The Federal Deposit Insurance Corp. (FDIC) on Aug. 23 came out with its quarterly list of problem banks. The list decreased for the first time since the start of the financial crisis.

This dip, according to a report by Moody's Investors Service, in FDIC problem banks will have a positive effect on TruPS CDOs issued privately by small and midsize regional banks. This is because TruPS CDOs from problem banks have shown a higher frequency of defaults and deferrals versus those from non-problem banks, the rating agency said. 

The dip implies that banks are emerging from their troubled circumstances and are improving their financial performance, which will lead to fewer new defaults in the sector, Moody's said.

Fewer problem banks benefits TruPS by taking down the number of banks that the FDIC can close. Bank closures typically cause a default on the bank’s TruPS, the rating agency explained.

As the FDIC adds less banks to the problem list, the number of these banks that the FDIC has closed that issued TruPS in CDOs has also dropped correspondingly. 

Thus far, only 30 banks closed in 2011 had issued TruPS held by CDOs as of Aug. 19, the rating firm stated. This is versus 48 as of the same date in 2010 and 42 as of the same date in 2009. There were 22 banks that closed in 2Q11, which is the lowest total closed banks since 2Q09. It is also the fourth consecutive quarterly dip in the number of closed banks. All banks that closed this year have been smaller with only a slight impact on the asset class.

Moody's further cited that the number of problem banks in the country that were identified by the FDIC has dipped for the first time since 2006, as reported in the government agency's latest quarterly report. The FDIC said that the number of problem banks dipped  to 865 in 2Q11 from 888 in 1Q11. The rate of increase of problem banks had been slowing since 4Q09. The new additions reached their lowest number in 1Q11, as there were only four new banks added.

Every quarter, Moody's explained that the government agency actually compiles a list of problem banks without disclosing their names. In looking at what makes up a problem bank, the FDIC examines the quarterly financial statements of all of the banks it oversees.

It also assigns internal ratings to each financial institution that is based on certain financial ratios. It classifies those banks that get poor safety-and-soundness ratings as problem banks.

The outcome for any problem banks placed on the FDIC list can be that it will either eventually recover, or a healthier bank will acquire it. The bank might also close or it stay as a problem bank. The last two alternatives make the probability of default higher on TruPS, Moody's stated.

The number of banks closed by the FDIC started falling in 3Q09. The total yearly bank closures were 157 in 2010, which is the most recorded in a single year since the recession of the early 1990s, and 140 in 2009.

In 2011, the government agency has closed 68 banks as of Aug. 19, much lower than the 110 that closed as of the same date last year and the 77 that closed as of the same day in 2009. 

Data presented by Moody's showed that the FDIC closed banks have declined substantially and the number of problem banks has stabilized.

Analysts from Moody's warn, however, that the banking sector is highly dependent on the economy recovering, particularly in terms of the residential and commercial real estate markets.

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