FDIC Receivership Banks

There is much in the allegory of Moby Dick that smacks of our efforts to kill the great banking crisis. Those of you familiar with my Geneva bank, Banque Rupp et cie, (see blogs passim) may not know of its US subsidiary, Bank Pequod, motto: "blubber is blubber you know; tho' you might get oil out of it?"
My strategic problem is currently to decide whether my bank should become, to use old fishing terms, a whale or a whaler, to double my bets by buying other banks hopefully dirt-cheap, or sell my own bank on, either way through the FDIC FBA policy-scheme. On July 9, the FDIC sought comments on “Proposed Statement of Policy on Qualifications for Failed Bank Acquisitions.” The policy statement suggests tough terms whereby the federal agency can sell failed banks to non-traditional buyers i.e. private equity firms. 61 comments were filed during the 30-day comment period – most from private-equity firms, their lawyers, financial-services trade associations and lobbyists, plus comments from academics, 4 U.S. senators and 6 individuals. The FDIC also received 3,190 form-letter comments in support mostly saying “yeah, sell the bastards! Good riddance!” It may no longer be fashionable to own a bank, but could be fashionable to buy one and then close it to new business, strip out its blubber, the assets, to get oil, from foreclosures, take maximum income and charge 80% of any remaining losses at the end to the FDIC?
Selling off busted, near-busted, banks, or banks than look like they could go bust sometime, to vulture fund investors strikes a dissonant chord about private equity players (hedge funds, or private corporate banks like Pequod etc.) among voting taxpayers, and of course to other banks who wonder why anyone is foolhardy to want to own a discredited bank? It may inadvertently lead to another storm of political discontent and even trigger more possible bank failures some way down the river, wrecked out to sea or on a landbank? So far this year, 81 US banks have failed, costing FDIC an estimated $21.5bn. And the situation may worsen - currently 416 distressed banks - highest level in 15 years (at end-June ’09, up from 305 at the end of March), maybe 800 by next year? The FDIC had that many on its “problem list” last in June 1994, when there were 434. Assets at troubled institutions total $300bn –worst level since end of '93.
FDIC’s insurance fund (at March 31), was down to $13.5bn. Bank failures in Q2 ‘09 cost FDIC’s insurance fund $9.1bn - offset by an emergency special assessment (raisings) of $6.2bn + $2.6bn raised in the regular quarterly assessment on FDIC-insured banks. Colonial Bank cost $2.8bn and Guaranty Bank, $3bn. FDIC Chairman Sheila C. Bair is seeking from the U.S. Treasury a $500bn line of credit (by the way, equivalent to the assets of the IMF, the BIS, and ECB).
FDIC’s special assessment in Q4 ’09 and another in Q1 ‘10 may tip more banks onto the butcher's block of the credit crunch. FDIC not only covers insured deposits; if costs of a troubled bank is judged to be getting too high by the FDIC it can seek to ‘combine’ the bank with another, or sell its carcass outright, and if not that it can manage the “unwinding” of a bank’s stockpile of smelly blubber. With 100s of banks potentially in receivership trouble and few willing to acquire the hard to value assets, private equity firms have offered to buy failed banks in the asset-stripping belief these banks can be restructured, perhaps into larger groupings, and profitably turned around or sold on, though not necessarily continued to operate as banks, or not until all current assets have been sold and debt recoveries completed. In fact the whole deal may appear to be more like paying receivers to take over and make for themselves whatever they can. Let’s not forget that mortgage assets have commercial, residential and land assets as collateral that should cover at least half of the outstanding loans. An owner can cherrypick. banks can deem loan contracts any time. Many accounts may have foreclosable collateral larger than the outstanding loan. Hence, a 60% asset discount should translate into a profit over time, which may be substantial once property and business values begin to regain lost ground. The FDIC issued a new version of its plan after comments were received, this time with weaker terms & conditions. These raise questions about federal government’s respect for existing covenants and regulations if set against its perception of the broader political-economy interest, including that of the FDIC balance sheet. In one instance, instead of the initially proposed requirement that new investors maintain a 15% Tier 1 common equity capital ratio to risk-weighted assets, the new ‘hurdle rate’ is only 10% . Private equity firms are excused the requirement of other bank holding companies and will not be called upon as a “source of strength,” should their investment in a bank they have bought need shoring up. This is a cause of concern. Bank holding companies have to make their reserves available if operations need support, but private equity firms don’t want to expose their investors’ capital by dedicating reserves to any one investment. For example, Cerberus Capital refused to put any more money into Chrysler – leaving it to government to bail out. FDIC made other compromises to attract private equity such as excusing them from having to cross-guarantee their portfolio-bank investments – unless they own at least 80% of two or more banks. Private equity did not get all it wanted. The final policy prohibits “insider” and “affiliated” loan transactions and strips firms of using a controversial “silo” structure to obfuscate ownership and control. Private-equity got FDIC to agree to share losses whereby the FDIC bears the larger share.
Acquiring banks also have such loss-sharing agreements with the FDIC, but at least they are regulated entities while private equity firms are not. Nor will private equity firms become regulated in order to buy banks, though this may change if Hedge Funds etc. come under SEC oversight. Private equity firms can buy failed or failing banks by banding together and dividing the equity commitment and investment liability. If there is no recourse against other private equity firm assets or even any cross-guarantees against other acquired banks, unless 80% owned, the consortia cannot be called upon or relied upon to be a “source of strength” for their depository, taxpayer-backed portfolio banks. Regardless of any rules on self-dealing, private equity firms will most probably find legal ways to lend from their newly acquired banks to leverage their other investment portfolio and extract fees. If they don’t lend to their own portfolio companies, they will surely lend to other private equity firms’ portfolio companies in a modified version of the “club deals” that bind them together. These firms have a mutual interest in generating deal fees, cutting up the assets, re-packaging ans selling on. The problem with banks is if over-leveraged they cannot borrow to fund their funding gaps because they cannot set aside sufficient “reserves,” and must rely on “off-balance-sheet” vehicles to sell assets, or if they cannot grow assets, then to acquire leveraged pools of assets, becoming leveraged inside and out. But now the originators of the leveraged-buyout business model want to apply another round of leverage to already crippled banks in order to squeeze out all possible profits. The FDIC needs therefore to be aware of the risk that ‘saved banks’ sold to high return financial engineers may become problem banks again in the future, much as Lehman Brothers did on a large scale having been saved several times in it history. In a comment letter to the FDIC, the Private Equity Council, without recognizing the irony of its comment, suggested that higher capital ratios for private equity buyers of failed banks would increase the risk at those banks because their owners would essentially have to employ more leverage to generate sufficient returns to meet the higher capital standards – while still generating returns high enough to satisfy the investors in their private-equity funds. This is a self-made argument by hedge funds/private equity funds for why they are inappropriate buyers of banks. They clearly do not understand that capital reserves must be ‘own funds’ clear of obligations, not loans to them by investors.
Private equity should be allowed to buy banks, but should also be held to a higher standard, and no less high than for fully-regulated banks. They have a proven record of success at leveraging companies when they have access to cheap funding, and they also have a record of spectacular failures. The last thing US banks need is management that leverage them to generate rates of return at double or triple the average for traditional banking. FDIC is probably aware of this, of the need to avoid resorting to solutions to problems that will repeat past behaviour. The original herbert Melville's Pequod's quest to hunt down Moby Dick itself is allegorical. To Ahab, making a big killing, the white whale, became the ultimate and only goal in his life, and if expanded allegorically, everyone's goals. His vengeance against the whale is analogous to man's struggle against fate, or the public's against the banks. The only escape from psychosis is seen through the Pequod's encounters with other ships, whose captains warn against the folly of risking all for the sake of getting the big win. Melville implies people in general need something to reach for in life, a goal that can destroy one if allowed to overtake all other concerns, and that seems a neat version of bankers, their bonuses and hedge funds and their 50% returns - "Nothing exists in itself. If you flatter yourself that you are all over comfortable, and have been so a long time, then you cannot be said to be comfortable any more."