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AN AWALYIIfl 07 MDBRAL MSERVB DISCOOKT WINDOW LOANS TO TAILED ZH8TZT0TZ0M8 Jun« 1 1 , 1991 by th« staff of TAB C0MMZTT8B OM DAHflNd, FWANCB AMD UWUUJ AJfAZRB TBB UMZTBD 8TATB8 EOUil Of BIPRS8SKTATZVI8 BACRgRQTOB The Committee on Banking, Finance and Urban Affairs is currently considering legielation (H.R. 2094) which would reform the proceee by which banking regulator* handle troubled and insolvent insured depository institution*. With the collapse of the savings and loan industry estimated to co«t the taxpayers $500 billion and bank failures increasing, auch refer* i* considered a top priority. The proca** oust ensure, that insolvent institutions are resolved in a manner which strictly results in the least possible cost to the insurance fund and the taxpayers. There are two dimension* to implementing a least aost resolution program, Tha first i* the pre-failure or takeover stage, which is the period prior to the formal declaration of inaolvency and takeover by the regulator; the second is the postintervention stage, which involves the process of liquidating or selling the inatitution and its asset*. The least coat resolution program contained in H.R. 2094 altero the latter stage by revising the coat test contained in the Federal Deposit Insurance Act to (1) ensure that all institution* are in fact resolved in the leaat coetly wanner, (2) prevent the insurance coverage of uninaured depoaits, and (3) abolish the too-big-to-fail doctrine. The pro-failure stage i* modified by curtailing excess regulatory discretion to keep open insolvent institutions long beyond the point of viability* The program require* prompt regulatory action, as set forth in h\R. 2034, to proaots the rehabilitation of a failing inatitution. But if the institution beaomee insolvent, then th* regulator must act in a timely manner to place the institution in conservatorship or reoeivership so that additional losses are limited, The <{U«vlJLuu t h « n « r i « « « a * t h « «x%ent *« w h i c h t h « l « « « t <">•* resolution program is circumvented by the lending practices of the Federal Reserve discount window. The. discount window serves an important stabilising function by satisfying the short term liquidity needs of viable depository inatitution*. Under the Federal Reserve Act the discount window can be used for seasonal, adjustment or extended credit need*. Our analysis shows that when a nonviable or insolvent depository institution receives openended extensions of credit at tha di«oount window in order to r*Tn«*n o M n lona bevond the point of viability, then the Federal Reserve 1* effectively increasing the coet of tfiximateiy resolving the institution. Since discount window loans are at least 100% collateralized, tha Federal Reserve a**umes no risk of lo*s and ha* no incentive to shut the window and contain the insurance fund*' losses. The « O 1 1 * * « Y « I i» in H\« f/ina ii.s. Treasury notes, other government securities, commercial loan* and other asset*. 1 The borrowed, funda can bo used by the institution during the pre-takeover period to allow uninsured depositors to withdraw their funda, Tha insurance fund must than absorb the loss that these account holdara would have otherwise bean forced to share« m addition, th« d+iay in olo«<ng the institution causes operating losses to escalate and increases losses from tha decline in asset values. In order to batter understand the practice and pattern of Federal Reserve discount window lending and its impact on the regulatory treatment of insured depository institutions, the Banking Committee requested and received from tha Federal Reserve extensive data on tha scope of discount window lending to Insured depository institutions. The Committee requested data on all insured depository institution* which borrowed funda from the discount window from January 1, 1985 through May, 10, 1991. the information was divided into two groups: Group 1 consisted of institutions which had been placed into conservatorship or receivership, or received assistance under Section 13(c) of the federal Deposit Insurance Act, and Group 2 consisted of all other institutions. The requested information included a schedule of the type and amount of loans extended, the CAMEt, ratings of each institution, and the amount and type of collateral taken. A copy of the letter requesting the Information is attached as Exhibit A. An analysis of tha data supports the following findings: 1. 90% Qf ALL IMflTITUTIONl WHICH RBCSIVBD "IXTBNDKD" CKEDIT S0B81QU1NTLY FAILED. ft, TBI flOlIAL AB8BAV8 ROUTXMBLY WXTBHDS IMiTXTvTIOMB WITH A CAK8L f RATtMd. 9. A QAMBL S RATIO XM8TXTUTXOH WHICH BOAAOWBD FROM THB DX8C0TOT WINDOW RBJCAIMJD OPBW FOR AM AVBRAOS FIRIOD 07 10 - 13 MOUTHS. 4 BORROWIWa FROM THB 0X8CO0MT WIKDOW XMCRBA0H8 DRAMATICALLY M AM IMSTITtJTIOW'S FIKAHCIAL COKDXTXOM BITBRIORATII. 1. THB FIDBAAL MfliRVH TAKJ0 THB HIQHliT QUALITY ASSBT8 OF THB XMiTITTOIOM IM Alt AKOTOTflUBSTAMTIALLYIK 8XCH88 OF THB LOAM AMOUMT Ad COLLATIAAL. 2 CABDXT TO STATISTICAL ANALYSIS Group 1, the insured depository institutions which borrowed from th« di«cotjnt window within three years of failure, consisted of 530 institutions. Group 2, a n otner institution* which borrowed for five or more consecutive days, consisted of 2,460 institutions, of the 530 Group 1 institutions, 67 (or 16%) had assets greater than or equal to $100 million, and 443 (or 04%) had assets lees than $100 million. Diacount Window Loans. The Federal Reserve categorises discount window loans into three types: seasonal, adjustment, and extended. A Federal Reserve description of each one is attached as Exhibit B, A summary of the use of each by the failed institutions followsi 320 (or 60%) of the Croup 1 Institutions were borrowing at the time of failure. 292 Croup 1 institutions were borrowing extended credit at tho time of failure. 26 Group l institutions were borrowing ad-iuatment credit at the time of failure. 2 Group l institutions were borrowing seasonal credit at the time of failure. Extended ctvAL±. The borrowing patterns of Group 1 institutions reveal that prior to failure, many insolvent institutions will enter into a period of continuous or intermittent extended credit borrowing veil beyond the short term periods viable institutions will need to borrow for liquidity purposes. The outstanding amount increases daily as the balance due is rolled over with now borrowings. 418 (14%) of the 2990 institutions studied received extended credit. 377, or 90%, of these 418 institutions subsequently failed. Thus, the extended credit offered by the Federal Reserve appears te operate ia praotioe as « for* of open assistance or forbear anas. C A M E L Bstincs. The term "CAMEL" represents the following performance standards; capital adequacy, Asset quality. Management, Barnings and Liquidity. The ratings given to an institution range from a high of 1 to a lev of 8. A description of what each level of CAMEL rating represents as far as the health of an institution is contained in Exhibit C- The reported CAMEL ratings of Group 1 institutions at the time of failure were as follows* 3 CAMEL 51 437 (82%) 41 51 (10%) 3: 11 (2%) 2: 5 (1.1%) 1: 1 (0.2%) not available .15 (4,9%) Total1 530 The length of time an institution with a CAMEL 5 rating was allowed to remain open ranged from less than a month to at long a« 56 months; Manilla w m ^ r of Tnatitutlona 0-3 4-6 7 - 9 10 - 12 13 - 15 16 - 18 1$ - 21 22 - 24 25-27 28-30 31-33 34-36 56-58 74 53 62 92 58 37 28 16 2 5 3 7 1 Tha average langth of time that an institution with a CAMEL 5 rating v&a allowed to remain open vai 10 - 12 Months. Amount..Pt_ Cyadlt. Regarding the amount of credit extended: 320 Croup l institution* had a total of M . M B billion in Federal Reserve loans outstanding at the timo of failure* A7.343 billion of this credit was extended when the institutions were operating with a C A M E L S rating. According to one Federal Reserve Bank document, the Banks normally receive notice of composite CAMEL l, 2 and 3 ratings with a 4 to d month lag from the time of examinationi however, composite CAMEL 4 and S ratings are normally known with little lag tin* ae a result of simultaneous holding company inspections or conversations with regulators. Peak borrowing for all 530 Group 1 institutions in the three months prior to failure totaled 818.1 frllllnn- 4 REPRBBBqyATiVB CAflH A T O P I E S (Summaries, see Appendix for detailed information) F}rnt ifopubllcBank Dallaa, N.A. fOallaa, TX1 . With aaaeta of $16,379,600,000, thia was the largest institution in Group 1. its borrowing from the discount window began on March IS, 1988, with an extended credit loan in the amount of $2.6 billion. The loans continued uninterrupted for 4 1/2 mc:>nh«t until First Republic was closed on July 29, 1988, Peak borrowing during this period was $3,278 billion and its last CAMEL rating was a 3 on September 30, 1986. The collateral taken was customer notes, and commercial and industrial loans with a book value of $6.4 billion and Federal Reserve estimated "lendable* value of $4.0 billion. The book value of the collateral represented 39% of the bank's assets. Boston T,rade Bank (Boston, MA). Boston Trade Bank was a »«<aium-«i«4k/* institution with asaets of $352.9 million, which failed on May 3, 1991. It illustrate* Uia « ; o o a u «^n«rlo of A financially deteriorating institution which begins borrowing from the discount window at the same time the regulator gives it a CAMEL 5 rating. The uninterrupted borrowing increases for five straight months until it is finally closed with outstanding loans of $53.6 million, representing 15% of its assets. First State ..Bank; cX-Blffln' fElgin, OR). The majority of the institutions using the discount window to delay closure wera small, such as this one with assets of $17.3 million. It operated at a CAMEL 5 rating for two years and was borrowing extended credit from the discount window every day during its last 12 months of operation. Bank of New England rBoafon. MAI. BNE was the second largest in Group 1 with assets of $13.9 billion whon it was doolared inuolvant on January 6, 1991, Peak lending reached $2,263 billion over a six ttonth period before a plan 'of major asset sales and borrowing from affiliates was implemented to replace discount window borrowing. Also, the Institution4* liquidity position was aldad by Department of Treasury deposits of tax receipts. Lincoln Savings and Loan Association /Irvine, CA). Lincoln S6L had assets of $2,752,800,000 at the time of receivership and was responsible for en estimated $2 billion loss to the taxpayers. Since the institution was placed in conservatorship on April 14, 1989, rather than receivership (whlah was done 4 months later), uninsured depositors were allowed to withdraw their funds without taking a loss. Federal Reserve loans as high as $98 million over the four month conservatorship period facilitated these withdrawals. The First National Bank and Trust Co. /Oklahoma city, om . This la another example of the discount window being used to keep open insolvent institutions. The bank obtained uninterrupted 9 credit for over one year with peak lending of $344 million, all the while operating with a CAMEL 3 rating. The peak loan amount represented 22% of the banks $1.6 billion in assets when it failed on July 17, 1986. First StatA Rank fAbilene. TXl. This bank received three consecutive CAMEL S ratings and was kept open for 17 months before it was placed in receivership on February 17/ 1989. Consecutive discount window borrowing began with « $4 million extended loan on May 12, 1986 and ended ten months later with a balance of $95.2 million, or 35% of the bank** $262,3 million in assets. ATTACHMENTS Exhibit A: Letter from Chairman Gonzales to Chairman creenspan, dated May 9, 1991. Exhibit B: Overview description (excerpt) of the types of credit extended by the Federal Reserve, from Tjifl r«deral Rtgqrvfl Discount Window (I9?g),. Exhibit C* Description of CAMEL ratings. Appendix: Detailed Information from each case study. 6 w^i«i^t»i9v^ EXHIBIT A O U V * U f<v*+MB* 4 k 4JWTUCC? SZSSSa •MMy^«.tMi«MKM<rn * v / * « « X * 4 * A . «*P* * * * * * u.s. HOUSE OF REPRESENTATIVES COMMlTTtC ON BANKING. HNANCE ANO V«8AN AffAI«S 2Hs5S lM ~ Srft^li".^^,**4 A — tMMsflsi AaAaVaaaa. v^*P r t V A M . ^ M m Tliwi t fVir* iVmiM •«** * «UJ*OA e~* ^H^3?&^Sr o , V M T T , WAI HiNOTON. oc joi ie r3CTl*%IV0MlTtf S^SSST" HK5j2»Z! • « " " * * * * * * . W^O^T Kay 9, 1991 ~"~" M « jwturmr.uMtf Tha Honorable M a n Greenspan Chairman Tha Board of Governors of tha Federal Reserve system 20th and Constitution Avenue, N.w. Washington, D . C 20591 Dear Mr, Chairman? Wa ara writing to you regarding an iaaua of tha utmost concern and urgency to tha Committee on Banking, Finance and Urban Affairs: Federal Reserve landing to infured depository institutions. As you will agree, this Committee and the Congress ara obligated to maintain the safety and soundness of the banking industry. We also have a fiscal responsibility to ensure that insolvent insured depository Institutions are resolved at tha least cost to tooth tha banking industry which pays premiums into the insurance funds and to the taxpayers who guarantee tha covorago of insured deposits. Federal Reserve loana to insured depository institutions have a significant impact on both of these goals. Extensions of credit far liquidity needs, including overnight edvancea, are important to maintaining the stability of the banking industry. However, when credit is extended to a failing institution by the Federal Reserve as the lender of last resort, the insurance funds and the taxpayers foot the bill* These Federal Reserve loans, which bear interest, are aade in exchange for at. leapt 100% collateral end priority creditor status. The aeaeta being held by the Federal Reserve as collateral are then unavailable to the institution to Beet its obligations. This itwv*ao«« tha coat of resolving the institution by depleting the institution's assets, when the institution i« finally closed, the FOXC repays the Federal Reserve in cash before all other creditor A, and the FOZC then takes back from the Federal Reserve th« collateral that secured the federal Reserve advances. Thus, those Federal Reserve loans increase the losses to the insurance fund* and the taxpayers standing behind then, and allow insolvent institutions to stay open long beyond the point of viability. In order for. the Committee to both fulfill ita oversight responsibilities and legislate in these important areas, we requaat that you submit the following information to the Committee: l. Regarding each insured depository institution that has been placed in vonservatorahip or receivership, or received assistance under Section 13(c) of the Federal Deposit Insuranoe Act, during the period of 1985 to data, please provide} (A) A schedule indicating each time the Federal Reserve extended oredit, directly or indirectly, to the institution during the three yea* period receding the appointment of the conservator or receiver, or the provision of the section 13(c) assistance; and include in the schedule: (1) the CAMEL rating of the Institution at the tine the credit was extended; (ii) the type of credit extended, inoluding seasonal credits, adjustment credits, and and emergency liquidity advances/ (ill) the amount of credit extended; (iv) the length of the repayment period; (v) the amount and type of collateral taken; and (vi) whether repayment was made on tine, late or not all, and specify whether in any case an extension of time or rollover occuredt 2. (B) the date and total of the largest amount or Federal Reserve loans to the institution outstanding at any one point in time; and (C) the aaount of Federal Reserve loans outstanding at the time the institution was placed into conservatorship or receivership, or received section 13(c) assistance; together with the book value and estimated fair market value (if known) of the collateral taken for each outstanding loan. Regarding all other insured depository institutions during the period from 1983 to date that are not included in the group defined in (1) above, p-lease provide: (A) the date(s), aggregate number and amount of loans extended to those institutions by the Federal Reserve during the past five years, for a poriod of 0 to 5 days, 6 to IS days, 10 to 30 days, 31 to 60 daya, and 61 day* or longer/ (B) the name of each institution which received a loan, directly or Indirectly, from the Federal Reserve for a period of 5 days or longer; and include the type and purpose of each such loan; and (C) the current status and C A M E L rating institution described in 2(B) above. of each When compiling the information requested include "conduit loan*" and, when compiling the information requested in (2) above, exclude non-rolled over loans for e tern of leaa than five consecutive days. The Committee** concern over this issue has been heightened by r«portfl that the Federal Reserve, in a seeming replay of its lending of approximately §soo m i n i o n to an i*«olvent National Bonk of Washington, has been extending credit to Kadi son National Bank even though the officers of the bank have publicly declared that it is insolvent. Furthermore, ve understand that this has allowed several large depositors of Madison National Bank to immediately withdraw their uninsured funds. The Committee will ttark up legislation very soon which could affect the lending activities of the Federal Reserve. Therefore, please devote sufficient resources to complying with this request so that we receive a complete response by May 30, 1991. Should you neod Additional personnel, we stand ready to ask the General Accounting office to assist yvv», if you have any questions concerning this request, please contact the Banking Committee Staff Director, Xalsay Meek, as soon as possible. Sincerely, (WRryBf JfnVaM Chairman Oerald D. Kleczkv Frank Annum io Chairman Subcommittee on Financial Institutions SJOW^iWto-a t^is^******** U.S. HOUSE OF REPRESENTATIVES C 0 M M 0 7 « ON CANKlNa ftNANC* ANO OMAN AWAWS 'MA.L9UjSO*a»«0 * > « WtMiOl WNCA* * k T V i U K l •M4MA9 4 CMNK. M U ^ M i QN€ HUNOA£0 6€C0N0 CONGRESS 2120 KAY1URN HOUSC OFfiCE GUiCOtNO WASHINGTON, OC 2 0 0 1 * J9ttiM #. M P s * * f. M^eiACHUMTni AflfO * f U s * . « * * t0«* CtJtfsyt/fl0tAt*MVl4M9 i f M « tAMQCPf, W M M T •J4M*S) ttilfc|fl& frt2>2J»~ft1«l fCXOM«a.«T<W( Wlfl TKttMDIATE ttJtLBAflg no wm.«mr row ja<unur.«M«J WASHINGTON, D . c , June 11, 1391—Hous« Banking Committee Chairman Henry B. Gonzales charged today that tho federal Receive has "expanded billions of dollars of public monies in backdoor bailouts of failing banks." Mr. Gonzalez said the Federal Reserve'e loans had kept brain-dead institutions open for extended periods, increasing losses for the Federal Deposit insurance funds, Mr. Gonzalez' comments were based on findingc of a Committee study of discount window operations between January l, 1985 and Kay 1991. The findings included: 1, Ninety percent of all institutions which received "extended" credit subsequently failed. 2, The Federal Reserve routinely extends credit to institutions with * CAM8L 5 rating—the lowest possible rating,. 3, A CAMEL 5 rated institution which borrowed from the discount windov remained open for an average period of 10-12 months. 4- Borrowing from the discount window increases dramatically as an institution*a financial condition deteriorates. The study revealod that 530 institutions failed within three year* of borrowing from the Federal Reserve, some 320 banks were borrowing at the time of failure and had outstanding loans of $8,325 billion when they wer« closed. Mr- Gonzalez said the Federal Reserve's loans to terminally ill institutions had allowed uninsured depocitors to withdraw funds and had kept bonk* opeirafcin? with bad tuanagomont »nd risky loan policies. "This is a massive form of forbearance—granted in secret by the Federal ft«*erve*«-at a huge cost to the insurance funds and the taxpayers/' th* Banking Committee chairman said. "We hear many complaints about the ills of money brokers who move money into failing inGtitution*, but their operations pale besido the mega-buck operation* of the Federal Resorve," Kr, Gonzalez oaid it is important that controls be placed on the Federal Reserve's dieoount window operations if the Congr*a« ia "serious about limiting losses to the insurance fund, ending the too-big-to-fall policies, and halting the costly practice of extended forbearance for poorly run banks."