FDIC Takes Gloves Off for Failed Bank Losses

NEW YORK CITY-The default rate on commercial mortgages approached historic highs in the third quarter, albeit at a far slower pace than before, Real Capital Analytics said this week. “The $604-million increase in the default balance in the third quarter is less than one-tenth of the $7.2-billion increase in the second quarter 2007,” writes Sam Chandan, RCA’s chief economist, in an RCA commentary on the Q3 results. “As property prices and rent measures stabilize in many markets, the increase in strain on bank health related to commercial real estate is also becoming more measured.”

However, even as banks have lowered their commercial real estate exposures, reducing their CRE balance sheets by $8.8 billion in Q3, the FDIC has made it clear that it plans to play hardball with recouping losses from failed financial institutions. Since the onset of the financial crisis in 2008, more than 300 banks have gone under, although Chandan, a regular blogger for GlobeSt.com, wrote in a June blog that “there has been little formal research thus far” on how significant a role CRE lending has played in pushing troubled institutions over the edge.

A recent directors-and-officers liability action taken by the agency centered on a defunct Illinois community bank that, according to the FDIC’s complaint, neglected to control its CRE exposure risks. The complaint filed Nov. 1 at US District Court in Chicago alleges that $20 million in losses incurred by Glenwood, IL-based Heritage Community Bank stemmed from a failure by 11 of the bank’s former directors and/or officers to “properly manage and supervise Heritage and its commercial real estate lending program.”

Named in the suit are former CEO John Saphir; former president Patrick Fanning; former CFO Stephen Faydash; former SVP of lending William Hetler; former CRE lending officer Thomas Jelinek; former VP of loan operations Lori Moseley; and former board members Stephen Anthony, Jerry Brucer, James Champion, Andrew Nathan and Mary Mills.

In a statement, the 11 defendants say the FDIC’s allegations are “utterly without merit” and call the agency’s actions “both regrettable and wrong. 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.”

In an article on the FDIC’s Heritage action, Washington, DC-based attorneys Thomas P. Vartanian, Robert H. Ledig and Lawrence Nesbitt, all with Dechert LLP’s financial institutions group, write that the suit demonstrates the agency’s “willingness to seek to recover losses from directors and officers of even relatively small community banks in order to recoup, what may be considered by some to be, relatively small losses. FDIC estimated that the resolution of Heritage would cost the Deposit Insurance Fund approximately $42 million.” The three Dechert attorneys are not involved with the case; GlobeSt.com’s calls to Vartanian for further comment were not returned by deadline.

The Heritage complaint is only the second D&O suit brought by the FDIC in recent months. An earlier action was brought against four senior executives of the former IndyMac Bank’s Homebuilders Division, based in Pasadena, CA.

The IndyMac defendants—including HBD’s former CEO, former chief lending officer, former chief compliance officer and former chief credit officer—similarly denied any wrongdoing in the FDIC’s suit against them, which was filed in July in federal court in California and seeks $300 million in damages. “The FDIC has unfairly selected four hard-working executives of a small division of the bank to blame for the failure of IndyMac,” defense attorney Kirby Behre of Paul Hastings told the Los Angeles Times.

Yet there may be more to come. In an interview with the Wall Street Journal two weeks ago, Fred W. Gibson, deputy inspector general at the FDIC, said the agency is conducting about 50 criminal investigations of former executives, directors and employees at US banks that have failed since the financial crisis began.

Gibson did not provide specifics, but Business Insurance reported that a speech by the FDIC’s Floyd Robinson suggested that commercial mortgage lending might be a common factor in many of the investigations. “What you see in Heritage is what you are going to see in a number of cases” before the FDIC, said Robinson, the agency’s senior counsel for the professional liability and financial crimes unit, in a presentation to the Professional Liability Underwriting Society’s 23rd annual PLUS International Conference in November. “Unfortunately, a number of community banks in the country got caught up in the commercial real estate lending frenzy.”