The chairman of the Federal Deposit Insurance Corporation warned that the market downturn is far from over, more banks will become troubled and more will fail. She also laid out a number of early signs of problem institutions.
FDIC Chairman Sheila Bair made the comments in a presentation before the Florida Bankers Association yesterday, according to a transcript of her speech.
She noted dismal second-quarter banking sector result were due to declining non-interest income, rising non-interest expense, declining gains on securities sales and mounting loss provisions. But the biggest factor was expenses for credit losses.
While one-third of operating revenue was devoted to building up reserves, the sector's coverage ratio remains at a 15-year low because of the rapid rate at which loans are going bad.
The FDIC chief also warned that banks must get their balance sheets in order.
"You simply must accept that the credit downturn is far from over," she said. "It's a tough slog but there's no easy way out."
Residential loans were responsible for the biggest share of the increase in troubled loans, but construction loans were the fastest-growing category. She noted 18 percent of banks were unprofitable in the second quarter, compared with 10 percent a year ago.
There were 117 institutions on the "problem list" as of June 30, the highest since mid-2003, and the list is growing. Assets at problem banks increased from $26 billion to $78 billion -- with $32 billion of the increase coming from failed IndyMac Bank.
And more banks are expected to fail, with the number reaching 10 so far this year.
"We will certainly see more banks fail," she stated.
But Bair said 98 percent of institutions are well-capitalized.
She explained that early signs of a problem bank include rapid asset growth funded by potentially volatile liabilities, a reliance on large depositors and concentrated funding sources, and offering rates significantly above the local deposit market and through Internet sites. Other signs include negative publicity, a decline in asset quality or earnings performance, and counter-parties who increase collateral requirements.
Bair also warned about relying on brokered deposits, which she said will be scrutinized more closely going forward at borderline institutions.