FDIC Friday Failure

Friday is the most common day for your friendly neighborhood regulator to lock the doors of your the local bank and take it over. The FDIC is keeping busy these days with yet another bank failure. On August 22, 2008 The Columbian Bank and Trust, Topeka, KS was taken over by the FDIC. That brings us to a total of 9 this year. The real question is if the failures of 2008 are the beginning of a 1980-1993 period or more like the period of 1994-2007? The answer to that will be in the numbers for 2008-2009.

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The FDIC has been getting prepared for the coming bank failures for some time now. The FDIC announced on Tuesday, August 22, 2008, that in the second quarter 117 banks and thrifts were considered to be trouble. That is the highest level in 5 years.

From MSNBC.com: Mortgage mess puts more banks at risk

The mortgage mess that has upended millions of homeowners’ finances is now taking a bigger bite out of the nation’s banking system.

And while depositors with insured accounts face little risk of losing their money, the insurance fund’s top regulator said it may have to borrow money from the Treasury to make good on that promise to consumers.

...

So far, only nine lenders have failed this year, the largest of which was Pasadena, Calif.-based IndyMac, which was taken over by the FDIC in July with about $32 billion in assets and $19 billion in deposits. It was the second-largest financial institution to close in U.S. history, after Continental Illinois National Bank in 1984.

Those failures have depleted the insurance fund, which now stands at $45 billion — less than the FDIC is supposed to have on hand, according to Daniel Alpert, an investment banker at Westwood Capital.

...

Bair also told the Wall Street Journal the FDIC couldn’t rule out the possibility that it may have ask the Treasury for capital to tide it over through the coming round of bank failures. The money would be used to pay depositors insurance claims, and then paid back after the assets of the failed bank are sold.

I suspect that 2008 will round out with a total bank failure of 14-17 failures. If you have any uninsured deposits, now may be a good time to shuffle some funds to make sure you are covered. Nothing like finding out your not covered after it is too late. You can visit the FDIC and read about how FDIC insurance works to make sure you are covered. If you have about 20 minutes, you can view this informative video provided by the FDIC which explains what Deposit Insurance is all about. You can skip to the "Common Ownership Categories" section or other relevant sections to hear just the part about how you are covered as an individual.

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I Hope My Bank Goes Bust

The FDIC took over IndyMac Bank on July 11, 2008. It was the 5th bank failure in 2008. Shortly after taking over Indymac, the FDIC temporarily halted all IndyMac foreclosures on July 14, 2008 as reported by Reuters. FDIC chairwoman Sheila Bair has been critical of banks and lenders for not doing enough to modify loans to help customers that are in trouble. Based upon the conversations that I have had with various people, I would have to agree. The banks would rather take the property and lose money than to modify a loan. The FDIC has finally announced what they are going to do about the 25,000 or so IndyMac owned loans that are in default.

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From the LATimes.com:

The regulators operating failed IndyMac Bank said Wednesday that they would try to modify about 25,000 troubled mortgages by slashing interest rates to as low as 3% for five years, extending payments over 40 years and in some cases charging interest on only part of the loan balance.

From the New York Times:

The regulator that seized IndyMac last month said Wednesday it would help thousands of the failed thrift institution's cash-short borrowers repay their mortgages and stay in their homes, a model it hoped other banks and collection companies would adopt to stem a wave of new foreclosures in the nation's weakened housing market.

…Ms. Bair said she strongly believed that keeping borrowers in their homes was the optimal low-cost choice.

"By turning troubled loans into performing loans, we enhance their overall value," she said. Recent F.D.I.C. research has shown that sales of nonperforming loans to outside investors recover 32 cents on every $1 of book value, while sales of performing loans recover about 87 cents.

From CNBC interview:

"Modified loans will be worth more than foreclosed loans," she said in an interview on CNBC television.

I can't agree more. As banks foreclose on more homes, they are simply adding to the already historically large inventory. This is good for home-buyers, but bad for the banks that will lose money on the loans and the properties.

Something to note, this is for borrowers that are behind on their mortgage payments. If you can afford your mortgage, regardless of how egregious the terms are, you will not be helped. I would hope that this does not encourage existing borrowers to stop paying in order to get a better deal.

I wish more banks would take the time to work with their borrowers. In the long run, we will all be better if those that are struggling in this economy to stay in their homes are enabled to. I certainly do not think that the banks should take it in the shorts, but neither should the general public. Providing the customer a lower rate while the market recovers will allow home to appreciate to the point where the borrower will be able to refinance or sell and pay the full value of the loan. In the long run, the banks will make more money by working with borrowers. In the long run, this will help the general public. Rest assured, these losses will be made up by the banks in the form of higher fees, higher loan interest rates, and lower savings interest rates.

Let's give a simple example. If you purchased a home for $300,000 at a rate of 4.5% and had that rate for 2 years and it then adjusted to 9.5% your payment would jump from $1520 per month to $2468 per month. The average middle class borrower would consider the jump in monthly payment impossible to pay. That is a jump of almost $1000 per month. That amount seems just simply insurmountable. I can understand why a borrower would simply mail the keys to the bank and let the bank have the house. It is just overwhelming imagining that for the next 336 months you will have to find an extra $1000. If the borrower is able to pay this, then they will pay an additional $539,452 in interest on the remaining balance. However, as we can see by the abysmal statistics of over 1500 foreclosures a day occurring in California, the borrower isn't going to do this. They are going to let the bank take the loss.

To keep borrowers in their home, they need a payment that is affordable. If the bank were to fix the rate at 6.5%, which is a reasonable rate for both the bank and the borrower today, and extend the existing balance out to 40 years the payment on the remaining balance would be $1696 per month. This is a more modest $176 increase. The borrower is not punished or rewarded for purchasing a home with a bad loan. If the borrower were to keep this loan and pay it in full, the bank will receive approximately $524,351 in interest on the balance. This isn't that much less than the original loan.

The alternative is for the bank to foreclose on the loan. They will have received approximately $36,482 in payments. After paying for expenses to foreclose and actually selling it at probably a $200k they will end up with about $200k. That is a loss of $100k. So they can lose $100k or make over $500k in interest.

Unfortunately these banks can't seem to think. Their greed has clouded their judgment and blinded them. Instead of waiting for their borrowers to give up and mail in the keys, they should be actively offering to modify the terms of their adjustable loans in their portfolios that are most likely to default. In the long run, it will increase the values of the portfolios enabling them to sell them to investors. This will increase their capital and keep them from being taken over by the FDIC.

I suspect that the banks will not do this. I hope the FDIC takes my bank over. I could certainly benefit from a fair modification of my loan.