Friday, March 5, 2010

This Week in Bank Failures

The bankruptcy trustee for Thornburg Mortgage has filed suit against four executives and their lawyer, claiming that the executives paid themselves bonuses after they knew their company was going bankrupt and used the money to fund a new competing company using a business plan taken from the failed lender. If the defendants knew their company was going bankrupt, all of these actions would be improper unless approved by the bankruptcy judge. The suit further alleges that thousands of dollars were paid from the failed company to suppliers for actions they took on behalf of the new startup. This kind of legal filing is routine in business bankruptcies, as the bankruptcy court is obliged to try to recover any money spent “in view of” bankruptcy in order to distribute the money to the company’s creditors. Thornburg Mortgage, before it went bust, was one of the largest jumbo mortgage lenders, and its bankruptcy was one of the largest bankruptcies last year.

Under new rules, European banks are not allowed to take loans off their books by purchasing credit default swaps, but a delayed transition is keeping several hundred billion dollars in these swaps active on AIG’s books. AIG is hoping to wind down its derivatives business by the end of this year, if the company lasts that long, but it now seems likely to still have some of these contracts active into next year. AIG’s derivatives business, once estimated at over a quadrillion dollars, if that’s possible, has been winding down and running off, and now may amount to “just” one to two trillion dollars — still a treacherous burden for a company whose market value has shrunk to $3 billion.

AIG has agreed to sell its struggling Asian life insurance unit, AIA, and according to sources, it is also close to selling its international life insurance unit, Alico. The two sales bring in about $30 billion in cash, but will leave AIG a shell of a company, with only a few small profitable divisions surrounded by dozens of divisions that apparently, if the transactions between the divisions are taken away, have been losing money for years.

The TARP fund is taking an estimated $70 million loss on its investment in Chicago-area bank Midwest Bank and Trust Company. Despite government help, the bank’s market value has fallen to $10 million, a 96 percent decline from its 2008 peak, meaning investors don’t hold much hope of it surviving its current troubles.

The First Niagara acquisition of Harleysville National Bank has been approved by stockholders, and the transition plan is well underway, but so far, the deal has not been approved by the Fed. The Fed reviews all mergers of bank holding companies to assure that the resulting company will be financially strong enough to function as a bank holding company. Dozens of bank failures in the past 15 months have resulted after the Fed has disapproved a merger plan, and there are reasons to wonder whether this could happen to Harleysville National Bank. First Niagara, though, is confident enough that is has purchased new First Niagara signs for all the Harleysville National Bank branches on the assumption that regulatory approval will come through by April 4. If it’s right, the Harleysville logo will disappear on the weekend of April 9.

At the top of the list of tonight’s bank failures is Sun American Bank. This bank, with 12 locations in southeast Florida and $444 in deposits, operated under several names during its short 23-year history: originally Florida First International Bank, then Southern Security Bank. In 2001 it acquired Pan American Bank and took on that name. A 2003 buyout changed the name to Sun American Bank. A series of acquisitions followed, and the bank never really recovered from those acquisitions. Its financial reports have declined quarter by quarter over the past three years, and its stock has tumbled during that time, losing 99 percent of its value and eventually leading Nasdaq to delist the stock at the end of last year. The Fed at that point issued a prompt corrective action with a February 5 deadline.

The locations, assets, and deposits are being transferred to North Carolina-based First Citizens Bank. First Citizens Bank previously acquired three other failed banks, all outside its core territory between Tennessee and Virginia.

In Utah, Centennial Bank failed tonight. Northern Utah has a plethora of banks, so the FDIC could not find a bank interested in taking over the failed bank’s 5 locations. Of the bank’s $205 million in deposits, approximately 99 percent were within the deposit insurance limits, and the FDIC will mail checks to the depositors beginning Monday. Zions First National Bank will accept direct deposits sent to Centennial Bank accounts for the next few weeks on behalf of the FDIC.

Centennial Bank was created in 1997 by local investors specifically for the purpose of making construction loans and other real estate development loans in Utah. The Utah real estate market has declined more than other areas of the country, so Utah real estate hasn’t been a favorable niche for a bank in recent years.

Bank of Illinois was the latest in a series of bank failures in that state. It was based in Normal, a suburb of Bloomington, in central Illinois, and had two offices and nearly $200 million in deposits. Heartland Bank and Trust Company is purchasing the deposits and assets, paying a 3.6 percent premium for the deposits.

The final nail in Bank of Illinois’ coffin apparently came in a legal tussle between the bank and a failed local real estate developer who was in default on $9 million in loans. The apparent cosigners for part of the loans filed legal papers two weeks ago saying that they had not cosigned the loans, and that the signatures on the documents were forged. Within days, the bank filed suit against the investors, claiming that the documents could not have been forged, although it could not say exactly how the documents came to be signed, as the investors had apparently never visited the bank’s offices. Based on its statements, the bank did not have clear procedures for obtaining signatures on loan documents, so it seems plausible that a bank employee or someone associated with the borrower could have added the signatures improperly. Needless to say, this kind of problem does not make a good impression on bank regulators, and may have encouraged the state to close the bank more quickly.

The final bank failure to report tonight is, to be blunt about it, a mystery. The bank is Waterfield Bank, which had its headquarters in Germantown, Maryland, in the Washington, D.C., metro area, although its operations, mailing address, and telephone number were in Irvine, California. The bank had been owned by Affinity Financial Corporation for only about two years. The bank had little former history, being founded in 2000 by an insurance organization and reorganized twice since that time. The bank apparently never had a profitable quarter, and its capital ratio went negative at the end of 2009. Around the time of its purchase by Affinity Financial, the bank purchased $125 million in mortgage-backed securities, amounting to nearly half its assets, a highly unusual transaction for a small bank.

Affinity Financial, for its part, is an intentionally mysterious organization, as its main emphasis is “private label” banking. This arrangement is supposed to allow membership organizations, apparently including AARP and American Medical Association, to give the appearance of having their own bank, with the banking actually provided by the banks of Affinity Financial. It is understandable that a private label banking operation would want to obscure its identity somewhat, yet in everything I could find out about Affinity Financial, it goes to astonishing lengths to obscure its true operational structure. Looking at the story it offers about itself reminded me, in an uneasy way, of Stanford International Group, which was seized a year ago for running an apparent Ponzi scheme. I must hasten to add that I have no evidence of anything improper in the operations of Affinity Financial, but as in the case of Stanford, its web sites and other public documents offer a great deal of puffery but surprisingly little substantial information that would allow a person to conclude that it is a legitimate banking business. An example from the failed bank’s web site, complete with grammatical error:

Waterfield Bank is a Waterfield Family Company. Waterfield Group is one of the largest private financial services organization in the United States.

The description does not correspond well with the FDIC’s report that the failed bank had $156 million in deposits — that would make it a bank of only average size. Other errors in the web sites include a claimed association with “Blue Cross Blue Shield,” which is not the name of any one company. This kind of error raises a red flag, as it suggests that Affinity Financial does not want potential customers to be able to verify its claims.

As I said, this bank failure is a mystery, and I will see what more I can find out about it.

The FDIC has set up a bridge bank to handle the failed bank’s checking and savings accounts. The bridge bank will operate for 30 days to give customers time to move their accounts to other banks, but customers should start immediately on Monday to make other banking arrangements. CD and IRA accounts are not being transferred to the bridge bank, and based on the bank’s business model, those were probably the vast majority of deposits. The FDIC will mail checks to those account holders beginning Monday. Because of the bank’s private label banking approach, customers may not realize they held accounts with the bank until they receive the checks in the mail.