By Binyamin Appelbaum
Washington Post Staff Writer
Wednesday, August 13, 2008
First the borrowers. Now the banks.
Federal and state regulators have closed eight banks this year, four since the start of July, as rising borrower defaults on residential and commercial real estate loans start to push some lenders into default, too.
There were no bank failures in 2005 or 2006 and only three in 2007. Now, some analysts expect a few hundred banks to fail over the next several years -- the most since the savings-and-loan crisis two decades ago.
And some critics say the failures aren't happening fast enough. They say regulators are keeping some troubled banks on life support by allowing them to spend money to stay in business that should be reserved to cover loan losses after the bank has failed.
"They are dragging their feet in forcing these banks to reserve realistically," said Bert Ely of Ely & Co., a bank consulting firm in Alexandria. "Some of these banks could have been closed two or three quarters earlier."
So far, the banking industry is facing the kind of plague that mostly claims the young and the weak, analysts say. The vast majority of the nation's banks are in stable financial condition. The failed banks, and those in danger of failing, tend to be smaller institutions burned by overexuberant real estate lending.
But as with the impact of foreclosures, the fallout from a relatively small number of failures may end up raising the cost of banking for everyone. One likely consequence is an increase in the insurance premium that banks must pay the Federal Deposit Insurance Corp. to guarantee customer deposits, which now averages 5.4 cents on every $100 of deposits.
James Chessen, chief economist at the American Bankers Association, said banks would "do what's required to ensure the health of the FDIC." But because the premiums are paid with money otherwise available for lending, Chessen said each one-cent rate increase would reduce the collective lending capacity of U.S. banks by about $5 billion.
The banks and their borrowers will thus be paying for the sins of the failed institutions. That has added urgency to the question of whether regulators are doing everything possible to limit the cost of the failures.
Some of the recent failures were of banks regulated by the Office of the Comptroller of the Currency, one of several agencies that oversee the country's financial institutions. Robert Garsson, deputy comptroller for public affairs at the OCC, said that when a bank is losing money, regulators must balance its chance of recovery against the cost of continued losses.
"We save a lot of banks by being able to work with them, avoiding failures that would be costly to the insurance fund," Garsson said. "The only ones that people see are the ones that fail."
He noted that the OCC closed the First National Bank of Nevada in July while it still had significant capital reserves, well above the level at which regulators are required to take action, because it concluded the bank could not be saved.
Still, critics say the handling of some recent failures resulted in unnecessary expenses for the FDIC's insurance fund. The question turns on a requirement that banks set aside money to cover possible losses on loans that seem likely to fail. Banks sometimes push to limit the loans classified as problematic, allowing them to keep more money for other purposes. Some critics say regulators have not pushed back hard enough. As a result, failing banks stay in business longer, sometimes compounding their losses and leaving less money to eventually cover those losses.
"In some of these cases, I believe regulators should act sooner than later to prevent future losses to the fund," said Ken Thomas, a lecturer in finance at the Wharton School at the University of Pennsylvania.
The issue may be headed to Capitol Hill, where the Senate Banking Committee plans to hold hearings on bank failures in September with a particular focus on the July collapse of mortgage lending giant IndyMac Bancorp. Sen. Charles E. Schumer (D-N.Y.) has charged that regulatory lapses led to the thrift's spectacular collapse. Regulators say the thrift failed because Schumer scared customers into withdrawing deposits.
During the real estate boom, it was nearly impossible to crash a bank. Loan defaults hit historic lows as borrowers who fell behind on payments simply refinanced. Banks that needed more money found investors eager to buy a piece of a very profitable industry. The absence of bank failures from June 2004 to February 2007 was the longest placid stretch since the 1920s.
Now, however, borrowers who fall behind are increasingly defaulting on their loans, and banks are struggling to survive the resulting revenue shortfalls. When a bank's reserves run out, regulators step in. The branches and the deposits are then sold to another, healthier institution.
This year's first failure came in January, when regulators closed a small bank that served the black community in Kansas City, Mo. There was another failure in March, then two in May. Then, on July 11, came the collapse of IndyMac, an institution larger than the total size of every bank that had failed in the previous 15 years. Three more failures have followed.
There are some common themes, analysts say. The banks paid high interest rates, attracting deposits from around the country to fuel rapid expansion. They focused on commercial or residential real estate lending. And they started lending in unfamiliar places.
ANB Financial, which was closed by regulators in May, was based in Bentonville, Ark. But almost 90 percent of its deposits came from far-flung investors attracted by the bank's high interest rates. And many of its loans were made from offices in St. George, Utah; Jackson, Wyo.; and Idaho Falls, Idaho.
"Ask yourself, 'Why would a borrower be interested in a lender that's three states away?' It's probably because they're having difficulty getting loans from banks that really know that community," said Chessen, commenting on the general pattern but not on ANB specifically.
The pace of failures will probably increase, particularly if the economy remains weak.
Federal regulators listed 90 institutions as troubled at the end of March, about 1 percent of U.S. banks and thrifts. The list is expected to grow when it is updated at the end of August. Historically, regulators end up closing about 13 percent of the institutions.
Some analysts say that regulators are understating the problem. Gerard Cassidy, an analyst with RBC Capital Markets, estimated in July that more than 300 banks could fail over the next three years.
The names of the banks on the federal list are not disclosed for fear that people will withdraw money and push the institutions even closer to the brink. Most depositors have little reason to withdraw funds because the government guarantees the repayment of at least the first $100,000. In most cases, the failed bank is closed at the end of business Friday and reopened Monday morning under new ownership and management.
About 38 percent of deposits are not insured by the government because they exceed the maximum; those deposits are sometimes repaid, at least in part, but can be lost completely. People who invested in the bank's stock generally lose every penny. Employees often lose jobs. Communities lose a local lender, though the arrival of a healthier bank can be an improvement.
The Washington area so far has been unscathed by the failures. Analysts say few local banks and credit unions appear to be in serious danger of failing, in part because the local economy has remained relatively strong. "What we're dealing with locally is just low profits," said David Danielson, president of Danielson Capital, a small-bank consulting firm in Vienna. "While the banks are suffering, they're well capitalized, and we wouldn't expect to see failures here."
In Virginia, a bank in Danville and a thrift in Martinsville appear on lists generated by financial analysts of troubled institutions, and the Martinsville thrift, Imperial Savings and Loan, has been ordered by the Office of Thrift Supervision to sell itself to a more stable institution.
The failures so far this year will drain the FDIC's insurance fund by an estimated $9.2 billion. Losses for the year could approach the inflation-adjusted record of $12.8 billion set in 1988.
The expected losses so far would cut 17 percent from the fund's total balance, which was at a record high of $52.8 billion at the end of the first quarter. That could drop the fund below a threshold requirement that it contain an amount equaling at least 1.15 percent of all U.S. insured deposits.
While the law gives the FDIC five years to return the fund to that level, officials have indicated they will act as early as this fall in the belief that more losses lie ahead.