May 20, 2022

FDIC Considers Borrowing From Treasury As Banking Failures Increase

FDIC May Request Treasury Loan As Losses Grow

The FDIC always takes pride in noting that it is self funding and covers failed bank losses by assessments on FDIC insured member financial institutions.

Congress created the Federal Deposit Insurance Corporation in 1933 to restore public confidence in the nation’s banking system. The FDIC insures deposits at the nation’s 8,195 banks and savings associations and it promotes the safety and soundness of these institutions by identifying, monitoring and addressing risks to which they are exposed. The FDIC receives no federal tax dollars – insured financial institutions fund its operations.

How much longer the FDIC can continue to fund itself based on fee assessments is questionable.  For the second quarter of 2009, the banking industry as a whole lost $3.7 billion dollars and second quarter FDIC assessments totaled $9.1 billion.

FDIC Insurance Fund Nearly Depleted

The FDIC did borrow money from the Treasury during the last banking crisis in the early 1990’s and later paid the money back.  The escalating number of costly bank failures over the last two years has reduced the FDIC Deposit Insurance Fund (DIF) to only $10.4 billion which  covers potential losses on almost $5 trillion dollars in FDIC insured deposits.  In addition, the number of banks on the FDIC Problem Bank List continues to expand.

The Problem Bank List grew to to 416 institutions from 305 last quarter.  The total assets at Problem Banks increased to $299.8 billion from $220 billion last quarter.  This is the largest number of problem banks since June 30, 1994.  The number of FDIC  insured institutions declined to 8,195 from 8,247 last quarter.

Earlier this year the FDIC’s line of credit at the Treasury was increased to $100 billion and up to $500 billion with the consent of both the Federal Reserve and the Treasury.  With a nearly depleted  DIF fund and the prospect of hundreds of additional banking failures, the FDIC may have no choice but to borrow from the Treasury as noted in the Wall Street Journal.

WASHINGTON –– Federal Deposit Insurance Corp. Chairman Sheila Bair said Friday her agency may tap its $500 billion credit line with the U.S. Treasury to replenish its deposit insurance fund, though she appeared cautious about doing so.

“We are carefully considering all options” including borrowing from the Treasury, Ms. Bair said Friday after a speech in Washington.

Ms. Bair has already warned banks that they may face an assessment increase to bolster the fund. Friday, she said there are also other little-known options available to the agency, including requiring banks to prepay assessments. The FDIC board of directors will meet at the end of this month to consider how to replenish the fund, she said.

Ms. Bair appeared cautious about resorting to the Treasury credit line, saying there are different views on when it should be used. She said some believe it should be reserved for emergencies only, rather than for covering losses that are already known.

Surging loan defaults show no sign of leveling off which in turn puts more banks at risk of failing.  The FDIC will need a Treasury bailout – the only question is will $500 billion be enough?

Noncurrent Loan Growth

Noncurrent Loan Growth

Can The Unemployed Afford A Mortgage Payment?

Government Determined To Keep Unwilling Homeowners In Homes

The FDIC announced a new initiative to reduce foreclosures on home mortgage loans held by failed banks that were acquired by another institution.   This new FDIC program goes far beyond previous government mortgage assistance programs such as the Home Affordable Refinance Program (HARP) and the Home Affordable Modification Program (HAMP).

Whereas the HARP and HAMP programs require income verification and attempt to lower a monthly mortgage payment to a level that is reasonable in relationship to a homeowner’s income, the new FDIC forbearance plan will attempt to help homeowners who are currently unemployed.

FDIC Encourages Forbearance To Unemployed

As part of its loss-share agreement with acquirers of failed FDIC-insured institutions, the FDIC is encouraging its loss-share partner institutions to consider temporarily reducing mortgage payments for borrowers who are unemployed or underemployed. This program will provide additional foreclosure prevention alternatives to these borrowers through forbearance agreements that will give them an opportunity to regain full employment and avoid an unnecessary foreclosure.

“With more Americans suffering through unemployment or cuts in their paychecks, we believe it is crucial to offer a helping hand to avoid unnecessary and costly foreclosures. This is simply good business since foreclosure rarely benefits lenders and would cost the FDIC more money, not less,” said FDIC Chairman Sheila C. Bair. “This is a win-win for the borrower, who can remain in his or her home while looking for a new job, and the acquiring institution, which continues to receive payments on the loan. Ultimately, by reducing losses under our loss-share agreements, this approach helps reduce losses to the FDIC as well.”

The recommendation to loss-share partners applies where unemployment, or underemployment, is the primary cause for default on a home mortgage. In such cases, the FDIC is urging its loss-share partners to consider the borrower for a temporary forbearance plan, reducing the loan payment to an affordable level for at least six months. The monthly payment during this period should be established based on an affordable payment – given the borrower’s circumstances – and it should allow for reasonable living expenses after payment of mortgage-related expenses.

FDIC Plan Likely To Help Few Homeowners

The objectives of the FDIC’s forbearance plan are well intentioned.  Allowing an out of work homeowner time to find a new job may prevent an unnecessary foreclosure and eliminate the need for a costly foreclosure by the bank.  From a practical standpoint, the FDIC plan may ultimately benefit very few homeowners for the following reasons:

  • The program is only available to those homeowners who have mortgages with failed banks that were acquired by another institution under a loss-share agreement with the FDIC.
  • Under the forbearance agreement, the bank will accept only a portion of the regular mortgage payment.  The FDIC is asking for only a 6 month forbearance.  Given the prospects of a “jobless economic recovery” and the difficulty in finding new employment, the FDIC appears wildly optimistic about a quick change in fortune for an unemployed homeowner.   Banks do not want to foreclose, but very few banks now offer a forbearance plan to the unemployed since they do not expect them to quickly find a new job.
  • The mortgage foreclosure prevention plans currently in effect have had dismal success rates and these programs are limited to candidates who have income.  The HARP program, expected to help millions of homeowners had at the end of July approved only 60,000 refinances.   The government loan modification program (for those not qualified under HARP) has been plagued by very high re default rates ranging from 17% to 45%.
  • The FDIC recommends that the lender establish an “affordable payment” for six months, allowing for reasonable living expenses.  Many homeowners with jobs are struggling to make their mortgage payments.  Many states pay only a fraction of previous earnings in unemployment benefits.   Unless the homeowner has put aside some savings, unemployment compensation will usually cover only basic needs, leaving nothing for a mortgage payment.  It is likely that any payment (other than zero) will be too high for unemployed homeowners.
  • Recent statistics on the “cure rate” for delinquent mortgages show a stunning decline.  The cure rate is the percentage of borrowers who are able to catch up and bring a delinquent mortgage current again.  As of July, the cure rate for prime mortgage loans plummeted to 6.6% from an average of 45% during  2000 to 2006.  Some of the delinquent borrowers had lost their jobs but many were still employed.  This is a sea change in attitudes towards home ownership.   Many of those financially able to catch up apparently saw no benefit in doing so; either the burden of home ownership outweighed the benefits or there was no perceived benefit in continuing to make payments on a home with large negative equity.   Many homeowners may view foreclosure as the best “program” for getting back on their feet since they could potentially enjoy years of “rent free” housing before the bank ultimately forecloses.

Trapped Homeowners Want Out

Heavy Load

Heavy Load

Courtesy: laprogressive

Many Americans are apparently rethinking the “dream” of home ownership and acting accordingly by relieving themselves of the costly burden of mortgage payments, taxes and maintenance on what has become a depreciating asset.

While the government says “yes we can”, impoverished homeowners are saying “no we can’t”.  Perhaps this is why the massive government initiatives to prevent foreclosures are failing.   Trapped homeowners are doing what’s best for them and walking away, while the government vainly attempts to impose home ownership on those who now reject it.

The FDIC Deposit Insurance Fund (DIF) – A Risky Game Of Confidence

FDIC Rightly Worries About Public Confidence

Due to the large number of bank failures during 2009 the FDIC Deposit Insurance Fund (DIF) has fallen to the lowest level since March 1993.  Numerous headlines are screaming that the FDIC is bankrupt and that the DIF fund is depleted.  Considering the perilous financial condition of the banking industry and the possibility of perhaps another 1,000 or more bank closings, the FDIC is probably not capable of fulfilling its mission without substantial loans from the US Treasury.  (The last time this happened was in the early 1990s during the savings and loan crisis when the FDIC had to borrow $15 billion from the US Treasury.)  This does not mean, however, that the upcoming FDIC  Quarterly Banking Profile will report a negative balance in the DIF.

The FDIC has made it clear that they consider it important to maintain a positive DIF number to avoid causing a lack of confidence in the banking system by the public.

The FDIC believes that it is important that the fund not decline to a level that could undermine public confidence in federal deposit insurance. A fund balance and reserve ratio that are near zero or negative could create public confusion about the FDIC’s ability to move quickly to resolve problem institutions and protect insured depositors.

In addition, the FDIC has increased assessments on FDIC insured institutions to replenish the DIF fund and predicted that the DIF would remain positive in 2009.

May 22, 2009 – With the special assessment adopted today, the FDIC projects that the DIF will remain low but positive through 2009 and then begin to rise in 2010. However, Chairman Bair also cautioned that given the inherent uncertainty in these projections and the importance of maintaining a positive fund balance and reserve ratio, “it is probable that an additional special assessment will be necessary in the fourth quarter, although the amount of such a special assessment is uncertain.”

Even though the FDIC has significant authority to borrow from the Treasury to cover losses, a fund balance and reserve ratio that are near zero or negative could create public confusion about the FDIC’s ability to move quickly to resolve problem institutions and protect insured depositors.  The FDIC views the Treasury line of credit as available to cover unforeseen losses, not as a source of financing projected losses.

The DIF Shell Game

So how does the FDIC manage to report a positive DIF when the March 31, 2009 balance was $13 billion and estimated FDIC losses on bank closing since March 31 total $19.3 billion?  Determining the DIF balance is not a matter of simply subtracting the banking failure losses from the DIF fund.  The FDIC uses accrual accounting to establish reserves against the DIF fund for estimated future losses.

For example, during 2008 the FDIC heavily reserved for anticipated future banking failures in 2009.  The FDIC established provisions for losses of $41.8 billion compared to actual losses on 2008 bank closings of $17.9 billion.  The reserve fund at March 31 had a balance of $28.5 billion against which the FDIC year to date losses since March 31 of $19.3 billion could be charged.  This would still leave the FDIC a reserve balance for future banking failures of $9.2 billion.

In addition, the FDIC has imposed large assessment on FDIC insured banks to replenish the DIF fund.   The assessments earned by the FDIC have increased steadily throughout 2008 as the banking crisis unfolded.   In the first quarter of 2009, the FDIC collected assessments of $2.6 billion to rebuild the DIF fund.  This compares to total assessments for all of 2008 of $2.965 billion and only $643 million in 2007.

In summary, if the FDIC offsets its losses against previously established reserves,  and collects an additional $3 billion in assessments, the FDIC could actually report an increase in the DIF fund to approximately $16 billion.   My guess is that the FDIC will only use a portion of the reserve balance, and report a DIF positive balance in the range of $10 to $13 billion when the Quarterly Banking Profile is released.   It’s all about confidence and an uneducated stupid public – the DIF balance of around $20 billion allegedly “protects” over $6 trillion in deposits! The only thing that would expose this “confidence game” is if the financial results for the banking industry come in much worse than the last quarter.  Stay tuned.

DIF

DIF

Disclosures:  None

Feds To CIT – “Your Loan Application Has Been Denied”

CIT Solution Is Bankruptcy – Not Bailout

A CIT spokesman said late today that “There is no appreciable likelihood of additional government support being provided over the near term”.   Taxpayers had previously supplied a massive $2.3 billion dollars in loans under the TARP program late last year.  The large TARP infusion did little to turn around CIT which has reported losses for the past two years of over $3.4 billion.

CIT has $60 billion in finance loans and leases outstanding, an amount that is a mere rounding error in a $14 trillion US economy.  CIT does not represent a systemic risk to the US financial system.  The large amount of losses reported by CIT over the past two years suggest that loan approvals were given to risky enterprises.  CIT would not be losing money and on the verge of bankruptcy if their lending policies had properly accounted for risk.

The weak economy certainly contributed to CIT’s losses, but they could have been mitigated by better risk management.   As a private lender, CIT has the right to lend based on whatever standards they chose.  As a private lender, they also bear the responsibility of loss.

The American taxpayer should not be stuck with the cost of bailing out every failed business enterprise.  There already is a solution for poorly run companies – the solution is known as bankruptcy.  The US Treasury can join other creditors in bankruptcy court – cutting your losses is often the best option.

CIT aggressively expanded its loan portfolio over the past fives years by almost 100% to $60 billion.   CIT attempted to rein in its lending as the recession deepened, but the losses continued.  Increased losses resulted in a dramatic reduction of new lending activity over the past year.  CIT has effectively shut down new lending to small businesses for over a year now.  Customers that qualify for financing have gone elsewhere.

CIT -courtesy WSJ

CIT -courtesy WSJ


For small businesses, CIT is already failing.

“In order to service its debt and meet obligations, [CIT] has been cutting back on new originations,” explains David Chiaverini, research analyst at BMO Capital Markets.

CIT CEO Jeffrey Peek said in November that his company was “the bridge between Wall Street and Main Street,” and “one of the few significant sources of liquidity for small and mid-sized businesses who are struggling to survive.” But by then, CIT was already burning down its bridge, turning away many of the small businesses that had come to rely on the company.

BMO Capital Markets’ Chiaverini sees bankruptcy as CIT’s most likely next step.

“The best case for CIT is to get its liquidity issues resolved — bankruptcy could actually get things back to normal on the lending front,” he says. “If it does go into bankruptcy, I think what will happen is unsecured debt holders will convert their debt into equity and it will emerge stronger without the overhang of debt coming due. Then, it can start lending again.”

CIT’s role in small business financing will be hard to fill, but for many companies, the damage is already happening. Saving CIT would only help Main Street businesses if the company became healthy enough to resume making loans.

FDIC Rejects CIT Loan Guarantee Request

Sheila Bair, FDIC Chairman, had previously expressed deep reservations about allowing CIT to access the Temporary Loan Guarantee Program (TLGP) due to CIT’s weak financial condition.   Due to the financial crisis, the FDIC was called upon to provide guarantees to bank issued debt under the TLGP.  This type of massive “mission creep” imperils the primary purpose of the FDIC which is to protect depositor funds.  The FDIC Deposit Insurance Fund (DIF) is nearly depleted.  Sheila Bair made the right call and so did the Federal Government.  Let the owners and creditors of CIT assume the risk of loss – not the US taxpayer.

“Cutting Your Losses”

cit-chart

Disclosures: No positions

More on this topic: Treasury Bets U.S. Financial System Can Weather CIT Collapse

FDIC Tells Banks California IOU’s Good As Gold

Bank Have Enough Bad Assets

Yesterday, a group of major banks, including Bank of America, Citigroup, JP Morgan and Wells Fargo,  said that they would stop accepting California IOU’s.  The State of California, virtually out of cash, has been issuing IOU’s, known officially as “individual registered warrants” to creditors in lieu of cash.  The State has promised to pay IOU holders 3.75% interest when the warrants mature on October 2.

With Fitch Ratings dropping California’s debt rating to BBB junk status, it is understandable that the banks do not want to cash the IOU’s.  Allowing warrant holders to cash in their IOU’s would effectively transfer the credit risk of the IOU’s to the banks.  Most major banks already have a mountain of non performing assets and, understandably, do not wish to add California IOUs to the list.

The reality of the situation is that California has already defaulted since they have reneged on their obligations to creditors.   I wonder what the State of California’s reaction will be when their citizens adopt the State’s method of bill payment and start sending in IOU’s instead of cash for tax payments due?  Many of California’s citizen have been placed in a horrendous financial situation by California’s “spend and borrow until we are bankrupt” policies.  If the banks won’t cash in the IOU’s, why would an average citizen or business want the IOU’s?   The IOU’s won’t pay for your groceries or rent and they can’t be converted to cash – what does that say about faith in California’s “promises to pay tomorrow what is due today”?

FDIC Issues Statement On California IOU’s

The FDIC today issued the following statement to its member banks regarding the credit worthiness of California’s IOU’s.

California Registered Warrants
Interagency Statement

Summary: The federal financial institution regulatory agencies are jointly issuing the attached supervisory guidance for financial institutions regarding the regulatory capital treatment for registered warrants issued by the State of California as payment for certain obligations.

Highlights:

  • The Attorney General of the State of California has opined that the registered warrants that the State is issuing as a form of payment for certain of its obligations are valid and binding obligations of the State.
  • The banking agencies’ risk-based capital standards permit a banking organization to risk weight general obligation claims on a state at 20 percent. These warrants, which are general obligations of the State, would, therefore, be eligible for the 20 percent risk weight for risk-based capital purposes.
  • Banks should exercise the same prudent judgment and sound risk management practices with respect to the registered warrants as they would with any other obligation of a state.

It would guess that the FDIC’s statement on the soundness of California’s IOU’s was more politically motivated than financially inspired.  If this is all the support that California is going to get from the Federal Government, the citizens of California have much to be concerned about.

The FDIC is telling the banks that the risk of the  California’s warrants is the same as any other state issued general obligation debt.  Nice try, but apparently, the biggest banks in the country, as well as the credit rating agencies, are not buying this line.  If the banks won’t cash the IOU’s and you can’t spend them, they are effectively worthless today.  Those stuck with California IOU’s may be in for a long wait before they can be cashed in.

Disclosures: None

The Cost Of Easy Money – $14 Trillion and Counting

Supervisory Insights – Where The Money Went

The FDIC released their Supervisory Insights report today which contains a detailed breakdown of the almost $14 trillion dollars committed by the Government to support the financial system over the past two years.   This huge commitment of taxpayer money can be viewed as the  cost of cleaning up after the Greenspan era of easy money.   The cost of the financial devastation that ensued from the easy money/easy lending era  far outweighs any illusory benefits that may have been gained.

The FDIC report easily recognized  the precipitating factors of the financial crisis of 2008.

The factors precipitating the financial turmoil of 2008 have been the subject of extensive public discussion and debate. The fallout from weak underwriting standards prevailing during a multi-year economic expansion first became evident in subprime mortgages, with Alt-A mortgages soon to follow. Lax underwriting practices fueled a rapid increase in housing prices, which subsequently adjusted sharply downward across many parts of the country.

Excessive reliance on financial leverage compounded problems for individual firms and the financial system as a whole.

One indicator of the gravity of recent developments is this: in 2008,  U.S. financial regulatory agencies extended $6.8 trillion in temporary loans, liability guarantees and asset guarantees in support of financial services.  By the end of the first quarter of 2009, the maximum capacity of new government financial support programs in place, or announced, exceeded $13 trillion.

And some of the old banking basics—prudent loan underwriting, strong capital and liquidity, and the fair treatment of customers—re-emerged as likely cornerstones of a more stable financial system in the future.

The obvious question is why were prudent loan underwriting standards abandoned in the first place?  Lenders, borrowers and regulators alike were all blinded by greed and the misguided belief that easy wealth was being created by the use of ridiculous amounts of cheap credit.  Now, at a cost of almost an entire year’s GDP, we know better – at least until next time.

Government Support for Financial Assets and Liabilities Announced in 2008 and Soon Thereafter ($ in billions)
Important note: Amounts are gross loans, asset and liability guarantees and asset purchases, do not represent net cost to taxpayers, do not reflect contributions of private capital expected to accompany some programs, and are announced maximum program limits so that actual support may fall well short of these levels
Year-end 2007 Year-end 2008 Subsequent or Announced Capacity If Different
Treasury Programs
TARP investments1 $0 $300 $700
Funding GSE conservatorships2 $0 $200 $400
Guarantee money funds3 $0 $3,200
Federal Reserve Programs
Term Auction Facility (TAF)4 $40 $450 $900
Primary Credit5 $6 $94
Commercial Paper Funding Facility (CPFF)6 $0 $334 $1,800
Primary Dealer Credit Facility (PDCF)5 $0 $37
Single Tranche Repurchase Agreements7 $0 $80
Agency direct obligation purchase program8 $0 $15 $200
Agency MBS program8 $0 $0 $1,250
Asset-backed Commercial Paper Money Market Mutual Fund
Liquidity Facility (AMLF)9 $0 $24
Maiden Lane LLC (Bear Stearns)9 $0 $27
AIG (direct credit)10 $0 $39 $60
Maiden Lane II (AIG)5 $0 $20
Maiden Lane III (AIG)5 $0 $27
Reciprocal currency swaps11 $14 $554
Term securities lending facility (TSLF) and TSLF options program(TOP)12 $0 $173 $250
Term Asset-Backed Securities Loan Facility (TALF)13 $0 $0 $1,000
Money Market Investor Funding Facility (MMIFF)14 $0 $0 $600
Treasury Purchase Program (TPP)15 $0 $0 $300
FDIC Programs
Insured non-interest bearing transactions accounts16 $0 $684
Temporary Liquidity Guarantee Program (TLGP)17 $0 $224 $940
Joint Programs
Citi asset guarantee18 $0 $306
Bank of America asset guarantee19 $0 $0 $118
Public-Private Investment Program (PPIP)20 $0 $0 $500
Estimated Reductions to Correct for Double Counting
TARP allocation to Citi and Bank of America asset guarantee21 – $13
TARP allocation to TALF21 – $80
TARP allocation to PPIP21 – $75
Total Gross Support Extended During 2008 $6,788
Maximum capacity of support programs announced throughfirst quarter 200922 $13,903

More on this topic:
FDIC Lists Root Cause For Failed Banks – Lax Regulation

Banks Loss Reserves Can’t Keep Pace With Troubled Loans

The latest FDIC Quarterly Banking Profile reveals that banks increased loan loss reserves by 11.5% and the ratio of reserves to total loans increased to 2.5%, an all time high.   Despite the large loan loss reserves, the ratio of reserves to noncurrent loans fell for the 12th consecutive quarter to 66.5%, the lowest level in 17 years.   This low reserve ratio, despite large increases in loan loss provisions  indicates that the banking industry’s estimates of future delinquencies has consistently been too low.

Reserve Coverage Ratio

Reserve Coverage Ratio

Even if the amount of noncurrent loans level off, the implications for future banking profits is a dismal picture.   In order to establish an adequate coverage ratio for noncurrent loans, loan loss provisions will have to rise dramatically.

Prime Mortgage Defaults – Another Black Swan

The banking industry’s low estimate for loan delinquencies may be due in large part to the unexpectedly large increase in default rates seen on prime mortgages.   Prime mortgages were never expected to have a default rate above the historical ratio of around 1% since these were mortgage loans made to the best customers.  In the past, the only defaults typically seen on prime mortgages were due to unexpected job loss, a divorce, illness or other factors beyond the control of the borrower.

The rapid increase of delinquencies on prime mortgages  has caught the banks off guard.   The default rates on prime mortgages is now almost 5% (5 times normal),  a true Black Swan event for the banking industry.  In addition, the  default rate could rise even higher since 25% of prime mortgage holders now have negative equity, a situation which enhances the odds of  delinquency and defaults.

Based on the rapidly deteriorating numbers for prime mortgages, loan loss reserves need to be increased significantly.  The myth that most of the smaller community banks are not exposed to the risks that afflicted the bigger banks is only partially true.   Banks of all sizes have significant exposure to the mortgage market and the growing number of defaults  by prime mortgage borrowers will cause significantly higher than expected losses at all banks.

Prime Mortgage Delinquencies

Prime Mortgage Delinquencies

Courtesy of:  moremortgagemeltdown.com

Problem Banks, Failed Banks Increasing Rapidly

The 36 failed banks we have seen this year has expanded dramatically from 25 for all of 2008, but has remained very low considering the extent of the losses in the banking sector.  Many very weak banks have apparently been allowed to stay open under the misguided hope that mortgage defaults would decrease as the economy improved.  The number of banks classified by the FDIC as “Problem Banks” has risen to 305 from 90 last year.  The latest surge in mortgage defaults due to job losses,  declines in real estate  prices and negative income trends will have a devastating effect on an already weakened banking industry.

The FDIC’s line of credit with the Treasury was recently increased to $100 billion from $30 billion.  The FDIC can borrow up to $500 billion with Federal Reserve and Treasury Department approval.  Expect to see the FDIC draw down significantly on their expanded line of credit with the Treasury as the FDIC is forced to close increasing numbers of insolvent banking institutions.