After the close of business on Friday, October 10, 2008, the FDIC announced (here and here) that state regulators had closed two banks, Meridian Bank of Eldred, Illinois, and Main Street Bank of Northville, Michigan. The closure of these two banks brings the 2008 total number of bank closures to 15.
By way of comparison, there were only three bank closured during all of 2007. Indeed, there were none at all between June 25, 2004 and February 2, 2007. (An FDIC table showing all bank closures since 2000 can be found here.) According to an October 11, 2008 Bloomberg article (here), the 15 bank closures during 2008 already represents the highest annual total since 1993, which of course was the tail end of the last era of failed banks.
Nor is this current wave of bank failures over. Conditions in the housing market continue to deteriorate, and job losses associated with the anticipated recession could only accelerate this process. A slumping economy will challenge borrowers across all lines of credit. This June 30, 2008 FDIC chart (here) graphically illustrates the dramatic growth in troubled loans over recent periods, and both trendlines and headlines suggest that this will only continue.
Moreover, the balance sheets of many banks are already under pressure because of the banks’ extensive holdings in securities of Fannie Mae and Freddie Mac, and, to a lesser extent, Washington Mutual, AIG, and Lehman Brothers. Banks dependent on short term interbank loans may also be experiencing liquidity issues as a result of the current disruption in the credit markets.
As of the end of the second quarter 2008, the FDIC listed (refer here) 117 banks on its "Problem List," which represents a 30 percent jump since the end of the first quarter. The "Problem List" numbers through the end of the third quarter are not yet available, but significant further deterioration seem probable given third quarter events, and developments already in the first two weeks of the fourth quarter certainly have not helped.
UPDATE: Consistent the hyperspeed circumstances that have come to characterize recent events, the announcement this evening after the close of the market that the U.S. will buy stakes in the Nation’s largest banks (refer to WSJ article here), along with related disclosures, potentially impacts the foregoing analysis as well as much that follows. In particular, the Journal is reporting that "one central plank of these new efforts is a plan for the Treasury to take approximately $250 billion in equity stakes in potentially thousands of banks." This obviously could impact the issue whether or not or to what extent other banks will fail. As these details are only now emerging (after I wrote this entire blog post, wouldn’t you know it), and as it will take some time before the details become clear, much less that the government acts, the discussion in this post may remain relevant. How relevant remains to be seen, depending on the specifics of the government’s plan and its implementation.
A significant part of the last era of failed banks was the appearance of a flotilla of lawsuits, in which investors and regulators sought to assign blame and recover losses. There already has been extensive litigation filed in connection with the two most prominent bank failures of 2008, IndyMac (refer here and here) and Washington Mutual (refer here).
The follow-on failed bank litigation has started to emerge in connection even with the lower profile failures, as illustrated by the recent lawsuit filed in connection with the failure of Integrity Bank of Alphretta, Ga.
State banking regulators closed Integrity on August 29, 2008, and the FDIC was appointed as its receiver (about which refer here). The bank’s deposit liabilities and some of its assets were sold to Regions Financial Corp. Prior to a March 2008 delisting, shares of Integrity’s holding company, Integrity Bancshares, traded on Nasdaq.
On September 12, 2008, Integrity shareholders filed a purported class action in Georgia (Fulton County) Superior Court against the holding company and four Integrity officers. On October 7, 2008, the defendants removed the case to the Northern District of Georgia. A copy of the removal petition, to which the state court complaint is attached, can be found here.
The plaintiffs’ complaint alleges that the defendants misled investors about the bank holding company’s health during 2006 and 2007, as a result of which the plaintiffs allege violation of state securities laws, common law fraud, and negligent misrepresentation. The complaint specifically alleges that the defendants understated or failed to disclose "the nature and degree of risk associated with the following conditions":
(i) a loan portfolio comprised almost entirely on real estate acquisition, development and construction, which risk was further by an unreasonable concentration of such toasts its borrower relationship (the "Related Loans"), (ii) a loan portfolio principally collateralized by real estate, (iii) operating with a Board of Directors that failed to provide adequate supervision over and direction to Bank management (iv) operating with inadequate management not sufficiently experienced in or Knowledgeable of good lending practices, (v) operating with inadequate equity capital and reserves in relation to the volume and quality of assets held by the operating with a large volume of poor quality loans, (vii) operating with inadequate allowance for loan and lease basses, (viii) operating with hazardous loan and administration practices, (ix) banking regulations concerning safe lending practices, (x) the potential for cross-defaults with respect to some or all of the Related Loans, (xi) potential difficulty in and realizing on loan collateral in market conditions, (xii) the potential and severity of losses from deteriorating market affecting borrowers, and (xiii) the adverse affect of losses from such loan defaults on the Bank’s liquidity, capital resources and operations.
The Integrity lawsuit is not the only complaint to be filed in connection with the current wave of bank failures. In addition to the Washington Mutual and IndyMac lawsuits cited above, investors also filed a securities class action lawsuit in connection with the failure of NetBank, about which refer here. The FDIC’s press release about the September 28, 2007 closure of NetBank, which coincidentally was also based in Alphretta, Georgia, can be found here.
The failure of additional banks, while not inevitable, seems more likely than not. (I doubt there are many informed observers now who would assert that there will be no further bank failures.) To the extent more banks fail, there undoubtedly will also be further related litigation. And to the extent the pace of bank closures quickens, which certainly is within the range of possibilities, there could be a surge of "dead bank" litigation comparable to the flood of lawsuits that kept so many lawyers employed during the late 80s and early 90s (including, it should be noted, your humble correspondent).
If the earlier era is any guide, the lawsuits that may arise will include not just investor lawsuits like the one involving Integrity, but also actions by regulators as well. And again, if the earlier era is any guide, the defendants will include not only the financial institutions’ directors and officers, but also the financial institutions’ outside professionals, particularly the auditors and attorneys.
During the competitive D&O insurance marketplace conditions that have prevailed in recent years, many financial institutions were able to procure D&O insurance policies without a so-called regulatory exclusion (for further background about which refer here). It may be that in light of current conditions in the banking industry, the regulatory exclusion could be poised for a comeback.
In any event, community banks and other small to medium-sized banks, which have enjoyed a competitive D&O insurance marketplace for several years may now face rapidly changing and less advantageous conditions. Certainly, the D&O insurance underwriters will undoubtedly approach these kinds of accounts with a great deal more caution than in recent years.
Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the Integrity removal petition.
That Goes for Subordinated Investors Too: In a prior post, here, I suggested that the dramatic failure of several prominent companies was drawing preferred shareholders into securities class action litigation. It appears that these events may be having the same effect on investors in subordinated securities as well.
According to the plaintiffs’ October 10, 2008 press release (here), a purported class action lawsuit has been filed in the Southern District of New York on behalf of person who purchased securities in the December 11, 2007 offering of 7.70% Series A5 Junior Subordinated Debentures of AIG, against certain AIG directors and officers, as well as the offering underwriters. The complaint alleges that the offering documents did not accurately represent AIG’s financial condition, and in particular misrepresented the company’s exposure to loss associated with credit default swaps.
As I noted in my earlier post, the massive investment losses associated with the collapse of these prominent financial companies is drawing many new classes of litigants who previously would not have become involved in securities litigation.
Run the Numbers: With the addition of the Integrity and the AIG subordinated debenture lawsuits, my current tally of the subprime and credit crisis-related securities lawsuits now stands at 124, of which 84 have been filed in 2008. The lawsuit tally can be accessed here.
When They Are Done in Reykjavik, Would They Be Willing to Come to Wall Street?: An October 13, 2008 Financial Times article entitled "Icelandic Women to Clean Up ‘Male Mess’" (here) reports that two women, Elín Sigfúsdóttir and Birna Einarsdóttir, are set to become chief executives of two nationalized banks the Icelandic government created in the wake of the recent banking crisis. A government official quoted in the ariticle said that these appointments were "an attempt to signal a new culture within the banking system"
The article quotes a banker who blames the Icelandic banking system’s collapse on "young and predominately male bankers" whose "eyes were bigger than their stomachs." A government official is quoted as saying that "now the women are taking over. It’s typical, the men make the mess and the women come in to clean it up."
Meanwhile, Iceland may run out of food, or at least imported food. Bloomberg reports (here) that due to the unwillingness of banks outside the country to trade in Iceland’s currency, the krona, the country’s foreign trade has come to a standstill. As a result, the country’s food shelves are being stripped bare, and they may not soon be replenished.