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As a consequence of the pretend approach described in my CRE "Primer" post, I would ultimately expect the FDIC to be the vehicle that will be saddled with hundreds of billions in impaired CRE. The longer they wait to resolve this issue, the worse the condition, the worse the recoveries, and the more slum like this CRE will become. It's a given that underwater property owners tend to neglect and sometimes loot properties. The FDIC is trying to cover on the sly, and it puts out its quarterly report on August 25. I will return to the subject at that time. In the meantime, here is how the FDIC reserve account intends to take care of this problem:

Chart source: MyBudget.com

So far the FDIC has merely dabbled in the bank system as part of the strategy of extend and pretend and to apparently give the appearance they are on the job. In reality, this is another false flag. Lately they have been talking tougher, suggesting the pace will quicken. Since mid- 2009, they have seized banks with $220 billion in assets representing 1.6% of the bank system ($13.4 trillion in assets and $9.2 trillion in deposits) and are claiming a cost of $44 billion for the task.

Meanwhile, just in one sector of CRE, $1.4 trillion of underwater or severely under-capitalized debt matures between now and 2014. This aspect was throughly covered in my "Primer" post, but I would anticipate losses on the order of $300 billion. That could easily turn out to be conservative and low. CRE needs a trillion dollars in equity and a halt in the price slide to be on solid ground.

On its seizures, the FDIC operates under a loss-share transaction. It agrees to absorb losses up to 80% of a failed bank’s assets that are purchased by an acquiring bank. As of June 2010, the FDIC has entered into 167 loss sharing agreements and the amount of assets guaranteed against loss has ballooned to $176.7 billion. The loss protection provides the incentive for private equity investors or other banks to purchase failed banks from the FDIC. When one considers "the cost" ($44 billion) as provided by the FDIC since mid 2009, it's important to realize that it will be some time before the results of the loss-share programs can be evaluated. Assets are covered by loss share agreements for up to 10 years. The cost of expected losses on a failed bank’s assets can and will be revised.

In addition to the open ended risk of loss-share transactions, the FDIC’s mountain of failed bank assets that could not be sold, despite the use of loss-share transactions, continues to grow. The FDIC is now holding a total of $39 billion in assets of failed banks that could not be sold and need to be disposed. This is the figure I expect to balloon along with the hundreds of billions of underwater CRE and debts.

The FDIC puts out various action orders on problem banks. A list of 811 such banks with $416.5 billion assets is tracked at Calculated Risk.Another filter of high Texas ratio banks can be found here. As mentioned in the CRE post, readily available information on banks is lagging. They are obviously playing games with what constitutes various non performing or delinquent loans. Finally, there is an enormous amount of dicey underwater loans that are working through the system that show up as technically current. All these factors combine to create an opaque situation.

I consider BankRegData.com the best online source for investors and even money managers. I imagine that, like so much else, this top notch and free Internet site will one day require a subscription and the information it provides will be be lost to the public at large. For now, it's available and 2Q banking will be updated on August 25. As an exercise, I scanned the problem list to get some idea of what the Texas Ratios and loan composition were on these banks. By doing so, I thought I could get some idea of just how their off the job the FDIC is.

You can search by bank and, in my first example, I use Cascade Bancorp (listed as Bank of the Cascades on the problem list) of Bend, Oregon. To save time, I just go straight to "asset quality" and voila there is the bank reg data for 1Q 2010 for the bank. You can see the awful Texas Ratio at 138.23, the so-so loan loss reserve ($51.5 billion) against the non-performing loans (NPL) ($130.8 billion). When you look at these distressed banks, you will sometimes see "improving" NPL. Cascade's have gone from $177 billion to $131 billion.

Now, perhaps Cascade's odor has improved. Actually the answer lies on the loan data page. They have shrunk their overall loan portfolio. How or to whom isn't clear. One would have to pursue the answer, but in these instances I suspect "small print" and an endless circle of give-back terms. I need to make it clear that I don't know in this instance. If I was a bank examiner, that's a question I would ask. Given the pattern of banking and regulation at loose in the land, I doubt this kind of questioning happens, hence the opaqueness "problem."

What I do know about Cascade is that they have 52% in CRE and, as you can see here, have NOT shrank that portion. What interests me about the CRE data is that Cascade is reporting that only 2.59% as 90PD+NA on CRE. Again, I'd want to know the structure of their maturity schedule and just how underwater their borrowers are.

Not to pick on Cascade, but to a macro extent this exercise applied to the others on the FDIC's list, barring miracles won't pass the smell test. Some banks aren't even opaque about it. Take for example Bank of the Midwest ($6 billion in assets) with a Texas ratio of 152 and 23% of its loans non-performing. What possible justification is there for this bank to even be open? To me, it's easy to surmise that the FDIC is going to be involved with handling hundreds of billions of properties in due course. If you are an investor or fund and are looking at a community to pick up real FDIC-owned bargains, this is useful information. We are clearly only in the early inning. In fact, that's why I am vulture tracking this particular bank.

I believe the FDIC is largely ignoring the equity gap situation (explained in my CRE post) all up and down the daisy chain, including their own inadequate reserves. In effect, the FDIC is underwater and pretending to back up underwater banks that, in turn, are pretending to back underwater debtors.

The problem is that such a system creates incentives for such actors to act like slumlords and vagabundos by looting their properties of appliances, failing to provide even basic maintenance, generating fraudulent appraisals, funny money "work outs" and "give backs," playing loose with US Government guarantees (moral hazard) or so-called insurance, violations of the spirit of banking regulations, and bank bonus loots. The end result can't and won't be pretty.

Disclosure: No positions

Source: FDIC: Let's All Play Daisy Chain