Introduction to Problem Banks eBook

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Introduction to Problem Banks

April 2-4, 2024 Virtual

@ www.csbs.org ♦ @csbsnews

CONFERENCE OF STATE BANK SUPERVISORS 1300 I Street NW / Suite 700 / Washington, DC 20005 / (202) 296-2840

Introduction to Problem Banks Live Virtual April 2-4, 2024

Tuesday, April 2, 2024 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 3:00 pm – 4:00 pm

Open Discussion

Wednesday, April 3, 2024 1:00 pm – 2:00 pm

Exam Plan and Process

Break

2:00 pm – 2:15 pm

Exam Plan and Process

2:15 pm – 3:00 pm

Open Discussion

3:00 pm – 4:00 pm

Thursday, April 4, 2024 1:00 pm – 2:00 pm

Enforcement Actions

Break

2:00 pm – 2:15 pm

Enforcement Actions

2:15 pm – 3:00 pm

Open Discussion

3:00 pm – 4:00 pm

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Introduction to Problem Banks Training April 2-4, 2024

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Instructor Contact Information

Assistant Deputy Commissioner Arkansas State Bank Department bmoseley@banking.state.ar.us Baker Moseley

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Instructor Contact Information

Regional Deputy Commissioner, Banking California Department of Financial Protection & Innovation catherine.nahnsen-robison@dfpi.ca.gov Cathy Nahnsen-Robison

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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 knew what would come next!

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The Pandemic Effect

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The Pandemic Effect and Beyond

Liquidity

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What’s coming next?

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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.

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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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List of Red Flags

• Internal reporting delays, errors, omissions • Concentrations, of any kind • Delinquencies • Over 90 and accruing • Weak audit/examination finding remediation tracking • Rapid growth and/or new material product lines • Unfunded commitments • Inaccessible/unresponsive management and/or board • Uninsured deposit levels • Adjusting policy limits simply to avoid exceptions

 Increase in non-core funding

 Decrease in core deposits or no core deposits  Loan renewals without any paydowns

High Net Interest Margin



 Loan review scope influenced by management

No audit



 Inadequate CECL (ALLL back in the day) methodology  Not reporting policy exceptions to the board

Turnover



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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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Maintain Documentation

Documentation is key!

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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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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….

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Problem Bank Training Enforcement Actions

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

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What is an enforcement action?

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Why do bank regulators use them?

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Types of Enforcement Actions

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

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Typically Joint Actions

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Contents of an Enforcement Action

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Contents of an Enforcement Action • Identifies parties to the document

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Contents of an Enforcement Action • References a specific examination

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Contents of an Enforcement Action • Requires signatures of directors

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

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Contents of an Enforcement Action • Usually requires reports to regulators

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Informal Actions

Focus on issues of risk/regulatory concern.

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

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Board Resolutions (BR)

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

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

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

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

Directors rescinds with regulator concurrence

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

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Memorandums of Understanding (MOU)

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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

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Memorandums of Understanding (MOU)

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

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Memorandums of Understanding (MOU)

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

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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

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

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

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

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

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Consent Orders

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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

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

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

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Consent Order Proceedings

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Consent Order Proceedings

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

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

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

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

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Prompt Corrective Action (PCA)

• Five capital categories • Specific legal ramifications

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New BASEL III Requirements

Total Risk Based Capital

Common Equity Tier 1 RBC Tier 1 RBC

Leverage Ratio

Supplementary Leverage Ratio

%

≥ 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

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

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

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PCA - Restrictions

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

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Other Enforcement Actions

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Revocation of Charters

• Most severe action • Also called closures • COB Fridays

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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)

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

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Questions