ProPublica

Journalism in the Public Interest

Chronicle of a Bank Failure Foretold

Ethan Miller/Getty ImagesFor years, Federal Deposit Insurance Corporation examiners warned Nevada-based Silver State Bank against the bad management practices that led to the bank’s spectacular collapse in September, yet the regulators failed to back up their concerns with concrete enforcement, according to a report released yesterday by the FDIC’s inspector general. Silver State’s demise took an estimated $553 million bite out of the fund the FDIC uses to cover insured deposits when banks fail.

The 38-page report echoes many of the conclusions ProPublica reached in its January story, “The Small Bank Bust.” Silver State focused its lending on high-risk commercial real estate loans fueled in part by a risky deposit base. The bank more than doubled in size in the space of a few years before collapsing from bad loans and fleeing depositors.

Many of the bank’s largest problem loans were pursued by the bank’s executive vice president for real estate lending who, in what the report describes as an “unusual” arrangement for an executive officer, received commissions on the business he brought into the bank. “These compensation arrangements did not emphasize loan quality,” the report said.

The bank’s vice president for commercial real estate lending was Douglas French. He could not immediately be reached for comment, but in January, French told ProPublica that he couldn’t have prevented the bank’s collapse.

“I was hired to be a real estate lender,” French said then. “I wasn’t in a position to say, ‘Hey, we are going to stop this.’”

Silver State also misused a common form of financing called “interest reserves,” where the bank gives the borrower both the principal and the interest on a loan and then books the interest as revenue.

The FDIC is collecting lessons from the collapse of Silver State and other banks for a larger report that will highlight common problems that led to the banks’ failures and the breakdowns in enforcement that contributed to them. The inspector general is required to investigate agency-examined banks whose failure causes a “material loss” to the FDIC’s deposit fund.

Examiner concerns about Silver State’s board of directors and management surfaced as early as January 2002 and continued through June 2008, according to the inspector general’s report. Former Silver State executives told ProPublica in January that the FDIC expressed misgivings about the bank’s business model. But despite the repeated warnings, the agency failed to get tougher on enforcement.

“[E]xaminers did not assertively address examination findings that were repeated areas of concern,” the report states. “[W]hen needed, a more progressively stringent supervisory tone was not presented in the [reports of examinations], and actions were not taken.”

Bank examinations are confidential, and in January the FDIC declined to explain to ProPublica why its examiners appeared to do nothing to stop Silver State from flaming out. The inspector general’s report now reveals the missing piece of the story.

In the report, Sandra Thompson, the FDIC’s director of supervision and consumer protection, the division that examines banks, responded to the inspector general’s criticism by citing Silver State’s bad practices as the reason for its failure. She also explained that its demise happened quickly. Much of the damage occurred after the FDIC held its annual examination of the bank in May 2007, when Silver State took in more risky deposits. It used those deposits to make further bad loans even as the Las Vegas-area real estate market softened, “contributing to its ultimate failure,” Thompson wrote.

The inspector general was not swayed by the explanation.  

“Nonetheless, our view remains that DSC could have exercised greater supervisory concern in the 2007 and prior examinations regarding SSB’s management, asset quality and liquidity and taken additional action to address both the conditions and risks in these areas,” the inspector general responded.

Thompson also listed a series of actions that her division has taken to deal with the problems revealed by Silver State’s failure. Most focus on new instructions to examiners and banks on best practices. The only increased enforcement she cites dates to November and December 2008, when examiners “conducted on-site visitations of certain banks in Georgia, Florida, and California” that had high concentrations of commercial real estate acquisition, development and construction loans. These are the loans in which Silver State specialized.

The inspector general highlighted other problems at Silver State that have turned up at other failed institutions, including risky deposits, interest reserves and failure to account properly for reserves needed to cover loan losses.

I have to agree with French’s comment, “I was hired to be a real estate lender,”
French followed the rules of the market.  The rules were loosened. Do you expect him to say, “I won’t do my job, because I don’t agree with the rules”?
s long as he did not do anything illegal, he cannot be faulted.  When Congress makes bad laws, like loosening credit terms for high risk borrowers, we should expect that the market will follow those rules, because they become the law.  Thus it makes no difference that the bank invested in development rather than mortgages, because if credit rates had not been lowered, the demand for development would not have increased as it did.  I do not disagree with the bank being at fault on the risky deposits, but none of this would have happened if Congress had not changed the rules.

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