However, the panic yesterday about Fannie and Freddie perhaps having to come up as much aswith $75 billion in equity ($75 billion?) diverted attention from what on any other day would likely have been the top story: the grim announcements by Indymac, briefly in possession of the dubious status of being America’s biggest independent mortgage lender.
The Wall Street Journal has a decent story, but its press release was bleak. While the bank is stopping virtually all new mortgage lending and ‘fesses up that it does not expect to be able to raise new capital unless the environment improves, the most serious admission is:
In light of the current environment and related deterioration of our financial position since last quarter, we have been working closely with our federal banking regulators with respect to the actions that they and we must take to meet our mutual goal of keeping Indymac safe and sound through this crisis period. In that respect, based on information we have provided to our regulators, they have advised us that we are no longer “well capitalized”, which we stated on May 12 was a possible scenario. Our regulators have also asked us to submit to them a new business plan for their review and approval, something on which we have been working with them for some time. We have agreed on the basic elements of the plan, and the regulators have directed us to begin executing on it. An important element of our plan is to improve our capital ratios. Without an external capital raise, the traditional way to improve safety and soundness is to sell assets and shrink the balance sheet, which in normal times generally has the effect of improving capital ratios and bolstering liquidity. Yet in this environment, where either there are no bids for most of IMB’s mortgage loans and securities or the bid/ask spreads are abnormally wide, “fire-selling” assets would actually deplete capital further. As a result, the most realistic and cost-effective way to shrink both our balance sheet and our servicing rights asset (which, as discussed in previous communications, is up against the regulatory cap limit), is to curtail most new loan production.
In addition to needing to shrink our assets to improve our capital ratios, we also need to do so to ensure that we maintain prudent operating liquidity. A consequence of falling below well-capitalized is that we are no longer permitted to accept new brokered deposits or renew or roll over existing ones, unless we get a waiver from the FDIC. While we have submitted a waiver application, it is uncertain as to whether such a waiver will be granted.
Reader Steve e-mailed some insightful comments:
For anyone who’s remained in denial, this press release paints a clear picture of the severity of the credit crisis: Indymac can’t raise needed capital, and can only sell off assets at a loss. Part of this story is specific to Indymac, but the problem of capital starvation and deflating assets is a general condition. Evidently the regulators can’t find a buyer for Indymac, and are shrinking it as a prelude to nationalization.
What’s interesting is how they are shrinking it. The prohibition on opening or rolling brokered deposits is an obvious thing to do, but forcing Indymac out of the non-GSE mortgage business is not. The problem for FDIC is that non-GSE mortgages wind up getting pledged to FHLB, and as a secured creditor with an over-collateralized position, FHLB borrowings must be paid off by FDIC if the bank becomes insolvent. This is a large cash flow hit to the insurance fund (over $10B or 1/5 of the Fund in the case of Indymac), but the obligation of FDIC as Receiver to marshall the assets of the estate leaves no discretion for over-collateralized borrowings. The Board of the FDIC made some public comments about this problem a few months ago. FDIC has no access to the Fed to liquify and park a FHLB portfolio. In a bridge bank scenario, the FHLB borrowings remain in place, but FDIC is still obligated to provide a combination of capital and guarantees against loss sufficient to launch a new, well-capitalized institution (perhaps in partnership with private capital)–also a large figure, and the main driver behind Fed/FDIC’s push to modify the bank holding company regulations to allow in more unregulated capital.
My view is that the regulators have adopted a go-slow program in order to kick these problems over to the next administration. The obvious danger to this stratagem is a deposit run requiring intervention. The less obvious danger is that the over-hang of impaired but not written down assets may further depress prices.
When Northern Rock blew up, invidious comparisons were made in the British press between the US system of deposit insurance and the hodge-podge of miniscule deposit guarantees and vague regulatory responsibilities in the UK. We’ll see how the US system holds up in a systemic crisis that has reached large institutions that aren’t `too big to fail’, but have combined liabilities many times larger than the Insurance Fund. FDIC could fall back on Treasury for additional emergency funds, but that’s precisely what the current—and no doubt next—administrations want to avoid at all costs.