How to tell if a bank's worthy of your money
— -- As major banks crumble under the weight of toxic debt, deposits have surged at small banks that provide a sense of security in the warm and friendly way they do business.
But though many small banks avoided high-risk loans, banking experts warn that friendly doesn't always mean safe. Of the 25 bank failures this year, 16 had less than $1 billion in assets, and five had assets between $1 billion and $5 billion. With the economy in recession, many more are likely to fail.
Nobody wants their money in a troubled bank. Nor does a small-business owner want to be in a position of being unable to access a line of credit to pay for crucial equipment or fill a big order.
It's a good idea to check the soundness of a bank by reading quarterly results that banks report on their websites. The Federal Deposit Insurance Corp. website, fdic.gov, also has information on banks. The most important thing is to make sure the institution is insured by the FDIC or the National Credit Union Administration. Both guarantee deposits up to $250,000.
Other things to consider:
•Liquidity. A bank should be solvent enough to handle unexpected withdrawals, says Tim Yeager, a University of Arkansas associate professor of finance. One way to determine that is to check if its loan-to-deposit ratio is less than 90%, indicating the bank hasn't lent out all its capital. Also, most banks report their leverage ratio or their reserves of cash and capital, a measure of their cushion against future defaults. A leverage ratio over 10% is good, while one below 7% is a warning sign.
•Growth strategy. If a steady bank suddenly sees outsize gains, check where the new growth is coming from. Some of this year's failed banks moved out of familiar territory to far-flung states and ended up getting burned after lending to unknown companies.
•Loan quality. A bank is as good as the quality of its assets, so it's not good if it has too many non-performing loans that are over 90 days past due. All banks have tightened lending standards, but where are they lending? Single-family homes and small businesses are steadier today than commercial real estate and construction loans, which are experiencing a sharp slowdown. Any sign that the bank has investments in exotic derivatives such as auction-rate securities or credit default swaps? Run.
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