California regulators shut down

1st Centennial Bank

of Redlands, Calif. Friday and named the Federal Deposit Insurance Corporation receiver. It is the third failure of a U.S. bank this year.

In a press release, the California Department of Financial Institutions didn't specify why it closed 1st Centennial. However, based on the bank's poor loan quality, continuing losses and low level of capital,

TheStreet.com Ratings

had assigned it an E (Very Weak) financial strength rating in September 2008, a downgrade from D- (Weak) in the previous quarter.

1st Centennial had $803 million in total assets and $677 in total deposits as of Jan. 9. The FDIC announced that the failed bank's six branches and insured retail deposits were acquired by First California Bank, of Westlake Village, a unit of

First California Financial Group

(FCAL) - Get Report

.

This left approximately $12.8 million in uninsured deposits, a figure the FDIC said was likely to be revised. As we saw last week with the failure of

Bank of Clark County

of Vancouver, Wash., depositors face major risks as the banking crisis continues to unfold, despite the temporary increase of deposit insurance limits.

The FDIC also said that 1st Centennial had $362 million in brokered deposits that weren't part of its transaction with First California Bank.

When a bank or savings and loan with brokered deposits fails, the FDIC asks the brokers to complete paperwork listing their customers and deposit amounts. Since brokered CDs are registered with a bank or S&L only in the name of the broker, the FDIC needs the brokers to provide detailed customer account information when an institution fails. The FDIC then cross-checks the information with other broker lists and the bank's retail deposits to make sure that a customer's total deposits with the failed institution don't exceed insurance limits. This process takes time, meaning it can take customers with brokered deposits a few weeks to get their money back.

Destructive Construction Loans

1st Centennial's major loan quality problems hit home in the first quarter of 2008, when the institution's ratio of nonperforming assets to total assets increased to 9.27%, from 2.22% at the end of 2007. Nonperforming assets include loans past due 90 days or more (less government-guaranteed balances) and repossessed real estate. Like so many banks in California and other states at the center of the housing boom, residential construction loans made up the bulk of the nonperformers.

Over the next two quarters, as loan losses mounted, the bank's level of capital declined below the minimum needed to be considered well-capitalized under regulatory guidelines. After 1st Centennial posted loan losses of $21.1 million and net losses of $19.1 million for the first three quarters of 2008, the bank's leverage and risk-based capital ratios fell to 4.43% and 8.18%, respectively, as of Sept. 30. These ratios need to be at least 5% and 10%, respectively, for an institution to be well-capitalized.

During the first three quarters of 2008, 1st Centennial faced liquidity problems, so it raised CD rates in order to attract brokered deposits. In the third quarter, brokered deposits increased by $273 million to $375 million, but total deposits only increased by $168 million. This means the institution suffered an outflow of retail deposits (that is, those originated in 1st Centennial's branches) of $105 million. That type of deposit outflow is unsustainable for an institution of 1st Centennial's size.

Of course, many troubled banks and thrifts will turn to brokered deposits, although they come at a steep price. 1st Centennial's net interest spread -- essentially the difference between what it earned from loans and securities investments and what it paid for deposits and wholesale borrowings -- was 2.37% (annualized) in the third quarter of 2008. The spread declined from 3.79% in the second quarter and 4.27% in the first quarter.

At the height of the real estate boom, 1st Centennial consistently achieved spreads of more than 5% in 2005, 2006 and 2007, while the aggregate for all domestic commercial banks ranged between 3.34% and 3.55%.

Deposit Risk and Ratings

As we have seen with the bank failures over the past two weeks, depositors remain exposed to risk, despite the FDIC's temporary increase of the basic individual deposit insurance limit to $250,000. That and the agency's waiver of the limit on insurance limits for non-interest-bearing business checking accounts are set to expire at the end of 2009.

Bank customers with CD deposits made through brokers also face (at least) the inconvenience of working with their brokers and waiting to receive their money when a bank or thrift fails.

Lastly, it's quite possible that your or someone you know are associated with a school district or other municipal entity with large amounts of somebody else's money on deposit with a local community bank.

TheStreet.com Ratings

issues independent and very conservative financial strength ratings on each of the nation's 8,500 banks and savings and loans. These are available at no charge on the

Banks & Thrifts Screener

. In addition, the Financial Strength Ratings for 4,000 life, health, annuity, and property/casualty insurers are available on the

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.

Philip W. van Doorn joined TheStreet.com Ratings., Inc., in February 2007. He is the senior analyst responsible for assigning financial strength ratings to banks and savings and loan institutions. He also comments on industry and regulatory trends. Mr. van Doorn has fifteen years experience, having served as a loan operations officer at Riverside National Bank in Fort Pierce, Florida, and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a Bachelor of Science in business administration from Long Island University.