Bank failures drain FDIC insurance

Nearly 100 banks have failed so far this year, pushing the Federal Deposit Insurance Corp.’s insurance fund into the red for only the second time since its founding in 1933.

As the worsening commercial real estate debacle continues to ravage the balance sheets of thousands of mostly small and medium-sized banks, analysts expect hundreds more could fail before the problem abates.

“While banks and thrifts are now well along in the process of loss-recognition and balance-sheet repair, the process will continue well into next year, especially for commercial real estate,” FDIC Chairman Sheila C. Bair told the Senate Banking, Housing and Urban Affairs financial institutions subcommittee last week.

“We expect the numbers of problem banks and failures will remain elevated, even as the economy begins to recover,” Mrs. Bair said when she revealed in late September that the insurance fund’s net worth turned negative. Problem banks and bank failures “tend to be lagging economic indicators,” she said.

Mrs. Bair put those failures in perspective on Friday by noting that more than 500 financial institutions collapsed in 1989.

This year’s 99 bank failures have already cost the FDIC more than $25 billion. That’s on top of the nearly $20 billion in costs absorbed by the federal agency from the 25 banks that failed last year.

The recession has so devastated the FDIC’s deposit insurance fund that the agency has had to take the unprecedented step of requiring banks to prepay $45 billion of insurance premiums by the end of this year in order to replenish the FDIC’s coffers. The premiums would cover the fourth quarter of this year and all of 2010, 2011 and 2012.

As recently as May, the FDIC estimated that bank failures from 2009 through 2013 would cost the agency $70 billion. In late September, the FDIC increased that estimate by more than 40 percent to $100 billion.

The $100 billion projection is “about right, unfortunately,” said Scott Talbott at the Financial Services Roundtable, a banking trade group that supports the FDIC’s prepayment plan.

The deposit insurance fund’s balance at the end of June was $10.4 billion, down from more than $45 billion a year ago. It is this balance that turned negative at the end of the third quarter; final figures are not yet available.

Noting that the negative net worth of the insurance fund was “a bad situation,” Mr. Talbott called the FDIC’s prepayment plan “a creative and elegant solution.”

Rob Strand, a senior economist at the American Bankers Association, which also supports the prepayment plan, said the FDIC has devised “an aggressive plan” to generate the needed cash. “We think that will handle the problem,” said Mr. Strand, who doesn’t expect the FDIC will need to tap the U.S. Treasury for a bailout.

Even though the agency’s insurance fund is in the red, the FDIC still has money to absorb losses. That’s because the insurance fund balance is just one part of the FDIC’s total reserves that are available to cover losses. The second part is the agency’s contingent loss reserve, which totaled $32 billion as of June 30.

Just as banks set aside reserves for loan losses, the FDIC sets aside reserves for bank failures. The $32 billion in its contingent loss reserve reflects its estimate of the cost of failures expected over the next year. As of June 30, these funds were available to absorb future losses. It is this $32 billion contingent loss reserve that is expected to be depleted early next year unless the prepayment assessments begin rolling in.

The FDIC has the power to exempt institutions from the prepayment requirement if it would adversely affect the safety of the institution.

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