Friday, May 15, 2015

This Week in Bank Failures

Banks might have invented the funny accounting that can make a moldy loan portfolio look fresh and healthy, but that doesn’t mean other lenders can’t do the same thing. The SEC charged for-profit college holding company ITT Educational Services Inc. with accounting fraud for hiding the deteriorating quality of its student loan portfolio and loan guarantees. ITT’s loan guarantees and related obligations look worryingly large, large enough to force it to restate its 2013 earnings, then large enough to eat up three fourths of its cash on hand in 2014. But more than that, loans are the lifeblood of a for-profit college. Without loans, there would be few new customers, but a college can find itself squeezed. The high tuition and low educational quality of for-profit colleges mean that many former students owe large amounts compared to their potential incomes, so that the loans are often beyond a former student’s ability to pay. At the same time, a college must show success with its old loans in order to write new loans. This squeeze can turn a for-profit college into something resembling a Ponzi scheme, in which a college spends huge sums to disguise the poor quality of its older loans, covering the costs with money that comes from new loans issued to new students. Like any top-heavy scheme, eventually it can all come crashing down, as in the case of Corinthian College, which ran out of cash and abruptly shut down last week after it got caught exaggerating its job placement results.

The SEC says there is reason to worry about ITT in a civil fraud case filed this week against the college and two executives. If you believe the SEC, ITT owes far more in loan guarantees than what it is telling investors. ITT failed to record the loans on the balance sheet it showed investors and failed to disclose money it set aside to cover loan defaults. Separately, ITT may have to pay up in a predatory bait-and-switch lending practice, in which it offered zero-interest loans to new customers. It canceled the loans after one year and steered customers toward high-interest replacement loans. New student enrollment at ITT is already down 16 percent from last year, a decline that analysts have said is rapid enough to put the college’s future in doubt, and that, of course, is a further deterrent to new customers.

Starbucks gift cards have become the new focus of organized transaction fraud. While not all the details are clear, criminal groups are obtaining the codes from existing cards and using this information to encode fake cards. It may also be that criminals are altering the value of legitimate Starbucks cards by generating false transactions in transaction networks. After creating fake card balances, the criminal groups then sell the cards at a steep discount online. Purchasers rush to take the fraudulent cards to a Starbucks location to transfer the balance to yet another new card before either Starbucks or the legitimate card owner figures out what’s going on. This scheme is spelled out almost openly in online forums that are easy to find in an Internet search.

In a related problem, more widely reported, criminal groups are guessing passwords for Starbucks card accounts and entering transactions on the Starbucks web site to transfer balances. For accounts with the auto-reload option, popular with Starbucks’ most frequent customers, this can result in draining the cardholders’ checking accounts. On the other hand, these are also the customers who are quickest to notice the problems with their accounts. Starbucks doesn’t seem to be aware of the scale of activity surrounding its gift cards, in part because many gift card holders have no idea what their card balances are on any given day. Based on the buzz surrounding online markets for hacked and forged Starbucks gift cards, though, the electronic thefts could easily exceed $1 million per day.

The U.K. government is taking longer than planned to liquidate its stake in bailed-out Lloyds Banking Group. It will not meet a self-imposed deadline of June 30. Instead, the stock sales may take until next year to complete, according to government sources cited by Reuters.

Argentina is considering punitive action against Citibank which could include withdrawing the bank’s license to operate in that country. Argentina has already barred one executive and revoked the bank’s authority to operate in capital markets. The moves do not come as a surprise and Citibank is presumably prepared to sell off or wind down its operations in Argentina. Separately, a national strike against all banks in Argentina is set for June, with bank workers asking for a 30 percent pay increase.

There were two actions on credit unions on April 30. The NCUA placed New Bethel Federal Credit Union into conservatorship. The church-related credit union in Portsmouth, Virginia has fewer than 200 members. The NCUA liquidated TLC Federal Credit Union of Tillamook, Oregon, which had 13,375 members, after finding that the credit union was insolvent. Member accounts were transferred to Washington-based Fibre Federal Credit Union. TLC Federal Credit Union was originally formed as a teacher’s credit union.