Banks Keep Failing, No End in Sight

Since WaMu Fell, 279 Lenders Have Collapsed; Lost Jobs, Curtailed Lending and the Big Get Bigger

The largest number of bank failures in nearly 20 years has eliminated jobs, accelerated a drought in lending and left the industry's survivors with more power to squeeze customers.

Some 279 banks have collapsed since Sept. 25, 2008, when Washington Mutual Inc. became the biggest bank failure on record. That dwarfed the 1984 demise of Continental Illinois, which had only one-seventh of WaMu's assets. The failures of the past two years shattered the pace of the prior six-year period, when only three dozen banks died.

Two more banks went down last Friday, and failures are expected to "persist for some time," according to a report issued Tuesday by Standard & Poor's. In the second quarter of this year, the Federal Deposit Insurance Corp. increased its number of problem banks by 6% to 829.

Between failures and consolidation, the number of U.S. banks could fall to 5,000 over the next decade from the current 7,932, according to the top executive of investment-banking firm Keefe, Bruyette & Woods Inc.

The upside of failures is that they can represent a healthy cleansing of a sector that grew too fast, with bank assets more than doubling to $13.8 trillion in the decade that ended in 2008. Many banks that failed were opportunistic latecomers. Of the failed banks since February 2007, 75 were formed after 1999, according to SNL Financial.

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Still, economists say, the contraction represents an enduring threat to capital, lending and the economy.

"When we step back and look at this financial disaster 10 years from now, the destruction of capital in our economy as a result of what we've endured will be the single greatest lasting impact on recovery and how the economy performs in the future," says Howard Headlee, president of the Utah Bankers Association.

The pain is less severe than in the Japanese banking crisis, in which banks languished for a decade despite $440 billion the government spent to assist the industry.

But, in the past two years, the whole U.S. banking system recoiled. Large banks like Countrywide Financial Corp. and Wachovia Corp. were acquired to avert failure while powerful banks including Citigroup Inc. and Bank of America Corp. were propped up by the government.

Between the failures and government assistance, Gerard Cassidy of RBC Capital Markets says, the impact to the system has been "far more severe" than the savings-and-loan crisis. Not only were government rescue measures more sweeping and more global this time, the weakness in real estate continues to constrain economic growth.

Since 2008, the industry's assets have shrunk by 4.5%.

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"If you reduce the amount of assets at a bank, it means they make fewer loans, and that has a negative impact on the economy," says Richard Bove, a bank analyst at Rochdale Securities in Lutz, Fla.

From small towns like Rockford, Ill., to Miami, the banks' disappearance means not only cutbacks in lending but fewer banking choices, lower interest rates on savings accounts, and lost jobs.

The recession and collapse of the housing bubble have cut bank-industry employment by 188,000 jobs, or 8.5%, since 2007, according to FDIC data. Failures alone have cost 11,210 jobs, or 32% of the employees at failed banks, according to FIG Partners, an Atlanta investment firm that specializes in the banking industry.

For more than a year, Martin Quantz and his co-workers at the Woodstock, Ill. branch of Amcore Bank checked the FDIC's website each Friday afternoon to see if their flailing bank had gone under. Regulators seized the bank in April and turned over its 58 branches to Harris National Association.

By August, Mr. Quantz was unemployed. He now hopes reconnecting with an old contact will lead to a new bank job.

"There's a lot of pain out there, and there are a lot of people in the industry who won't go back," says Mr. Quantz, 41 years old.

The city of Clinton, Utah, may never be refunded $83,000, a portion of their cemetery-maintenance funds that wasn't insured when nearby Centennial Bank failed without a buyer.

In nearby Ogden, Utah, Weber State University lost $100,000 in scholarship money that had been pledged by Barnes Banking Co., a 119-year-old local institution that failed in January. The scholarships, to be distributed in $1,000 increments, represented one quarter of in-state tuition, says a Weber State administrator. Earlier this month, the college restored the Barnes Banking Lecture Hall to its original name: "Room 110."

Failed bank assets are now strewn across the banking system.

The FDIC is burdened with $38 billion of remnants it is trying to sell. They range from virtually worthless mortgaged-backed securities to office decorations such as plastic Christmas trees.

The tough times follow cresting prosperity in which banks with few loan losses chased customers into hot real-estate markets. When the subprime mortgage bubble burst, failures were concentrated among mortgage lenders such as IndyMac Bank, which left $1 billion of depositors' money uninsured when it failed in 2008.

Various autopsies of expired banks all point to real estate as the primary cause. A tally by SNL Financial LC found that 94% of bank failures since 2008 had either residential or commercial real-estate as their largest category of delinquent loans. KBW says their riskier construction loans were 23% of their total portfolio, compared with 7.2% for the industry as a whole. The delinquency rate of commercial real estate was 13.5%, far above the current national average of 1.7%, SNL said.

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Federal and state bank regulators arrive to close Midwest Bank on May 14 in Melrose Park, Illinois. Midwest, with assets totalling $3.17 billion, was seized by regulators after failing to raise the necessary capital needed to stay independent, and taken over by Ohio-based Firstmerit Bank.

The Imperial Capital Bank unit of Imperial Capital Bancorp in La Jolla, Calif., specialized in real estate. Like many other small banks, it extended beyond its home turf and made loans nationwide. The bank more than doubled its assets to $4.1 billion in the five years ended in 2008, according to an FDIC report. Then, the nine-branch bank purchased $826 million of mortgage-backed securities.

Real estate accounted for more than 95% of its loans, compared to 35% or less for its peers. The bank failed in 2009.

Some economists argue that, for all the damage, the failures' impact on the economy was muted because the largest banks that failed or came close were quickly absorbed by other institutions or helped by the government.

"I don't think enough banks have failed, or have been failing fast enough, to have a macro-economic impact," says economist Edward Yardeni.

Surviving banks have raised more than $500 billion in new capital, reducing the risks of new failures by boosting rainy-day funds.

Failure can occasionally jumpstart lending. To conserve capital, regulators often block sickly banks from making new loans. When a bank buys the assets of the failed institution, that buyer often resumes lending.

Since acquiring operations of the failed Frontier Bank in Everett, Wash., last April, Union Bank N.A. has started originating loans in Frontier's region in western Washington and Oregon. Though Union lowered interest rates on certificates of deposit, "We desire to grow our loan portfolio and are eager to find ways to make loans that make sense," says Tim Wennes, chief retail banking officer for Union Bank, a unit of San Francisco-based UnionBanCal Corp.

Such consolidation also means the biggest are getting bigger: Bank of America, J.P. Morgan Chase & Co. and Wells Fargo hold 33% of all U.S. deposits, up from 21% in 2006, according to SNL Financial. That gives them more market power to squeeze out smaller competitors.

John Squires, who was chief executive officer of Old Southern Bank when it failed in March, protests that his larger competitors in his Orlando, Fla., neighborhood all survived thanks to heavy doses of government support, which allowed them to raise capital more easily.

"Absolutely unfair—the big boys have the clout," says Mr. Squires. "Community banks are in jeopardy all over the country."

—Dan Fitzpatrick contributed to this article.