Bank failures: How bad will it be?

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Washington Mutual, Wachovia and National City are among the financial institutions that have announced huge losses and are looking for billions of dollars from private equity firms or others in the industry just to keep their doors open. In all likelihood, the bigger banks and savings and loan associations will survive the mortgage debacle and ensuing credit crunch, albeit somewhat battered and bruised.

But smaller banks may not fare as well, although it doesn’t appear that we’ll see a cascade of bank failures. Nevertheless, the increased risk has prompted the Federal Deposit Insurance Corp., or FDIC, to beef up its staffing in anticipation of banks going belly-up.

The FDIC insures approximately 8,500 institutions; 79 of them are on the agency’s secret list of problem banks as of Dec. 31, 2007. Being on the problem list doesn’t mean that a bank will fail; in fact, the agency says historically about 13 percent of banks on the list fail. The greater problem is that the damage done to financial institutions in 2007, and continuing through 2008 and perhaps beyond, may add many more names to the list.

U.S. bank failures 2003 to 2008
Bank name Closing date
Hume Bank, Hume, Mo. March 7, 2008
Douglass National Bank, Kansas City, Mo. Jan. 25, 2008
Miami Valley Bank, Lakeview, Ohio Oct. 4, 2007
NetBank, Alpharetta, Ga. Sept. 28, 2007
Metropolitan Savings Bank, Pittsburgh Feb. 2, 2007
Bank of Ephraim, Ephraim, Utah June 25, 2004
Reliance Bank, White Plains, N.Y. March 19, 2004
Guaranty National Bank of Tallahassee,

Tallahassee, Fla.

March 12, 2004
Dollar Savings Bank, Newark, N.J. Feb. 14, 2004
Pulaski Savings Bank, Philadelphia Nov. 14, 2003
First National Bank of Blanchardville,

Blanchardville, Wis.

May 9, 2003
Southern Pacific Bank, Torrance, Calif. Feb. 7, 2003

“When you get on that list it means the regulators are working more closely with you on a supervisory basis,” says FDIC spokesman David Barr. “We’re trying to work with the institution to recognize the problems and have them work out their difficulties so they get off the list.”

Community banks are the institutions raising the most concern, because, some industry analysts say, they are the ones that may be at the most risk. But Karen Thomas, executive vice president for government relations at Independent Community Bankers of America, an organization representing 7,500 community banks, says that on balance, the group is in good shape.

“The industry as a whole is coming off a period of record profits and strong liquidity. As a result, 99 percent of banks and thrifts remain well-capitalized and meet or exceed the highest regulatory capital standards. Community bankers are strong, responsible, commonsense lenders. They didn’t cause this crisis and we expect them to weather this storm very well. They’re looking at their asset quality and their loan portfolios and taking any actions that they deem are prudent.”

Bert Ely, principal of Ely & Co., a banking industry consultant, agrees that most community banks are in good shape and that they didn’t get heavily involved in subprime, but, he says, they have other problems.

“Banks of all sizes, including community banks, have gone overboard in some areas. One is home equity lending, another is lending to developers for property development, and the third area is commercial real estate. We’re going to see some banks fail with these problems. But if regulators move aggressively, the problems can be resolved before the bank becomes insolvent.

“One area where we’ll continue to get failures — and recessions tend to bring this out — is failures due to fraud; particularly when there’s internal fraud of some kind. Fraud is much more likely to bring down a small bank than a large one. Good economic conditions can mask fraud, especially if it’s fraudulent lending.”

Ely says that failures can lag the business cycle, and if we see a burst of failures, it may not peak until 2009 or 2010.

What happens after a failure
If an FDIC-insured bank does fail, the FDIC usually shuts down the bank on a Friday and reopens it by the following Monday. Even in times such as this, it hasn’t been difficult to find a buyer to take over the institution. (For more specific information on what happens after a bank failure, read a
Q&A with the FDIC’s Barr.)

“The FDIC can carve out all the problem loans and other assets of the bank and just pass a clean institution to the acquiring bank,” says FDIC’s Barr. “Even if all they want are the branches, then they just take the insured deposits and they get an instant bank. Many times they’ll take the front-line employees too.

“We try to market the liabilities as quickly as possible. The FDIC is not a financial institution; we’re a liquidator. If they are marketable loans that could easily be sold on the secondary market, we’ll try to sell those. If they’re troubled loans, then we work with the customers to get them to perform.

“The good news for the taxpayer is that this costs them nothing since the FDIC is funded by charging banks premiums for deposit insurance. Now, if we run out of money, then the full faith and credit of the United States stands behind our insurance fund. Luckily, the FDIC hasn’t had to go there, but if you remember back in the 1980s, the insurance fund for (savings and loan associations) actually went out of business and it cost the taxpayers $150 billion.”

While insured deposits are covered 100 percent in the event a bank fails, Barr says that over the past 15 years uninsured depositors have received an average of 72 cents on the dollar for the portion of their funds that exceeded the insurance limit. There have been instances where uninsured depositors received 100 percent of their money, but others have received much less, as was the case with the Oakwood Deposit Bank in Ohio in 2002, where uninsured depositors received just 42 percent. While you may recover your uninsured deposits, it can take a long time, even years. On the other hand, insured deposits are paid very quickly, usually within 48 hours.

There are several ways to insure more than $100,000 at a single bank. Read ”
Are your deposits insured?” for tips on making the most of FDIC coverage.