A number of financial institutions throughout the country have been subject to some level of enforcement action over the years. Most recently, the banking industry has been affected by the weak economy and deteriorating asset quality related to commercial and residential loans, and, as a result, enforcement actions have risen sharply over the past several months. For the purpose of this article, we will examine formal enforcement actions, which are publicly disclosed by the federal banking agencies and are easily accessible via the Internet. We will examine actions issued since 2007, just prior to when the credit and liquidity problems began affecting our economy and, ultimately, the banking industry. We will also focus our attention on actions issued against financial institutions, rather than individuals (e.g., civil money penalties, prohibition orders, section 19 letters, and other types of formal actions will not be addressed in this article). Finally, we will discuss the provisions that comprise System-related actions and the underlying reasons for the provisions.
Enforcement actions have been a key supervisory tool for over 40 years, and they complement traditional supervisory policies and procedures.1 The federal banking agencies have supervisory tools to limit potentially risky behavior by financial institutions and have a broad range of enforcement powers over the institutions they supervise. The agencies have the power to improve capital, restrict asset growth and riskier lending, restrict dividends, levy fines, and remove management.
Enforcement actions can be either formal or informal, depending on the severity of the situation. The objective of a formal action generally is to correct practices that the agency believes to be unlawful, unsafe, or unsound. As mentioned earlier, formal supervisory actions may be taken against a financial institution or any institution-affiliated party and are legally enforceable and publically available.2
During the banking crisis of the 1980s and early 1990s, federal banking agencies widely used formal actions. During the mid-1980s, as the number of problem banks increased dramatically, so did the number of formal actions. A typical 1980s formal action required banks to take corrective actions in various areas: compliance with regulations, improvement in operating procedures, the raising of new capital, the replacement of managers, and so forth. As the number of problem banks declined in the late 1980s, the issuance of formal actions also declined.
But then came 1991 and 1992 and a growing number of problem banks, particularly in New England, which brought another increase in the number of formal actions. During the later part of the decade, the number of actions declined as the economy improved and financial institutions' earnings rebounded. This trend continued during the economic expansion through early 2003. However, there was a spike in formal enforcement actions in 2004 and 2005 that focused on compliance with the Bank Secrecy Act and other anti-money laundering standards.
During the past several months of the financial markets being in turmoil, lax credit extensions, breakdowns in underwriting practices, and the decline in housing prices have all triggered increases in the issuance of formal enforcement actions by the federal banking agencies. All of the federal banking agencies are issuing enforcement actions against companies at a record pace; the first nine months of 2009 have seen an unprecedented growth in actions.
|* Based on data from federal banking agency websites as of 9/30/2009. Excludes actions issued against both individuals and companies, such as prohibition orders and civil money penalties.|
For the first nine months of 2009, the federal banking agencies have already issued 488 formal enforcement actions-a 76% increase from 2008 and a 400% increase from 2007. So far this year, the actions have been issued to institutions located in every state, except five: Alaska, Hawaii, West Virginia, New Hampshire, and Vermont. Currently, the hardest hit states are Georgia (51), California (50), Florida (41), and Illinois (33). In these four states alone, the aggregate number of actions issued (175) constitute approximately 36% of the total number issued (488) so far this year. Banks in these states were greatly affected by housing-related loans and a weakening economy, resulting in severe asset-quality deterioration. The geographic pattern may be expressed in a number of different ways, but the message is clear: given the current regulatory and economic climate, the number of enforcement actions is rising and likely to increase more in the months ahead.
At the time of this writing, the Federal Reserve issued 106 Written Agreements, 6 Cease and Desist Orders, and 6 Prompt Corrective Action (PCA) directives for institutions so far this year. This is a far cry from 2007 and 2008, when the Federal Reserve issued a total of 50 formal enforcement actions against financial institutions. A majority of these actions were issued against bank holding companies whose subsidiary banks were designated as problem banks (composite 4 or 5 rating) at their most recent examination. A longstanding Federal Reserve Bank policy states that the bank holding company (BHC) should act as a source of strength for its depository institution subsidiaries.
|Bank Holding Companies (BHCs)||74 (63%)|
|State Member Banks (SMBs)||19 (16%)|
|Both BHCs and SMBs||25 (21%)|
|Written Agreements||106 (90%)|
|Cease and Desist Orders||6 (5%)|
|PCA Directives||6 (5%)|
Because of the credit crunch, the Federal Reserve, along with the other federal regulatory agencies, has focused its attention on basic safety and soundness issues like capital retention, asset quality, liquidity and funds management, and board oversight, and the recent actions support these issues. Some of the common issues found in today's examinations are: weak board oversight, rapid loan growth, commercial real estate concentrations, inadequate ALLL, and weak credit risk management controls and practices.
The following is a list of the corrective actions, ranked by frequency, that have been included in the 118 formal actions issued by the Federal Reserve for bank holding companies and state member banks so far this year:
|Debt and Stock Redemption Restrictions||95||81%|
|Capital Plan Submission Requirement||69||58%|
|ALLL Reserves and Methodology||39||33%|
|Asset Improvement Plans||34||29%|
|Contingency Funding Planning||27||23%|
|Cash Flow Projections||25||21%|
|Tie: Lending/Credit Administration Plans, Credit Risk Management|
Policies, and Loan Review Plans
|Strategic Planning and Budgeting||19||16%|
|Tie: Earnings Plans, Management Reviews, and Affiliate|
|Concentrations of Credit||11||9%|
|Tie: Source of Strength, Interest Rate Risk||7||6%|
|Tie: Brokered Deposits, Internal Audit||6||5%|
As mentioned earlier, one fundamental principle is that a BHC should serve as a source of managerial and financial strength to its subsidiary banks.3 Therefore, the Federal Reserve expects organizations to hold capital commensurate with its overall risk profile. During tough economic times, capital preservation takes on added importance. As such, it is not surprising that the Federal Reserve included in over 80% of its actions this year requirements that BHCs must inform the Federal Reserve in advance of declaring or paying dividends or redeeming or repurchasing stock. In addition, over 50% of actions issued provisions requiring plans for the institution's capital needs.
Over 30% of the actions include provisions that require organizations to address asset quality deterioration-replenishing low ALLL levels and planning how institutions will improve their classified assets. Addressing lax board oversight and developing stronger liquidity and contingency funding plans were other provisions that appeared in over 20% of the actions issued so far this year.
The 1980s and early 1990s saw high interest rates and high inflation compared to today, with low interest rates and possible deflation. Corporate governance must keep pace with the challenges in the present economic and financial environment, or a financial institution's board and senior management risk receiving enforcement actions resulting from breakdowns in business practices and noncompliance with laws and regulations. Economists and financial experts have been saying that we may have reached the bottom and can only go up. Whether the trends presented in this article will hold true in the future remains to be seen; unfortunately, given the current economic and regulatory climate, the number of enforcement actions may continue to increase.
The following agency websites offer information on enforcement actions against the respective types of institutions and their affiliated parties:
|Agency||Institutions and Parties|
|Federal Reserve||State member banks, bank holding companies, and branches and agencies of foreign banking organizations|
|Federal Deposit Insurance Corporation||State nonmember banks and insured branches of foreign banks|
|Office of the Comptroller of the Currency||National banks and federally chartered branches and agencies of foreign banks|
|Office of Thrift Supervision||Thrift associations|