UPDATE: 11-25-08  MORE BANKS PLACED ON WATCH LIST

According the the Associated Press ...

"The Federal Deposit Insurance Corp. said Tuesday the list of banks it considers to be in trouble shot up nearly 50 percent to 171 during the third quarter—yet another sign of escalating problems among the institutions controlling Americans' deposits."

"The 171 banks on the FDIC's "problem list" encompass only about 2 percent of the nearly 8,500 FDIC-insured institutions. Still, the increase from 117 in the second quarter is sharp, and the current tally is the highest since late 1995."

Under this new "on the shelf" registration program, it has occured to me that hedge funds and other capital pools could also exchange their toxic loans for the acquired financial institution's good assets under some pretense of purchasing additional equity using non-cash assets. While these assets would have to be of high quality (rated AAA by the ratings agencies -- as we know now a number of toxic assets were) and have some justifiable value (under mark-to-market accounting rules -- which we know are being circumvented by allowing unsustainable valuations to remain in place), it is possible under the current rules and regulations. Not to say that someone would attempt it, but you never know when big money is on the line.

The major unanswered question of the FDIC is: did these potentially "unsound" financial institutions receive additional federal funds which failed to improve their capital sufficiency? Has management been changed? And what are the common factors that caused this uptick in problematical banks and can they be mitigated by merger and/or acquitistion without spreading toxicity like ant bait that is brought back to the nest by infected ants.

Original blog entry ...

It is no secret that the Federal Reserve Board of Governors under the direction of Fed Chairman Ben Bernanke and the United States Department of the Treasury under Secretary Henry Paulson have done everything in their power to pump trillions of dollars into the financial system.

Expanding the definition of a regulated bank …

Where banks were once at the top tier of regulated financial institutions, we now find that the two largest investment banks, Goldman Sachs and Morgan Stanley, have been allowed to assume a new status as regulated bank holding companies. Ditto, credit card issuer American Express.

Expanding governmental insurance coverage to non-banks …

In addition, Sheila Bair, Chairperson of the FDIC (Federal Deposit Insurance Corporation) has likewise greatly expanded her agency’s mission to guarantee bank deposits into supporting all means of other financial products and institutions.

Inventing new ways to shuffle financial institutions …

Now we find that the Office of the Comptroller of the Currency (OCC) which serves as the primary regulator of national banks has also entered the game with a new type of bank regulatory process.

Known as a “Shelf Charter” the process is designed to expand the pool of so-called “qualified” bidders for troubled institutions which have been highlighted by the FDIC and other regulatory agencies.

Providing legitimacy to hedge funds and capital pools?

Aimed at those with access to the global pool of capital – and large hedge funds – this new bank charter methodology will serve two basic purposes: one, it will allegedly remove a troubled institution from the roles of troubled institutions; two, it will allegedly facilitate a return to soundness, possibly involving a shift of management leadership; and three, it will allow the newly acquired/formed institution to tap into the extensive pools of capital assistance that are being made to financial institutions of all kinds.

Danger?

Which is why I see a major degree of danger in allowing hedge funds and other well-funded bidders to acquire troubled institutions.

The first danger is that it ONLY requires the necessity of a strong balance sheet and a suitable political/managerial group of entrepreneurs to acquire a troubled financial institution. After the conclusion of the acquisition, it is likely that the institution may access governmental capital sources and allow the bidder to withdraw their initial capital and thus acquire a troubled financial institution with the government’s money – and with minimal risk to its own capital and investors.

The second danger is that I believe it adds additional systemic risk to the banking industry and may greatly dilute the protections available to ordinary depositors from the FDIC. Many of these bidders are likely to be the same “fast money” operators whose machinations in the domestic and global financial markets are associated with the root causes of the current financial crisis.

And the third danger is that there is no guarantee that the newly enhanced management will use its capital availability to improve the profitability of the bank by traditional lending, and instead, seek to grow the financial institution by other mergers and acquisitions.

For the depositors, the management’s emphasis will be on paying the lowest possible return on depositor’s dollars while maximizing the rates on lending and greatly increasing the institution’s fee income. While you would think that competition would keep fees in check, one need only look at the credit card issuers who are maintaining an extremely high interest rate on advanced consumer funds. In addition, rates for CDs and other bank depository products seem to be priced in relationship to their risk: the soundness of the financial institution and their need to maintain core capital requirements. Thus we find a failing institution offering the highest rates to ordinary depositors. Possibly a key metric to judge any newly acquired financial institution.

How does it work?

According to the OCC …

“The new mechanism involves the granting of preliminary approval to investors for a national bank charter. The charter remains inactive, or ‘on the shelf’ until such time as the investor group is in a position to acquire a troubled institution.”

“By granting the preliminary approval, the OCC expands the pool of potential buyers available to buy troubled institutions, and in particular the new equity capital available to bid on troubled institutions through the Federal Deposit Insurance Corporation’s bid process.”

“The process involves several stages:

In the initial review, the OCC evaluates the qualifications of the proposed management team, the sources and amount of capital that would be available to the bank, and a streamlined business plan that describes how the acquired bank will be operated. At the end of this process, the OCC can grant conditional preliminary approval of a national bank charter, subject to certain conditions and to requirements that more detailed operating plans, satisfactory to the OCC, be submitted if the bank targets a specific institution for acquisition.

The investor group is thereby positioned to make proposals to acquire troubled institutions, and, in particular, to be cleared to view the FDIC’s list of failing or troubled institutions and to submit bids for those institutions. Through the conditions imposed in connection with the approval and the operating plan, the OCC retains the ability to oversee how the shelf charter will activate and provide for the new institution to be operated on a safe and sound basis.

In the case of an FDIC resolution of a failing institution, after a bid is submitted, the OCC will evaluate the specific proposal. If it is found to be acceptable, and if the FDIC approves the bid, final charter approval can be granted, together with final approval of deposit insurance by the FDIC. If the bid is not accepted by the FDIC, the charter remains on the shelf for up to 18 months. During that time, the charter can be used for other bids.”

What I don’t understand …

Why does the OCC need to undertake this particular process? It seems to me that when an investor group makes a bid for a troubled institution, the management and capital sufficiency is jointly evaluated by the OCC, Treasury Department, Federal Reserve and the FDIC. Upon completion of the vetting process, the acquiring group simply assumes the charter of the troubled institution or a new piece of paper with the new group’s name is produced by the OCC. It seems to me that troubled institutions have been purchased, acquired and merged without any resort to this newly created procedure.

Further danger …

I see an additional danger in allowing these hedge funds and other capital operators to openly view the FDIC’s list of troubled institutions. While the public can generally calculate the risk of a depository failure from publicly available statistics, it seems to me that exposing the true list to these so-called “operators” tremendously increases the risk of insider trading which could easily result in the complete collapse of the troubled institution or the possibility of insiders making undue profits based on their unique knowledge. Considering the laxity of the Securities and Exchange Commission under the present Administration, the risk of adverse requirements is at the lowest point in history – especially if the acquisition team included heavyweight “fixers” with political connections.

First test …

“The Office of the Comptroller of the Currency announced today it had granted its first conditional preliminary approval of a new type of national bank “shelf-charter,” designed to facilitate new equity investments in troubled depository institutions.”

“The first such approval was granted Monday to establish the Ford Group Bank, National Association.”

Who might these investors be?

From the Conditional Preliminary Approval Letter (see reference link below), we find that the organizing group is known as “Commerce Street Capital LLC” a group of financial professionals engaging in bank development and other investment banking activities.

“The Bank will be a wholly-owned subsidiary of Ford Group Holdings, Inc. (the "Company"), a Texas corporation organized to become a bank holding company for the Bank. The Company will be a one-bank holding company and will own all of the issued and outstanding shares of the Bank.”

Several companies in turn would invest in the Company (collectively, the "Investors") thereby indirectly own the Bank. Hilltop Holdings, Inc. ("Hilltop Holdings") is a public company actively pursuing acquisition opportunities in the financial services industry. It reports approximately $700 million available to be invested in the Company and Bank. Flexpoint Ford
Overage Fund II, L.P. ("Overage"), Flexpoint Ford Fund II, L.P. ("Fund II"), Flexpoint Fund,
L.P. ("Flexpoint") are private equity funds with, respectively, $480 million, $140 million, and $67.5 million in committed capital available to be invested in the Company and Bank) In total, the Bank would have approximately $1.38 billion immediately available for a transaction of the kind described below, although the amount initially invested will depend on the size on the initial
transaction. The applicants represent that sufficient capital will be injected to ensure the Bank is well-capitalized when it opens for business and thereafter.”

And the people behind the investment …

“The OCC poses no objection to the following persons serving as executive officers, directors, and/or organizers as proposed in the application:

• Gerald J. Ford, Organizer, Chairman of the Board
• Carl Webb, Organizer, Director, Chief Executive Officer
• Randy Staff, Organizer, Director, Chief Financial Officer
• Larry Willard, Organizer, Director, Chief Credit Officer
• Jeremy Ford, Organizer, Director”

“We have not completed our background checks for the above individuals. Continued service of these individuals will be dependent on satisfactory completion of the background investigation process.”

Hilltop Holdings Inc. Company Description <Source: Hoovers>

“Manufactured housing communities by any other name are no longer called trailer parks, and Hilltop Holdings is no longer Affordable Residential Communities (ARC). In 2007 Farallon Capital Management and partners acquired the majority of Hilltop's business, which comprised 275 residential communities with more than 57,000 home sites in some two dozen states. What's left? Hilltop Holdings is a property and casualty insurance provider that offers coverage for low-value homes through its NLASCO subsidiary. It sells its insurance through some 6,600 independent agents in more than 20 states. NLASCO operates primarily in the southern US through subsidiaries National Lloyds Insurance and American Summit Insurance.”

The primary two executives of Hilltop are: Gerald J. Ford, Chairman; and Larry D. Willard, President, CEO, Director

Bottom line …

This is a pretty sophisticated play of interlocking interests to extend investments into the banking sector. Considering the management’s background in housing and insurance, there are a number of synergistic possibilities that can occur. This financial play should be watched with great interest by both the regulators and the public.

What can YOU do?

Watch out for your own investments and reduce your personal expenditures in times of financial difficulties.

Watch what the government does with the taxpayer’s money and remember the results of their actions when deciding on future support for political parties and politicians.

There is a great deal of money to be made from the current financial crisis, especially since the regulators and most of the government is in a transitory phase and in not really minding the store.

Be well, be safe, be prudent.

-- steve

Quote of the Day: ”Sharing money is what gives it its value.” -- Elvis Presley

A reminder from OneCitizenSpeaking.com: a large improvement can result from a small change…

The object in life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane. -- Marcus Aurelius

Reference Links:

OCC Conditionally Approves First National Bank "Shelf Charter" to Expand Pool of Qualified Bidders for Troubled Institutions

Conditional Preliminary Approval Letter|OCC

Commerce Street Capital|Website

Hilltop Holdings|Website