How to tell if your small bank is in trouble

By Maureen Farrell and Brett Nelson

updated 12:06 p.m. ET Oct. 16, 2008

Every morning now seems to bring the dread of wondering which financial shoe will be the next to drop. If giants AIG, Lehman Brothers, Wachovia and Merrill Lynch can fall so hard and fast, what about smaller lending institutions serving thousands of U.S. small-business customers?

Somewhat comforting: The new $700 billion economic-recovery package ensures that the Federal Deposit Insurance Corporation will safeguard up to $250,000 in deposits — including checking, savings, money-market accounts and certificates of deposit — at any bank, up from $100,000 before the financial crisis hit, and the assurance is good through December 2009. (The FDIC does not ensure stocks, bonds, mutual funds, life insurance policies or municipal securities.)

Now there's even talk of insuring all deposits, though nothing specific has been proposed. "If your bank can make it through this year, it will probably be okay," says Jim Nolen, a professor of finance at the University of Texas at Austin.

Spotting trouble isn't easy (witness the current crisis), but there are some warning signs, if you know where to look. One spot: the FDIC's call report on your bank. The FDIC keeps these quarterly financial reports on every U.S. financial institution.

Clearly, economic conditions have changed in the last three months, and as detailed as these reports appear to be, there still are plenty of unknowns. However, these reports do offer some clues as to your bank's ability to weather the storm.

First, a healthy word of warning: A few numbers in a call report don't mean you should snatch your funds and run for cover. If you're worried that your bank might teeter, don't panic. Talk at length with your financial adviser before making any sudden moves. If you want some extra protection in the meantime, think about diversifying your risk by making additional deposits in a few other banks.

One important measure of a bank's financial stability is its risk-based capital ratio. By law, commercial banks need to keep a certain amount of capital on hand to cushion their loan portfolios. The FDIC mandates that a bank's risk-based capital be no less than 6 percent of its total assets. You'd like a little more cushion than that — perhaps 8 percent. To find this ratio in the call report, turn to the Regulatory Capital section, called Schedule RC-R, and look for the line item "Total risk-based capital ratio."

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Next, look at the bank's loan-to-deposit ratio. Even if your lender didn't lard up on mortgage-backed securities, it might still be "loaned up" — meaning that it has maxed out its percentage of loans to deposits on hand. The larger that percentage, the greater the risk the bank has taken on. If customers begin to pull deposits, the bank might be suddenly strapped for cash.

Healthy loan-to-deposit ratios typically fall between 95 percent to 105 percent, says Dick Bove, bank analyst at Punk Ziegel & Co., a boutique investment bank and advisory. Venture much higher than that and the bank could be courting trouble. To find this ratio, divide "loans and leases, net of unearned income and allowance" (item 4.d. in Schedule RC-Balance Sheet) by "deposits" (item 13 in the same Schedule).

A third metric is the percentage of the dollar amount of non-current loans (those 30 days or more past due) vs. total dollars lent. Some fraction of those non-current loans will have to be written off, eating into the bank's precious capital. During the 1991-1992 U.S. recession, the industry-wide percentage crept north of 6 percent, a historic high, according to Standard and Poor's.

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"When 10 percent of your loans are non-performing, that starts to become very problematic," says Haluk Ünal, professor of finance at the Robert H. Smith School of Business of the University of Maryland .

To calculate your bank's percentage, divide the total dollar amount of loans that are 30 days or more past due (found in Schedule RC-N) by total loans and leases (again, item 4.d. in Schedule RC-Balance Sheet).

In addition to offering a glimpse of a bank's financial footing, the June call reports also illustrate the extent to which lenders do business with small companies. Shopping for a new bank and want to know if it likes to make loans under $100,000 or up to $1 million? Check Schedule RC-C.

If your bank is struggling and the FDIC takes it over, know that you may not have access to your funds for several days during the change-over period. To be safe, small-business owners should have a week's worth of operating expenses deposited at another institution.

Whatever happens in the coming months, expect at least some consolidation in the banking sector. Some good news there: Say you have $250,000 at Bank A and Bank B, and those two choose to merge. For a grace period, typically six months, all $500,000 are FDIC-insured, as opposed to just $250,000.

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