By Richard B
Friday evening, July 23, 2010, the FDIC announced seven more bank failures, bringing the totals to 103 so far this year and 270 since 2007. The seven banks closed this week had collective assets of $2.16 billion and deposits of $2.02 billion.

Their closings cost the FDIC an estimated $431 million, about 21% of deposits. So far this year, bank closings have cost the FDIC an estimated $18.55 billion.

Five of the seven closings were accomplished with the FDIC entering into loss-share agreements with the acquiring banks. That means, in effect, that the FDIC makes a guarantee to the acquiring bank that assets it has taken over from the failed bank will not decrease in value beyond a pre-agreed limit.

In connection with those five closings this week, the FDIC entered into loss share agreements covering an additional $1.25 billion in assets. So far in this crisis, the FDIC has entered into loss share agreements covering about $180 billion.

How Loss Share Agreements Figure Into Bank Failures:

Loss share agreements save the FDIC money at the time of the closing, because the FDIC does not have to pay the acquiring bank as much money up front to honor the failed bank’s deposits. However, a loss share agreement is by nature a bet.

The FDIC is betting that over the next ten years, the failed bank’s assets will turn out to be worth more than any party was willing to bid for the assets at the time each bank was closed. Future asset values are calculated net of selling expenses, meaning that things like foreclosure costs, property taxes, utilities and maintenance fees paid by the acquiring bank in disposing of the assets is deducted from their eventual sales price.

This is why it is important to keep track of the total value of assets the FDIC has guaranteed under loss share agreements throughout this financial crisis. It is similar to keeping track of the total dollar value of mortgages guaranteed by Fannie Mae or Freddie Mac. The two major distinctions are that the FDIC’s assets under loss share are, by definition, distressed assets and their value has already been significantly discounted.

The FDIC’s future exposure lies in the possibility that these assets may turn out to be worth even less than the discounted value agreed to at the time of each bank failure. This is a distinct possibility; otherwise the acquiring bank would not insist on the loss share agreement. In the event the assets turn out to be worth less than the amount agreed to by the parties up front, the FDIC’s losses could grow dramatically beyond its original projections.

Remember, the assets in question are illiquid and difficult to value, and their future value depends in large part on how this financial crisis plays out. You can bet the FDIC’s loss projections assume the current downturn is over and we will be experiencing income growth, less foreclosure activity and recoveries in the residential and commercial real estate markets going forward.

The parties that have acquired these assets under loss share agreements can afford to be indifferent as to what happens going forward. They are protected either way.

This is yet another avenue of quantitative easing. The US Treasury, by way of the FDIC, is guaranteeing a value for the Country’s most distressed bank assets much higher than anyone is actually willing to pay for them. In the process, it is helping disguise how “worth-less or worth-little” (Jim’s words) these assets have become.

More Evidence of FASB-Blessed Overvaluations:

Each bank failure announcement allows us a peek into how extensively bank management have been exaggerating the value of their least liquid assets since the FASB’s roll-back last year of fair value accounting requirements. Four of the worst examples of asset overvaluation exposed by this week’s closings were as follows:

SouthwestUSA Bank, Las Vegas, Nevada, had stated assets of $214 million and deposits of $186.7 million. The FDIC estimated its closing cost $74.1 million (40% of deposits). Based on that estimate, the bank’s assets were really only worth $112.6 million, and had been overvalued by 90%.

SouthwestUSA Bank’s situation was so bad, the acquiring bank was only willing to take over $137.3 million (stated value) of its assets, with its losses on $111.3 million of those assets limited by a loss share agreement with the FDIC. The FDIC had to take the remaining $76.7 million (stated value) of assets onto its own books for later disposition. Under these circumstances, the FDIC’s loss estimate could only be called a “guesstimate,” because its eventual losses are made uncertain both by the loss share agreement and the difficulty gauging how much it will be able to realize on the sale of the assets it was forced to take over.

Crescent Bank and Trust Company, Jasper, Georgia, had stated assets of $1.01 billion and deposits of $965.7 million. The FDIC estimated its closing cost $242.4 million. Based on that estimate, the bank’s assets were really only worth $723.3 million, and had been overvalued by 40%.

Thunder Bank of Sylvan Grove, Kansas, had stated assets of $32.6 million and deposits of $28.5 million. The FDIC estimated its closing cost $4.5 million. Based on that estimate, the bank’s assets were really only worth $24 million, and had been overvalued by 36%.

Community Security Bank of New Prague, Minnesota, had stated assets of $108 million and deposits of $99.7 million. The FDIC estimated its closing cost $18.6 million. Based on that estimate, the bank’s assets were really only worth $81.1 million, and had been overvalued by 33%.

Courtesy: www.jsmineset.com

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