Dear Jim,

The FDIC closed seven more banks this week, making it 140 so far this year. This week’s closures cost the FDIC a total of about $1.8 billion.

For those keeping score, the FDIC was reported to have run out of assets as of approximately November 2009. It then came up with a plan to order banks to pre-pay three years’ worth of deposit insurance premiums – amounting to about $45 billion – in order to remain solvent. Since then, the FDIC has been hit with another $5.45 billion in projected costs.

Several observations about this week’s closings:

A Very Big Question Mark

The largest bank closed this week was First Federal Bank of California, based in Santa Monica, CA, which had 39 branches. According to the FDIC, First Federal had assets of about $6.1 billion and deposits of $4.5 billion.

The FDIC press release states it will cost an estimated $146.3 million to close First Federal. That suggests that First Federal’s assets were being carried at a value of at least $1.45 billion (32%) more than they were worth. This is consistent with the pattern seen across the board this year since the Financial Accounting Standards Board (“FASB”) caved into political pressure and suspended fair value accounting requirements.

On the other hand, the relative cost to the FDIC of closing this bank – 3.25% of the value of its deposits – is significantly lower than what has been seen in recent weeks. By way of comparison, the cost to the FDIC of closing the first three banks in this cycle (in late 2007) was about 5.7% of deposits; however, in the past couple of months the trend has been at least 25% of deposits on average.

The problem with this bit of good news is that it appears unbelievably over-optimistic given the structure of the deal. The FDIC had to enter into a loss-share agreement with respect to $5.3 billion of the assets purchased by the acquiring bank.

Manipulation Of Perspective Of Bank Closings

It seems very unrealistic for the FDIC to estimate its costs will be limited to $146 million when it shares the future downside risk on $5.3 billion worth of questionable assets. The whole reason parties enter into loss-share agreements is because there is serious concern the assets in question will decrease in value more than expected over time.

About ten days ago it was reported that the closing of Colonial Bankgroup, Inc., in mid-August 2009, was already being projected to cost the FDIC $5.6 billion, twice its original estimate of $2.8 billion, because of the FDIC’s exposure on a loss-share agreement in that transaction. This is strong evidence that the FDIC is making unrealistically low estimates of its exposure under these agreements when it makes its original loss projections.

In all likelihood this is Manipulation of Perspective Economics (“MOPE”) applied to bank closings. There is only so much bad news that U.S. government policymakers are likely to permit be released in any given period of time.

It stands to reason that as the frequency and size of bank closures increases, FDIC staff will be subjected to incredible pressure to under-estimate losses. It will be justified as being in the public’s interest, as revealing too much would only lead to unnecessary panic. A compliant press will be counted on to not dig deeper.

More Evidence of Worrisome Trends

Looking at the six banks other than First Federal closed this week, their total reported deposits were about $6.66 billion, and the FDIC’s cost of covering those deposits about 1.66 billion (25%). That number is consistent with the very high average loss rates seen in recent weeks.

Of these six failed banks, the largest three had combined assets of $7.3 billion and deposits of $5.7 billion, yet it cost the FDIC $1.39 billion to cover those deposits. That implies the assets were really only worth about $4.31 billion, approximately 59% of the value claimed. This is more evidence of false valuations brought about courtesy of the FASB and shortsighted politicians.

In these three cases the acquiring banks purchased a total of $6.4 billion of the failed banks’ assets and required the FDIC to enter into loss-share agreements with respect to $5.1 billion of these assets. This exposure may prove to be costly to the FDIC over time, as recent updates regarding the closure of Colonial Bankgroup, Inc., have made clear.

A Couple of Very Bad Apples

Two of the banks closed this week, Rockbridge Commercial Bank of Atlanta, Georgia (with reported assets of $294 million) and Citizens State Bank of New Baltimore, Michigan (with reported assets of $168.6 million), call attention to themselves due to their unprecedented loss rates. The FDIC’s estimated cost of closing Rockbridge amounts to about 42.6% of deposits, and Citizens State about 48.8% of deposits. These are not figures you expect to see in a system where banks are supposedly monitored and kept in check.

It should also be noted that in the case of these two banks and one other this week, the FDIC was unable to find another bank to take them over. The FDIC therefore became responsible for taking over these banks’ assets and managing them for eventual sale.

This brings to mind Jim’s recent observation in his December 9, 2009, General Editorial that “we do in fact [today] have a 90s type Resolution Trust, but it carries another name. This time the Resolution Trust is the Federal Deposit Insurance Company.”

Respectfully yours,
CIGA Richard B.