Margin of Risk Is Bottom Line in Failed-Bank Takeovers

Just hours after Newport Harbour National Bank collapsed, a Monterey Park bank, eager to expand into Orange County, got the nod from the federal government to take over the insolvent institution.

Now, just two years later, executives at Trans National Bank are less than enthusiastic about their decision.

“There were a lot of negatives, now that I look back,” said bank President James Liu, as he ticked off a list of headaches, including ridding Newport Harbour of the favorable loan rates and chauffeured limousines it offered its wealthy Newport Beach-area customers.

“I’m not telling anyone not to go out and buy a failed bank . . . ,” Liu said. “But if I had to do it over again, I wouldn’t.”

Bankers and industry consultants generally agree with Liu’s assessment that such acquisitions are risky and often turn out to be more trouble than they are worth.

But as bank failures nationwide have increased dramatically from 10 in 1981 to a post-Depression record of 79 in 1984, many financially stable banks are jumping at the chance to buy their doomed brethren.

At first glance the benefits of buying a failed bank seem appealing: It is cheaper and quicker to acquire an existing bank than to start a new one; the acquiring bank instantly inherits an established clientele and presence in a new market, and regulators often allow the new bank to reject the failed bank’s bad assets so it can start with a clean financial slate.

Still, Edward Carpenter, a banking consultant who has worked on many such takeovers, said, “It’s been my general experience that banks that have bought failed banks have historically found they did not live up to their expectations.”

Referring to the rushed and clandestine atmosphere surrounding negotiations with the Federal Deposit Insurance Corp. for purchase of a failed bank, Carpenter said, “There is never enough time to verify the core depositors or do a full review of the bank’s loan portfolio. They’re often buying a little bit blind.”

Ernest Leff, a Los Angeles banking attorney, agrees.

“The situation is always worse than you assume it to be. The people who know the problems are gone, so you have people who don’t know . . . and they botch it.”

Leff said another drawback is the drain on management. The acquiring banks often have to take their most talented managers out of the healthy bank and assign them to the offices of the failed bank in order to get those branches back on their feet and running smoothly.

With 43 failures so far this year, and 2,500 of the country’s 14,700 federally insured banks in financial trouble, the opportunities for expansion-minded banks to take them over will undoubtedly grow. The action is particularly hot in California, where 18 institutions have collapsed since 1981. And Orange County, which leads the state in bank failures, is a prime testing ground for expansion-minded banks.

“It’s at a point now, with so many failures, that you can at least call some of your banking brethren to find out some of the common pitfalls” of a takeover, said Jack Abe, president of Los Angeles-based Wilshire State Bank. Wilshire State paid the FDIC $200,000 for insolvent West Olympia Bank’s two Los Angeles branches in February 1984.

Nonetheless, Abe added, “All of us pretty well feel it takes a couple of years to digest (the acquisition of a failed bank).” Abe said that like most acquiring banks, Wilshire State had the unpleasant task of laying off a number of employees and spent almost one year meshing the two banks’ computer systems.

“In general, if you have really done your homework and researched the failed banks’ numbers based on the information given to you by regulators at the pre-bidding meetings, you can pick up a good facility,” according to Jack Fried, a Los Angeles attorney who represents banks throughout California. Fried cautioned, however, that banks sometimes overpay the FDIC--which serves as receiver for all federally insured failed banks--”because they don’t understand what they’re getting.”

Liu’s case is instructive.

Trans National Bank, then Trans American National Bank, paid the FDIC $475,000 in March 1983 to assume the leases on Newport Harbour’s building and equipment. It also acquired assets with an estimated value of $13.9 million and assumed liability for the failed bank’s 2,200 deposit accounts, which held about $40 million in FDIC-insured funds.

By June, 1984, deposits at the Newport Beach branch had dwindled to $2,396,000, according to figures provided by the Comptroller of the Currency.

Thus, in just over one year Trans American had to pay out nearly $38 million to deserting depositors. Those pay-outs erased the $31.2 million the bank got from the FDIC to cover the difference between Newport’s assets and insured liabilities. The result: a decline in the cash available to Trans American for funding profit-producing loans.

“Many of the depositors were very negative about another bank coming in from outside Newport Beach,” said Liu.

Liu described Newport Harbour as a bank with poor lending practices and high overhead, including a variety of “freebies” for employees and customers. He said the bank also conducted business primarily on a handshake basis.

“Then we go in and make some changes which are really an about-face. . . . We start charging fees. They (customers) move on.”

Referring to the spectacular exodus of deposits, Liu said, “It’s not to say we shouldn’t have realized that would have happened. (But) if we (had) continued those practices, we would have wound up like the original bank.”

Moreover, Liu said, “I don’t think we negotiated very well” during talks with the FDIC on implementing the takeover of Newport Harbour’s facilities and operations.

Typically, the acquisition of a failed bank is as fast-paced as it is high-pressured.

Once government regulators--the Comptroller of the Currency or the state Banking Department for state-chartered banks--are convinced an ailing bank cannot survive, the FDIC secretly invites a number of banks with sound management and sufficient capital to make an offer for the troubled bank.

A bid package replete with financial information on the troubled bank’s assets, liabilities and locations is distributed to the interested bidders, who submit their sealed bids the next day, usually the same day the problem bank is to be closed.

Alan Whitney, chief spokesman for the FDIC, said his agency does not pressure banks to bid and defended the tight timetable, maintaining that “any competent number-cruncher can go through that data and make a solid judgment as to whether they want to bid on that bank and how much it is worth to them to get that bank’s business.”

Working quickly and quietly is necessary, regulatory officials say, to keep word of an impending bank failure from leaking out--a situation that can cause consumer panic and a run on the bank’s deposits.

The successful bidder typically reopens the failed bank under its own name the next business day and, according to Whitney, is given an option to sell back to the FDIC any assets it decides are of low quality and to buy back any of the loans the FDIC originally had retained.

“While bank failures cause disruption in a community and create hardship on some people in the short run, in the overall picture, the community is better served because of the kind of transactions that we are able to put together,” said Whitney, adding that the procedure is usually accomplished with a minimum of fuss.

Moreover, Whitney said, not only do consumers benefit from uninterrupted banking, they also benefit because of the lower cost to the FDIC, resulting in a stronger insurance fund. The FDIC insures individual deposits up to $100,000.

Whitney said that about 80% of all failed banks are merged--taken over by other banks. In California, for example, of the 18 banks that have failed since 1981, 14 were merged.

In cases where there are no bidders, the FDIC closes the insolvent bank, pays off its insured depositors and proceeds to liquidate the bank’s assets--a process that takes an average of seven years.

Whitney said there are a handful of banks across the country that have become regular bidders on failed banks. But because mergers in such volume are still a relatively new phenomenon, no one bank has emerged as being in the forefront of these acquisitions.

For those banks that have recently become first-time buyers of a failed institution, optimism runs high.

“Things are going to be very successful and fruitful for us,” said Kenneth G. Walker, the president of Farmers & Merchants Bank of Long Beach. Walker’s bank expanded to 15 offices when it acquired collapsed Capistrano National Bank’s three Orange County offices last month. “We now cover (Orange County) from north Orange clear to San Juan Capistrano,” Walker added with pride. Robert Turicchi, president and chief executive of Long Beach-based Harbor Bank, echoed Walker’s sentiments, remarking that his bank’s venture has been beneficial so far.

Harbor went from five to seven offices overnight when it took over South Coast Bank’s Fountain Valley and Costa Mesa offices. The bank was closed by regulators just a week after Capistrano National failed.

‘Key to Successful Acquisition’

“The key to a successful acquisition appears to be how much deposit runoff you’re going to have when you take over a failed bank,” said Turicchi, whose bank paid $915,000 for the two offices. “We have been very fortunate. We lost only about $1.5 million of the $23 million we acquired in deposits” in the April takeover.

Some banks, particularly nationally chartered ones looking to expand, have a different agenda in taking over a failed bank.

When Security Pacific Corp., the holding company for Security Pacific National Bank, purchased the state-chartered Bank of Irvine last May, it was with two things in mind. The bank wanted to add to its customer base, but more important, it hoped to take advantage of the more liberal investment rules governing state-chartered banks.

“Owning a state bank may permit us to get into businesses that the (federal) law currently does not permit a nationally chartered bank to do, like investing in real estate,” said Susan Taha, a senior vice president at Security Pacific Corp.

Seeking Deregulated Markets

Taha characterized Security Pacific as “aggressively seeking” deregulated markets, noting that 30% of Security Pacific National Bank’s 1984 profits came from non-banking activities.

She declined to give specifics on the new Security Pacific State Bank’s real estate ventures, saying only that officials “are making plans and talking with the regulatory authorities.”

But sometimes, as in the case of Trans National Bank, even the best-laid plans go awry.

Liu, who said that Trans National’s Newport Beach branch is “holding its own” by serving small retailers and local professionals, is philosophical about his bank’s 2-year-old acquisition.

Asked what his bank--with three offices in Los Angeles County and two in San Francisco--ultimately gained by taking over Newport Harbour National Bank, the Monterey Park banker said, “We got the ability to do business down there. That’s about it.”