Bank of America executives must have known their bank was underwater before last year began. Otherwise, how do you explain the stock-swap deal in which Bank of America offered its own seemingly valuable stock in exchange for the seemingly worthless stock of Countrywide Financial? In retrospect, of course, Bank of America stock was not as valuable as Wall Street thought at the time, and stockholders have seen the market value of their shares decline by about three fourths since that deal closed. Bank of America is weighed down not just by losses at Countrywide Financial, but also within its own portfolio and at Merrill Lynch, which it tragically acquired at the end of the year.
It is that last deal that is getting the most scrutiny, and this week, it is easy to get the sense that we are watching the world’s largest bank unravel. CEO Ken Lewis, who has spent most of this year resisting investigations into the Merrill Lynch acquisition, lost his position as chairman of the board of directors this week after his angry defense of the deal at a Wednesday meeting of stockholders failed to persuade them to reelect him to that position. Today Congress is talking about possible hearings into the deal, which might resolve the contradictory statements various parties have made about the sequence of events. Bank of America’s position is likely to get more complicated next week when the Fed is expected to release results of the stress test it conducted in conjunction with the Treasury. According to published reports, the stress test for Bank of America showed that it does not have enough capital to get through next year even under the rosy economic scenarios used for the stress test.
The most troubling bank failure of the current recession occurred just after closing time this afternoon, when the OCC, the licensing authority for national banks, seized Silverton Bank, one of the largest correspondent banks in the United States. This failure is troubling both for its causes and its consequences.
As a correspondent bank, Silverton did not take deposits from the public, nor did it make consumer loans. Instead, its customers were banks, mainly in the southeastern and central states. It cleared checks, arranged loans between banks, and managed credit card operations for banks. However, between 2006 and 2008, at the same time that it took on the Silverton name and its national charter, Silverton started to make real estate loans, primarily to residential developers. The timing was poor, but Silverton was not so aggressive in its expansion, so that its real estate loan portfolio is not falling apart the way you might see at some banks that came late to the real estate boom.
The real estate lending couldn’t have helped Silverton’s fortunes, but its failure appears to be more closely tied to its primary business within the banking industry, particularly its involvement in loan participations. These are financial instruments that allow the income and risk of individual loans to be divided among several banks. Silverton was supposed to be primarily an intermediary in these arrangements, but with so many loans going bad for its bank customers, Silverton apparently ended up with more losses and expenses than it could handle for these loan participations.
This is what is most troubling about the Silverton story. If the loan participation costs were large enough to bring down Silverton, then they must also be having a profoundly negative impact on hundreds of Silverton’s bank customers that bought into the loan participations, along with those that originated the bad loans. To make matters worse, Silverton was mostly owned by these same banks, so its failure erases assets from the balance sheets of a large numbers of banks, reducing the capital levels for those banks.
The FDIC could not allow Silverton to shut down abruptly, as the uncertainty surrounding its outstanding loan participations and the disruption in credit card operations and check clearing could trigger failures at some of the banks that are Silverton’s customers. Nor could it realistically expect to find a buyer for a bank with no retail customers. Instead, the FDIC is forced to operate Silverton for now and probably until the recession is over. At that point, it may be able to sell or spin off a smaller version of Silverton.
Silverton was part of the real estate banking bubble, hugely profitable during the boom, then facing wrenching difficulties as soon as real estate values peaked. And being largely bank-owned, its success during the boom may have encouraged overexpansion by its bank owners. The trouble with overexpansion is that it leads to high expenses that make it hard for a bank, or any other business in this situation, to turn a profit.
Silverton had $4.1 billion in assets, and the FDIC is guessing its costs will be about a third of that amount.
Bank failure spread to New Jersey tonight, as Citizens Community Bank of Ridgewood, New Jersey, was closed. Its $44 million in deposits were transferred to North Jersey Community Bank. North Jersey Community Bank paid a small premium for the deposits and is also purchasing about a fourth of the failed bank’s assets.
Citizens Community Bank had only one office and should not be confused with the banks elsewhere in the state that use the same name. Its location in Ridgewood may have contributed to its decline. Ridgewood is a suburb barely 20 miles from Wall Street, and many of its residents lost their Wall Street jobs last year.
For North Jersey Community Bank, which already operates in the same suburban area, the new office is its seventh, and the expansion fits with its gung-ho commercial identity as “the fastest growing bank in New Jersey.”
In Utah, America West Bank was closed. America West Bank had offices in Layton, Ogden, and the Salt Lake City suburb of Murray, and a loan office at the opposite corner of the state in St. George. It is not associated with American West Bank, which is also located in the intermountain West, but farther north in Washington and Idaho, nor with the much larger WestAmerica Bank of California.
America West Bank is involved in a spectacular lawsuit, in which the chairman of the bank’s board of directors sued his own bank for $4 million in connection with an alleged embezzlement scheme by an employee of five of the chairman’s other companies, during a period when the employee also had a job at the bank. According to the Standard-Examiner, the suit alleges the employee “improperly diverted $558,441 from plaintiffs’ deposit accounts at the bank to her personal accounts,” yet no criminal complaint was ever filed, and the employee claims that none of this ever took place. There is no telling whether this lawsuit or the alleged management lapses helped to persuade the Utah Department of Financial Institutions to close the bank, but the closing took place just two weeks after the suit was filed. I am not even sure it is possible for the chairman of a corporation to sue his own corporation for management negligence, but this may be a moot question now.
America West Bank had $284 million in deposits, which have been transferred to Cache Valley Bank. Cache Valley Bank identifies itself as “a home-town bank” with its two offices both located on Main Street in Logan, Utah, a one-hour drive north of Layton and Ogden. In addition to the deposits, it is purchasing a small part of the failed bank’s assets.
There is suspense in South Florida after a deadline passed for BankUnited. The $8 billion thrift had discovered that its losses last year were worse than previously thought and its book value had become negative, a condition generally not seen or permitted in a bank. It had promised the Office of Thrift Supervision (OTS) to work out a deal to be sold to another bank by Wednesday, with the deal to be completed by next Monday, although the OTS could extend either deadline. There are reports of two parties preparing offers to buy, but the offers would likely request a degree of government help that the Treasury and FDIC would be reluctant to provide. Similar situations earlier in the year have led to banks being seized the following Friday, so people will be watching for that if Monday’s deadline passes without an announcement.