Indy Mac Could Drain 10% of FDIC's Insurance Fund

Indy Mac is a real hit the FDIC Insurance Fund. This is going to be a story worth following over the next few months, until the next big bank seizure. As an historical note, I guess I worked for the bank at the time of its failure which is still the largest bank failure in US history. From the WSJ:

IndyMac Bank, a prolific mortgage specialist that helped fuel the housing boom, was seized Friday by federal regulators, in the third-largest bank failure in U.S. history.

IndyMac is the biggest mortgage lender to go under since a fall in housing prices and surge in defaults began rippling through the economy last year -- and it likely won't be the last. Banking regulators are bracing for a slew of failures over the next year as analysts say housing prices have yet to bottom out.

The collapse is expected to cost the Federal Deposit Insurance Corp. between $4 billion and $8 billion, potentially wiping out more than 10% of the FDIC's $53 billion deposit-insurance fund.

The Pasadena, Calif., thrift was one of the largest savings and loans in the country, with about $32 billion in assets. It now joins an infamous list of collapsed banks, topped by Continental Illinois National Bank & Trust Co., which failed in 1984 with $40 billion of assets. The second-largest failure was American Savings & Loan Association of Stockton, Calif., in 1988.

The director of the Office of Thrift Supervision, John Reich, blamed IndyMac's failure on comments made in late June by Sen. Charles Schumer (D., N.Y.), who sent a letter to the regulator raising concerns about the bank's solvency. In the following 11 days, spooked depositors withdrew a total of $1.3 billion. Mr. Reich said Sen. Schumer gave the bank a "heart attack."

"Would the institution have failed without the deposit run?" Mr. Reich asked reporters. "We'll never know the answer to that question."

Mr. Schumer quickly fired back.

"If OTS had done its job as regulator and not let IndyMac's poor and loose lending practices continue, we wouldn't be where we are today," Sen. Schumer said. "Instead of pointing false fingers of blame, OTS should start doing its job to prevent future IndyMacs."

IndyMac had been troubled for months, and investors were concerned about its possible downfall well before Sen. Schumer's comments. It specialized in Alt-A loans, a type of mortgage that can often be offered to borrowers who don't fully document their incomes or assets. The company sold most of the loans it originated, but continued to hold some on its books. As defaults piled up, IndyMac's finances deteriorated.

The bank will be run by the FDIC and reopen Monday. The FDIC typically insures up to $100,000 per depositor. IndyMac had roughly $19 billion of deposits. Nearly $1 billion of those deposits were uninsured, affecting about 10,000 people, the FDIC said.

IndyMac's arc -- rapid growth, followed by an even more rapid descent -- is a microcosm of the mortgage industry. It boomed in the first part of this decade, as investors were willing to fund loans on ever-looser terms, then hit hard times when the housing market began to turn down in late 2006.

Small mortgage lenders started going under quickly, with the number of failures climbing into the hundreds. Now the fallout has spread world-wide, bringing down some of America's largest financial institutions. Bear Stearns Cos., which suffered losses on mortgage-related investments, underwent a meltdown in March and had to be rescued by J.P. Morgan Chase & Co.

Countrywide Financial Corp., at one time the nation's largest mortgage lender, saw its stock price plunge this year and was forced to sell itself to Bank of America Corp. at a firesale price.

IndyMac, in a last-ditch effort to fend off collapse after it failed to raise fresh capital, said this past week it was firing more than half its work force and closing most of its lending operations. While its shares had been tumbling since early 2007, the move was nonetheless jarring for a company that ranked as the ninth-largest U.S. mortgage lender last year in terms of loan volume, according to trade publication Inside Mortgage Finance.

IndyMac is one of the few federally insured banks to fail in recent years. Banking regulators are bulking up their staff of bank examiners and taking a tough approach toward banks that are seen as risky.

Mr. Reich, the thrift regulator, noted that the IndyMac case had some "unique" features, including the involvement of Sen. Schumer and the rapid fall in its deposits. Officials said most of the recent withdrawals came from depositors at branches, rather than those making deposits at IndyMac's online bank.

IndyMac was set up by Countrywide in 1985, but the two companies severed ties in 1997 and became direct competitors. The company's name stands for Independent National Mortgage. It was created to specialize in jumbo mortgages -- those that are too big to be sold to government-backed Fannie Mae and Freddie Mac. In 1997, under the direction of Chief Executive Michael Perry, a protege of Countrywide chief Angelo Mozilo, IndyMac set off on its own.

The company grew quickly, pioneering the issuance of so-called Alt-A mortgages to people with blemished credit histories. The loans have gained notoriety as an example of the type of lax lending that came to characterize much of the mortgage industry.

Early last year, Mr. Perry remained optimistic about IndyMac's future, insisting that the company had the resources to remain independent. At the time, IndyMac's stock was trading for about $45 a share.

But the combination of the frozen credit markets and mounting defaults on IndyMac loans steadily sapped investor confidence in the company. In February, IndyMac reported the first annual loss in its 23-year history. By this week, its shares, which ended last year at less than $7 each, were trading for 28 cents apiece.

The company was desperate for more capital but couldn't find investors willing to put fresh funds into what looked like a crippled institution.

The failure could be felt across the entire banking industry, as the FDIC will likely have to raise insurance assessments for all banks to build up government reserves. "It takes a big chunk out of the FDIC insurance fund," said Chip MacDonald, a banking lawyer at law firm Jones Day. He said that if the FDIC hikes insurance fees, that will add to already-intense pressure on bank profits.

The OTS and FDIC didn't secure any outside firm to acquire the bank's assets. The FDIC will temporarily run the bank through a new bank it has created, called IndyMac Federal Bank, FSB.