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Banking & Finance

Former Exec Weighs In On What Happens Next

By Bonnie Eksten, posted Oct 2, 2009

Last month (September) Federal Reserve Chairman Ben Bernanke said from a technical perspective, “the recession is very likely over.”

That does not mean that banks are out of the woods. Although banks are now lending, credit is still hard to get, foreclosures continue to plague homeowners and more banks are expected to fail. As of the first week of September, 92 banks have failed just this year. This summer Sheila Bair, Federal Deposit Insurance Corp. chairman, reported that an additional 400-plus are on the Federal Deposit Insurance Corp.’s troubled bank list. The FDIC does not identify these banks in order to prevent further erosion of public confidence and to forestall a possible run on a troubled bank.

The FDIC has taken drastic steps to keep the nation’s financial engine running. But now, the federal insurer’s very deep pockets are emptying.

Wilmington resident Dick Verrone, former chief credit officer at both Wachovia and RBC, took some time from his teaching schedule at the University of North Carolina Wilmington to talk about the FDIC, the continuing banking crisis and what it means for us.

By now we all know what happened to banks. Verrone succinctly recapped where we are and how we got here. Some banks, he said, forgot the basics, engaged in writing mortgages that exceeded, in some cases 100 percent of the value of the property, and basically got caught up in the euphoria of the times. The good banks, he said, did not.

Verrone, an executive in residence at UNCW, is finishing his 12th year teaching in the business school. Even with a busy schedule, he manages to keep in touch with what’s happening outside the confines of the campus through a network of friends and business acquaintances made over a 32-year career.

“Banks are lending,” Verrone said, but “they’ve drawn in their horns. Bankers now want to see more equity, some of the developers’ money  at least 20- to 30 percent so developers share the risk.” Office building or apartment developers now are asked to show how many units are already leased before they get development money. Verrone said lenders now want to see 75-90 percent pre-leasing agreements before they sign on to a loan. Before new development loans are made, bankers want to see the developers’ track records; what other projects have they completed, whether this is the biggest project they’ve ever done, a routine one, or one they’re betting the ranch on.

What of the old loans made during the euphoric times? If these loans go bad, will it shock the banking system once again? That is where the FDIC’s loss-share program comes into play.

David Barr, FDIC spokesman, explained how the federal insurer assumes the brunt of the risk when it finds a new buyer for a failed bank. Barr used Cape Fear Bank as an example. When the Wilmington bank failed in April, the bank was sold to First Federal. The FDIC assumed 95 percent of the risk of bad loans, the new owner only five percent. FDIC‘s “best guess” was in the worst-case scenario, it could lose $131 million with a massive loan failure. To date, Barr said, it has not had to absorb all of that loss. But, Barr said, First Federal was insulated with its loss-share program. “We take some of the hit.”

The federal insurer is willing to talk with developers who have outstanding loans, but Barr cautions, “If they are asking for more money to complete the project, they’re not just getting money.” The FDIC will need to see a budget and how well developers are sticking to their budget. “If we’re not satisfied with the information, we’re not going to throw good money after bad. (Developers) have no skin in the game,” he said.

Loss-sharing with FDIC makes deals to acquire banks more attractive, Verrone said, because the federal insurer will eat the losses.

The acquiring bank increases its market share and gains customers with very little risk.

The problem, however, Verrone said, is that due to the number of failed banks and the loss-sharing guarantees, the FDIC now only has about $10 billion in its fund balance.
“They’re expected to pay out more than they have in their fund.” Bank failures are a trailing indicator. After a while the weight of bad loans will get too heavy, he said.

Then what happens? The FDIC will have to go to the Treasury Department which will print more money, Verrone said. But, as long as you have unlimited resources from the government, printing money becomes a ticking time bomb.

One week later, Barr announced that it was possible the FDIC was “considering all options, including borrowing from Treasury,” to replenish the dwindling fund that insures bank deposits.

The FDIC has raised its insurance rates that banks pay into the system. Verrone said that the FDIC could continue to ante up insurance fees and that could go on for years.

He said he doesn’t want to sound so pessimistic, but he tells his UNCW students that this generation is “mortgaging your future. You and your children, and your grandchildren have to pay for this. You could be the first generation with a standard of living that is not as good as your parents,” he said.

“It will be a crushing burden. Inflation, interest rates, taxes will go up because the government has to raise money to pay back the debt,” Verrone said.

Trying to be positive, Verrone said he believes we will find a solution to our current financial difficulties because he has faith in the American people.

Sometimes, he said, Americans have “to be pushed into a corner before we stand up and say enough’s enough. We’re going to unite, somehow, someway, and figure out a way to get out of this problem.”

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