business

Banks are failing at the fastest pace since the savings-and-loan crisis in the early 1990s amid the worst economic slump since the Great Depression. Yet many bank experts say they're actually not failing fast enough.

Across Minnesota, and the nation, regulators have moved cautiously to close troubled institutions in the hope of finding buyers. However, the situation at some of these banks is so grim, and the pool of available buyers so limited, that sales have been slow to materialize.

A number of bankers and industry experts are beginning to question why regulators choose to prolong the agony for so-called "zombie" banks that are doomed to fail and have all but stopped making new loans.

Four Minnesota banks have closed since the start of the financial crisis while the state's watch list of troubled banks has more than doubled over the same period to 69 institutions. The latest -- Brickwell Community Bank in Woodbury -- was seized Friday, felled in part by heavy loads of failed loans on commercial real estate, such as housing subdivisions and retail stores. Another eight banks across the state are undercapitalized by federal regulatory standards.

No one is cheering for more bank failures. Indeed, too many bank closings at once could shake the public's already rattled confidence in the banking system and further drain the insurance fund that safeguards bank deposits, industry experts warn. But in some cases, regulators have made matters worse by allowing problem banks to fester while searching for buyers, increasing the cleanup costs and the future cost to taxpayers, some industry experts argue.

The slow death of Brickwell, which had $73 million in assets, was a case in point. The bank's Tier 1 capital ratio, a key measure of its ability to absorb loan losses, fell below federal regulatory minimums in December and dipped into negative territory -- effectively making the bank insolvent -- this spring. It was put under tighter regulatory supervision in March, after regulators filed a cease-and-desist order accusing the bank of operating with inadequate capital and reserves.

Ivar Peterson, president of Brickwell, did not return telephone calls seeking comment for this article.

To some in the banking industry, it's unclear what the regulators gained by waiting. "The longer a bank twists and turns out there, the worse its problems can become, making it worth less to those looking to come in and buy" problem banks, said Robert Viering, a bank consultant from Monticello.

Besides a lack of buyers, some experts blame the slow pace of shutdowns on the reluctance of the Federal Deposit Insurance Corp. to close banks because its dwindling deposit insurance fund may force it to tap taxpayer money at the U.S. Treasury.

"They don't want to admit that the FDIC insurance fund is insolvent. That's probably the biggest single reason," said William Black, a former senior financial regulator, associate professor of economics and law at the University of Missouri-Kansas City and an outspoken critic of the current bank regulation regime.

Former banker and bank consultant Jeff Judy, of Jeff Judy & Associates in Bloomington, agreed. The FDIC is handcuffed by staffing constraints and its shrinking fund, he said. "The issue is people and funding," Judy said.

The fund, which insures individual depositors up to $250,000 per account, had just $10.4 billion at the end of June, down from about $45 billion a year ago. Although the fund has reserves, it's not enough to cover the cost of future bank failures, which the FDIC estimates will reach $70 billion by 2013.

To beef up its coffers, the FDIC earlier this year levied special assessments on all banks nationwide. But with hundreds more bank failures expected over the next few years, analysts say the agency will eventually be forced to turn to taxpayers. Last month, FDIC Chairwoman Sheila Bair said the agency might have to borrow money from the U.S. Treasury -- something the agency has not done since the savings-and-loan crisis of the 1990s.

"They're blowing through the deposit fund, so they're trying to do some creative things to avoid losses now," said Robert Bliss, a business professor at Wake Forest University in Winston-Salem, N.C. "The important question is whether, by keeping zombie banks on their feet, are they increasing the size of these losses?"

The FDIC wouldn't respond to questions about how the shrinking insurance fund might be affecting the rate of closures, saying that the final decision to close a bank is made by the government agency that charters it. The FDIC, however, plays a major role in just about every aspect of bank closings down to the disposal of office furniture -- including the decisions to shut banks down. Some people familiar with the bank closing process say FDIC officials have been careful to pace bank closings so as not to overwhelm the agency's resources.

In Minnesota, the chartering authority for most banks is the state Commerce Department, an agency that has come under criticism for being slow to react to the bank crisis. It declined to comment on questions about whether it was moving fast enough on closing problem banks.

The state's Commerce Department has one of the lowest ratios of state examiners to banks in the nation; and according to a recent investigation by the Star Tribune, the agency reduced the hours it spent examining banks as the financial crisis deepened in 2007 and 2008.

444 job vacancies

The FDIC, which has staffed up considerably to deal with the wave of bank failures, hiring a raft of contractors, says it has enough staff to handle closures.

"Last week, five banks closed without a hiccup," said FDIC spokesman David Barr.

The agency's Resolutions and Receiverships division, which collects bids for failed banks and sells their assets, has more than doubled its staff to 911 people from 396 since the end of last year. It has opened two new facilities in Irvine, Calif., and Jacksonville, Fla. Still, it has 444 vacancies it's trying to fill.

Despite the extra reinforcements, the FDIC is not prepared to deal with an onslaught of bank failures, experts argue. So far this year 89 banks have failed -- an average of a little less than three banks a week. The FDIC now has 416 banks on its "problem list," up from 305 at the end of March.

"It's pretty obvious to everyone, given the problems in the industry, that if the FDIC had more staff that they'd close more banks," said Larry Ness, president of First Dakota National Bank of Yankton, S.D., which recently acquired deposits from a failed bank.

John L. Douglas, bank insolvency expert and former FDIC general counsel now at Davis Polk & Wardwell, agreed that staffing constraints at the FDIC are probably slowing the pace of closures. But, he said, he isn't sure a faster pace would necessarily enhance the bidding at auctions. For one, many bidders are restrained by their own challenges at home, he said.

"To do 10 failures a week would really strain any staff regardless of how big, so it's been cut back to a more manageable number," Douglas said. "I'm frankly not sure it make sense to do a lot more at one time."

Others said the FDIC has simply had a difficult time attracting willing and able buyers. For instance, when regulators finally pulled the plug on Mainstreet Bank in Forest Lake last month, the FDIC managed to attract just a single bid. A similar fate befell Horizon Bank of Pine City, which was shut down in late June. Horizon received just one bid although the FDIC solicited bids from 547 potential buyers, according to the FDIC.

Signs that the agency may be having difficulty attracting buyers are the generous deals the FDIC has been cutting with bidders through so-called "loss-share agreements." Under these arrangements the regulator agrees to soak up millions of dollars in future losses on dicey loan portfolios that acquiring banks are taking on. Without such arrangements, many troubled banks would still lack buyers, critics say.

With Mainstreet, the FDIC agreed to assume future losses on about $268 million of Mainstreet's $459 million in assets. In the case of Horizon Bank, the FDIC extended a loss-share agreement on $65.1 million of the Pine City bank's $87.6 million in assets.

"It's a pressure-cooker situation out there," said Bliss of Wake Forest University. "The FDIC's got a stack of problem banks they've got to clear off their plate, and not a lot of buyers. Then a bank says, 'I'll buy the bank if you guarantee the losses.' It's an easy way out."

For many troubled banks, the prospect of being shut down may be better than being kept on life support until a buyer emerges.

Viering said he is now advising a number of Midwest banks that have seen their capital shrink to worrisome levels. Morale at these banks, which he declined to identify, has deteriorated considerably; some of their best customers have left, and one of his clients is operating under such tight regulatory scrutiny that it has nearly ceased making new loans.

With each passing week, these banks become less attractive to potential bidders, Viering said.

"Every Friday, they live in fear of the FDIC showing up," he said. "Word gets out and the ones that figure this out first are the stronger customers, who end up leaving -- because no one wants to get caught up in a failure."

cserres@startribune.com • 612-673-4308

jennifer.bjorhus@startribune.com • 612-673-4683