Friday, August 7, 2009

This Week in Bank Failures

The Colonial BancGroup, Inc. announced today that on August 6, 2009, it was informed by the U.S. Department of Justice that it is the target of a federal criminal investigation relating to the Company’s mortgage warehouse lending division and related alleged accounting irregularities. The Company has been informed that the alleged accounting irregularities relate to more than one year’s audited financial statements and regulatory financial reporting, and the Company’s Board of Directors and Audit Committee are making every effort to determine the impact of these alleged accounting irregularities on the Company’s financial statements and regulatory financial reporting.

No company likes to make a statement like this, but it has an extra element of pathos coming from Colonial Bank. It is a large bank whose fortunes are declining so rapidly, I can only describe the sequence of events as stunning.

Colonial Bank is based in Montgomery, Alabama, but does half of its business in Florida and has offices as far away as Nevada. It has been in perilous financial condition since the fourth quarter of 2008. It reported a pre-tax loss of $1 billion during that quarter, a loss large enough to wipe out about 4 years of profits. More than 80 percent of Colonial Bank’s loans are in real estate, and its financial condition has deteriorated accordingly this year.

All that is bad enough, but it gets worse. Colonial Bank announced a deal to be bought out in April. When investors pulled out last week, Colonial Bank issued a going-concern warning. A going-concern warning is an accounting event by which a company recognizes that it is not bringing in enough money to stay in business.

And that’s just the beginning. On Monday, in what I believe is an unprecedented move, the Special Inspector General of the Troubled Asset Relief Program (TARP) got search warrants for Colonial Bank and a related company. Federal agents executed the warrants on Monday at the Orlando, Florida, Mortgage Warehouse Lending Division of Colonial BancGroup, Inc. and an office of mortgage company Taylor, Bean & Whitaker, which regularly does business with that division, and which had led the investment group that had planned to buy out Colonial Bank. Both companies were cooperating with the investigation and at that point, were conducting business as usual.

On Tuesday, though, the Federal Housing Administration (FHA) suspended Taylor, Bean & Whitaker. The FHA said the lender had failed to disclose a pattern of “irregular” transactions that could indicate fraud. The next day, a similar suspension followed from Freddie Mac. Taylor, Bean & Whitaker immediately shut down its lending operations, canceling thousands of pending mortgages and leaving hundreds of mortgage brokers and small banks to find other channels for their mortgages. It remains in business for now with a skeleton crew, and continues to collect payments on its existing mortgage portfolio.

Then yesterday, Colonial Bank learned that it is the target of a federal criminal investigation. One possible explanation for the sequence of events is that investigators started out looking at the possibility of TARP fraud, then began to question the mortgage accounting practices at both companies.

It was unlikely anyway for a bank as large as Colonial Bank to be acquired in the current financial climate. But it is rare for anyone to acquire a bank under criminal investigation — usually that must wait until after the investigation and any subsequent administrative actions are complete — and it is almost impossible to buy out a company whose accounting records are in doubt. Colonial Bank’s hands are tied; all it can do now is wait for its borrowers’ fortunes to improve.

When the federal government took over Fannie Mae a year ago, there were some who wondered whether that move was really necessary. Yesterday’s quarterly report, it is fair to say, removed any lingering doubt. Fannie Mae’s going-concern warning reads: “We are dependent on the continued support of Treasury in order to continue operating our business.” It lost $15 billion during the quarter, 6 times its loss of a year ago. It needs another $11 billion in government money to keep operating. Bizarrely, it continues to pay dividends.

The U.S. Treasury’s debt limit has been raised twice in the last year, and it is about to be raised again. The current limit, $12.1 trillion, is expected to be exceeded at the beginning of October. The Treasury formally requested the increase today. The debt ceiling is especially important to the FDIC. If the FDIC depletes its Deposit Insurance Fund and then a large bank failure occurs while the Treasury is already near its debt ceiling, the FDIC might not be able to pay depositors immediately.

Two banks in west central Florida were closed tonight. Florida closed First State Bank, which was based in Sarasota and had most of its nine offices in the St. Petersburg area. It had $387 million in deposits. In the same county, the OCC closed Community National Bank of Sarasota County. It had four offices and $93 million in deposits.

The successor for both banks is Stearns Bank, based in St. Cloud, Minnesota. Stearns Bank had already acquired failed banks in Minnesota and Georgia. It is taking over the deposits and purchasing about 97 percent of the assets of the two Florida banks.

First State Bank had been reporting losses, losing $37 million in the last three quarters. Its losses were unusually large, almost twice its revenue during that period. The FDIC warned it two weeks ago that it was critically undercapitalized.

Community National Bank of Sarasota County was also considered critically undercapitalized and had been given a July 17 deadline to raise capital. Its second quarter earnings report, released a week ago, gave it a negative net worth.

The two Florida closings will cost the FDIC an estimated $140 million.

In central Oregon, Community First Bank was closed. Community First Bank had eight offices in three counties, and $182 million in deposits. The offices, deposits, and most of the assets are being purchased by a bank in the neighboring state of Idaho, Home Federal Bank, which has 15 offices near Boise.

Community First Bank had its best year in 2006, reporting earnings of $1.5 million. It did not begin to report losses until a year ago, but the losses were large, over $6 million in the second half of 2008. It had not yet reported results for the first two quarters of 2009. The closing is expected to cost the FDIC $45 million.