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Regulators Close Downey, Other Banks

Twenty two banks and thrifts have failed failed in 2008.

Three more U.S. financial institutions failed Friday, bringing to 22 the number of banks and savings and loans that have collapsed this year.

The Office of Thrift Supervision closed Downey Savings & Loan held by Downey Financial Corp. of Newport Beach, Calif. late Friday, placing the long-troubled thrift into Federal Deposit Insurance Corp. receivership.

Regulators also shut down PFF Bank & Trust (held by PFF Bancorp of Pomona, Calif., and The Community Bank of Loganville, Ga.

The FDIC sold all of Downey's deposits and nearly all of its assets to U.S. Bank, NA (the main subsidiary of U.S. Bancorp).

In its press release announcing the closing of Downey and PFF Bank & Trust, the OTS said the failures demonstrated "the tremendous impact of the housing market distress on the state of California," and Director John Reich pointed out that all of the larger OTS-supervised institutions failing during 2008 "had major concentrations in housing finance in that state."

The OTS is the chief regulator of all federally chartered and many state-chartered thrift institutions, so it was responsible for overseeing companies like Downey throughout the real estate boom and bust. Other thrifts that failed under the OTS' supervision include Washington Mutual, IndyMac, Countrywide and the old option-ARM specialist Golden West (which almost destroyed its acquirer, Wachovia).

Downey's failure was not a surprise, because it had a high level of nonperforming option-ARMs. The immediate catalyst for its collapse was a 68% drop in the holding company's share price, to 46 cents, on Nov. 11. That followed Downey's expression of doubt about its prospects in its third quarter report to regulators. This may have led to a run on deposits, although, of course, none of the regulatory press releases made any mention of liquidity concerns.

As we have been discussing all through the mortgage crisis, the option-ARMs, which, believe it or not, were still being offered by large banks and thrifts until recently, were among the riskiest of the loans that defined the run-up in the U.S. housing market.

Option-ARMs are residential mortgage loans that feature several monthly payment choices for borrowers, including an option to pay no principal and even pay less than the previous month's accrued interest. When the lowest option payment is made, the unpaid interest is tacked onto the loan's principal balance, while the lender books the unpaid interest as revenue. This increase in a loan balance is called "negative amortization."

When offering these loans, which would typically garner higher commissions for loan officers and mortgage brokers, a commonly used argument was that option-ARMs were appropriate for "sophisticated borrowers." Many of these sophisticated borrowers were tempted by teaser ads that directed attention to teaser rates and the lowest payment options, without mentioning in a clear way how easily a borrower could be hurt by an increasing loan balance, especially if home prices failed.

These loans factored heavily in the failure of Washington Mutual and nearly caused Wachovia to fail, before it was sold to Wells Fargo (which trumped a bid from Citigroup that now seems like ancient history).

JPMorgan Chase recently announced plans to modify mortgage terms for up to 400,000 borrowers, many of whom had option-ARMs the bank inherited when it purchased Washington Mutual's loans and deposits from the FDIC. Bank of America has a similar loan modification program for loans it acquired when it purchased Countrywide.

Downey had total assets of $12.8 billion and $9.7 billion in deposits. The FDIC estimated the loss to its deposit insurance fund from Downey's failure would be $1.4 billion.

The institution had been assigned a D- (Weak) financial strength rating by Ratings back in March. The most recent ratings were based on June 30 financial reports, and Downey's relatively high capital ratios kept the rating from falling further.

As we discussed last week, Downey's leverage ratio of 7.48% and risk-based capital ratio of 14.50% were well above the normal regulatory requirements of 5% and 10%, respectively, for a bank or thrift to be considered well-capitalized. The ratios also exceeded the respective minimum capital ratios of 7% and 14% required by an OTS consent order the institution entered into Sept. 5.

PFF Bank & Trust

U.S. Bank, NA also took over the banking operations and all deposits of PFF Bank & Trust, which was shuttered by the OTS.

U.S. Bank, NA acquired a total of 213 branches from Downey and PFF, with all branches set to reopen according to their normal hours of operation.

PFF Bank & Trust was assigned an E (Very Weak) financial strength rating by Ratings in September, which was a downgrade from an E+ in June and a D- (Weak) in March. The institution had $3.7 billion in total assets and $2.4 billion in deposits.

PFF's problem was that nearly all of its residential and commercial construction loans (mainly in the "Inland Empire" in Riverside and San Bernardino counties) had gone bad, with nonperforming assets comprising 19.22% of total assets as of September 30, even after net loan charge-offs of $199 million year-to-date. PFF was also considered undercapitalized per regulatory guidelines, with a leverage ratio of 4.53% and a risk-based capital ratio of 6.72% as of September 30.

The FDIC's estimated its insurance fund would lose $700 million from PFF's failure.

The Community Bank

The Community Bank was closed by state regulators Friday and was the third Atlanta area bank closed this year. The FDIC took the institution into receivership and sold all of its deposits to Bank of Essex, of Tappahannock, Va. The failed institution had total assets of $611 million.

The Community Bank was assigned an E- (Very Weak) financial strength rating by Ratings in September, a downgrade from E+ rating, assigned back in March.

Like the other failed Georgia banks, The Community Bank was an exuberant construction lender, with construction loans (mainly builder loans) comprising 63% of total assets as of Sept. 30. Nonperforming assets comprised 37.83% of total assets and overwhelmed The Community Bank's capital base. The institution was considered significantly undercapitalized per regulatory guidelines as of Sept. 30, with a leverage ratio of 3.71% and a risk-based capital ratio of 5.39%.

The FDIC expected that losses to its insurance fund from the Community Bank's failure would range between $200 million and $240 million.

Good News for Depositors

While the pace of failures has certainly picked up lately, the good news is that the FDIC continued its recent streak of avoiding any losses to depositors. In all of the failures following the shutdown of Silver State Bank on Sept. 5, the FDIC has managed to sell all deposits, including those exceeding deposit insurance limits, to other institutions.

Please click here for a summary of the previous 19 bank closings this year, including losses to depositors and to the FDIC's insurance fund.

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