Material Loss Review of Security Savings Bank, Henderson, Nevada
As required by section 38(k) of the Federal Deposit Insurance Act (FDI Act), the Office of Inspector General (OIG) conducted a material loss1 review of the failure of Security Savings Bank, Henderson, Nevada (Security Savings). On February 27, 2009, the Nevada Department of Business and Industry, Financial Institutions Division (NFID) closed the institution and named the FDIC as receiver. On March 20, 2009, the FDIC notified the OIG that Security Savings’ total assets at closing were $202 million and the material loss to the Deposit Insurance Fund (DIF) was $59 million.
When the DIF incurs a material loss with respect to an insured depository institution for which the FDIC is appointed receiver, the FDI Act states that the Inspector General of the appropriate federal banking agency shall make a written report to that agency which reviews the agency’s supervision of the institution, including the agency’s implementation of FDI Act section 38, Prompt Corrective Action (PCA); ascertains why the institution’s problems resulted in a material loss to the DIF; and makes recommendations to prevent future losses.
The audit objectives were to: (1) determine the causes of the financial institution’s failure and resulting material loss to the DIF and (2) evaluate the FDIC’s supervision2 of the institution, including implementation of the PCA provisions of section 38 of the FDI Act. Appendix 1 contains details on our objectives, scope, and methodology.
Appendix 2 contains a glossary of terms, and Appendix 3 contains a list of acronyms used in the report.
This report presents the FDIC OIG’s analysis of Security Savings’ failure and the FDIC’s efforts to ensure Security Savings’ management operated the bank in a safe and sound manner. We are not making recommendations. Instead, as major causes, trends, and common characteristics of financial institution failures are identified in our reviews, we will communicate those to management for its consideration. As resources allow, we may also conduct more in-depth reviews of specific aspects of DSC’s supervision program and make recommendations, as warranted.
Security Savings was an FDIC-supervised state-chartered industrial loan company (ILC) established by the NFID and insured by the FDIC effective April 3, 2000. Security Savings, which was headquartered in Henderson, Nevada, had two full-service branch offices in Nevada, and three loan-production offices in Virginia, Florida, and Texas. The loan production offices and one branch were closed before the failure of the bank. The bank’s business model was that of a wholesale operation focusing on purchasing loan participations from across the nation. In particular, Security Savings specialized in commercial real estate (CRE) lending, with concentrations in CRE and acquisition, development, and construction (ADC) loans. The bank also invested in lower-rated investment-quality securities. In addition, the bank was dependent on potentially volatile liabilities for its funding.
Security Savings was 100 percent owned by Stampede Holdings, Inc. (Stampede), Las Vegas, Nevada, a one-bank, non-commercial holding company. Stampede was a closely-held company with 41 shareholders. Stampede acquired the bank in September 2004. At the time of acquisition, Stampede replaced the bank’s management team, injected capital, opened the three loan production offices, and implemented a high-growth strategy.
There was also an affiliate institution, which examiners determined to have been controlled by the principal shareholder of Stampede. (A matter related to an apparent violation of Federal Reserve Board (FRB) Regulation 23A, regarding covered transactions, is discussed later in this report.)
A summary of Security Savings’ financial condition, as of December 2008, and for the 4 preceding calendar years follows in Table 1.
Table 1: Financial Condition of Security Savings
CAUSES OF FAILURE AND MATERIAL LOSS
Security Savings failed because bank management did not adequately control the risks associated with its business strategy that focused on (1) rapid asset growth, (2) significant concentrations in ADC loans, (3) investments in lower-quality mortgage-backed securities, and (4) reliance on high-cost core deposits and volatile non-core funding. The deteriorating housing market in areas where Security held most of its loans led to significant loan and security losses that eroded the bank’s capital and strained liquidity. Ultimately, Security Savings was closed by NFID due to the bank’s capital insolvency.
Evidence of the cause of a bank’s failure can often be seen in its adverse asset classifications. In the case of Security Savings, its adverse classifications resulted primarily from its portfolios of ADC loans and securities. As adverse asset classifications increased, earnings eroded, liquidity became strained, and capital became increasingly deficient.
The bank’s business model was that of a wholesale operation focused on purchasing loans and loan participations across the nation. Since year-end 2006, three of the bank’s primary markets — Florida, California, and Nevada — experienced significant real estate price deterioration. As the deterioration in the housing market spread, Security Savings began to incur and recognize greater losses in its ADC loan portfolio. Specifically, adversely classified assets increased from $15.6 million reported in the June 2007 Report of Examination (ROE) to $40.9 million reported in the July 2008 ROE. The majority of adversely classified assets were purchased ADC loans to finance condominium and CRE construction projects in high-growth markets, including Florida, California, and Nevada. Further, for the periods ended December 2004 to December 2008, the bank’s net loan charge-offs (losses) totaled $13.3 million, of which $11.9 million was in the ADC loan portfolio. Additionally, for the years ended December 2007 and 2008, the bank recognized $12.7 million in losses associated with its securities.High-Risk Business Strategy
Security Savings’ management employed a rapid-growth business strategy in which it concentrated assets in higher-risk ADC loans and securities, and funded its asset growth with higher-cost core deposits and potentially volatile liabilities, without sufficient mitigating controls. Security Savings’ total assets increased 227 percent from December 2004 to September 2007, peaking at almost $304 million. Losses associated with this high-risk
strategy were a significant contributing factor to the failure of Security Savings. In particular, the following concerns were noted.
ADC Loans and Other Mortgage-Backed Securities Concentrations. Security Savings’ asset quality problems were exacerbated by the bank’s rapid growth, emphasis in high-growth and dispersed national markets, and concentrations in ADC loans that were acquired from and serviced by others. In addition, the bank held concentrations in lower-quality securities that were not backed by the U.S. Government. Specifically, as of December 2008, the bank’s ADC loans totaled 495 percent of total capital and its portfolio of Other Mortgage-Backed Securities3 totaled 461 percent of total capital. Further, Security Savings’ management permitted these loan and security concentrations to exist without adequate risk identification, measurement, monitoring, and control. As shown in Figure 1, which follows, the bank’s ADC loans began to increase significantly in 2005 and exceeded the bank’s peer group averages. In addition, the bank’s concentrations in Other Mortgage-Backed Securities began in 2004, and equaled 224 percent of total capital as of December 2004. Both categories of assets remained major product segments into 2008.
Figure 1: ADC Loan Concentrations (Loans as a Percentage of Total Capital)
* The re-growth of the concentration level in 2008 is the result of increasing losses and declining capital levels, rather than asset growth.
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Also of note, the FDIC issued joint guidance titled, Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices, dated December 12, 2006 (2006 CRE Guidance), which emphasized the need for increased supervisory concern for those banks with significant CRE concentrations, and especially for institutions that focus on ADC lending.
In particular, the 2006 CRE Guidance defined significant concentrations, in part, as total ADC loans representing 100 percent or more of total capital.
Volatile Liability Funding Dependence. Security Savings’ management employed a funding structure that was centered on high-cost, potentially volatile funds to support its rapid-growth strategy. The bank’s funding structure relied on wholesale and high-cost funding sources, including:
Further details on the bank’s funding sources are presented in Table 2, which follows.
Table 2: Funding Sources
As stated in the DSC Risk Management Manual of Examination Policies (DSC Examination Manual), a heavy reliance on potentially volatile liabilities to fund asset growth is a risky business strategy because the availability and access to these funds may be limited in the event of deteriorating financial or economic conditions, and assets may need to be sold at a loss in order to fund deposit withdrawals and other liquidity needs. Management did not establish policies or controls that adequately limited or mitigated the level of risk related to these activities.
A bank’s net non-core dependency ratio indicates the degree to which the bank is relying on non-core/volatile liabilities to fund long-term earning assets. Generally, a lower ratio reflects less risk exposure, whereas higher ratios indicate greater risk exposure and a reliance on funding sources that may not be available in times of financial stress or adverse changes in market conditions. For the years ended December 2004 to December 2008, the bank’s net non-core dependency ratio indicated that the bank was moderately to highly dependent on volatile funding, as shown in Table 3.
Table 3: Net Non-Core Fund Dependence Ratios
a PCT represents the bank’s percentile ranking within the bank’s designated peer group average.
b As an ILC with assets greater than $100 million, the bank could not accept transaction accounts. This restriction could result in a net non-core funding dependence ratio for ILCs that is (on average) inherently higher than other (non-ILC) charter types.
The bank also increased its funding risk through the use of (1) high-rate and Internet core deposits and (2) long-term repurchase agreements.
Table 4: Cost of Deposits
a Peer Diff. represents the difference between the bank’s rate and the peer group average’s rate. This difference provides an indication of which deposit products are potentially “brokered like.” For this assessment, a benchmark of 75 basis points is typically used.
bPCT represents the bank’s percentile raking within the bank’s designated peer group average.
cCustom Peer Diff. represents the difference between the bank’s rate and the custom (designated by the bank’s charter type) peer group average’s rate.
below the PCA capital designation of Well Capitalized and/or was placed under a Cease and Desist Order (C&D) with a capital provision, the bank was in default of the repurchase agreements and subject to the $4 million charge described above. As of December 2008, the breakage fee represented 83 percent of the bank’s Tier 1 Capital.
OVERVIEW AND ASSESSMENT OF FDIC SUPERVISION
Over the life of Security Savings, the FDIC provided supervisory oversight in many areas, including risk management examinations, visitations, and offsite monitoring.Overview of FDIC Supervision
The FDIC and NFID performed joint safety and soundness examinations of Security Savings in compliance with the examination frequency requirements of the FDI Act. Since Security Savings’ inception in 2000, the FDIC and NFID conducted a total of eight examinations and two visitations. After the bank underwent a change in control in September 2004, the FDIC and NFID conducted four examinations, as shown in Table 5, which follows. Security Savings’ composite rating was downgraded to a 3, indicating increasing risk, in the June 2007 ROE. As a result of the July 2008 examination, Security Savings’ composite rating was downgraded to a 5, indicating extremely unsafe and unsound practices or conditions, critically deficient performance, and inadequate risk management practices. Also of note, the FDIC performed the June 2006 and June 2007 examinations under challenging circumstances due to bank management’s uncooperative behavior and adversarial demeanor.
Table 5: Examination History of Security Savings
* Financial institution regulators and examiners use the Uniform Financial Institutions Rating System (UFIRS) to evaluate a bank’s performance in six components represented by the CAMELS acronym: Capital adequacy, Asset quality, Management practices, Earnings performance, Liquidity position, and Sensitivity to market risk. Each component, and an overall composite score, is assigned a rating of 1 through 5, with 1 having the least regulatory concern and 5 having the greatest concern.
As a result of these examinations, the FDIC took various supervisory actions. In particular, within the ROEs, the FDIC made specific recommendations to Security Savings related to areas of its operations where improvements were needed. In the May 2005 to July 2008 ROEs, the FDIC recommended varying enhancements and/or improvements to the bank’s allowance for loan and lease losses (ALLL) methodology, ALLL position, identification
and monitoring of concentrations, and internal/external audit programs. In the June 2006 ROE, the FDIC also largely identified the bank’s securities portfolio weaknesses and recommended various policy improvements.
Further, when the bank’s adversely classified loans began to significantly increase, as reported in the June 2007 ROE, the FDIC identified more significant concerns with, and recommended improvements to, the bank’s management and BOD supervision, loan underwriting and administration, ongoing assessment of the bank’s securities portfolio, and volatile liability funding.
Supervisory action was effective in reducing certain risks and in mitigating losses to the DIF. During the June 2007 examination, these actions included the identification and resolution of a significant violation of FRB Regulation 23A, related to covered transactions with affiliates. Examiners identified an affiliated relationship that existed between the bank and a non-bank financial institution that bank management failed to fully disclose. As a result, examiners caused the removal of $26 million in loan participations from the bank’s loan portfolio. Of the $26 million, the FDIC estimated that 50 percent of the loan balances outstanding would have been classified as loss had they remained with Security Savings. Another supervisory action included the examiners’ convincing bank management to halt Security Savings’ continued growth of ADC lending and investment in lower-grade securities.
Further, to address examiner concerns as documented in the June 2007 ROE, including apparent violations of laws and regulations, inadequate risk management controls, and other safety and soundness issues, the bank adopted a Bank Board Resolution (BBR) on July 19, 2007. Subsequently, the FDIC and NFID determined that a Memorandum of Understanding (MOU) would be more appropriate. The MOU became effective in May 2008 and contained 15 provisions addressing: management, capital, commercial real estate concentrations, the ALLL methodology, adversely classified assets, the strategic business plan, violations, investment and related-party transactions, and restrictions on non-agency mortgage-backed securities. The MOU also required Security Savings to maintain a Tier 1 Leverage Capital ratio of at least 9.75 percent, and for management to develop a plan to monitor and reduce the CRE loan portfolio concentration to 250 percent of total risk-based capital. In addition, the MOU contained a provision that addressed the bank’s management, stating:
… the Bank shall retain management acceptable to the Regional Director… Such management must include a chief executive officer and an appropriate number and type of senior officers, with the requisite knowledge, skills, ability, and experience…
According to the July 2008 ROE, the BOD hired a chief operating officer, a compliance officer, two additional asset managers, and two new information technicians. In addition, an outside consultant was hired to review bank management. The ROE also noted that the core executive management team remained the same and that the BOD did not have the power to employ or terminate an executive officer without unanimous consent of the BOD, of which the
bank’s executive managers were members. Based on the FDIC’s actions, the BOD obtained the power to hire and terminate executive management by a majority vote. Following the July 2008 examination, the executive management team was replaced.
The FDIC’s final supervisory action before the bank was closed was the issuance of a C&D on February 3, 2009.Assessment of FDIC Supervision
Although the FDIC’s supervision was comprehensive and effective in mitigating certain losses to the DIF, we concluded that the Corporation could have performed certain additional analysis, exercised greater supervisory concern, and taken additional action to help mitigate the potential level of losses incurred.
ADC Loan Portfolio. In retrospect, the FDIC did not recognize the extent to which Security Savings had ADC loan underwriting and credit administration weaknesses on a timely basis. Beginning in 2005, management began purchasing higher yielding and higher-risk ADC loans. As noted previously, some of these loans were mezzanine loans, and 22 percent of the bank’s total loan portfolio contained interest rates exceeding 10 percent, rates that were significantly higher than its competitors. Although these loans were in the bank’s portfolio since the middle of 2005, the volume of higher yielding and higher-risk ADC loans was not raised as a concern until the June 2007 examination. Examiners told us that these loans were not raised as a concern due, in part, to the loans being current, relatively new, and/or unseasoned. However, based on our review of the June 2006 examination work papers, we noted that 5 of 15 ADC loans that were not adversely classified contained potential areas of concern, including apparent project delays and/or questionable collateral valuations.6
The FDIC also reported on numerous loan underwriting and administration deficiencies involving the bank’s policies and procedures in the June 2007 examination. These weaknesses included such areas as the following:
Had these issues been identified earlier, then FDIC could have taken earlier actions to reduce and/or mitigate the level of Security Savings’ risk.
Other Mortgage-Backed Securities Portfolio. In the June 2006 ROE, the FDIC identified the excessive risk and weaknesses within Security Savings’ securities portfolio and recommended to Security Savings various critical policy and procedural improvements. Specifically, the ROE cited a contravention of the Supervisory Policy Statement on Investment Securities and End-User Derivatives, noting that the BOD had not established risk tolerances for the type and quality of investments, criticizing the lack of independence within the investment function, and stating that the pre-purchase analysis should be strengthened and that this information should be provided to the board. However, it was not until the June 2007 examination that the FDIC recommended that bank management perform a more comprehensive (on-going) review of the higher-risk securities – beyond a verification of the ratings assigned. Had bank management developed a more comprehensive risk management process, it could have better anticipated and reacted to changing market conditions. For example, management could have discontinued its purchase of these higher-risk securities, or mitigated risk by selling securities in its portfolio or increasing capital. Security Savings purchased its last Other Mortgage-Backed Security in September 2006. However, bank management did not formally commit to halt its investment practices until May 2008 – in response to the June 2007 ROE and May 2008 MOU – and examiners continued to report managerial weaknesses over the bank’s investment portfolio until just before the bank’s failure.
The FDIC subsequently issued a FIL titled, Risk Management of Investments in Structured Credit Products, dated April 2009. The guidance re-emphasizes to banks the importance of monitoring the underlying collateral performance in structured investments. The guidance states:
Institution must understand not only an investment’s structural characteristics, but also the composition and credit characteristics of the underlying collateral. Management should conduct analysis at both the deal and pool level using information that sufficiently captures collateral characteristics. Such analysis should be conducted prior to acquisition and on an ongoing basis to monitor and limit risk exposures.
Volatile Liability Dependence. Since the May 2004 examination, the FDIC reported on the bank’s level and trend of net non-core funding. Although the bank’s net non-core funding dependence ratio fluctuated from a moderate level of 37 percent to a high of 73 percent, the FDIC noted that the bank’s volatile liability dependence risk was mitigated based on one or more of the following:
Notwithstanding the above mitigating factors, the FDIC could have expressed a greater level of concern when the bank’s net non-core funding dependence ratio was reported at 73 percent in the May 2005 ROE and 70 percent in the June 2006 ROE. In addition, based on our review of the 2004 Change of Control Business Plan, the clarity of the bank’s future risk profile was not clearly established, and should not have been used as a mitigating factor. In particular, the volume of higher-risk ADC loans was understated and residential loans were overstated, the quality of investment grade securities was not detailed, and the use of long-term repurchase agreements was not discussed or accounted for within the bank’s projected borrowings.
Further, the FDIC could have required the bank to improve its Asset/Liability Management Policies with regard to establishing reasonable volatility risk limits and creating/improving its contingency liquidity plan7 to help mitigate the risk earlier. The FDIC did not require the bank to reduce its dependence on potentially volatile funding sources, set reasonable limits, or require the development of, or improvements to, a contingency liquidity plan until the July 2008 examination.
Long-Term Repurchase Agreements. Until the July 2008 examination, the FDIC did not review for, and the bank did not perform, a formal pre-purchase analysis of the bank’s long-term repurchase agreements. Based on the sequence of transactions, one long-term repurchase agreement was initiated before, and two were initiated after, the completion of the June 2006 examination. However, during the June 2006 examination, the FDIC did not identify or assess the nature of the bank’s repurchase agreements. As a result, the excessive and uncontrolled risk posed, in particular, by the long-term maturities of the agreements and breakage fees was undetected. As discussed earlier, the DSC Examination Manual discusses the risky nature of these long-term agreements. In addition, the Liquidity Examination Documentation Module suggests that examiners assess the reasonableness of the bank’s use of wholesale and rate-sensitive funding sources, in part, by identifying and evaluating the sources, terms, and embedded options of all significant borrowings or market instruments (such as repurchase agreements) and by determining the extent and use of those funds. If the FDIC had reviewed for and detected these risks earlier, then the latter two transactions could have been halted and/or more conservative funding agreements urged. As a result, the FDIC could have prompted the bank to reduce its potential funding risk and loss exposure.
IMPLEMENTATION OF PCA
The purpose of PCA is to resolve problems of insured depository institutions at the least possible long-term cost to the DIF. PCA establishes a system of restrictions and mandatory and discretionary supervisory actions that are to be triggered depending on an institution’s capital levels. Part 325 of the FDIC’s Rules and Regulations implements PCA requirements by establishing a framework for taking prompt corrective action against insured nonmember banks that are not adequately capitalized.
PCA had limited impact in mitigating the bank’s losses, because Security Savings was not categorized as Critically Undercapitalized until just prior to its failure. Specifically, based on the FDIC’s analysis of the December 31, 2008 Call Report filed on January 30, 2009, the FDIC calculated the bank’s key capital ratios as follows:
Under PCA provisions in Part 325 of the FDIC’s Rules and Regulations, a Tangible Equity Capital ratio at or below 2 percent reflects a Critically Undercapitalized capital category. As a result, on February 5, 2009, the FDIC presented Security Savings’ BOD with a PCA Notification of Capital Category letter that notified the bank of its Critically Undercapitalized capital category. In addition, the letter notified bank management that Security Savings was required to submit a capital restoration plan, was subject to certain mandatory restrictions, and was required to obtain the FDIC’s written approval before engaging in certain activities.
Subsequent to the June 2007 examination, Security Savings did attempt to obtain additional capital to strengthen the bank’s balance sheet. Specifically, the bank identified potential investor groups willing to provide capital. However, according to senior officials in the FDIC’s San Francisco Regional Office, the FDIC ultimately determined with the concurrence of the NFID that such sources were not viable or appropriate solutions to address the bank’s worsening financial condition.
It should be noted that 2 days prior to the bank’s official PCA notification of Capital Category, the bank was subject to a formal action that contained a capital provision. Specifically, based on the results of the July 2008 examination, the FDIC and NFID issued a joint C&D on February 3, 2009 that contained a capital provision that directed Security Savings to maintain its Tier 1 Leverage Capital ratio to 10 percent. As a result of the C&D provision, Security Savings was subject to certain PCA restrictions, including those related to increasing the amount of brokered deposits.
CORPORATION COMMENTS AND OIG EVALUATION
After we issued our draft report, we met with management officials to further discuss our results. Management provided additional information for our consideration, and we revised our report to reflect this information, as appropriate. On September 16, 2009, the Director, DSC, provided a written response to the draft report. That response is provided in its entirety as Appendix 3 of this report.
DSC reiterated the OIG’s conclusions regarding the cause of Security Savings’ failure. With regard to our assessment of the FDIC’s supervision of Security Savings, DSC summarized several supervisory actions taken in relation to the institution’s activities. DSC also noted that a well-managed balance sheet with a diversified asset portfolio is a sound banking practice, and that effective supervision is necessary in the early stages for institutions developing asset concentrations or reliance on volatile funding. In that regard, DSC stated that it has issued updated guidance reminding examiners to take appropriate supervisory action when capital levels are inadequate for CRE concentrations or funding risks are imprudently managed.
OBJECTIVES, SCOPE, AND METHODOLOGY
We performed our audit field work at the OIG offices in Arlington, Virginia.Internal Control, Reliance on Computer-processed Information, Performance Measurement, and Compliance with Laws and Regulations
Consistent with the audit objectives, we did not assess DSC’s overall internal control or management control structure. We relied on information in DSC systems, reports, ROEs, and interviews of examiners to understand Security Savings’ management controls pertaining to causes of failure and material loss as discussed in the body of this report.
We obtained data from various FDIC systems but determined that information system controls were not significant to the audit objectives, and therefore, did not evaluate the effectiveness of information system controls. We relied on our analysis of information from various sources, including ROEs, correspondence files, and testimonial evidence to corroborate data obtained from systems that were used to support our audit conclusions.
The Government Performance and Results Act of 1993 (the Results Act) directs Executive Branch agencies to develop a customer-focused strategic plan, align agency programs and activities with concrete missions and goals, and prepare and report on annual performance plans. For this material loss review, we did not assess the strengths and weaknesses of DSC’s annual performance plan in meeting the requirements of the Results Act because such an assessment was not part of the audit objectives. DSC’s compliance with the Results Act is reviewed in OIG program audits of DSC operations.
Regarding compliance with laws and regulations, we performed tests to determine whether the FDIC had complied with the provisions of PCA and limited tests to determine compliance with certain aspects of the FDI Act. The results of our tests were discussed where appropriate in the report. Additionally, we assessed the risk of fraud and abuse related to our objectives in the course of evaluating audit evidence.
GLOSSARY OF TERMS
|Adversely Classified Assets||Assets subject to criticism and/or comment in an examination report. Adversely classified assets are allocated on the basis of risk (lowest to highest) into three categories: Substandard, Doubtful, and Loss.|
|Allowance for Loan and Lease Losses (ALLL)||Federally insured depository institutions must maintain an ALLL that is adequate to absorb the estimated loan losses associated with the loan and lease portfolio (including all binding commitments to lend). To the extent not provided for in a separate liability account, the ALLL should also be sufficient to absorb estimated loan losses associated with off-balance sheet loan instruments such as standby letters of loan.|
|Cease and Desist Order (C&D)||A C&D is a formal enforcement action issued by a financial institution regulator to a bank or affiliated party to stop an unsafe or unsound practice or a violation of laws and regulations. A C&D may be terminated when the bank’s condition has significantly improved and the action is no longer needed or the bank has materially complied with its terms.|
|Concentration||A concentration is a significantly large volume of economically related assets that an institution has advanced or committed to a certain industry, person, entity, or affiliated group. These assets may, in the aggregate, present a substantial risk to the safety and soundness of the institution.|
|Prompt Corrective Action (PCA)||
The purpose of PCA is to resolve the problems of insured depository
institutions at the least possible long-term cost to the DIF. Part 325, subpart B,
of the FDIC Rules and Regulations, 12 Code of Federal Regulations, section
325.101, et. seq., implements section 38, Prompt Corrective Action, of the FDI
Act, 12 United States Code section 1831o, by establishing a framework for
taking prompt supervisory actions against insured nonmember banks that are
less than adequately capitalized. The following terms are used to describe
capital adequacy: (1) Well Capitalized, (2) Adequately Capitalized,
(3) Undercapitalized, (4) Significantly Undercapitalized, and (5) Critically
A PCA Directive is a formal enforcement action seeking corrective action or compliance with the PCA statute with respect to an institution that falls within any of the three categories of undercapitalized institutions.
|Uniform Bank Performance Report (UBPR)||The UBPR is an individual analysis of financial institution financial data and ratios that includes extensive comparisons to peer group performance. The Federal Financial Institutions Examination Council produces the report quarterly, from banks’ Call Report data, for use by banking supervisors, bankers, and the general public.|
September 16, 2009
Pursuant to Section 38(k) of the Federal Deposit Insurance Act (FDI Act), the Federal Deposit Insurance Corporation’s Office of Inspector General (OIG) conducted a Material Loss Review of Security Savings Bank (Security), which failed on February 27, 2009. This memorandum is the response of the Division of Supervision and Consumer Protection (DSC) to the OIG’s Draft Audit Report (Report) received on August 28, 2009
The OIG found that Security failed primarily due to management’s pursuit of rapid growth in Acquisition, Development, and Construction (ADC) loans and lower quality mortgage-backed securities, funded with higher cost core deposits and volatile wholesale sources. With the significant real estate price declines in Florida and Nevada, two of Security’s primary markets, and general economic downturn that accelerated in 2007, operating losses eroded earnings and capital, straining liquidity to the magnitude that led to capital insolvency and ultimately failure.
The Report concludes that the FDIC and Nevada Department of Business and Industry, Financial Institutions Division (NFID) made specific recommendations and took various supervisory actions related to improving Security’s operations as early as 2005. Furthermore, the Report notes that supervision was effective in reducing certain risks through the issuance of an enforcement action following the 2007 examination. This action halted the growth of ADC lending and investments in lower-graded securities. Examiners also identified a significant regulatory violation, resulting from transactions with a previously unreported affiliate, which resulted in the removal of $26 million in loan participations from Security’s portfolio, thereby mitigating the ultimate loss to the Deposit Insurance Fund.
A well managed balance sheet with a diversified asset portfolio is a sound banking practice. Effective supervision is necessary in the early stages for institutions developing asset concentrations or reliance on volatile funding. DSC has issued updated guidance reminding examiners to take appropriate supervisory action when capital levels are inadequate for CRE concentrations or funding risks are imprudently managed.
Thank you for the opportunity to review and comment on the Report.
ACRONYMS IN THE REPORT
|ADC||Acquisition, Development, and Construction|
|ALLL||Allowance for Loan and Lease Losses||BBR||Bank Board Resolution|
|BOD||Board of Directors|
|C&D||Cease and Desist Order|
|CAMELS||Capital, Asset Quality, Management, Earnings, Liquidity, and Sensitivity to Market Risk|
|CRE||Commercial Real Estate||DIF||Deposit Insurance Fund|
|DRR||Division of Resolutions and Receiverships|
|DSC||Division of Supervision and Consumer Protection|
|FDI||Federal Deposit Insurance|
|FHLB||Federal Home Loan Bank|
|FIL||Financial Institution Letter|
|FRB||Federal Reserve Board|
|ILC||Industrial Loan Company|
|MOU||Memorandum of Understanding|
|NFID||Nevada Department of Business and Industry, Financial Institutions Division|
|OIG||Office of Inspector General|
|PCA||Prompt Corrective Action|
|ROE||Report of Examination|
|UBPR||Uniform Bank Performance Report|
|UFIRS||Uniform Financial Institution Rating System|
|Last updated 11/23/2009|