Analysis of bank failure reveals the horrific damage

CIGA Richard’s analysis of bank failure reveals the horrific damage that is being done by FASB’s capitulation allowing financial entities to value worth-less assets at values that the financial entity has concluded is correct, not values that are market related.

"There is not enough information available at this point to determine the causes of this huge discrepancy between the claimed and actual values of AmTrust’s assets. However, in the absence of an allegation of criminal fraud it stands to reason that the failure to require fair value accounting contributed substantially to this discrepancy."

Six more banks were closed this week. Collectively, they had assets of $13.425 billion and deposits of $9.368 billion. The total estimated cost to the FDIC’s Deposit Insurance Fund (“DIF”) is $2.384 billion.

Consistent with recent trends, by the time these banks were finally closed their condition had deteriorated to a point far worse than banks were allowed to in the years before this crisis. As a result, the FDIC continues to incur much higher rescue costs than it would if it were able to close them at a stage more like they have been historically.

The total cost to the DIR of closing this week’s failed banks exceeds 25% of their total deposits. By contrast, the FDIC was only required to make up about 5.7% of insured deposits in connection with the three banks it closed in 2007, at the beginning of this crisis.

The details of this week’s closings also point out some troublesome discrepancies between the value of assets stated on the banks’ balance sheets and their perceived market value.

Five of the six acquiring banks this week required the FDIC to enter loss-share agreements as a condition of their purchasing the assets of the failed institutions.

Insisting upon a loss-share agreement indicates the prospective buyer is so worried about the value of the assets it is purchasing, it is unwilling to alone bear the risk that their value will turn out to be lower than anticipated. In the case of the three banks closed in 2007, none of the acquiring banks required that the FDIC enter into a loss-share agreement.

The largest of this week’s bank failures, AmTrust Bank of Cleveland, Ohio, gives us an unsettling preview of the kind of unsubstantiated asset valuations we are certain to see more of in light of the Financial Accounting Standards Board (“FASB”)’s having suspended fair value accounting requirements at the beginning of this year. On paper, AmTrust appeared to be very well capitalized.

It claimed to have assets of $12 billion against deposits of $8 billion, a ratio of 1.5:1.

However, closing AmTrust cost the FDIC an estimated $2.0 billion, 25% of the value of its deposits.

Furthermore, the purchasing bank, New York Community Bank (“NYCB”), was only willing to purchase about $9.0 billion (75%) of AmTrust’s assets, and did so only on the condition that the FDIC agree to share the risk of loss with respect to $6.0 billion of that amount. In the final analysis, it appears that NYCB had confidence in the value of only $3 billion of the $12 billion in assets on AmTrust’s balance sheet.

Furthermore, the parties appear to have concluded that the $12 billion in assets listed on AmTrust’s balance sheet were only worth about $6 billion. Otherwise, the FDIC would not have allowed for a $2 billion charge to the DIR to make good on AmTrust’s $8 billion in deposits.

There is not enough information available at this point to determine the causes of this huge discrepancy between the claimed and actual values of AmTrust’s assets. However, in the absence of an allegation of criminal fraud it stands to reason that the failure to require fair value accounting contributed substantially to this discrepancy.

The facts surrounding the closings of the remaining five banks this week raise similar concerns.

Buckhead Community Bank of Atlanta, Georgia, had total stated assets of $874 million and deposits of $838 million. The FDIC’s projected cost to close this bank is $241.4 million (approximately 29% of deposits).

The acquiring bank purchased essentially all of Buckhead’s assets valued at $874 million, but it required the FDIC to enter into a loss-share transaction with respect to $692 million of that amount. The FDIC’s loss estimate suggests that it considers the fair value of Buckhead’s claimed $874 million in assets to actually be about $596.6 million.

Greater Atlantic Bank of Reston, Virginia, had total stated assets of $203 million and deposits of $179 million. The FDIC’s projected cost to close this bank is $35 million (approximately 19.5% of deposits). The acquiring bank purchased essentially all of Greater Atlantic’s assets valued at $203 million, but it required the FDIC to enter into a loss-share transaction with respect to $145 million of that amount.

The FDIC’s loss estimate suggests that it considers the fair value of Greater Atlantic’s claimed $203 million in assets to actually be about $144 million.

Benchmark Bank of Aurora, Illinois, had total stated assets of $170 million and deposits of $181 million.

It is the only one of the six closed this week that on its face showed assets valued below deposits.

The FDIC’s projected cost to close this bank is $64 million (approximately 35.4% of deposits). The acquiring bank purchased essentially all of Benchmark’s assets valued at $170 million, but it required the FDIC to enter into a loss-share transaction with respect to $139 million of that amount. The FDIC’s loss estimate suggests that it considers the fair value of Benchmark’s claimed $170 million in assets to actually be about $117 million.

First Security National Bank of Norcross, Georgia, had total stated assets of $128 million and total deposits of $123 million.

The FDIC’s projected cost to close the bank is $30.1 million (approximately 24.5% of deposits). The acquiring bank purchased about $118 million of First Security’s assets, but it required the FDIC to enter into a loss-share agreement with respect to $82.4 million of that amount.

The FDIC’s loss estimate suggests that it considers the fair value of First Security’s claimed $128 million in assets to be $92.9 million.

Finally, Tattnall Bank, Reidsville, Georgia, had stated assets of $49.6 million and deposits of $47.3 million. The FDIC’s projected cost to close the bank is $13.9 million (approximately 29.4% of deposits). This estimate suggests the FDIC considers the fair value of Tattnall’s claimed $49.6 million in assets to be $33.4 million.

Full details of all these closings can be seen at the FDIC’s web site: http://www.fdic.gov/index.html

This week’s bank closings continue to warn of U.S. banks’ deteriorating balance sheets and of the FDIC’s inability to resolve troubled banks before they cause extraordinary losses. Nationwide, banks are going broke much faster than the FDIC can close them. This creates a domino effect whereby the FDIC loses the ability to mitigate losses at the same time it exhausts its capacity to pay claims.

As of November 12, 2009, the DIF had fallen into deficit and in order to replenish it, the FDIC ordered banks to pre-pay three years’ worth of deposit insurance premiums, amounting to about $45 billion. In the three weeks since then, the FDIC has been forced to acknowledge another $3.394 billion in liabilities – more than 7.5% of the new revenue it is attempting to raise by way of the pre-payments.

Very soon the entire $45 billion will be wiped out and the U.S. Treasury will become the FDIC’s sole source of funding for years to come.

Any suggestions that U.S. federal deficits will be reduced, quantitative easing will be curbed or the Fed will attempt to drain liquidity from the financial system need to be evaluated in this context.