	Background

Ten states concentrated in the western, midwestern, and southeastern  United States—all areas where the housing market had experienced  strong growth in the prior decade—experienced 10 or more bank failures  between 2008 and 2011 (see fig.1). Within these 10 states, 86 percent (257) of the failed banks were small  institutions with assets of less than $1 billion at the time of failure, and 52  percent (155), had assets of less than $250 million. The rising level of  nonperforming loans, particularly ADC loans, appears to have been the  key factor in the failures of small and medium banks in the 10 states  between 2008 and 2011. Our analysis showed that small failed banks in  the 10 states had often pursued aggressive growth strategies using  nontraditional and riskier funding sources such as brokered deposits. The IG reviews noted that in the majority of failures, management  exercised poor oversight of the risks associated with high CRE and ADC  concentrations and engaged in weak underwriting and credit  administration practices. Credit Losses and Charge- offs from Nonperforming Loans Contributed Significantly to Bank Failures Nationwide, but Losses Due to Fair Value Accounting Did Not

We found that losses related to bank assets and liabilities that were  subject to fair value accounting contributed little to bank failures overall,  largely because most banks’ assets and liabilities were not recorded at  fair value. We analyzed the assets and liabilities on the balance sheets of failed  banks nationwide that were subject to fair value accounting between 2007  and 2011. However, state banking  associations said that the magnitude of the losses was exacerbated by  federal bank examiners’ classification of collateral-dependent loans and  evaluation of appraisals used by banks to support impairment analysis of  these loans. Federal banking regulators noted that regulatory guidance in  2009 directed examiners not to require banks to write down loans to an  amount less than the loan balance solely because the value of the  underlying collateral had declined and that examiners were generally not  expected to challenge the appraisals obtained by banks unless they  found that any underlying facts or assumptions about the appraisal were  inappropriate or could support alternative assumptions. GAO, Banking Regulation: Enhanced Guidance on Commercial Real Estate Risks  Needed, GAO-11-489 (Washington, D.C.: May 19, 2011). FDIC Used Shared Loss Agreements to Attract Bidders at Least Cost to the Deposit Insurance Fund

FDIC is required to resolve a bank failure in a manner that results in the  least cost to the Deposit Insurance Fund (DIF). During the most recent financial crisis, FDIC facilitated these sales by  including a loss share agreement, under which FDIC absorbed a portion  of the loss on specified assets purchased by the acquiring bank. From  January 2008 through December 31, 2011, FDIC was appointed as  receiver for the 414 failed banks, with $662 billion in book value of failed  bank assets. From 2008 to the end of 2011, FDIC resolved 281  of the 414 failures (68 percent) by providing a shared loss agreement as  part of the purchase and assumption. In addition, future payments under DIF  receiverships are estimated at an additional $26.6 billion over the duration  of the shared loss agreements, resulting in total estimated lifetime losses  of $42.8 billion (see fig. 2). Impact of Bank Failures on Local Communities Was Mixed

The acquisitions of failed banks by healthy banks appear to have  mitigated the potentially negative effects of bank failures on communities,  although the focus of local lending and philanthropy may have shifted. However, the effects could be significant for those limited areas that were  serviced by one bank or where few banks remain. Second, our econometric analysis of call report data from 2006 through  2011 found that failing small banks extended progressively less net credit  as they approached failure, but that acquiring banks generally increased  net credit after the acquisition, albeit more slowly. For example, several noted that in the wake  of the bank failures, underwriting standards had tightened, making it  harder for some borrowers who might have been able to obtain loans  prior to the bank failures to obtain them afterward. Acquiring bank officials we interviewed told us that they  had generally increased philanthropic activities compared with the failed  community banks during the economic downturn and in the months  before failure. This is a work of the U.S. government and is not subject to copyright protection in the  United States.
Why GAO Did This Study

Between January 2008 and December 2011--a period of economic downturn in the United States--414 insured U.S. banks failed. Of these, 85 percent (353) had less than $1 billion in assets. These small banks often specialize in small business lending and are associated with local community development and philanthropy. These small bank failures have raised questions about the contributing factors, including the possible role of local market conditions and the application of fair value accounting under U.S. accounting standards.
This statement is based on findings from the 2013 report on recent bank failures (GAO-13-71). This testimony discusses (1) the factors that contributed to the bank failures in states with the most failed institutions between 2008 and 2011 and what role, if any, fair value accounting played in these failures; (2) the use of shared loss agreements in resolving troubled banks; and (3) the effect of recent bank failures on local communities. To do this work, GAO relied on issued report GAO-13-71 and updated data where appropriate.
GAO did not make recommendations in the report.

What GAO Found

Ten states concentrated in the western, midwestern, and southeastern United States--all areas where the housing market had experienced strong growth in the prior decade--experienced 10 or more commercial bank or thrift (bank) failures between 2008 and 2011. The failures of the smaller banks (those with less than $1 billion in assets) in these states were largely driven by credit losses on commercial real estate (CRE) loans. The failed banks also had often pursued aggressive growth strategies using nontraditional, riskier funding sources and exhibited weak underwriting and credit administration practices. Fair value accounting also has been cited as a potential contributor to bank failures, but between 2007 and 2011 fair value accounting losses in general did not appear to be a major contributor, as over two-thirds of small failed banks' assets were not subject to fair value accounting. During the course of our work, some state banking associations said that the magnitude of the credit losses were exacerbated by federal bank examiners' classification of collateral-dependent loans and evaluation of appraisals used by banks to support impairment analysis of these loans. Federal banking regulators noted that regulatory guidance on CRE workouts issued in October 2009 directed examiners not to require banks to write down loans to an amount less than the loan balance solely because the value of the underlying collateral had declined, and that examiners were generally not expected to challenge the appraisals obtained by banks unless they found that underlying facts or assumptions about the appraisals were inappropriate or could support alternative assumptions.
The Federal Deposit Insurance Corporation (FDIC) used shared loss agreements to help resolve failed banks at the least cost during the recent financial crisis. Under a shared loss agreement, FDIC absorbs a portion of the loss on specified assets of a failed bank that are purchased by an acquiring bank. FDIC officials, state bank regulators, community banking associations, and acquiring banks of failed institutions GAO interviewed said that shared loss agreements helped to attract potential bidders for failed banks during the financial crisis. During 2008- 2011, FDIC resolved 281 of 414 failures using shared loss agreements on assets purchased by the acquiring bank. As of December 31, 2011, Deposit Insurance Fund (DIF) receiverships are estimated to pay $42.8 billion over the duration of the shared loss agreements.
The acquisitions of failed banks by healthy banks appear to have mitigated the potentially negative effects of bank failures on communities, although the focus of local lending and philanthropy may have shifted. For example, GAO's analysis found limited rural and metropolitan areas where failures resulted in significant increases in market concentration. GAO's econometric analysis of call report data from 2006 through 2011 found that failing small banks extended progressively less net credit as they approached failure, and that acquiring banks generally increased net credit after the acquisition. However, acquiring bank and existing peer bank officials GAO interviewed noted that in the wake of the bank failures, underwriting standards had tightened and thus credit was generally more available for small business owners who had good credit histories and strong financials than those that did not. Moreover, the effects of bank failures could be significant for those limited areas that were serviced by one bank or where few banks remain.