Mortgage Meltdown: Second Wave Approaches as Banks Fail

Financial Services
Bad News Banks
Liz Moyer, 05.29.08, 3:00 PM ET 


The number of troubled U.S. banks is rising. The outlook: more pain as the credit crisis enters its second wave.

The Federal Deposit Insurance Corp. (FDIC) is now tracking 90 “problem” banks, 18% more than in the fourth quarter and the most in almost four years. Banks are struggling with mounting loan losses and the need to reserve for future losses at a time when revenues are slowing or even falling.

Loan loss reserves also rose 18% in the first quarter, to $120 billion, the largest increase in two decades, but non-current loans rose at an even faster pace, and approach $140 billion. That means reserves aren’t keeping pace with loan deterioration, a potentially worrisome development.

The FDIC said Thursday the reserve “coverage ratio,” which describes loss reserves as a percentage of non-performing loans, fell to 89 cents for every $1 of non-current loans, from 93 cents per $1 in the previous quarter.

“It’s the kind of thing that gives regulators heartburn,” said Sheila Bair, the chairman of the FDIC. “Given the weaker economy and rising level of problem loans, we’re encouraging bank managers to stay on their toes.”

Another sign of stress in an industry that has been walloped by the credit crisis: Bank failures are rising. The FDIC is adding staff to prepare for an increase in troubled banks after a historic period of calm that ended last year when problems in the subprime mortgage sector erupted. Still, just three banks have failed so far this year, including ANB Financial of Bentonville, Ark., earlier this month.

One significant contributor: a high percentage of brokered deposits, purchased from other banks to help fuel rapid lending growth. Four of the last five bank failures involved institutions that relied on them. ANB, for example, had $1.6 billion of brokered deposits out of $1.8 billion of total deposits.

Brokered deposits are not a new phenomenon, but they have lost some of the stigma they carried for decades after sharing the blame for the savings and loan crisis of the late 1980s. Wall Street’s heavyweights, including Citigroupand Merrill Lynch, do a brisk business arranging brokered deposits, which rose to $520 billion for the industry last year, from $482 billion the year before and well up from $58 billion a decade ago.

The criticism of them is that they tempt banks, which have to pay a premium to buy the deposits, to make riskier loans to keep a profitable margin. They also put physical and psychological distance between the depositor and his bank, which is counter to the idea of a community bank. Finally, depositors don’t have an incentive to pick soundly managed banks because of the back-stop of federal deposit insurance.

“All deposit insurance is a moral hazard, and brokered deposits are a moral hazard, squared,” says Alex Pollock, a former head of the Federal Home Loan Bank of Chicago and now a fellow at the American Enterprise Institute.

Often start-up banks rely on brokered deposits to get their businesses moving and then wean themselves off them. But that is something regulators are taking a closer look at. There have been 40 applications this year to start new banks (incidentally, that’s half the levels of last year), and the FDIC is taking a much closer look at their reliance on them.

“We’ll be reminding our examiners about the risks,” said Serena Owens, who oversees the application process for the FDIC, in a recent interview.

The FDIC, like other bank regulators, has been encouraging banks to raise capital levels to buffer against the expected rise in losses and write-downs. Half of the 3,776 banks that pay dividends paid lower dividends in the first quarter, which is one way to preserve capital.

A total of $156 billion has been raised for financial companies so far this year, according to Keefe Bruyette & Woods, $94 billion of that on behalf of 30 large and mid-sized banks. Texas Pacific Group, the private equity firm that took a $2 billion stake in Washington Mutual earlier this year, even has its eyes on a $7 billion new fund focused on financial services.

That is something regulators are only too happy to encourage.

“We’re urging all institutions to make sure their reserves are large enough to cover expected losses,” the FDIC’s Bair said Thursday. “We also want them to beef up their capital cushions beyond regulatory minimums, given uncertainties about the housing markets and the economy.”

2 Responses

  1. First, of the four last failures, only one ANB relied heavily on brokered deposits. I go into quite a bit of detail on the blog, but to summarize, it isn’t the deposits that are the problem. It is the loan strategies that the banks set out on.

    Secondly, many community banks are having to use brokered deposits to maintain their funding because of all of the high yield savings accounts being offered out there on the internet. They are losing core deposits, hand over fist.

    They also have a heck of a time competing with troubled banks such as Countrywide, IndyMac, etc. which are offering high rates on CDs. If the FDIC is going to scrutinize deposits, they should scrutinize all out of area deposits. Many banks skirt the brokered deposit issue by using the internet or rate listing services. Those funds are just as volatile as brokered deposits.

    Jumbo CD Investments, Inc.

  2. I think this is just the tip of the FC iceberg.

    Good story – thanks

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