IndyMac's fate could test U.S. banking regulators

WASHINGTON, July 9 Wed Jul 9, 2008 6:20pm EDT

WASHINGTON, July 9 (Reuters) - Deeply troubled mortgage lender IndyMac Bancorp Inc IMB.N may have bought some time through sharp cuts in operations and selling some branches but its survival remains in question, creating a major test for banking regulators.

In particular the significant size of IndyMac's deposits that are insured by the Federal Deposit Insurance Corp might present a challenge. If the deposits, which total more than $17 billion, had to be guaranteed, that could temporarily dent the FDIC's war chest of around $53 billion.

IndyMac said this week it was unable to raise new capital, would slash staff by 60 percent, and had stopped making most home loans. Its shares have sunk to 38 cents, with one analyst forecasting they will be worthless.

Major victims of the credit crisis to this point have either been the subject of rescues by bigger banks, as in the case of mortgage lender Countrywide and investment bank Bear Stearns, or weren't major deposit-taking entities.

The FDIC insures up to $100,000 per deposit account and up to $250,000 per retirement account at insured banks.

But even if the FDIC had to step in and be responsible for IndyMac's insured deposits, the agency's fund wouldn't take a hit equal to the amount of those deposits.

"Clearly they wouldn't be on the hook for all of that," said Ann Graham, a law professor at Texas Tech University and former FDIC official.

She said that if IndyMac closed, the FDIC could arrange to have another institution pay to acquire the good assets.

Chip MacDonald, a banking lawyer at Jones Day in Atlanta, said about $11.3 billion of IndyMac's deposits are non-brokered deposits that would be easy to sell to another institution.

"The remaining $6 or $7 billion may have to be absorbed," he said.

The FDIC would then dip into its $53 billion fund to pay off the insured depositors but would quickly replenish that amount through assessments on healthy banks.

TRUSTING IN BAIR

The Financial Services Forum industry group expressed confidence in the FDIC and its chairman, Sheila Bair.

"Bair, in many ways, has been out in front of the financial crisis, sounding the alarm before it happened," said John Dearie, the forum's senior vice president.

"I have confidence that the FDIC will be able to deal with the challenges it might face," he said.

But the FDIC could still be tested by what might be the biggest bank failure since the U.S. savings and loan crisis of the late 1980s. And it could be a harbinger of more problems.

"They probably are girding their loins to face another wave of failures," Graham said.

At the end of March, the FDIC had about 90 banks on its list of troubled institutions, with combined assets of $26 billion.

So far, four commercial U.S. banks have failed this year. Last year, a total of three bank failures occurred.

MacDonald said the FDIC is not fully staffed up for a lot of big bank failures, putting a strain on its resolution division, which is responsible for paying insured depositors.

"But they have more than enough money in the FDIC fund to cover bank failures," he said.

CIRCLING THE DRAIN

Even though IndyMac is in trouble, one former FDIC official said a federally orchestrated fire sale would take some time.

"This bank could live for the rest of the summer if the liquidity is maintained and their capital ratios are not too low," said the former official.

"This is a big bank, (and) it's a fairly involved process to sell the bank, if, in fact, that's what the agency wants to do," he said, speaking on condition of anonymity.

Depositors have been withdrawing cash at an elevated pace since senior Democratic Sen. Charles Schumer late in June questioned IndyMac's ability to survive the housing crisis.

Late Tuesday, IndyMac boosted its balance sheet by agreeing to sell some 60 of its retail mortgage branches to Prospect Mortgage, an affiliate of private equity fund Sterling Partners.

California-based IndyMac is subject to supervision by several regulators, including the FDIC and the Office of Thrift Supervision (OTS).

The FDIC monitors a bank's capital levels and its liquidity -- whether there is enough cash on hand to meet deposit withdrawals. If the bank is not liquid enough, the agency can step in to avoid a run on the bank.

The FDIC declined to comment. OTS, the IndyMac's main regulator, said it was aware of the situation and was working closely with the institution.

"What the FDIC and the Fed have to determine is whether there is a irrational run on the bank or a serious insolvency problem," said Hal Scott, a Harvard Law School professor specializing in international financial systems.

"If there is an insolvency problem, if it is perilously close to having negative capital, the FDIC should apply its normal procedures for dealing with a failed bank," Scott said.

When a bank fails, the FDIC typically sells a portfolio of the institution's deposits to recover much of its insurance outlay.

But there may be implications if the FDIC cannot find a buyer for a good portion of IndyMac's assets, especially if there are a large number of nontraditional mortgage loans, and if it takes time to liquidate the assets.

Graham said it is better for the depositors and for the banking system as a whole when the FDIC can quickly find a buyer for the viable assets.

"It is to be hoped that the FDIC will be able to arrange something like that if IndyMac closes, and it looks like it's circling the drain," she said. (Additional reporting by Julie Vorman; Editing by Tim Dobbyn)

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