A Shock To The System

All through the 1980s, the annual number of bank failures kept growing, an annoying sign that despite general prosperity, all was not well with the nation's banking system. Yet the public, well-instructed in the security of federal deposit insurance, kept pumping fresh savings into the banks without batting an eye. Even as the estimated cost of the thrift bailout hit a staggering $500 billion, public confidence barely wavered.

Less than one week into 1991, that air of insouciance seems blown away. The nation's depositors were jolted awake first on New Year's Day as Rhode Island Governor Bruce G. Sundlun uttered those Depression words, "bank holiday," and closed 45 credit unions and small banks after a private deposit insurer failed. Then, on Jan. 6, savers' confidence was shaken even harder as the Federal Deposit Insurance Corp. seized the Bank of New England and a couple of smaller banks held by its parent. At an estimated cost of $2.3 billion, the BNE bailout is the third-costliest ever.

'SCARY.' The feds moved in to halt nothing short of panic. On Friday, Jan. 4, BNE disclosed that it may have lost $450 million in the final quarter of 1990, forcing it into insolvency. BNE depositors that day lined up at branches all across New England to cash in their accounts. Overnight and on Saturday and Sunday, jittery depositors raided automated-teller machines. Soon, they had withdrawn up to $1 billion. "I've lost confidence in the bank," Boston resident Harvey C. Hilton explained. "It's scary to watch this happen," said Kathy Neylon, who cleaned out her account despite the federal insurance.

The FDIC has pledged to pay BNE depositors in full--even those with accounts above the $100,000 insurance limit. Yet the fear didn't end in New England. Many banks, such as MNC Financial Inc. in Baltimore, are reporting that customers are trimming accounts to $100,000 by spreading their money into several accounts. New Jersey's Midlantic Corp., which is about the same size as BNE, was deluged with phone calls from nervous depositors on Jan. 8. The local media picked up an erroneous report that the bank was on the brink of insolvency. Midlantic Chairman Robert Van Buren was forced to call a news conference the same day to clear up the confusion.

Worried depositors elsewhere phoned their banks for reassurance. And the three phone lines at Veribanc Inc., a Wakefield (Mass.) company that ranks banks' safety, were jammed for days after the run on BNE. "It's sad," says Warren Heller, Veribanc's research director. "There's beginning to be a recognition that not all banks are safe."

Why are folks so worried? It can't help that the nation has plunged into recession. Or that a war may be waged in the Mideast. That's enough to set people on edge. But depositors have more direct reasons to fret. One big concern is that the regulators might not be as generous in future bailouts. Indeed, the FDIC paid big depositors at New York City's Freedom National Bank, a black-run bank that counted Jackie Robinson among its founders, just 50~ cents on every dollar of deposit above the $100,000 maximum when it failed last November. Those that have lost money include not just wealthy individuals and businesses, but local churches and charities.

The uneasiness about banks is far from over. True, most analysts dismiss suggestions that the banking system is anywhere close to a Depression-era kind of collapse. And they doubt the troubles afflicting the banks will ever match those that doomed hundreds of thrifts.

Yet the banking industry these days is far from healthy. Commercial real estate loans continue to sour as office-vacancy rates rise and the real estate market deteriorates. "It's not unique to New England," observes Lawrence K. Fish, BNE's chief executive. "The economy, and particularly the real estate markets, are continuing to slip." Loan write-offs are 10 times higher than a decade ago. Making the industry's fundamental troubles more worrisome is the plunging balance in the FDIC's bank-insurance fund (charts).

A severe recession could jeopardize some of the $200 billion in loans that banks made to finance leveraged buyouts during the Roaring Eighties. And with unemployment rising, consumers are no longer lining up for personal loans and home mortgages. They're even having trouble paying off the debt they've already taken on. Some 4% of credit-card loans were past due at the end of the third quarter last year, the highest delinquency rate in three years.

UPHILL FIGHT. None of those woes are fresh, and neither were BNE's. It had been teetering for most of 1990, the result of aggressive growth led by former Chief Executive Walter J. Connolly Jr. BNE binged on New England's thriving real estate market of the 1980s. When that market collapsed in 1989, the bank was overwhelmed by bad loans. An examination by federal regulators in December, 1989, disclosed that BNE had more than $2 billion in bad real estate loans. Today, nearly 15% of its $22 billion in assets are nonperforming.

All along, BNE faced an uphill fight. Though regulators have praised Fish's management, a steadily weakening regional economy and sickly real estate market couldn't be overcome. Recently, a deal for bondholders to swap their debt for BNE stock stalled when regulators wouldn't offer any guarantees against seizing the bank. Such an agreement would have saved BNE $60 million a year in interest payments, while creating $706 million in new equity.

Without that new capital, the bank's position became untenable once BNE totted up its losses in 1990. The figures suggested fourth-quarter red ink of $450 million--enough to obliterate the $255 million in shareholder equity still separating the bank from insolvency.

So on Thursday, Jan. 3, Fish and other executives dashed off to Washington to give the regulators the bad news. After meeting with FDIC Chairman L. William Seidman, they spent that evening with Comptroller of the Currency Robert L. Clarke. Friday morning, they hit the Federal Reserve. Among the options Fish suggested: a debt-for-equity swap with bondholders, or government ownership like the feds' 1984 takeover of Continental Illinois.

SWIFT RESPONSE. But once BNE acknowledged news reports Friday morning of its big expected loss, panic began to spread. Regulators watched anxiously as the lines formed at the branches and deposits started pouring out. At first, they considered making a reassuring statement, stressing that the federal government stood behind BNE deposits. But with the threat of a more severe run when the bank reopened on Monday, that gesture seemed quite inadequate.

So the FDIC moved in Sunday night. Almost from the start, regulators agreed to guarantee all BNE deposits. Their big fear: Public confidence had been so damaged that other big, troubled New England banks--Bank of Boston and Shawmut among them--would find themselves besieged by depositors clamoring for their money. "Given the condition of the financial system in New England, it would be unwise to send a signal that large depositors weren't going to be protected," Seidman said. Moreover, the Fed was concerned about wider damage to the banking system and possible international repercussions. BNE, like other large banks, held over-the-limit deposits from other banks, which would have been hurt by getting less than full repayment.

Washington's swift response calmed most depositors. The FDIC has injected $750 million in fresh capital into BNE's insolvent banks, which besides Bank of New England include Connecticut Bank & Trust and Maine National Bank. They will continue to operate under Fish and his management team.

Regulators are now looking for a buyer for all or part of BNE's banks. A bank from outside the region would bring in fresh capital, boosting the local economy. San Francisco's BankAmerica Corp. and Banc One Corp. of Columbus, Ohio, have shown interest. BofA may already have a team of 40 bankers going over BNE's books. "We're not banking on a rapid turnaround," in the region, says BofA's chief financial officer, Frank N. Newman.

BAND-AID. In a surprising sign of the times, there has been little criticism of regulators' decision to bail out all depositors. The Administration had planned to introduce limits on deposit-insurance coverage this year as part of a broader banking-reform package. But many in Congress believe such a move may be too risky now. Representative Barney Frank (D-Mass.) says Congress should delay any decision. "It's too dangerous to make an example out of a particular bank," he says.

Nonetheless, the bailout is only a Band-Aid on one of the industry's many grave wounds. Economists fear the credit crunch could worsen in New England, condemning the region's economy to a lengthy recession. With much of the staff at BNE unsure about their future, many fear that lending officers will spend more time getting their resumes together than looking for new business. And other big banks in New England may grow even more timid about new loans as they try to clean up their own balance sheets. Indeed, in a recent study by Advest Inc., a Hartford securities firm, New England banks had the highest percentage of nonperforming loans out of 360 banks surveyed.

ACCOUNT SHIFTING. Once the regulators have cleaned up the immediate mess at BNE, their work will hardly be over. For with the public's confidence in the nation's banks declining into unknown territory, regulators must find a way to head off unexpected crises. For instance, David C. Cates, chairman of Ferguson & Co., a Washington bank consultant, wonders whether small savers might start shifting funds from small banks to larger banks and from weaker to stronger institutions. That could create liquidity crunches for those banks that can least afford them.

Worse, big commercial depositors could follow suit. "If I was a corporate treasurer, I wouldn't like the idea of explaining why I had a big account at the Bank of New England--even if I didn't lose any money," says consultant Christie A. Sciacca of the Secura Group. And it's just that mentality, for so long so foreign to Americans, that's now catching on.


Anxious depositors rely on three federal insurance funds to protect their savings. The programs cover deposits up to $100,000 per account in banks, thrifts, and credit unions. But their financial health varies widely


The Federal Deposit Insurance Corp.'s Bank Insurance Fund covers about 13,000 institutions, mostly commercial banks. The fund's reserves were about $9.2 billion at the end of 1990. That's only 46~ for every $100 in covered deposits, the lowest level ever


The FDIC's Resolution Trust Corp. backs deposits in failed thrifts. Next year, the FDIC will set up a fund to guarantee deposits at the remaining thrifts. The RTC, which started with $50 billion, has run out of money, but Congress is expected to replenish the fund this year


Credit-union members should be safer. The National Credit Union Share Insurance Fund is in good condition, with $2.1 billion in equity


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