FDIC and the Bank Failures of First Federal Bank and Imperial Capital in California. Two Banks Brought Down by Option ARMs and Commercial Real Estate.

First Federal Bank of California failed on Friday because of a heavy over indulgence on risky option ARMs.  Imperial Capital also failed on the same day because of an inability to raise capital and also mounting losses of commercial real estate loans.  These two bank failures, two of the 140 in 2009, show that the reason for defaults is shifting.  Option ARMs have brought down many lenders including IndyMac and Washington Mutual.  For the latter two banks, option ARMs were merely another toxic loan in a portfolio of years of horrible lending.  So who acquires First Fed?  OneWest.  Who is OneWest you ask?  The bank that emerged from the failure of IndyMac.

First Fed was a big failure.  It has $6.1 billion in total assets.  Imperial Capital has $4 billion.  This brings bigger issues for the FDIC since they are now in the red and these bank failures will cost additional sums of money.  Money the FDIC doesn’t have.  The failure of First Fed shows us the reality that option ARMs are still wrecking havoc on the balance sheet of banks.

You don’t need to be an expert to know First Fed was heading into trouble.  Take a look at their option ARM sheet sent to brokers during the boom:

Anyone reading the above will see that the sheet looks like a bullet point of toxic lending guidelines.  100 percent option ARMs for loans up to $500,000.  You also see gigantic cash out options being made at the peak of the bubble.  No income and no assets were no problem with the above.  Only 12 months of bank statements and even then there was room to fudge.  The bottom line is First Fed put decades of stability in front of risky toxic lending.  They are not the first and last to be lured by the Wall Street siren call.  The sheet above was issued in January of 2007.  Almost three years later they fully implode.

And let us look at how their balance sheet looked like in January of 2008:

So by January of 2008 First Fed had some $3.2 billion in one-year ARMs that included option ARMs and $1.1 billion in three-to-five year ARMs that also included option ARMs.  By this time First Fed was already feeling the brunt of its mistake in toxic mortgage lending.  Many of those one-year loans blew up in its face since First Fed has been losing money for seven straight quarters until Friday’s seizure.

Those that think option ARMs have a way out are mistaken.  The bulk of these loans sit in California.  60% of outstanding option ARMs are here in the state.  The vast majority do not qualify for HAMP or any other programs.  Wells Fargo and JP Morgan have gone ahead and pushed these loans into interest only products but 40% of the borrowers are already in some form of distress.  It is hard to see how these banks don’t have additional problems.  Just because they are too big to fail doesn’t mean money isn’t being lost.

What is happening with the FDIC is that they are creating even bigger banks that will have a harder time failing but have a direct lifeline to taxpayer money.  Take for example the above failures.  City National will now pick up Imperial Capital and will have $21 billion in assets while OneWest will pick up First Fed and have $24 billion in assets.  It is a twist of economic insanity that failing banks are only getting bigger.

Some might argue that seeing this fall with First Fed was hard to predict.  Actually some saw this back in 2006 and made big bets on it:

“(LA Times) Seiver recommended short sales of stock in the parent company, FirstFed Financial Corp. He wasn’t the first to suggest this strategy, which would turn a profit if the company’s stock price fell: In fact, the volume of such short-sale bets against First Federal nearly tripled from late 2004 to early this year, before dropping slightly in March after the thrift reported solid earnings.

The short sellers question whether First Federal’s financial results are being inflated by accounting rules, which they contend may overvalue risky loans. And they are among those predicting a meltdown in California’s recently superheated housing market.

Other critics accuse First Federal and other West Coast thrifts of overindulging borrowers’ lust for artificially low initial payments. By generating so-called exotic or nontraditional mortgages, they warn, these S&Ls have allowed speculators to buy homes they can ill afford — and will be unable to resell when the mortgage payments rise and home prices take a tumble.”

It was only a matter of time that these ticking time bombs would hit hard.  That is why banks like Wells Fargo, Chase, and Bank of America through their acquisitions of toxic mortgage lenders will be facing years of pain with option ARMs.  Not only with option ARMs, but with commercial real estate.

The failure of Imperial Capital shows us that CRE is now here and hitting California hard.  The big problem with Imperial Capital was with loans on apartments and commercial mortgages.  The CRE market is slated as the next big issue in the coming years.  With $3 trillion in CRE loans outstanding many regional banks such as Imperial Capital will face failure.  However with what occurred on Friday, it is disturbing to see the FDIC funnel these banks into larger too big to fail banks that have direct access to taxpayer money.  What they are inevitably doing is putting the taxpayer on the hook for additional losses.

What is clear with the failure of First Fed and Imperial Capital is we are in the middle innings of the option ARM and CRE fallout.  Those that doubted these loans as problems should put that notion to rest.

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