A closer look at bank closures

Posted by Ray on October 24, 2009 under Main | Be the First to Comment

The FDIC has made it clear that bank closures are no big deal and that they have the capital to cover the increasing amount of closures that we are seeing. However, when we hear 106 bank closures it sounds bad, but not really that bad, especially when put into the perspective of the S&L crisis of 20 years ago. I would first like to point out that the S&L crisis involved institutions that were much smaller in size, which is very important to note. Second, did the FDIC ever run out of money during the S&L crisis? No, it did not. So a comparison is kind of ridiculous in my opinion.

When we examine the frequency of bank closures we see a dramatic increase after the supposed recovery has begun in the economy. How could that possibly be? If the economy if recovering bank closures and unemployment cannot both be lagging indicators, especially bank closures with the Fed having rates at zero and the yield curve favorable towards lending. Well, we know banks are not lending, but that is the story we are being fed, so it stands to reason that if we were having a recovery then banks would not be failing at the rate we are seeing.

I also see an anomaly that I cannot explain in bank closures. We have been averaging, in the second half of 2009, between 2 and 4 banks shutting down a week. However, in the first 2 weeks of October there were almost no closures or 1 per week, very odd. This of course comes after the FDIC announces it is virtually broke, so I do not believe this is a coincidence. Last Friday we saw a huge increase in closures from 1 to 7 banks, after the FDIC is guaranteed to collect 3 years worth of fees from institutions which will raise some $45B.

However, even with an additional $45B in hand there is no way the FDIC can remain solvent and cover the remaining 400 or so troubled banks on their watch list, based on historical factors from this year. What does that mean? It means it will have to tap its banks, again, or its emergency line of credit with Treasury, either way the FDIC is facing a crisis in the near future and to deny that is an insult to any level headed person’s intelligence, see charts below.

When a bank fails the FDIC steps in and tries to find a buyer for the institution. Now the buyer can take all or some of the failed bank leaving the rest for the FDIC to handle. Of the assets the acquiring bank takes they can enter a loss-share agreement with the FDIC on those assets to cover non-performing assets or unknown losses because these deals often happen extremely quickly, within a couple of days or in hours in some cases. The FDIC will pay up on some or all of those loss-share agreements, see BB&T, WFC or any other bank earnings statement to verify that statement, but it’s true. Not to mention the FDIC also guarantees some debt offerings, see Goldman Sachs and other banking institutions, which it may have to cover in the future as well.

The point being is the FDIC pays out on a bunch of things that most people do not even consider. Especially the loss-share agreements which most people simply ignore on the weekly closure press releases, but I do not. I do not for a couple of reasons, I have been around too long, I am too cynical and I have worked for a bank in a former life so I know the game. If you are going to offer a bank a guarantee on an asset they are going to find a way to collect on that guarantee, wouldn’t you?

As far as the actual bank closures themselves, they have actually slowed down, see below. This should not make you feel good about the situation because I fear there is something going on simply because the FDIC hasn’t actually received its funding from the banking system yet. In other words, closures should be higher, about 15-17% higher based on the averages and velocity, it’s just math that’s all.

Exhibit 1-1

However, the costs of these closures, which includes loss-sharing agreements, has just ballooned far beyond where I thought they would be. The last time I did this chart was in August so this was a bit of a shocker for me. Granted, the actual losses will vary from my projected losses, but trust me, not by as much as you might think. By my guesstimate perhaps no more than 20-25% on the high end. Could I be wrong? Sure, but there are a few things to take into account. We do not know how much real estate, residential or commercial, was inherited or what the other credit portfolios look like. Given they were small banks, my guess is they are a mess so this means a higher percentage of the loss-shares will have to paid out.

Exhibit 1-2

There is also a few really big banks that collapsed which huge credit looses. Those loss-shares, totaling billions of dollars will have to be paid out probably 100%. The other thing to consider is the fact that velocity of closures will pick up and what we see here is about the same size of the iceberg as the folks on the Titanic saw. That means the other 80-90% of the troubled institutions are still out there, lurking in the dark spreading bad credit trying to stay afloat and that means they are doing dangerous things because they lost hope and know all is lost. That is the same as locking the stair wells to third class on the Titanic to let all the first class passengers off first, essentially killing off the masses to try and save the few. This is guaranteeing that the system will have to absorb their reckless behavior when they know all is lost.

While Sheila Bair can claim that the taxpayer has never funded the FDIC all I have to say id that 2008/09 has had its fair share of firsts. If she has to turn to the treasury then the taxpayer is essentially bailing out the FDIC and to think differently is crazy. Not to mention that every time she levies the banks we pay for it through a higher ATM fee or some other small fee, so it is always taxpayer funded somehow. If you can look at those numbers and tell me that $45B will carry the FDIC for an additional 1 year and back that up with reasonable data, I will listen. However, there is no way that is possible when there are 400 banks on the watch list and we have only had just over 100 failures and the FDIC is broke already.

I have nothing against the FDIC or Sheila Bair, I am just running the numbers and it is not possible. The numbers simply do not lie and when you have 4x the amount of troubled banks as the amount of failed banks already and you are broke, the math doesn’t add up. We got problems, where it goes from here, I do not know, but it may not be pretty.