The failing bank scenario - An explanation and suggested analysis for a bank's board of directors and management

Banking Law Journal

Volumn 126, Issue 9, 2009, Pages 771-786

  Lynyak III, Joseph T ^a  

^a NONE

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EID: 77955082478     PISSN: 00055506     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (22)

1. For purposes of this article, the term "Bank Regulators" includes the Federal Deposit Insurance Corporation (the "FDIC"), the Office of the Comptroller of the Currency (the "OCC"), the Office of Thrift Supervision (the "OTS") and the Board of Governors of the Federal Reserve System (the "FRB"). (In addition, please note that, while the emphasis in this article will be on the regulatory actions and responsibilities of the federal banking regulators, the same discussion will apply to the regulatory oversight and safety and soundness responsibilities of comparable state banking agencies).
2. The examination rating scheme utilized by the Bank Regulators utilizes the acronym "CAMELS," which stands for capital, assets, management, earnings, liquidity and sensitivity to interest rate risk. A Bank Regulator assigns a rating to each component of the CAMELS, as well as an overall composite rating, with a 1 constituting the optimum or best rating and a 5 indicating the probable failure of the bank.
3. Because the Bank Regulators use standard forms of C&D orders to achieve remedial action, it is not unusual that such orders in potential failure situations bear striking resemblance to each other, and include provisions addressing issues and requirements such as : (a) maintaining capital at specified levels; (b) reducing classified assets; (c) maintaining adequate allowances for loan and lease losses; (d) developing an asset/liability management plan; (e) retaining acceptable management; (f) correcting violations of law and eliminating unsafe and unsound practices; (g) reducing unsafe concentrations of credit; (h) developing a comprehensive loan policy; (i) developing an acceptable strategic plan; (j) developing an acceptable budget and profit plan; (k) reporting progress to the Bank Regulator on a quarterly basis; and (l) similar corrective measures and reporting requirements.
4. While there are circumstances in which a formal or informal administrative challenge to the conclusions of a bank examination and/or proposed C&D order may benefit a bank, such options becomes less viable as the capital position of the bank deteriorates.
5. 12 U.S.C. § 1811 et seq. See, The Banking Law Journal, Responding to Proposed Enforcement Actions by the Federal Banking Agencies (January 2005).
6. 12 U.S.C. § 3907.
7. Although a capital directive may be issued as a stand-alone document, it is typically included as one of the terms of a C&D order.
8. Because the use of a capital directive is often used before a bank falls below well-capitalized status, its impact on management and a board of directors is not well appreciated as constituting the first indication by the Bank Regulators of capital concerns for the bank.
9. 12 U.S.C. § 1831o.
10. 12 C.F.R. § 325 et seq.
11. Pursuant to Section 1818(u) of the FDIA, the Bank Regulators are required to publically announce the issuance of enforcement orders, which typically are made public in the month following the effective date of the enforcement order.
12. Even though ultimately the imposition of these reporting requirements can be salutary in their eventual effect, at this stage of the bank's existence the result can be disruptive of management's focus and divert scant personnel and other resources to satisfy the terms of a C&D order.
13. Although the logic of this approach might be debated, die "lock-down" authority of the prompt corrective action order in a failure situation prevents a bank from taking emergency action to save itself by selling at fire sale prices valuable loan assets or other assets such as branches - and thereby diminishing the franchise value of the bank when placed into receivership by the FDIC.
14. Among other things, avoiding or limiting the sale of a bank's performing loans and core deposits preserves the franchise value of the bank when being marketed by the FDIC - thereby reducing potential loss to the Deposit Insurance Fund.
15. Among other things, this means that a bank experiencing a potential failure should maintain close communications with its Bank Regulator regarding transactions that are not in the ordinary course of business. (Note that a sale of assets that is not in the ordinary course of business may also violate an operational restriction contained in a PCA order).
16. While beyond the scope of this article, copies of records that may prove to be valuable include: (a) board minutes; (b) loan committee minutes; (c) documentation of compliance with regulatory criticisms; and (d) formal and informal communications and correspondence with Bank Regulators.
17. Although the actual language of the provisions of the FDIA indicates that there is some discretion by the primary bank regulator not to appoint the FDIC as conservator or receiver of a failing bank, that language is formalistic in deferring to a determination regarding the conservator or receiver; in fact, the FDIC possesses statutory authority under the FDIA to cause its appointment as receiver should a primary bank regulator ever make an election to the contrary.
18. The powers and authorities of the FDIC as receiver are formidable and generally are viewed as exceeding the powers exercisable by a bankruptcy trustee. See Section 1821 et seq. of the FDIA.
19. Of particular note is the approach the FDIC has taken through the loss share provisions of recent P&A transactions, which minimizes the asset management obligations of the FDIC in exchange for a broad loss guaranty by the successful acquiring institution. See, http://www.fdic.gov/bank/individual/ failed/bankunited-P-and-A.pdf.
20. As an indication of the potential number of failures that might occur in the next 24 months, the OCC and the OTS have announced an expedited application process to pre-approve investors that are not existing banks, thrifts or holding companies. This application approach may encourage hedge funds and others to make investments in banks without the threat of being deemed to be in control and hence become subject to direct regulation and supervision.
21. Detailed descriptions of numerous tasks performed by the FDIC immediately prior to a bank closing, during the weekend immediately following and thereafter are set forth in several receivership and liquidation manuals employed by the FDIC to standardize as much as possible the bank closing process.
22. It should be noted that the FDIC's receivership authority also permits it to exercise setoff rights against non-affiliated borrowers and depositors, which authority is not based upon potential malfeasance or misfeasance claims, but merely upon its rights as receiver under the FDIA to collect on loans and other obligations owed.