Friday, July 29, 2011

This Week in Bank Failures

With some kind of Monday-morning financial train wreck in Washington now looking more likely than not, how would a default or a partial government shutdown affect the pace of bank failures? Much depends on the Fed’s reaction, but I doubt you would actually see more than one or two banks fail after losing liquidity because of problems with Treasury payments.

No, the greater risk to banks comes via changes in consumer behavior when people’s incomes are interrupted. It is important to remember that it is not just federal employees who are at risk, but also employees of state governments, hospitals, and construction contractors, along with retirees, unemployed workers, and others, and the extended families of everyone who is directly affected. The shock to consumer incomes would result in missed loan payments from the consumers themselves, but also from businesses that depend on consumer spending. That, over any extended period of time, could result in a new round of bank failures, and there is little the Fed can do about that. And it is important to note that this is not merely a risk of a government default, but also of the more severe austerity budgets that have been proposed in Congress as alternatives.

As long as there is a sign of a default, banks and money funds will no longer be able to freely purchase Treasury bonds. Some people at Treasury have said that bond auctions will have to be suspended, or at least drastically reduced in size, if the debt ceiling continues to loom, because there won’t be many bidders for the bonds as long as they are considered potentially illiquid.

Regardless of next week’s drama, bank failures rolled on tonight. A $2 billion bank failed in Indiana. The OCC closed Indiana’s Integra Bank, which had 52 branches in 4 states, $1.9 billion in deposits, and $2.2 billion in assets.

Old National Bank, also of Indiana, is paying a 1 percent premium for the deposits and is also purchasing the assets. The $19 million dollar premium (with the exact amount depending on the actual deposit balances today) is, to the best of my recollection, the largest the FDIC has received in the current sequence of bank failures.

A series of acquisitions five years ago, particularly in the Chicago and Cincinnati areas, left Integra Bank off balance and unable to recover from the economic turmoil that was already underway at that point.

The bank was founded in 1850 and named Canal Bank amid hopes that a new canal would lead to a boom in the Evansville economy. But the canal failed in less than 20 years, and the bank changed its name again and again over the years. It took on the Integra name in 1999 along with the goal of becoming one of the largest banks in the country. Instead, by the end of last year, it had a negative net worth and no realistic prospect of digging itself out of its financial hole.

Small banks failed tonight in Virginia and South Carolina. In Virginia, state regulators closed Virginia Business Bank, which had one office, in Richmond, and less than $100 million in deposits. The failed bank will become a branch of Xenith Bank.

In South Carolina, the OCC closed BankMeridian. It had three offices, in Columbia, Hilton Head, and Spartanburg, and $215 million in deposits. It opened in 2006 as the largest new bank in the state’s history, and grew rapidly over the next two years, a disastrous scenario that likely sealed the bank’s fate regardless of what else it did right. Problems in the real estate market that were already evident in 2006 never did turn around, and by betting big as the economy continued to sour, the bank never gave itself a chance to find out what it could do. Although it was making bad loans from day one, it took until the end of 2009 for the bank’s management to realize the trouble the bank was in. The deposits are being taken over by regional bank SCBT, which is also purchasing the assets.

We are nearing the peak of the quarterly bank failure cycle, as regulators react to the financial statements for the quarter that ended four weeks ago. The pace of bank failures is likely to continue for the next five weeks before slowing down for the end of the quarter.