May 29, 2008
SAN FRANCISCO: By April, Gary Holloway was almost three years into retirement. He’d built a new home by a lake in Texas, bought a boat and was working on his golf game. While taking on some part-time work, Holloway also travelled for months across the US with his wife, from Seattle to Washington DC, catching up with old friends and family.
That life of leisure abruptly changed about six weeks ago when Holloway got a phone call from his former employer, the Federal Deposit Insurance Corp, or FDIC, which regulates US banks and insures deposits.
Earlier this year, the FDIC began trying to lure roughly 25 retirees like Holloway back to prepare for an increase in bank failures. It’s also hiring about 75 new staff. Holloway quickly went back to work. ANB Financial NA, a bank in Bentonville, Ark with $2.1 billion in assets and $1.8 billion in customer deposits, was failing and an expert like Holloway was needed to value the assets and find a stronger institution to take them on.
On May 9, life for ANB ended when the FDIC and the Office of the Comptroller of the Currency, another bank regulator, announced that the lender was closing. Only three banks have failed so far in 2008. But that number is set to surge as the credit crunch slows economic growth and hammers some lenders that grew too fast during the recent real-estate boom, experts say.
Things may get worse before they get better: At least 150 banks will fail in the US during the next two to three years, according to a projection by Gerard Cassidy and his colleagues at RBC Capital Markets.
If the current economic slowdown deteriorates into a recession on the scale of those from the 1980s and early 1990’s, the number of failures will be much higher this time around — probably as high as 300 of them, by RBC’s reckoning. That’s a massive surge compared to the recent boom years of the credit and real estate markets. From the second half of 2004 through end of 2006 there were 10 consecutive quarters without a bank failure in the US — a record length of time, Cassidy notes.
Texas Ratio: Cassidy and his colleagues have developed an early-warning system for spotting future trouble at banks called the Texas Ratio. The ratio is calculated by dividing a bank’s non-performing loans, including those 90 days delinquent, by the company’s tangible equity capital plus money set aside for future loan losses. The number basically measures credit problems as a percentage of the capital a lender has available to deal with them.
Cassidy came up with the idea after covering Texas banks in the 1980s. Until the recession hit that decade, many banks in the state were considered some of the best in the country. But as problem assets climbed, that view was cruelly challenged, Cassidy recalls. Along with his colleagues, Cassidy applied the same ratio to commercial banks at the end of this year’s first quarter and found some disturbing trends.
UCBH Holdings Inc, a San Francisco-based bank, saw its Texas Ratio jump to 31% at the end of the first quarter from 4.7% in 2006, according to RBC. The Texas Ratio of Colonial BancGroup, based in Montgomery, Ala., jumped from 1.5% in 2006 to 25% at the end of March.Sterling Financial Corp., headquartered in Spokane, Wash., had a Texas ratio of 1.9% in 2006. It was nearly 24% at the end of the first quarter, RBC data show.
These banks are nowhere near RBC’s 100% critical threshold, and several lenders have raised new capital since the first quarter. For instance, National City Corp. topped RBC’s list with a Texas Ratio of 40% at the end of March, though the bank did raise $7 billion in new capital in April.
CD signs of stress: Other lenders are already in more dire straits. IndyMac Bancorp a large savings and loan institution and a leading mortgage lender, is one of Cassidy’s biggest concerns, with a whopping Texas Ratio around 140%.
IndyMac is currently offering the highest rates on one-year CDs, according to Bankrate.com. Others in the top 10 include Corus Bankshares, Imperial Capital Bancorp and GMAC bank.
When Countrywide Financial was struggling last year, its federal savings bank unit began offering some of the highest CD rates in the US to build deposits. Bank of America has since agreed to acquire Countrywide and it didn’t make it onto Bankrate.com’s list of top 10 CD rates this week.
Construction loan destruction: Construction and development, or C&D, loans made up 83% of the Chicago-based bank’s total loans at the end of 2007, according to RiskMetrics Group. This type of loans helps to pay for things like the building of real-estate development projects and the construction of office buildings.
Small and medium-sized banks found it difficult to compete with large lenders in the national markets for mortgages and other consumer loans. So many focused on C&D loans because this type of financing relies more on local, personal connections, said Zach Gast, financial sector analyst at RiskMetrics. As the real estate market boomed, C&D loans did too. A decade ago, bank holding companies had $60 billion of these loans. That number is now $480 billion, according to Gast, who also notes that C&D loans are almost never securitized, so they’re held on banks’ balance sheets.
Such rapid loan growth usually creates trouble later. Indeed, delinquencies represented 7.1% of total C&D loans at the end of the first quarter, up from 0.9% at the end of 2005, Gast said. Colonial BancGroup had 37% of its loans in C&D loans at the end of last year, while Sterling Financial had 33% and UCBH had 20%. East West Bancorp a rival to UCBH, is also exposed, with 25% of total loans in C&D assets at the end of 2007, RiskMetrics data show.
Regulators: Where were regulators when these banks built up such large exposures? That’s a question RBC’s Cassidy has been asking himself, noting that “they dropped the ball in a big way.” Officials at the FDIC declined to comment.
Efforts by the Securities and Exchange Commission to make sure banks report accurate earnings may have made the situation worse, Cassidy says. Bank regulators try to encourage institutions to build reserves in good times, so they’re ready for downturns. But the SEC has been worried that banks might use reserves to smooth reported earnings, so it advised some lenders that they couldn’t set aside reserves if they weren’t experiencing commensurate credit losses, Cassidy explained.
Crisis redux? The FDIC had highlighted 76 banks that it considered troubled at the end of 2007. That’s up from 50 at the end of 2006, which was the lowest level for at least 25 years. Once identified by regulators, troubled banks are often required to limit or halt loan growth and shrink their balance sheets by selling some assets, Cassidy said. Resolution and receivership specialists at the FDIC, like Gary Holloway, value troubled banks’ assets as quickly as possible and try to find a stronger bank to absorb the weaker entity through an acquisition.
The current crisis hasn’t reached the scale of the savings and loan crisis. In 1990, more than 1,500 banks were on the FDIC’s troubled watch list, out of a total of roughly 15,000. More than 1,000 banks failed in 1988 and 1989, FDIC data show. But it’s possible for such comparisons to understate the scope of the coming wave of insolvencies.
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