Survival of the Fittest: FDIC Comforts Consumers While Shooting Down Fledgling De Novo Banks

The FDIC’s closing of seven banks on Friday, October 23, 2009, has received widespread publicity. Chairman Sheila Bair recorded a three minute video which is posted on YouTube and the FDIC’s home page reassuring the public that their insured deposits have always been and will always be safe. These statements and the constant positive publicity are good news for consumers who get nervous when their bank is on the “Friday List”.
       
Many of these closings have been small, local, and relatively new institutions. Previous FDIC policy mandated that a newly chartered institution be considered a “de novo” for the initial three-years. During this phase the institution was subject to higher capital requirements and more frequent examinations. However, the FDIC has found that institutions are still at a higher risk of failure for the initial seven years of operation. In accordance with this finding, the FDIC on August 28, 2009 issued Financial Institution Letter (FIL) 50 formally extending the de novo period.

At a Regulator Town Hall Meeting in Tampa, Florida, on October 22, 2009, a senior regional FDIC executive reiterated this finding by remarking that the “four to seven year de novo period is the biggest risk to the deposit insurance fund”. Last Friday four of the seven institutions closed by the FDIC were still in the newly defined de novo phase.

The aforementioned FIL lists these common risk factors during the first seven years of operation:

• rapid growth 
• over-reliance on volatile funding, including brokered deposits 
• concentrations without compensatory management controls 
• significant deviations from approved business plans 
• noncompliance with conditions in the deposit insurance orders 
• weak risk management practices 
• unseasoned loan portfolios, which masked potential deterioration during an economic downturn 
• weak compliance management systems leading to significant consumer protection problems 
• involvement in certain third-party relationships with little or no oversight

While all elements are risky, concentrations of credit seem to be the most significant risk at this time due to the fundamental decline in commercial real estate. A good stress testing model can help management’s forecast and greatly assist in concentration management.