The federal insurance fund set up to protect money deposited at failed banks will have to shell out up to $8 billion to depositors of shuttered IndyMac Bancorp ( IMB).

The Federal Deposit Insurance Corp. estimated its insurance fund would have to pay out between $4 billion and $8 billion to cover some $18 billion in insured deposits at IndyMac Bank, which the Office of Thrift Supervision closed down on Friday after a run on the bank left it illiquid and its stock in ruins.

IndyMac is not likely to be the last bank to go under amid the current crisis. BankUnited ( BKUNA) and Downey Financial ( DSL) are both on very thin ice, as pointed out last week, and while it is not in immediate danger, Washington Mutual ( WM), which raised $7 billion from a group of investors led by private equity firm TPG during the second quarter, will be watched very closely when it reports results on July 22.

Unwinding IndyMac

When a depository institution is shut down, insured funds in retail deposit accounts are made available almost immediately by the FDIC. While the FDIC usually starts selling off assets immediately when regulators close a bank or thrift, IndyMac was so big that the agency established a successor institution, IndyMac Federal Bank FSB, which will temporarily operate to "maximize the value of the institution for a future sale."

The FDIC said uninsured deposits totaled approximately $1 billion, and were held by about 10,000 depositors.

Depositors with uninsured deposits in a failed institution become creditors to the receivership or conservatorship, and receive "dividends" out of proceeds from asset sales. In the case of IndyMac, these creditors have received an advance dividend of 50 cents on the dollar. They may receive more, but that seems doubtful at this stage. IndyMac's mortgage loans are very difficult so sell in this environment, and most are pledged as collateral to the Federal Home Loan Bank of San Francisco, which had $10.1 billion in advances (loans) outstanding to IndyMac when the thrift was shut down.

After the failure of IndyMac Bancorp (IMB) and the government's pledge to backstop mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), what will be the next financial company to require federal help?

Lehman Brothers (LEH)
Washington Mutual (WM)
National City (NCC)
Downey Financial (DSL)
Let the market sort all this out.

It's actually quite surprising the FDIC made any advance dividend to uninsured depositors, considering the agency's insurance fund is on the hook for so much.

For insured deposits made through brokers, which totaled $6.88 billion as of March 31, it will take longer for depositors to gain access to their money. As we discussed when ANB Financial failed, it can take several weeks for the FDIC to sort through a large institution's brokered deposits.

The reason it takes so long is that when an institution like IndyMac gathers deposits through a broker, the accounts are maintained in the name of the broker. Only the broker has the records of individual deposit customers. The FDIC will be mailing packages to all the brokers, so they can obtain customer information which the regulator will then cross-reference with IndyMac's retail deposit records, to make sure each customer's total insured deposits are calculated correctly.

It's very important that customers who took out CDs with IndyMac through their brokers contact the brokers to help move the process along.

Schumer Has a Point

While IndyMac faced a litany of problems -- rapidly declining loan quality, the inability to sell its Alt-A (low-documentation) mortgages and its failure to raise capital -- the institution's run on deposits was ignited by Sen. Charles Schumer's (D., N.Y.) letters to the OTS, FDIC and the Federal Housing Finance Board (the regulator of the Federal Home Loan Bank System), which the senator leaked to the Wall Street Journal on June 26.

Schumer was concerned about IndyMac's declining health, and the threat to the Federal Home Loan Bank of San Francisco.

After IndyMac was shut down, the OTS put out a statement bashing the senator for being the catalyst for the run on deposits. Schumer responded by saying the OTS was "asleep at the switch" and "If OTS had done its job as regulator and not let IndyMac's poor and loose lending practices continue, we wouldn't be where we are today."

That point was well-taken, considering that so many of the largest institutions with troubled portfolios of option-ARMs and low-documentation mortgages are OTS shops.

BankUnited shares closed down 14.3%, to 66 cents on Monday, and Downey Financial's stock finished down 24.3%to $1.28.

Washington Mutual, while better capitalized than those two banks, is supervised by the OTS, as well. Investors will be looking to see how much further WaMu's loan quality deteriorated in the second quarter, when it reports results on Thursday. The stock plummeted 34.8% on Monday, prompting the bank to issue a statement saying it was well-capitalized intended to soothe investors.

Countrywide FSB, now held by Bank of America ( BAC) is supervised by the OTS, as are two large Wachovia ( WB) charters, which hold the option-ARMs acquired from the former GoldenWest Financial. Wachovia will release its second quarter earnings results on July 22.

Before IndyMac's failure, the FDIC had roughly $53 billion in its deposit insurance fund. With the fund taking such a large hit from IndyMac's failure and the possibility of more large failures, the agency may have to increase the assessment rates charged to insured depository institutions.

FHLB of San Francisco is Sitting Pretty

Friday night, the Federal Home Loan Bank of San Francisco put out a statement saying the IndyMac advances were collateralized with approximately $21.6 billion in mortgages. That's a lot of collateral securing $10.1 billion in advances. The FHLB had prudently raised its haircuts on IndyMac's mortgage collateral and is quite unlikely to lose a dime. The most likely scenario is that the successor institution, IndyMac Federal Bank will continue paying interest on the advances for a while, and then start paying them off.

To dispel misinformation flying around last week among the mainstream media, as well as misinformed blogs, Federal Home Loan Bank advances are not a "bailout." They are a normal funding source for most U.S. banks and thrifts. Contrary to another piece of misinformation, there are no tax dollars on the line when the FHLB lends money to banks.

The Federal Home Loan Banks are a system of 12 regional wholesale banks that were chartered by Congress to help ensure liquidity sources for mortgage lenders. The FHLBs are cooperatively owned by their members -- banks, S&Ls, credit unions and some insurance companies -- who hold capital stock in the wholesale banks. The amount of capital stock held by members depends on their size and on their level of FHLB borrowings.
Philip W. van Doorn joined 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.

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