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Wednesday, June 18, 2008


again, bank failures are coming

i've been saying for many months now that bank failures are very certainly coming. indeed some already have, including countrywide and bear stearns.

i previously cited institutional risk analytics in its comments on jpmorgan chase. jpm subsequently has raised capital, though its future remains widely undoubted.

now IRA discusses the buildup of the FDIC following a factfinding mission to washington.

The IRA was trolling the financial services channel in Washington last week, meeting with regulators and members of Congress to discuss the various topics arising from the widening subprime debacle. Probably the most significant discovery during our trip is news that the FDIC is making feverish operational preparations for an unprecedented wave of bank failures, large and small. This data point tracks with the rising number of calls we have been receiving at IRA HQ in Los Angeles from retail customers about the financial condition of specific banking institutions.

Just as abnormally low loan loss rates at US banks during the past five years suggested an eventual and equally abnormal upsurge in default rates, the fact of virtually no bank failures during that same period now means we shall see an above-normal number of failures in coming months and years. Our colleagues at the FDIC, at least among Washington regulators, seem to understand the systemic significance of this fact.

The largest failed bank resolutions by the FDIC to date involved institutions with tens or hundreds of thousands of depositors, but we hear in the channel that plans are being implemented to staff call centers to deal with inquiries from millions of depositors from multiple failed banks. The model for this effort, of note, is NetBank, the $2.5 billion asset Internet bank which failed last year at a cost of over $100 million to the deposit insurance fund. We described same in our comment (Death of a Business Model: NetBank, October 1, 2007).

We hear that the FDIC resolution of the virtual Netbank generated more than 3x the normal volume of inbound calls from depositors compared to a conventional, brick and mortal bank of similar asset size. We also hear that the FDIC is preparing a rule-making process to require banks to uniformly tag deposit accounts within their internal systems so that a resolution of a larger institution is possible.

FDIC Chairman Sheila Bair reportedly has made the completion of the deposit identification project the agency's top priority for 2008. At present, when FDIC personnel go into a failed institution, they often must manually reconstruct deposit ownership records using external software tools. The new rule is intended to address this potentially huge operational deficiency, but it may be too late - years too late -- to affect the outcome of the anticipated number and magnitude of bank failures.

the beginning of those failures may be in the near term. minyanville's bennet sedacca commnets on today's report regarding fifth third bank and its need to raise capital with punitively-priced preferred convertibles.

They're based in the Rust belt, where manufacturing jobs are losing ground by the day. To come to market with a preferred offering, if I had to take a guess, it would need to be 10+%. FITB announced that it's slashing the dividend and will attempt to sell $2 billion in convertible preferred shares with a yield in the 8.5% along with some nasty dilution for current equity owners. This is a disastrous turn of events, but one that was inevitable. Welcome to desperation station.

Who are the usual buyers of all the preferred deals we've been seeing over the past year? Mom and Pop retail—they won’t buy anymore, as Wall Street has jammed them full of securities that are severely underwater. Insurance companies--hmmm, let’s see--they won’t buy as they're so deep in Level 3 Assets that they're issuing themselves! What about the PIMCO’s of the world? It's most likely full up as well. So the capital raising window, in the sense we're used to is in the process of closing.

This means that corporations will now do whatever they must in order to stay solvent? They'll slash jobs and dividends and attempt to raise capital by issuing common equity. The problem is that they're too late; they should have done this already. Instead they were stubborn and ‘hoped’ they would be OK and the economy would recover. But as they say ‘hope is a poor roadmap to success'.

and more, via mish:

Minyan Peter, former treasurer for a major US bank offered these comments on Fifth Third:

While the announcement out of Fifth Third this morning is simple, I can't understate its importance.

Fifth Third to Sell certain noncore businesses.

By all accounts the market for hybrid securities - straight preferred and convertible preferreds - for financial institutions has or is in the process of closing. This now leaves institutions with the Sophie's Choice of either wickedly diluting shareholders (some again) through the issuance of common stock or selling off "non core" assets to cover losses.

Like the last minutes of "Around the World in 80 Days", banks will now burn the side of the ship with hopes of making it to shore.

Please take note: The game has changed.

as capital raising becomes virtually impossible, with credit markets still largely frozen and deleveraging by security sales actually impossible -- see lehman brothers' duplicitous efforts at closely-held spinoffs disguised as deleveraging -- what is already a manifestly deflationary credit contraction will likely accelerate rapidly as banks are broken up in forced sales or fail outright. i have felt increasingly confident -- here and here most recently -- that debt deflation is the probable resolution of the popped credit bubble we face. i wonder if in fact the next few quarters will not, at some distant date, be seen as one of the most difficult economic periods in the history of the united states.

UPDATE: from a may 19 commentary by institutional risk analytics:

With Q1 earnings releases from most US banks completed, it's time to assess the progression of loan loss rates from 2007 through the first three months of 2008 and what it implies for the rest of the year. ...

... A number of our colleagues have commented recently that credit cards do not seem to be experiencing unusually high default rates, but the results of COF's credit card unit seem to contradict that view. Overall, in 2008 we look for loss rates among all US banks to at least double from the 80bp of defaults reported to the FDIC for 2007.

... We continue to worry about the rate of change in bank default rates going in to Q2 2008 and the rest of the year. We worry that the rate of change in bank default rates may not slow until 2009, a scenario that is pretty close to a worst case scenario for the US economy that sees many US banks at 2x early 1990s levels of loan defaults. If the rate of increase in bank loan defaults accelerates in Q2 2008 for most banks, then all of the proverbial bets are off.

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