WASHINGTON — While the failure of troubled banks has become a weekly occurrence during the financial crisis, the collapse of FBOP Corp.'s nine subsidiaries last week included something new: the closure of two healthy and viable institutions.
The Federal Deposit Insurance Corp. dusted off rarely used authority to charge the banks for the resolution costs of the other seven insolvencies — ultimately causing the $4.7 billion-asset Park National in Oak Park, Ill., and the $118 million-asset Citizens National Bank in Teague, Texas, to fail as well.
The move significantly cut the overall cost of the failures, and is likely to be something the agency uses to handle future failures, observers said.
"It could be a wake-up call for some chain banks or multibank holding companies that really haven't focused on the FDIC's authority," said Kip Weissman, a partner at Luse Gorman.
The FDIC's authority to assess "cross guaranty" charges on institutions dates back to 1989, after the failures of several banking organizations in Texas led to a call to hold chains liable for failures even if some of their institutions were healthy.
The intent at the time was to find a source of assets to mitigate the FDIC's costs, but also to prevent holding companies from moving bad assets into troubled banks, and allow their "good" banks to flourish.
"It was designed to address some very real abuses that occurred in the late 1980s," said Wayne Abernathy, the executive director for financial institutions policy at the American Bankers Association.
The absence of such a law "creates the opportunity for you to dump your bad assets from your good bank into your bad banks, and then walk away from them. … It's considered an unfair strategy when you have healthy banks that are trying to basically dump on the FDIC all of their problems and walk away nice and clean."
FBOP's collapses were largely a result of heavy investments in Fannie Mae and Freddie Mac stock that plummeted when regulators seized the government-sponsored enterprises last fall. The holding company could not raise capital to cover its losses and some of its largest institutions — including the $7.8 billion-asset California National Bank in Los Angeles — also were dragged down by nonperforming commercial real estate and construction loans.
But Citizens and Park National had relatively high capital ratios as late as June 30. Park National was adequately capitalized, with a total risk-based capital ratio of 9.66%. Citizens' ratio was 11.43%.
Park National was even showing some signs that it was business as usual on the day it was closed.
Its subsidiary, Park National Bank Initiatives, was announced Friday as a recipient of the latest round of funding from the New Markets Tax Credit Program. The program, run through the Treasury Department's Community Development Financial Institutions Fund, awarded Park National $50 million, and Treasury Secretary Tim Geithner was on hand in Chicago Friday to announce the awards.
Under the law, a cross-guaranty liability is assessed when the FDIC figures it would lead to a "least-cost" resolution. Typically, the amount of the assessment against the healthy units is equal to the estimated loss to the Deposit Insurance Fund of the other affiliated institutions.
When Park National and Citizens could not pay the full amount, the Office of the Comptroller of the Currency closed them. Even though neither would have failed without the cross-guaranty charge, observers said it was justified.
"I'm not sure a bank holding company deserves the benefit of the doubt if they're running some dodgy banks and some better banks," said Richard Herring, a finance professor at the Wharton School. "If they're not exercising the kind of risk control that they should to be a consolidated entity, then I think it's a perfectly logical thing to do."
The agency has been pushing for the power to take over entire holding companies, arguing it would streamline the process for resolving bank subsidiaries that now could get held up in bankruptcy court.
The cross-guaranty authority is "as close as the FDIC can get" to consolidated resolutions, Herring said.
If the agency had the ability to resolve holding companies, the cross-guaranty "wouldn't be necessary," he added. "It's really an accommodation of the fact that they can't get at those other banks through the holding company."
Weissman agreed that the FDIC is interested in "as many assets as they can" reach that are affiliated with a failed bank in order to reduce their costs.
"Even if they didn't pursue the cross-guaranty, they would pursue cross-claims against the other banks," he said. "From the regulators' point of view, it's part of the same pie. They're going to try to get their hands on as much of those assets as possible."
Ralph "Chip" MacDonald, a partner at the law firm Jones Day in Atlanta, said the FDIC's move could call into question the benefits of running numerous institutions through a holding company.
"If you treat them all like one bank, what's the advantage of having separate charters?" he said. "In terms of a failure, FDIC can come in and wipe out all the banks through the cross-guaranty as if they were one charter."
Michael Krimminger, a special policy adviser at the FDIC, said the authority prevents holding companies from simply sticking their bad assets in institutions that have no hope.
"You would not want to have a situation … where someone put bad assets in a particular bank and the FDIC could not recover" costs "from the commonly controlled banks that did not have the bad assets because they were separate banking subsidiaries," Krimminger said.
The agency may take similar action in the future, he said.
"We would certainly reserve the right to cross-guaranty in the future where we've got commonly controlled insured banks or thrifts, where there are losses in some that failed and we can reduce our costs by assessing their other commonly controlled banks or thrifts," he said.
Still, there is a limited pool of subsidiaries that could face such a charge. Of the roughly 5,000 commercial bank holding companies at the end of June, only 9% owned more than one institution.
Many multi-holding companies also include just a few institutions that are so interconnected that if one failed, it would be hard to prevent the others from falling too.
"I don't think the opportunity presents itself all that often," said Robert Clarke, a senior partner at Bracewell & Giuliani and a former comptroller of the currency. "Usually most banks run their holding companies as an integrated operation, where even if you have the various banks, they really act almost like branches."