2008: Better For Banks Than You Think

This post first appeared on Minyanville.

2008 certainly tried the nerves of American bankers - but other years were far worse.

University of Michigan economics professor Mark Perry notes that the 25 bank failures last year pale in comparison to banking crises past. Skeptical of comparisons with the Great Depression, Perry suggests first comparing the current situation to the S&L crisis of the 1980s, when almost 3000 banks were forced to close up shop.

As ugly as 2008 was, the banking system survived. And although many would argue (probably correctly) that it survived only because of unprecedented government intervention, survive it did. US banks are now set to benefit from the biggest economic stimulus package in a generation.

Stuffed with cash from the housing boom, years of low interest rates, and unnaturally high risk appetites, American banks entered the crisis with reserves to spare. In a year that saw the entire global financial system buckle, federal bailouts of AIG (AIG), Fannie Mae (FNM), Freddie Mac (FRE), General Motors (GM) -- and the collapse of Bear Stearns, Lehman Brothers, Wachovia and Washington Mutual -- the fact that only a handful of banks actually folded is remarkable.

Those that did collapse, however, did so in spectacular fashion.

The FDIC seized IndyMac Bank last July, in what was the second largest bank failure in history. The southern California-based lender -- which was spun off from also-defunct Countrywide -- was heavily leveraged to so-called Alt-A mortgages. Alt-A occupies the uneviable spectrum of home loans just barely good enough not to be considered subprime.

In late September, Washington Mutual collapsed, and its more than $300 billion in assets were absorbed by JPMorgan (JPM). WaMu's failure was the biggest bust of all time.

Downey Savings, another southern California mortgage specialist, survived until November, when it finally sucumbed under the weight of its portfolio of option adjustable-rate mortgages, or Option ARMs. Along with Charlotte-based Wachovia (which was forced to sell itself to Wells Fargo (WFC) in October) Downey found that giving out loans without bothering to charge interest turned out to be a bad business model.

Despite dour headlines and predictions of widespread bank runs, most smaller community banks avoided the fae of their larger brethren and survived. Weakened by worsening economic conditions, banks across the board are tightening loan guidelines and hoarding cash just to stay afloat.

2009 isn't likely to be a banner year for the country's bankers - but if they can fare at least as well as they did in 2008, few would be likely to raise a fuss.

Unlucky Number 13: Washington Mutual Fails

This post first appeared on Minyanville.

It’s official: The biggest bank failure in US history is now, well, history.

Last night, troubled thrift Washington Mutual (WM) collapsed into the open arms of JPMorgan (JPM), who again picked up a former competitor courtesy of a government-orchestrated bailout. The failure marks the 13th bank failure this year.

In the past 10 days, since the financial crisis began to escalate after the failure of Lehman Brothers and the government’s seizure of AIG (AIG), WaMu lost almost $17 billion in deposits, according to the Wall Street Journal. This exodus of cash left it in a precarious position, one regulators felt was too weak to allow the bank to continue as an independent entity.

Details are hazy, but JPMorgan will acquire the Seattle-based bank’s deposits, retail branches and certain other operations. Initial reports indicate the FDIC’s war chest to protect against bank failures won’t need to be tapped (some feared WaMu’s collapse would cost more than $20 billion to clean up). It remains unclear what will happen to WaMu’s battered loan portfolio.

WaMu has been trying to sell itself for weeks, after its share price fell so low that raising capital through traditional means became all but impossible, but potential suitors like Wells Fargo (WFC) and Citibank (C) balked when they got a good look at the bank’s books. Saddled with future losses on its deteriorating mortgage portfolio, even WaMu’s alluring footprint on the West Coast couldn’t coax an offer out of its suitors.

JPMorgan CEO Jamie Dimon, however, seems to have a penchant for making deals endorsed by the federal government.

Shareholders, who have already undergone considerable pain, will likely get nothing as a result of the takeover, and the Journal reports senior debt holders could be wiped out as well. This could set off a chain reaction in the market for credit default swaps, or financial insurance policies that allow traders and investors to bet on the likelihood of defaults on various debt instruments.

If in fact WaMu defaults on its senior debt, financial institutions that sold these swap agreements could face liabilities that dwarf the nominal value of the debt itself. The credit default swap market is huge and unregulated, and obligations to pay out in the event of default typically exceed the outstanding amount of the underlying security by orders of magnitude. This market is already busily trying to deal with the fallout from Lehman Brothers’ bankruptcy: Another round of defaults won’t simplify matters.

Almost 10 months ago, WaMu announced plans to lay off workers, close branches and scale back its lending operations in an attempt to cut costs. We noted on the Buzz at the time that WaMu has been ahead of the curve in nearly every aspect of the credit crunch, dating back to a decision in 2006 to stop buying loans from some of the small mortgage banking institutions that originated the worst quality loans during the mortgage bubble.

Since that time, banks of all shapes and sizes have cut costs, laid off workers and scaled back lending. It should come as no surprise if WaMu’s collapse is the first of many bank failures that make the FDIC’s first 12 "problem children" seem like toddlers in comparison.

Two More Banks Go Belly Up

This post first appeared on Minyanville.

The Federal Deposit and Insurance Corporation's (FDIC) $53 billion war chest is under attack.

Already forced to use almost 10% of its stash to repay depositors at now-defunct IndyMac, the FDIC will cough up another $860 million from its deposit insurance fund after seizing two more banks over the weekend.

On Friday, regulators took control of First National Bank of Nevada and First Heritage Bank of Newport Beach, California. Both are units of First National Bank Holding Company, headquartered in Scottsdale, Arizona. The FDIC, however, was able to avoid an IndyMac-style bank run by selling the failed institutions to Mutual of Omaha, a Nebraska bank.

All retail branches opened for normal business this morning, under the Mutual of Omaha name, avoiding check-cashing problems that still plague some IndyMac customers. Last week, after news leaked the FDIC wouldn’t cover a portion of uninsured IndyMac deposits, Washington Mutual (WM) and Wells Fargo (WFC) balked at IndyMac checks, placing a hold on deposits until their value could be verified.

While small in comparison to IndyMac’s $32 billion in assets, the two banks had almost $4 billion in combined assets, making the failures large by historical standards.

Working with the FDIC, the Office of Comptroller of the Currency issued a statement saying First National Bank of Nevada "was undercapitalized and had experienced substantial dissipation of assets and earnings due to unsafe and unsound practices." First Heritage was simply called “undercapitalized.”

Both banks were active issuers of subprime mortgages. Now, with losses that outweigh capital reserves, regulators have taken preemptive action and seized the banks to prevent panic.

While the FDIC is aggressively staffing up in advance of more failures, its Chairman, Sheila Bair, is moving to assuage concerns it won’t be able to live up to its obligations. In a press release last week, Bair reiterated the rights of American depositors and sought to inject confidence into the country’s banking system:

“The banking system in this country remains on a solid footing through the guarantees provided by FDIC insurance. The overwhelming majority of banks in this country are safe and sound and the chances that your own bank could fail are remote. However, if that does happen, the FDIC will be there -- as always -- to protect your insured deposits.”

The FDIC expects hundreds of banks to fail as a result of the current credit crisis, straining the cash its saved up to protect depositors. The seven failures so far this year tops the number of banks than went bust from 2004 through 2007, but is nowhere near the thousands that failed during the Savings and Loan crisis of the 1980s and 90s.

Today’s financial system, however, bears little resemblance to 20 years ago. The shadow banking system and the vast interconnectedness of the world’s financial institutions means no one bank can fail without potentially infecting its neighbors.

The FDIC has a tough road ahead.