growing public demand for timely US bank data. Made operational just in January of 2009, we’ve just collected Q1 2009 CALL reports for over 7,600 reporting units, a goodly portion of which came out of submittal confirmation only a couple of days ago.

These CALL reports are submitted to the FDIC during a 30 day submission window beginning the first day of the quarter. We’ve been testing a variation of IRA’s ratings analyzer on these Q1 CALL’s since April 1st. The result is that IRA is now positioned to deliver preliminary bank stress estimates for the new quarter roughly two to three weeks ahead of the FDIC’s mid-quarter research master file release. Based on this maiden run, we are pleased to report that the FDIC’s CDR engine has the potential to enable a quantum leap in granularity looking at the U.S. banking industry.

Coupled with our data analyzers, it’s possible to generate analysis on bank units as they file their CALL’s and, based our findings, generate a industry picture in around 36 to 48 hours after the close of the CALL submittal window. That’s pretty good!

Stable Pie Slices, But Dramatic Increase in Banking Industry Stress

Based on looking at sample set of around 91% of the test population used in Q4 2008, we observe that the distribution of IRA Bank Stress Rating grades for Q1 2009 retains the roughly 2/3rd to 1/3rd ratio of banks with A+/A grades versus elevated stress institutions IRA detected was characteristic of the banking industry throughout 2008.

We see indicators of a continued migration of banks from the A+ range where stress fall below the index Dec-1995 = 1.0 start mark into the A range indicating more banks are now feeling the effects of economic conditions regardless of the business practice models they’ve had in place.

At this time we do not know what the disposition of the remaining 750 or so institutions that are not in the CDR as of 5/3/2009 now have we had a chance to determine who these missing units are. Most are likely thrifts because the OTS tends to hold the data for internal analysis before releasing it to the FDIC.

At first glance the situation as of Q1 2009 may seem to be getting better. But it’s not. In prior quarters, banks wound up getting “F” grades because they were barely making money; that is, they had small but positive net incomes that produced ROE’s sufficiently below industry averages to indicate elevated business operating stress. A lot of these institutions were suffering due to mark-to-market accounting, goodwill write-downs and other ROE issues.

In Q1 2009, the data indicates a dramatic climb in the industry aggregate average Bank Stress Index from 1.8 at the end of Q4 2008 to a whopping 5.57 coming out of 1Q 2009 or half an order or magnitude above the 1995 benchmark. The reason for this is the number of banks who delivered negative net incomes in the first quarter of 2009, one thousand five hundred seventy-five (1,575) of them.

Keep in mind what the Q1 2009 FDIC data is saying: Even with the change in the FASB rule for M2M accounting, and Fed liquidity programs, the leading factor driving higher industry stress scores remains ROE degradation, not charge-offs or operational factors such as efficiency. When charge-offs are the leading factor in the IRA Banking Stress Index, then the industry will be through the worst.

The Q1 2009 results calculated by IRA are looking a little like a table from the CDC’s H1N1 confirmed laboratory cases page. Our overall observation is that U.S. policy makers may very well have been distracted by focusing on 19 large stress test banks designed to save Wall Street and the world’s central bank bondholders, this while a trend is emerging of a going concern viability crash taking shape under the radar.

We’ve noted in the past that US banks have been migrating down the quality slope taking an average of 9 months to complete the journey from “A” to “F” on the stress scale. The story is predictable. It begins with business losses and recriminations. This is followed by lending engine contraction as the propensity to create exposure narrows towards risk aversion and “quality lending” exclusivity. This is a rare diet to try to live on in these times. The bank, which makes its’ living wage from the interest it collects from its’ lending engine slowly starves.

At a certain point the carry cost of the infrastructure outweighs the earnings rate. Then you start to see strange shifts to seek incremental income from service fees, a move that often only serves to increases customer reluctance and mistrust. The end result is a stressed business model that can only be remedied by getting the core business, its’ lending engine, running again.

Counting the fourth quarter of 2007 when IRA’s data indicates this phenomenon began to emerge, we are now eighteen (18) months or one-half of a business cycle dragging this massive boat anchor the behind the US economy. We may have wasted valuable time trying to save Wall Street at the cost of Main Street.

At this point the reasons no longer matter. It’s time to win by thinking gracefully. The numbers indicate we need to seriously ask the question as to whether economic recovery for the United States can still come from repairing Wall Street – or whether instead we should be worried about addressing the underlying loss rates that are driving the provisioning behind these poor ROE results. Has the time come to shift the policy focus away from the things that we love, namely big zombie banks, to those tackle things that are truly hurting us?

IRA is presently working on adapting the accompanying bank-holding company (BHC) extension of our ratings system to also feed of CDR collected preliminary data. IRA preliminary indicators will be incorporated into both of our online products, the IRA Bank Monitor for Professionals and the IRA Bank Ratings Service for Consumers. We continue to support our “prime solution” philosophy that it takes everyone with fair, equal and transparent access to risk information to collectively guide our economy to recovery.

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