Introduction to Problem Banks

Intro duction to Problem Banks

April 11-13 , 202 3 Virtual

@ www.csbs.org � @csbsnews

CONFERENCE OF STATE BANK SUPERVISORS 1 300 I Street NW / Suite 700 / Washington, DC 20 005 / (202) 296-2840

Introduction to Problem Banks Live Virtual April 11 ‐ 13, 2023

Tuesday, April 11, 2023 1:00 pm – 2:00 pm

Opening and History Perspectives

Break

2:00 pm – 2:15 pm

Red Flags

2:15 pm – 3:00 pm

Open Discussion

3:00 pm – 4:00 pm

Wednesday, April 12, 2023 1:00 pm – 2:00 pm

Exam Plan and Process

Break

2:00 pm – 2:15 pm

Exam Plan and Process (continued)

2:15 pm – 3:00 pm

Open Discussion

3:0 pm – 4:00 pm

Thursday, April 13, 2023 1:00 pm – 2:00 pm

Enforcement Actions

Break

2:00 pm – 2:15 pm

Enforcement Actions (continued)

2:15 pm – 3:00 pm

Open Discussion

3:00 pm – 4:00 pm

Introduction to Problem Banks Virtual April 11 ‐ 13, 2023

ATTENDEES American Samoa Office of Financial Institutions Langkilde, Teresa

teressa.langkilde@tr.as.gov

Arkansas State Bank Department Lockwood, Aaron

alockwood@banking.state.ar.us rpuloma@banking.state.ar.us

Puloma, Richard

California Department of Financial Protection and Innovation Ang, Kurt

Kurt.Ang@dfpi.ca.gov

Bautista, George Chen, Michelle Miranda, Angelito Nguyen, Helen Park, Christopher Pineschi, Robert

George.Bautista@dfpi.ca.gov Michelle.Chen@dfpi.ca.gov Angelito.Miranda@dfpi.ca.gov Helen.Nguyen@dfpi.ca.gov Christopher.Park@dfpi.ca.gov Robert.Pineschi@dfpi.ca.gov Denny.Tjie@dfpi.ca.gov Camtu.Tran@dfpi.ca.gov Marisol.vazquez@dfpi.ca.gov

Tjie, Denny Tran, Camtu

Vazquez, Marisol

Wei, Ying

Ying.Wei@dfpi.ca.gov

Indiana Department of Financial Institutions Delaney, Matthew

mdelaney@dfi.in.gov TShearer@dfi.in.gov

Shearer, Tyler

Kansas Office of the State Bank Commissioner Phillips, SaraJane

sarajane.phillips@osbckansas.org

Mississippi Department of Banking & Consumer Finance Strider, Anna

anna.strider@dbcf.ms.gov

Missouri Division of Finance Marshall, Tess

Tess.Marshall@dof.mo.gov Cole.Meyer@dof.mo.gov Eric.Miller@dof.mo.gov

Meyer, Cole Miller, Eric

Nebraska Department of Banking and Finance Kiolbasa, Ben New York State Department of Financial Services Muluk, Robert Utah Department of Financial Institutions Lundgren, Megan Virginia Bureau of Financial Institutions Armstrong, Perry Washington Department of Financial Institutions Wu, Sarah Wisconsin Department of Financial Institutions Alanis, John Hana, John

benjamin.kiolbasa@nebraska.gov

robert.muluk@dfs.ny.gov

meganlundgren@utah.gov

Perry.Armstrong@scc.virginia.gov John.Hana@scc.virginia.gov

sarah.wu@dfi.wa.gov

john.alanis@dfi.wisconsin.gov

SPEAKERS Arkansas State Bank Department Moseley, Baker

bmoseley@banking.state.ar.us

California Department of Financial Protection and Innovation Nahnsen ‐ Robinson, Catherine

Catherine.Nahnsen ‐ Robison@dfpi.ca.gov

CSBS STAFF Hoyle, Katie

khoyle@csbs.org

Richardson, Amy

arichardson@csbs.org

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Defining Problem Banks and History Perspectives When good banks go bad…

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Zoom Annotation Tool Click View Options at the top then click Annotate.

Click the Text Tool to type your answers.

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What is a problem bank? Using the annotate tools, type some characteristics below of what makes a bank a problem bank. (View Options > Annotate> Text tool)

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Definition: • A financial institution with a composite rating of 3, 4, or 5 • A financial institution under an enforcement action • Not to be confused with “Troubled Bank”

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Two Scenarios Known Problem Bank

Known Non-Problem Bank – Surprise!

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What’s the difference? Using the annotate feature: • How would you prep for each scenario?

• How would the examination change once you got there?

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Today’s Landscape: In the chat, describe what you see as either present or looming risks?

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What we plan to cover in this course:

1. Red Flags 2. Examination Techniques 3. Enforcement Actions

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Brief History of Crisis and Response

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The Great Depression • The Banking Act of 1933 • The Security and Exchange Act of 1934 • The Banking Act of 1935

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The 1980s

• Depository Institutions Deregulation and Monetary Control Act of 1980 • Competitive Equality Banking Act of 1987 • Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) • Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991

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The Great Recession – December 2007

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Who knows what will come next!

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The Pandemic Effect

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What’s next, inflation, recession, ?????

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Or is it…

Liquidity

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Questions

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Problem Bank Training Red Flags

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Objectives of this section:

Define Red Flags

Sources of information used in Red Flag identification

If seen, some questions to ask.

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Definition – Red Flags

• Indicators of actual or potential problems or heightened risk

• Can be indicators of root problems (leading indicators) or symptoms/results (lagging indicators).

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Where do we find red flags? Use the annotate feature to type your answers:

What sources can you use to find red flags?

How do you evaluate or decide which red flags to look at?

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Poll

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Whistleblowers – who are they and why do they contact us?

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Former Management or Directors

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Objectives:  Definition  Sources of red flags

 Questions to ask

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Questions to ask Breakout group exercise (20 minutes) In your group: 1. Select a spokesperson 2. Discuss the red flag

3. Come up with questions (at least 3) you would ask management or areas you want to follow-up on. 4. Your group will present their questions to the larger group. 5. Email your list of questions to khoyle@csbs.org.

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Questions to ask Breakout group exercise Red flag is: • Groups 1 & 4 : Increase in borrowings with the FHLB • Groups 2 & 5: Increase in the level of AOCI (negative) in the bank’s AFS securities. • Groups 3 & 6: Increase in concentration of depositors in one market sector.

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In conclusion:  Definitions  Sources for red flags  Questions to ask

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Questions?

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Problem Bank Training Examination Plan & Process

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Go to www.menti.com and use the code provided

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Preparing for Exam

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Exam Scope

Exam scope should be highly detailed.

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Identify a Strategy

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Successful Resolution

ORDER CHAOS

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Organization

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In the chat: What are some examples in a word or two that were a challenge for you being an EIC in more of a problem situation?

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Maintain Documentation

Documentation is key!

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Gather information

Organized, accurate & complete information.

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Document Management’s Promises

Generally speaking, avoid personal opinions.

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Federal Counterparts

Present a united front with federal counterparts.

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Key Points: • Workpaper procedures • No extra copies • Learn about the bank

• You aren’t alone • CBOs & RBOs

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Communication

Communication is critical to the exam process.

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Reporting

Reporting frequency depends on situation.

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Awareness

Consider regular meetings with examiners.

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Poll: What is your experience with joint exams? Positive, Negative, or Neutral?

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Communicate with Bank Management

Bank management should not be hearing about Issues for the first time at the exit meeting.

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Written Communication

E ‐ mails should be protected through encryption.

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Confidential Meetings

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Be Detailed

Detail is important for investigation/prosecution.

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Documentation • Make copies or scan • Keep organized • Limit to facts • Answer:

• Who • What • Where • When • Why • How

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Documentation • Include only information about subject bank • Buddy up at meetings • Learn from others & self • Body language & words

• No ultimatums • Keep your cool

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Education

Focus on requirements – level of compliance/improvement.

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Enforcement Actions

Be familiar with enforcement actions.

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Exam Reports and Enforcement Actions

Prioritize recommendations/areas of weakness.

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Exam Reports and Enforcement Actions

Clearly communicate expectations & timelines.

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Exam Reports and Enforcement Actions

Obtain & document commitments for corrective action.

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Exam Reports and Enforcement Actions

Escalate regulatory action when appropriate.

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Exam Reports and Enforcement Actions

Put in your best effort.

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Exam Reports and Enforcement Actions

Communicate & compromise where you are able.

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Factors Influencing Upgrades and Elimination of Enforcement Actions

Sustainability is key.

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Factors Influencing Upgrades and Elimination of Enforcement Actions

Consider consequences.

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Factors Influencing Upgrades and Elimination of Enforcement Actions

Terminate action after substantial compliance & sustained performance.

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Go to www.menti.com and use the code provided

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Attendee thoughts….

Problem Bank Training Enforcement Actions

Go to www.menti.com and use the code provided

What is an enforcement action?

Why do bank regulators use them?

Types of Enforcement Actions

Informal Enforcement Actions

Formal Enforcement Actions

Poll: Which types of Enforcement Actions have you seen? Formal, Informal, or Both

Typically Joint Actions

Contents of an Enforcement Action

Contents of an Enforcement Action • Identifies parties to the document

Contents of an Enforcement Action • References a specific examination

Contents of an Enforcement Action • Requires signatures of directors

Contents of an Enforcement Action • Sets time frames for initiating change

Contents of an Enforcement Action • Usually requires reports to regulators

Contents of an Enforcement Action

Goal: buy ‐ in and consent to the agreement.

Informal Actions

Focus on issues of risk/regulatory concern.

In the chat: In what areas have you seen management push back?

Board Resolutions (BR)

Board Resolutions (BR) • Most informal option • Initiated by regulator • Based on exam findings • Management crafts • Similar to MOU • Not public

Board Resolutions (BR) • Documented in minutes • Required progress reports

Board Resolutions (BR) • Understand the problems • Capable of correcting • Possess skill sets needed • Willing to act in a timely manner

Board Resolutions (BR) • Can be effective • If breached, the foundation for future actions • In place until Board of

Directors rescinds with regulator concurrence

Poll: Do you think Board Resolutions can be effective? Yes or No

Memorandums of Understanding (MOU)

Memorandums of Understanding (MOU) •Regulators are a party to & craft the document •Developed for banks needing assistance with:

• Weakness identification • Develop corrective action • Set timeframes/prioritize • Reporting progress

Memorandums of Understanding (MOU)

•Not publicly reported by regulators •Bank disclosure? •Issued to state member and non-member banks

Memorandums of Understanding (MOU)

•Typically, joint action •Signed by Regulators & Board •Likely prohibit branching & merger activity

Memorandums of Understanding (MOU) •Challenges with joint documents •Follow-up visits to assess compliance •In place until points addressed,

overall condition is materially better – determined by exam

Poll: Which do you see more often? Board Resolutions or MOUs?

Written Agreements • Formal/public actions • FRB’s preferred method • OCC often uses • Signed by all parties • FDIC rarely uses

Written Agreements • Condition more severe or management willingness in question • Lengthier documents • Required audited financial statements disclosure

Written Agreements • Joint actions • Terminated after compliance • Issued to state member banks, signed by Regulators & Board • Public action

Consent Orders

Consent Orders • Used by states & FDIC, sometimes FRB & OCC • Unsafe/unsound practices and/or violations • Reasonable cause • Issued to state member and non-member banks

Consent Orders • Severe compliance issues • Legal involved in drafting • Legally enforceable • Signed by Regulators & Board

Consent Orders • Exams to determine compliance • Statements of fact addressing each point • Requires bank to immediately stop inappropriate action or implement affirmative action

Consent Order Proceedings

Consent Order Proceedings

•Agency Issues Notice of Charges and of Hearing • Hearing with ALJ – public & similar to bench trial

Consent Order Proceedings •Hearing held in 30-60 days •ALJ decision effective after 30 days • US Circuit Court of Appeals •States have similar procedures

Raise your hand if you have specifically been involved in the development and issuance of any enforcement action?

Prompt Corrective Action (PCA) • Capital key part of decisions • Since FDICIA in 1991 • Framework to preserve value to an acquiring institution

Prompt Corrective Action (PCA)

• Five capital categories • Specific legal ramifications

PCA Ratios – Minimums

PCA Designation

Total Risk Based Capital

Tier 1 Risk Based Capital

Tier 1 Leverage

Well-Capitalized

10%

6% 4%

5% 4%

Adequately Capitalized

8%

Undercapitalized Significantly Undercapitalized

<8% <6%

<4% <3%

<4% <3%

<2% tangible equity to total assets

Critically Undercapitalized

New BASEL III Requirements

Total Risk ‐ Based Capital

Common Equity Tier 1 RBC

Leverage Ratio

Supplementary Leverage Ratio

%

Tier 1 RBC

≥ 10

≥ 8 ≥ 6 < 6 < 4

≥ 6.5 ≥ 4.5 < 4.5

≥ 5 ≥ 4 < 4 < 3

N/A

Well Capitalized

≥ 8 < 8 < 6

≥ 3 < 3

Adequately Capitalized

Undercapitalized

< 3

N/A

Significantly Undercapitalized Critically Undercapitalized

N/A

Tangible Equity (defined as Tier 1 Capital plus non ‐ Tier 1 perpetual Preferred stock) to Total Assets ≤ 2

Prompt Corrective Action (PCA) Capital Categories 1. Well capitalized 2. Adequately capitalized 3. Undercapitalized 4. Significantly undercapitalized 5. Critically undercapitalized

Prompt Corrective Action (PCA) Capital Categories 1. Well capitalized 2. Adequately capitalized 3. Undercapitalized 4. Significantly undercapitalized 5. Critically undercapitalized

PCA - Restrictions

•Regardless of PCA category o No dividends o No management fees o No capital distributions if it moves bank to undercapitalized

Other Enforcement Actions

Revocation of Charters

• Most severe action • Also called closures • COB Fridays

Revocation of Charters • Process begins months prior to closing • Failure date designated • DRR role • Bidding process • No winning bid, a payout bank • Closed by licensing regulator (State or OCC)

What is one thing you have learned from this series that will help you if you encounter a problem bank?

Questions