The Failure of BestBank, Boulder, Colorado

(Audit Report No. 99-005, January 22, 1999)

The Office of Inspector General (OIG) has completed a material loss review of the failure of BestBank, Boulder, Colorado. BestBank was closed on July 23, 1998 with total assets of $314 million. As of December 31, 1998, the estimated loss to the Bank Insurance Fund was $171.6 million. This audit was performed in accordance with Section 38(k) of the Federal Deposit Insurance Act (FDI Act), which provides that if a deposit insurance fund incurs a material loss with respect to an insured depository institution on or after July 1, 1993, the Inspector General of the appropriate federal banking agency shall prepare a report to that agency reviewing the agency's supervision of the institution.

The objectives of the audit were to (1) determine the causes of BestBank's failure and resulting material loss to the deposit insurance fund and (2) assess FDIC's supervision of the bank, including implementation of the Prompt Corrective Action requirements of section 38 of the FDI Act.

BestBank's demise was attributable to bank management's failure to operate the institution in a safe and sound manner, which led to substantial losses sustained in the high-risk unsecured credit card travel program. These losses were exacerbated by a third party contractor's apparent actions to make delinquent accounts appear current, which delayed the recognition of losses in the portfolio. We concluded that the FDIC Division of Supervision's (DOS) regulatory oversight of BestBank could have been more effective in controlling the bank's rapid asset growth and curbing the subsequent losses to the deposit insurance fund. Most significantly, obstacles created by BestBank management and existing regulatory authority impeded the regulators' access to both the bank and a third-party entity that directly controlled a majority of the bank's assets. In addition, the examiners continued to rate BestBank without sufficient or reliable information to support the ratings, particularly asset quality. Furthermore, the supervisory tools that were available to the regulators were not aggressively pursued in a timely or effective manner.

Recommendations

We recommended that the Director, DOS, take the following actions:

1. (1) Work with the Federal Reserve Board to expand its interpretations under section 23A of the Federal Reserve Act to include any entity whose business relationship with an insured depository institution has the ability to significantly affect the safety and soundness of the institution in the definition of "affiliate."
2. (2) Work with the Legal Division to pursue alternative means of obtaining access to third party servicers.
3. (3) Modify the DOS Manual of Examination Policies to address how examiners should handle situations where access to bank employees and records is impeded during an examination.
4. (4) Establish a remedy for the FDIC to gain immediate, unfettered access to an insured depository institution that attempts to impede the examiners' access to bank employees or records.
5. (5) Modify existing policies to require the Regional Director to provide a written justification for taking no supervisory action on a "3," "4," or "5" rated institution.
6. (6) Develop and implement a policy regarding how examiners should address scope limitations during an examination. For instance, the policy could provide that significant scope limitations during an examination will be considered an unsafe and unsound practice justifying a composite "5" rating for the institution.
7. (7) Develop and implement a policy where examiners take prompt action to address allegations of potential wrongdoing, including referring such allegations to the Regional Director, Regional Counsel, and, in certain circumstances, the OIG.
8. (8) Develop and implement a policy where examiners, as part of DOS's quarterly off-site review and pre-examination planning work, review Division of Compliance and Consumer Affairs (DCA) and State consumer complaint files on financial institutions that have been identified as a supervisory concern.
9. (9) Develop and implement a policy that requires examiners to document significant examination obstacles, such as impeded access to bank employees and records or unrealistic time constraints, including the Regional Director's resolution of such obstacles.
10. (10) Expand DOS's Credit Card Specialty Bank Examination Guidelines to include policies and procedures for examining subprime credit card lending.
11. (11) Issue policy reminders to DOS examiners and supervisors related to assessing compliance with outstanding supervisory actions, identifying concentrations of credit, preparing the pre-examination planning memorandum, and scheduling board meetings.

Management Response

On January 14, 1999, the Director, Division of Supervision provided a written response to the draft report. DOS agreed with 3 of the 11 recommendations in this report (recommendation numbers 3, 6, and 10) and disagreed with 1 recommendation (recommendation number 8). However, DOS did not provide clear agreement or disagreement with the remaining 7 recommendations, nor did DOS propose alternative actions. We will continue to work with DOS to obtain management decisions on all recommendations. The Associate Director, DCA also provided brief comments on our report, but that response did not address our recommendations.