As Bank Failures Rise, FDIC Funds Sink

The FDIC has reported the failure of 77 banks so far this year. It is the highest rate of bank failures since the height of the Savings and Loan crisis in 1992. The cause of the failure for many of these banks are mounting loan loses on commercial loans made to commercial real estate developers and small and mid-sized businesses (SME). This is dramatically different from the banking crisis that unfolded in the later part of 2008. Bank solvency was threatened due to high default rates in sub-prime mortgage loans and the erosion of value in residential mortgage backed securities (RMBS) held by larger banking intuitions. This led to the TARP program that was created to purchase distressed assets and inject much needed capital into struggling banks.

Most of the bank failures are the result of the macroeconomic factors spawned by the recession. High unemployment and tightening credit availability has stressed many consumer oriented businesses. It has led to alarming bankruptcy rates of SMEs. This has hurt community banks who have a significant portion of their commercial lending portfolios exposed to commercial real estate dependent on a vibrant SME segment. Bank failures remove liquidity from the credit markets. As more banks fail funding sources and loan capital are withdrawn from the system. This is yet another dangerous headwind c0nfronting SMEs as they struggle with a very difficult business cycle.

The FDIC is growing increasingly alarmed about the solvency of its insurance fund and its ability to cover depositors of failed banks. This years largest bank failure, Colonial Bank Group is expected to cost the FDIC insurance fund$2.8 billion. Its a large amount for the stressed fund to cover in light this years high number of bank failures and an expectation that failures will continue to rise.

According to Forbes online, the FDIC has indicated concern that the Guaranty Financial Group Inc., a Texas-based company with $15 billion in assets that racked up losses on loans to home builders and borrowers in California, and Corus Bankshares Inc., a $7 billion Chicago lender to condominium, office and hotel projects are also at risk of failing. Each failure will place a added strain on the FDIC insurance fund. The costliest failure was the July 2008 seizure of big California lender IndyMac Bank, on which the fund is estimated to have lost $10.7 billion.

The FDIC expects bank failures will cost the fund around $70 billion through 2013. The fund stood at $13 billion – its lowest level since 1993 – at the end of March. It has slipped to 0.27 percent of total insured deposits, below the minimum mandated by Congress of 1.15 percent.

The FDIC has a huge challenge on its hands. It needs to maintain the orderly working of the banking system to alleviate the waning confidence of consumers and shareholders. Recently it was announced that restrictions on private equity firms purchasing banking companies will be relaxed to assure that the industry remains sufficiently capitalized. Regulators will need to increase oversight of community banks risk management controls. The added transparency may be resented by bank management but it may help to stem the tide of accelerating bank failures as the difficult conditions in the commercial real estate market persists. In any case bankers should expect to see an increase in FDIC insurgence premiums to recapitalize the depleted fund. Unfortunately bank customers will be burdened with rising fees banks charge for services as they seek ways to cover the rising expense of default insurance.

Bankers must become more vigilant in their assessments to determine the credit worthiness of SMEs. Sum2’s Profit|Optimizer is helping bankers assess small business credit worthiness; leading to lower loan defaults, higher profitability and more harmonious client relationships. The Profit|Optimizer is also available for purchase on Amazon.com.