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NetBank's Failure Is Proof That Ratings Matter

Five years of warning signs preceded the fall of the online bank.

No depositor ever wants to be in the position of hoping to get money back after a bank failure.

In the case of NetBank (formerly a unit of



Inc.),'s financial strength ratings provided five years of warnings, with ratings of D (weak financial strength) or below. NetBank's rating was downgraded to D- in December 2006, E (very weak) in March 2007 and finally E- in June 2007.

After NetBank's deal to be acquired by EverBank fell through, the Office of Thrift Supervision closed down NetBank on Friday, and named the Federal Deposit Insurance Corp. as receiver. The FDIC then issued a statement saying that NetBank's insured deposits had been acquired by ING Bank, FSB (a unit of

ING Group

(ING) - Get Report


ING Bank did not acquire NetBank's $109 million in deposit accounts that exceeded FDIC insurance limits. Customers with uninsured deposits will receive immediate payment of 50% of their uninsured balances. These customers will become creditors to the receivership for the remaining 50%. This means that $54.5 million in deposits may never be recovered by these customers.

Quarterly Ratings publishes Financial Strength Ratings for every U.S. bank and thrift on a quarterly basis. These are not bank holding company stock ratings, but rather safety and soundness ratings for the institutions themselves. You can look up the ratings using the

Ratings Screener.

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The NetBank story shows how important ratings are for depositors with account balances exceeding the FDIC insurance limits of $100,000 or $250,000 for some retirement accounts. If you have large deposits in an institution with a rating below a C (Fair Financial Strength) consider spreading your deposits over several banks and thrifts.

Please see Terry Savage's

story from last week, about how easy it can be to spread a large CD deposit over several institutions.

Here are two more reasons why the bank and thrift financial-strength ratings are important:

You could face major risk if the bank servicing your mortgage fails

. If you got your mortgage from a bank, chances are the loan was sold to Fannie Mae or Freddie Mac, or was securitized and sold to another investor. This process was probably invisible to you, and your loan may still be serviced by the original bank.

If the bank servicing your mortgage were to fail, the owner of the loan would need to take over the servicing or find another servicer. If your mortgage is escrowed for taxes and insurance and the troubled bank fails to deliver the loan files to the new servicer quickly, the insurance premium and property tax payments that your bank normally makes could be made late, or not at all. Freddie Mac recently faced this problem, when American Home Mortgage Investment Corp. (a nonbank loan servicer) went bankrupt and failed to quickly deliver loan files to Freddie Mac.

It can only help to monitor the rating of the bank or thrift servicing your mortgage. If the institution has a very low rating, contact them. Make sure they are paying any insurance premiums and property taxes on time. You should try to find out who ultimately holds the mortgage and who to contact if the servicing is transferred to another institution.

You may be responsible for business or municipal deposits

. Businesses, nonprofit organizations and municipal depositors tend to keep large cash balances. Because these entities want the convenience of doing business with one institution, even though the majority of their deposits are uninsured, our ratings can be a critical part of their risk management.

School districts are a great example. They have a very large seasonal revenue spike, followed by a full year of disbursements.'s ratings can be part of a municipality's regular due diligence, to make sure uninsured deposits are with a safe institution.

Philip W. van Doorn joined Ratings 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 15 years of experience, having served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank o f 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 degree in business administration from Long Island University.