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— Analysis —
Would the federal government's deposit insurance fund cover any of the bank's uninsured deposits? Would the FDIC shop IndyMac around to other banking institutions or run the institution itself? How big a loss would the insurance fund absorb after making good on deposits and selling off the bank's loan portfolio? Those same issues would have to be decided three more times before July ended, as the FDIC had to take over more struggling banks in California, Florida and Nevada. No doubt Bair will face these questions more times than she would like over the next year, as the industry heads into what is expected to be the worst spate of bank failures in more than a decade.
On July 25, the FDIC took control of First National Bank of Nevada in Reno and First Heritage Bank NA in Newport Beach, Calif. On Aug. 1, it assumed control of First Priority Bank in Bradenton, Fla. The four failures in rapid succession brought the total number of FDIC takeovers so far this year to eight. Since enactment of the Federal Deposit Insurance Corporation Improvement Act in 1991, the FDIC is supposed to resolve each bank failure in a way that poses the least cost to the deposit insurance fund, the pool of money ostensibly set aside to cover insured deposits at banks. In the case of the three failures that followed IndyMac, the least costly solution was for the FDIC to find a competitor willing to take over the troubled institution. In such cases, the FDIC quietly approaches local banks in hopes that one will be willing to assume deposits, branches and performing loans of the troubled institutions. Typically, bids are solicited on a Wednesday, and the new owner is announced after the close of business Friday. By Monday morning, branches of the old institution open as part of a healthy bank. That option is possible only when the troubled bank still has elements of an attractive franchise. Such takeovers can be pretty attractive to acquirers if branches have good locations and a strong core of deposits, says former FDIC Chairman William Isaac, now chairman of regulatory advisory group Secura Group LLC in Washington. When an institution is deteriorating rapidly and depositors are lining up to withdraw their money, the FDIC may simply seize and run the institution itself, as it did with IndyMac. In most cases, regulators know a bank is shaky long before it reaches the point of needing a takeover. Examiners from the FDIC or one of the other federal banking agencies -- the Comptroller of the Currency, the Federal Reserve System and the Office of Thrift Supervision -- practically live at each federally insured banking institution. Just who a bank's examiners are depends on whether an institution is federally or state-chartered, a bank or a thrift, and whether it is a member of the Federal Reserve System. Examiners regularly pore over an institution's books, looking for problem loans, risky concentrations of lending to particular industries and weaknesses in the deposit base. Banks are rated on a scale of 1 to 5. Banks graded 1 or 2 pose no problem; institutions with a grade 3 receive a closer watch by the Feds, and banks graded 4 or 5 are considered problem banks. Landing on the problem list isn't a terminal prognosis, Isaac says. Half the 5-rated banks fail, but the rest on the list lope along or strengthen their loan portfolios, raise capital or sell themselves. Typically, regulators want to identify problem institutions at least six months before they are in danger of failing. Occasionally, banks fall into serious trouble with little warning, as IndyMac did. The FDIC has released the number of institutions as of March on the problem list -- 70 banks with $20 billion in assets -- so $32 billion-asset IndyMac was not on the watch list six months ago. "IndyMac was an outlier," says banking consultant Bert Ely, noting that it relied on risky low-doc "liar" loans and expensive brokered deposits. The loan quality was so uncertain that the FDIC preferred to run the institution and its 33 branches while it goes over the books rather than sell it at a fire-sale price. Although the FDIC insures each depositor's accounts up to only $100,000 ($250,000 for retirement accounts), the $1 billion in uninsured IndyMac deposits were covered at 50 cents on the dollar. The FDIC estimated that the eventual sale of the bank's assets would yield at least enough to justify that amount. Uninsured depositors may get even more if asset sales are better than predicted. At First National and First Heritage, buyer Mutual of Omaha Bank feared a repeat of the run that plagued IndyMac and wanted all depositors covered in full. In return, it agreed to pay a 4.4% premium to cover the additional expense to the government. "We almost always offer to cover uninsured depositors, but we will only do it if the acquiring bank picks up the associated losses," says FDIC spokesman David Barr. "It's up to the bidder to decide whether it wants to pump in the money." Though Barr says most choose not to cover all depositors, in four of the seven failures this year, the buyers were willing to pay enough to do so. Any time the FDIC takes over a bank, the agency estimates potential losses the bank insurance fund will likely endure. But the number is a guess, and the true figure won't be known for up to five years after problem loans and other questionable assets are sold or written off. In the case of IndyMac, the predicted hit to the federal government is a particularly wild guess: The FDIC pegged the future cost at somewhere between $4 billion and $8 billion. Given that the deposit insurance fund is now estimated at $53 billion, the higher estimate prompted a number of news outlets to question whether the FDIC can cover the number of bank failures expected in the next year or two. It does and it doesn't. Most banks on the problem list are small community institutions suffering from troubled construction loans. Their eventual losses are unlikely to exceed $53 billion. This doesn't take into account the possibility that one or more large banks could deteriorate rapidly. Bair has said she expects no failures of the magnitude of IndyMac, but then again, she and her staff were surprised by that failure. The deposit insurance fund doesn't exist as a free-standing pool of money. Instead, it is a bookkeeping convention, like the Social Security Trust Fund. The premiums banks pay to the fund are invested in U.S. Treasury bills, and, on paper, the fund grows with interest. In reality, the money is spent to help fund the federal budget. To cover the cost of the IndyMac bailout, the Department of the Treasury was forced to issue additional debt. Increased federal borrowing will also cover costs of future failures. Eventually, the industry as a whole must repay the federal government through higher annual premiums. Federal law requires the deposit insurance fund to show a balance covering 1.15% of eligible deposits. Although the FDIC actually aims to keep the fund at 1.25% of deposits, the fund was hovering closer to 1.19% before the IndyMac failure. To rebuild the fund, banks will face higher assessments. Each bank's assessment is based on the risk category examiners assign it. Most pay 5 to 7 basis points of their insured deposits, Ely says. He estimates that an increase of 1 basis point would bring in $700 million in additional annual revenue to the fund. Ely predicts the typical assessment will rise to 12 basis points when the FDIC board examines the state of the fund in September. "Over the next few years, deposit insurance will be on a pay-as-you-go basis." |
Sheila Bair, (pictured) chairman of the Federal Deposit Insurance Corp., faced a number of important questions before announcing July 11 that the agency would
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