18 banks have gone under so far this year. But how do you know if yours will be next? Keith Fitz-Gerald says the IRA Bank Industry Stress Index can be used like a financial X-ray to see what’s really going on in the banking sector.

This from Money Morning:

When federal banking regulators last week seized the Houston-based Franklin Bank SSB (FBTX), it became the 18th bank failure this year amid the ongoing credit crisis. With total assets of $5.1 billion and total deposits of $3.7 billion, Franklin wasn’t the largest bank failure this year – that honor belongs to IndyMac Bancorp Inc. (OTC: IDMCQ), which had more than $30 billion in estimated assets when it was seized by U.S. banking regulators in July. At the time, IndyMac was also the third-largest bank failure in U.S. history, reaching all the way back to 1934, U.S. News & World Report said at the time.

That begs the question: Is your bank safe? And perhaps a second question: Why should you care? After all, aren’t deposits guaranteed by the Federal Deposit Insurance Corp. (FDIC)? And weren’t the limits on covered deposits raised from $100,000 to $250,000 as part of the $700 billion banking bailout deal?

Those all are true points. So long as we continue to see a bank failure here and another one there, everything should be copacetic.

But here’s the thing: By the end of 2009, about 110 U.S. banks with assets of more than $850 billion will fail – and that could cost the FDIC as much as $200 billion more than it has, says Christopher Whalen, co-founder of the Los Angeles-based Institutional Risk Analytics, a risk-management and consulting firm with an expertise in the financial-services industry.

Most banks are fine, IRA says. But even industry insiders say the banking business is in for some rough times.

“It’s not going to be Armageddon,” Mark Vaughan, an economist and an assistant vice president for banking supervision and regulation at the Federal Reserve Bank of Richmond, told Bloomberg Markets magazine recently. “But it’s going to be bad.”

If bank failures accelerate, and the FDIC insurance fund goes bust, there will probably be a taxpayer bailout. But no one knows what form that could take or what the payout ratio might be. And industry experts do expect dozens of banks to fail in the months to come.

So why take the chance?

You shouldn’t. But how can you tell if your bank could be one of them?

Ironically, if you look to the Federal Deposit Insurance Corp. (FDIC) for guidance – as most investors do right now – you won’t have a clue. That’s because its list of so-called “troubled institutions” is a closely guarded secret. The FDIC will tell you that 117 banks were on the list recently, up 30% from 90 at the end of the first quarter. And, in its desire to be ever so helpful, the agency also will tell you that the combined assets of troubled banks recently rose to $78 billion, a jump of 200% from only $26 billion at the close of the first quarter. Capital-loss provisions rose 240% to $50.2 billion.

But the FDIC won’t tell you – no matter how politely you ask – which institutions are most at risk (nor which are the healthiest) even though the government has this information at its fingertips. The FDIC says that it maintains this secrecy to prevent a run on troubled banks and enhance the overall stability of the banking community.

To me that seems an awful lot like asking investors to buy insurance after they’ve crashed their car.

So, we’ve got to turn to other sources in an effort to protect our capital.

One of our favorites is the IRA Bank Industry Stress Index published by Whalen and his colleagues at Institutional Risk Analytics. What makes the IRA Stress Index so compelling is that it’s based on the FDIC’s own data. That means it’s sort of like a financial X-ray that allows you to see what’s really under the hood – even though the government won’t tell you.

“Problems in the financial industry are of a scale that most people simply can’t imagine,” Whalen says. “Existing ratings and research coverage are clearly inadequate. That means we’ve got to come up with new ways to look at bank safety and soundness – particularly when it comes to increasing consumer awareness of transparency. And safety.”

Martin Hutchinson, a fellow editor here at Money Morning and a 30-year veteran of the banking industry, agrees, noting that “knowledge, after all, is power. Particularly when consumers are caught in the middle like they are now.”

Although this financial intelligence originally was designed for institutions trying to make sense of the FDIC’s database, IRA recently created a personal report that allows individual investors to X-ray their own banks. Available for $50, the report classifies data into six broad categories at combine to create what IRA calls the “Key Safety and Soundness Indicators:”

• An overall “Stress Rating.”
• Return on Equity (ROE).
• Loan defaults.
• Capital.
• Lending capacity.
• Efficiency.

In contrast to other free services that simply provide a numerical grade or a star ranking without much in the way of helpful context, IRA provides an industry benchmark for each category so that investors can make “apples-to-apples” comparisons between banks. It also helps investors judge for themselves how risky any U.S. financial institution tracked by the FDIC actually is – or isn’t.

Whalen notes that the IRA model frequently provides early warnings, too. In the early months of 2006, for instance, he noted that the “Overall Industry Banking Stress Index began climbing at a time when most of Wall Street was in denial.”

Pointing to a sample report on Washington Mutual Inc. (OTC: WAMUQ), which he shared with Money Morning, Whalen said that, “in June 2008, just before Uncle Sam crashed WaMu’s party, the beleaguered bank had an Overall Stress Rating of 21.6 – versus an industry average of 1.4.”

In other words, according to IRA’s calculations, WaMu was more than 10 times riskier – which equates to more than a full order of magnitude – than the average bank. WaMu has since been purchased by JPMorgan Chase & Co. (JPM).

Obviously, WaMu is hardly alone. And it won’t be the last bank to fail.

According to Whalen, the IRA Overall Industry Banking Stress Index is still rising, which is why as many as 110 banks are at risk of failure.

But individual investors no longer have to fly blind, for they now have a tool to gauge whether their bank is likely to be on the FDIC’s watch list.
To find out more, please click here.

Source: Credit Crisis Safety Plays: Banking Ratings Report Can Provide Peace of Mind and Warn You if Your Bank is Weak