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While pundits focus on the fate of larger banks like Citibank, Wachovia and Washington Mutual, far less attention is paid to the 8,500 smaller banks that are the backbone of Main Street America. Some, but certainly not all, of these banks are exposed to the same risks in the housing market that are plaguing their larger counterparts, as loan defaults strain their balance sheets. A wave of defaults, similar to what occurred during the S&L crisis, is in many ways investors’ worst nightmare and could cause thousands of these local banks to fail.
We spoke with the CEOs of two firms that specialize in analyzing risks in the banking system. Both agree banks are experiencing stress, but say the overall system is healthy. However, the current data available is as of June 30 and, as we discuss below, third quarter data could reveal a very different picture.
Institutional Risk Analytics
Chris Whalen, founder and CEO of Institutional Risk Analytics (IRA), says the broader banking system may face some challenges, but the risk of widespread failures is small and the problems facing these banks do not pose significant challenges to the economy.
Whalen founded IRA in 2003 and now collects data on banks directly from regulatory agencies. He tracks approximately 400 data points at the individual bank level and about the same amount of data at the bank holding company level. Whalen organizes his analyses to be accessible to both analysts and the general public and, more importantly, he tracks trends and changes, particularly at the individual bank level. IRA’s original initial clients were bank auditors, who look for signals of insufficient disclosure which might be indicative of fraud or a failure of internal controls. IRA’s clients now extend to all segments the investment community and, through a new product we discuss later, to the general public.
IRA monitors banks’ compliance with Basel II standards, which include default ratios, capital ratios, recovery rates, loan maturity distributions, and levels of exposure to potential default. Whalen said his data break down usage of bank clients’ credit card lines, in order to see the number of clients that have “maxed out” their credit limit. “We can see why a bank like Wells Fargo is so healthy,” said Whalen. “They keep their clients on a tight leash, as measured by the bank’s level of unused credit lines to total assets.”
One of the most critical metrics Whalen follows are banks’ efficiency ratings. Whalen has seen industry-wide efficiency levels rise from the mid-60% level to approximately-80% over the last year. He notes that Bank of America and J.P. Morgan are very strong, with efficiency levels around 50%, but that Citibank is above 60%, meaning they must spend 60 cents to generate each dollar of revenue. This is why Citibank CEO Vikram Pandit and his team have their work cut out for them,” said Whalen.
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