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An Address By

L. William Seidman
Federal Deposit Insurance Corporation

Before The

Government Relations Committee
of the
Association of Bank Holding Companies

September 17, 1986
Washington, D.C.

I'm pleased to have the opportunity to join you today and share a few
thoughts about FDIC assistance to troubled banks. However, before I begin I
must warn you — we're taking the names of those w h o show mor e than idle
curiosity a b o u t thi s topic.
W h a t I'd like to do is briefly g o over F D I C assistance (Section
13(c)), talk about some of the problems w e face a n d finally p r o v i d e an
indication of what to expect from the F D I C in the future. I'll b e h a p p y to
e n t e rtain q u e s t i o n s at t h e end.
As background,

let m e e m p h a s i z e a f e w p r i n c i p a l points.

First, things hav e changed since the F D I C formulated its current
written policy on open b a n k assistance. T h e n u m b e r of c o m m e r c i a l b a n k
failures is up sharply and growing. Unlike past experience, m a n y of today's
failures largely result from severe economic conditions— -not incompetent or
dishonest management.
Second, the vast majority of failures are small commercial banks, a
fact which focuses attention on the need for equitable treatment. This goal
w a s s o m e t i m e s o v e r l o o k e d in t h e past.
Third, a n u m b e r of t r o u b l e d institutions a re subs i d i a r i e s of
multibank holding companies. Assistance to such b a n k s presents a series of
questions which frankly were not contemplated w h e n our existing policy was
written. Among the more significant of these is the treatment and status of
h o l d i n g c o m p a n y creditors.
Fourth, free enterprise and the desire for market discipline mandate
shareholders a n d m a n a g e m e n t a re h e l d r e s p o n s i b l e for t h e i r actions.
A s s i s t a n c e policies s h o u l d n o t d i s r u p t this relationship.
With these thoughts in mind, let m e provide some history of FDIC
a s s i s t a n c e a n d an indication of w h e r e w e a re heading.
The FDIC first received authority to assist b a n k s to prevent them
from failing in 1950. S uch assistance could b e given only if c o n t i n u e d
operation was considered essential to provide adequate banking service in the
community. With the number of banks and branches in most areas, essentiality
was a p retty tough test. A s y ou might expect, there w as not a significant
number of assistance transactions. Of course, there weren't m a n y failures,
U p until 1982, only five b a n k s o b t a i n e d assistance.
Normally, we either arranged a purchase and assumption transaction
(P & A) or simply liquidated the b a n k and p a i d off i n s u r e d depositors.
Philosophically, the FDIC was opposed to giving assistance— w e thought then
(and still do) that it is best if unprofitable institutions are allowed to
exit the marketplace. So we provided assistance only in those cases w h e r e the
bank was just too big to handle with a P & A transaction (back then the FDIC
could not go out-of-state to find a merger partner) and w e were convinced a


payoff would have major adverse consequences for the community. Small banks
simply weren't eligible for assistance unless there was s o m e o v e r r i d i n g
consideration. In fact, the only small b a n k w e assisted w a s Unity Bank, a
special case b e c a u s e it w a s a m i n o r i t y - o w n e d b a n k in M a s s a c h u s e t t s .
In October 1982, Congress passed the G a m - S t Germain Act. This Act
had some pretty important provisions for dealing with troubled institutions.
It authorized the n e t w o r t h certificate p r o g r a m , w h i c h w e h a v e u s e d
successfully to assist mutual savings banks. It also gave the FDIC authority
to look nationwide for bidders for large failed banks.
Both tools proved to
b e useful, a n d as y o u k n o w t h e y e x p i r e d M o n d a y .
More relevant to our current topic, Garn-St Germain considerably
expanded our authority for providing direct financial assistance to banks.
Assistance could be provided in any case where the cost would b e less than
t h a t of closing a n d l iquidating t h e bank.
Although this law dearly expanded our powers, the philosophical view
was open bank assistance should be avoided except perhaps to facilitate the
acquisition of a failing bank. T h e dominant concern w as assistance would
r e p r e s e n t a n u n d u e b e n e f i t f or an institution's shareholders.
This philosophy was reflected in the Board's 1983 policy statement
which established the basic criteria for an assistance transaction. The y are:
Executive management, directors, shareholders and subordinated
creditors should not receive financial benefit greater than they would have if
t h e b a n k h a d closed;
(2) Any funds obtained from nonbook sources such as recoveries on
charged off assets, b o n d claims, and claims against officers and directors
w o u l d flow t o t h e F D I C until a s s i s t a n c e w a s repaid;


(3) The bank must obtain new sources of capital sufficient for it to

(4) Assistance must represent the least costly alternative for the
FDIC. W e also described a variety of criteria which elaborated u p o n these
T h ese policies wer e intended to s u p p o r t o u r b a s i c belief tha t
institutions m ust b e allowed to fail; and that shareholders, creditors and
u n i n s u r e d d e p o s i t o r s m u s t n o t b e p r o t e c t e d f r o m financial loss.
It also made d e a r that active mana g e m e n t and directors should not
escape the normal legal and financial liability associated with the inadequate
performance of their duties. In other words w e did not, and still do not,
w a n t t o bail o u t t h e losers.


Under these policies, the F D I C has agreed to provide assistance to
only t h r e e b a n k s so t h e y c o uld r e m a i n o p e r a t i n g entities.
One was
Continental. The other two were approved within the past six months. T hey
are The Talmage State Bank— a $10 million institution— and B a n k of Oklahoma.
T h e other assistance arrangements were designed to facilitate open b a n k
In r e c e n t months, r e q u e s t s fo r a s s i s t a n c e h a v e i n c r e a s e d
Currently, w e h ave around half a dozen applications f r o m
commercial banks under consideration in Washington, plus others in th e field.
In addition to these applications we have been approached b y n u m e r o u s other
The most common problems with unsuccessful requests were they were
not cost effective or management responsible for the banks' problems would
have benefited. Other problems included requests designed primarily to bail
out the bank stock lender or shareholders and/or the bank w as not considered
in d a n g e r of failing.
Today, w e find t h a t w e m u s t m e e t n e w situations a n d d e v e l o p
innovative packages to meet the increasing supply of failed and failing banks
(150 or more expected this year). W e must deal with failures of units in
multibank holding companies and one bank holding companies, large and small.
Constructing a lower cost alternative for the insurance fund is an increasing
Given this environment it makes sense for the F D I C to review its
policy toward open bank assistance. W e do adhere to the general philosophy
bdiind our current policy; but, at the same time, w e want to increase our
options for providing open b a n k assistance w h ere it is cost effective and
beneficial to t h e stability of t h e system.
In this regard our present written policy presents some difficulty.
One obstacle is the requirement that shareholders and subordinated creditors
(and those standing behind them, holding company creditors) b e n o better off
than if t h e b a n k h a d closed.
T h i s p r e s e n t s t w o practical problems.
One, any program which benefits the bank will eventually provide some
benefit to shareholders and creditors. Second, without the opportunity for
some marginal benefit, shareholders and creditors will h a v e n o incentive to
consummate an assistance transaction which could result in substantial savings
for the FDIC. Thus, while w e consider a bailout clearly inappropriate, a
total wipeout is not always in the insurance fund's best interest. N o r is it
a l w a y s justified.
Assistance transactions are particularly difficult in holding company
situations. Our underlying philosophy is there is an obligation on the part
of the whale organization to the health of each affiliate. T h e failure of one
bank within a holding company could well lead to the failure of other banks in
the organization.
Problems should not b e viewed on a stand alone basis.


In that respect w e anticipate shareholders and creditors of t he
holding company will share in some of the loss, not unlike w hat would have
occurred if one of the b a n k s in the holding c o m p a n y failed.
But again, a
total wipeout is not required. This would not necessarily b e t he likely
result if only one ailing subsidiary bank failed. Thus, the F D I C should seek
a contribution from the holding company to reflect the equivalent of failure
of a part of the holding company. And, that contribution m ust b e significant.
Two recent examples demonstrate some of the problems and alternative
approaches to dealing with failing b a n k s a n d t h e i r h o l d i n g companies.
Recently, the First National B a n k of Oklahoma failed. In this case
an open b a n k assistance transaction w as explored but the effort was n ot
successful. Quite frankly, the institution ha d deteriorated significantly.
The failed bank was the principal asset of the parent holding company.
the interests of holding company shareholders and creditors in the b a n k were
virtually eliminated.
This demonstrates a key point. Creditors of a holding co m p a n y are
not in t he same position as creditors of a bank. T h e y are in a position
similar to b a n k shareholders.
Let me compare this approach to the one used for t he Oklahoma City
based Bank of Oklahoma. At Bank of Oklahoma, the holding company was highly
leveraged and because of operating losses could not raise n e w funds in the
marketplace. The subsidiary bank accounted for only 20 percent of the holding
company's consolidated assets. It was about to fail. T h e recognized inability
of the holding c o m p a n y to deal with the situation b e g a n to cause funding
problems at the lead b a n k in Tulsa. If the Oklahoma City b a n k h a d failed,
liquidity pressures could well h a v e lead to the failure of other affiliated
What w e agreed to do is assume $40 million of the bank's loans from
the Federal Reserve and also purchase $90 million of cumulative convertible
preferred stock. In return the FDIC will receive warrants at a nominal price
r e p r e s e n t i n g 55 p e r c e n t of t h e b a n k h o l d i n g c o m p a n y ' s stock.
Provided the FDIC's preferred stock is redeemed, the holding company
may repurchase up to 80 percent of the FDIC's warrants at a price which repays
most of our $40 million loan. The remaining 20 percent remain with the FDIC.
In addition, dividends will not be paid on stock of the parent holding company
for an extended period. The basic idea was to structure a transaction that
provided temporary capital along with incentives for the holding company to
repay the FDIC. Failing that, shareholders would suffer substantial dilution.
Moreover, creditors of the holding co m p a n y agreed to convert $23
million, or just over 30 percent of their debt, to a capital instrument. They
will earn no interest for three years and a below market rate thereafter.


Negotiations on this transaction resulted in severed n e w twists to
o u r e x i sting policy statement.
The FDIC did not take out assets as a part of the assistance plan nor
did w e obtain first rights to recoveries from charged off assets. Incentives
were provided to the b a n k to maximize revenues from edl sources, through
penalties which increase with the amount of time that FDIC assistance remains
outstanding. There was a small amount of widely o w ned subordinated debt in
the bank. These creditors did not suffer the loss they probably would have
experienced had the bank failed (because there was n o w a y to negotiate such
c o n c e s s i o n s o n a t i m e l y basis).

Assistance clearly appeared to b e least expensive route for t h e
FDIC. It helped preserve the value of both the b a n k and t he entire holding
company system. At the same time it was not a free ride. Shareholders and
line b a n k c r e d i t o r s all g a v e material concessions.
In conclusion, let m e s u m m a r i z e w h e r e w e are.
Recent open bank assistance transactions have been considered for the
following reasons:
One, they provide the opportunity for substantial savings to the
i n s u r a n c e fund.
Two, they provide a mechanism for keeping loans and other assets
within the banking system.
Borrowers will b e deeding with bankers, not
Three, they can minimize the disruption to the local community which
results f r o m b a n k failures.
However, these advantages h a v e to weighed against the substantial
disadvantages of the FDIC's short term (hopefully) involvement in the private
sector t h r o u g h its o w n e r s h i p of warrants, p r e f e r r e d s t o c k or loans.
Thus, Section 13 assistance to o p e n b a n k s i n v o l v e s a c o m p l e x
situation in which advantages and disadvantages must b e weighed b y t h e
Corporation. The Board of the FDIC will b e considering these factors as it
deals with further policy statements in the area of open b a n k assistance.