The FDIC to draw on its line of credit at Treasury soon

The FDIC has just released a press statement outlining the second quarter results for the fund and the financial institutions it regulates.  What was particularly notable in the statement was the decrease in funds available to deal with failed institutions and the increase in the number of problem institutions to 416. This surely indicates that the financial system in the U.S. is weakening even while the economy seems to be stabilizing.

At the end of March, the Deposit Insurance Fund had just $13 billion available for seizing failed institutions and dealing with the losses that result.  In this statement for the period ended Jun. 30, the fund had $10 billion on hand – a number that would be less by now given the failure of a number of large institutions.  Clearly, the fund has to draw on a line of credit with Treasury that it received in legislation just signed in May.  Under this provision, the FDIC may draw down up to $500 billion.

Excerpts of the FDIC press release text are below (emphasis added).

My highlights:

• The number of problem institutions is still increasing. It was 252 at the end of 2008. It grew to 305 when the FDIC last reported.  It is now 416.
• Loan losses are increasing, not decreasing. Both the charge-off rate and the non-current loans and leases are increasing.  They are at the highest level since data collection began.
• The financial sector is clearly deleveraging as $303 billion fewer assets were in the system in Q1 and an additional $238 billion fewer assets were in the system in Q2.
• The FDIC only has $10 billion left in the kitty. Clearly, more funds are needed to deal with eventual losses by failed institutions.

Commercial banks and savings institutions insured by the Federal Deposit Insurance Corporation (FDIC) reported an aggregate net loss of $3.7 billion in the second quarter of 2009, a decline of $8.5 billion from the $4.8 billion in profits the industry reported in the second quarter of 2008. Insured institutions earned $424 million in net operating income during this latest quarter even after a special assessment of $5.5 billion to bolster the FDIC’s insurance fund. However, one-time losses and other items totaling $4.1 billion pulled the industry results into negative territory…

Provisions for loan losses totaled $66.9 billion in the quarter, an increase of $16.5 billion (32.8 percent) over the second quarter of 2008. Extraordinary losses stemming from writedowns of asset-backed commercial paper totaled $3.6 billion, compared to extraordinary losses of $366 million a year earlier. Noninterest expenses were $1.7 billion (1.7 percent) higher, primarily due to increased FDIC deposit insurance premiums.

Indicators of asset quality continued to worsen during the second quarter. Both the quarterly net charge-off rate and the percentage of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) reached the highest levels registered in the 26 years that insured institutions have reported these data. Insured institutions charged off $48.9 billion in uncollectible loans during the quarter, up from $26.4 billion a year earlier, and noncurrent loans and leases increased by $40.4 billion during the second quarter. At the end of June, noncurrent loans and leases totaled $332 billion, or 4.35 percent of the industry’s total loans and leases…

Total assets of insured institutions declined by $238 billion. A $125.5 billion decline in loan and lease balances accounted for more than half of the decline in total assets of insured institutions during the second quarter. The 1.8 percent decline in industry assets followed a $303.2 billion decline in the first quarter of 2009. Banks’ balances with Federal Reserve banks fell by $99.4 billion (20.4 percent) during the quarter, and assets in trading accounts declined by $65.5 billion (7.9 percent). The industry’s investment securities portfolio increased by $130.6 billion (5.9 percent).

The number of institutions on the FDIC’s "Problem List" rose. At the end of June, there were 416 insured institutions on the "Problem List," up from 305 on March 31. This is the largest number of institutions on the list since June 30, 1994, when there were 434 institutions on the list. Total assets of "problem" institutions increased during the quarter from $220.0 billion to $299.8 billion, the highest level since December 31, 1993.

Total reserves of the Deposit Insurance Fund (DIF) stood at $42 billion. Just as insured institutions reserve for loan losses, the FDIC has to provide for a contingent loss reserve for future failures. To the extent that the FDIC has already reserved for an anticipated closing, the failure of an institution does not reduce the DIF balance. The contingent loss reserve, which totaled $28.5 billion on March 31, rose to $32.0 billion as of June 30, reflecting higher actual and anticipated losses from failed institutions. Additions to the contingent loss reserve during the second quarter caused the fund balance to decline from $13.0 billion to $10.4 billion. Combined, the total reserves of the DIF equaled $42.4 billion at the end of the quarter.

Chairman Bair distinguished the DIF’s reserves from the FDIC’s cash resources, which included $22 billion of cash and U.S. Treasury securities held as of June 30, as well as the ability to borrow up to $500 billion from the Treasury. "A decline in the fund balance does not diminish our ability to protect insured depositors," Chairman Bair concluded.

Putting this report in proper context

The report indicates that the financial sector is still in distress. Many data points suggest that the banking system is in fact weaker today than it was just last year – one reason that some bank analysts believe we will see as many as 300 more bank failures before the crisis is over. 

The weakness is very worrying given we have already had a crisis of historic proportions. John Lounsbury recently penned an analysis that indicates the share of assets owned by institutions which have failed in this crisis is an order of magnitude larger than it was in previous crises including the Great Depression and the S&L crisis.

Today’s data suggest we are by not out of the woods yet. The question is what to do.  Nationalization is off the table.  Instead, the Obama Administration and the Federal Reserve seem to be attempting to increase asset prices in order to relieve pressure on weak institutions to write down asset values(see my post “It’s the writedowns, stupid”). 

However, this tactic has not been enough to save the weakest institutions. Therefore, the FDIC has had to take on the dirty work of seizing the assets of failed banks and selling them on. Yesterday, I argued that they do so in a manner that is favorable to the institutions buying the assets but unfavorable to American taxpayers.  This is a outgrowth of the desire to dispose of those assets without nationalizing the institutions (i.e. having the government own and run the banks for a considerable period).

And late yesterday word came that, indeed, the FDIC is loosening standards for commercial buyers like private equity companies (see Rolfe Winkler’s take here and the Wall Street Journal report here).  I take a dim view of the loosening of these standards because it looks to be another Depression-era rule that is being violated in this age of de-regulation.

At the end of the day, regulators have few options.  Despite the talk of recovery, the financial sector is still weak – and this means many more bank failures are to come.  In order to process these transactions the FDIC desperately needs willing buyers of the assets of the failed institutions.  However, with the financial sector still in deleveraging mode, the ones with the most cash on hand seem to be commercial buyers.