Friday, May 29, 2009

FDIC Fund Running Dry

  • On Wednesday May 27, 2009, 2:22 pm EDT

We highlight JP Morgan Chase & Co., Inc. (NYSE: JPM - News), BankUnited Financial Corp. (NasdaqGS: BKUNA - News), Wells Fargo & Co. (NYSE: WFC - News) and Bank of America Corp. (NYSE: BAC - News).

As the FDIC has had to step in to take over more and more insolvent banks, the fund has dwindled to dangerously low levels. At the same time, the number of problem banks continues to grow at a rapid pace.

At the end of the first quarter there were 305 'problem institutions' with a total of $220.0 billion in assets, up from 252 institutions and $159.4 billion in assets at the end of 2008. At the end of the quarter, the Deposit insurance fund was at just $13.0 billion, or 0.27% of insured deposits, a decline of 24.7% in the quarter alone.

The first graph (from shows the steep drop in the coverage ratio. Just a year ago, the fund was equal to 1.01% of covered deposits. The current level is its lowest since the first quarter of 1993, when we were digging out from the S&L fiasco.

However, don't worry about losing the money in your checking account if your bank goes under. Congress has already approved a $500 billion line of credit to the FDIC. Without a doubt, that line of credit is going to have to be tapped. This does emphasize the insanity of having the FDIC provide the guarantees for the PPIP [Public-Private Investment Program]. The fund simply does not have the resources available to do it. The money for the inevitable large losses that the fund will take on the program will come from that line of credit.

The prospect of the FDIC paying back that loan anytime soon from increased assessments on the banks is extremely remote. This is simply a back-door bailout of the FDIC, structured as a line of credit so it does not increase the reported budget deficit.

Using the FDIC to backstop the PPIP program is simply a way to bypass Congress. There is no way that Congress could not have approved the line of credit and let the FDIC become insolvent. By all rights, the assessments on the banks should be raised to make up for the shortfall in the FDIC, but now is not exactly the time to do it, since it would simply deplete their capital at a time when they desperately need to improve their capital base.

To bring the fund up to a more normal 1.2% of insured assets would require $44.8 billion, not counting the losses that the fund has incurred so far in the second quarter, or any subsequent losses. That would be a pretty hefty tax for the banks to pay. Still, fairness demands that it be paid by the banks, not by the general taxpayer.

During the quarter, 21 banks with $9.5 billion of assets failed, at an estimated cost to the fund of $2.2 billion. In the 12 months to 3/31/09 there have been 44 failures with $381.4 billion in assets at a total cost to the fund of $20.1 billion. The 5.3% of failed assets cost to the fund over the last year is somewhat misleading since by far the largest failure was Washington Mutual, which was bought by J.P. Morgan (NYSE: JPM - News) at no cost to the FDIC (but very generously backstopped by the Fed).

It is noteworthy that Wamu never showed up on the 'problem bank' list. This is a good reminder than not all problem banks fail, and not all failures are identified as problem banks before they go under. The 23.2% cost of failed assets in the first quarter is much more representative of a typical bank failure.

Since the end of the first quarter, 15 more banks have failed, and one, BankUnited (NasdaqGS: BKUNA - News) had more assets ($12.8 billion) and cost the fund more ($4.9 billion) than all the failures of the first quarter combined. It is thus very likely that the fund is already approaching a single-digit basis-point coverage ratio of insured deposits.

If we simply subtract out the $4.9 billion from the $13.0 billion at the end of the quarter (very generously assuming that assessments coming in equal the cost of the other 14 smaller failures) the fund is down to just $8.1 billion, or 3.7% of identified problem assets. As commercial real estate tanks, hundreds of smaller banks with massive exposure to it will be in danger of failing.

It is very likely that the list of problem banks and their assets will continue to grow. When looking at the second graph (from the FDIC, by way of note that the difference between the last bar and the second to last bar is only a quarter, while the other bars are annual differences. Thus the increase in the assets of problem banks is actually accelerating by increasing $60.6 billion in the first quarter, almost twice the $34.3 billion average increase per quarter during 2008.

Similarly, the quarterly increase in the number of problem institutions, 53, is significantly higher than the average quarterly increase during 2008, which was 44. In short, we still have many significant problems in the banking system, and the rate of increase shows no sign of slowing down.

While the big boys like Wells Fargo (NYSE: WFC - News) and Bank of America (NYSE: BAC - News) may be in the process of raising enough capital to repay the TARP, there are many smaller banks which are in deep trouble. While individually they do not pose a systemic risk, collectively they will prove to be a significant drag on any economic recovery.

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