Current crisis is different from R.I.'s credit union debacle

Sep 18, 2008 (The Providence Journal - McClatchy-Tribune News Service via COMTEX) -- GRPD | Quote | Chart | News | PowerRating -- Sep. 18--EAST PROVIDENCE -- It stands just off Taunton Avenue, empty and abandoned, a kind of silent sentry that serves as a reminder of one of the darkest chapters in Rhode Island history.

It is a branch of Greater Providence Deposit & Trust, one of 45 banks and credit unions that collapsed amid the state's banking crisis in 1991, freezing millions of dollars in depositors' money.

The failure was caused, in part, by bad loans and insider dealing in the real estate and housing sectors.

Those are among the root causes of today's broader crisis that has hobbled the nation's financial markets.

But there are two important differences:

--This time around, the events unfolding on Wall Street mainly involve investment banks, not regular banks that accept deposits and make loans, said Allan W. Graham, professor of accounting at the University of Rhode Island's College of Business Administration.

--Deposits at the banks and credits unions that collapsed in 1991 were insured by a private firm, which failed. Today, all banks and credit unions in Rhode Island that accept deposits carry federal deposit insurance, said A. Michael Marques, director of the Rhode Island Department of Business Regulation.

The Wall Street giants that have failed in recent months -- such as Bear Stearns and Lehman Brothers -- are investment banks.

Although they are often referred to, in shorthand, as banks, they typically do not take deposits.

Instead, they generally put together large corporate stock and bond transactions and deal in investments, such as packages of home loans, Graham said.

"They arrange large transactions between sophisticated investors, and so they're not at all like [a local Rhode Island bank such as] Washington Trust," he said.

A big part of the current financial crisis stems from mortgage loans made to risky borrowers -- generally called sub-prime loans. A number of big investment banks assembled these loans into packages, then sold the packages to investors, passing them off as "high quality corporate debt," Graham said.

As the homeowners defaulted on their loans, the investment packages containing the loans dropped in value -- crippling the investment banks and hurting the investors who bought the packages.

Some big, national banks that expanded into investment banking have also suffered for the same sort of reason, Graham said.

But smaller local banks and credit unions "don't have the exposure to those risky assets that have been the problem for the big failures," Graham said.

Some local financial institutions may have some risky assets on their books, but the amount is not significant, he said. In addition, local banks and credit unions tend to be more conservative in their lending practices, in part because they are closely regulated.

Thus, Rhode Island's banks and credit unions are safe, Graham said.

They are not immune to problems resulting from the nation's current economic downturn, said Marques, who is Rhode Island's top business regulator.

For example, some local banks and credit unions have seen an uptick in loan delinquencies, in such areas as home and auto loans, he said.

However, he said, "This is what you would expect when you lend … especially in an economy like this," with rising unemployment and high energy costs. "But it's manageable," he said.

Like other states, Rhode Island has also seen an increase in foreclosures, and Rhode Island's financial institutions have been affected by the nation's credit crunch, which has resulted in generally tighter lending standards, Marques said.

But overall, "I would say they're all safe and sound," Marques said of Rhode Island's banks and credit unions.

Veribanc, an independent bank research and rating concern based in Woonsocket, recently reached the same conclusion.

Veribanc said it analyzed the 40 banks, thrifts and credit unions that are based in Rhode Island. Of that total, 26 institutions qualified for Veribanc's highest possible rating for safety -- and none received Veribanc's lowest possible rating, according to Michael M. Heller, Veribanc's president.

Even if a local bank or credit union were to suffer significant financial problems, depositors are protected, said Edward D. Pare Jr., former state superintendent of banking.

The banks and credit unions that collapsed amid the state's banking crisis in 1991 carried deposit insurance that was issued by a private firm, the Rhode Island Share and Deposit Indemnity Corporation (RISDIC).

Many of the RISDIC-insured institutions carried bad loans on their books, Pare said. "A lot of the bad loans were commercial real estate loans built on a red-hot real estate market," he said.

Risk was heightened because many of the loans were concentrated among a small group of investors, said Pare, now a partner at the Providence office of the Brown Rudnick law firm.

As the real-estate market declined, loan defaults increased. Many of the RISDIC-insured institutions suffered -- including Greater Providence Deposit -- and RISDIC was unable to protect either them or their depositors.

Eventually, depositors recovered their funds through a state-backed bailout.

Amid that crisis, however, legislation was approved by the General Assembly, and signed into law by then-Gov. Bruce G. Sundlun, which required that all institutions that accept deposits in Rhode Island carry federal deposit insurance.

Thus, even if a local bank or credit union were to collapse and close its doors for good -- like the Greater Providence branch in East Providence -- depositors' money would be protected under federal deposit insurance rules.

Those rules generally provide full coverage for up to $100,000 per depositor, per account category, per institution.

In addition, as a result of legislation approved by Congress and signed into law by President Bush in 2006, the insurance limit for the retirement-account category is now $250,000.

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