First NBC Bank: Implications of Material Loss Review
On November 3, 2017, the Office of the Inspector General (“OIG”) of the Federal Deposit Insurance Corporation released its report (“OIG review”) in respect of the failure of First NBC Bank, New Orleans, Louisiana (“First NBC”). The objectives of the OIG review were (1) to determine the causes of the First NBC’s failure and resulting loss to the Deposit Insurance Fund and, (2) evaluate the FDIC’s supervision of First NBC over the course of First NBC’s problems. The causes of the failure of First NBC contained many of the characteristics of bank failures identified in prior material loss reviews: (1) a dominant executive with broad lending authority and limited board of directors’ oversight, (2) rapid growth funded by high-cost deposits, and (3) large lending relationships in concentrations without adequate risk management controls. In addition, First NBC developed concentrations in trade receivables and complex tax credit investments. The losses incurred on the latter severely diminished earnings and depleted capital to a point that First NBC was unable to recover. However, it is the warning telegraphed by the second prong of the review – the FDIC supervision of First NBC - that should concern bankers.
Between First NBC’s opening in 2006 and its closure in 2017, there were nine full-scope joint safety and soundness examinations and six visitations by the FDIC and Office of Financial Institutions of the State of Louisiana. Although examiners identified repeated risk management weaknesses, the examination staff relied heavily on First NBC’s financial condition and ability to raise capital in taking supervisory action and in assigning management and asset quality ratings. The FDIC used four board resolutions from 2009 to 2015 to address examination findings and matters requiring board attention (MRBA). MRBAs are used to communicate concerns that require the attention of the board or senior management. These are a subset of supervisory recommendations and signal a significant level of concern. Supervisory recommendations are not formal or informal in force of an action, but they are communications of the FDIC’s expectation of banks. When unacceptable practices are detected early, the examiners should bring these matters to the attention of management and discuss the problematic areas and potential corrective actions. The OIG found that the MRBAs raised in 2009 and 2010 were never effectively addressed or were subject to repeat criticisms and ultimately contributed to First NBC’s failure.
The OIG determined that reliance on board resolutions and MRBAs was largely ineffective in correcting the issues raised and stronger enforcement action such as a Memorandum of Understanding was warranted as early as 2010 based on First NBC’s risk profile. Formal action was not taken until late 2016.
The OIG determined that the FDIC should have set a strong supervisory tone by pursuing more formal action. Examiners reported continued concerns with bank management and asset quality from inception through 2015, but assigned improved ratings to both areas in 2011 and 2014, the years that First NBC received significant capital injections. First NBC’s rapid growth, reliance on volatile funding and concentrations in risky loans and complex investments warranted a more critical assessment of the Chief Executive Officer’s influence on First NBC’s activities. The OIG could not identify any significant improvements in First NBC’s adversely classified asset trends during the 2011 and 2014 examinations that would warrant an increase in the asset quality rating. Further, the asset quality ratings did not reflect the complex nature of the assets.
Bankers should take heed of the following quote from the OIG review:
When actions do not achieve the desired result or if the initially identified problems are more serious, FDIC guidance states that the issuance of an informal or even formal corrective action may be warranted. This may be the case even when an institution is rated a composite “1” or “2” for safety and soundness examinations so that the specific actions or inactions by the financial institutions can be addressed and corrected.
Despite the perceived change in the current regulatory environment, this OIG review is likely to signal to examination staff that there should be less reliance on MRBAs and board resolutions to address examination issues and that staff should move earlier toward a Memorandum of Understanding or formal enforcement action to ensure correction of repetitive examination issues.