The FDIC’s August 27, 2009 announcement in its latest Quarterly Banking Profile (here) that during the second quarter of 2009 it had increased the number of financial institutions on its "Problem List" from 305 to 416 (a 36% increase) caused quite a stir. The Wall Street Journal’s lead article the next day referred to the FDIC’s "sick list" and other media sources also buzzed with the news.


And well they might. As I noted in the prior issue of InSights (here), the number of banks on the FDIC’s "Problem List" and the assets they represent have both grown rapidly. The 416 institutions on the list at the end of the second quarter of 2009, representing assets of $299.8 billion, contrasts dramatically with the end of the second quarter of 2008, when there were "only" 117 institutions on the list representing $78.3 billion in assets. This nearly 300 percent increase in the number of problem banks in just one year, along with the nearly 400 percent increase in the assets the problem banks represent, are both deeply troublesome developments.


The FDIC itself noted in its Quarterly Banking Profile that the current number of problem banks is the highest such count since June 30, 1994, and the assets they represent are at the highest level since December 31, 1993.


It is hardly surprising that these disturbing developments and the trends they represent have triggered some daunting projections about what the future may hold. Among the most alarmist, and the one that has garnered the most media attention, is the statement on CNBC by banking veteran and investor John Kanas that the number of failed banks could reach 1,000 by the end of next year. Other commentators have made other pessimistic albeit less dire projections (refer for example here.)


It may not be possible simply to write off the question whether 1,000 bank failures over the next year and a half is a possibility. Certainly, banks failed at a tremendous rate during the S&L crisis. During the dark days of 1989, banking regulators took control of 534 banking institutions. Overall, during the S&L crisis, over 1,000 financial institutions failed.


In addition, other details in the FDIC’s latest Quarterly Banking Profile certainly underscore the deteriorating conditions facing many banks. Among other things, the banks’ loan portfolios are weakening faster than the banks can set aside loss reserves. At the end of the second quarter, the industry’s ratio of reserves to bad loans stood at just 63.5%, its lowest level since 1991.


The data in the FDIC’s report also highlights how problems are spreading beyond just the real-estate sector where the problems in the current economic crisis first emerged. Credit card losses are increasing and the banks find themselves collectively holding billions of dollars worth repossessed real estate. Persistent high levels of unemployment raise the risk that even low-risk borrowers could fall behind or default on their loan payments. For further details about reasons why banks are failing now, refer to my recent post here.


Though we are still a very long way from 1,000 failed banks, the number of failed banks has continued to surge. With the addition of three more bank closures this past Friday night, the number of 2009 year to date bank failures now stands at 84. Since January 1, 2008, 109 banks in 29 states have failed. These bank failures have ranged from the smallest banks with assets under $15 million, to Washington Mutual’s failure, which with assets of $307 billion was the largest bank falure in U.S history. The FDIC’s complete list of failed banks since October 2000 can be found here.


All of that said, it is still a very long way from 84 bank failures – in and of itself a significant number – to 1,000 bank failures by the end of 2010. This truly pessimistic prediction presumes that more than double the number of current problem banks will fail in the next 14 months. This despite the fact that while both the number of problem banks and the number of failed banks have climbed dramatically in the past year, the number of failed banks has remained well below the number of problems banks.


Because of the historical example of the S&L crisis, it is hard to say that 1,000 bank failures couldn’t happen. It happened before and it could happen again. However, in the range of possible outcomes, the likelihood of 1,000 bank failures has to rank among the remote possibilities. Among other things, the prediction of 1,000 bank failures seems to reckon without the possibility that eventually the effects of the economic recovery might start to alleviate the harsher trends of the economic downturn.


Unfortunately, the current trends do seem to suggest that things will continue to get worse before they get better. But one of the lessons we were all supposed to have learned from the events that preceded the credit crisis is the fallacy of projecting from current conditions and presuming current conditions will continue indefinitely into the future.


Just as it was a mistake in the late stages of the housing bubble to assume, for example, that housing prices would continue to rise indefinitely, so too it could be a mistake to presume that current adverse banking conditions will continue unabated into the future. Yes, circumstances are difficult and there undoubtedly will be further bank failures, perhaps many more bank failures. The possibility of as many as 1,000 bank failures seems remote and unlikely, even given current adverse and deteriorating conditions. Securities Analyst Meredith Whitney’s projection of 300 bank failures (refer here), although also arguably pessimistic, by comparison seems less radical.


Among other questions raised when discussing these issues on recent days is whether the rising tide of bank failures, no matter how large it ultimately proves to be, will lead to a wave of lawsuits against the former directors and officers of the failed institutions, as happened during and following the S&L crisis.


As I have noted previously, most recently here, there have been some lawsuits filed by shareholders of failed banks, who claim that their investment losses were the fault of the banks’ former directors and officers. There have also been a number of securities class action lawsuits filed by shareholders of publicly traded failed banks. Indeed, of the 25 banks that failed in 2008, six were sued in securities class action lawsuits, even though just eleven of the 25 were publicly traded.


These seems to have been less of this shareholder litigation in connection with the 2009 bank failures so far, perhaps in part due to the fact that fewer of the 2009 bank closures involve publicly traded financial institutions.


Prospective litigants are not likely to be encouraged by the recent developments in one of the 2008 securities class action lawsuits involving a failed bank. That is, on August 21, 2009, the court granted with prejudice the defendants’ renewed motion to dismiss the amended complaint plaintiffs had filed to try to cure the defects noted in the earlier dismissal motion rulings in the subprime-related securities class action lawsuit involving Downey Financial. A copy of the court’s ruling can be found here. This development underscores the pleading obstacles plaintiffs may face in trying to survive dismissal motions in any case involving a failed bank, particularly against the larger background of the global economic crisis and wave of bank failures.


One recurring question I am asked is whether the FDIC will, as it did during the S&L crisis, pursue liability claims against the former directors and officers of failed financial institutions. These kinds of lawsuits were a major part of the FDIC’s efforts to try to recoup its losses during the last banking crisis. There would seem to be every reason to expect the FDIC to attempt to do the same thing this time around as well.


However, at least so far, the FDIC does not seem to have actually filed these kinds of claims, at least as far as I am aware. I have been informed by reliable sources that the FDIC has presented written notices of potential claims in certain instances (perhaps in an effort to preserve a possible later recovery from D&O insurance policy proceeds before the policy’s lapse). However, so far, the FDIC does not seem to have actually pursued these claims.


One thing that seems certain is that if there really were to be as many as 1,000 failed banks, or any number remotely in that neighborhood, the latent prospect for litigation involving the former directors and officers of the failed banks would potentially be enormous.


Special thanks to the many readers who sent me links, comments and questions about the FDIC’s latest Quarterly Banking Profile and related media developments.