In Depth Analysis: CalculatedRisk Newsletter on Real Estate (Ad Free) Read it here.

Sunday, July 13, 2008

The Coming Bank Failures

by Calculated Risk on 7/13/2008 10:02:00 PM

There have now been 5 FDIC insured bank failures in 2008, the most since 2002 (11). But this is nothing compared to number of failures during the S&L crisis in the '80s and early '90s.

FDIC Bank Failures Click on graph for larger image in new window.

To put the 2008 failures into perspective, here is a graph of bank failures since the FDIC was created in 1934. The 5 failures this year hardly show up on the graph.

Note: thousands of banks failed during the Depression, and bank failures were very common even before the Depression, with about 600 banks failing every year during the Roaring '20s. And, yes, there is a Bank Implode-O-Meter that includes credit unions and other banking problems too.

One of the interesting aspects of the IndyMac failure was the average size of the insured deposits. According to the FDIC, there were $18 billion in insured deposits and "over" 200,000 depositors. If we divide $18 billion by 200 thousand, this gives an average deposit of $90,000. This average seems very high; I'd expect most banks would have many depositors with just a few thousand dollars - and, therefore, a far lower average insured deposit size.


This suggests that many of these deposits were from conservative investors chasing the highest FDIC insured yields. Banks that rely on this type of deposit (and pay the highest yields) would seem to be the most susceptible to online bank runs. These relatively high yield FDIC insured deposits are an example of moral hazard.

In the insurance context, the term "moral hazard" refers to the tendency of insured parties to take on more risk than they would if they had not been indemnified against losses. ... The moral hazard problem is particularly acute for insured depository institutions that are at or near insolvency but are allowed to operate freely because any losses are passed on to the insurer, whereas profits accrue to the owners. Thus problem institutions have an incentive to take excessive risks with insured deposits in the hope of returning to profitability.
Although I believe deposit insurance is an important safety net - because many depositors cannot fully evaluate the safety and soundness of their bank - I'm not convinced this is working properly when investors can easily place just under the FDIC limit at multiple banks and chase yield.

Note: the reason investors usually deposit under the limit (say deposit $95,000) is to keep the earned interest insured too.

From Robin Sidel, David Enrich and Jonathan Karp at the WSJ: Bank Fears Spread After Seizure Of IndyMac
[Banks] wooed customers with new high-yield savings accounts and certificates of deposit, and special Internet-only promotions. ... Regional and specialized institutions that have been battered by soured loans have been among the most aggressive in luring new money. Last week, IndyMac was offering 4.35% interest on a one-year online CD.
Surprisingly the WSJ reports that the percentage of uninsured deposits has been growing rapidly:
[T]he percentage of uninsured deposits has doubled since 1992, climbing to about 37% of the nation's $7.07 trillion in deposits at the end of the first quarter, according to an analysis of data reported to the FDIC.
And from Louise Story at the NY Times: Analysts Say More Banks Will Fail
[T]he troubles are growing so rapidly at some small and midsize banks that as many as 150 out of the 7,500 banks nationwide could fail over the next 12 to 18 months, analysts say.

“Everybody is drawing up lists, trying to figure out who the next bank is ...” said Richard X. Bove, the banking analyst with Ladenburg Thalmann, who released a list of troubled banks over the weekend. ... In his “Who Is Next?” report ... Mr. Bove listed the fraction of loans at banks that are nonperforming ... He came up with what he called a danger zone, which was a percentage above 5 percent. Seven banks fell in this category.
Jane Wells at CNBC has Bove's list: After IndyMac, Who's Next?. Here is Bove's list of banks in the 'danger zone' according to Wells: Downey Financial, Corus Bankshares, Doral Financial, FirstFed Financial, Oriental Financial, and BankUnited Financial.
Then Bove ran a second set of numbers dividing a bank’s non-performing assets by its reserves plus common equity. ... You have all the same names as listed before, PLUS WASHINGTON MUTUAL.
And just today, from MarketWatch on Downey Financial:
Downey Financial said Sunday that its nonperforming assets hit 14.33% of its total assets in May, up from 10.75% at the end of February. A year ago, Downey's nonperforming assets were 1.3%.
Going forward, I expect many more bank failures, although probably far fewer than in the '80s and early '90s. Unlike IndyMac that failed mostly because of bad Alt-A mortgage loans, most of the coming bank failures will probably be small regional banks with too much exposure to Construction & Development (C&D) and Commercial Real Estate (CRE) loans. Clearly there is the possibility of a huge failure too. FDIC Chairman Sheila Bair told a Senate Banking Committee in early June:
"There is also the possibility that future failures could include institutions of greater size than we have seen in the recent past."
Maybe she was thinking of IndyMac.
Read on ... there is much more.