Is your bank healthy? How to tell

By SmartMoney

The Federal Deposit Insurance Corp., or FDIC, has been guaranteeing deposits since 1933 -- and since then, savers have not lost a single penny.

But now the banking system is so stressed that the FDIC itself is running out of money. Currently, the agency insures up to $250,000 per account (that amount is good at least through Dec. 31, when it may drop back to $100,000).

The FDIC, which is funded by insurance premiums paid by banking institutions, recently doubled those premiums to raise cash. Now it's turning to Uncle Sam for more help. Last week, Chairwoman Sheila Bair requested that the government more than triple the organization's borrowing authority, to $100 billion from $30 billion.

We're not telling you to take your money out of the bank. Indeed, almost everyone expects the government to find a way to keep deposits insured should more banks fail.

But just how likely is it that you'll wind up relying on the FDIC's insurance anyway?

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If you're wondering about the health of your bank, you can get a pretty solid picture by looking at some basic numbers that publicly held banks must disclose in annual financial reports filed with the Securities and Exchange Commission. (Privately held banks must file "call reports" with the FDIC; they contain this information as well.)

Here are four key numbers that will tell you whether your bank is the epitome of fiscal health or is gasping its final breath.

Tier 1 ratio

The Tier 1 ratio tells you how much capital a bank has set aside to absorb losses.

"Essentially, it shows how strong (the bank's) balance sheet is," says Chris Fortune, an analyst at investment firm T. Rowe Price who covers regional banks.

Generally, a Tier 1 ratio needs to be at least 6% for a bank to be well capitalized. But in today's environment, banks should have 8% or 9% to be considered healthy, Fortune says.

Look for Tier 1 information in the Management Discussion sections of 10-K Annual Report forms.

Spotlight on JPMorgan Chase: According to its 2008 annual report, the bank's Tier 1 capital ratio at year's end was 10.9%.

Nonperforming asset ratio

The nonperforming asset ratio, also known as the NPA ratio, tells you how much exposure your bank has to assets that are potentially problematic.

Loans that are overdue by 90 days or more, for example, are considered nonperforming assets.

This ratio is determined by dividing these problem assets by the bank's total assets.

"Today, anything below 1% is really good," says Fortune. "Below 2% is OK. And, as you start to get above 4%, you start to worry."

Spotlight on Bank of America: In its 2008 annual report, the bank reported that its nonperforming loans and leases were 1.77% of total loans and leases.

Tangible common equity ratio

The tangible common equity ratio shows how big a loss a bank can absorb before its common shareholders are wiped clean, says Jamie Peters, an equity analyst at Morningstar. If a bank's common equity ratio is 3%, for example, the bank would have to write off 3% of its assets before shareholders lose everything.

As a rule of thumb, a ratio below 3% is too low, says Peters.

Figuring out this ratio is tricky, since banks don't generally disclose it in their financial statements. To calculate it, divide your bank's tangible common equity by its tangible assets. (Tangible common equity is total shareholders' equity minus preferred stock minus goodwill and intangibles; tangible assets is total assets minus goodwill and intangibles.) All the numbers you need to calculate this are listed in the bank's balance sheets.

Spotlight on Citigroup: Its tangible common ratio was 1.5% before the government stepped in to bail it out. If that effort works properly, the ratio should increase to above 4%, says Peters.

Loan loss reserves

This is the amount a bank has set aside to deal with problem loans. This figure will give you a good idea of the bank's ability to remain healthy in an unhealthy environment.

To calculate your bank's loan-loss reserve ratio, simply divide its allowance for loan losses by its total loan portfolio. The higher the percentage is, the better your bank's ability to cover potential losses.

A reserve of 1% or less is considered weak, Fortune says, while anything over 2% is considered strong.

Spotlight on Wells Fargo: The bank's allowance for loan losses was slightly more than $21 billion at the end of 2008, while its loan portfolio was valued at $864.8 billion. That produces a reserve ratio of a healthy 2.4%.

This article was reported by Aleksandra Todorova for SmartMoney.

Published March 11, 2009