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Beware False Indicators of Bank Health

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People Line up at IndyMac After FailureWith IndyMac being taken into conservatorship, a lot of folks have been researching FDIC insurance and how best to protect their assets. I know I was checking all the bank ratings and announcements, looking to see if I should be worried about my assets at banks like E*Trade, ING Direct, Emigrant Direct, and HSBC Direct.

Common sense tells me that my research was unnecessary because I don’t have assets above the FDIC $100,000 insurance limit. As long as you don’t, your assets are safe. If the FDIC insurance program ever failed to protect assets up to that limit, we’d have much bigger issues to deal with. However, I wanted to get a sense as to whether recommending any of those online banks was still a smart idea. I don’t want to tell my friends that HSBC Direct is great only to find out that it’s going into conservatorship tomorrow! They already make fun of me for having a “blog.” :)

Anyway, in doing my research, I saw a lot of false indicators of bank health. These are ideas I had in my own head, like checking Bankrate’s ratings, seeing how old the bank was, the stock price, and whether it had any brick and mortar locations I could visit.

Sadly, I realized that none of these indicators were strong assurances that a bank was safe. Let’s look at each of them.

Bank Age

Banks aren’t like people, they have turnover, their personality changes, and the company you knew 80 years ago isn’t the same one that operates today. In 1995, Nick Leeson brought down Barings Bank, the oldest merchant bank in London with origins back to 1762 (and the Queen’s personal bank and the financier of the Napoleonic Wars), through futures trading and fraud. It was absolutely stunning when it happened since it was all the work of one trader (you can see a depiction in Rogue Trader with Ewan McGregor).

Barings Bank RIP (1762-1995).

Brick & Mortar Locations

If you were aware of online banks when NetBank failured last year, you probably got a little spooked. I know I was spooked a little. When junk hit the fan, there wasn’t even anywhere for anyone to go!

Whether or not the bank has a physical location isn’t a good indicator of a bank’s health. There are several banks that are entirely online, or extremely limited physical presences, such as ING Direct, that are, by all other measures, perfectly safe. IndyMac has physical locations, as the latest news reports have shown, and that didn’t help at all.

Ratings

Bankrate has a Safe & Sound rating for banks and credit unions that is a good indicator of a bank’s soundness in most cases. A rating of 1 (Superior) is better than a 5 (Lowest Rated) but neither score is really a good indicator of whether a bank is going to fail. The problem is that failures can occur extremely quickly (“The second lesson of IndyMac is that it underlines the speed with which banks can go under once confidence in them is lost.”) and Bankrate, along with many other rating services, might not update fast enough to catch the changes.

Here is the disclaimer from Bankrate’s Safe & Sound site: “Events occurring after safe & sound CAEL ratings and reports were prepared and before they are updated as scheduled may have altered an institution’s financial condition. For example, the FDIC reports that approximately 280 banking institutions were impacted by Hurricane Katrina.”

Sagging Stock Prices

IndyMac’s stock fell as it failed, much like the stock of any company going under. You might be tempted to think that a rapidly falling stock price is a good indicator of whether a bank will fail, just as how a rising stock price is a good indicator that I won’t. Sadly, the falling stock price is merely a trailing indicator because it lags what the market knows. The prime example is of all the banks and financial companies pulling money out of profits to protect against potential future subprime losses. Washington Mutual, National City, and M&T Bank all had big falls this week because of market fear though the banks themselves reiterate that they haven’t experienced any problems.

At the end of the day, your money is protected by the FDIC.

(Photo: zoliblog)

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6 Responses to “Beware False Indicators of Bank Health”

  1. Wonderful post!

    I take advantage and recommend bank deals to my friends, too, and these same thought have crossed my mind.

    Thanks for sharing your thought and insight.

  2. Jadin says:

    i am worried, not about our money in the bank, rather our HELOC at WaMu. We are planning a big remodel using it in the next few months, and while I don’t expect the line to be frozen since our home value is four times the entire LOC plus mortgage, I do worry we won’t have access should WaMu go south. Also wonder what would happen to contractual agreements such as interest rate on the HELOC.
    Any thoughts?

  3. jim says:

    Is that rate locked in? I don’t know much about HELOCs but I imagine they have the freedom to amend it as usual.

  4. Jadin says:

    Our WaMu HELOC is at prime, not locked in. This, of course, is great right now. I guess the more global question is whether -should there be a takeover (of any bank)- can the new “owners” change this part of the contractual agreement? Obviously banks have no problem changing the amounts of a line of credit, or freezing it entirely, which I, as well as most others, would have assumed is guaranteed. I think I’ll try and do some research on this tonight!

  5. Jadin says:

    If anyone cares, apparently they’re “honoring” all agreements at IndyMac, so would assume that’s good news for others in similar positions.

  6. jim says:

    Thanks for the update Jadin. I think that if there is a takeover, they can change the details (chances are the contract does have that contingency written in).

    I wouldn’t think that IndyMac Federal would want to be in the loan business, just in the tying up loose ends business.


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