US Bancorp took over the two banks' branches, deposits, and most of their assets, the Federal Deposit Insurance Corp said.

Downey, which specialised in exotic mortgages known as 'option ARMs', is the third largest bank to fail this year as plummeting housing prices and the slowing economy have triggered massive mortgage defaults.

Concerns about bank credit quality pulled the stock market into a tailspin for much of the week.

US Bancorp is one of the few banks that have sidestepped most of the woes of the credit market cycle. It agreed to change the terms of mortgages taken out by Downey and PFF customers, in a program similar to the one the Federal Deposit Insurance Corp is using for mortgages held by IndyMac. The FDIC agreed to share losses on the acquired loans with the bank's US Bank unit.

Downey, a thrift owned by Downey Financial Corp, had US$12.8 billion (S$19.6 billion) in assets and US$9.7 billion in deposits, and PFF Bank had US$3.7 billion in assets and US$2.4 billion in deposits as of Sept 30, the FDIC said.

So far this year, 22 banks have failed. That already represents the most bank failures in the US since 1993, when 50 banks failed.

The FDIC estimated that Downey's failure will cost the deposit insurance fund US$1.4 billion, while PFF will cost another US$700 million. As of the end of June, the fund had US$45.2 billion, although the FDIC has multiple ways to boost the fund if necessary, including emergency lines of credit.

Downey, based in Newport Beach and PFF, based in Pomona, have a combined 213 branches that will reopen as US Bank branches on Saturday.

The FDIC normally insures US$100,000 per depositor, but US lawmakers increased coverage to US$250,000 through 2009 as part of the recent US$700 billion bailout package aimed rescuing financial institutions.

Not acquiring liabilities
US Bancorp said US Bank will buy almost all of PFFs and Downey's assets, but it will not acquire assets or liabilities of their parent holding companies.

The FDIC's loan modification plan, stemming from seizure of big mortgage lender IndyMac, is the centrepiece of the agency's efforts to rescue troubled homeowners and the US economy.

The agency has repeatedly urged banks and mortgage backed security investors to systematically modify troubled mortgages, arguing that the loans are the root cause of the US financial malaise but has met resistance.

US Bank had 2,556 branches before this transaction, of which 353 were in California. Downey has 170 branches in California and five in Arizona, and PFF Bank has 38 branches in California.

Morgan Stanley advised US Bancorp in the transaction. -- REUTERS