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It is sad when any bank fails.  But Guaranty Bank’s failure on Friday, May 5, 2017 was tragic.

The Bank loyally served an underserved population.  107 of its 119 branches were primarily located in grocery and convenience stores in the inner cities of Milwaukee, Chicago, Detroit, Atlanta, and Minneapolis.  When the acquirer of the Bank’s assets and deposits took over on May 5, all 107 branches and their ATMs were closed.  Overnight, many who depended on those ATMs and branches lost their only banking alternative other than the pay-day lender.

In the past 34 months alone, the Bank had assisted more than 25,000 individuals either in obtaining a FICO score or materially increasing their FICO score.  It has received a number of Bank Enterprise Awards from the U.S. Treasury for its service to its communities.

Nearly sixty percent of the Bank’s employee base was minority.  Most of those jobs have disappeared or soon will.

Guaranty’s management and Board worked tirelessly for many years to turn the Bank around.  The Bank and its investment advisor believed that it was within 30 days of recapitalizing with up to $100 million, bringing the Bank back to well-capitalized status.

Its problems started in 2008 or 2009 when its large home equity loan portfolio began to decline in asset quality.  Although the Bank had prudently purchased private insurance against default of the loans, the carriers reneged on their obligations.  The Bank sued, and was successful in obtaining some large judgments or settlements, but not enough to enable the Bank to return to its previous well-capitalized status.

For years, the Bank labored under the constraints of the Prompt Corrective Action (“PCA”) authority of the OTS, then OCC in 2011 following the OCC’s assumption of OTS’s supervisory responsibilities.

This meant that any new lines of business and a variety of other activities in which banks normally engage in the ordinary course of business had to be preapproved by the regulators.  Many opportunities to increase earnings had to be approved.  Opportunities were lost because of that process.  Millions of dollars of projected earnings that would have hastened the Bank’s recovery and recapitalization were not realized.

Nonetheless, the Bank continued to achieve what Congress intended to happen under PCA – to resolve the problems of insured depository institutions “at the least possible long-term loss to the Deposit Insurance Fund.”

The Bank estimated that if it had been closed in 2009, the Deposit Insurance Fund (“DIF”) would have suffered a loss of about $740 million.  By the end of March 2017, the Bank’s estimate was $23 million.

The Bank had accomplished this through de-risking of the loan portfolio and booking new loans that had performed extremely well.

The Bank’s financial condition was dramatically improving and the economy was continuing to improve.  For the six months through the March 2017 quarter, the Bank had net profits of $2.2 million.  The Bank projected a net profit for all of 2017 of $3.6 million.

The Bank successfully reduced loan charge offs.  For the six months ending March 31, 2017, the Bank’s charge offs were $133,000; for the six months prior to that, $400,000; and for the six months prior to that, $1.6 million.  The Bank had not written off any loans booked since 2013 and the delinquencies on those loans were 0.17% of those loans.

The Bank’s non-performing assets (“NPAs”) were greatly diminished, uninsured past due non-performing assets (“NPAs”) were substantially lower than they had been in many years, and its Allowance for possible loan and lease losses (“ALLL”) was reviewed by a national public accounting firm prior to filing the March 31, 2017 Call Report and found to be appropriate under GAAP.

Other than a low level of capital, which the Bank had experienced for the entire six year period that it had been subject to OCC’s Special Supervision (“SPSU”) oversight, the Bank resembled, at the time of closing, many banks that remain in business.

The Bank’s capital plan called for exactly what actually occurred.  The Plan was to continue to de-risk the loan portfolio, replacing bad loans with good loans, operate efficiently, and achieve consistent operating profits.  Then it would be able to recapitalize.

While it lost money in 2016, that loss was a result of extraordinary write downs that were legitimately disputed by the Bank.  And those losses were a fraction of what the Bank lost in 2012.

Once the Bank had achieved substantial de-risking of the loan portfolio and an operating profit, it was positioned for the recapitalization.

It retained Hovde Group in March 2017 to raise $80-$100 million in new capital.  Hovde obtained conditional commitments from two highly regarded private equity firms totaling $50 million.  Additional commitments were expected the week of May 8, 2017.  The investors were to meet with the Bank to go over the terms of the investment.  Hovde deemed the success of the recapitalization probable.

This was a success story in the making.  The PCA authority that Congress granted to the agencies in 1991 was working.  The Bank had successfully de-risked its portfolio, substantially reducing the potential losses to the DIF while positioning itself for a successful recapitalization.  The successful resolution was near.

But on Friday, May 5, 2017, the OCC closed the Bank.

The law did not require the OCC to close the Bank.  The OCC chose to.

The law requires the OCC to close a bank at some point only if the bank becomes critically undercapitalized.  The Bank was not.

The Bank was like a marathon runner finishing the 26th mile, and then collapsing within 385 yards of the finish line, but not because of anything it did wrong.

In a press release announcing the closing, the OCC provided several reasons why it closed the Bank.  On closer inspection, none of these reasons would have justified its closing as of the date of closing.

The OCC stated that the Bank was closed because there was a substantial dissipation of assets or earnings.

There has been no substantial dissipation of assets.  The Bank has had about $1 billion in assets for a number of years.

Over many years, the Bank lost millions of dollars; but it wasn’t closed for that reason earlier – for example, in 2012, the Bank lost $28 million and its core capital ratio dropped to about 1%.  As mentioned, during the six months ending March 31, 2017, the Bank had a profit of $2.2 million.  It was heading up, not down.

The OCC also asserted that the losses were a result of unsafe or unsound banking practices.

The Bank believed that the losses derived mainly from the ill-fated home equity loan portfolio.   When originated, the loans in that portfolio were made consistent with safe and sound banking practices.  It was the refusal of the insurance carriers to honor their commitments to pay upon default that caused the losses.

The OCC press release also stated that the Bank did not have a Capital Restoration Plan (“CRP”) that was accepted by the OCC.

But that really is not meaningful as a reason to close a bank.

Our experience has been that most undercapitalized banks have not had their CRPs accepted by the OCC or the other agencies until they were virtually recapitalized.  That is not what the PCA statute requires, but that is a widespread regulatory practice – don’t accept CRPs until the bank can prove without a doubt that it will recapitalize.

The absence of an acceptable CRP had no significance other than a convenient statutory ground to close the Bank.  The Bank was operating under its own capital plan, and was successful at implementing it – minimizing risk, returning to profitability, then attracting new capital.

The most significant issue with the language of the press release is not what was stated but what was not stated.

Unlike most press releases announcing a bank closing, the OCC did not include language stating that there was “no reasonable prospect that the Bank would become adequately capitalized.”

The OCC could not have asserted that because the Bank did have a reasonable prospect to become adequately capitalized, and soon.

The trajectory of almost all banks that fail is down.  They continue to lose money and if they are not already critically undercapitalized, they are likely to become so. Their local and regional economies are weakening.  The prospects of raising capital are dim.

In order to reduce potential losses to the DIF, the OCC closes those banks, sometimes even before they reach critically undercapitalized status.

Guaranty Bank was on the opposite trajectory.  Waiting 30-60 days to find out whether it could recapitalize would likely have cost the DIF nothing, and might have actually benefited the DIF.  By closing the Bank, the losses to the DIF are now estimated by the FDIC to be over $147 million.

So why then did the OCC decide to close the Bank at that moment of time?

What were the hidden, unstated motivations for the decision?  Was it concern over possible criticism from the Treasury Inspector General that the OCC had left the Bank in an undercapitalized status for too long?  Was it retribution or bias?  Was it simply irrational?

Guaranty Bank should now become a case study for how not to supervise an undercapitalized bank.

The case of Guaranty Bank should be scrutinized not because the Bank will ever be reconstituted.  The community and bank employees will never get their bank back.

But a review of what happened may help Congress to identify weaknesses in how the banking agencies are implementing their PCA authority.

It may also allow struggling banks to recover more readily and avoid being closed.

Over 500 banks (almost entirely community banks) failed during and immediately following the Great Recession.  About 1800 failed during the S&L crisis.  How many could have survived had the agencies properly supervised them?

While the effects of the Great Recession on American banks are largely gone, there is no doubt that we will experience other recessions.  Banks do not do well in recessions.  With recessions, there will be perfectly healthy banks that will suddenly find themselves with high non-performing assets, losses, and low capital.  It is these banks that need the full support of the banking agencies to recover when the time comes.

The OCC should conduct its own independent investigation.  So should the Treasury IG and one or more of the oversight committees of the US Congress.

What should the investigation consider?

The decision-making process.  Who made the decision to close Guaranty Bank and on what basis?  How about other banks?

It is not a question of whether OCC had the authority to close the Bank.  The statutory authority to close banks is broad.  Twenty separate bases exist.  See Appendix I.  We believe that a majority of the banks in the country could be closed at any time based on one or more of the grounds.

The question is whether a bank should be closed.  Will it likely cost the DIF more if it is not closed immediately?

In recent years, to our knowledge, the decision to close a national bank (and since 2011, a federal savings association) has not been made by the Comptroller of the Currency even though the statute authorizing the closing of such banks specifies the Comptroller of the Currency.

Instead, we understand that the Comptroller of the Currency (at least under the time that Comptroller Curry served) has delegated that life and death decision to one person, a Senior Deputy Comptroller of the Currency.  But that person carries huge burdens, with responsibility over more than 1,000 national and federal savings associations.

In the past, the Senior Deputy Comptroller has made his or her decision on whether to close a bank based on two memoranda – a legal brief and a fact or supervisory memorandum.

Both are advocacy pieces – how to justify the closing of a bank on statutory grounds based on facts derived from those who prepare the memos and other sources of information created by examiners and others within the agency to support the closing.

They are not an analysis of the objective pros and cons of closing a bank at a particular time.  They do not evaluate whether closing a bank at that particular time will likely reduce the potential losses to the DIF, as the PCA statute requires the agencies that are overseeing undercapitalized banks to do.

The statutory grounds to close a bank are breathtakingly broad.

Any “unsafe or unsound banking practice” that is “likely to weaken” the bank is one ground.  So is any time that a bank is in an “unsafe or unsound condition”.  “Unsafe or unsound” is not defined, leaving the agencies the broad power to determine the meaning.

Another ground is where the agency does not accept the capital restoration plan of an undercapitalized bank even though the decision whether to accept a capital restoration plan is entirely within the discretion of the agency and most undercapitalized banks are not successful in convincing their agency to accept their CRPs.

There is no assurance that the “facts” presented to the Senior Deputy Comptroller are correct and complete.  Reports of Examination commonly use harsh and critical language to describe bank practices, particularly for undercapitalized banks.  But there often is another story to tell that is not reflected in the reports.  That story is revealed in bank responses to reports of examination or bank appeals to the Ombudsman.

Is the Senior Deputy Comptroller fully reviewing those facts before he or she makes a life or death decision?

Does the Senior Deputy consider the loss of banking services to an underserved population and community before deciding to close a bank?

These decisions are shrouded in secrecy.  Only the OCC through an internal investigation, the Treasury IG, or one of the oversight committees or subcommittees are in a position to find out the details.

There will be those in the OCC who may claim that the Treasury and other Inspectors General already evaluated their performance under their PCA authority.  But that study (“Evaluation of Prompt Regulatory Action Implementation”) was in September 2011.  The study did not appear to consider whether banks were being unnecessarily or prematurely closed, whether there was more that the agency could have done to keep a bank open longer, or whether the agency actually made it harder for the bank to recover.

Instead, the study evaluates whether the agencies should have done more to restrict the banks.

See also the “Report to the Congress on Prompt Corrective Action” of the Financial Stability Oversight Council dated December 2011 and “Modified Prompt Corrective Framework Would Improve Effectiveness” of GAO dated June 2011.  These reports do not analyze the questions raised in the previous paragraph.

Material Loss Reviews (“MLRs”), conducted by the banking agency Inspectors General where the loss to the DIF is greater than a statutory tripwire for such reviews, also address how the agencies are doing under their PCA authority.  These are after-the-fact reviews into why a bank failed.  Most of the MLRs that AABD has reviewed question why the supervising bank agency was not more aggressive earlier in identifying and forcing correction of unsafe or unsound banking practice.  But they do not question whether a bank was closed prematurely, or whether the supervision of an undercapitalized bank may have hindered the Bank’s recovery by imposing overly stringent restrictions on income-producing activities and services.

AABD’s 2013 report on MLRs, recommended that the bank Inspectors General (Treasury, Fed and FDIC) request former board members and management of failed banks to have input into the Inspector General review.  See Appendix II.  None of the Inspectors General adopted that recommendation.  For now, they will only hear the agency’s version of events and facts, not those at the Bank.  That presents the Inspectors General with an incomplete picture of how and why the bank failed and whether the agencies met the Congressional purpose of reducing potential losses to the DIF.

Oversight hearings could help determine why Guaranty Bank was closed, whether there was any evidence of bias or retribution, and whether the broad discretionary authority of the OCC’s Special Supervision Division was used appropriately in examinations, supervisory actions, and allocation of resources of both the OCC and the Bank in order to resolve the problems of the Bank “at the least possible long-term loss to the Deposit Insurance Fund”.

The oversight hearings would not just be about Guaranty Bank but also other banks that have been through the same or similar process, and with an eye to the many others who some day, during future recessions, will inevitably become subject to PCA authority.

The objectives of a Congressional oversight hearing could include:

  • How well has Special Supervision performed under the OCC’s PCA authority to reduce the potential losses to the DIF in the case of Guaranty Bank and other national banks or federal savings associations?
  • How can Special Supervision improve its performance?
  • What is wrong with the decision-making process at the OCC in determining whether to close a bank and what can be done to improve it?
  • Are the other federal banking agencies acting consistent with their PCA authority?
  • Are the banking agency Inspectors General considering all information available to them that is germane to determining why a bank failed and how the agencies may improve their performance and whether the supervision of the bank limited the bank’s recovery unnecessarily
  • If the Inspectors General are not considering all of the available information, why not? What role, if any, has the agency Ombudsmen played in responding to appeals filed by undercapitalized banks and any allegations of retaliation and bias, and how effective and independent has been that role?
  • Has the OCC conducted an independent, internal review of Special Supervision’s oversight of Guaranty Bank to determine whether it was consistent with the Congressional intent for it to resolve the Bank’s problems at the least possible long-term loss to the DIF?
  • Have the MLRs, which typically determine that the agencies should have acted sooner and more stringently against banks, inadvertently created an incentive for the banking agencies to take actions against undercapitalized banks that were unnecessary or counterproductive, or to close banks prematurely?

Congress should also consider legislative changes, including.

  • FDIC should be required to approve any closing of a national bank or federal savings association. Why does the OCC have the unilateral power to close a national or federal savings association?  Why shouldn’t the FDIC, as the party responsible for the solvency and administration of the DIF, have a right to concur or not in that decision?  By the time most banks fail, there are FDIC examiners assigned to examinations of undercapitalized banks.  The FDIC is in a position to know everything about the bank that the OCC knows.
  • The grounds to close a bank are too broad and allow too much discretion. Are the grounds to close banks too numerous and too susceptible to manipulation?  Should the OCC have the authority to close a bank simply because, in its opinion, the bank engaged in an unsafe or unsound practice that was likely to weaken the bank’s condition even though the bank did not otherwise warrant a closing? Or if the OCC has not approved a capital restoration plan within its sole discretion to approve?
  • Due process guarantees. The OCC has practically unbridled discretion to close a bank based on one or more statutory grounds.  The statutory right to sue the OCC within 30 days of failure is an illusory right.  No court will return the bank to its rightful owner after the FDIC has dismembered it.  The almost limitless agency discretion is not tempered by a meaningful, objective process that allows divergent views to be aired.  The bank has no right to provide reasons why the bank should not be closed.  The life or death decision apparently is made by a subordinate of the Comptroller without any assurances that that decision-maker will have all of the facts necessary to make the right decision.  Legislation should provide for certain due process guarantees, including administrative hearings and fact gathering unless it can be determined that the agency has met a high bar of demonstrating that it is an emergency to close the bank immediately without due process protections and that the public interest requires it.
  • The Comptroller cannot delegate the decision to close a bank to a subordinate. Legislation should require the Comptroller to make the decision to close such an institution (no delegation should be allowed).  We cannot imagine a more consequential bank supervisory decision than the decision to close a bank.  That decision should not be left to a subordinate.
  • Before a bank is closed, its service to the underserved communities should be evaluated and considered before the decision to close is made, and alternatives to closing are fully considered. This issue arose during the hearings in January 2010 of the House Financial Institutions Subcommittee on the closing of Park National Bank, a bank serving the inner city Chicago community.  Questions were raised about the need to close the bank especially given its exemplary community service.
  • The banking agency Inspectors General shall be required to consider the views of management and board and representatives of the failed bank in preparing their Material Loss Reviews. The current practice of the Inspectors General is not to consider or seek the views of former management and board.  Its MLRs suffer as a result.
  • The banking agencies shall accept capital restoration plans if the plans are viable and the banks act in accordance with the limitations in the PCA statute regardless of how long such plans may take to accomplish a recapitalization. We believe that the agencies have effectively legislated a requirement that the capital restoration plans must call for a recapitalization within a very short period of time and demonstrate that it will be successful even though the PCA statute does not impose a time frame to recapitalize.
  • Banking agency officials should be held to the same personal liability standards as bank directors and officers. That is, if they engaged in gross misconduct or gross negligence, they should be held accountable through a private suit against them individually.  The current law, which defers to the agency official’s “discretion”, should be amended to hold agency officials accountable for gross negligence or gross negligence.  Personal accountability is important not just for bank directors and officers, but also agency officials.  Otherwise, such officials will feel immune from any challenge to the exercise of their vast powers.

David Baris is the President of the American Association of Bank Directors. He represented Guaranty Bank in a legal capacity.