December 31, 2010 – Banking failures for 2010 were at the highest level since 1992 as 157 financial institutions collapsed, the victims of collapsing real estate prices, a weak economy and poor lending decisions.
The depth and breath of the current banking crisis makes the savings and loan crisis of the late 1980’s and early 1990’s look like a minor event. Only the extraordinary intervention by the Federal Government with trillions of dollars in taxpayer bailouts prevented the collapse of the largest US financial institutions.
Total banking failures between the years 1993 to 2007 totaled only 123 institutions as increases in property values made every lending decision appear sound. When the real estate bubble collapsed in 2008, some of the nation’s largest and most aggressive lenders quickly became insolvent and were either closed by regulators or forced into shotgun marriages with other banks through FDIC assisted transactions.
Although only 25 banking failures occurred during 2008, the failures involved some of the countries biggest institutions including Washington Mutual with $307 billion in assets and Indy Mac Bank with $31 billion in assets. During 2008, a total of 9 institutions with assets exceeding $1 billion dollars failed. The total assets of failed banks in 2008 clocked in at a huge $372 billion in assets.
The cost to the FDIC Deposit Insurance Fund of almost $20 billion quickly wiped out the fund which remains in negative territory today with a reserve ratio of negative .15%. The depleted Deposit Insurance Fund provides insurance coverage on $5.4 trillion of assets. If the economy does not recover and real estate values continue to depreciate, another wave of banking failures will force the FDIC to access its line of credit with the US Treasury.
Beyond the direct cost of banking failures in 2008, the FDIC and US Treasury provided hundreds of billions of dollars in aid to banks on the brink of failure through the controversial $750 billion dollar Troubled Asset Relief Program. A total of 5 institutions with over $1.3 trillion in assets were saved from collapse during 2008.
As the banking crisis worsened during 2009, the number of banking failures and assistance transactions expanded dramatically. During 2009, eight financial institutions with over $1.9 trillion in assets were saved from collapse with unlimited government assistance. Only one of the three largest institutions that received government assistance, Bank of America, survives today.
Ironically, two of the other largest potential failures of 2009, Countrywide Bank and Merrill Lynch, were taken over by Bank of America in government assisted transactions. A total of 140 institutions with almost $170 billion in assets failed during 2009 at a cost of $37.5 billion dollars or 22% of total assets.
During 2010, many of the largest banks were ostensibly recovering after receiving massive government aid and profiting from the benefit of zero funding costs, courtesy of a zero interest rate policy by the Federal Reserve. Smaller banks, however, unable to raise additional capital and facing increased loan losses, continued to fail in large numbers. 2010 saw the failure of 157 financial institutions with over $92 billion in assets.
The estimated cost of the banking failures for 2010 was approximately $26 billion or 28% of total assets. Although many of the failed banks in 2010 were smaller institutions, many larger banks also failed. A total of 19 banks with over $1 billion in assets failed during 2010. The largest banking failure of 2010 was $10.8 billion asset Westernbank of Puerto Rico.
A total of 322 banks with over $633 billion in assets have failed since 2008, at a cost of almost $80 billion to the FDIC.
Will 2011 See A Recovery In The Banking Industry?
The FDIC is forecasting that the number of banking failures peaked in 2010, yet the FDIC has been constantly adding more banks to its Problem Bank List.
As of the latest report released by the FDIC there were 860 problem banks at September 30, 2010, up from 829 at June 30, 2010. Total assets held by the troubled institutions is $379.2 billion, a slight decrease from $403.2 billion in the previous quarter.
The historic low for the Problem Bank List was reached in the third quarter of 2006 with 47 banks. The FDIC’s Problem Bank List of 860 banks is the largest number since March 31, 1993 when there were 928. Problem Banks now account for over 11% of all banking institutions. As of September 2010, there were 7,760 FDIC insured banking institutions with FDIC insured deposits of $5.4 trillion.
In general, banks included on the Problem Bank List have serious deficiencies with their finances, operations, or management that threaten their continued solvency. Once a bank is included on the list, they are subject to closer regulatory scrutiny. They can also expect to receive instructions from regulators about what steps must be taken to rebuild their financial strength.
With an empty Deposit Insurance Fund, the FDIC has to put forth an optimistic scenario. Realistically, however, there are many reasons why 2011 could see another wave of banking failures.
- Unemployment remains stubbornly high and real income growth, the ultimate driver of a sustainable economic recovery remains subdued. Higher energy and food costs have more than wiped out meager income gains for the middle class wage earner.
- Housing prices continue to decline, with October price data showing the third consecutive month of falling prices. Approximately 25% of homeowners with a mortgage are now underwater and negative equity is a major contributing factor to mortgage default. If prices continue to decline expect another wave of foreclosures resulting in major losses to bank loan portfolios.
- Despite the desperate efforts of the Federal Reserve to lower long term interest rates with “quantitative easing”, thus far the result has been a 1% point increase in mortgage rates. Refinance activity has dropped dramatically as a result. Expect home purchases to decline as banks maintain vigorous underwriting standards and buyers wait for prices to stabilize. Logically, lower prices should result in increased home buyer demand, but the prospect of seeing your home drop in value immediately after purchase is not an inducement to buy.
- Analysts at Core Logic expect foreclosures to accelerate in 2011 citing negative equity as a significant factor. The number of foreclosures during 2010 is estimated at 1.3 million, up from 1.1 million in 2009. Core Logic estimates that almost 11 million homeowners are in a negative equity position. The default of millions of additional mortgages will wreak havoc on bank’s balance sheets and income statements.
- Financial crises do not end quickly as documented in the classic study, The Aftermath of Financial Crises, by Carmen Reinhart and Kenneth Rogoff.
“Broadly speaking, financial crises are protracted affairs. More often than not, the aftermath of severe financial crises share three characteristics. First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Second, the aftermath of banking crises is associated with profound declines in output and employment. Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post–World War II episodes.
Interestingly, the main cause of debt explosions is not the widely cited costs of bailing out and recapitalizing the banking system.”
- A dramatic increase in banking regulations due to the Dodd-Frank legislation will impede bank lending as banks struggle to implement a tidal wave of new rules. Banks will also remain conservative due to the risk of recourse losses on loans sold to Fannie Mae and Freddie Mac.
- Bank balance sheets already hold assets at values in excess of fair market. This can be seen in the case of every failed bank as the FDIC routinely marks down assets by 25 to 35% when calculating losses based on expected realizable values. A further drop in real estate values will further increase losses for both failed and surviving banks.
The FDIC may be optimistic about next year, but unless real estate markets dramatically improve, expect a large number of failed banks in 2011.
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