I read two interesting perspectives on the recent lawsuit filed by the FDIC against former officers and directors of the failed Heritage Community Bank of Glenwood, Illinois. You're going to need to pay to read either of them, however. Bank Safety & soundness Advisor set forth a nice summary of the FDIC's claims in its complaint, the second such lawsuit filed as a result of the rash of bank failures over the past two years (the first was a few months ago against former officers of the more infamous IndyMac): The lawsuit contends that the bank's directors breached their fiduciary duties by: Not establishing and enforcing lending policies, including limits on CRE concentrations; Not establishing sufficient reserves for loan losses and adequate capital; Not ensuring that the bank had "sufficient, capable personnel" to administer the CRE program; and Not correcting deficiencies recommended by regulators in exam reports. The Advisor also discusses the alleged failures of the FDIC in the years leading up to the collapse of the bank, as set forth in an FDIC Inspector General's report. The Monday morning quarterbacking by the OIG of each federal bank regulatory agency provides an incentive for agency minions to allege, as some have in e-mails to me, that no federal bank regulator has ever been found guilty of shutting down a banks too hastily, but rather of not "putting the incompetent fools who ran these banks out of their misery much sooner." No wonder these drones have trouble cutting it in a world where a worker's performance is measured by the bottom line. It's got to be like trying to breath while lying naked on the surface of Mars. Critics of the filing accuse the FDIC itself of Monday morning quarterbacking. The complaint has an element of Monday morning quarterbacking in that it asserts repeatedly that the board and management pushed the bank into CRE lending at a time (December 2006) when they were aware of the existence of a real estate "bubble," and based their lending on the "unsupportable" assumption that real estate values would rise or remain stable," says David Baris, executive director of the American Association of Bank Directors and a law partner at Buckley Sandler in Washington, D.C. "This suggests that bank boards should curtail or stop real estate lending if they cannot prove that real estate values will rise or remain stable," Baris adds. "I am sure that Chairman Bernanke or President Obama will not be pleased to hear that the FDIC is suggesting that bank boards of directors risk personal liability by permitting their banks to make loans when they cannot predict with certainty that the economy or real estate values will fare well or better." In fairness to the FDIC, however, its "quarterbacking" mirrors that of a shareholder lawsuit filed last year by the banks former president and other disgruntled shareholders. The allegations of the two complaints are similar and its likely the earlier suit provided a road map to the FDIC. The American Banker had a clever insight into one possible effect of this lawsuit and the others that are sure to follow. The litigation, or at least the threat of a lawsuit, could be enough to make leaders of other troubled banks squirm, with the broader potential of spurring more distressed sales, industry experts said. "If you are a director of a troubled community bank and you have had your head in the sand, this is your siren," said Michael Iannaccone, the president of MDI Investments Inc. in Chicago. "It is time to cut a deal that gives you massive dilution or leaves you with nothing, rather than let your bank be taken over and have the FDIC hound you," Iannaccone said. That is if a bank can find a buyer. Some lawyers believe a fear of professional liability is hefty enough that some bankers might even pay an acquirer. I've been involved in deals where the owners of banks that were under duress sold at an extremely favorable price, assumed "bad assets," agreed to sizable hold-backs of the purchase price to cover future losses on identified asset pools, and provided other incentives to an acquirer, usually with the "encouragement" of the federal and (where applicable) state bank regulators. Where the controlling shareholders decide that they no longer want the cheese, just out of the trap, we may see more of those. In this economic environment, the risks going forward are even higher than they were during the downturn of the late 1980s and early 1990s. Therefore, there may, in fact, be one or more instances where the sellers actually pay the buyer to take the bank. In the interim, we'll sit back and watch to public posturing by both the FDIC and the defense. As expected, the defendants in the Heritage Bank case have an entirely different reading of the facts. The leaders of Heritage said they were blindsided like everyone else. "The FDIC's action is both regrettable and wrong," the defendants said in a press release. "With the advantage of 20-20 hindsight, the FDIC blames the former officers and directors of a small community bank for not anticipating the same market forces that also caught central bankers, national banks, economists, major Wall Street firms and the regulators themselves by surprise." I suppose they can always quote Sheila Bair: "Even I didn't think things would ever be this bad."
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