It was a week of intrigue in the banking industry. A Freddie Mac executive talked about quitting, then the next day met a violent death that is being investigated. There were conflicting statements about Bank of America’s dealings with the Fed, Treasury, and New York State Attorney General. As banks seemed to accelerate their efforts to abuse their credit card customers, a reform bill gained momentum in Congress, and the President weighed in, suggesting that banks should be required to simplify credit cards for consumers. And two months of suspense ended for the 19 largest banks in the United States as Treasury officials briefed them today on their stress test results. The Fed disclosed a few key details of the stress test methodology to the public, but has not yet decided what test results will be made public.
The stress tests were based on two scenarios that are far more mild than what is likely to happen to the economy over the next two years. The assumptions about changes in real estate values are realistic enough, but the view of employment and income is surprisingly conservative for something that is called a stress test. The more optimistic of the two scenarios basically assumes that the economy hit bottom in March, and we just haven’t noticed it yet. The more adverse scenario assumes that things will not get much worse — that unemployment will hold right about where it is this year and rise only slightly next year.
One reason the stress test scenarios are so rosy is that they were created in February, at a time when many forecasters were unaccountably optimistic about the economy’s prospects. But I fear the real reason that the test scenarios are more optimistic than actual economic data is that the Treasury is hoping to help the banks raise money in private capital markets. To do that, it has to make the banks look like survivors, even if it’s not true. But this is a game that Wall Street is familiar with — every business startup exaggerates its prospects — and it’s hard to imagine any player on Wall Street giving the banks hundreds of billions of dollars based on that old song and dance. The test results surely show that nearly all of the banks that were tested are likely to need some additional capital, so where is that capital supposed to come from?
The Georgia Department of Banking gave the FDIC an early start on its bank closings tonight, seizing American Southern Bank of Kennesaw, in the Atlanta metro area, as soon as it closed at 4 p.m. Although the FDIC lined up an acquiring bank, this one is mostly on the FDIC; nearly half of the deposits were brokered, and the FDIC will be paying out those deposits to the brokers. The remaining estimated $56 million in deposits are being assumed by Bank of North Georgia, which is also purchasing $31 million in assets. The FDIC expects to take a loss of $42 million disposing of the other assets. American Southern Bank opened in 2005 and had just one office, although it apparently had a second office at some point.
The bigger story for the FDIC tonight, though, was the failure of First Bank of Beverly Hills in California. With around $1 billion in deposits, it might have been too large for the FDIC to round up another bank to take the deposits. Or, the number of retail depositors might have been too small to interest another bank. Instead, the FDIC will begin mailing checks to depositors on Monday.
First Bank of Beverly Hills had just one office, not in Beverly Hills, but 25 miles to the west in Calabasas. It was previously known, until 2004, as Wilshire Financial Services Group. It specialized in California real estate loans, especially in bridge loans for commercial developers. Bridge loans are meant to be short-term loans, sometimes just for a week or two as borrowers complete planned transactions, yet that became a high-risk business in California in the last three years. The bank’s stock market value had plunged from $7 million at the beginning of the year to less than $1 million in March. It had announced a deal to be acquired by a lending company, but that deal apparently would not have passed regulatory scrutiny, and was called off on April 15. The FDIC estimates a cost of $394 million for this bank closing.
The FDIC took another substantial hit with the closing of First Bank of Idaho, which had seven offices in Idaho and Wyoming. Three locations used the name First Bank of the Tetons. The FDIC’s cost to close this bank is estimated at $191 million. U.S. Bank, a large regional bank that has dozens of branches in Idaho and a presence across the west and as far east as Pennsylvania, is assuming the deposits and acquiring the offices of First Bank of Idaho, paying a 0.55 percent premium for the deposits. The FDIC is retaining most of the assets.
First Bank of Idaho steered clear of subprime mortgages, it said in a statement released April 14, but took substantial loan losses from the decline in real estate values. The Office of Thrift Supervision ordered it on April 6 to improve its operations and increase its capital levels.
The largest bank failure tonight, though, was a credit union. Credit unions were thought to have steered clear of most of the lending failings of commercial banks, but on the other hand, credit unions make a high proportion of home mortgage loans, which puts them at risk in a real estate downturn. The National Credit Union Administration (NCUA) tonight took over Eastern Financial Florida Credit Union and appointed temporary managers for it. The credit union has $1.6 billion in assets and 200,000 members.
Credit union failures are so rare that there isn’t a well-established sequence of actions for the NCUA to follow. The objectives in a credit union failure are quite different from those in a failure of a commercial bank. In a bank failure, ordinarily, the objective is to protect the depositors, while the owners of the bank get paid only in the rare instance that there is money left over at the end of the process. At a credit union, however, the depositors are the owners. There is, then, relatively little to be gained by closing a failed credit union or by merging it with another credit union. Instead, the NCUA will try to change the management approach of the credit union to make it more successful so that the deposits are protected. Eastern Financial Florida Credit Union will continue normal operations for now, and the NCUA will evaluate it in detail to determine its next moves.
There was one more bank failure tonight, this one in eastern Michigan. Michigan Heritage Bank, based in Farmington Hills, was closed. The deposits are being transferred to another local bank, Level One Bank, which is paying a 1.16 percent premium for the deposits. Level One Bank is also purchasing one fourth of the assets. The FDIC expects this closing to cost it $71 million.
Michigan Heritage Bank had three offices within a ten mile radius. Level One Bank, prior to acquiring these offices, had one office, one mile down the road from the headquarters of Michigan Heritage Bank. Level One Bank issued a press release describing the acquisition of its three new offices as an appropriate growth opportunity.
After a series of losses at Michigan Heritage Bank, the Fed ordered it to suspend its dividend in December, then ordered it to raise capital by April 15. But the bank’s stock market value last year fell from $9 million to about $200,000, giving it little prospect of raising capital by issuing more shares of stock. The bank signed a letter of intent with a private investor on April 15, but that deal was called off on Monday, leading to tonight’s closure.