Five Colorado bank failures this year could cost the nation’s deposit insurance fund slightly more than $1 billion.
That represents a fifth of the $5 billion in overall losses to the fund from bank failures through July 22, said Federal Deposit Insurance Corp. spokesman Greg Hernandez.
Only Georgia, with 16 failures costing $1.5 billion, has taken a bigger bite. Colorado and Georgia combined account for half of the hit to the FDIC fund this year.
That $1 billion exceeds the $970.6 million that three Colorado bank failures in 2009, led by Greeley’s New Frontier Bank, cost the fund.
Deposit insurance protects individual bank accounts for up to $250,000 and is a key reason why the country doesn’t see bank runs during a financial crisis.
But when banks fail, surviving banks pick up the tab, through higher premiums to replenish the fund. Those costs eventually pass down to customers and investors.
And if things ever got bad enough, taxpayers could be asked to ante up.
“There is a bit of moral hazard involved in deposit insurance,” said Matt Anderson, a managing director at Trepp, an Oakland firm that does analysis on commercial real estate and banking.
The moral hazard exists because bankers and investors, knowing they won’t be fully liable if a bank collapses, may take bigger risks.
Although bank failures almost always wipe out the money investors put into banks, they also leave behind much bigger messes for everyone else to clean up.
“It is frustrating, but we built a business model that can absorb it,” said Mariner Kemper, chief executive of UMB Financial Corp. “I try not to think about it too much.”
The loss a failed bank passes on to the deposit insurance fund is one measure of its failure to properly price risk, said Denver banking consultant Larry Martin.
The losses at the five Colorado banks represent about 22 percent of their assets, which are made up mostly of loans.
“That is probably pretty much ballpark with what has been going on so far nationally,” Anderson said.
His measures show that the bank failures in June nationwide passed on losses of 25 percent of assets, up from a 19 percent rate in April.
Three failed Colorado banks — FirsTier, Colorado Capital Bank and Signature Bank — face potential losses equal to about a third of their assets.
What is more remarkable about those percentages is that they come after a borrower’s equity in the project is consumed and after the bank has eaten through its capital cushion of 8 percent to 12 percent.
Even in the pre-crisis days, it wasn’t unusual for banks to lend only 70 percent or less of the value of a project, although some banks pushed that amount up to win business in an overheated market.
So how is it possible for bankers to get the valuation of collateral backing loans wrong by such a wide margin?
About 80 percent of bank failures in this cycle are tied to commercial real estate, the remaining 20 percent to mortgages, Anderson said.
Raw land and construction projects in particular are hard to value and volatile. But they also generate larger fees upfront than other loans.
Easy credit fuels higher prices, which supports larger loans, which fuels higher prices, until the whole thing collapses. Empty land or unfinished strip malls don’t generate rents and, when a bust sets in, aren’t worth even a fraction of the amount loaned against them.
Many community banks focused on commercial real estate because that was the need in their communities and larger institutions were not providing money, said Don Childears, CEO of the Colorado Bankers Association.
But more than a specific sector, an inability of some bankers and bank directors to ask the question “what if” paves the road to ruin, Martin said.
What if land prices fall 50 percent, what if this project doesn’t get built, what if our loan portfolio is too concentrated in one loan type?
“They have rose-colored glasses on, and they don’t think beyond their nose,” said Martin, who as an outside adviser tries to get bankers to look at the big picture.
Failure carries a long tail. Bank directors, unlike directors of corporations, are liable beyond their investment, Childears said.
The FDIC can and will sue them for up to three years after a failure, Hernandez said.
The FDIC is pursuing claims against 248 bankers and bank directors seeking to recover $6.8 billion against their professional liability policies, Hernandez said.
That is driving up insurance premiums surviving banks have to pay for their directors and officers, adding another cost to the system, Martin said.
Failures also depress the price of collateral backing other loans in a market, weakening the balance sheet of the remaining banks.
Colorado’s hit to the insurance fund matched the deficit the deposit insurance fund was running as of March 31.
The fund since has come into the black, in part because losses are declining in most states, Colorado being an exception.
Back in 2009, bank failures cost the fund $37 billion, followed by a $23 billion loss in 2010 and only $5 billion so far this year, Hernandez said.
Aldo Svaldi: 303-954-1410 or asvaldi@denverpost.com
