Anatomy of a Bank Failure: What Happens when the FDIC Pulls the Plug?A Behind-the-Scenes Look at How Regulators Mobilize to Protect the Assets of Troubled Banks
What happens when a bank fails?
Here is an inside look at the Federal Deposit Insurance Corporation (FDIC) - the nation's largest bank regulatory agency - and how it mobilizes and takes action when a bank fails, such as Colonial Bank., of Montgomery, Alabama, did this past weekend.
Why Banks Fail
Banks fail for many reasons: under capitalization, poor loan portfolio performance. For a bank to begin the slide into failure, it usually (not always) is placed on the FDIC's troubled bank list, which right now includes 305 banks (up from 117 at this time last year). Banks are graded on a 1 to 5 scale of safety and soundness by their regulators, and those banks that score of 4 or 5 are placed on the "troubled" list.
The number of failed banks thus far in this year (77 so far, as opposed to 25 in 2008) led to the discovery of an interesting statistic from David Barr of the FDIC's public relations department. Over the past 25 years, there have been many banks that have made the troubled bank list. Yet of those, 87 percent of them have successfully made it off the list and returned to the safe end of the banking pool.
But the other 13 percent -- those are the ones that have headed in the wrong direction, and despite regulators stepping in to help, have ended up closed, a failed bank. Barr explains what happens to a bank after it makes it onto the troubled list, at risk of failure.
Steps Before Failure
"There is a lot of pre work that goes into a bank closing that many people don't realize happens," he says. This involves many man hours on the part of the dedicated teams the FDIC has headquartered in its Dallas, TX offices.
The banks that are on the troubled list are a primary focus for their examiners. "Whenever a bank gets a poor supervisory rating, the examiners work closely with that bank to get them turned around," Barr notes. The bank is typically given a 90-day period to work out whatever made it receive a 4 or 5 rating. But during that 90-day period, the FDIC begins to collect information on the bank's assets, deposits and overall financial picture. If, by the time that the institution nears its final deadline, the bank hasn't turned itself around to receive a 3 or higher, that is when the FDIC begins a bidding process with other banks that may be interested in acquiring the troubled bank's assets, deposits or both, Barr says.
There are a number of reasons that a bank can land on the "troubled" list, and a number of solutions. "If the capital level is low, capital restoration plans are submitted. Maybe there is a bad group of loans that have to be addressed, or changing policies and procedures need to be changed, or the board needs to be more active, or that the bank needs to find competent, qualified and experienced senior loan officers to oversee the lending program," Barr says. He also notes that the majority of failed banks in the 13 percent that do fail are either sold or have a portion of their assets and deposits bought by other banks.
When Failure is an Option
For banks that are facing closure, the FDIC takes the following steps:
Depending on how quickly a bank fails, under the prompt corrective action rules, if a bank is critically undercapitalized (under 2%), then a prompt corrective action letter is sent to the bank, telling the institution it has 90 days to correct the capitalization level, or face closure.
Once that letter goes out, this is when the information collection begins. The FDIC gathers financial information on the bank, the deposits, the makeup of its loan portfolio and its asset size. "We work with the primary federal regulator (if it is not the FDIC) to obtain this information and financial conditions to begin our own analysis of the bank," Barr says.
This is done for two purposes: First, for the FDIC's analysis of the best way to market the bank, and then to measure the extent of the problems, evaluate those problems and estimate value of the bank's assets and strategy to divide them. "Once we've downloaded and analyzed the information, we will contact interested banks that may want to bid on the bank." The FDIC maintains a database of banks who have expressed interest in buying failed banks from the FDIC.
In the first communication, the FDIC gives the interested banks very general information that there is a bank that looks like it is going to fail. "We ask them within the next X number of days or weeks, would you be interested in bidding on it?" explains Barr.
Out of that wide net, the banks that show interest are then given some more information, but not the bank's name. The FDIC then gives out a bit more information such as size, and geographic location and makeup of the branches. Then if those banks contacted show interest and the field narrows, they are given a password to the FDIC's secured website, where they are allowed to see on that bank's database the information the FDIC gathered from the bank on loan portfolio makeup, assets, deposits, and analyze the information to form a bid. The bidding banks are given a deadline to submit their bids. "For example if we are going to close a bank on a Friday, we'll ask those banks that are bidding on it to submit their bids by noon on Tuesday," he notes. The banks submit bids, and the FDIC calculates them, and "the one that is the least costly to the insurance fund, that's the winning bidder," Barr says. The winning bidder is notified by the end of the day, and then the acquiring bank is included in the bank closing strategy and plans.
By Thursday afternoon before the Friday afternoon closing, FDIC meets with the acquiring bank's team in the city where the failed bank is located. "This is to discuss any concerns or questions they have about the procedures. When the bank is closed on Friday, they are there with us, and work with us side by side," Barr explains.
There are several actions that the FDIC is doing in the 90-day period leading up to the bank closing. First, all the deposits are downloaded and analyzed to determine what percentage of them could be uninsured. Assets are downloaded; loan portfolios are sifted through to determine their makeup. When a bank is closed on a Friday, the FDIC's asset team starts dividing the bank into two pieces -- one would be what's going over to the acquiring institution, the second part is what is being left in receivership. "We begin to carve out asset pools and types of assets and do a better analysis of those assets," Barr notes. The FDIC works during the bidding process to try to sell as many of those assets as possible, so it is not left holding them in receivership.
"Sometimes we see a bidder will bid on the assets and not the deposits, so there are some attractive assets out there that we may offer separately to a third party," Barr notes. What is attractive to an acquirer is based on what it is looking to add to its holdings. "For example, a failing bank could have a large pool of small consumer loans that the bidding bank doesn't want," he says. It all boils down to the assuming bank and what it is looking for. Despite what many may believe, "It's not always the difference between good loans and bad ones, but loan type."
Behind the Scenes
When the 90-day term begins, a bank is assigned to one of the core group of six teams in the Dallas office that handles bank closings. Depending on the size and complexity and makeup of the individual bank, the closure team may draw upon a wider team of resources within the FDIC. "For an average-sized [closure], the FDIC can have up to 100 people on the ground over that 48-hour period of a weekend to make sure that everything happens. This doesn't include the acquiring bank's staff either," Barr notes.
For a bank the size of more than a billion dollars, (like in the case of Colonial) the support team swells up to 200 people. "It really depends on the groundwork we do before we hit the ground on closing day, but we have laid out our plans in advance as to who will be needed at the bank," Barr says. "We don't have time to find someone on that Friday. Once that charter is pulled on Friday, we have until 8:30 on Monday to get that bank reopened.
So the entire focus of that weekend is to ensure that everything is completed and done before 8:30 a.m. on Monday morning."
The closing's core teams include a variety of FDIC staff from IT operations, lawyers, accountants, facilities, HR, and marketing. It is almost a military operation in its precision because so much has to happen within that time that a bank closes its doors on Friday until it reopens on Monday morning. Augmenting the core teams from the Dallas office are examination workforce members. "We've also been tapping our examiners lately to have an FDIC presence at every branch on the Friday at closing," Barr says. "The examiners act with the branch manager as a liaison, as well as liaise between that branch and the acquiring bank." If the acquiring bank wants to get people into branches to talk to the existing staff and get their own brands into those branches for rebranding to the acquiring bank brand, that's what the examiners help facilitate.
The majority of bank closures go smoothly, but require long hours by the FDIC team. An average IT operations team member will spend up to 18 hours a day working to make all of the IT operations shutdown, reset and turnovers happen in that 48 hour period.
Barr cites one example of long hours by IT operations team, "In the case when IndyMac's systems were coming back online, on Monday morning at 1 a.m., 2 a.m. and every hour leading up to 7 a.m., the IT staffers were up and sending out notifications on what systems were up and ready to go."
When it comes to failure, what's the measure of success?
"When a bank closing/acquisition is successful is when, come Monday morning, the customers have hardly noticed any change other than the name on the door," Barr says.