FDIC's insurance fund falls as problem bank list surges to 416

— -- The recession is wreaking havoc on U.S. banks at a level not seen in nearly two decades.

On Thursday, the Federal Deposit Insurance Corp. said banks posted a loss of $3.7 billion in the second quarter, only the industry's second quarterly loss in 18 years. At the same time, the FDIC's list of "troubled" institutions grew to 416 banks, the largest number since June 1994. And delinquencies on loans and leases reached their highest levels in 26 years.

"The difficult and necessary process of recognizing loan losses and cleaning up balance sheets continues," says Sheila Bair, FDIC chair.

Widely viewed as a barometer of the health of the banking industry, the FDIC quarterly banking report showed that banks are continuing to gird up for future losses — provisions for loan losses hit $66.9 billion in the second quarter, up 33% from a year earlier.

"The banking industry is paying upfront for its losses, which means it has better earning power going forward," says Bert Ely, of banking consultant Ely & Co.

Indeed, banks are starting to become more savvy in terms of writing profitable loans. The net interest income, a measure of profitability from their core borrowing and lending operations, totaled $100 billion in the quarter, up from $96.6 billion a year earlier. Loan losses also started to taper off in at least one category — home equity — for the first time in three years.

Still, some of the worst losses flowed from the real estate bust. Loans and leases that are "non-current," or considered uncollectible, increased 14%, or $41.4 billion. Of that, the largest amount of losses, totaling $15.4 billion, came from residential mortgages, followed by $10.2 billion from real estate construction and development loans.

The losses have taken a huge toll. So far this year, 81 banks have failed, draining the reserves from the government's insurance fund, which guarantees deposits. The FDIC charged all banks an emergency fee to raise $5.6 billion for the Deposit Insurance Fund, which was depleted to $10.4 billion at the end of June, from $13 billion in the previous quarter. That was the lowest since 1993, when the banking industry was going through the savings-and-loan crisis.