BankUnited's resurrection illustrates everything that went wrong in the housing bubble.

Commentary about business and finance.
Jan. 26 2011 7:22 PM

The Sure Thing

BankUnited's resurrection illustrates everything that went wrong in the housing bubble.

BankUnited logo.

On Jan. 24 BankUnited, a smallish thrift based in Coral Gables, Fla., filed a prospectus for an initial public offering. It was an astounding resurrection. Not quite two years earlier BankUnited had filed for bankruptcy, brought down by bad residential real estate loans concentrated in its home state of Florida. Subsequently BankUnited had been taken over by a consortium of investors—including big-name private equity firms Blackstone, Carlyle, W.L. Ross, and Centerbridge—that put in $945 million to recapitalize the bank. Now BankUnited and its investors are having their moment of triumph. The IPO is supposed to raise some $630 million, almost $500 million of which will go directly into the pockets of the private-equity firms—a stunning windfall, especially in these days of more meager returns for private equity. 

Bethany  McLean Bethany McLean

Bethany McLean is a contributing editor at Vanity Fair and the co-author of All the Devils Are Here: The Hidden History of the Financial Crisis.

Bethany McLean writes a weekly business column for Slate and is a contributing editor to Vanity Fair. She is the author (with Joe Nocera) of All the Devils Are Here: The Hidden History of the Financial Crisis and (with Peter Elkind) "The Smartest Guys In The Room."

If you took BankUnited's rebirth to be a parable about the private market's ingenuity and its capacity for renewal you would be missing the point. What it really illustrates is private equity's ability to make a fortune off a government guarantee. Most of the risk in the deal is borne not by the private equity firms, but by the Federal Deposit Insurance Corporation's deposit insurance fund. The FDIC expects to take a $5.7 billion loss on BankUnited, making this the second most costly bank failure ever, right behind the notorious IndyMac. Nor are BankUnited's customers getting any government handouts. Even as the FDIC shields investors from too much downside risk, one way the private equity firms can collect from the FDIC is by kicking people out of their homes. If you were searching for an example of what went wrong in the bubble years, you couldn't do much better than BankUnited.

BankUnited was founded in 1984 as a state-chartered savings association by Alfred "Fred" Camner, a Wharton graduate who also got a law degree from the University of Miami. The bank got a federal thrift charter in 1993 and became the largest financial institution headquartered in Florida. BankUnited was known as a conservative lender that focused on residential real estate. As other companies were being sold to industry giants in the consolidation wave that followed the savings and loan crisis of the late 1980s, BankUnited became known as a survivor.

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The bank lost its reputation for sobriety during the more recent bank crisis. As lending fever took hold in the aughts, BankUnited executives dove into the riskiest of risky loans: so-called option adjustable rate mortgages. An option ARM allows the borrower to choose how much to pay every month. One of the borrower's options is a minimum monthly payment that allows the borrower to pay an amount that's even less than just the interest owed. That results in a phenomenon called "negative amortization," wherein the principal, instead of shrinking, actually grows because the unpaid interest gets added to the original principal amount. Once the balance of the loan reaches a certain level—usually 110 percent to 115 percent of the original principal—the minimum monthly payment option is withdrawn and the borrower is now required to pay in full a monthly mortgage that is suddenly a lot more money. Given that the borrower probably selected the minimum payment because that was all she could afford, you can see how this arrangement would usually end badly. According to a letter written by the law firm that represents the FDIC, BankUnited's mortgage portfolio more than doubled from $6.1 billion at the end of 2004 to $12.5 billion at the end of 2007, by which point option ARMs represented a stunning 70 percent of the total mortgage loans outstanding. By 2008, option ARMs represented 575 percent—yes, that's the right number—of the bank's total capital. (A bank's capital isn't the same thing as its assets; it's the money on hand to serve as a cushion in the event of losses.)  By spring of that year, fully 92 percent of the option ARM portfolio was in a state of "negative amortization," meaning borrowers probably couldn't pay, according to an audit report later done by the Treasury's Office of the Inspector General. By the following year, the stock had gone into free fall, and the regulators stepped in.

The FDIC's lawyers alleged that the bank's former executives had committed "wrongful acts committed in connection with the origination and administration of unsafe and unsound real estate loans." BankUnited, the FDIC lawyers also said, had made "the special Option ARM lending product—appropriate for only a small portion of the population—available to every potential bank customer."  (Camner, in a statement to the South Florida Business Journal, called these assertions "nothing more than unfounded speculation.") According to one confidential witness in a class action lawsuit, there were "numerous customer complaints about not understanding the effect of negative amortization." Another witness said that managers told loan officers to "sell Option ARMs to every customer, including those that could not afford them."

After the FDIC took BankUnited into receivership three separate groups submitted bids. The FDIC chose the investor consortium of Blackstone, Carlyle, and various others. The new owners installed as CEO John Kanas, a highly regarded bank executive who'd made a fortune after he built, and then in 2006 sold to Capital One Financial, North Fork Bank. Kanas reportedly invested $23.5 million of his own money in the BankUnited deal.