Troubled Bank Management 101: A Detailed Analysis of an FDIC Cease and Desist Order
Restructuring Bank Operations, Practices, and Procedures to Comply with the Requirements of Cease and Desist Orders and Banking Laws and Regulations.
When a bank reaches some magical level that makes the Federal Deposit Insurance Corporation (“FDIC”) nervous, they issue a Cease and Desist Order (“C&D”) to the bank directing them to take various actions. Technically, the bank has a right to a hearing and so forth; but I recommend that a bank not even waste time and resources over this technical legal step. The reality is that if the FDIC feels that the bank is operating in an unsafe and unsound manner, then the outcome will be that a Cease and Desist Order will be issued.
Let’s take a close look at what typically appears in one of those Cease and Desist Orders:
● It states that the banking regulators believe that the Bank is operating in an unsafe and unsound manner, and that the Bank has violated banking regulations and laws.
● If the Bank is state chartered, then the state banking regulators also sign the C&D.
● The way that a C&D is structured is that the bank, technically, without admitting or denying the alleged charges of unsafe or unsound banking practices and violations of law and/or regulations, consents to the issuance of the C&D by the FDIC and the State Banking Commissioner.
● Then, technically, the FDIC and the Commissioner accept the Consent Agreement and issue the C&D,
Having cleared up the legal technicalities up front, then the C&D gets down to the nitty-gritty and starts citing specific points that the banking regulators picked up from the Bank’s previous examination report. Here are some examples from an actual C&D, and are rather standard among C&Ds I have seen:
(a) Operating with a Board of Directors (“Board”) that has failed to provide adequate supervision over and direction to the management of the Bank;
(b) Operating with management whose policies and practices are detrimental to the Bank and jeopardize the safety of its deposits;
(c) Operating with marginally adequate equity capital and reserves in relation to the volume and quality of assets held by the Bank;
(d) Operating with an excessive level of adversely classified items;
(e) Operating with inadequate provisions for liquidity and funds management;
(f) Operating with hazardous loan underwriting and administration practices;
(g) Operating in such a manner as to produce operating losses; and
(h) Operating in apparent violation of laws, regulations, and/or statements of policy as more fully described in the FDIC’s Report of Examination dated Month xx, 200x (“ROE”).
Then, a typical Cease and Desist Order recites positive actions that the Bank and its affiliates must take, such as:
● Board of Directors
The banking regulators want the Board of Directors to increase their participation in the affairs of the Bank, approve sound policies, strategic plans, and budgets for the supervision of all of the Bank’s activities, and to establish specific procedures to make sure that the Board is informed as to what is going on within the Bank, and to meet at least monthly. Each meeting of the Board shall cover at least the following areas, which shall be reviewed and approved: reports of income and expenses; new, overdue, renewed, extended, restructured, insider, non-accrual, charged-off, and recovered loans; investment activity; operating policies; personnel actions; audit and supervisory reports; and the minutes summarizing individual committee meetings and actions.
A typical C&D states that within thirty days from the effective date of the C&D, the Board shall establish a Board of Directors’ committee (“Directors’ Committee”), consisting of at least four members, at least three of which must be outside directors, responsible for ensuring compliance with the C&D, overseeing corrective measures with respect to the C&D, and reporting to the Board. Every thirty days after the issuance of the C&D, the Director’s Committee shall submit a written report to the full Board detailing the Bank’s compliance with the C&D; and the report and any related discussion shall be recorded in the minutes of the Board’s meeting.
The banking regulators want the Bank to “have and retain qualified management.” Each member of management shall have qualifications and experience commensurate with his or her duties and responsibilities at the Bank. Management shall include:
■ A chief executive officer.
■ A senior lending officer.
Within thirty days of the issuance of the C&D, Board shall develop a written analysis and assessment of the Bank’s management and staffing needs (“management plan”), which shall include, at a minimum:
(i) The type and number of officers needed to manage and supervise the affairs of the Bank;
(ii) Identification and establishment of such Bank committees as are needed to provide guidance and oversight to active management; and
(iii) An evaluation of the qualifications of each Bank officer.
The qualifications of management shall be assessed on its ability to:
(i) Comply with the requirements of the Cease and Desist Order;
(ii) Operate the Bank in a safe and sound manner;
(iii) Comply with applicable laws and regulations; and
(iv) Restore all aspects of the Bank to a safe and sound condition, including asset quality, capital adequacy, earnings, management effectiveness, liquidity, and sensitivity to market risk.
This management plan shall be submitted to the banking regulators for review and comment. The banking regulators then will respond to the bank and possibly comment on the management plan, and the Bank’s Board shall approve the management plan and/or any subsequent modification.
A C&D normally states that the Bank shall notify the banking regulators in writing of the resignation or termination of any of the Bank’s directors or senior executive officers; and the Bank will obtain the prior approval of the banking regulators before hiring any new Board members of senior executives.
(a) A C&D normally requires that within 120 days from the effective date of the C&D, the Bank shall have Tier 1 Capital of at least eight percent (8%) of the Bank’s total assets and total risk-based capital in such an amount as to equal or exceed ten percent (10%) or the Bank’s total risk-weighted assets; and thereafter, the Bank shall maintain Tier 1 Capital and total risk-based capital ratios equal to or exceeding eight percent (8%) and ten percent (10%), respectively, during the life of the C&D.
(b) A C&D normally requires that Tier 1 Capital and total risk-based capital to be maintained during the life of the C&D shall be in addition to a fully funded Allowance for Loan and Lease Losses (“ALLL”), the adequacy of which shall be satisfactory to the banking regulators.
(c) A C&D normally requires that any increase in Tier 1 Capital necessary to meet the requirements the C&D may not be calculated through a deduction from the Bank’s ALLL. For purposes of the C&D, the terms “Tier 1 Capital,” “total risk-based capital,” “total assets,” and “total risk-weighted assets” shall have the meanings given to them in Part 325 of the FDIC Rules and Regulations, 12 C.F.R. Part 325.
A C&D normally requires a Bank to eliminate from its books, by charge-off or collection, all assets or portions of assets classified “Loss” and fifty percent (50%) of those assets classified “Doubtful” in the ROE that have not been previously collected or charged-off within ten days of the issuance of the C&D.
A C&D normally requires that while the C&D is in effect, the Bank shall, within thirty days of the receipt of any future report of examination or visitation, eliminate from its books, by collection, charge-off, or other proper entries, the remaining balance of any assets classified as “Loss” and fifty percent (50%) of those assets classified as “Doubtful.”
A C&D normally states that the elimination or reduction of assets by refinancing through the proceeds of other loans made by the Bank is not considered a valid collection.
● Reduction of Classified Items
A C&D normally requires that within sixty days from the effective date of the C&D, the Bank shall formulate a written plan to reduce the Bank’s risk exposure in each asset in excess of $1,000,000 classified as “Substandard” in the ROE.
● No Additional Credit
A C&D normally prohibits the extension of further credit to any existing borrower who has a loan that has been charged off or is classified, “Substandard,” or uncollected.
There are certain exceptions available if the failure to extend a certain troubled credit could hurt the interests of the Bank.
● Lending Practices
A C&D normally states that within sixty days from the effective date of the C&D, the Bank must implement a written lending and collection policy to provide effective guidance and control over the Bank’s lending function.
● Concentrations of Credit
A C&D normally requires that within sixty days from the effective date of the C&D, the Bank shall perform a risk segmentation analysis with respect to the concentrations of credit listed in its most recent ROE, and a plan to reduce any concentrations that are deemed by the banking regulators to be problematic.
● Special Mention
As a catch-all, a C&D normally states that within thirty days from the effective date of the C&D, the Bank shall develop a plan to correct all deficiencies in the assets listed for “Special Mention” in the ROE.
● Loan Review and Grading System
A C&D normally requires that within sixty days from the effective date of the C&D, the Bank’s Board shall develop an effective system of independent loan review to appropriately assess and grade the overall quality of the loans that make up the Bank’s loan portfolio.
● Establish/Maintain Allowance for Loan and Lease Losses
A C&D normally states that within thirty days from the effective date of the C&D, the Bank’s Board shall review the adequacy of the ALLL and establish a comprehensive policy for determining the adequacy of the ALLL.
● Plan to Improve Earnings
A C&D normally requires that within sixty days from the effective date of the C&D, the Bank shall formulate and fully implement a written plan and a comprehensive budget for all categories of income and expense. The plan and budget shall include formal goals and strategies to improve the Bank’s net interest margin, increase interest income, reduce discretionary expenses, and improve and sustain earnings of the Bank; and thereafter, the Bank shall formulate such a plan and budget by November 30th of each subsequent year and submit it to the banking regulators for their approval. Each quarter going forward, the Bank’s Board shall evaluate the Bank’s actual performance in relation to the plan and budget, and shall record the results of the evaluation, and any actions taken by the Bank, in the minutes of the Board’s meeting.
● Cash Dividends
A C&D normally requires that the Bank cease paying cash dividends without the prior written consent of the banking regulators, which is not very likely.
● Asset/Liability Management
A C&D normally requires that within sixty days from the effective date of the C&D, the Bank’s Board shall implement an asset/liability management policy which establishes an acceptable range for the Bank’s present and future net non-core funding dependence ratio, as computed by the Uniform Bank Performance Report.
A C&D normally requires that within sixty days from the effective date of the C&D, the Bank shall review, and amend as necessary, the Bank’s written interest rate risk policy.
● Liquidity Contingency Funding Plan
A C&D normally requires that within sixty days from the effective date of the C&D, the Bank shall develop or revise, adopt, and implement a written liquidity contingency funding plan. The written liquidity contingency funding plan shall incorporate the applicable guidance contained in Financial Institution Letter (FIL) 84-2008 dated August 26, 2008, entitled Liquidity Risk Management. The liquidity contingency funding plan shall provide restrictions on the use of brokered and internet deposits consistent with safe and sound banking practices. Such plan shall be submitted to the Supervisory Authorities for review and approval, and its implementation shall be in a form and manner acceptable to the Supervisory Authorities.
● Brokered Deposits
A C&D normally requires during the life of the C&D, the Bank shall not accept, renew, or rollover brokered deposits without obtaining a brokered deposit waiver approved by the FDIC, which is not likely to be granted.
● Bank Secrecy Act Program
A C&D normally requires that within sixty days from the effective date of this C&D, the Bank shall review and implement all Bank Secrecy Act compliance program deficiencies set forth on pages 7, 8, 13, and 14 of the ROE.
● Eliminate/Correct all Violations of Law
A C&D normally requires Within sixty days from the effective date of the C&D, the Bank shall take all necessary steps, subject to safe and sound banking practices, to eliminate and/or correct the violations of law set and contraventions of policy out by the bank examiners in the ROE.
A C&D normally requires that the Bank shall send to its shareholders a complete description of the C&D in conjunction with the Bank's next shareholder communication.
● Progress Reports
A C&D normally requires that within thirty days of the end of the first quarter following the effective date of the C&D and within thirty days of the end of each quarter thereafter, the Bank shall furnish written progress reports to the banking regulators.
● A Cease and Desist Order normally concludes by stating that it shall become effective immediately, and that the provisions of the C&D shall remain effective and enforceable until modified, suspended, or terminated by the banking regulators.
Then the Cease and Desist Order is usually executed by the FDIC and, if issued to a state chartered institution, executed by the state banking regulators.
Every corrective banking job is different, and there is no magic formula. The best advice is to cooperate and put forth your best efforts to meet the requirements set out in the Cease and Desist Order in a timely and complete manner.
One of the unfortunate keys to recognize is that when a C&D is issued by the banking regulators, it is a fairly safe assumption (though not always so) that the banking regulators are displeased with the Bank’s present management and level of oversight by the Board of Directors. This creates a problem because what Bank CEO wants to go to his Board and recommend that he be replaced? Therefore, it falls to the Board to step up and take action.
Find competent and experienced management to help whip the bank into shape. Remember, the goal is the continued existence of the Bank. The Banking Regulators want to see the Bank survive just as much as do the management, officers, employees, directors, and shareholders of the Bank.
ABOUT THE AUTHOR: Don Coker
Don Coker is a heavily experienced former financial institution manager and high-level governmental banking regulator who was chosen several times by the banking regulators to serve as an interim manager and in several regulatory oversight positions. Based upon extensive experience and achievements in banking and lending at Citicorp and entities that are now Bank of America, JPMorgan Chase Bank, and Regions Financial, he was chosen to serve as the on-site supervisory regulatory agent interim manager for two insolvent financial institutions and two bank-owned mortgage banking companies. Duties included the hands-on management of $1.8 billion (2009 USD) in assets including $635 million in troubled assets, and participation in the review and recommendation of recapitalization, restructuring, and merger plans. Mr. Coker also was called upon by the governmental banking regulators to serve in regulatory oversight positions for insolvent institutions and as the regulator's expert witness.
Copyright Don Coker
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.