Thomas Curry – No cause for concern
The nation’s economy is battered and bad loans are on the rise. The loan loss reserves of the country’s banks have fallen to the lowest level in eight years. How prepared are Bay State banks to weather the economic storm? Even in the case of the weakest banks in Massachusetts, loan loss reserves are for the most part strong enough to withstand the current and future economic climate, according to industry observers.
Weiss Ratings Inc., an independent bank-rating agency, releases quarterly reports of the strongest and weakest financial institutions in the nation and in each state. As of Sept. 31, the top five strongest banks and thrifts in Massachusetts were: Bristol County Savings Bank in Taunton, Needham Cooperative Bank, Framingham Co-operative Bank, Walpole Cooperative Bank and Norwood Cooperative Bank. The five weakest, as rated by Weiss, were South Coastal Bank in Rockland, TeleCom Cooperative Bank in Malden, Benjamin Franklin Savings Bank in Franklin, Mercantile Bank and Trust Co. in Boston and Merrimac Savings Bank.
Weiss ratings are derived from five major indices: capitalization, asset quality, profitability, liquidity and stability, not all of which are weighted evenly. Loan loss reserves fall under asset quality and play a significant role in the overall rating of a bank.
Weiss recently noted that, nationally, banks set aside 42 percent more for potential losses in 2001 than in 2000, but that the industry’s charge-offs jumped 50 percent, leaving only an incremental increase in reserves for bad loans. Non-performing loans have also been rising for the last few quarters, up 20.8 percent from last year. Because the rise in reserves isn’t catching up to the rise in losses, there may be a lag effect even when the economy recovers, cautioned David Proko, Weiss bank analyst.
The banking industry has got a steeper slope to climb to recover, he said. We’re just now starting to see banks recognizing their loan problems. Some of the larger institutions have been starting to jack up their loan loss reserves.
But in the weakest banks in the state, poor ratings don’t seem to be stemming from non-performing loans, Proko said, with the exception of Merrimac Savings Bank. In the case of that bank, if all its loans had to be charged off, 20.4 percent of its capital would be in jeopardy, Proko said.
In their case, it seems their non-performing loans ? their asset quality ? is driving their rating, Proko said.
James Gardner, president and chief executive officer of Merrimac, maintains that the bank’s loan loss reserves are deemed adequate by regulators, and that the bank has not had to increase its reserves, although it will be keeping an eye on this area, he said.
Gardner has been president of the bank for a little over a year. When I came, it was obvious the bank was experiencing difficult times, but I came anyway because I felt the bank had some tremendous fundamental strengths, Gardner said, such as good capitalization, strong earnings potential and a loyal customer base.
We’ve spent the past year working on and improving the bank’s infrastructure from the inside out, Gardner explained. We’re positioning the bank for future growth; now we have a very strong foundation.
‘Conservative’ Approach
Other banks with low Weiss ratings may be judged weak for different reasons, said Proko. For Benjamin Franklin Savings Bank, for example, the capital leverage ratio is key. For federal regulators, 5 percent is the cutoff for capital leverage ratio strength; a ratio below 5 percent but greater than 4 percent is considered not strong but adequate. Benjamin Franklin has the lowest capital leverage ratio among the weakest five banks in the Bay State at an adequate 4.81 percent. The capital leverage ratio of the strongest banks ranges from 12 to 31 percent.
Benjamin Franklin Bank President Kenneth Osborn noted that the weakness likely resulted from a combination of circumstances where various losses were written off, contributing to weak earnings in 2000. So, in 2001, the bank concentrated on improving its earnings, he said.
The bank has not been increasing its loan loss cushion. We’ve been using a standard formula approved by our auditors, and we haven’t had to add to those reserves. We have a very low, low delinquency ratio, Osborn said.
In general, the loan loss reserves of the state’s banks are no cause for concern, according to state Commissioner of Banks Thomas J. Curry.
Fortunately, we really don’t have a weak banking industry, Curry said. We have a very well-capitalized industry. The industry has been conservative in terms of the risk it has been willing to take on in the last couple of years.
The state’s banks have adequate loan loss reserves, he added. We’re in a good position to withstand the current economic downturn.
In the case of the strongest five banks, Proko noted that their return on assets remains strong despite the weakened economy.
Most of these banks have very little problems with non-performing loans. They’ve been able to manage their loan quality as well as keep their returns strong, said Proko. In terms of leverage ratio, the banks are all very well capitalized, he added.
We have a very strong capital-to-asset ratio, which is one of the key ingredients. We’ve had very strong earnings over the past four, five years, as well as good liquidity, said Ron Mallette, president and chief executive officer of top-rated Norwood Cooperative.
In terms of loan quality, the bank has no real losses to speak of, and has had strong reserves for the last 10 years.
We have added to our reserves over the last six months not because we needed to, but because we thought it was the prudent thing to do in this economy, Mallette said. As a bank operating in Norwood and the surrounding towns, we do a lot of construction/subdivision lending, which is our biggest potential concern. But all our customers continue to build and sell everything they say they will.
As for the value of rating systems like Weiss, portfolio manager Bob Segal of J. William Mantz Investment Advisors in Gloucester noted that ratings matter, especially for out-of-state investors who commonly rely heavily on such rating services.
With banks, information is so public … that if a rating firm rates a bank as good or poor, investors are likely to look at the banks in the same way, Segal said.
But some of the weaker banks view their low Weiss rating as an opportunity to explain how much stronger their institutions actually are.
It’s difficult to just place one judgment call on what you see on paper. Some institutions cleaned out their portfolios and cleaned house, which is what we did, and whenever you do that, it looks bad and your earnings will be low, Osborn said. When you compare last year’s earnings with this year, it will look like night and day.
In the case of South Coastal in Rockland, the bank is undergoing a major shift from a purely investment bank to a deposit-taking bank.
We’ve taken $2.5 million out of the earnings of the bank to put in the organization of this for the past two years, explained President and Chief Executive Officer John J. O’Connor III.
Out of Weiss’ five judging criteria, South Coastal rates well on everything but profitability. And according to other ratings systems, the bank receives safe ratings, O’Connor said.
We have $9 million in capital, and no non-performing loans, he said. A weak rating causes a little heartburn, but in the end means nothing.
