(JPM) Federal Deposit Insurance Corporation Announces Fewer Banks on Problem List

The number of banks on the Federal Deposit Insurance Corporation’s (FDIC) list of problem institutions saw a sharp decline to 865 in the second quarter from 888 in the sequentially preceding period, the agency said in its quarterly report on the health of the nation’s banking system on Tuesday. This represents the first quarterly drop since 2006.

Things looked so much brighter in the second quarter given the shrink in the problem list accompanied by overall profit earned for the eighth straight quarter by FDIC insured banks.

The problem list includes banks that face imminent failure due to low capital support, though some may survive and pull out of the crisis. As of now, only less than a quarter of the banks on FDIC’s problem list have actually failed. This ratio may however change if more banks heretofore on FDIC’s problem list begin to fail.

Size of Problem Banks

Most of the problem banks are small institutions. Total assets of these banks decreased to $372 billion at the end of the second quarter from $397 billion at the end of the previous. This nevertheless represents a phenomenal 62 fold jump from $6 billion in assets of 50 problem institutions in 2006.

Bank Failures So Far

There have been 68 bank failures so far this year, preceded by 157 in 2010, 140 in 2009 and 25 in 2008. On a cautionary note, increasing loan losses on commercial real estate could trigger hundreds of bank failures in the coming years. However, considering the “fail trail” so far this year, the FDIC does not expect the number of bank failures in 2011 to exceed the 2010 tally.

While the financials of bigger banks have been stabilizing on the back of an economic recovery, many smaller banks are still struggling to survive. Nagging issues like rock-bottom home prices along with still-high loan defaults and unemployment levels continue to trouble such institutions.

Lingering effects of the financial crisis continue to weigh on many banks. It becomes obligatory for such banks to absorb bad loans offered during the credit explosion, making them susceptible to severe problems. The uncertain environment is aggravating the risk of bank failures even further.

What’s the FDIC’s Role?

The FDIC insures deposits in 7,513 banks and savings associations in the country as well as promotes the safety and soundness of these institutions. The number is, however, down from 7,575 in the prior quarter. Now, the problem banks represent about 11.5% of the total number of institutions covered by the FDIC. When a bank fails, the agency reimburses customers for deposits of up to $250,000 per account.

Financial Health of FDIC

Though the FDIC has managed to shore up its deposit insurance fund over the last few quarters, the ongoing bank failures have kept it under pressure. However, at the end of the second quarter, the fund returned to the black with a surplus of $3.9 billion, substantially better than a deficit of $1.0 billion in the prior quarter. The positive fund balance seen for the first time in two years was aided by a moderate pace of bank failures and assessment revenue.

Strong Profit: Another Confidence Booster?

Besides the heartening decline in the list of problem institutions, the eight straight quarter of consolidated profit from FDIC-insured banks fails no less to impress us. The consolidated second quarter profit of FDIC-insured banks came in at $28.8 billion, up 37.9% year over year but down nominally from $28.9 billion in the sequentially preceding quarter. The year-over-year rise was primarily driven by a drop in provisions for bad loans.

However, in terms of numbers, it is only a handful of banks that generated consolidated profit during the quarter. These are primarily the large banks, of the likes of JPMorgan Chase & Co. (JPM), Wells Fargo & Co. (WFC), The Goldman Sachs Group Inc. (GS) and Citigroup Inc. (C), which were supported by government bailout money and low borrowing rates. On the other hand, smaller banks not doing too well failed to make any meaningful contribution.

The Price of Consolidation

With repeated bank failures, consolidation has become the industry trend. For almost all of the failed banks, the FDIC enters into purchase agreements with healthy institutions. When Washington Mutual collapsed in 2008 (branded as the largest bank failure in the U.S. history), it was acquired by JPMorgan Chase & Co. The other major acquirers of failed institutions since 2008 include U.S. Bancorp (USB) and BB&T Corporation (BBT).

If the current pace of consolidation continues, we will see the emergence of an oligopolistic market with a handful of large banks. Consequently, the country’s wealth and welfare optimization could be at stake.

BB&T CORP (BBT): Free Stock Analysis Report

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US BANCORP (USB): Free Stock Analysis Report

WELLS FARGO-NEW (WFC): Free Stock Analysis Report

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