The Staff reviewed information provided in each of the failed banks’ income statements to identify income statement items that significantly reduced each bank’s Tier 1 capital. The Staff also gathered data on the extent to which recurring and non-recurring fair value measurements were recognized in income, thereby impacting Tier 1 capital.168 Presenting income statement data consistently for all of the failed banks is difficult because the Call Report and the Thrift Financial Report categorize and group income statement items in different formats. For example, in the Call Report, net realized gains and losses on AFS securities include gains and losses recognized upon sale, as well as impairment losses. In the Thrift Financial Report, gains and losses recognized upon sale of AFS debt securities are grouped with gains and losses
recognized upon sale of loans HFS, while impairment losses for AFS securities are grouped with provisions for credit losses. With the exception of one bank in each group, the banks included in the aggregate information for failed banks with assets less than $1 billion and assets between $1 billion and $10 billion each filed Call Reports, and therefore the Call Report format is used in the
166 In the December 12, 2008 issue of American Banker, James Lockhart, the Director of the Federal Housing Finance Agency, stated “[m]y view on fair value is I think it provides useful information and is important to have. If an asset is impaired, it should be written down.” Steven Sloan, FHFA Director Talks Rate Plan, GSE Debt, FHLBs, American Banker, December 12, 2008.
167 According to its website, the Basel Committee on Banking Supervision’s objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. It is best known for its international standards on capital adequacy, the Core Principles for Effective Banking Supervision, and the Concordat on cross-border banking supervision. The Committee's members come from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom and the United States. Countries are represented by their central bank and also by the authority with formal responsibility for the prudential supervision of banking business where this is not the central bank. See www.bis.org/bcbs. The comment letter is available at:
http://www.iasb.org/NR/rdonlyres/DE4ACB8D-1750-4288-BA8F-D39F731B3326/0/CL94.pdf.
168 Because goodwill reported under U.S. GAAP is currently excluded from Tier 1 capital, goodwill impairment charges recognized in income under U.S. GAAP do not currently impact Tier 1 capital, and are therefore not included as a fair value measurement that impacts Tier 1 capital.
related exhibits. Each of the failed banks with assets greater than $10 billion filed Thrift
Financial Reports, and therefore the Thrift Financial Report format is used in the related exhibits for these banks.
1. Aggregate Failed Banks < $1 Billion of Total Assets
As illustrated in Exhibit III.23 and Exhibit III.24, for failed banks with less than $1 billion of assets, the reduction in their capital was driven by increases in provisions for credit losses, which appear to have been caused by rising levels of performing loans. The level of
non-performing loans at the failed banks with less than $1 billion of assets far exceeded the levels of non-performing loans experienced by the non-failed banks of similar size.
Exhibit III.23: Income Categories as a Percent of Net Interest Income
-400%
(a) For all tables of this type: (1) for banks filing Call Reports, net interest income as reported in Schedule RI and (2) for banks filing TFRs, net interest income as reported in Schedule SO.
(b) For all tables of this type: (1) for banks filing Call Reports, credit losses are based on provisions for loan and lease losses as reported in Schedule RI and (2) for banks filing TFRs, credit losses are based on provisions for losses on interest bearing assets as reported in Schedule SO, which includes fair value losses recognized on foreclosed property and impairment losses recognized on debt and equity securities.
(c) For all tables of this type: (1) for banks filing Call Reports, the impact on income of other real estate owned is based on net gains (losses) on sales of other real estate owned as reported in Schedule RI, which includes gains and losses recognized upon sale of foreclosed property and fair value losses recognized prior to sale and (2) for banks filing TFRs, the impact on income of other real estate owned is based on operations and sale of repossessed assets as reported in Schedule SO, which includes costs of maintenance of foreclosed property and gains and losses upon sale.
(d) For all tables of this type: (1) for banks filing Call Reports, the impact on income of loans HFS is based on net gains (losses) on sales of loans and leases as reported in Schedule RI, which includes gains and losses recognized upon sale and fair value losses recognized prior to sale and (2) for banks filing TFRs, the impact on income of loans HFS is based on the lower-of-cost-or-fair-value adjustments made to HFS assets as reported in Schedule So of the TFR, which does not include gains or losses recognized upon sale.
(e) For all tables of this type: (1) for banks filing Call Reports, the impact on income of AFS and HTM securities is based on realized gains (losses) on AFS and HTM securities as reported in Schedule RI, which includes impairment losses recognized and (2) for banks filing TFRs, the impact on income of AFS and HTM securities is based on operations and sale of HFS assets and AFS securities and sales of securities HTM as reported in Schedule SO, which does not include impairment losses.
(f) For all tables of this type: (1) for banks filing Call Reports, the impact on income of recurring fair value measurements is based on trading revenues and net gains (losses) on assets and liabilities accounted for under FVO as reported in Schedule RI and (2) for banks filing TFRs, the impact on income of recurring fair value measurements is based on gains and losses on financial assets and liabilities carried at fair value as reported in Schedule SO.
(g) For all tables of this type: (1) for banks filing Call Reports, income (loss) before taxes and extraordinary items and other adjustments as reported in Schedule RI and (2) for banks filing TFRs, income before taxes as reported in Schedule SO.
Exhibit III.24: Percent of Loans Non-Performing
*The percent of loans that are non-performing for all banks with less than $1 billion of assets is based on the information provided in “Quarterly Banking Profile” issued by the FDIC, which covers all FDIC-Insured Institutions for banks with asset size between $100 million and $1billion.
2. Aggregate Failed Banks > $1 Billion, but < $10 Billion of Total Assets As illustrated in Exhibit III.25, increases in provisions for credit losses were also the most significant reason for the decrease in capital for the failed banks with assets between $1 billion and $10 billion. Exhibit III.26 shows that for these banks, the increase in credit losses appears to have been caused by rising levels of non-performing loans, which again far outpace the levels for all non-failed banks of similar size.
Exhibit III.25: Income Categories as a Percent of Net Interest Income
-350%
Exhibit III.26: Percent of Loans Non-Performing
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
First NB Nevada
Silver State Bank
ANB FNA Integrity Bank
Franklin Bank
PFF B & T All >$1 Billion and
<$10 Billion*
12/31/2006 12/31/2007 3/31/2008 6/30/2008
*The percent of loans that are non-performing for all banks with less than $1 billion of assets is based on the information provided in “Quarterly Banking Profile” issued by the FDIC, which covers all FDIC-Insured Institutions for banks with asset size between $1 billion and $10 billion.
3. Failed Banks > $10 Billion of Total Assets
As was found at the smaller banks, Exhibit III.27 shows that non-performing loans for the failed banks with assets greater than $10 billion also greatly exceeded the levels experienced generally for non-failed banks of similar size.
Exhibit III.27: Percent of Loans Non-Performing
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
Washington Mutual
IndyMac Bank Downey S&L All >$10 Billion*
12/31/2006 12/31/2007 3/31/2008 6/30/2008
*The percent of loans that are non-performing for all banks with more than $10 billion of assets is based on the information provided in
“Quarterly Banking Profile” issued by the FDIC, which covers all FDIC-Insured Institutions with assets greater than $10 billion.
a. Washington Mutual
Exhibit III.28 shows that credit losses were the most significant cause of declines in income at WaMu. During the periods analyzed, WaMu recognized fair value losses, but these losses were significantly less than the credit losses recognized during the same periods. As discussed more fully below, the fair value gains and losses WaMu recognized for financial instruments used to hedge its MSRs were partially offset by gains and losses recognized in income for changes in the fair value of its MSRs.
Exhibit III.28: Income Categories as a Percent of Net Interest Income (a) For all tables of this type: Net interest income as reported in Schedule SO of the TFR.
(b) For all tables of this type: Credit losses as reported in provisions for losses on interest bearing assets in Schedule SO of the TFR, which includes fair value losses recognized on foreclosed property and impairment losses recognized on debt and equity securities.
(c) For all tables of this type: HFS losses is based on lower-of-cost-or-fair-value adjustments made to HFS assets as reported in Schedule SO of the TFR.
(d) For all tables of this type: Gains / Losses on sales is based on sale of HFS assets and AFS securities as reported in Schedule SO of the TFR.
(e) For all tables of this type: Servicing income is based on mortgage loan servicing fees and servicing amortization and valuation adjustments as reported in Schedule SO of the TFR.
(f) For all tables of this type: Recurring fair value is based on gains and losses on financial assets and liabilities carried at fair value as reported in Schedule SO of the TFR.
(g) For all tables of this type: Income before taxes as reported in Schedule SO of the TFR.
In its 2007 Form 10-K, WaMu disclosed the following:
The Company recorded a net loss for 2007 of $67 million, or $0.12 per diluted share, compared with net income of $3.56 billion, or $3.64 per diluted share, in 2006. The decline was primarily the result of significant credit deterioration in the Company’s single-family residential mortgage loan portfolio and significant disruptions in the capital markets, including a sudden and severe contraction in secondary mortgage market
liquidity for nonconforming residential loan products.
Based on disclosures made in its 2007 Form 10-K, during 2007 WaMu recognized
approximately $500 million of fair value losses for trading securities, which primarily consisted of below investment grade retained interests in credit card securitizations, and $200 million of losses for fair value write-downs of non-conforming residential mortgage loans HFS, compared to $3.1 billion of credit losses recognized.
Based on disclosures made in its first and second quarter 2008 Forms 10-Q, during the first quarter of 2008, WaMu recognized approximately $600 million of fair value gains due to
derivatives that economically hedged the fair value of MSRs, which were partially offset by fair value declines in the related MSRs. During the second quarter of 2008, WaMu recognized losses on the derivatives it used to economically hedge the fair value of MSRs, which again were partially offset by gains in the fair value of its MSRs. In addition to the fair value effects of hedging activities, based on disclosures made in its second quarter 2008 Form 10-Q, it appears that WaMu recognized during the six months ended June 30, 2008 approximately $500 million of fair value losses for credit card retained interests and securities backed by Alt-A loans that were accounted for as trading securities, which was significantly less than the $9.4 billion of credit losses recognized during the same period.
b. IndyMac
As illustrated in Exhibit III.29, for IndyMac, the reduction of its capital was driven equally by the recognition of incurred credit losses and losses recognized for the decrease in fair value of its portfolio of HFS loans, investment securities, and derivatives. As discussed below, fair value gains and losses recognized for financial instruments used to hedge MSRs were partially offset by changes in the fair value of MSRs. Also, as discussed more fully below, a portion of the fair value losses IndyMac recognized related to incurred credit losses embedded in IndyMac’s trading securities portfolio. While IndyMac stated that it believed that a portion of the fair value losses it recognized during 2008 would recover over time, IndyMac also stated that it used its judgment to arrive at a fair value estimate for these securities that it believed did not represent a fire-sale valuation.
Exhibit III.29: Income Categories as a Percent of Net Interest Income
-500%
-400%
-300%
-200%
-100%
0%
100%
200%
Net Interest Income (a)
Credit Losses (b)
HFS Losses (c)
Gain/Loss Sale (d)
Servicing Income -MSR FV (e)
Recurring FV -Financial (f)
Net Pretax (g)
12/31/06 12/31/07 3/31/08 6/30/08
In its 2007 Form 10-K, IndyMac disclosed the following:
2007 was also severely impacted by worsening credit conditions as home prices and home sales declined. This has led to a significant increase in delinquencies in many products, particularly in higher loan-to-value (“LTV”) first and second lien loans and builder construction loans. As a result of the significantly worsening trends in home prices and loan delinquencies, we recorded significant charges, principally related to credit risk in our HFI (held-for-investment) portfolio, builder construction portfolio, and consumer construction portfolio. In addition, we recorded significant valuation
adjustments in our loans held for sale, investment and non-investment grade securities and in residual securities.
Based on disclosures made in its 2007 Form 10-K, IndyMac recognized its largest write-downs (valuation adjustments) for its non-investment grade securities and attributed a significant portion of these write-downs to incurred credit losses embedded in these securities. During 2008, IndyMac recognized additional charges for credit losses and valuation adjustments. In its Form 10-Q for the quarter ended March 31, 2008, IndyMac stated that the declines in the fair value of its trading portfolio were primarily due to widening credit spreads on non-agency mortgage-backed securities, but that “[t]hese losses are unrealized and we believe are a result of reduced liquidity in the currently disrupted market for these bonds and that actual realized losses will be much lower. As a result, we expect to substantially recover these losses over time as we have the ability and intent to hold the securities to recovery or maturity.” IndyMac also disclosed that it used its judgment to arrive at what it believed was a reasonable fair value measurement, instead of basing the values solely based on broker quotes, as follows:
Our determination of the fair values of our Level 3 assets, as described herein, involves significant judgment and, in our view, results in a reasonable measurement of fair value in accordance with the requirements of generally accepted accounting principles. These recorded fair values could be significantly in excess of the actual proceeds that would be received if we were forced to sell these assets in a short period of time into the current market which is characterized by illiquidity and opportunistic pricing by a limited number of buyers. In addition, given the current market illiquidity characterized by a lack of relevant and reliable market inputs for the private-label mortgage-related
securities, had we relied solely on broker market indications the fair values of the trading securities would have declined by $120 million.
Offsetting these decreases in fair value was an increase in fair value of the bank’s MSRs which resulted from slower loan prepayments given the changes in available refinancing opportunities.
These increases in fair value did not affect regulatory capital, because the amount of MSRs included in capital is limited by the regulatory capital instructions. IndyMac disclosed in its Form 10-Q for the quarter ended March 31, 2008, “we are currently required to hold capital on a dollar-for-dollar basis against the portion of our MSRs that exceed our Tier 1 core capital, even though we have a long track record of successfully hedging this asset, and it is our highest earning asset in this environment.” IndyMac did not file a second quarter 2008 Form 10-Q, so it is not possible to determine the extent to which fair value losses recognized for the six month
period ended June 30, 2008 related to instruments that were hedging MSRs, which were offset by fair value gains recognized for MSRs.
c. Downey Savings and Loan
Exhibit III.30 shows that, similar to banks with assets less than $10 billion, credit losses were the most significant cause of declines in income at Downey, and there were no losses recognized for recurring fair value measurements. Since Downey did not recognize any significant fair value losses during the periods reviewed, no analysis was needed to understand the source of fair value losses recognized.
Exhibit III.30: Income Categories as a Percent of Net Interest Income
-350%
F. Evaluation of the Circumstances Surrounding Each Bank Failure
In this subsection, the Staff provides publicly-obtainable descriptive information regarding the circumstances surrounding each of the 22 bank failures as of December 1, 2008. Based on review of this information, it does not appear that fair value reporting was the primary cause of any of these bank failures. While currently available analysis is, in some cases, limited due to the recent nature of many of these failures, the information analyzed by the Staff appears to indicate that the most significant factor in these bank failures was the underlying lending activities of the banks. For most of these banks, fair value accounting was applied in only limited circumstances. The decreasing levels of regulatory capital for these banks, which, for most, led to their failure, was caused primarily by recognized credit losses as opposed to the recognition of general fair value declines. One question that cannot be analyzed from the available filings is whether fair value accounting, if more extensively applied, could have prevented such failures by adding transparency to the lending and risk management practices of these banks.
For the three banks with assets greater than $10 billion (WaMu, IndyMac and Downey), the Staff compared changes in the holding company’s stock price to changes in the U.S. GAAP-based book value per share. Based on this analysis, it appears that market concerns regarding these companies pre-dated any significant fair value losses that these companies recognized.
Beginning in the third quarter of 2007, the stock price for each of these companies fell below the U.S. GAAP-based book value per share.
Unless otherwise noted, the source of the financial information included in this section, such as capital levels, income statement, and balance sheet descriptions, is quarterly Call Reports or Thrift Financial Reports and, as applicable, public reports filed with the SEC.
1. Failed Banks < $1 Billion of Total Assets
As illustrated in Exhibit III.31, all of the failed banks with assets less than $1 billion experienced a significant decrease in their Tier 1 capital during 2007, causing their leverage ratio to fall below the average for that relative size bank.
Exhibit III.31: Leverage Ratio for Banks with Less than $1 Billion of Assets
-5%
December 31, 2006 December 31, 2007 March 31, 2008 June 30, 2008
*The leverage ratio is Tier 1 capital divided by Average Assets. The source of the failed bank leverage ratios is the Call Report or TFR. The source of leverage ratios for all banks with assets under $1 billion is based on the information provided in “Quarterly Banking Profile” issued by the FDIC, which covers all FDIC-Insured Institutions for banks with asset size between $100 million and $1 billion.
*The leverage ratio is Tier 1 capital divided by Average Assets. The source of the failed bank leverage ratios is the Call Report or TFR. The source of leverage ratios for all banks with assets under $1 billion is based on the information provided in “Quarterly Banking Profile” issued by the FDIC, which covers all FDIC-Insured Institutions for banks with asset size between $100 million and $1 billion.