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FSOC Adopts Rules for Determination of Systemically Important Non-Banks

Jerry Blanchard — Thu, 17 May 2012 20:52:12 +0000

The Financial Stability Oversight Council has adopted a final rule that went into effect on May 11, 2012 describing the framework that the Council intends to use to determine whether a non-bank financial company is systemically important to the US financial system and whose failure could pose a threat to the U.S. financial stability. The consequences of being designated a systemically important company is that the Federal Reserve is given the authority to impose risk based capital requirements, leverage limits, liquidity requirements, resolution plans, concentration limits, a contingent capital requirement; enhanced public disclosures; short-term debt limits; and overall risk management requirements.

The Council adopted a three-stage process for making its determination. The first stage is designed to narrow the universe of non-bank financial companies by establishing certain size or other quantitative thresholds. The second stage applies the analytic framework (i) size, (ii) interconnectedness, (iii) substitutability, (iv) leverage, (v) liquidity risk and maturity mismatch, and (vi) existing regulatory scrutiny to determine whether company could pose a risk to U.S. financial stability. The third stage will utilize qualitative and quantitative information obtained directly from the companies through the Office of Financial Research.

The quantitative thresholds a company would need to get past the stage 1 review are as follows:

Total Consolidated Assets. $50 billion.

Credit Default Swaps Outstanding. $30 billion in gross notional credit default swaps (‘‘CDS’’) outstanding for which a nonbank financial company is the reference entity. Gross notional value equals the sum of CDS contracts bought (or equivalently sold). If the amount of CDS sold on a particular nonbank financial company is greater than $30 billion, this indicates that a large number of institutions may be exposed to that nonbank financial company and that if the nonbank financial company fails, a significant number of financial market participants may be affected. This threshold was selected based on an analysis of the distribution of outstanding CDS data for nonbank financial companies included in a list of the top 1,000 CDS reference entities.

Derivative Liabilities. The Council intends to apply a threshold of $3.5 billion of derivative liabilities. Derivative liabilities equal the fair value of derivative contracts in a negative position. For nonbank financial companies that disclose the effects of master netting agreements and cash collateral held with the same counterparty on a net basis, the Council intends to calculate derivative liabilities after taking into account the effects of these arrangements. This threshold serves as a proxy for interconnectedness, as a nonbank financial company that has a greater level of derivative liabilities would have
higher counterparty exposure throughout the financial system.

Total Debt Outstanding. The Council intends to apply a threshold of $20 billion in total debt outstanding. The Council will define total debt outstanding broadly and regardless of maturity to include loans (whether secured or unsecured), bonds, repurchase agreements, commercial paper, securities lending arrangements, surplus notes (for insurance companies), and other forms of indebtedness. This threshold serves as a proxy for interconnectedness, as nonbank financial companies with a large amount of outstanding debt are generally more interconnected with the broader financial system, in part because financial institutions hold a large proportion of outstanding debt. An analysis of the distribution of debt outstanding for a sample of nonbank financial companies was performed to determine the $20 billion threshold. Historical testing of this threshold demonstrated that it would have captured many of the nonbank financial companies that encountered material financial distress during the financial crisis in 2007–2008, including Bear Stearns, Countrywide, and Lehman Brothers.

Leverage Ratio. The Council intends to apply a threshold leverage ratio of total consolidated assets (excluding separate accounts) to total equity of 15 to 1. The Council intends to exclude separate accounts from this calculation because separate accounts are not available to claims by general creditors of a nonbank financial company. Measuring leverage in this manner benefits from simplicity, availability and comparability across industries. An analysis of the distribution of the historical leverage ratios of large financial institutions was used to identify the 15 to 1 threshold. Historical testing of this threshold demonstrated that it would have captured the major nonbank financial companies that encountered material financial distress and posed a threat to U.S. financial stability during the financial crisis, including Bear Stearns, Countrywide, IndyMac Bancorp, and Lehman Brothers.

Short-Term Debt Ratio. The Council intends to apply a threshold ratio of total debt outstanding (as defined above) with a maturity of less than 12 months to total consolidated assets (excluding separate accounts) of 10 percent. An analysis of the historical distribution of the short-term debt ratios of large financial institutions was used to determine the 10 percent threshold. Historical testing of this threshold demonstrated that it would have captured a number of the nonbank financial companies that faced short-term funding issues during the financial crisis, including Bear Stearns and Lehman Brothers.

The Council is required to notify the non-bank financial companies in writing of their designation as systemically important and the companies may request an opportunity for a written or oral hearing before the Council to contest the designation. If the Council makes a final determination with respect to a nonbank financial company, the company may, not later than 30 days after the date of receipt of the notice of final determination bring an action in the United States district court for the judicial district in which the home office of such nonbank financial company is located, or in the United States District Court for the District of Columbia, for an order requiring that the final determination be rescinded. Judicial review is quite limited, however, in that the review of such an action shall be limited to whether the final determination was arbitrary and capricious.

The final rule still leaves a great deal of ambiguity for companies seeking to determine whether they will be covered or not. For example, will large insurance companies be covered or will the fact that they are subject to an existing regulatory supervision by state insurance commissioners be sufficient to knock them out in the second stage? The Council noted that it was not adopting any sort of industry-wide exclusion and indicated that the evaluation of any non-bank company would be company-specific. Likewise, the Council is analyzing the extent to which there are potential threats to U.S. financial stability arising from asset management companies. This analysis is considering what threats exist, if any, and whether such threats can be mitigated by subjecting such companies to Board of Governors supervision and prudential standards, or whether they are better addressed through other regulatory measures.

Jim McAlpin and Rob Klingler to Present at PKM’s CFO Peer Group Meeting

Bryan Cave — Thu, 17 May 2012 20:07:37 +0000

On Tuesday, May 22, 2012, Atlanta partners Jim McAlpin and Rob Klingler will be presenting at Porter Keadle Moore’s CFO Peer Group meeting.

Jim will present “Risk Management from a Legal Perspective.”

The regulators are raising the bar for enterprise risk management at community banks. Bank boards and senior management need to be thinking of how to satisfy these requirements within the context of the limited resources that community banks can deploy. One more area of focus is being added to an already crowded Board agenda.

Rob will present “The Impact of the Jobs Act on Community Banks.”

In a time of ever increasing regulation, Congress has passed the Jobs Act, a significant piece of deregulation of the federal securities laws. Public and private offerings are both impacted, and likely to be permanently changed. Capital is still hard to raise, but at least a few obstacles have been relaxed.

Please click here for more information or to register for the event.

Bryan Cave Expands Financial Institutions Practice in San Francisco

Bryan Cave — Tue, 15 May 2012 13:10:26 +0000

We are pleased to announce that Dan Wheeler has joined the international law firm Bryan Cave LLP as a partner in the firm’s San Francisco offices. He will practice with the firm’s Banking Client Service Group.

“Having Dan join us as another West Coast member of our team complements the breadth of our nationwide banking practice and our ability to serve our clients’ needs,” added Kathryn Knudson, leader of Bryan Cave’s Financial Institutions Industry Practice Team. “Our team represents more than 300 financial institutions and is consistently ranked among the leading deal making banking practices in the U.S., so Dan’s experience and client base will be a welcome expansion of our practice on the West Coast.”

“Dan’s scope of practice will be invaluable in serving and strengthening our relationships with financial institutions throughout the Bay Area and beyond,” said Lee Marshall, managing partner of Bryan Cave’s San Francisco offices. “We are excited to welcome him to our firm and we look forward to adding his perspective and insight to our team.”

Wheeler advises banks, credit unions, finance lenders and other financial institutions on lending, operational and regulatory issues. He helps lenders close a wide variety of loans, including large syndicated credits, commercial real estate loans and other middle market loans. Wheeler advises on loan administration and enforcement, as well as sales of loan portfolios, participation and intercreditor agreements, letters of credit and swap agreements. He represents financial institutions with operational projects such as negotiations with key vendors and resolution of deposit, privacy and data security issues. Wheeler’s regulatory practice includes general regulatory matters before the Federal Reserve, FDIC, OCC and state departments of financial institutions as well as advice on the development and refinement of financial products.

Wheeler received his J.D. in 1997 from New York University and his B.A. in 1993 from Indiana University of Pennsylvania.

Daniel Wheeler has joined the international law firm Bryan Cave LLP as a partner in the firm’s San Francisco offices. He will practice with the firm’s Banking Client Service Group.

Wheeler received his J.D. in 1997 from New York University and his B.A. in 1993 from Indiana University of Pennsylvania.

Regulators’ “No Stress” Message to Smaller Banks Only Tells Part of the Story

Jonathan Hightower — Mon, 14 May 2012 18:20:39 +0000

On May 14, 2012, the Federal Reserve, FDIC and the OCC released a joint statement confirming that that banking organizations with total consolidated assets of $10 billion and under will not be required to conduct formal stress tests. Management of many smaller banking organizations had been concerned that the stress testing required of larger banks would “trickle down” in an informal sense to smaller banks. With this regulatory statement, that concern is alleviated, at least in the official sense.

We continue to believe that the heightened (or perhaps renewed) emphasis on risk management by the regulators will affect banks of all sizes. It is likely that regulators, directors, and shareholders of all banks will want to confirm that management has identified the key risk factors affecting the institution and that the board has established the institution’s tolerance for accepting those risks and implemented any appropriate mitigants.

We recommend that banks of all sizes, even the smallest community banks, undertake an enterprise risk management analysis to identify the key risks facing the institution. The board of the institution, as a subpart of its strategic planning function, should review those risks and establish the institution’s risk tolerance with respect to each category of risk (many consultants will capture this analysis in a “risk appetite statement”). Establishing and understanding those risk tolerances will form a roadmap for setting and executing the institution’s strategic initiatives. In implementing this analysis, some institutions may undertake some level of stress testing with respect to certain risks.

This risk management analysis is a natural adjunct to the self examination process used we recommend using in preparing for a regulatory exam (see our prior “Self Exam” post). While the self exam process is typically more focused on the bank’s current position and past performance and this risk management analysis is more forward-looking, both processes require an introspective review. Senior regulators have repeatedly confirmed to us (and we have seen in practice) that where banks take the initiative in implementing credible risk management programs and other pre-examination preparation, the examiners are much more likely to defer to the judgment of management and the board of the bank – with the result being a much better interaction with regulators (who, in an ideal scenario, can be a partner in the risk identification process).

We believe the key for banks and bank boards is to conduct an honest, forward-looking, and customized analysis of the risks facing your institution. While the guidance related to development of a stress test framework for larger banks may serve as a useful data point in developing an approach to enterprise risk management, management of community banks should focus on developing a risk analysis that is totally unique to the institution and its business model. We believe that implementing this type of risk analysis will satisfy the regulators, better inform the board, and, most importantly, add economic value for the institution’s shareholders.

Treasury Confirms TARP Exit Plan(s)

Robert Klingler — Fri, 04 May 2012 20:28:08 +0000

On May 3, the Treasury Department announced (via blog post) its intentions with regard to the 343 banks that remain in the TARP Capital Purchase Program. Specifically, Treasury identified three approaches: (1) allow repayments over the next 12-18 months; (2) limited restructurings in the context of mergers or capital raises; and (3) auctioned sales of the TARP securities, either for individual banks or in pools. These intentions are flexible and sufficiently vague to allow Treasury to moderate from these plans, particularly if political pressures necessitate. However, they also provide a road map (at least a current road map) of the path that Treasury anticipates using.

Treasury invested a total of $245 billion under the TARP bank programs, and has already recovered $264 billion through repayments and other income. This represents a $19 billion positive return, without providing any value to the remaining investments. Every additional dollar recovered is an additional return for the US taxpayers.

Of the 364 remaining investments, Treasury notes that most are smaller, community banks. Treasury is careful to point out that these banks have just as much desire to repay TARP, but have generally found it harder to raise funds from private investors in the capital markets and have often been particularly hard hit by troubled real estate loans.

Notably, Treasury now indicates that it intends to continue to hold the TARP securities of those banks that Treasury believes will have the ability to repay over the next 12 to 18 months. This could suggest that those banks that Treasury believes could obtain regulatory approval to repay will not be provided the opportunity, at least in the short term, to participate in a public auction (and therefore repurchase their securities at a discount to par value). The Treasury also indicates that they will communicate “regularly” with the group of banks that they think can repay over the next 12 to 18 months and will share with them Treasury’s “expectations” for repayment. Treasury has expressly indicated that its expectations regarding which banks will be able to repay may change over time.

Treasury acknowledges that the majority of the remaining banks will not be in position to repay within the next 12 to 18 months … or in the foreseeable future. For these institutions, Treasury is focused on restructuring or selling the TARP investment.

Treasury will continue to accept proposals, typically in connection with mergers or plans to raise capital, to restructure its investment; “but only if the terms represent the best deal for taxpayers under the circumstances.” Treasury indicates that it has approved 20 of these restructurings, and anticipates continuing to do so “in limited cases.”

When looking to sell its TARP investment, Treasury indicates that it will continue to use the auction process. Treasury indicates that the results of the first six auctions were in line with what the Treasury had estimated. However, the Treasury also indicates that they will only sell above a pre-set reserve price in order to best protect taxpayer value. Future auction sales will include individual investments as well as pooled securities, conducted over time in stages. Treasury notes that it will continue to evaluate its strategies as it proceeds.

Although may of the same reasons may exist for the Treasury to desire to exit TARP’s Community Development Capital Initiative (CDCI), the Treasury specifically indicates that Treasury currently intends to continue to hold onto its CDCI investments and make disposition decisions regarding that program at a later date.

Sharing Directors Brings Added Experience to Your Board but Could Cause Problems

Jonathan Hightower — Thu, 03 May 2012 22:29:47 +0000

Many financial institutions, particularly community banks, have enhanced the experience level of their boards by adding a director who is a banker or serves on the board of another financial institution. In general, utilizing a director who has current experience with another financial institution is a great way to add valuable perspective to a variety of issues that the board may encounter. In addition, as private equity funds made substantial investments in financial institutions, they often bargained for guaranteed board seats. The individuals selected by private equity firms as board representatives often serve on a number of different bank boards. As market conditions have led to increased bank failures, however, a problem has resurfaced that may cause some financial institutions to take a closer look at nominating directors who also serve other financial institutions: cross-guarantee liability to the FDIC.

The concept of cross-guarantee liability was added to the Federal Deposit Insurance Act by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The pertinent provision states that any insured depository institution shall be liable for any loss incurred by the FDIC in connection with:

the default (failure) of a “commonly controlled” insured depository institution; or
open bank assistance provided to a “commonly controlled” institution that is in danger of failure.

This means that if two banks are “commonly controlled” and one of them fails, the other bank can be held liable to the FDIC for the amount of its losses or estimated losses in connection with the failure. As many of us see each Friday, the amounts of these estimated losses are often quite high. In fact, the FDIC’s estimated losses for 2011 bank failures were approximately 20 percent of total failed bank assets for the year. Accordingly, the prospect of cross-guarantee liability can be a tremendous financial issue for the surviving bank.

The concept of cross-guarantee liability was developed in response to some perceived abuses by multi-bank holding companies during the 1980s. In those instances, one or more institutions owned by a multi-bank holding company failed, causing significant losses to the FDIC, while the other subsidiaries of the multi-bank holding remained open and viable, allowing the holding company to continue to profit from their operations while the FDIC was stuck with the losses from the failed institutions. With authority to assess cross-guarantee liability now in hand, however, the FDIC has shown a willingness to assert cross-guarantee liability under facts that would not be considered by most to be abusive. In this cycle, the FDIC appears to be willing to take full advantage of the assessment authority granted to it by FIRREA, using cross- guarantee liability as a “sword” to provide a recovery to the Deposit Insurance Fund.

The imposition of cross-guarantee liability starts with an assessment of control. Whether institutions are “commonly controlled” for purposes of determining cross- guarantee liability depends upon whether each institution is under the control of a common entity under the Bank Holding Company Act of 1956, as amended (BHC Act). Because the determination of control is made under the BHC Act, the Federal Reserve’s BHC Act control guidance is helpful. However, this guidance is very dense and can be quite complicated, requiring a review of the ownership structure, management practices, and other business affiliations of the two institutions. However, one thing is clear: In questions of control, institutions that share “management officials”—common directors and/or executive officers—are generally more likely to be found to be under common control than those that do not, all other factors being similar.

As a result, institutions with directors who serve on other bank boards or as officers of other banks should assess potential cross-guarantee risk through the director nomination process. Nominating committees (or other committees of the board reviewing director qualifications) should ask the following questions:

Does the individual serve on as a director or officer of another financial institution?
Is there a basis for determining that the two institutions are under common control? Answering this question will likely require consultation with legal counsel.
Is the other financial institution in a financial condition that is less than sound?

If the answer to all of these questions is “yes,” the nominating committee should think carefully about whether nominating that individual is a good idea. In addition, institutions guaranteeing board seats to investors (such as in connection with a private equity investment) should consider an exception to the nomination requirement when the election of the representative could create a risk of assessment of cross-guarantee liability.

A risk assessment requires an in-depth factual, legal and financial analysis. There are few organizations that will find out this issue places them at risk, but it’s worth attention because the consequences can be severe. As a result, an assessment of this risk should be an integral part of the annual nomination process.

This article was original published on BankDirector.com.

Bryan Cave Presenting at the Power of Prepaid Conference

Bryan Cave — Thu, 03 May 2012 21:42:25 +0000

Bryan Cave is a proud sponsor and speaker for the 2012 NBPCA Annual Congress, the Power of Prepaid.

The Power of Prepaid
June 3-6, 2012
Gaylord National Hotel & Conference Center
Washington, D.C.

Bryan Cave Partner Judith Rinearson will be speaking on a panel on the second day about Scaling for Growth: Keeping up to Date and up to Speed as your Portfolio Grows in Size and Scope. The full conference brochure can be downloaded here.

11th Circuit Upholds Deposit Agreement Arbitration Provision

Jerry Blanchard — Wed, 02 May 2012 14:40:17 +0000

The United States Court of Appeals for the 11th Circuit rendered an important decision on March 5, 2012, addressing the enforceability of binding arbitration provisions in consumer deposit agreements. The case began when Lawrence and Pamela Hough brought suit against Regions Bank for allegedly violating federal and state law by collecting overdraft charges under its deposit agreement. The deposit agreement contained an arbitration provision and Regions moved to compel arbitration. The federal district court hearing the case denied the motion to compel on the ground that the arbitration clause was substantively unconscionable because it contained a class action waiver. Regions appealed the decision to the 11th Circuit Court of Appeals and the appellate court vacated the ruling and sent it back to the trial court in light of a recent United States Supreme Court which held that the Federal Arbitration Act preempted a California’s judicial rule regarding the unconscionability of class arbitration waivers in consumer contracts. This time around the district court found other reasons to deny Regions’ motion to compel arbitration, holding that the arbitration clause was substantively unconscionable under Georgia law because it believed that a provision granting Regions the unilateral right to recover its expenses for arbitration allocated disproportionately to the Houghs the risks of error and loss inherent in dispute resolution.

The lower court decision was again appealed to the 11th Circuit. On appeal the Houghs argued that while the arbitration provision in the deposit agreement capped the Houghs’ costs for the arbitration proceeding at $125, another paragraph required the Houghs to reimburse Regions as a prevailing party for its costs of arbitration. The arbitration agreement permitted Regions, if it was “the prevailing party,” to obtain “reimburse[ment] for [its] costs and expenses (including reasonable attorney’s fees) … [in] arbitration” and to collect that amount by “charg[ing] [the Houghs'] account.” The district court concluded that the reimbursement provision was unconscionable because Regions had an exclusive right of setoff. The 11th Circuit disagreed, and noted that under Georgia law an arbitration provision is not unconscionable because it lacks mutuality of remedy. The district court also ruled that the arbitration clause had a degree of procedural unconscionability, but the 11th Circuit found that to be unconscionable under Georgia law, a contract must be so one-sided that “no sane man not acting under a delusion would make and that no honest man would participate in the transaction.” The court found that the arbitration clause in the Houghs’ agreement fell well short of that standard. Although the district court found it troubling that the clause was presented to the Houghs “on a take-it-or-leave-it basis with no opt-out provision,” the 11th Circuit noted that under Georgia law, an adhesion contract (i.e., one that is not truly negotiated between the parties such as a deposit agreement or a credit card agreement) is not per se unconscionable.

This is a timely decision for banks, particularly in light of the announcement by the Consumer Financial Protection Bureau on April 24 that it is launching a public inquiry into how consumers and financial services companies are affected by arbitration and arbitration clauses. Financial institutions began using binding arbitration provisions in the late 1980’s as a means of managing legal risk. Arbitration provides for a neutral forum to hear customer complaints without the risk of a runaway jury swayed by an emotional appeal from a plaintiff’s counsel. To that end it has served an important role as part of the overall enterprise risk management program for financial institutions. When the arbitration provisions are fair procedurally, meaning that the venue for the arbitration is easy to get to and the costs imposed on the consumers are minimum, the courts, from the United States Supreme Court on down, have upheld the enforceability of such provisions. Banks are understandably concerned that the CFPB will now frown upon a process which the Supreme Court has upheld as both procedurally and substantively fair.

D&O Carrier Seeks Denial of Coverage Against Former Directors of Failed Bank

Jake Bielema — Tue, 01 May 2012 16:51:27 +0000

On March 30, 2012, Progressive Casualty Insurance Company filed an action naming as defendants the FDIC as Receiver of Omni National Bank, as well as the former officers and directors of Omni whom the FDIC had previously sued. The Complaint asserts a claim for declaratory judgment that Progressive is not obligated to cover any of the claims asserted by the FDIC against the former directors and officers in the Omni litigation. This action is significant in that it raises a number of coverage issues which former directors and officers of failed banks may see raised by their own D&O insurance carriers, and the presence or absence of D&O coverage is a critical factor considered by the FDIC in determining whether to bring an action seeking any kind of recovery.

Progressive had underwritten a director and officer liability policy for the directors and officers of Omni with a total policy limit of $10 million. The policy did not contain any exclusion which would directly exclude coverage for any action brought by a governmental or regulatory agency such as the FDIC (a so called “regulatory exclusion”). Nonetheless, apparently after having received notice of the claim by the FDIC, Progressive denied coverage on a number of separate bases, which now form the basis of the declaratory judgment lawsuit.

First, Progressive alleged that coverage for the former directors and officers of Omni was barred by the insured v. insured exclusion contained in the policy. An insured v. insured exclusion is a common feature of a directors and officers liability policy, and essentially provides that any claim brought by, on behalf of, or at the behest of any insured company or insured person under the policy against insured persons under that same policy are not covered. Progressive alleges that, because the FDIC steps into the shoes and succeeds to all the rights and privileges of the Bank, and brought the action against the directors and officers in its capacity as Receiver for the Bank, the insured v. insured exclusion is triggered and therefore no coverage is available. Whether a standard insured v. insured exclusion in fact bars coverage for an action by the FDIC against former officers and directors is an important question, and is certainly debatable.

Next, Progressive alleges that, because unpaid unrecoverable loan losses are carved out from the definition of “loss” under the policy, there is no coverage for the losses alleged in the FDIC’s complaint against the former Omni directors and officers. Progressive alleges that the FDIC’s complaint is specifically based on $24.5 million in losses that the bank suffered on over 200 loans.

The complaint concludes with various allegations that certain claims contained in the FDIC’s complaint are not covered by virtue of having been made outside the policy period or the extended discovery period or because certain claims are based on alleged wrongful acts that took place after the expiration of the policy. As to one particular defendant who had previously pleaded guilty to a criminal violation, Progressive alleges that no coverage exists based on an exclusion for loss arising out of fraud and/or acts in violation of the criminal laws.

It will be interesting to see what the Courts do with these kinds of coverage positions taken by director and officer liability carriers. Given that the existence of insurance coverage for former directors and officers is such a central component of the FDIC’s decision making process in determining whether it is cost effective to bring claims, this is an issue that is worth watching.

FDIC Sues Former D&Os of Cape Fear Bank

Bard Brockman — Mon, 30 Apr 2012 20:15:43 +0000

On April 4, 2012, the FDIC filed an action against the former directors and officers of Cape Fear Bank, Wilmington, NC (“Cape Fear” or the “Bank”). The lawsuit was filed shortly before the expiration of the 3-year statute of limitations which commenced when the Bank was closed and placed into FDIC receivership on April 10, 2009. For a copy of the FDIC’s complaint, click here.

The FDIC’s complaint identifies two central causes of Cape Fear’s failure. First, the FDIC alleges that the D&O defendants pursued a flawed strategy of opening branch operations without consideration for the cost of new branch operations and without any plan to monitor those operations. Second, the FDIC alleges that the defendants were enticed by the real estate “bubble,” and that they aggressively pursued rapid growth through high-risk and speculative real estate lending. The defendants approved loans even where the Bank lacked sufficient capital, causing the Bank to become overly dependent on brokered deposits, which in turn severely impaired earnings. Worse yet, the defendants failed to employ basic prudent lending practices and controls. Specifically, the FDIC alleged that the defendants routinely approved loans that: (i) violated the Bank’s own loan policy and applicable lending regulations; (ii) lacked proper financial analysis or verification of the borrower’s creditworthiness; (iii) lacked a proper appraisal of the collateral; and (iv) increased CRE and ADC concentrations that had previously been criticized by regulators. To make matters even worse, the FDIC alleges, the defendants attempted to mask the Bank’s mounting capital problems by approving additional bad credits and making new advances on non-performing loans, often replenishing interest reserves that allowed borrowers to pay interest with borrowed funds. The complaint identifies 23 specific failed CRE and ADC loans that resulted in approximately $11.2 million of losses, which is the amount the FDIC seeks in damages.

One of the unique aspects to this case is the allegation that Cape Fear’s president and CEO “dominated” the board of directors and the Bank’s lending function. This unique case theory does not offer any insulation to the other directors and officers, however, as the FDIC contends that they failed to exercise their independent judgment and duties.