Last Monday witnessed the reopening of IndyMac under the management and receivership authority of the Federal Deposit Insurance Corporation (FDIC). Photos of lines formed by anxious depositors appeared in numerous news accounts and triggered widespread concern about the safety of depositor funds.
(1) IndyMac’s regulator, the Office of Thrift Supervision (OTS), closed the institution on Friday, July 11 and turned it over, as the law requires, to the FDIC to act as receiver and insurer of deposits. The FDIC’s preliminary estimates are that the failure will cost it somewhere between $4 and $8 billion. This is despite the requirements in the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) that regulators intervene and attempt to minimize losses to the insurance fund.
(2) In fact, the theory behind FDICIA intends that an instuition should be closed before its net worth goes to zero, so that creditors can be repaid without loss to the FDIC or taxpayers.
The statement that the OTS released announcing the failure indicated that it had been concerned about IndyMac’s “precarious financial condition” as early as November of 2007.
(3) The institution had modified its business plan and sought to raise additional capital. Furthermore, additional steps had been taken following OTS examination of the institution in January of 2008, to return it to financial health.
The press release intimates that these plans and efforts were frustrated by the leaking of a letter from Senator Schumer to the OTS, questioning IndyMac’s financial viability, which triggered a deposit run and caused the demise of the institution. Clearly, Senator Schumer’s actions seem reckless. Had his remarks been uttered by a private citizen and not protected by the legal immunity accorded to our federal legislators, that person might have been subject to prosecution, if the claims proved to be false. That said, it seems the OTS’s responses were equally reprehensible and self-serving.
As in most highly charged events, the facts have mostly gotten left behind, so it would pay to restate them and to delve into why the losses are likely to be so large.
IndyMac was a hybrid savings institution spun off from the now defunct Countrywide, that specialized in the origination, servicing, and securitization of Alt-A (low-documentation) mortgage loans. It grew very rapidly, doubling in size between March 2005 and December 2007 from $16.8 billion to $32.5 billion.
(4) Its funding, in rough order of importance, consisted primarily of Federal Home Loan Bank (FHLB) advances and insured and uninsured deposits. The advances were a particularly important source of funding, accounting for between 32% to 45% of its total liabilities.
(5) IndyMac’s reported capital declined over the period from its peak of $2.7 billion in June of 2007 to $1.8 billion at the end of March 2008. Uninsured deposits began to run off in mid-2007, long before Senator Schumer’s letter. In fact, the bank actively replaced slight declines in FHLB advances and a drop in uninsured deposits with insured deposits, and particularly with fully insured brokered deposits under $100K. At about the same time, the bank’s stock price began to plummet, dropping from a high of about $35 per share in June to about $3 just prior to the Schumer letter. Additionally, earnings also turned negative in the fall of 2007. These factors all pointed to a very troubled institution whose situation was continuing to worsen.
Despite the OTS examination in January and subsequent actions by the institution to change its strategy, its capital position continued to decline and earnings deteriorated. In the face of this, OTS director Reich maintained that IndyMac was adequately capitalized and the institution touted that fact in its SEC filing. In fact, in the bank’s March 31, 2008 10Q it stated that tangible and Tier 1 core capital stood at 5.74%, well above the regulatory requirements for the bank to be classified as well-capitalized. Risk-Based Tier 1 capital was 9% and Total Risk-Based capital was at 10.26%. Given that it was supposedly adequately capitalized and was done in by a liquidity problem as some $1.3 billion of deposits ran off, it stretches credibility that the bank’s failure would lead the FDIC to estimate that it could stand to lose between $4 and $8 billion.
(6) How could losses of this magnitude accumulate in just a matter of a few days due to a supposed run of $1.3 billion? The answer, of course, is that they didn’t.
The bank was likely to have been deeply economically insolvent, which was masked by faulty accounting according to current rules and regulatory standards. Clearly, the bank’s active bidding for brokered deposits and reliance upon funding from the FHLB amounted to a big gamble – financed by other government entities – that it might weather the storm. Keep in mind that IndyMac had, at closing, about $10.1 billion in FHLB advances and perhaps even Federal Reserve discount window borrowings as well. Any such borrowings would be over-collateralized with high-quality assets – in this case the collateral was largely mortgage-backed securities. Such claims stand ahead of insured deposits or the FDIC in the liquidation. This means that much of the best collateral that could have been used to backstop the FDIC or shared to reduce losses to uninsured claimants was instead siphoned off by other agencies. Indeed, the FDIC initial estimates are that uninsured depositors may receive fifty cents on the dollar of uninsured deposits.
What emerges from even a partially informed and quick analysis of the available evidence and data is the suggestion that
(a) the institution was in deep trouble long before it was closed;
(b) the OTS appeared to be late to the party, despite market signals;
(c) OTS actions were ineffective when measured against the intent of FDICIA;
(d) the institution engaged in moral hazard behavior by pumping up its brokered deposits that were 100% insured and borrowing from the FHLB, and possibly the Federal Reserve.
The bottom line is that the FDIC is left to clean up the mess and the costs associated with regulatory ineptitude, and the moral hazard behavior will be paid for collectively by the banking system through higher FDIC premiums on the surviving banks.
(1) As of this writing, it is unclear whether those photos pre- or post-dated the opening of the bank under FDIC receivership.
(2)“FDIC Establishes IndyMac Federal Bank, FSB as Successor to IndyMac Bank, FSB, Pasadena, California,” FDIC press release, July 11, 2008.
(3)“OTS Closes IndyMac Bank and Transfers Operations to FDIC,” Office of Thrift Supervision press release, July 11, 2008.
(4) Data from FDIC Quarterly Reports of Condition and Income.
(5) Data from FDIC Quarterly Reports of Condition and Income.
(6) It is likely, given estimates of the amount of deposits in the institution in excess of $100K, that most of this runoff was uninsured deposits.