warning; how safe is your bank?

1. warning; how safe is your bank?

When banks run into financial problems, they behave like any other troubled company. They sometimes try to hide problems and limp along the best they can. For the customer, services can quickly deteriorate. Growing companies can be especially hurt because most rely on their banks to expand credit lines. On the contrary, too often a troubled bank will call in its loans because the bank needs the money---not because the customer is at any growth risk.

Ironically, thousands of customers are hurt unneccessarily. Many could have avoided problems by watching for early-warning signals of bank weakness. Typically, these distress signals show up as early as two years before an outright failure.

Chances are good, of course, that your bank is among the vast majority of healthy ones in the US. But ignoring the signs of problems now adds to your future risks.

Most recent bank problems stem from decisions to grow aggressively. Some banks that failed, funded an ambitious growth strategy with "purchased" funds (such as large CDs), as opposed to deposits from their local customer base. That strategy puts them on shaky ground.

Customers that have delt for some time with banks in this situation usually sense that something is wrong:

• warning; There's high turnover among the officers.
• warning; Paperwork and record keeping become sloppy.
• warning; The bank encourages customers to extend credit when officers know it really isn't neccessary.

Essential steps: If a friendly bank officer has recently quit, invite him to lunch and ask him tough questions about his former employer.

If you think there's a problem, get a copy of the bank's Call Report. This twice a year document has the data that tell the financial conditions of a bank. (In fact, regardless of whether a customer senses trouble, his finance officer should routinely get Call Reports for banks with which the company does business.)

Although Call Reports are public documents, not all banks make copies available (usually obtainable from the bank's shareholder-relations department). But if a bank balks, copies are available from the state agency that regulates banks or from the federal agency under whose jurisdiction it falls (Comptroller of the Currency, Federal Reserve Board or the Federal Deposit Insurance Corp.).

What to look for: By comparing figures of Call reports over time, a customer can read the warning signals. According to Cates Consulting Analysts, Inc., the signals include:

• Rapid expansion as reflected in a big increase in loan yield relative to other banks of similar size.
• Loan recovery rate of less than 20%. This is the percentage of written-off bad loans that a bank is ultimately able to recover. It should be well over 20% and is an excellent indication of how riskilythe bank is willing to operate.
• Low return on assets for a bank its size (can range from 0.6% for large banks like CitiBank and Chase Manhattan to over 1,0% for a small bank).
• High overhead ratio. Failed banks had overhead expenses that amounted to nearly 80% of their income base, compared with a nationwide average of 56%.