FINANCIAL 

INSTITUTIONS

Causes and 

Consequences of 

Recent Bank Failures

Report to Congressional Committees

January 2013

GAO-13-71

United States Government Accountability Office

GAO
United States Government Accountability Office

Highlights of GAO-13-71, a report to 

congressional committees 

January 2013

FINANCIAL INSTITUTIONS

Causes and Consequences of Recent Bank Failures

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 (see below). 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. The 

rapid growth of CRE portfolios led to high concentrations that increased the 

banks’ exposure to the sustained real estate and economic downturn that began 

in 2007. GAO’s econometric model revealed that CRE concentrations and the 

use of brokered deposits, a funding source carrying higher risk than core 

deposits, were associated with an increased likelihood of failure for banks across 

all states during the period. Several state regulatory and community banking

Number of Bank Failures by State, 2008-2011 

association officials told GAO that in some cases, the losses failed banks 

incurred on their CRE loans were caused by declines in the value of the 

underlying collateral of impaired, collateral-dependent loans. However, data are 

not publicly available that indicate the extent to which loan losses were driven by 

such declines in collateral values. 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. 

The Department of the Treasury and the Financial Stability Forum’s Working 

Group on Loss Provisioning have observed that the current accounting model for 

estimating credit losses is based on historical loss rates, which were low in the 

prefinancial crisis years. They said that earlier recognition of loan losses could 

View GAO-13-71. For more information, 

contact Lawrance Evans Jr., at (202) 512-

4802 or Evansl@gao.gov. 

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 

or 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 in the states with 

the most failures, including the 

possible role of local market conditions 

and the application of fair value 

accounting under U.S. accounting 

standards. As required by Pub. L. No. 

112-88, this report 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. GAO analyzed call report 

data, reviewed inspectors general 

reports on individual bank failures, 

conducted econometric modeling, and 

interviewed officials from federal and 

state banking regulators, banking 

associations, and banks, and market 

experts. GAO also coordinated with the 

FDIC Inspector General on its study.

GAO is not making any 

recommendations at this time. GAO 

plans to continue to monitor the 

progress of the ongoing activities of the 

accounting standardsetters to address 

concerns with the loan loss 

provisioning model. The Board of 

Governors of the Federal Reserve 

System, the FDIC, and the Office of 

the Comptroller of the Currency 

provided technical comments that GAO 

incorporated as appropriate.
Highlights of GAO-13-71 (Continued) 

United States Government Accountability Office

have potentially lessened the impact of the crisis, when 

banks had to recognize the losses through a sudden series 

of provisions to the loan loss allowance, thus reducing 

earnings and regulatory capital. The Financial Accounting 

Standards Board has issued a proposal for public 

comment for a loan loss provisioning model that is more 

forward-looking and focuses on expected losses, which 

would result in banks establishing earlier recognition of 

loan losses for the loans they underwrite and could 

incentivize prudent risk management practices. Moreover, 

it should help address the cycle of losses and failures that 

emerged in the recent crisis as banks were forced to 

increase loan loss allowances and raise capital when they 

were least able to do so.

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. Bank officials that 

acquired failed banks confirmed that they would not have 

purchased them without FDIC’s shared loss agreements 

because of uncertainty of the market and valuation of 

assets. FDIC said the benefits of shared loss agreements 

included reductions in its immediate cash needs, less 

disruption to failed bank customers, and the movement of 

assets quickly into the private sector. 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 made shared loss payments totaling $16.2 

billion. In addition,

Estimated Lifetime Losses and Yearly Shared Loss Payments, 2008-

2011 

DIF receiverships are estimated to pay an additional $26.6 

billion over the duration of the shared loss agreements, 

resulting in total estimated lifetime losses of $42.8 billion 

(see figure). By comparing the estimated cost of the 

shared loss agreements to the estimated cost of directly 

liquidating the failed banks’ assets, FDIC estimates that 

the use of shared loss agreements saved the DIF over $40 

billion. While total estimated lifetime losses of the shared 

loss agreements may not change, the timing of the losses 

may change and payments from shared loss agreements 

may increase as the terms of the agreements mature. 

FDIC officials stated that the acquiring banks are 

monitored for compliance with the terms and conditions of 

the shared loss agreements. FDIC is issuing guidance to 

the acquiring banks reminding them of these terms to 

prevent increased shared loss payments as these 

agreements approach maturity.

The acquisitions of failed banks by healthy banks appears 

to have mitigated the potentially negative effects of bank 

failures on communities, although the focus of local 

lending and philanthropy may have shifted. First, while 

bank failures and failed bank acquisitions can have an 

impact on market concentration—an indicator of the extent 

to which banks in the market can exercise market power, 

such as raising prices or reducing availability of some 

products and services—GAO found only a limited number 

of metropolitan areas and rural counties were likely to have 

become significantly more concentrated. The lack of 

increases in concentration was because in many 

instances, the failed banks were acquired by out-of-market 

institutions. Second, 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. Third, officials from regulators, banking 

associations, and banks GAO spoke with said that 

involvement in local philanthropy declined as small banks 

approached failure but generally increased after 

acquisition. Yet, these acquiring banks may not focus on 

the same philanthropic activities as did the failed banks. 

Finally, GAO econometrically analyzed the relationships 

among bank failures, income, unemployment, and real 

estate prices for all states and the District of Columbia 

(states) for the 1994 through 2011 period and found that 

bank failures in a state were more likely to affect its real 

estate sector than its labor market or broader economy.
Page i GAO-13-71 Recent Bank Failures 

Letter 1 

Background 6

Bank Failures Were Largely Related to Nonperforming Real Estate 

Loans but Also Highlight Impact of Impairment Accounting and 

Loan Loss Provisioning 17

FDIC Used Shared Loss Agreements to Attract Bidders at Least 

Cost to the Deposit Insurance Fund 39

Impact of Bank Failures on Local Communities Was Mixed 43

Agency Comments 55

Appendix I Objectives, Scope and Methodology 57

Appendix II FDIC Resolution Methods for Failed Institutions and the 

Least Cost Test Process 65

Appendix III GAO Analysis of Bank Characteristics and the Likelihood of 

Failure 69

Appendix IV Analysis of the Impact of Fair Value Accounting on Recent 

Commercial Bank Failures 73

Appendix V Analysis of the Impact of Fair Value Accounting on Recent 

Thrift Institution Failures 103

Appendix VI Analysis of HFI Loans Compared to HFS Loans of Large 

Banks 133

Appendix VII GAO Analysis of Net Credit Extended by Failing Banks and 

Acquiring Banks 139

Contents 
Page ii GAO-13-71 Recent Bank Failures 

Appendix VIII GAO Analysis of the Effect of Bank Failures on State 

Economic Conditions 144

Appendix IX GAO Contacts and Staff Acknowledgments 148

Tables

Table 1: Bank Failures in States with 10 or More Failures by Asset 

Size, 2008-2011 8

Table 2: Numbers, Asset Size, and Percentage of Banks and Failed 

Banks in the 10 States by Size, as of 2007Q4 and 2008-2011 11

Table 3: Impact of Bank Failures and Failed Bank Acquisitions on 

Market Concentration, 2007-2012 47

Table 4: Summary of Relationships among Bank Failures, Personal 

Income, Unemployment, and Real Estate Prices in U.S. 

States, 1994-2011 55

Table 5: Bank Characteristics Associated with the Likelihood of 

Failure, 2008-2011 71

Table 6: HFI Loans as a Percentage of Total Assets for Failed and 

Open Commercial Banks, 2007-2011 76

Table 7: Trading Assets as a Percentage of Total Assets for Failed 

and Open Commercial Banks, 2007-2011 77

Table 8: Nontrading Assets Measured at Fair Value Through 

Earnings on a Recurring Basis as a Percentage of Total 

Assets for Failed and Open Commercial Banks, 2007-2011 78

Table 9: Nonfinancial Assets Measured at Fair Value Through 

Earnings on a Recurring Basis as a Percentage of Total 

Assets for Failed and Open Commercial Banks, 2007-2011 79

Table 10: Trading Liabilities Measured at Fair Value Through 

Earnings on a Recurring Basis as a Percentage of Total 

Assets for Failed and Open Commercial Banks, 2007-2011 80

Table 11: HTM Securities as a Percentage of Total Assets for Failed 

and Open Commercial Banks, 2007-2011 81

Table 12: AFS Securities as a Percentage of Total Assets for Failed 

and Open Commercial Banks, 2007-2011 82

Table 13: HFS Loans as a Percentage of Total Assets for Failed and 

Open Commercial Banks, 2007-2011 83

Table 14: OREO Assets as a Percentage of Total Assets for Failed 

and Open Commercial Banks, 2007-2011 84
Page iii GAO-13-71 Recent Bank Failures 

Table 15: YTD and Accumulated OCI as a Percentage of Equity 

Capital 102

Table 16: HFI Loans as a Percentage of Total Assets for Failed and 

Open Thrifts, 2007-2011 106

Table 17: Trading Assets as a Percentage of Total Assets for Failed 

and Open Thrifts, 2007-2011 107

Table 18: Nontrading Assets Measured at Fair Value Through 

Earnings on a Recurring Basis as a Percentage of Total 

Assets for Failed and Open Thrifts, 2007-2011 108

Table 19: Nonfinancial Assets Measured at Fair Value Through 

Earnings on a Recurring Basis as a Percentage of Total 

Assets for Failed and Open Thrifts, 2007-2011 109

Table 20: Liabilities Measured at Fair Value Through Earnings on a 

Recurring Basis as a Percentage of Total Assets for Failed 

and Open Thrifts, 2007-2011 109

Table 21: HTM Securities as a Percentage of Total Assets for Failed 

Thrifts, 2007-2011Failed thrifts 110

Table 22: AFS Securities as a Percentage of Total Assets for Failed 

and Open Thrifts, 2007-2011 111

Table 23: HFS Loans as a Percentage of Total Assets for Failed and 

Open Thrifts, 2007-2011 112

Table 24: OREO Assets as a Percentage of Total Assets for Failed 

and Open Thrifts, 2007-2011 113

Table 25: Estimated Effect of Bank Characteristics on Net Credit, 

2006-2011 140

Table 26: Estimated Net Credit Extended by Failing, Acquiring, and 

Nonfailing, Nonacquiring Banks, 2008-2011 142

Table 27: Granger Causality Tests for Personal Income, 

Unemployment, House Price, and Failed Bank Deposit 

Equations, 1994-2011 146

Figures

Figure 1: Number of Bank Failures by State, 2008-2011 7

Figure 2: Quarterly Average CRE and ADC Loan Balances as a 

Percentage of Total Loan Balances at Failed and Open 

Small Banks in the 10 States, 2001-2011 19

Figure 3: Credit Losses as a Percentage of Net Interest Income for 

Small Failed Commercial Banks and Small Open 

Commercial Banks in All States, 2008-2011 29

Figure 4: FDIC’s Resolution Methods, 2008-2011 40

Figure 5: Shared Loss Agreements Entered into by Year, 2008-2011 42
Page iv GAO-13-71 Recent Bank Failures 

Figure 6: Estimated Lifetime Losses and Yearly Shared Loss 

Payments, 2008-2011 43

Figure 7: Estimated Net Credit Extended by Failing, Acquiring, and 

Nonfailing, Nonacquiring Banks, 2008-2011 50

Figure 8: FDIC’s Least Cost Test Process 66

Figure 9: Nonperforming Loans as a Percentage of Total Loans for 

Small Failed and Open Commercial Banks, 2007-2011 85

Figure 10: Income Categories as a Percentage of Net Interest 

Income for Small Failed Commercial Banks, 2007-2011 86

Figure 11: Income Categories as Percentage of Net Interest Income 

for Small Open Commercial Banks, 2008-2011 88

Figure 12: Nonperforming Loans as a Percentage of Total Loans for 

Medium-Size Commercial Banks, 2007-2011 89

Figure 13: Income Categories as a Percentage of Net Interest 

Income for Medium-size Failed Commercial Banks, 2007-

2011 90

Figure 14: Income Categories as a Percentage of Net Interest 

Income for Open Medium-size Banks, 2008-2011 91

Figure 15: Nonperforming Loans as a Percentage of Total Loans for 

Large Failed Commercial Banks, 2007-2011 92

Figure 16: Income Categories as a Percentage of Net Interest 

Income for United Commercial Bank, 2007-2009 93

Figure 17: Income Categories as a Percentage of Net Interest 

Income for Colonial National Bank, 2007-2009 95

Figure 18: Income Categories as a Percentage of Net Interest 

Income for Westernbank, 2007-2010 97

Figure 19: OTTI Losses on HTM and AFS Debt Securities as a 

Percentage of Net Interest Income for Failed Banks 99

Figure 20: Goodwill and Other Intangible Expenses as a Percentage 

of Equity Capital (Failed Banks), 2007-2011 100

Figure 21: Goodwill and Other Intangible Expenses as a Percentage 

of Equity Capital (Open Banks), 2008-2011 101

Figure 22: Nonperforming Loans as a Percentage of Total Loans for 

Small Failed Thrifts, 2007-2011 114

Figure 23: Income Categories as a Percentage of Net Interest 

Income for Small Failed Thrifts, 2007-2011 115

Figure 24: Income Categories as a Percentage of Net Interest 

Income for Small Open Thrifts, 2007-2011 116

Figure 25: Nonperforming Loans as a Percent of Total Loans for 

Medium-Size Failed Thrifts, 2007-2011 117

Figure 26: Income Categories as a Percentage of Net Interest 

Income for Medium-size Failed Thrifts, 2007-2011 118
Page v GAO-13-71 Recent Bank Failures 

Figure 27: Income Categories as a Percentage of Net Interest 

Income for Medium-Size Open Thrifts, 2007-2011 119

Figure 28: Nonperforming Loans as a Percent age of Total Loans 

for Large Failed Thrifts, 2007-2009 120

Figure 29: Income Categories as a Percentage of Net Interest 

Income for Large Failed Thrifts, 2007-2009 121

Figure 30: Income Categories as a Percentage of Net Interest 

Income for Large Open Thrifts, 2007-2011 122

Figure 31: IndyMac Income Categories as a Percentage of Net 

Interest Income, 2007-2008 124

Figure 32: Downey Income Categories as a Percent of Net Interest 

Income, 2007-2008 125

Figure 33: Washington Mutual Income Categories as a Percentage 

of Net Interest Income, 2007-2008 127

Figure 34: AmTrust Income Categories as a Percentage of Net 

Interest Income, 2007-2009 128

Figure 35: BankUnited Income Categories as a Percentage of Net 

Interest Income, 2007-2009 130

Figure 36: Guaranty Income Categories as a Percentage of Net 

Interest Income, 2007-2009 131

Figure 37: Amtrust Volume of HFI Loans Compared to HFS Loans 

as a Percentage of Total Assets 134

Figure 38: IndyMac Volume of HFI Loans Compared to HFS Loans 

as a Percentage of Total Assets 135

Figure 39: WaMu Volume of HFI Loans Compared to HFS Loans as 

a Percent age of Total Assets 136

Figure 40: Downey Volume of HFI Loans compared to HFS Loans 

as a Percentage of Total Assets 137

Figure 41: UCB Volume of HFI Loans Compared to HFS Loans as a 

Percentage of Total Assets 138

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Page 1 GAO-13-71 Recent Bank Failures 

United States Government Accountability Office 

Washington, DC 20548

January 3, 2013

The Honorable Tim Johnson

Chairman

The Honorable Richard C. Shelby

Ranking Member

Committee on Banking, Housing, and Urban Affairs

United States Senate

The Honorable Spencer Bachus

Chairman

The Honorable Barney Frank

Ranking Member

Committee on Financial Services

House of Representatives

Between January 2008 and December 2011, 414 insured U.S. 

commercial banks and thrifts (banks) failed.1

These bank failures, which were concentrated in certain parts of the 

United States and occurred against the backdrop of the worst financial 

crisis since the Great Depression, raised a number of concerns. First, the 

number and proportion of failed banks varied across states, prompting 

questions about the role local market conditions and related economic 

factors played, particularly in those areas with the largest numbers of 

failures. Further, in an era of declining asset values and rising mortgage 

delinquencies, concerns have also been raised that the failures may have 

been due to losses recognized from the application of fair value 

Of these, 85 percent (353), 

were small banks with less than $1 billion in assets. These small banks 

tend to be community banks that are depository institutions, with a 

relatively limited geographic scope of operations and often specialize in, 

among other things, providing credit to local small businesses. 

Community banks are also associated with local community development, 

leadership, and philanthropy.

 

1

In this report, we refer to both these types of financial institutions as banks unless 

otherwise indicated. Commercial banks accept deposits, make business loans, and offer

related services. They serve individuals but focus primarily on servicing and making loans 

to businesses. Thrifts accept deposits and make loans, particularly for home mortgages. 

No banks failed in 2005 or 2006, and only three failed in 2007. 

 
 

Page 2 GAO-13-71 Recent Bank Failures 

accounting under U.S. generally accepted accounting principles (GAAP).2

According to its critics, fair value accounting may have contributed to 

some bank failures by requiring the reduction of the book value of assets 

(write-downs) such as investments in mortgage-backed securities to 

abnormally low market prices, lowering earnings and depleting the banks’ 

regulatory capital.3 These critics thought that the write-downs were based 

on values in inactive or illiquid markets and did not specifically reflect the 

underlying value of the assets.4

The Federal Deposit Insurance Corporation (FDIC) is required to resolve 

a bank failure in a manner that results in the least cost to the Deposit 

Insurance Fund (DIF).

Moreover, they maintain that the writedowns created a procyclical effect in that they caused banks to sell assets 

in an attempt to boost regulatory capital, putting further downward 

pressure on market prices and triggering further write downs and 

depletion of capital. The large number of small bank failures has also 

raised concerns about the potential effect on the communities where the 

banks were located, particularly in terms of credit availability, income and 

employment, and philanthropic activity.

5

In light of the questions raised about the recent failures, particularly those 

of small banks, and the potential costs to the DIF, Congress has required 

The DIF is funded by assessments levied on 

insured banks and savings associations and is used to cover all deposit 

accounts at insured institutions, such as checking and savings accounts, 

up to the insurance limit. FDIC resolved most bank failures during 2008 

through 2011 by facilitating their acquisitions by other banks and often by 

including a shared loss agreement, under which FDIC absorbed a portion 

of the loss on specified assets purchased by the acquiring bank.

 

2

Fair value accounting is a financial reporting approach that requires or permits financial 

institutions to measure and report on an ongoing basis certain financial assets and 

liabilities at the price that would be received to sell an asset or paid to transfer a liability in 

an orderly transaction between market participants at the measurement date.

3

Regulatory capital can be measured as total capital or tier 1 capital. Total capital consists 

of the sum of tier 1 and tier 2 capital. Tier 1 capital consists primarily of equity capital and 

retained earnings (the profits a bank has earned but has not paid out to shareholders in 

the form of dividends). Tier 2 capital includes subordinated debt, a portion of loan loss 

allowances, and certain other instruments. 

4

An inactive or illiquid market is one in which observable inputs such as quoted prices are 

not available due to infrequent transactions. 

5

12 U.S.C. § 1823(c)(4).
 

Page 3 GAO-13-71 Recent Bank Failures 

us to conduct a study of recent bank failures in states with 10 or more 

failures.6

(1) the factors that contributed to the failure of banks in states with 10 or 

more failures between 2008 and 2011, including the extent to which 

losses related to fair value accounting treatment affected the regulatory 

capital positions of failed banks;

Accordingly, the objectives of our report are to discuss

(2) market factors that affected FDIC’s choice of resolution method, or the 

amount of FDIC coverage offered on the shared loss agreements, and

the costs that the DIF incurred as a result of these shared loss 

agreements; and

(3) the effect of recent small bank failures on local communities.

To address the factors that contributed to the recent bank failures, we 

analyzed data from FDIC’s Historical Statistics on Banking–Failures and 

Assistance Transactions database, and Statistics on Depository 

Institutions as well as call report and thrift financial report data. In doing 

so, we reviewed information from FDIC on the policies and procedures it 

used to ensure that the data were complete and accurate and determined 

them to be reliable for our purposes. We reviewed material loss reviews 

(MLRs), failed bank reviews (FBR), and in-depth reviews (IDR) issued by 

the inspectors general (IG) of the federal banking regulators and 

estimated an econometric model to investigate bank characteristics that 

 

6

Pub. L. No. 112-88, § 3, 125 Stat. 1899, 1902 (2012). As part of this act, the FDIC 

Inspector General (IG) must also conduct a separate study on the impact of bank failures. 
 

Page 4 GAO-13-71 Recent Bank Failures 

may have contributed to failure.7

To address the effect of small bank failures on local communities, we 

estimated the change in market concentration from bank failures and 

In addition, we analyzed call reports and 

thrift financial report data for failed and open commercial banks and thrifts 

to identify and compare trends in the use of fair value accounting. We 

also interviewed officials from federal banking regulators, state banking 

regulators, national and state banking organizations, and market experts 

and had two accounting experts, a former comptroller general and a 

professor of accountancy, review a draft of the report. To identify the 

costs the DIF has incurred to date under shared loss agreements, we 

obtained and analyzed FDIC loss payment information and the estimate 

of lifetime losses that FDIC develops for each failed institution. We 

determined that these estimates were sufficiently reliable. Also, we 

interviewed FDIC officials and reviewed and summarized FDIC policies 

and procedures for determining that shared loss agreements were the 

least costly method for resolving bank failures compared to other 

available resolution methods during this time period. We interviewed 

federal and state banking regulators, national and state banking 

associations, and market experts. We also conducted a cluster sampling 

of 10 failed small banks in three states and interviewed officials from 

acquiring and peer banks of these failed banks.

 

7

Section 38(k) of the Federal Deposit Insurance Act (FDI Act) requires that the inspector 

general of the appropriate federal banking agency complete an MLR of the agency’s 

supervision of a failed institution when the projected loss to the DIF is material to, among 

other things, ascertain why the institution’s problems resulted in a material loss to the DIF. 

12 U.S.C. § 1831o(k). Prior to the enactment of the Dodd-Frank Wall Street and 

Consumer Protection Act (Dodd-Frank Act) on July 21, 2010, the FDI Act defined a 

material loss to the DIF as the greater of $25 million or 2 percent of the institution’s total 

assets. The Dodd-Frank Act amended the FDI Act to define a material loss to the DIF for 

the period January 1, 2010, to December 31, 2011, as an estimated loss in excess of 

$200 million; for the period January 1, 2012, to December 31, 2013, as an estimated loss 

in excess of $150 million; and on or after January 1, 2014, as an estimated loss in excess 

of $50 million. Pub. L. No. 111-203, § 987. The Dodd-Frank Act also created new 

reporting requirements—the failed bank review, or FBR—for failures that resulted in 

losses below the “material loss” threshold. The Inspector General, every six months, shall 

conduct FBRs to determine the grounds identified by the federal banking agency or state 

bank supervisor for appointing FDIC as receiver, and whether any “unusual 

circumstances” exist that might warrant an IDR of the loss. If an in-depth review is 

warranted, the Inspector General must prepare the IDR consistent with the requirements 

of an MLR. 
 

Page 5 GAO-13-71 Recent Bank Failures 

acquisitions of failed banks using data from 2007 through 2012.8 We 

measured market concentration using the Herfindahl-Hirschman Index 

(HHI), which is equal to the sum of the squared market shares of banks in 

a market.9 We analyzed the impact of bank failures on the availability of 

credit using 2006 through 2011 call report data to estimate changes in the 

size of a bank’s loan portfolio in the quarters leading up to failure for failed 

banks and in the quarters following acquisition of a failed bank (for 

acquiring banks).10 We conducted an econometric modeling exercise 

designed to assess the relationship between bank failures and overall 

economic conditions in a state. Specifically we analyzed the relationship 

between bank failures, income, unemployment, and real estate prices for 

U.S. states and the District of Columbia, using data from1994 through 

2011.11

We conducted this performance audit from February 2012 to December 

2012 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

We interviewed federal and state banking regulators, national and 

state community banking organizations, market experts and officials from 

acquiring banks and peer banks of the failed banks that were part of our 

cluster sample. Appendix I provides a more detailed description of our 

scope and methodology.

 

8

Market concentration is an indicator of the extent to which firms in a market can exercise 

power by raising prices, reducing output, diminishing innovation, or otherwise harming 

customers as a result of reduced competitiveness. A key variable used in this analysis, 

deposits in bank branches, is available annually as of June 30 of each year, so we used 

observations for 12-month periods starting on June 30 of each year from 2007 through 

2011 to cover the period from 2008 to 2011. Data on bank failures for the first half of 2012 

are used to create observations on the 12month period beginning on June 30, 2011. 

9

The HHI is one of the measures of market concentration that government agencies, 

including Department of Justice (DOJ) and Federal Trade Commission (FTC), use to 

enforce U.S. antitrust laws. DOJ and FTC often calculate the HHI as the first step in 

providing insight into potentially anticompetitive conditions in an industry. However, the 

HHI is a function of firms’ market shares, and market shares may not fully reflect the 

competitive significance of firms in the market. Thus, DOJ and FTC use the HHI in 

combination with other evidence of competitive effects when evaluating market 

concentration. 

10We used data for 2006 through 2011 to analyze data on banks that failed in 2008 

through 2011 up to 8 quarters prior to their failures.

11We used data for the longest time period for which data on personal income, 

unemployment, real estate prices, and deposits in failed banks for U.S. states and the 

District of Columbia are all available. 
 

Page 6 GAO-13-71 Recent Bank Failures 

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives.

A bank failure is the closing of a bank by a federal or state banking 

regulatory agency. One indicator of a bank’s health is its relative level of 

regulatory capital, which cushions banks against losses from nonpayment 

of loans and other losses on assets. Regulators require banks to maintain 

certain minimum capital requirements to help ensure the safety and 

soundness of the banking system and generally expect banks to hold 

capital above these minimums at levels commensurate with their risks. 

Federal law generally requires federal banking regulators to close a bank 

that has become critically undercapitalized within a 90-day period.12

As figure 1 shows, 10 states experienced 10 or more bank failures 

between 2008 through 2011: Arizona, California, Florida, Georgia, Illinois, 

Michigan, Minnesota, Missouri, Nevada, and Washington, with the most 

failures occurring in California, Florida, Georgia, and Illinois. Together, 

failures in these 10 states comprised 298 of the 414 bank failures (72 

percent) across all states during this time period.

 

12Section 38 of the FDI Act requires federal banking regulators to classify banks into one 

of five capital categories and take increasingly severe actions, known as prompt corrective 

action, as a bank’s capital level deteriorates. 12 U.S.C. § 1831o. A bank is declared 

critically undercapitalized if its tangible equity is equal to or less than 2 percent of its total 

assets. Tangible equity is equal to the amount of Tier 1 capital plus outstanding 

cumulative perpetual preferred stock minus all intangible assets not previously deducted, 

except certain purchased mortgage-servicing rights. 

Background
 

Page 7 GAO-13-71 Recent Bank Failures 

Figure 1: Number of Bank Failures by State, 2008-2011

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 (see table 1). Twelve 

percent (36) were of medium-size banks with more than $1 billion but less 

than $10 billion in assets, and 2 percent (5) were large banks with assets 

of more than $10 billion at the time of failure.
 

Page 8 GAO-13-71 Recent Bank Failures 

Table 1: Bank Failures in States with 10 or More Failures by Asset Size, 2008-2011

State 

Small banks (less 

than $1 billion)

Medium-size banks 

(more than $1billion 

but less than 

$10 billion)

Large banks 

(more than 

$10 billion) Total

Arizona 12 0 0 12

California 21 14 3 38

Florida 53 4 1 58

Georgia 69 5 0 74

Illinois 40 7 0 47

Michigan 11 1 0 12

Minnesota 17 0 0 17

Missouri 12 0 0 12

Nevada 7 3 1 11

Washington 15 2 0 17

Total 257 36 5 298

Source: GAO analysis of FDIC data.

Small banks—those with less than $1 billion in assets—tend to differ from 

larger banks in their relationships with customers. Large banks are more 

likely to engage in what is called transactional banking, which focuses on 

the provision of highly standardized products that require little human 

input to manage and are underwritten using “hard” statistical information.

Small banks are more likely to engage in what is known as relationship 

banking, which involves more one-on-one interaction with customers. In 

relationship banking, banks consider not only hard information in the 

underwriting process, but also “soft” information that is not readily 

available or quantifiable and is acquired primarily by working with the 

banking customer. Using this banking model, small banks may be able to 

extend credit to customers such as small business owners who might not 

be considered for a loan from a larger bank.13

 

13Although no commonly accepted definition of a community bank exists, the term often is 

associated with smaller banks (e.g., under $1 billion in assets) that provide relationship 

banking services to the local community. For the purposes of this report, we use the term 

“small” banks and “community” banks interchangeably. 

Small Banks and 

Community Lending
 

Page 9 GAO-13-71 Recent Bank Failures 

As we have previously reported, small banks tend to have a larger portion 

of small business loans in their portfolios than larger banks.14 The Board 

of Governors of the Federal Reserve System (Federal Reserve) reported 

that in 2011, banks with assets of $250 million or less accounted for 66.8 

percent of all banking organizations but only 4.0 percent of all banking 

assets. Moreover, they held 13.7 percent of all small business loans 

(business loans equal to or less than $1 million) and 13.9 percent of 

business microloans (business loans equal to or less than $100,000).15

Regulators define CRE loans to include acquisition, development, and 

construction (ADC) loans that are secured by real estate to finance land 

development and construction, including new construction, upgrades, and 

rehabilitation. CRE loans also include unsecured loans to finance 

commercial real estate, loans secured by multifamily properties, and 

loans secured by nonfarm nonresidential property. ADC loans generally 

are considered to be the riskiest class of CRE loans due to their long 

development times and because they can include properties (such as 

housing developments or retail space in a shopping mall) that are built 

before having firm commitments from buyers or lessees. In addition, by 

the time the construction phase is completed, market demand may have 

fallen, putting downward pressure on sales prices or rents, making this 

type of loan more volatile.

In 

part because of competitive pressures, small banks have increasingly 

moved toward providing commercial real estate (CRE) loans rather than 

other types of credit. During the last decade, large banks and other 

financial institutions increased their market share for consumer loans, 

credit cards, and residential mortgages. Over the same period, small 

banks shifted their focus to CRE lending, an area in which they had a 

competitive advantage, according to market observers. Market observers 

have noted that small banks generally know their local CRE markets 

better than larger banks and are well positioned to gather specific 

information on properties.

 

14See GAO, Troubled Asset Relief Program: Status of Programs and Implementation of 

GAO recommendations, GAO-11-74 (Washington, D.C.: Jan.12, 2011).

15Board of Governors of the Federal Reserve System, Report to Congress on the 

Availability of Credit to Small Businesses, (Sept. 2012). In addition, our analysis indicates 

that between 2007 and 2011, banks with assets of about $1 billion or more made an 

average of 85-90 percent of their small business loans in markets where they had 

branches, and at least 95 percent of banks with assets of $1 billion or more made at least 

half of their small business loans in markets where they had branches. 
 

Page 10 GAO-13-71 Recent Bank Failures 

The dramatic decline in the U.S. housing market that began in 2006 

precipitated a decline in the price of mortgage-related assets, particularly 

mortgage assets based on nonprime loans in 2007. Some financial 

institutions found themselves so exposed that they were threatened with

failure, and some failed because they were unable to raise capital or 

obtain liquidity as the value of their portfolios declined. Other institutions, 

ranging from government-sponsored enterprises such as Fannie Mae and 

Freddie Mac to large securities firms, were left holding “toxic” mortgages 

or mortgage-related assets that became increasingly difficult to value, 

were illiquid, and potentially had little worth. Moreover, investors not only 

stopped buying private-label securities backed by mortgages but also 

became reluctant to buy securities backed by other types of assets. 

Because of uncertainty about the liquidity and solvency of financial 

entities, the prices banks charged each other for funds rose dramatically, 

and interbank lending conditions deteriorated sharply. The resulting 

liquidity and credit crunch made the financing on which businesses and 

individuals depend increasingly difficult to obtain. By late summer of 

2008, the ramifications of the financial crisis ranged from the continued 

failure of financial institutions to increased losses of individual wealth and 

reduced corporate investments and further tightening of credit that would 

exacerbate the emerging global economic slowdown.

Federal banking regulators—FDIC, Federal Reserve, and the Office of 

the Comptroller of the Currency (OCC)—are responsible for supervising 

the activities of banks. They are also responsible for taking corrective 

action when the banks’ activities and overall performance present 

supervisory concerns or could result in financial losses to the DIF or 

violations of law or regulation.16

 

16Until 1989, thrift deposits were federally insured by the Federal Savings and Loan 

Insurance Corporation (FSLIC), which was created by the National Housing Act, 48 Stat. 

1246 (1934). After experiencing solvency problems in connection with the savings and 

loan crisis of the 1980s, FSLIC was abolished and its insurance function was transferred 

to FDIC by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, 

Pub. L. No. 101-73, § 401, 103 Stat. 183 (1989). 

The Federal Reserve is the primary 

regulator for state-chartered member banks (banks authorized to do 

business under charters issued by states) that are members of the 

Federal Reserve System and for bank and thrift holding companies. OCC 

is the primary regulator of national banks and federal thrifts, and FDIC is 

the primary regulator for state-chartered nonmember banks (i.e., stateFinancial crisis (2007-

2011)

Bank Regulators
 

Page 11 GAO-13-71 Recent Bank Failures 

chartered banks that are not members of the Federal Reserve System) 

and state-chartered thrifts.17 In addition, FDIC insures the deposits of all 

federally insured banks, generally up to $250,000 per depositor, per 

insured bank. Prior to July 21, 2011, the Office of Thrift Supervision 

(OTS) was the primary regulator of federally and state-chartered thrifts 

and thrift holding companies.18

Table 2 shows the number of banks under federal supervision as of 

December 31, 2007, prior to the wave of bank failures, and their related 

level of assets. The vast majority of the 8,544 banks under supervision at 

that time were small banks (7,870 or 92 percent) whose assets comprised 

11 percent of the total $13 trillion in assets under supervision. Of the 

7,870 small banks under supervision as of December 31, 2007, 62 

percent were supervised by FDIC, 18 percent by OCC, 10 percent by the 

Federal Reserve, and 9 percent by OTS. During this time period, about 

3.6 percent of small banks in the 10 states that were supervised by FDIC 

failed, followed by 3.2 percent that were supervised by the Federal 

Reserve, and 2.5 percent supervised by OCC and OTS.

State-chartered banks are also subject to 

the supervision of their respective state banking regulators.

Table 2: Numbers, Asset Size, and Percentage of Banks and Failed Banks in the 10 States by Size, as of 2007Q4 and 2008-

2011

Federal Reserve FDIC OCC OTS Total

Number of 

supervised 

banks as of 

2007Q4 

(assets in 

billions)

All 

banks

878 $1,518.20 5,205 $2,195.13 1,635 $7,785.23 826 $1,551.97 8,544 $13,050.54

Small 

banks

789 $171.92 4,909 $871.89 1,455 $293.47 717 $155.37 7,870 $1,492.65

 

17The responsibilities of the Federal Reserve include supervising and regulating banks 

and other important financial institutions to ensure the safety and soundness of the 

nation’s banking and financial system and to protect the credit rights of consumers. 

18The Dodd-Frank Act eliminated OTS. Supervisory authority previously vested in OTS 

was transferred to the OCC for federal savings associations, to FDIC for state savings 

associations, and to the Federal Reserve for thrift holding companies and their 

subsidiaries, other than depository institutions. The transfer of these powers was 

completed on July 21, 2011, and OTS was officially dissolved 90 days later (Oct. 19, 

2011).
 

Page 12 GAO-13-71 Recent Bank Failures 

Federal Reserve FDIC OCC OTS Total

Number of 

supervised 

banks that 

failed 

between 

2008-2011 in 

the 10 states 

(assets in 

billions)

All 

banks

29 $18.57 196 $87.54 46 $49.16 27 $384.74 298 $540.01

Small 

banks

25 $9.68 178 $47.18 36 $8.11 18 $4.13 257 $69.10

Percent of 

supervised 

banks in 

2007Q4 that

failed 

between 

2008-2010 in 

the 10 states 

(assets in 

billions)

All 

banks

3.3% 1.2% 3.8% 4.0% 2.8% 0.6% 3.3% 24.8% 3.5% 4.1%

Small 

banks

3.2% 5.6% 3.6% 5.4% 2.5% 2.8% 2.5% 2.7% 3.3% 4.6%

Source: GAO analysis of FDIC data. 

Note: Small banks are defined as banks with asset under $1 billion. 

FDIC acts as the receiver of failed banks and is charged with evaluating 

various resolution strategies in order to facilitate the sale of assets 

belonging to failed depository institutions. The 1991 Federal Deposit 

Insurance Corporation Improvement Act (FDICIA) requires FDIC to 

resolve failed institutions using the least costly method to the DIF, or the

least-cost transaction.19

FDIC is required to resolve failed institutions using the least costly 

method to the DIF, and FDIC evaluates various resolution strategies to 

identify the least costly method. FDIC primarily uses two methods to 

resolve failing banks and thrifts: purchase and assumption (P&A) 

transactions (the direct sale of a failed bank to another, healthier bank) 

and deposit payoffs. A P&A transaction is a resolution in which an 

acquiring institution purchases some or all of the assets of a failed bank 

Congress enacted FDICIA in response to the 

savings and loan crisis, and the law contained a number of reforms, 

including some designed to address criticisms that federal regulators had 

not taken prompt and forceful actions to minimize or prevent losses to the 

deposit insurance funds caused by bank failures.

 

19Pub. L. No. 102-242, § 141, 105 Stat. 2236, 2273 (1991), codified at 12 U.S.C. §

1823(c)(4). 

FDIC Resolution Methods 

for Failed Institutions
 

Page 13 GAO-13-71 Recent Bank Failures 

or thrift and assumes some or all of the liabilities, including all insured 

deposits. Some P&As include a shared loss agreement in which FDIC 

absorbs a portion of the loss on a specified pool of assets (such as 

loans), which helps maximize asset recoveries and minimize FDIC 

losses. FDIC executes a deposit payoff only if it does not receive a bid for 

a P&A transaction that meets the least cost test—the process by which 

FDIC selects the least costly option to the DIF. There are three types of 

deposit payoffs. The first is a straight deposit payoff, in which FDIC pays 

deposited amounts due up to the insured limits. The second type is an 

insured deposit transfer, which allows FDIC to transfer the insured 

deposits to a healthy institution to limit service interruptions for insured 

depositors. The third type is the creation of a new depository institution in 

the same community of the failed bank in order to conduct an orderly 

liquidation of the insured deposits, also referred to as a deposit insurance 

national bank (DINB).20

GAAP establishes the basis on which items reported on a bank’s balance 

sheet should be measured. Currently, assets and liabilities are reflected 

in the balance sheet at fair value, historical cost, or another basis, such 

as lower-of-cost or fair value.

• Fair value. Fair value is the price that would be received to sell an 

asset or paid to transfer a liability in an orderly transaction between 

market participants at the measurement date. Fair value accounting 

standards under GAAP establish a standardized framework for 

 

20See appendix II for more information on FDIC’s resolution methods for failed institutions 

and its least cost test process. 

Fair Value, Historical Cost, 

and Impairment 

Accounting
 

Page 14 GAO-13-71 Recent Bank Failures 

measuring the fair value of an asset or liability.21 According to the 

Securities and Exchange Commission, fair value is most prevalently 

used to measure “financial” assets and liabilities, such as investment 

securities and derivative instruments. Fair value measurements that 

are required on a quarterly basis (or each reporting period) are often 

referred to as “recurring.” For some assets and liabilities that are 

measured at fair value on a recurring basis, such as securities 

designated for trading, unrealized gains or losses flow through the 

bank’s earnings in the income statement and affect regulatory capital. 

For certain other assets and liabilities that are measured at fair value 

on a recurring basis, such as securities designated as available for 

sale, unrealized fair value gains and losses generally do not impact 

earnings, and thus, generally are not included in regulatory capital 

calculations. Instead, these gains or losses are recorded through 

other comprehensive income (OCI), unless the institution determines 

that a decline in fair value below amortized cost constitutes an otherthan-temporary impairment (OTTI) in which case the instrument is 

written down to its fair value, with credit losses reflected in earnings.22

• Historical cost. Measurement using historical cost can be done in 

several ways, but the general concept is to record items on the 

 

21In 2006, the Financial Accounting Standards Board issued Statement of Financial 

Accounting Standards (SFAS) No. 157, Fair Value Measurements, which defined fair 

value, established a framework for measuring fair value under GAAP, and required 

expanded disclosures about fair value measurements. SFAS No. 157 became effective for 

an entity’s first fiscal year beginning after November 15, 2007. Prior to its issuance, fair 

value measurement principles were not consistently defined and codified in a single 

accounting standard, which led to the potential for disparate fair value measurement 

practices under different accounting standards. SFAS No. 157 was intended to provide a 

single set of measurement principles to be uniformly applied for fair value measurement 

when GAAP requires or permits reporting entities to measure or disclose the fair value of 

an asset or liability. However, SFAS No. 157 did not change which assets and liabilities 

are subject to fair value accounting or when fair value should be applied, as other 

previously existing accounting standards provide the requirement or permission to 

measure assets and liabilities at fair value. SFAS 157 was subsequently codified as 

Accounting Standards Council (ASC) 820 and amended, and additional staff guidance 

was issued on the application of fair value accounting.

22OCI refers to revenues, expenses, gains, and losses that are included in comprehensive 

income but excluded from net income. Comprehensive income is the total non-owner 

change in equity for a reporting period. An other-than-temporarily impaired instrument is 

one whose fair value has fallen below its amortized cost and its value is not expected to 

recover to its amortized cost through the holding period. As a result of an April 2009 

change to the relevant GAAP standard, an OTTI of either a debt security classified as 

available-for-sale or held-to-maturity in certain circumstances in separated into the (1) 

credit loss amount recognized in earnings and (2) the amount related to all other factors 

(non-credit loss) recognized in OCI, net of applicable taxes.
 

Page 15 GAO-13-71 Recent Bank Failures 

balance sheet using the original amount paid or received, with 

adjustments when appropriate in subsequent periods for depreciation, 

amortization, principal pay downs, or impairment. Generally, loans 

that a bank holds for investment (HFI), for example, are recorded at 

amortized cost, net of an impairment allowance for estimated credit 

losses.23

• Loan impairment accounting: GAAP requires financial institutions to 

maintain an allowance for loan losses (loan loss allowance) at a level 

that is appropriate to cover estimated credit losses incurred as of the 

balance sheet date for their entire portfolio of HFI loans. Under GAAP, 

institutions must recognize impairment on HFI loans when credit 

losses are determined to be probable and reasonably estimable, that 

is, when, based on current information and events, it is probable that 

an institution will be unable to collect all amounts due (i.e., both 

principal and interest) according to the contractual terms of the 

original loan agreement. An increase in the loan loss allowance 

results in a charge to expenses, termed a provision for loan losses 

(loan loss provision), except in the case where there are recoveries of 

amounts previously charged off. Loan loss provisions reduce the net 

interest income earned as part of a bank’s earnings, and regulatory 

capital declines.

Such loans typically comprise the bulk of assets held by 

FDIC-insured banks.

24 Impairment accounting standards under GAAP set 

forth the measurement methods for estimating the amount of 

impairment attributable to individually impaired loans. Regulators 

generally require institutions to establish policies and procedures for 

determining the loan loss allowance based on GAAP requirements.25

 

23Essentially, amortized cost is outstanding principal adjusted for any charge offs, 

deferred fees or costs, and unamortized discount or premium. 

Under GAAP, credit losses for an individually impaired loan are 

measured based on the present value of expected future cash flows 

discounted at the loan’s effective interest rate (the contractual interest 

24Net interest income is the difference between the interest income recognized on earning 

assets and the interest expense on deposits and other borrowed funds. Increases in the 

loan loss allowance for credit losses on nonperforming loans are charged to the bank’s 

expenses on the income statement, thus reducing its net interest income. Reductions in a 

bank’s income are reflected in its earnings, which are included in retained earnings, a 

component of regulatory capital. 

25Section 121 of FDICIA requires that the accounting principles used for regulatory 

reporting should be no less stringent than GAAP in order to facilitate prompt corrective 

action to resolve failed banks at the least cost to the DIF. 
 

Page 16 GAO-13-71 Recent Bank Failures 

rate adjusted for any net deferred loan fees or costs, premium, or 

discount existing at the origination or acquisition of the loan), except 

that as a practical expedient, impairment may be measured based on 

the loan’s observable market price, or, if the loan is a collateraldependent loan, the fair value of the collateral.26 GAAP requires the 

impairment measurement to be based on the fair value of collateral 

when foreclosure is probable.

In examinations, federal banking examiners review a sample of loans and 

banks’ internal ratings of loans to determine the adequacy of credit risk 

administration and identify loans that have a higher degree of risk of 

nonpayment. As part of this review, examiners determine which loans are 

considered “pass,” due to their having a lower risk of nonpayment, as well 

as those that are adversely “classified” because they have a higher risk of 

nonpayment. There are three adverse classification categories used by 

the federal banking regulators: “substandard”, “doubtful”, and “loss”. 

Loans subject to adverse classifications plus the internal ratings that 

banks apply to their loan portfolios are incorporated into how each bank 

calculates its loan loss allowance. Therefore, an increase in the amount 

of loans adversely classified substandard or doubtful typically results in a 

bank’s updating its loan loss allowance estimates to reflect the increased 

risk in those loans. Loans or portions of loans that are classified loss are 

removed from the bank’s balance sheet because they are considered 

uncollectible and their continuance as bankable assets is not warranted. 

This loss amount is charged against the loan loss allowance, which 

reduces the allowance. Charge offs also cause regulatory capital to 

decline to the extent that additional provision expenses are needed if the 

loss has not been previously recognized through the loan loss allowance.

 

26GAAP defines a loan to be a collateral-dependent loan when the repayment of the debt 

will be provided solely by the sale or operation of the underlying collateral, and there are 

no other available and reliable sources of repayment.

Loan Classifications
 

Page 17 GAO-13-71 Recent Bank Failures 

In the 10 states with 10 or more failures between 2008 and 2011, failures 

of small and medium-size banks were largely associated with high 

concentrations of CRE loans, and in particular, ADC loans, and 

inadequate management of the risks associated with these loans. The 

rapid growth of their CRE portfolios resulted in concentrations that 

exceeded regulatory thresholds for heightened scrutiny and increased the 

banks’ exposure to the sustained real estate and economic downturn that 

began in 2007. In addition, these failed banks had often pursued 

aggressive growth strategies using nontraditional, riskier funding sources 

and exhibited weak underwriting and credit administration practices.

Large bank failures in the 10 states were associated with some of the 

same factors—high-risk growth strategies that relied on nontraditional 

residential mortgage products, weak underwriting and risk controls, and 

excessive concentrations that increased these banks’ exposure to the 

real estate market downturn. We found that losses related to bank assets 

and liabilities subject to fair value accounting contributed little to bank 

failures overall, largely because most banks’ assets and liabilities were 

not recorded at fair value. Several state regulators and community 

banking association officials told us that at some small failed banks, 

declining collateral values of impaired collateral-dependent loans—

particularly CRE and ADC loans—drove both credit losses and charge 

offs and resulted in reductions to regulatory capital. However, data are 

not publicly available that indicate the extent to which credit losses or 

charge offs at the failed banks were driven by declines in the fair value of 

the collateral. The Department of the Treasury (Treasury) and the 

Financial Stability Forum’s Working Group on Loss Provisioning (Working 

Group) observed that the current accounting model for estimating credit 

losses is based on historical loss rates, which were low in the years 

before the financial crisis. 27

 

27See Financial Stability Forum, Report of the FSF Working Group on Provisioning (March 

2009) and Department of the Treasury, A New Foundation: Rebuilding Financial 

Supervision and Regulation (June 2009). The Financial Stability Forum (FSF) was a group 

consisting of major national financial authorities such as finance ministries, central 

bankers, and international financial bodies. Its Working Group on Provisioning was cochaired by the Securities and Exchange (SEC) Commissioner and the Chair of the 

Technical Committee of the International Organization of Securities Commissions, and the 

Comptroller of the Currency and Chair of the Joint Forum. In April 2009, the FSF was relaunched as the Financial Stability Board and its membership expanded and mandate 

broadened to promote financial stability. 

They noted that earlier recognition of loan 

losses could have potentially reduced the procyclicality in the recent 

crisis. To address this issue, the Financial Accounting Standards Board 

Bank Failures Were 

Largely Related to 

Nonperforming Real 

Estate Loans but Also 

Highlight Impact of 

Impairment 

Accounting and Loan 

Loss Provisioning
 

Page 18 GAO-13-71 Recent Bank Failures 

(FASB) has issued a proposal for public comment for a loan loss 

provisioning model that is more forward-looking and focuses on expected 

losses, which would result in banks establishing earlier recognition of loan 

losses for loans they underwrite and could incentivize prudent risk 

management practices. 

Failures of almost all small and medium-size banks in our 10 states were 

associated with high concentrations of CRE lending, particularly the 

higher risk ADC lending segment, and inadequate management of the 

risks associated with these high concentrations.28

 

28We reported similar findings in GAO, Banking Regulation: Enhanced Guidance on 

Commercial Real Estate Risks Needed,

Eighty-eight percent of 

the 251 IG reviews that we obtained for small and medium failed banks 

cited high concentrations of CRE and ADC loans as a primary 

contributing factor to the failures. Figure 2 shows that the quarterly 

average loan balances of CRE lending and the subset of ADC lending as 

a percentage of the total loan balances at the 258 small banks that failed 

between 2008 and 2011 increased significantly in the years prior to the 

housing market downturn. Small banks that did not fail exhibited markedly 

slower growth rates of these types of loans as well as substantially lower 

levels of these loans. The trends for the 35 medium-size banks were 

similar over this time period.

GAO-11-489 (Washington, D.C.: May19, 2011).

Failures of Small and 

Medium-Size Banks in Our 

10 States Were Largely 

Associated with High 

Concentrations of Risky 

CRE Loans
 

Page 19 GAO-13-71 Recent Bank Failures 

Figure 2: Quarterly Average CRE and ADC Loan Balances as a Percentage of Total Loan Balances at Failed and Open Small 

Banks in the 10 States, 2001-2011

The rapid growth in CRE and the subset of ADC lending led to 

concentrations—measured through the ratio of total CRE loans to total 

risk-based capital—that exceeded regulatory thresholds for heightened 

scrutiny and increased the banks’ exposure to the risks associated with a 

sustained downturn in the real estate market and economy. Guidelines 

issued by federal banking regulators in 2006 provided that banks with 

ADC concentrations greater than 100 percent or CRE concentrations 

greater than 300 percent when the outstanding balance of the institution’s 

CRE portfolio has increased by 50 percent or more during the prior 36 

months would be subject to greater regulatory scrutiny.29

 

29On December 12, 2006, federal banking regulators issued Concentrations in 

Commercial Real Estate Lending, Sound Risk Management Practices to reinforce existing 

regulations and guidelines for real estate lending and safety and soundness. The Joint 

Guidance stated that the federal banking regulators had observed an increasing trend in 

the number of banks with concentrations in CRE loans and noted that such concentration 

may make institutions more vulnerable to cyclical CRE markets. 71 Fed. Reg. 74,580 

(Dec. 12, 2006).

CRE 

concentrations at small failed banks grew from 333 percent in December 
 

Page 20 GAO-13-71 Recent Bank Failures 

2001 to 535 percent in June 2008, while ADC concentrations grew from 

104 percent to 259 percent. Small banks that did not fail exhibited 

significantly lower concentrations. Overall, CRE concentrations grew from 

210 percent to 276 percent over the same time period, while ADC 

concentrations grew from 46 to 71 percent. We found similar trends for 

medium-size banks.

With the downturn in the housing market and onset of the financial crisis, 

the level of nonperforming loans began to rise, as did the level of 

subsequent charge offs.30 The rising level of nonperforming loans, 

particularly ADC loans, appears to be the key factor driving the decline in 

regulatory capital and resulting failures of small and medium banks in the 

10 states between 2008 and 2011. In December 2001, only 2 percent of 

ADC loans at the small failed banks were classified as nonperforming. 

With the onset of the financial crisis, the level of nonperforming ADC 

loans increased quickly to 11 percent by June 2008 and 46 percent by 

June 2011. As banks began to deem nonperforming loans or portions of 

these loans uncollectible, the level of net charge offs also began to rise.31

FDIC staff told us that small banks first began incurring credit-related 

losses in their consumer loan and credit card portfolios and later in their 

construction-related portfolios. Particularly in the southeastern and 

southwestern United States, ADC projects began to stall because 

developers could not find buyers or tenants for their completed or ongoing 

projects. Further, many banks had made loans to developers for the 

purpose of constructing primary residences, and demand for these 

residences fell sharply. FDIC staff also noted that ADC loans, in 

particular, were usually based entirely on collateral values, and that 

repaying the loans depended on selling the developed properties. They 

added that rapidly declining real estate values meant that collateral 

values dropped beneath the outstanding balance of the loans, making it 

In December 2001, net charge offs of ADC loans at small failed banks 

were less than 1 percent. By June 2008, net charge offs were 2 percent, 

and by June 2011, 12 percent.

 

30Nonperforming loans are defined as loans that are 90 days or more past due and loans 

on which the bank is no longer accruing interest. Institutions must estimate the credit 

losses on nonperforming loans and increase the loan loss allowance accordingly.

31Net charge offs are the total amount of loans that are charged off (removed from the 

balance sheet because of uncollectibility), less amounts recovered on loans previously 

charged off. 
 

Page 21 GAO-13-71 Recent Bank Failures 

difficult for developers to refinance their loans if they could not pay down 

the principal amount to a level acceptable to the lender.

CRE, and especially ADC, concentrations in failed banks often were 

correlated to poor risk management and risky funding sources. The IG 

reviews noted that in the majority of the failures, management exercised 

poor oversight of the risks associated with high CRE and ADC 

concentrations and engaged in weak underwriting and credit 

administration practices. In many cases, the IG reviews noted that the 

failed banks did not maintain an adequate loan loss allowance. In other 

instances, failed banks had engaged in out-of-territory lending, that is, 

participating in CRE and ADC loans outside of their normal geographical 

trade areas where they did not have experience. Further, 28 percent (84) 

of the 298 failed banks in the 10 states were young banks that had been 

chartered for less than 10 years at the time of failure. Both FDIC and 

OCC staff said a number of these banks that later failed were formed to 

take advantage of the CRE and ADC market as it was picking up and did 

not have the experience necessary to manage the risks associated with 

high concentrations in these loans. FDIC staff noted that in many cases, 

young failed banks departed sharply from the approved business plan 

originally filed with FDIC upon receiving their charter by aggressively 

pursuing growth in higher risk ADC loans.

The IG reviews noted that in general failed small and medium banks had 

often pursued aggressive growth strategies using riskier funding sources, 

such as brokered deposits.32

 

32A “brokered deposit” is defined as a deposit obtained, directly or indirectly, from or 

through the mediation or assistance of a deposit broker. The term “deposit broker” is 

defined by statute as “(A) any person engaged in the business of placing deposits, or 

facilitating the placement of deposits, of third parties with insured depository institutions or 

the business of placing deposits with insured depository institutions for the purpose of 

selling interests in those deposits to third parties; and (B) an agent or trustee who 

establishes a deposit account to facilitate a business arrangement with an insured 

depository institution to use the proceeds of the account to fund a prearranged loan,” 

subject to certain exclusions. 12 U.S.C. § 1831f(g). The broker pools large-denomination 

deposits from many small investors and markets the pooled deposits to financial 

institutions, usually in blocks nearing $100,000, and negotiates a higher rate for the 

pooled certificates of deposit. In contrast, core deposits are largely derived from a bank’s 

regular customer base, and are typically the most stable and least costly source of funding 

with the lowest interest rates. 

We found that for small failed banks, the 

average percent of total deposits that were brokered deposits increased 

from 3 percent in December 2001 to 20 percent in December 2008, and 
 

Page 22 GAO-13-71 Recent Bank Failures 

for medium-size failed banks, from 3 percent to 28 percent. For small and 

medium-size banks that did not fail, the level of brokered deposits was 

considerably lower, increasing from 2 percent to 6 percent and from 4 to 

13 percent, respectively, over the same time period. According to a 2011 

FDIC study, high rate deposits, which can include brokered deposits, 

appear more likely to lead a bank to take greater risk because, all else 

being equal, to net the same amount a bank must earn more on its assets 

for a high rate deposit than for a low rate deposit.33 Moreover, once a 

bank is not well capitalized, federal law prohibits banks from renewing or 

accepting brokered deposits, which makes it difficult to replace these 

funds when they mature.34

Several state banking regulators and one federal banking regulator noted 

that other small and medium banks also exhibited high levels of CRE and 

ADC concentrations prior to the onset of the financial crisis, but did not 

fail. They attributed the nonfailure of these institutions to better risk 

management practices. For example, they noted that these banks tended 

to engage in more sound underwriting and maintained higher capital 

levels than the banks that failed. Similarly, an FDIC IG study issued in 

October 2012 found that some banks with high ADC concentrations were 

able to weather the recent financial crisis without experiencing a 

corresponding decline in their overall financial condition. The factors that 

the IG identified that contributed to their success included a well-informed 

and active board, strong management, sound credit administration and 

underwriting practices, and adequate capital. In addition, the IG found 

that the banks in their sample did not rely on brokered deposits to fund 

growth and had significantly diversified their loan portfolio by shifting their 

 

33FDIC, Study on Core Deposits and Brokered Deposits, (Washington D.C.: July 2011). 

3412 U.S.C. § 1831f; 12 C.F.R. § 337.6(b). FDIC may, on a case-by-case basis, waive the 

prohibition on renewing and accepting brokered deposits for banks that are adequately 

capitalized (but not well capitalized) if it finds that the acceptance of such deposits does 

not constitute an unsafe or unsound practice. 
 

Page 23 GAO-13-71 Recent Bank Failures 

loan mix away from ADC loans and to shrink the volume of ADC loans in 

response to the economic decline.35

The IG reviews also identified the decline in the fair value of real-estate 

related investment securities as a contributing factor to the failure of some 

small and medium-size banks. The IG reviews noted that about 10 

percent of failed small and medium-size banks had made investments in 

instruments such as private label residential mortgage-backed securities 

(MBS) and preferred stock of the housing-related government-sponsored 

enterprises (GSE), Fannie Mae and Freddie Mac, which subsequently 

declined in value. When the real-estate market began to deteriorate in 

2007, residential MBS securities began experiencing significant price 

declines as a result of credit rating downgrades that reflected the decline 

in the quality of the underlying mortgages. On September 7, 2008, 

Treasury and the Federal Housing Finance Agency announced that the 

GSEs had been placed into conservatorship. GSEs’ equity prices 

dropped considerably in response, and, as a result, those banks that held 

sizable amounts of the GSEs’ preferred stock suffered substantial losses.

Our econometric analysis suggests that across the country, banks with 

high concentrations of ADC loans and a greater use of brokered deposits 

were more likely to fail from 2008 to 2011, while banks with greater 

capital adequacy and better asset quality were less likely to fail. To 

investigate factors associated with bank failures across the United States, 

we analyzed data on FDIC-insured commercial banks and state-chartered 

savings banks from 2006-2011.36

 

35FDIC Office of the Inspector General, Acquisition, office of Audits and Evaluations, 

Acquisition Development, and Construction Loan Concentration Study, no. EVAL-13-001 

October 2012. The IG had identified 436 institutions that had an ADC concentration of 100 

percent or greater as of December 2007 and were in satisfactory condition as of April 

2011. From those, the IG chose a sample of 18 institutions that had ADC concentrations 

of 300 percent or more. The IG noted that it did not identify a significant number of banks 

with high concentrations in 2007 that were in satisfactory condition in 2011, which it stated 

was reflective of how difficult it was for institutions with exceedingly high ADC 

concentrations to mitigate the concentration risk during an economic downturn. 

We collected data on characteristics 

that described a bank’s capital adequacy; asset quality; earnings; 

liquidity; ADC lending; multifamily real estate lending; non-farm, non36We excluded savings associations and insured branches of foreign banks from our 

analysis because these institutions did not report data on key variables for the time period 

we analyzed.

Econometric Analysis 

Suggests That Riskier 

Lending and Funding 

Sources Were Associated 

with an Increased 

Likelihood of Bank Failure 

Nationwide
 

Page 24 GAO-13-71 Recent Bank Failures 

residential real estate lending; commercial real estate lending not secured 

by real estate; brokered deposits funding; and size. We then used an 

econometric model to estimate the likelihood of failure as a function of 

these characteristics, controlling for factors that affect the likelihood of 

failure of all banks, such as the market for the banks’ products and 

services and overall economic conditions.37

We found that greater amounts of ADC lending and greater reliance on 

brokered deposits were associated with an increased likelihood of failure, 

while higher asset quality and better capital adequacy were associated 

with a reduced likelihood of failure, all else being equal. Banks were more 

likely to fail if they had higher concentrations of ADC loans three to eight 

quarters in the past. Banks were also more likely to fail if they relied more 

heavily on brokered deposits six to eight quarters in the past. However, 

banks were less likely to fail if they had better capital adequacy in the 

past six quarters or if they had better asset quality in the past eight 

quarters.

Separate analyses of banks by size yielded results that were generally 

consistent with our aggregate results. To allow for the possibility that 

different factors were associated with the failure of banks of different 

sizes, we repeated the analysis separately for small banks and mediumsize banks.38

Our results likely reflect both factors that are generally associated with the 

likelihood that a bank fails and the specific characteristics of the time 

period we analyzed, and therefore our results may not be generalizeable 

to other time periods. Furthermore, our results reflect average 

relationships between bank characteristics and the likelihood of failure for 

all of the observations we used. As such, they may not reflect the specific 

We found that ADC lending was associated with an 

increase in the likelihood of failure for both types of banks. We also found 

that capital adequacy was associated with a decreased likelihood of 

failure for both small and medium-size banks and that asset quality was 

associated with a decreased likelihood of failure for small banks.

 

37We used a discrete-time hazard model to estimate how various variables impacted the 

likelihood that a bank would fail in a future time period. See appendix III for more details 

on our econometric model.

38The number of failures of large banks (average assets of $10 billion or more) was too 

small to analyze separately.
 

Page 25 GAO-13-71 Recent Bank Failures 

circumstances of any one bank. Finally, the list of characteristics we 

analyzed highlights important characteristics of banks that are related to 

the likelihood of failure, but because many other characteristics play a 

role in whether or not a bank fails, our list of characteristics is likely not 

exhaustive. Specifically, we did not completely control for a number of 

factors thought to drive the failures such as risk management practices or 

excessive growth.

The four largest failures in our 10 states—Washington Mutual Bank 

(WaMu); IndyMac Bank (IndyMac), FSB; Bank United, FSB; and Downey 

Savings and Loan, FA— were caused primarily by management’s pursuit 

of a high-risk growth strategy that relied on high-risk residential 

mortgages. According to the IGs’ review, these banks had developed 

excessive concentrations in risky nontraditional loan products, such as 

payment option ARMs, Alt-A loans, and nonprime loans, and had 

inadequate underwriting and risk controls.39

 

39Payment option ARMs are a type of adjustable rate mortgage that allows borrowers to 

make minimum payments that do not cover principal or all accrued interest, but can result 

in increased loan balances over time (negative amortization). Typically after 5 years, or if

the loan balance increases to a cap specified in the mortgage terms, payments recast to 

include an amount that will fully amortize the outstanding balance over the remaining 

years of the loan.

For example, according to 

the Treasury IG, as its primary business, IndyMac originated high-risk 

residential mortgage loans or bought loans from others, including 

mortgage origination brokers, and packaged them together in securities 

that it sold on the secondary market to other banks, thrifts, or investment 

banks. IndyMac maintained mortgage servicing rights for the loans it sold. 

The IG noted that IndyMac held the loans in its “available for sale” 

portfolio from the time they were packaged until they were sold to 

investors. The IG’s review noted that Indy Mac had engaged in an 

aggressive growth strategy focusing on Alt-A and other nontraditional 

loan products—often making loans without verification of the borrower’s 

income—insufficient underwriting, credit concentrations in residential real 

estate in the California and Florida markets, and heavy reliance on 

noncore funding such as brokered deposits. When home prices declined 

in the second half of 2007 and the secondary mortgage market collapsed, 

IndyMac was left with $10.7 billion in loans it could not sell. Its reduced 

liquidity was further exacerbated in late June 2008 when account holders 

withdrew $1.55 billion during the month. OTS closed IndyMac on July 11, 

Most Large Bank Failures 

in the 10 States Were 

Primarily Associated with 

Losses from Subprime and 

Nontraditional Residential 

Mortgage Loans
 

Page 26 GAO-13-71 Recent Bank Failures 

2008, and named FDIC as receiver. FDIC re-opened the bank on July 14, 

2008, as IndyMac Federal Bank, F.S.B. and later sold it to OneWest 

Bank, F.S.B. in March 2009.

As another example, the joint FDIC and Treasury IGs’ review noted that 

payment-option ARMs at WaMu grew to represent as much as half of all 

loan originations and approximately $59 billion(47 percent), of the home 

loans on WaMu’s balance sheet at the end of 2007. In addition to 

payment option ARMs, WaMu’s business strategy included underwriting 

subprime loans, home equity loans, and home equity lines of credit to 

high-risk borrowers. In line with that strategy, WaMu purchased and 

originated subprime loans, which represented approximately $16 billion 

(13 percent), of WaMu’s 2007 home loan portfolio. The joint IG review 

noted that home equity products totaled $63.5 billion (27 percent), of 

WaMu’s loans secured by residential real estate in 2007—a 130 percent 

increase from 2003. After the mortgage market meltdown in mid-2007, 

WaMu began experiencing severe losses due to loan charge offs and 

provisions for loan losses—$1 billion between fourth quarter 2007 and 

first quarter 2008 and another $3 billion by second quarter 2008—and its 

stock price decreased by 55 percent. The joint IG review also noted that 

with the failure of IndyMac in July 2008, WaMu’s liquidity was stressed as 

it encountered significant deposit withdrawals. The Federal Home Loan 

Bank of San Francisco also began to limit WaMu’s borrowing capacity. As 

a result, WaMu began offering deposit rates in excess of competitors in 

order to bring in deposits to improve liquidity. Shortly thereafter, Lehman 

Brothers collapsed on September 15, 2008, and within the following 8 

days, WaMu incurred net deposit outflow of $16.7 billion, creating a 

second liquidity crisis. WaMu’s ability to raise funds to improve its liquidity 

position was hindered by, among other things, its borrowing capacity 

limits, share price decline, and portfolio losses, according to the IG 

review. On September 25, 2008, OTS closed WaMu and appointed FDIC 

as receiver; FDIC sold WaMu to JP Morgan Chase & Co.

In contrast, one of the five largest bank failures in our 10 states during the 

period resulted, in part from CRE and ADC loans. Specifically, the FDIC 

IG identified contributing factors to the failure of the fifth largest bank, 

United Commercial Bank (UCB), as high concentrations in CRE and ADC 

loans and heavy reliance on nontraditional funding sources to support its 

expansion efforts, all of which increased the bank’s risk profile. For 

example, between 2005 and 2009, ADC concentrations grew from 72 

percent to 211 percent of total capital. According to the IG, UCB’s board 

and management failed to control the risks associated with the 

institution’s rapid expansion. As the commercial real estate market 
 

Page 27 GAO-13-71 Recent Bank Failures 

declined, losses and provisions associated with ADC and CRE 

concentrations eroded the bank’s earnings and capital and led to 

inadequate liquidity.40 The California Department of Financial Institutions 

closed UCB and appointed FDIC receiver on November 6, 2009.

Concerns have been raised that recent bank failures may have been 

driven, in part, by unrealized losses resulting from changes in the fair 

value of certain assets and liabilities and that such losses had a 

procyclical impact on banks’ balance sheets. Based on our analysis, fair 

value losses related to investments in certain types of mortgage-related 

investment securities were a contributing factor in some bank failures; 

but, fair value related losses in general contributed little to the decline in 

net interest income and regulatory capital that failed banks experienced 

overall once the financial crisis began.

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. We found that generally over two-thirds of the assets of all 

failed commercial banks (small, medium-size, and large) were classified 

as held-for-investment (HFI) loans, and, as discussed earlier, were not 

subject to fair value accounting.41

Investment securities classified as available for sale (AFS) represented 

the second-largest percentage of assets for all failed and open banks 

For example, small failed commercial 

banks held an average of 77 percent of their assets as HFI loans in 2008 

compared to small open commercial banks, which held an average of 69

percent in such loans. Small failed thrifts, as well as failed and open 

medium-size and large commercial banks and thrifts, exhibited similar 

percentages.

 

40The IG further noted that management controls were insufficient to prevent inaccuracies, 

omissions, and misrepresentations that affected key UCB financial statements, prompting 

the bank’s audit committee to start an investigation in May 2009. UCB reported that its 

2008 financial statements were materially inaccurate and required revision. The 

investigation and inaccurate financial statements made it harder for UCB to raise the 

capital the bank needed in 2009 to absorb substantial provisions and losses associated 

with its loan portfolio.

41We analyzed commercial banks and thrifts separately for this section because the call 

report and the thrift financial report categorize and group income statement items in 

different formats and because thrift financial report filers were not required to report the 

fair value of certain types of assets and liabilities. 

Credit Losses and Chargeoffs from Nonperforming 

Loans Contributed 

Significantly to Bank 

Failures Nationwide, but 

Losses Due To Fair Value 

Accounting Did Not
 

Page 28 GAO-13-71 Recent Bank Failures 

over our 5-year time period.42 For example, in 2008, small failed 

commercial banks held an average of 10 percent of their assets as AFS 

securities, while small open banks averaged 16 percent. Generally, AFS 

securities are recorded at fair value on a recurring basis with changes in 

fair value recorded in OCI; however, these fair value changes do not 

impact earnings or regulatory capital, unless the institution determines 

that those fair value changes constituted an other-than- temporary 

impairment with credit losses reflected in the income statement through 

earnings, thereby reducing regulatory capital.43

Several other asset and liability categories are recorded at fair value on a 

recurring basis through income or at the lower of cost or fair value under 

certain circumstances. However, together these categories did not 

account for a significant percentage of total assets at either failed or open 

commercial banks or thrifts. For example, in 2008, assets and liabilities 

recorded at fair value on a recurring basis through income at small failed 

banks ranged from 0.00 percent to 0.03 percent. As a consequence, fair 

value changes of these assets and liabilities, generally, were not a key 

driver in institutions’ financial performance.44

Declines in regulatory capital at failed banks in the 10 states and the rest 

of the United States were driven by rising levels of credit losses related to 

nonperforming loans held by the banks and subsequent charge offs of 

these loans. For failed commercial banks and thrifts of all sizes 

nationwide, we found that the credit losses, which resulted from 

nonperforming HFI loans, were the largest contributors to the institutions’ 

overall losses when compared to any other asset class. These losses had 

a greater negative impact on institutions’ net interest income and 

 

42Investments in debt securities that are not classified as trading securities or as HTM 

securities are classified as available-for-sale (AFS) securities. AFS securities also include 

equity securities that have readily determinable fair values and are not classified as 

trading securities. 

43As a result of an April 2009 change to the relevant GAAP standard, an OTTI loss on

either a debt security classified as AFS or held-to-maturity in certain circumstances is 

separated into (1) the credit loss amount, which is recognized in earnings and (2) the 

amount related to all other factors (noncredit loss), which is recognized in OCI, net of 

applicable taxes. See appendix IV for further discussion of the impact of this change on 

the balance sheet of failed and open banks. 

44Appendices IV and V provide more information on the various bank assets and liabilities 

subject to fair value accounting in open and failed small, medium-size, and large 

commercial banks and thrifts.
 

Page 29 GAO-13-71 Recent Bank Failures 

regulatory capital levels than those recorded at fair value. For example, 

from 2008 to 2011, credit losses at small failed commercial banks 

accounted for on average of over 140 percent of net interest income (see 

fig. 3), compared with 24 percent for small open commercial banks. Net 

losses from other income categories did not represent a significant 

percent of net interest income for either small failed or open commercial 

banks.45

Figure 3: Credit Losses as a Percentage of Net Interest Income for Small Failed 

Commercial Banks and Small Open Commercial Banks in All States, 2008-2011

While fair value accounting did not play a significant role in bank failures, 

several state regulators and community banking association officials told 

us that at some failed community banks, declining collateral values of 

impaired collateral-dependent loans—particularly CRE and ADC loans—

 

45See appendix IV and V.

Declining Collateral Values

Contributed to Credit 

Losses and Charge Offs at 

Small Failed Banks
 

Page 30 GAO-13-71 Recent Bank Failures 

drove both credit losses and charge-offs and resulted in reductions to 

regulatory capital.

Under GAAP, when a creditor such as a bank has determined that a loan 

is impaired it must establish the amount of the impairment on the basis of 

the present value of expected future cash flows, discounted at the loan’s 

effective interest rate (the contractual interest rate adjusted for any net 

deferred loan fees or costs, premium, or discount existing at the 

origination or acquisition of the loan). However, as a practical expedient 

to measuring the discounted expected cash flows, impairment may also 

be measured in one of two other ways: either using the loan’s observable 

market price, or if the loan is collateral-dependent, the “fair value” of the 

collateral. A loan is considered “collateral dependent” when the 

repayment of the debt will be provided solely by the sale or operation of 

the underlying collateral and there are no other available and reliable 

sources of repayment.

Federal banking regulators have issued guidance allowing banks to 

choose one of these three methods on a loan-by-loan basis for measuring 

impairment on an individually impaired loan, except for an impaired 

collateral-dependent loan. In that case, the regulators require that banks 

determine the amount of the loan impairment and the required increase to 

the loan loss allowance using the fair value of the collateral (the fair value 

of collateral method).

46 The guidance directs banks to consider the 

appraised value of the collateral as the starting point for determining its 

fair value.47

 

46Interagency Policy Statement on the Allowance for Loan and Lease Losses (December 

2006) and Policy Statement on Prudent Commercial Real Estate Loan Workouts (October 

2009). GAAP requires the use of the fair value of the collateral method when foreclosure 

is probable on collateral-dependent loans. 

In addition, the guidance provides that any portion of the loan 

balance on an impaired collateral dependent loan that exceeds the fair 

value of the collateral (less costs to sell in certain circumstances) and can 

be identified as uncollectible should generally be classified as a loss and 

47According to the guidance, an institution should consider the appraised value of the 

collateral as the starting point for determining its fair value but should also consider other 

factors and events in its environment that could have affected the current fair value of the 

collateral since the appraisal was performed. For example, the timing of when the cash 

flows are expected to be received from the underlying collateral could affect the fair value 

of the collateral if the timing was not contemplated in the appraisal. This generally results 

in the appraised value of the collateral being greater than the institution’s estimate of the 

collateral’s fair value (less costs to sell). 
 

Page 31 GAO-13-71 Recent Bank Failures 

charged off against the loan loss allowance. This principle applies when 

the repayment of the debt will be provided solely by the sale of the 

underlying real estate collateral (as opposed to the operation of the 

collateral) and there are no other available and reliable sources of 

repayment.

As discussed earlier, many failed banks’ had high concentrations in ADC 

loans, which are considered the riskiest class of CRE loans because they 

can include properties that are built before having firm purchase or lease 

commitments from buyers or lessees. For many of these loans, market 

demand had fallen by the time the construction phase was completed, 

putting downward pressure on sales prices or rents. Data are not publicly 

available that indicate the extent to which credit losses or charge-offs at 

the failed banks were driven by declines in the collateral values of 

impaired collateral-dependent CRE or ADC loans.48

 

48Neither bank call reports nor thrift financial reports specify the nature of credit losses or 

charge offs reported by banks and thrifts.

However, several 

state regulators and state banking associations from the 10 states that we 

spoke with said that such declines in the collateral underlying impaired 

CRE and ADC loans were significant drivers in the levels of credit losses 

and charge-offs, and thus declines in regulatory capital, experienced by 

failed community banks, especially in those areas where real estate 

assets prices declined severely. Some state banking associations said 

that these effects were exacerbated by federal bank examiners’ 

classification of collateral-dependent loans and their evaluation of 

appraisals used by banks to support impairment analysis of these loans. 

First, two state banking associations said that during examinations federal 

bank examiners adversely classified some performing collateraldependent loans. These associations stated that in these instances, 

borrowers were making interest and principal payments as agreed; 

however, regulators questioned borrowers’ future capacity to repay the 

loan. As such, the banks were then required to conduct an impairment 

analysis based on the appraised value of the collateral, which resulted in 

significant credit losses and charge-offs. Second, another association 

expressed concerns about the appraisals used to determine the fair value 

of the collateral and examiners’ judgments concerning these appraisals. 

This association said that after the financial crisis began, examiners 

questioned some of the appraisals banks had obtained and made 
 

Page 32 GAO-13-71 Recent Bank Failures 

adjustments to them, driving larger valuation allowances, and when 

required, larger write-downs, than may have been warranted.

FDIC, Federal Reserve, and OCC staff agreed that the underlying 

collateral value of collateral-dependent loans that many failed banks had 

held had declined noticeably. However, they noted that regulatory 

guidance 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.49

 

49Policy Statement on Prudent Commercial Real Estate Loan Workouts.

The 

guidance stated that for many CRE projects, the value of the collateral 

and the repayment of the loan both depended on the cash flows that the 

underlying project was expected to generate. Because of this linkage, 

collateral values are considered an important indicator of project viability 

and could signal changes that would adversely affect the cash flow 

available to service or repay the loan. The guidance stated that in making 

decisions to write down loans, bank examiners are to first focus on the 

adequacy of cash flows to service the debt, including cash flows from the 

operation of the collateral, and support from financially responsible 

guarantors or other bona fide repayment sources. However, the guidance 

noted that if these sources did not exist, and the only likely repayment 

source was the sale of the collateral, then examiners would direct the 

bank to write down the loan balances to the fair value of the collateral, 

less estimated costs to sell in certain circumstances. For example, one 

Federal Reserve staff told us that at some failed banks, ADC loans were 

being extended on an interest-only basis with no evidence that the 

borrower would be able to repay the principal and with underlying 

collateral whose value had declined by a very significant amount. In those 

cases, examiners questioned whether the banks would ever be repaid the 

principal owed. Absent any evidence the borrowers could pay through 

other means, the examiners would require a write-down under such 

circumstances. The guidance also addressed the appraisals banks 

obtained to support their impairment analyses. The guidance stated that 

examiners were generally not expected to challenge the appraisals 

obtained by banks unless they found that any underlying facts or 
 

Page 33 GAO-13-71 Recent Bank Failures 

assumptions about the appraisal were inappropriate or could support 

alternative assumptions.50

One banking association we spoke with noted that the required use of the 

fair value of collateral method to measure impairment resulted in larger 

increases to the loan loss allowance and loan loss provisions and 

resulting reductions in capital than would have occurred if the regulators 

had allowed the banks to use the present value of expected future cash 

flows method. This could occur particularly in those instances where 

repayment of the loan depended on the operation, as opposed to the 

sale, of the underlying collateral (e.g. rent collected from an apartment 

building). In such instances, as one of the valuation techniques used to 

determine appraised value, which is the starting point for applying the fair 

value of collateral method, expected cash flows from the income source 

are to be discounted using the market interest rate. The banking 

association also noted that the impairment amounts associated with the

fair value of collateral method were greater because the market interest 

rate used in the appraisal process to discount the expected future cash 

flows was higher than the effective interest rate used under the present 

value of expected cash flows method.

FDIC and Federal Reserve staff told us that the federal banking 

regulators required banks to use the fair value of collateral method when 

determining the appropriate impairment amount of a collateral-dependent 

loan for consistency and comparability as well as for safety and 

soundness reasons. The effective interest rate used under the present 

value of expected cash flows method is the contractual interest rate on 

the loan and essentially a historical rate. Federal Reserve staff said that 

because different loans have different effective interest rates, values 

obtained using the present value of expected cash flows method are not 

comparable across loans or banks. Federal Reserve staff said that the 

fair value of collateral method facilitated comparability because it required 

the use of the same interest rate—the market interest rate—to value 

collateral.

 

50In GAO-11-489, we reported that interviews with officials from 43 banks in different parts 

of the country had identified multiple concerns with examiner treatment of CRE loans and 

related issues. As part of its mandated study under Pub. L. No. 112-88, the FDIC IG 

reviewed examiner classification of loans reported by the institution as current, as well as 

the policies and procedures examiners use for evaluating the appraised values of property 

securing real estate loans and the extent to which those policies and procedures were 

followed.
 

Page 34 GAO-13-71 Recent Bank Failures 

Federal Reserve staff also said that the fair value of collateral method 

promotes safety and soundness by ensuring that a loan that is impaired is 

not carried on the books at a higher value than what can be obtained if 

the collateral were liquidated. FDIC staff agreed that the fair value of 

collateral method generally results in larger increases to the loan loss 

allowance for individually impaired loans and thus higher loan loss 

provisions than the present value of expected future cash flows method. 

From a safety and soundness perspective, they said that federal bank 

examiners require that the loan loss allowance be adequate within the 

confines of GAAP to absorb the potential losses on loans. Further, they 

said that the decision to require the use of the fair value of collateral 

method to determine the appropriate increase to the loan loss allowance, 

and, if required, the write-down and charge-off of an impaired collateraldependent loan reflected long-standing examination practices.

Treasury and the Working Group have observed that the current 

accounting model for determining credit losses is based on historical loss 

rates, which were low in the years before the financial crisis. Under 

GAAP, the accounting model for estimating credit losses is commonly 

referred to as an “incurred loss model” because the timing and 

measurement of losses are based on estimating losses that have been 

incurred as of the balance sheet date, indicating a probable loss. In a 

2009 speech, the Comptroller of the Currency, who was a co-chair of the 

Working Group, noted that in a long period of benign economic 

conditions, such as the years prior to the recent downturn, historical loan 

loss rates would typically be low. As a result, justifying significant loan 

loss provisioning to increase loan loss allowance can be difficult under the 

incurred loss model.51

 

51Remarks by John C. Dugan, Comptroller of the Currency before the Institute of 

International Bankers, Loan Loss Provisioning and Pro-cyclicality, (Mar. 2, 2009). He also 

noted that by building up a large loan loss allowance when times were good, banks could 

recognize and deal with credit problems early. Later, when the loan losses materialize, the 

loan loss allowance can absorb the losses without impairing capital, keeping the bank 

safe, sound, and able to continue extending credit. He also said that in theory, the loan 

loss allowance could have an important macroeconomic benefit as well. He said that 

allowing banks to recognize losses early should result in charges against earnings (and 

possibly capital) during the favorable part of an economic cycle, because banks 

anticipated higher future losses when the cycle turned negative. At the same time, 

charges would be reduced during downturns, since banks anticipated smaller losses when 

the cycle turns positive. In other words, the loan loss reserving process can have the 

important economic benefit of being counter cyclical. 

Treasury and the Working Group said that earlier 

Current Accounting 

Practices for Loss 

Provisioning May Have 

Delayed Reporting of 

Credit Losses during the 

Recent Crisis
 

Page 35 GAO-13-71 Recent Bank Failures 

recognition of loan losses could have potentially reduced the procyclicality 

of provisioning in the recent crisis—when banks had to recognize 

increases in their incurred credit losses through a sudden series of loan 

loss provisions, reducing earnings and regulatory capital—while still 

providing the necessary transparency to users of financial reports on 

changes in credit trends.52

In a 2010 speech, the chief national bank examiner for the OCC noted 

that the existing accounting rules made it difficult for examiners to require 

banks to make provisions to increase their loan loss allowances when it 

became clear that credit troubles were on the horizon. He said the result 

was that when subsequent charge-offs on impaired loans occurred, the 

allowances were not there to support them, and the higher provision 

levels that were then needed reduced capital, accelerating the spiral into 

insolvency for many banks.53

 

52Several empirical studies have found evidence linking lower levels of loan loss 

allowances to procyclicality in the banking system and, conversely, that higher levels of 

loan loss allowances reduce procyclicality. For example, a 2009 Federal Reserve Bank of 

Richmond study compared the incurred loss model as implemented in the United States 

and the dynamic provisioning model as implemented in Spain, which is intended to build 

loan loss allowances to protect banks against losses expected but not yet identified in the 

loan portfolio. The authors conducted an empirical simulation and concluded that a 

dynamic provisioning framework could have allowed for a build-up of allowances during 

the boom years in the United States and the need to provision for loan losses would have 

been significantly lower during the financial crisis of 2007–2009. See Eliana Balla and 

Andrew McKenna, “Dynamic Provisioning: A Countercyclical Tool for Loan Loss 

Reserves,” Economic Quarterly 95(4), (fall 2009), 383-418. Similarly, a 2012 Bank for 

International Settlements study examined Asian banks provisioning practices in the 

aftermath of the Asian financial crisis of the late 1990s to determine whether these banks 

were provisioning in a manner that reduced procyclicality. Based on a sample of 240 

banks in 12 Asian countries, the researchers found that loan loss allowances and 

provisioning levels were generally higher in the run-up to the recent financial crisis. The 

researchers reported that countercyclical loan loss provisioning—increasing provisioning 

in good times in response to rising levels of risk dominated in emerging Asian economies 

and ameliorated swings in bank earnings and the macroeconomy. See Frank Packer and 

Haibin Zhu, “Loan Loss Provisioning Practices of Asian Banks,” Bank For International 

Settlements, Working Paper No. 375, (April 2012). 

FDIC and Federal Reserve staff also said 

that the existing accounting rules restricted examiners’ ability to require 

banks to increase their loan loss allowances to recognize credit losses 

that were expected to occur in the future even as the examiners saw 

banks developing high concentrations of CRE and ADC loans and 

53Remarks by Tim Long, Senior Deputy Comptroller for Bank Supervision Policy and Chief 

National Bank Examiner, AICPA National Conference on Banks and Savings Institutions 

(September 14, 2009). 
 

Page 36 GAO-13-71 Recent Bank Failures 

loosening underwriting standards. They also noted that the incurred loss 

model in effect creates “hurdles” for the examiners, outside auditors, and 

bank management who see credit trends and have the experience to 

know that problems are brewing but cannot incorporate this knowledge of 

growing risk into provisioning adequately for expected loan losses.

FDIC staff said that examiners can require banks to increase regulatory 

capital (i.e. by increasing shareholder equity) if they believe the level of 

the bank’s capital or loan loss allowance does not adequately address the 

credit risk in the loan portfolio.54

To address this issue, Treasury and the Working Group called for 

accounting standards setters to reevaluate the incurred loss model 

underlying current loan loss provisioning requirements and to reevaluate 

the existing accounting standards to develop forward-looking loan loss 

provisioning practices that incorporated a broader range of available 

credit information. In January 2011 FASB published a Supplementary 

Document, pursuant to a joint project with the International Accounting 

Standards Board (IASB) which proposed a model based on expected 

However, FDIC staff said that it is 

important for the loan loss allowance methodology to reflect best 

practices in credit risk management, so that bank management is forced 

to think about the potential amount of losses they might expect from the 

loans they are making. Similarly, Federal Reserve staff said that if 

management at the failed banks had been required to recognize loan 

losses earlier for the types of loans they were underwriting, it might have 

provided an incentive for them to not concentrate so heavily in the loans 

that later resulted in significant losses.

 

54Staff from the federal banking regulators told us that FDICIA precludes them from 

requiring banks to follow loan loss provisioning accounting methodologies that are not 

GAAP-compliant. Section 121(a) of FDICIA states that accounting principles applicable to 

reports or statements that federal banking regulators require insured depository 

institutions to file must, among other things, result in financial statements and reports of 

condition that accurately reflect the capital of such institutions and facilitate their effective 

supervision. 12 U.S.C. § 1831n(a)(1). Section 121(a) also requires such accounting 

principles to be uniform and consistent with GAAP. 12 U.S.C. § 1831n(a)(2)(A). If a 

federal banking regulator determines that the application of any generally accepted 

accounting principle to any insured depository institution is inconsistent with the objectives 

described in (1), it may prescribe an accounting principle which is applicable to such 

institutions which is no less stringent than GAAP. 
 

Page 37 GAO-13-71 Recent Bank Failures 

losses.55 For the purpose of determining impairment allowance, financial 

assets that were managed on an open portfolio would be split into two 

groups: the “good book” and the “bad book,” with an allowance computed 

for both books separately.56

Some comment letters received in response to the proposal expressed 

concerns about potential complexities in the application of the proposed 

model, including uncertainty as to how institutions would actually estimate 

expected losses over the life of a portfolio. For example, the proposed 

approach for the good book required dual computations and introduced 

the need to estimate the expected remaining life of each portfolio in order 

to apply a “time proportional” approach. Concerns were also expressed 

about how companies would divide the portfolio into the good book and 

bad book and how transfers between the two books would occur. Based 

on the comments received, FASB and IASB began developing a revised 

credit impairment approach that would divide portfolios into three buckets 

of assets that determined the timing and amount of credit losses.

The division of the good book and bad book 

portfolios is based on an evaluation of the degree of uncertainty about 

collectability. The bad book requires the entire amount of expected credit 

losses over the remaining life of the portfolio to be recognized 

immediately. The good book requires the higher of (1) the time 

proportional expected credit losses or (2) the credit losses expected to 

occur within the foreseeable future. The time proportional expected credit 

losses represents a portion of expected lifetime losses based on the age 

of the financial assets relative to their expected life.

57

 

55Expected losses are those losses that result from specified past, present, and future 

events. Unexpected losses, on the other hand, are losses that are unanticipated due to 

various economic or other factors that cannot be controlled by bank management. 

However, as a result of comments received regarding the 

56FASB, Supplementary Document: Accounting for Financial Instruments and Revisions to 

the Accounting for Derivative Instruments and Hedging Activities: Impairment (January 

2011). 

57According to this concept, Bucket 1 assets would be evaluated collectively for 

impairment if they do not meet the definition of Bucket 2 or 3, including loans that have 

suffered changes in credit loss expectations as a result of macroeconomic events that are 

not specific to either a group of loans or a specific loan. Conversely, Bucket 2 assets 

would include those that have been affected by observable events that indicate a direct 

relationship to possible future defaults; however, the specific assets in danger of default 

are not known. Bucket 3 assets would consist of loans for which information is available 

that specifically identifies credit losses that are expected to, or have, occurred on the 

individual assets. 
 

Page 38 GAO-13-71 Recent Bank Failures 

understandability, operability, and auditability of this proposal, FASB 

announced on August 1, 2012, that it would instead explore a revised 

approach. In its Summary Board Decisions of August 22, 2012, FASB 

stated it was considering an alternative approach to impairment 

measurement called the “Current Expected Credit Loss Model”. Under 

this model, the credit deterioration (or improvement) reflected in the 

income statement would include changes in the estimate of expected 

credit losses resulting from, but not limited to (1) changes in the credit risk 

of assets held by the entity, (2) changes in historical loss experience for 

assets like those held at the reporting date, (3) changes in conditions 

since the previous reporting date, and (4) changes in reasonable and 

supportable forecasts about the future. Such a model would recognize 

losses, if any, earlier than the current incurred loss model. On December

20, 2012, FASB issued a proposal for public comment regarding this 

model.58

In their comment letters to FASB on its proposals, federal banking 

regulators stated that they support the development of improved 

impairment standards and in particular an impairment standard that is 

more forward looking and recognizes credit losses earlier than the current 

incurred loss model.59

 

58FASB Exposure Draft, “Financial Instruments—Credit Losses (Subtopic 825-15)”, 

(December 20,2012).

FDIC staff said that given the unprecedented 

nature of the financial crisis, it was not clear to what extent recent bank 

failures would have been prevented had an expected loss model been in 

effect instead of the incurred loss model. However, they said that loan 

loss allowances under an expected loss model would certainly have been 

higher than they were at the beginning of the financial crisis, which would 

59Federal Reserve staff said that it is important that the accounting standards setters are 

addressing expected losses via their development of an expected loss model for loan loss 

provisioning because other ongoing efforts to address procyclicality in the banking system 

are focused solely on unexpected credit losses. They noted that proposed standards 

under Basel III, which is intended to strengthen the global regulatory framework related to 

bank capital, address unexpected losses in their proposed capital measures but not 

expected loan losses. The Basel Committee on Banking Supervision, which drafted the 

proposed Basel III framework, stated it strongly supports the accounting standard setters’ 

initiative to promote stronger loan loss provisioning practices by moving towards an 

expected loss model and that it sees its work and that of the accounting standards setters 

as complementary in addressing procyclicality. See Basel Committee on Banking 

Supervision, Basel III: A Global Regulatory Framework For More Resilient Banks And 

Banking Systems (December 2010). 
 

Page 39 GAO-13-71 Recent Bank Failures 

have provided banks’ earnings and capital more protection against the 

rising credit losses.

We agree that loan loss allowances were not adequate to absorb the 

wave of credit losses that occurred when the financial crisis began, in part 

because current accounting standards for loan loss provisioning require 

banks to estimate losses using an incurred loss model and that earlier 

recognition of loan losses could have potentially reduced the procyclicality 

in the recent crisis. FASB is in the process of taking important steps to 

address this issue by proposing a model for loan loss provisioning that is 

more forward-looking and focuses on expected losses instead of incurred 

losses. Although examiners have the flexibility to require banks to 

increase regulatory capital if they determine that capital or loan loss 

allowances do not adequately address the credit risk in the loan portfolio, 

we agree with federal banking regulators that it is important for the loan 

loss reserving methodology to reflect best practices in credit risk 

management. Doing so would not only result in bank managements’ 

establishing loan loss allowances for the loans they underwrite that reflect 

expected losses, but also could incentivize prudent risk management 

practices. Moreover, it should help address the cycle of losses and 

failures that emerged in the recent crisis as banks were forced to write 

down impaired loans and increase loan loss allowance and raise capital 

when they were least likely to be able to do so.

During the recent financial crisis, FDIC used shared loss agreements to 

help resolve failed financial institutions at the least cost to the DIF.60

 

60As part of FDIC’s annual financial statement audit, GAO evaluates the controls over the 

least cost test process, total estimated lifetime losses, and shared loss payments. We 

found no material weaknesses in these controls. Most recent audit results can be found in 

FDIC 

officials, state bank regulators, community banking associations, and 

acquiring banks of failed institutions we interviewed told us that shared 

loss agreements helped to attract potential bidders interested in 

purchasing the failed banks. According to FDIC officials, at the height of 

the financial crisis in 2008, FDIC sought bids for whole bank purchase 

and assumption agreements with little success. Banks that we spoke to 

said that, because of uncertainties about the market and the value of the 

assets, they would not have purchased the failed banks without FDIC’s 

shared loss agreements. According to acquiring banks and peer banks 

we interviewed, while total estimated lifetime losses of the shared loss 

GAO-12-416. Appendix II provides more information on FDIC’s least cost test process. 

FDIC Used Shared 

Loss Agreements to 

Attract Bidders at 

Least Cost to the 

Deposit Insurance 

Fund
 

Page 40 GAO-13-71 Recent Bank Failures 

agreements may not change, the timing of the losses may change and 

payments from shared loss agreements may increase as the terms of the 

shared loss agreements mature. FDIC officials stated that the acquiring 

institutions were being monitored for compliance with the terms and 

conditions of the shared loss agreements. FDIC is issuing guidance to the 

acquiring institutions reminding them of the terms to prevent increased 

shared loss payments as these agreements mature and expire.

For most of FDIC’s history, purchase and assumption transactions (the 

direct sale of a failed bank to another, healthier bank) have been the 

preferred resolution method for failed banks. FDIC has said that such 

sales are generally less costly than directly paying off depositors of the 

failed bank and keep customers with insured deposits from suffering any 

loss of service.61 FDIC strives to effect a whole bank purchase and 

assumption agreement, in which essentially all of the failed bank’s 

deposits, assets, and certain liabilities are sold and transferred to the 

acquiring institution.62

Figure 4: FDIC’s Resolution Methods, 2008-2011

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. FDIC used purchase and assumption 

agreements to resolve 394 failed institutions amounting to approximately 

$652 billion in failed institution assets, which represents 98 percent of the 

total assets of failed banks and thrifts since 2008 (see fig. 4).

 

61A bank we spoke with expressed concern that failed banks acquired via shared loss 

agreements had negatively impacted competition because the acquired banks received 

significant loss coverage on potential credit losses that peer banks did not. We discuss 

these views later in the report. 

62In a whole bank purchase and assumption agreement, the acquiring institution typically 

assumes all of the deposits and essentially all of the assets of the failed institution. 

FDIC Used Shared Loss 

Agreements to Attract 

Bidders for Failed Banks
 

Page 41 GAO-13-71 Recent Bank Failures 

However, FDIC was only able to resolve so many of these banks with 

purchase and assumption agreements because it offered to share in the 

losses incurred by the acquiring institution. According to FDIC officials, at 

the height of the financial crisis in 2008, FDIC sought bids for whole bank 

purchase and assumption agreements with little success. Potential 

acquiring banks we interviewed told us that they did not have sufficient 

capital to take on the additional risks that the failed institutions’ assets 

represented. Because shared loss agreements had worked well during 

the savings and loan crisis of the 1980s and early 1990s, FDIC decided to 

use this method to solicit bids to provide potential buyers some protection 

on the purchase of failed bank assets, reduce immediate cash needs, 

keep assets in the private sector, and minimize disruptions to banking 

customers.63 Under the agreements, FDIC generally agrees to pay 80 

percent for covered losses with the acquiring bank covering the remaining 

20 percent.64

From 2008 to the end of 2011, FDIC resolved 281 of the 414 failures (68 

percent) by providing a shared loss agreement (see fig. 5).65

 

63The majority of the commercial and residential loan assets are purchased under shared 

loss agreements, where FDIC agrees to share in future losses and recoveries 

experienced by the acquirer on those assets covered under the agreement.

Banks that 

we spoke to said that, because of uncertainties in the market and the 

value of the assets, they would not have purchased the failed banks 

without FDIC’s shared loss agreements. By comparing the estimated cost 

of the shared loss agreements versus the estimated cost of directly 

liquidating the failed bank, FDIC claims that the use of shared loss 

agreements saved the DIF over $40 billion.

64Losses on the covered assets are shared between the acquirer and FDIC in its 

receivership capacity of the failed institution when losses occur through the sale, 

foreclosure, loan modification, or charge-off of loans in accordance with terms of the 

shared loss agreements. The majority of the agreements are for 8 to 10 years.

65The agreements covered about $135 billion of total remaining covered assets purchased 

by the acquiring institutions as of December 31, 2011.
 

Page 42 GAO-13-71 Recent Bank Failures 

Figure 5: Shared Loss Agreements Entered into by Year, 2008-2011

In 2012, FDIC has been able to resolve more failed institutions without 

having to offer to share in the losses. For example, year to date as of 

September 30, 2012, there had been 43 bank failures, and FDIC has only 

had to agree to share losses on 18 of those failures (42 percent). 

Additionally, some potential bidders were willing to accept shared loss 

agreements with lower than 80-percent coverage.

FDIC officials stated that the acquiring institutions were being monitored 

for compliance with the terms and conditions of the shared loss 

agreements. As shown in figure 6, FDIC estimated the DIF receiverships 

would have to pay $42.8 billion over the life of the agreements.66

 

66Any shared loss payments are made from receivership funds from the specific failed 

institution or, if those are insufficient, from the DIF.

As of the 

end of 2011, FDIC had paid out about $16.2 billion under the agreements, 

and FDIC estimated it would have to pay an additional $26.6 billion over 

the life of the agreements. Shared loss payment claims may be submitted 

unevenly over the life of the agreements. FDIC estimates that most of 

those losses will be experienced at the beginning of the agreement and

will increase somewhat in the final year of the agreement. For financial 

reporting purposes for year-end 2012, for example, FDIC assumes in its 

commercial shared loss agreement that 40 percent of the lifetime losses 

occur in the first year and approximately 18 percent occur in the 5th and 

final year of the agreement. FDIC officials stated that they monitor the 

agreements to ensure the acquirer is adhering to the terms and 

conditions for proper loss recognition. Additionally, FDIC is issuing 

guidance reminding them of the terms of the agreements to prevent an 

FDIC Monitors Acquiring 

Institutions’ Adherence to 

Agreements’ Terms and 

Conditions
 

Page 43 GAO-13-71 Recent Bank Failures 

increase in shared loss payments as the agreements mature and expire 

due to inappropriate loss claims. The uneven claims do not change the 

total estimated lifetime losses, but affect the year in which the losses are 

incurred. FDIC revises its estimate of lifetime losses for financial reporting 

(and management purposes) each year based on current market 

conditions.

Figure 6: Estimated Lifetime Losses and Yearly Shared Loss Payments, 2008-2011

The acquisitions of failed banks by healthy institutions may have 

mitigated the potentially negative effects of bank failures on communities, 

although the focus of local lending and philanthropy may have shifted. 

First, while bank failures and failed bank acquisitions can increase market 

concentration— thereby potentially impacting banks’ ability to exercise 

market power, such as raising prices or reducing availability of some 

products and services,—our analysis suggests that a limited number of 

metropolitan areas and rural counties were likely to have become 

significantly more concentrated. This is because in many instances the 

failed banks were acquired by out-of-market institutions. Second, our 

analysis of call report data from 2007 to 2011 found that failing small 

Impact of Bank 

Failures on Local 

Communities Was 

Mixed
 

Page 44 GAO-13-71 Recent Bank Failures 

banks extended progressively less net credit as they approached failure, 

but that acquiring banks generally increased net credit as measured by 

changes in loan balances. However, officials of acquiring banks and 

surviving peer banks of failed banks in Georgia, Nevada, and Michigan 

we interviewed noted that in the wake of the bank failures, underwriting 

standards had tightened and thus credit was generally more readily 

available for small business owners who had better credit histories and 

stronger financials than for those who did not. Further, several bank 

officials said that new lending in certain kinds of loans was restricted in 

certain areas, such as collateral dependent loans in areas where asset

values declined severely. Third, regulators, banking associations, and 

banks we spoke with said that involvement in local philanthropy declined 

as small banks approached failure but generally increased after 

acquisition. However, these acquiring banks may not focus on the same 

philanthropic activities as the failed bank did. Finally, our analysis of 

personal income, unemployment, house prices, and bank failures in 

states from 1994 to 2011 suggests that bank failures are more likely to 

affect the real estate sector in a state than the labor market or overall 

economy in a state.

Bank failures and failed bank acquisitions had a significant impact on 

market concentration in a limited number of metropolitan areas and rural 

counties. Market concentration is an indicator of the extent to which firms 

in the market can have the potential to exercise market power—that is, 

raise prices, reduce output, diminish innovation, or otherwise harm 

customers as a result of diminished competitive constraints or incentives.

Bank failures and failed bank acquisitions have the potential to affect 

market concentration—and thus market power—in some metropolitan 

areas and rural counties. Of the 414 banks that failed in the period from 

January 1, 2008, to December 31, 2011, 393 were acquired by other 

banks. In some cases, the failed bank was acquired by a bank with 

branches in some of the same geographic areas as the failed bank’s 

branches, thereby changing the numbers and relative sizes of banks 

doing business in those areas. The failures of the 21 banks that were not 

acquired also led to changes in the numbers and relative sizes of the 

banks that remained in the areas where the failed banks had been 

located. As a result, these bank failures and failed bank acquisitions had 

the potential to affect banking market concentration and the cost and 

availability of credit and other banking services.

Federal and state banking regulators and national and state community 

banking organizations we interviewed generally agreed that the impact of 

With Exceptions, Bank 

Failures Have Not 

Resulted in Significant 

Increases in Local Market 

Concentration
 

Page 45 GAO-13-71 Recent Bank Failures 

a small bank failure in an urban area would likely differ from the impact of 

failure in a rural area. Urban areas typically have a number of financial 

institutions, including other small banks, which can meet the community’s 

needs if one community bank fails. But several interviewees stated that 

the severity of the effect of a bank failure on a rural county with just one 

bank whose branches were located entirely within the county would likely 

depend on whether the bank was acquired or the bank’s assets were 

liquidated through a direct payout. If a bank was resolved through a direct 

payout, the community might find it had less access to credit and other 

banking services than it would have if the failed bank were purchased by 

a healthy bank.

However, our analysis showed that market concentration likely increased 

after a bank failure and acquisition in a small percentage of both urban 

and rural communities.67 We analyzed the impact of bank failures and 

failed bank acquisitions on local credit markets using data for the period 

from June 2007 to June 2012 to calculate the Herfindahl-Hirschman Index 

(HHI), a key statistical measure used to assess market concentration and 

the potential for firms to exercise their ability to influence market prices.68

 

67Appendix I contains a complete description of our analysis.

The HHI reflects the number of firms in the industry and each firm’s 

market share. It is calculated by summing the squares of the market 

shares of each firm competing in the market. The HHI also reflects the 

distribution of market shares of the top firms and the composition of the 

market outside the top firms. The HHI is measured on a scale of 0 to 

10,000, with larger values indicating more concentration. According to the 

Department of Justice (DOJ) and the Federal Trade Commission (FTC), 

markets in which the value of the HHI is between 1,500 and 2,500 points 

are considered to be moderately concentrated, and those in which the 

value of the HHI is in excess of 2,500 points are considered to be highly 

concentrated, although other factors also play a role.

68The HHI is one of the measures of market concentration that government agencies, 

including DOJ and FTC, use to enforce U.S. antitrust laws. DOJ and FTC often calculate

the HHI as the first step in providing insight into potentially anticompetitive conditions in an 

industry. However, the HHI is a function of firms’ market shares, and market shares may 

not fully reflect the competitive significance of firms in the market. Thus, DOJ and FTC use 

the HHI in combination with other evidence of competitive effects when evaluating market 

concentration. 
 

Page 46 GAO-13-71 Recent Bank Failures 

We estimated the difference between pre- and postfailure HHIs for each 

local market as of June 30 of each year from 2007 to 2011 using deposits 

to measure banks’ market shares.69 We defined local markets as 

metropolitan statistical areas and micropolitan statistical areas 

(collectively, metropolitan areas) and rural counties (counties that are not 

components of metropolitan areas) as identified by the Census Bureau as 

of December 2009.70

 

69We calculated the prefailure HHI for June 30 of each year using banks’ market shares 

as of June 30 of each year. We calculated the postfailure HHI for June 30 of each year 

assuming that the bank failures and failed bank acquisitions that occurred over the next 12 

months occurred at the beginning of the period. Although we included failed banks of all 

sizes in this analysis, over 90 percent of the bank failures were of small banks. 

Table 3 summarizes the number of markets where 

at least one deposit-taking branch of a failed bank was doing business as 

of June 30 of each year from 2007 to 2011 and the number of markets in 

which the difference between pre- and postfailure HHI was at least 100 

and the postfailure HHI was 1,500 or more, the benchmark for raising 

significant competitive concerns. Our results suggest that a small number 

of the markets affected by bank failures and failed bank acquisitions were 

likely to have become significantly more concentrated. For example, 8 of 

the 188 metropolitan areas affected by bank failures and failed bank 

acquisitions between June 30, 2009, and June 29, 2010, met the criteria 

for raising significant competitive concerns. Similarly, 5 of the 68 rural 

counties affected by bank failures during the same time period met the 

same criteria. Our analysis also showed that in most markets, bank 

failures and failed bank acquisitions were likely to have no impact on 

market concentration. For example, 120 of the 188 metropolitan areas 

affected by bank failures between June 30, 2009, and June 29, 2010, 

likely experienced no change in market concentration as a result of those 

failures and acquisitions. Similarly, 62 of the 68 rural counties affected by 

bank failures and failed bank acquisitions during the same period likely 

experienced no change in concentration as a result. The failed banks in 

these markets were acquired by banks that had not previously been 

operating in the markets, so the failures and acquisitions had no impact 

on market concentration in the area. In general, a small number of 

70Metropolitan and micropolitan statistical areas are geographic entities defined by the 

Office of Management and Budget for use by federal statistical agencies in collecting, 

tabulating and publishing federal statistics. A metro area contains a core urban of 50,000 

or more population, and a micro area contains an urban core of at least 10,000 (but less 

than 50,000) population. Each metro or micro area consists of one or more counties and 

includes the counties in the core urban area, as well as any adjacent counties that have a 

high degree of social and economic integration with the urban core. 
 

Page 47 GAO-13-71 Recent Bank Failures 

markets were likely to become significantly more concentrated as a result 

of the bank failures and bank acquisitions because, in most instances, the 

acquiring bank was a bank that had not previously been operating in the 

community.

Table 3: Impact of Bank Failures and Failed Bank Acquisitions on Market Concentration, 2007-2012

June 30, 2007- 

June 29, 2008

June 30, 2008- 

June 29, 2009

June 30, 2009- 

June 29, 2010

June 30, 2010- 

June 29, 2011

June 30, 2011- 

June 29, 2012

Metropolitan areas 942 942 942 942 942

Number with bank failures 4 150 188 124 102

Number with changes in market 

concentration that are consistent with 

potentially significant competitive effects from

bank failures and failed bank acquisitions

0 6 8 3 8 

Number with changes in concentration that 

are not consistent with potentially competitive 

effects from bank failures and failed bank 

acquisitions

0 45 60 31 28

Number with no change in concentration from 

bank failures and failed bank acquisitions

4 99 120 90 66

Rural counties 1331 1331 1331 1331 1331

Number with bank failures 2 31 a 68 32 45

Number with changes in concentration that 

are consistent with potentially significant 

competitive effects from bank failures and 

failed bank acquisitions

0 7 5 5 5 

Number with changes in concentration that 

are not consistent with potentially competitive 

effects from bank failures and failed bank 

acquisitions

0 3 1 0 3 

Number with no change in concentration and

failed bank acquisitions

2 21 62 27 37

Source: GAO analysis of Census Bureau, FDIC, and OCC data.

Note: A market had a failed bank if one or more banks with deposits in that market as of June 30 

failed over the next 12 months. The change in concentration is the difference between the pre- and 

post-failure HHI. The prefailure HHI for each year is the HHI calculated using banks’ market shares 

as of June 30 of each year. The postfailure HHI is the HHI calculated as of June 30 of each year 

assuming that all the bank failures and failed bank acquisitions that occurred over the next 12 months 

occurred at the beginning of the period. Markets with changes in concentration that are consistent 

with potentially significant competitive effects of bank failures and failed bank acquisitions are those in 

which the postfailure HHI is at least 1,500 and the difference between the pre- and postfailure HHI is 

at least 100. Markets with no change in concentration are those in which difference between and preand postfailure HHI is zero. Markets with changes in concentration that are not consistent with 

potentially significant competitive effects of bank failures and failed bank acquisitions are those in 

which the difference between the pre- and postfailure HHI is greater than zero but either the 

postfailure HHI is less than 1,500 or the difference between the pre- and post-failure HHI is less than 

100. We used a bank’s share of total deposits in a market to measure its market share in that market. 

However, a bank’s share of total deposits in a market may be measured with error, depending upon 
 

Page 48 GAO-13-71 Recent Bank Failures 

how banks allocate deposits to their branches when reporting branch level deposits. Furthermore, a 

bank’s share of total deposits in a market may not reflect its share of the market for other banking 

products and services. In addition, this table focuses on the impact of bank failures and failed bank 

acquisitions on market concentration, but many other factors contribute to the actual amount of 

concentration in a market. Finally, the HHI can only indicate the potential for firms to exercise market 

power and it does not imply that firms will actually choose to exercise market power if they have it. 

a

Number includes Glascock, GA, because the one bank doing business in that county on June 30, 

2008, failed and was not acquired by another bank in the next 12 months. 

Although the number of markets with potentially significant competitive 

effects is small, households and businesses in those markets may face 

higher prices or reduced availability of at least some banking products 

and services. These competitive effects are more likely to impact banking 

products and services that are more local in scope, such as checking 

account services or lines of credit. However, customers may be able to 

obtain some products and services from banks outside their local market, 

and the extent to which the market for any particular banking product or 

service is local as opposed to regional, national, or even international, is 

likely to vary.

Our analysis of market concentration has limitations and thus should be 

interpreted with caution. In particular, a bank’s share of total deposits in a 

market may be measured with some error, depending upon how banks 

allocate deposits to their branches when reporting branch-level deposits 

to FDIC. Furthermore, a bank’s share of total deposits in a market may 

not reflect its share of the market for other banking products and services.

In addition, our analysis focuses on the impact of bank failures and failed 

bank acquisitions on market concentration. However, many other factors 

contribute to the actual amount of concentration in a market, including 

changes in banks’ business models over time, fluctuations in consumer 

demand, and entry into and exit from the market by non-bank financial 

institutions. Finally, the HHI can only indicate the potential for firms to 

exercise market power and does not imply that firms will actually choose 

to exercise market power if they have it.

The amount of credit extended by failing banks fell as the banks 

approached failure and their balance sheets deteriorated, but the amount 

of credit extended by acquiring banks remained positive even after the 

acquisition of a failed bank. We used FDIC and Federal Financial 

Institutions Examination Council (FFIEC) data from 2006 through 2011 to 

estimate the net credit that all failing banks extended in the quarters 

Acquiring Banks Mitigated 

the Decline in Credit 

Extension Due to Failing 

Institutions
 

Page 49 GAO-13-71 Recent Bank Failures 

before they failed and by acquiring banks in the quarters following their

acquisition of a failed bank.71

 

71We used an econometric model to estimate net credit extended by banks during a 

quarter as a function of the capital adequacy; asset quality; earnings; liquidity; ADC 

lending; non-farm, non-residential real estate lending; multifamily real estate lending; 

commercial real estate lending not secured by real estate; brokered deposits; size; and 

other factors. We also included indicators for each quarter to control for factors affecting 

the likelihood of failure that are common to all banks at the same time, such as the 

regulatory environment, the state of the market for bank products and services, and the 

condition of the overall economy. We then used the results of our model to predict net 

credit extended by failing banks in the quarters leading up to their failure and by acquiring 

banks in the quarters following acquisition of a failed bank. See appendix VII for more 

information on our econometric model. 

Estimates from our modeling procedure 

suggest that, on average, net credit extended by banks that failed in the 

period from 2008 to 2011 decreased continuously over the eight quarters 

prior to failure and became negative about five quarters prior to failure, 

indicating that failing banks were contracting and reducing the overall 

amount of credit they provided (see fig. 7). Our estimates also suggest 

that net credit extended by banks that acquired failed banks during the 

same period generally decreased immediately after the acquisition and 

then partially recovered, but always remained positive. It follows that, on 

average, acquiring banks continued to expand the amount of credit they 

made available, albeit more slowly than they did prior to the acquisition of 

the failed bank.
 

Page 50 GAO-13-71 Recent Bank Failures 

Figure 7: Estimated Net Credit Extended by Failing, Acquiring, and Nonfailing, Nonacquiring Banks, 2008-2011

Note: Net credit extended by a bank in a quarter is calculated as the percent change in the size of the 

bank’s loan portfolio over the quarter and thus reflects the overall effect of actions that increase the 

size of a bank’s loan portfolio, such as originating new loans or purchasing loans, and actions that 

decrease the size of a bank’s loan portfolio, such as charging off delinquent loans or selling loans. 

Estimates reflect average relationships between bank characteristics and net credit extended by 

banks for all of the observations we used and thus may not reflect trends in net credit extended by 

any one bank. 

To examine the robustness of our results, we repeated our analysis for 

small and medium-sized banks as separate groups. Our estimates for 

small and medium-size banks suggest that net credit extended by failed 

banks in these categories followed a pattern similar to that shown in 

figure 7, declining continuously in the quarters preceding failure and 

becoming negative four to five quarters before failure. Net credit extended 

by small acquiring banks declined on average immediately following the 

acquisition of a failed bank and then partially recovered, but remained 

positive except in the first quarter following the acquisition. For mediumsized acquiring banks, net credit appears to have declined more slowly 

following the acquisition of a failed bank, remaining positive for several 

quarters but actually becoming negative around a year after acquiring the 

failed bank. Overall, however, our estimates suggest that failing banks 

extend less and less credit as they fail and that acquiring banks continue 

to extend additional credit after they acquire a failed bank.
 

Page 51 GAO-13-71 Recent Bank Failures 

Our results likely reflect both factors that are generally associated with net 

credit extended by banks and factors that are specific to the particular 

time period we analyzed. Thus, the extent to which our results can be 

generalized to other time periods is limited. Furthermore, our results 

reflect average relationships between bank characteristics and net credit 

extended by banks for all of the observations we used. As such, they may 

not reflect the particular circumstances of any one bank. In addition, we 

note that the list of characteristics we analyzed is meant to highlight 

important characteristics of banks that are related to the provision of 

credit, but many other factors—including demand for credit by 

borrowers—play a role in the net amount of credit a bank extends and our 

list of characteristics is not exhaustive. Finally, we used the change in the 

size of a bank’s loan portfolio over a quarter to measure the net amount 

of credit it extended over that quarter. However, several factors affect the 

size of a bank’s loan portfolio outside of making new loans, including 

charging off delinquent loans.72 Thus, the change in the size of a bank’s 

loan portfolio is a measure of the net effect of increases in the amount of 

credit a bank is extending, but it is an imperfect proxy for new loan 

originations.

We interviewed officials of selected acquiring banks of small failed banks 

and open peers of these banks that were their competitors (peers) in 

Georgia, Nevada, and Michigan to learn about the effects of the failures 

on local communities in those states. According to banks in urban and 

rural areas in the three states that we interviewed, acquisitions of failed 

small banks mitigated some potential negative effects on the cost and 

availability of credit and on philanthropic contributions in these 

communities. For example, officials from acquiring banks in the three 

states we interviewed told us that, since taking over the failed banks, they 

had increased lending and noted that the failed banks had generally 

ceased making new loans in the community prior to their failures. Several 

acquiring and peer banks in the three states said that credit was more 

readily available for small business owners who had good credit histories 

 

72For example, the loan portfolio grows when the bank makes new loans or purchases 

existing loans. It shrinks when the bank charges off a delinquent loan; when the bank 

forecloses on a delinquent real estate loan, charges off the difference between the market 

and face values of the loan, and reclassifies the collateral as “other real estate owned;” 

and when a the bank sells or securitizes a loan. It also changes when loans are paid 

down, extended, or repurchased. 

According to Interviews 

with Banks, Acquisitions 

Generally Mitigated Other 

Potential Impacts of Small 

Bank Failures on 

Communities
 

Page 52 GAO-13-71 Recent Bank Failures 

and strong financials. Several acquiring and peer banks in the three 

states we interviewed noted that in the wake of the bank failures, 

underwriting standards had tightened, making it harder for some 

borrowers who may have been able to obtain loans prior to the bank 

failures than to obtain them afterward.73

However, the bankers we interviewed also said that new lending for 

certain types of loans could be restricted in certain areas. Bankers in all 

three states said that the CRE market, and in particular the ADC market, 

had contracted, and new lending in this area had declined significantly.

For example, one acquiring banker in the Atlanta area said that upon 

acquiring the failed bank it made all of its lending products available, thus 

considerably expanding the types of credit available to the community. 

However, this banker said that the bank no longer made new CRE loans 

and that much of the growth in new lending had been in small business 

and commercial and industrial lending. This banker also noted that ADC 

lending had largely ceased in the Atlanta area and that CRE loans were 

now focused on owner-occupied properties, which are considered less 

risky than other types of CRE loans.

For example, several bankers 

said that they would not consider making new loans to small business 

owners with weak credit histories. Several banks we interviewed also said 

that finding new high-quality borrowers was difficult.

Several acquiring and peer banks in the three states stated that weak 

demand due to economic uncertainty, particularly among high quality 

borrowers, was inhibiting growth in new loans.74

 

73Our results are not generalizable to all local communities that experienced small bank 

failures. 

A few banks in the three 

states noted that competition, particularly for customers with good credit 

has pushed interest rates to lower levels. However, one bank in Michigan 

noted that even with the lack of demand for credit, larger acquiring banks 

tended to bring more products and services to the community.

74We attempted to contact groups representing small businesses in the communities that 

were part of our sample to obtain their views on credit availability and loan demand, but 

did not receive any responses. However, a recent survey conducted by the National 

Federation of Independent Business noted that 90 percent of 740 small business owners 

surveyed reported that all their credit needs were met or that they were not interested in 

borrowing. National Federation of Independent Business, “Small Business Economic 

Trends” survey (July 2012). 
 

Page 53 GAO-13-71 Recent Bank Failures 

One peer bank in Georgia indicated that failed banks acquired via shared 

loss agreements had negatively impacted competition because the 

acquired banks received significant loss coverage on potential credit 

losses that peer banks did not. This bank said that it might have to absorb 

larger credit losses than acquiring banks for comparable loans. For 

example, this bank said that the acquiring banks had driven down real 

estate values in the local market by selling off assets such as 

collateralized loans covered by shared loss agreements at depressed 

prices. As a result of these sales, existing collateralized assets might 

have to be reappraised at the lower values, possibly leading to further 

credit losses. However, officials of several acquiring banks told us that the 

shared loss agreements gave them more time to work out problem loans 

held by existing customers and allowed them to hold onto the assets.75

Federal and state banking regulators, national and state banking 

associations, and acquiring and existing bank officials we interviewed in 

Georgia, Nevada, and Michigan told us that involvement in local 

philanthropy declines as community banks approach failure but generally 

increases after they have been acquired. State banking regulators and 

national and state community banking associations we interviewed told us 

that failed community banks were highly involved in local philanthropic 

activities before the recession—for example, by designating portions of 

their earnings for community development or other charitable activities.

Many community bank board members and managers were leaders in the 

community who supported local charities and civic groups. Acquiring bank 

officials we interviewed told us that they had generally increased 

philanthropic activities compared to the failed community banks during 

the economic downturn and in the months before failure. However, 

acquiring banks may or may not focus on the same philanthropic activities 

as the failed banks. For example, one large acquiring bank official told us 

that it made major charitable contributions to large national or statewide 

philanthropic organizations and causes and focused less on the local 

community charities to which the failed bank had contributed. However, 

another acquirer told us that by retaining the failed bank’s employees, it 

 

75The FDIC IG is required under Pub. L. No. 112-88 to evaluate, among other things, the 

impact of shared loss agreements on existing banks and the borrowers of banks that fail, 

including FDIC’s policies and procedures for monitoring LSAs, including those designed to 

ensure institutions are not imprudently selling assets as a depressed value and the extent 

to which LSAs provide incentives for loan modifications and other means of increasing the 

probability of commercial assets being considered performing. 
 

Page 54 GAO-13-71 Recent Bank Failures 

had been able to continue contributing to the charities the employees had 

previously selected.

To assess the relationship between bank failures and overall economic 

conditions in a state, we used an econometric model to analyze the 

relationships among four variables—bank failures, income, 

unemployment, and real estate prices—for U.S. states and the District of 

Columbia (states) using data for the period from 1994 through 2011.76

Our analysis suggests that bank failures in a state were more likely to 

affect its real estate sector than its labor market or broader economy. The 

results suggest that failed banks’ share of deposits in a state—our 

measure for bank failures—do not impact personal income in a state in 

the sense that past values of failed banks’ share of deposits do not help 

explain the current level of personal income in a state (table 4).

Our results are limited by several factors and thus should be interpreted 

with caution. First the econometric procedure we used is a useful 

diagnostic tool but it is based largely on timing patterns in the variables as 

opposed to actual causality. Second, as with the results of our other 

analyses, they may not generalize to other time periods or, in this case, to 

the national, city, or county level. Third, the model reflects average 

relationships among the variables and thus may not apply to the specific 

circumstances of any one state. Finally, the specific group of variables we 

analyzed was chosen to highlight particular relationships and may not 

contain all of the variables that contribute to explaining personal income, 

unemployment, house prices, or failed bank deposits in states.

77

 

76Although we included failed banks of all sizes in this analysis, over 90 percent of the 

bank failures were of small banks. 

Similarly, past values of personal income in a state do not appear to help 

explain the current value of failed banks’ share of deposits in a state. In 

particular, this analysis did not suggest that bank failures in a state were 

associated with a decline in personal income in that state.

77Our measure of bank failures captures both the size of the failing banks and their share 

of the deposits (a proxy for their weight in a state), whereas the absolute number of 

failures or the simple failure rate does not. We used the concept of Granger causality to 

determine the extent to which variables are associated with each other. Granger causality 

measures whether the current value of one variable is correlated with past values of 

another variable, but it does not imply that one variable is the result of or the effect of 

another variable. See appendix VIII.

Bank Failures in a State 

Are More Likely to Affect 

the Real Estate Sector 

Than the Labor Market or 

Broader Economy
 

Page 55 GAO-13-71 Recent Bank Failures 

Table 4: Summary of Relationships among Bank Failures, Personal Income, 

Unemployment, and Real Estate Prices in U.S. States, 1994-2011

Variable may be explained in part by past values of

Variable

Personal 

income Unemployment house prices

Failed 

bank 

deposits

Personal income —- Yes In some 

specifications

No

Unemployment Yes —- In some 

specifications

No

House prices In some 

specifications

Yes —- Yes

Failed bank 

deposits

No Yes Yes —- 

Source: GAO analysis of data from the Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Deposit Insurance 

Corporation, and the Federal Housing Finance Agency.

Note: The extent to which our results can be generalized to other time periods or other geographic 

units–either larger units, such as nations, or smaller units, such as cities or counties—is limited.

To the extent that there is a relationship between the unemployment rate 

and failed banks’ share of deposits in a state, it appears that the 

unemployment rate has more bearing on failed banks’ share of deposits 

than vice versa. Past values of the unemployment rate appear to partially 

explain the current value of failed banks’ share of deposits. However, we 

did not find evidence that past values of failed banks’ share of deposits in 

a state help explain the current value of the unemployment rate.

Failed banks’ share of deposits and the house price index in a state 

appear to be significantly related to each other. Past values of failed 

banks’ share of deposits appear to help explain the current value of the 

house price index in a state, and vice versa. Altogether, these results 

suggest that the impact of bank failures on a state’s economy is most 

likely to appear in the real estate sector and are less likely to appear in 

the overall labor market or in the broader economy.

We provided a draft of this report to the Federal Reserve, FDIC, and OCC 

for review and comment. The agencies did not provide formal written 

comments, but provided written technical comments, which we 

incorporated as appropriate.

Agency Comments
 

Page 56 GAO-13-71 Recent Bank Failures 

We are sending this report to the Senate Committee on Banking, 

Housing, and Urban Affairs and the House Committee on Financial 

Services. We are also sending copies of the report to the Federal 

Reserve, FDIC, and OCC. The report also is available at no charge on 

the GAO website at http://www.gao.gov.

If you or your staff have any questions about this report, please contact 

Lawrance Evans, Jr. at (202) 512-4802 or evansl@gao.gov. Contact 

points for our Offices of Public Affairs and Congressional Relations may 

be found on the last page of this report. GAO staff who made key 

contributions to this report are listed in appendix IX. 

Gene L. Dodaro

Comptroller General of the United States
Appendix I: Objectives, Scope and 

Methodology

Page 57 GAO-13-71 Recent Bank Failures 

The objectives of our report were to review (1) the factors that contributed 

to the failure of banks in states with 10 or more failures between 2008 

and 2011, including the extent to which losses related to fair value 

accounting treatment affected the regulatory capital positions of failed 

banks; (2) market factors that affected the Federal Deposit Insurance 

Corporation’s (FDIC) choice of resolution method, or the amount of FDIC 

coverage offered on the shared loss agreements, and the costs that the 

DIF incurred as a result of these shared loss agreements; and (3) the 

effect of recent small bank failures on local communities.

To address the factors that contributed to the failures of banks in states 

with 10 or more failures between 2008 and 2011, including the extent to 

which losses related to fair value accounting treatment affected the 

regulatory capital positions of failed banks, we used data from FDIC’s 

Historical Statistics on Banking–Failures and Assistance Transactions 

(HSOB) database to identify states that met the criterion. We identified 10 

states that experienced 10 or more failures (the 10 states) over the 

relevant time period. We then used data from the HSOB database to 

develop characteristics that described the failed banks in these 10 states, 

such as asset size, charter type, bank type, length of operations and 

failed bank assets as a percentage of total assets. We reviewed material 

loss reviews (MLR), failed bank reviews (FBR), and in-depth reviews 

(IDR) issued by the inspectors general (IG) of the federal banking 

regulators for these same institutions and summarized the factors they 

identified as contributing to the failures.1

 

1

Section 38(k) of the Federal Deposit Insurance Act (FDI Act) requires that the inspector 

general of the appropriate federal banking agency complete an MLR of the agency’s 

supervision of a failed institution when the projected loss to the DIF is material to, among 

other things, ascertain why the institution’s problems resulted in a material loss to the DIF. 

12 U.S.C. § 1831o(k). Prior to the enactment of the Dodd-Frank Wall Street and 

Consumer Protection Act (Dodd-Frank Act) on July 21, 2010, the FDI Act defined a 

material loss to the DIF as the greater of $25 million or 2 percent of the institution’s total 

assets. The Dodd-Frank Act amended the FDI Act to define a material loss to the DIF for 

the period January 1, 2010, to December 31, 2011, as an estimated loss in excess of 

$200 million; for the period January 1, 2012, to December 31, 2013, as an estimated loss 

in excess of $150 million; and on or after January 1, 2014, as an estimated loss in excess 

of $50 million. Pub. L. No. 111-203, § 987. The Dodd-Frank Act also created new 

reporting requirements—the failed bank report, or FBR—for failures that resulted in losses 

below the “material loss” threshold. The inspector general, every six months, shall conduct 

FBRs to determine the grounds identified by the federal banking agency or state bank 

supervisor for appointing FDIC as receiver, and whether any “unusual circumstances” 

exist that might warrant an IDR of the loss. If an IDR is warranted, the inspector general 

must prepare the IDR consistent with the requirements of an MLR. 

We then used data from FDIC’s 

Appendix I: Objectives, Scope and 

Methodology 
Appendix I: Objectives, Scope and 

Methodology

Page 58 GAO-13-71 Recent Bank Failures 

Statistics on Depository Institutions (SDI) database to develop trend 

statistics for the period 2001 through 2011 that described bank 

characteristics in the years leading up to the failures for these institutions. 

In conducting our analyses, we carried out a data reliability assessment of 

the HSOB and SDI databases. To do so, we reviewed information on the 

processes and procedures FDIC uses to help ensure that data entered 

into these databases are accurate and complete. We also reviewed the 

data for missing values, and, where we observed instances of such, 

determined the reason. On the basis of this information, we determined 

that these data were reliable for our purposes. We also interviewed 

officials from FDIC, the Board of Governors of the Federal Reserve 

System, and the Office of the Comptroller of the Currency (federal 

banking regulators), state banking regulators from the 10 states, national 

banking organizations, state community banking organizations from 7 of 

the 10 states, and market experts to obtain their views on the causes of 

bank failures in the 10 states.2

We also estimated, as a function of the bank characteristics discussed 

above, the likelihood that a bank might fail. More specifically, we analyzed 

nationwide data from FDIC and Federal Financial Institutions Examination

Council (call report data) on FDIC-insured commercial banks and statechartered savings banks for the period from 2006 through 2011.3 We 

examined characteristics that describe a bank’s capital adequacy, asset 

quality, earnings, liquidity, CRE lending, brokered deposits funding, and 

size. We used econometric models to estimate the relationships between 

these characteristics and the likelihood that a bank fails.4

 

2

Three state banking associations declined our request for an interview. 

We included 

indicators for each quarter to control for factors affecting the likelihood of 

failure that are common to all banks at the same time, such as changes in 

the regulatory environment, the market for bank products and services, 

and the overall economy. In conducting our analyses, we carried out a 

data reliability assessment of the FDIC and FFIEC call report data. To do 

so, we reviewed information on the processes and procedures used to 

help ensure that these data were complete and accurate. We also 

3

We excluded savings associations and insured branches of foreign banks from our 

analysis because these institutions did not report data on key variables for the time period 

we analyzed.

4

We employed discrete-time hazard models. For more information on these econometric 

models, see appendix III. 
Appendix I: Objectives, Scope and 

Methodology

Page 59 GAO-13-71 Recent Bank Failures 

reviewed the data for missing values, and, where we observed instances 

of such, determined the reason. On the basis of this information, we 

determined that these data were reliable for our purposes.

To address the extent to which losses related to fair value accounting 

treatment affected the regulatory capital positions of failed banks, we 

identified and reviewed those accounting standards under U.S. generally 

accepted accounting principles (GAAP) that pertain to fair value, historical 

cost, and impairment accounting and identified those assets and liabilities 

on banks’ balance sheets that are subject to each. We also reviewed 

guidance issued by the federal banking regulators as to the application of 

these standards. We then analyzed bank call report and thrift financial 

data from 2007 through 2011 for failed and open commercial banks and 

thrifts nationwide to identify and compare trends in (1) the use of historical 

cost accounting and fair value accounting and (2) the extent to which 

losses were credit related. In conducting our analysis, we followed the 

methodology used by the Securities and Exchange Commission in their 

2008 report on mark-to-market accounting, which examined the linkages 

that occurred between fair value accounting and bank failures that 

occurred in 2008.5

To address the market factors that affected FDIC’s choice of resolution 

method, or the amount of FDIC coverage offered on shared loss 

agreements, and the costs the Deposit Insurance Fund (DIF) incurred as 

a result of the shared loss agreements, we first obtained and analyzed 

FDIC loss payment information from its New Financial Environment 

accounting system. To identify the future costs to the DIF that will result 

from shared loss agreements, we obtained and analyzed the estimate of 

lifetime losses that FDIC develops for each failed institution. We 

determined that these estimates were reliable for purposes of financial 

We also reviewed reports issued by the Department of 

the Treasury and the Financial Stability Forum’s Working Group on Loss 

Provisioning to obtain views on the adequacy of current accounting 

models for loan loss provisioning and reviewed proposals issued by 

accounting standard setters to revise the current accounting model and 

comment letters received in response to these proposals. We provided a 

copy of the draft report to two accounting experts, a former comptroller 

general and a professor of accountancy for their review.

 

5

Securities and Exchange Commission, “Report and Recommendations Pursuant to 

Section 133 of the Emergency Economic Stabilization Act of 2008: Study on Mark-toMarket Accounting,” (December 2008). 
Appendix I: Objectives, Scope and 

Methodology

Page 60 GAO-13-71 Recent Bank Failures 

reporting. Also, we interviewed FDIC officials and reviewed and 

summarized FDIC policies and procedures in order to assess how FDIC 

determined that shared loss agreements were the least costly method for 

resolving bank failures during this time period. In order to describe factors 

in the market environment from 2008 through 2011 that may have 

affected the choice of resolution method or the structure of FDIC shared 

loss agreements, we interviewed officials from federal banking regulators, 

state banking regulators from the 10 states, national banking 

organizations, state community banking organizations from 7 of the 10 

states, and market experts.

To assess the effect of recent small bank failures on local communities, 

we first assessed the impact of nationwide bank failures and failed bank 

acquisitions on concentration in local credit markets using data for the 

period from June 2007 through June 2012 by calculating the HerfindahlHirschman Index (HHI)—a commonly used measure to assess the 

competitive environment and enforce U.S. antitrust laws. Market 

concentration is an indicator of the extent to which firms in the market can 

exercise market power, that is, to raise prices, reduce output, diminish 

innovation, or otherwise harm customers as a result of diminished 

competitive constraints or incentives. The HHI is equal to the sum of the 

squares of the market shares of each firm in the market and thus reflects 

both the number of firms in the market and each firm’s relative size.6

We compared the pre- and postfailure HHIs for each local market across 

the country as of June 30 of each year from 2007 through 2011. We 

The 

HHI ranges from 10,000 (if there is a single firm in the market) to a 

number approaching zero (in the case of a perfectly competitive market).

Department of Justice (DOJ) and Federal Trade Commission (FTC) 

guidelines suggest that markets with an HHI of less than 1,500 are 

unconcentrated, those with HHIs between 1,500 and 2,500 are 

moderately concentrated, and those with HHIs greater than 2,500 are 

concentrated. They also suggest that a change in a market’s HHI of 100 

or more that results in an HHI of more than 1,500 may raise significant 

competitive concerns, while a change in a market’s HHI of 200 or more 

that results in an HHI of 2,500 is presumed to be likely to enhance market 

power.

 

6

For example, a market with four firms with market shares of 30 percent, 30 percent, 20 

percent, and 20 percent would have an HHI of 2,600 (900 + 900 + 400 + 400). 
Appendix I: Objectives, Scope and 

Methodology

Page 61 GAO-13-71 Recent Bank Failures 

defined local markets as metropolitan statistical areas and micropolitan 

statistical areas (collectively, metropolitan areas) and rural counties 

(counties that are not components of metropolitan areas) as identified by 

the Census Bureau as of December 2009. We used data on FDICinsured institutions, including commercial banks, savings banks, savings 

associations, and insured branches of foreign banks from FDIC’s Survey 

on Deposits database. We defined a banking organization as the 

collection of all banks that are subsidiaries of the same bank or thrift 

holding company, or the consolidated bank for those banks that are not 

subsidiaries of a holding company. We identified a banking organization 

as doing business in a market if at least one of the banks in that banking 

organization had at least one deposit-taking branch in that market.7

 

7

A branch is any location, or facility, of a financial institution, including its main office, 

where deposit accounts are opened, deposits are accepted, checks paid, and loans are 

granted. Branches include, but are not limited to, brick and mortar locations, detached 

drive-in facilities, seasonal offices, offices on military bases or government installations, 

paying/receiving stations or units, and Internet and Phone Banking locations where a 

customer can open accounts, make deposits and borrow money. A branch does not 

include automated teller machines (ATMs), consumer credit offices, contractual offices, 

customer bank communication terminals (CBCT), electronic fund transfer units (EFTU), or 

loan production offices (FDIC, Summary of Deposits Reporting Instructions, June 30, 

2011).

We 

used deposits to measure a banking organization’s market share. We 

calculated the prefailure HHI for each local market as of June 30 of each 

year by summing the squared market shares of each banking 

organization doing business in that market as of that date. We calculated 

the postfailure HHIs for each local market by treating the bank failures 

and acquisitions that occurred during the period from June 30 of one year 

to June 29 of the next year as if they occurred at the beginning of the 

period. We assigned deposits in failed banks that were acquired to the 

acquiring bank, and we assigned deposits in failed banks that were not 

acquired to other banks in the market proportionally. Although we 

included failed banks of all sizes in this analysis, over 90 percent of the 

bank failures were of small banks, and thus the analysis largely reflects 

the impact of their failures on market concentration. In conducting our 

analyses, we carried out a data reliability assessment of the Survey on

Deposits database. To do so, we reviewed information on the processes 

and procedures FDIC uses to help ensure that data entered into this 

database are accurate and complete. We also reviewed the data for 

missing values, and, where we observed instances of such, determined 
Appendix I: Objectives, Scope and 

Methodology

Page 62 GAO-13-71 Recent Bank Failures 

the reason. On the basis of this information, we determined that these 

data were reliable for our purposes. 

Our analysis of market concentration has limitations and thus should be 

interpreted with caution. In particular, a bank’s share of total deposits in a 

market may be measured with some error, depending upon how banks 

allocate deposits to their branches when reporting branch-level deposits 

to FDIC. Furthermore, a bank’s share of total deposits in a market may 

not reflect its share of the market for other banking products and services. 

In addition, our analysis focuses on the impact of bank failures and failed 

bank acquisitions on market concentration. However, many other factors 

contribute to the actual amount of concentration in a market, including 

changes in banks’ business models over time, fluctuations in consumer 

demand, and entry into and exit from the market by non-bank financial 

institutions. Finally, the HHI can only indicate the potential for firms to 

exercise market power and does not imply that firms will actually choose 

to exercise market power in ways that are detrimental to consumers.

We also assessed the impact of bank failures on the availability of credit 

by using 2006-2011 call report data to estimate changes in the size of a 

bank’s loan portfolio in the quarters leading up to failure for failed banks 

and in the quarters following acquisition of a failed bank (for acquiring 

banks). We used the change in the size of a bank’s loan portfolio over a 

quarter as a proxy for the net amount of credit it extended over that 

quarter. The change in the size of a bank’s loan portfolio over a quarter 

reflects the net effects of new loan originations, loan purchases, chargeoffs, loan sales and securitizations, and other factors. As a result, it 

reflects net credit extended by a bank rather than the extension of new 

credit only. We first estimated the relationship between the characteristics 

of banks that were associated with the likelihood of failure and changes in 

the size of banks’ loan portfolios. We then used our estimates to predict 

the average change in the size of a bank’s loan portfolio in the quarters 

leading up to failure for failed banks and in the quarters following 

acquisition of a failed bank (for acquiring banks).8

 

8

For more information on these econometric models, see appendix VII.

We conducted this 

analysis for all banks, and then for small banks and medium-size banks. 

We did not conduct a separate analysis for large banks because there 

were insufficient observations.
Appendix I: Objectives, Scope and 

Methodology

Page 63 GAO-13-71 Recent Bank Failures 

We assessed the relationship between bank failures and overall 

economic conditions in a state by analyzing the relationship between 

bank failures, income, unemployment, and real estate prices for U.S. 

states, including the District of Columbia, using data for the period from 

1994 through 2011. We measured bank failures in a state as the fraction 

of deposits in a state that were in banks that failed during the past year 

using data from FDIC. Although we included failed banks of all sizes in 

this analysis, over 90 percent of the bank failures were of small banks, 

and thus the analysis largely reflects the impact of their failures. We 

measured income in a state using state personal income, adjusted for 

inflation, from the Bureau of Economic Analysis. We measured 

unemployment in a state using the unemployment rate from the Bureau of 

Labor Statistics. We measured real estate prices using house price 

indices for single-family detached properties with conventional conforming 

mortgages from FHFA. We assessed the reliability of data from each of 

these sources and found it to be sufficiently reliable for our purposes. For 

each variable, we estimated the relationship between the variable, its past 

values, and past values of the other three variables. We used a technique 

that controls for time-invariant characteristics of states, that controls for 

features of the national economy that affect all states at the same time, 

and that allows for the possibility that all four variables are jointly 

determined and affected by each other.9

We interviewed officials from federal banking regulators, state banking 

regulators from the 10 states, a national banking and community banking 

organizations, and state community banking organizations from 7 of the 

10 states and market experts. We also conducted a cluster sampling of 

10 failed small banks in three states and interviewed officials from 18 

acquiring and existing peer banks of these failed banks to obtain their 

views of the effects of the failures on their communities.

We then estimated the likelihood 

that the past values of each variable help explain current values of the 

other variables.

10

 

9

For more information on the linear dynamic panel approach, see appendix VIII.

The three 

states we chose to focus on were Georgia, Nevada, and Michigan. The 

three states reflect the three major areas where the bank failures were 

concentrated—the southeast, southwest, and Midwest. They reflect 

10We attempted to interview local organizations representing the perspective of small 

businesses that relied for credit on the failed banks in our sample, but the organizations 

did not respond to our interview requests. 
Appendix I: Objectives, Scope and 

Methodology

Page 64 GAO-13-71 Recent Bank Failures 

states with either highest numbers of bank failures or highest failure rates. 

They also reflect the economic conditions that contributed to the bank 

failures—high unemployment rates, and for two states, high declines in 

house prices.

For each of the states selected, we selected several failed small banks 

within a targeted metropolitan area and nonmetropolitan area within the 

state. Reviewing several failed banks within the same state allowed us to 

more carefully evaluate the impact of other contributing factors associated 

with the failures, for example, size of the failed institution, purchase 

agreement terms, number of surrounding banks, characteristics of the 

acquiring bank, and feedback from nearby existing small banks without 

the complexities created by differences in economic climates that can 

occur across states.

In determining which failed banks to review, we obtained and reviewed 

data on the failed banks in these three states, as well as the acquiring 

banks (if the failed banks were not liquidated), and the peer banks that 

currently operate in the same geographic area as the failed banks. We 

focused on failed banks that were small banks, typically defined as banks 

with less than $1 billion in assets. For each state, we chose at least three 

failed banks to target—two that failed within a metropolitan statistical area 

and one that failed in a nonmetropolitan statistical area. Within each 

state, to the extent possible we chose failed banks that represented 

different types of resolutions (whole bank purchase, whole bank purchase 

with a shared loss agreement, and liquidation) and different types of 

acquiring banks (other state chartered community banks, out of state 

regional banks, and national banks). Once we chose the failed banks to 

target, we then examined the population of existing peer banks within the 

same county or zip code; that is, other small banks. Our first priority was 

to choose peer banks that were headquartered in the same county, but if 

none existed, we looked for small banks from nearby counties or zip 

codes that had branches in the same community as the target failed 

bank.

We conducted this performance audit from February 2012 to December 

2012 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives.
Appendix II: FDIC Resolution Methods for 

Failed Institutions and the Least Cost Test 

Process 

Page 65 GAO-13-71 Recent Bank Failures 

The Federal Deposit Insurance Corporation (FDIC) has two primary types 

of closing transactions, with multiple variations of both, to resolve failing 

institutions:

• Purchase and Assumption. A resolution transaction in which a healthy 

institution purchases some or all of the assets of the failed financial 

institution and assumes some or all of the liabilities, including all 

insured deposits.

• Basic Purchase and Assumption. Assets transferring to the 

acquiring institution (AI) are limited to cash and cash-equivalents.

• Modified Purchase and Assumption. Cash and a portion of the 

loan portfolio (loan pools) transfer to the acquiring institution.

• Whole Bank Purchase and Assumption. The acquiring institution 

assumes essentially all assets and liabilities.

• Whole Bank Purchase and Assumption with Shared loss 

Agreements (SLA). Specific assets assumed by the assuming 

institution are covered (FDIC reimburses the acquiring institution 

or shares in loan losses).

• Bridge Bank Resolution Transaction. A type of purchase and 

assumption transaction for which FDIC itself acts temporarily as 

the assuming institution.

• Deposit Payoff Transaction. A resolution strategy that occurs when 

there is no assuming institution, and FDIC directly pays the insured 

amounts to the depositor and becomes the subrogated holder of the 

claim.

• Straight Deposit Payoff. This is only executed if FDIC does not 

receive a bid for the purchase and assumption transaction, thus 

no liabilities are assumed and no assets are purchased by an

acquiring institution.

• Insured Deposit Transfer. The deposits and secured liabilities of a 

failed institution are transferred to a healthy institution. This means 

no assets are purchased.

• Deposit Insurance National Bank (DINB) – Insured deposits are 

transferred to a newly charted federal financial institution, which is 

operated for a limited period of time by the FDIC to permit 

depositors to make an orderly withdrawal of funds.

Appendix II: FDIC Resolution Methods for 

Failed Institutions and the Least Cost Test 

Process 
Appendix II: FDIC Resolution Methods for 

Failed Institutions and the Least Cost Test 

Process 

Page 66 GAO-13-71 Recent Bank Failures 

• Open Bank Assistance. FDIC determines it is least costly to the DIF to 

provide assistance rather than close the failing bank.1

FDIC is required to resolve failed institutions using the least costly 

method to the DIF. FDIC contacts qualified insured depository institutions 

to bid on deposits and the failing bank’s assets. After all bids are 

received, FDIC selects the least costly option to the DIF, which may 

include a purchase and assumption transaction with accompanying 

shared loss agreements. Figure 8 provides an overview of the least cost 

test process.

Figure 8: FDIC’s Least Cost Test Process

The authority to approve any resolution transaction, including any shared 

loss provisions, rests with the FDIC Board of Directors (BOD). The FDIC 

 

1

Prior to 2010, a systemic risk determination would have permitted open bank assistance 

to an individual insured depository institution (IDI). However, since the passage of the 

Dodd-Frank Act on July 21, 2010, the systemic risk determination authority under section 

13 of the FDI Act is limited to IDIs put in an FDIC receivership. Accordingly, open bank 

assistance is no longer an option. In an open bank assistance agreement, the FDIC 

provided financial assistance to an operating insured bank or thrift determined to be in 

danger of closing. 

Least Cost Test Process
Appendix II: FDIC Resolution Methods for 

Failed Institutions and the Least Cost Test 

Process 

Page 67 GAO-13-71 Recent Bank Failures 

Division of Resolutions and Receiverships (DRR) Franchise and Asset 

Marketing Branch (FAMB) must obtain approval from the BOD before 

executing a resolution transaction. Because the FAMB must obtain 

approval before executing a resolution transaction, FAMB, Risk 

Management Supervision and Legal begin preparing a Failing Bank 

Board Case (FBC) immediately following notification from the bank’s 

primary regulator that it has been identified as a potential failing 

institution.

FBC provides a history of the failing institution, an economic overview, 

comparable market and demographic data, and FDIC’s estimated cost to 

liquidate the institution. This cost assumes a payout of insured deposits 

and a liquidation of all assets by FDIC. The FBC is prepared prior to the 

receipt of any bids and therefore, any premium paid by the successful 

bidder for the assets or deposits is not considered in this analysis and 

subsequently reduces FDIC’s liquidation costs. In addition to information 

related to the failing institution, the FBC also includes a broad set of 

delegations allowing FDIC staff to approve and implement a resolution 

strategy. Once approved by the BOD, the BOD delegates authority to the 

Director of DRR to approve the transaction that resolves the financial 

institution at the least cost to the DIF.

The FAMB presents resolution strategies including a whole bank 

purchase and assumption transaction with and without shared loss 

agreements for approval from the BOD. The whole bank purchase and 

assumption transaction is the preferred method of resolution strategy.

Under the whole bank purchase and assumption transaction, essentially 

all assets and liabilities are transferred to a healthy institution. This type of 

transfer includes transferring performing and nonperforming assets based 

on competitive bids. If no acceptable bids are received, a new depository 

institution in the same community as the failing bank may be organized to 

assume the insured deposits in order to payout those deposits, and to 

temporarily perform certain functions to wind up the affairs of the bank in 

an orderly fashion.

The FAMB marketing specialist starts marketing the bank to qualified 

institutions when the bank is issued a Prompt Corrective Action notice by 

its primary regulator. The FAMB marketing process involves getting asset 

and liability information from the failing institution and allowing the 

potential acquiring institutions to review this information. FAMB generates 

a bid list of qualified depository institutions that are approved by the 

primary regulators and is used to solicit bids. FDIC targets banks that are 

usually double the size of the failing bank and are financially stable. The 
Appendix II: FDIC Resolution Methods for 

Failed Institutions and the Least Cost Test 

Process 

Page 68 GAO-13-71 Recent Bank Failures 

bidders sign confidentiality agreements in order to review the failing 

banks’ information. FDIC performs a LCT analysis on all bids that are 

received.

The bids are submitted to FAMB for evaluation. These bids may contain 

several elements related to the bidder’s valuation of the bank. Once all 

the bids have been received, FAMB compiles the bids and creates the 

Bid Summary Report. The Bid Summary Report indicates if a bid is 

conforming or nonconforming, as well as identifies other key information, 

including the proposed terms of the bid. A conforming bid follows the 

standard terms of the transaction and bid instructions, while a 

nonconforming bid is submitted with contingencies or conditions that 

deviate from the standard terms of the transaction and bid instructions.

Conforming bids are always considered and evaluated when determining 

the least costly resolution. Nonconforming bids are considered as well, if 

they can be analyzed.

FAMB completes the LCT Analysis that is contained in the LCT Excel 

Workbooks including the bank’s balance sheet, asset loss and recovery 

information, uninsured deposit estimate, bids and the Shared loss 

Worksheet (LSW), if applicable. The LSW is used to estimate the cost of 

a shared loss transaction. This cost may include an estimate of the initial 

cash outlay by FDIC or the acquirer, shared loss payments, payments to 

creditors left behind in the receivership, monitoring costs for those shared 

loss covered assets, FDIC receivership costs, and future estimated 

recoveries on assets retained by the receivership. Losses and recoveries 

are estimated by the financial advisors hired by the FDIC to perform the 

asset valuations.

After completing the LCT Analysis, the Bid Approval Memorandum 

addressed to the Director of DRR is prepared. The Bid Approval includes 

a description of all bids received, and a summary of the estimated cost to 

liquidate the institution, as well as the least costly transaction. The 

Director of DRR has the delegation of authority from the FDIC BOD to 

approve the least costly bid. The Director of DRR signs the memorandum 

to indicate approval of the winning bid.
Appendix III: GAO Analysis of Bank 

Characteristics and the Likelihood of Failure 

Page 69 GAO-13-71 Recent Bank Failures 

We conducted an econometric analysis to estimate the relationship 

between bank characteristics and the likelihood of bank failure, using data 

on FDIC-insured commercial banks and state-chartered savings banks 

(banks) for the period from 2006 through 2011 along with data on banks 

that failed during the period from 2008 through 2011 and their acquiring 

banks. We used a discrete-time hazard model to estimate the likelihood 

that a bank fails in a quarter as a function of its balance sheet 

characteristics in the previous quarter, including capital adequacy; asset 

quality; earnings; liquidity; brokered deposits use; ADC lending; nonfarm, 

nonresidential real estate lending; multifamily real estate lending; 

commercial real estate, construction, and land development lending not 

secured by real estate; and size.

• Capital adequacy. Capital adequacy measures the net worth or 

solvency of the bank. Bank capital performs several important 

functions, such as absorbing losses, promoting public confidence, 

restricting excessive asset growth, and providing protection to 

depositors and the FDIC insurance fund. We calculated capital 

adequacy as bank equity capital as a percent of total assets.

• Asset quality. Asset quality measures the quality of the bank’s assets, 

which may include losses not yet reflected in capital. The primary 

factor affecting overall asset quality is the quality of the loan portfolio 

and the credit administration program. We calculated asset quality as 

performing assets as a percent of total assets, where performing 

assets are total assets less assets 90 days or more past due but still 

accruing interest, assets in nonaccrual status, and other real estate 

owned.

• Earnings. Earnings measure profitability. Earnings absorb losses and 

augment capital, provide the initial safeguard against the risks of 

engaging in the banking business, and represent the first line of 

defense against capital depletion resulting from reduced asset values.

We calculated earnings as bank net income as a percent of total 

assets.

• Liquidity. Liquidity represents the ability to fund assets and meet

obligations as they become due, and it is essential in all banks to 

compensate for expected and unexpected balance sheet fluctuations 

and to provide funds for growth. One component of liquidity is the 

extent to which a bank relies on stable funding sources. We 

calculated liquidity as stable liabilities as a percent of total liabilities, 

where stable liabilities are total liabilities less federal funds purchased 

and securities sold under agreements to repurchase, demand notes 

issued to the U.S. Treasury and other borrowed money, time deposits 

over the limit for insured deposits held in domestic offices, deposits 

Appendix III: GAO Analysis of Bank 

Characteristics and the Likelihood of Failure
Appendix III: GAO Analysis of Bank 

Characteristics and the Likelihood of Failure 

Page 70 GAO-13-71 Recent Bank Failures 

held in foreign offices, and trading liabilities net of revaluation losses 

on derivatives.

• Brokered deposits. Brokered deposits measure reliance on high-cost 

and potentially volatile funding sources. We calculated brokered 

deposits—deposits accepted through a deposit broker—as a percent 

of total liabilities.

• ADC loans. ADC loans measure concentration in one type of risky 

lending. We calculated ADC loans as a percent of total assets.

• Nonfarm, nonresidential real estate loans. Non-farm, non-residential 

real estate loans measure concentration in one type of risky lending.

We calculated non-farm, non-residential real estate loans as a percent 

of total assets.

• Multifamily real estate loans. Multifamily real estate loans measure 

concentration in one type of risky lending. We calculated multifamily 

real estate loans as a percent of total assets.

• Commercial real estate, construction, and land development loans not 

secured by real estate. Commercial real estate, construction, and land 

development loans not secured by real estate measure concentration 

in one type of risky lending. We calculated these loans as a percent of 

total assets.

• Size. Size accounts for other factors that are correlated with the 

likelihood of failure, such as product mix or business model, that may 

vary by bank size. We calculated size as the natural logarithm of total 

assets.

We included indicators for each quarter to control for factors affecting the 

likelihood of failure that are common to all banks at the same time, such 

as the regulatory environment, the state of the market for bank products 

and services, and the condition of the overall economy. We adjusted the 

standard errors of our estimates to reflect the lack of independence 

between observations on the same bank in different quarters. Specifically, 

we clustered our standard errors by bank to allow for arbitrary correlation 

between observations on the same bank in different quarters and we 

multiplied our standard errors by the square root of the average number 

of observations per bank to reflect the fact that the series of observations 

on a single bank constitutes a single observation in our model. We used a 

similar model to estimate the likelihood that a bank fails in a quarter 

based on the characteristics of its balance sheet two quarters in the past, 

three quarters in the past, and so on up to eight quarters in the past.

To allow for the possibility that different factors were associated with the 

failure of banks of different sizes, we repeated the analysis separately for 

small and medium-sized banks. Small banks are banks with average 

assets of less than $1 billion and medium-sized banks are banks with 
Appendix III: GAO Analysis of Bank 

Characteristics and the Likelihood of Failure 

Page 71 GAO-13-71 Recent Bank Failures 

average assets of at least $1 billion and less than $10 billion. The number 

of failures of large banks—banks with average assets of $10 billion or 

more—was too small to permit us to separately analyze this group of 

banks.

We found that ADC lending and brokered deposits were associated with 

an increased likelihood of failure, while asset quality and capital adequacy 

were associated with a reduced likelihood of failure, all else being equal 

(see table 5). A bank was more likely to fail in a quarter if it had high 

concentrations of ADC loans on its balance sheet in the past, specifically, 

three, four, five, six, seven, or eight quarters in the past. A bank was also 

more likely to fail in a quarter if it relied heavily on brokered deposits six, 

seven, or eight quarters in the past. On the other hand, a bank was less 

likely to fail in a quarter if it had more adequate capital in the previous six 

quarters and if it had better asset quality in the previous eight quarters.

Our analyses of small and medium-sized banks generated results that 

were broadly consistent with our analysis of all banks. A small bank was 

more likely to fail in a quarter if it had high concentrations of ADC loans 

on its balance sheet four, five, six, seven, or eight quarters in the past, 

while a medium-sized bank was more likely to fail in a quarter if it had 

high concentrations of ADC loans seven or eight quarters in the past. 

However, a small bank was less likely to fail in a quarter if it had better 

capital adequacy in the previous six quarters and a medium-sized bank 

was less likely to fail in a quarter if it had better capital adequacy in the 

previous three quarters. Finally, a small bank was less likely to fail in a 

quarter if its asset quality was better in the period from two quarters in the 

past to eight quarters in the past.

Table 5: Bank Characteristics Associated with the Likelihood of Failure, 2008-2011

Bank size

Lagged factors that increase the likelihood 

of failure in the current quarter

Lagged factors that decrease the likelihood 

of failure in the current quarter

Number of lags 

(quarters)

All banks

Brokered depositsc, ADC loansa Asset qualityb 8 

Brokered depositsc, ADC loansa Asset qualityb 7 

Brokered depositsc, ADC loansa Asset qualitya, capital adequacyb 6 

ADC loansa Asset qualitya, capital adequacyb 5 

ADC loansb Asset qualitya, capital adequacya 4 

ADC loansc Asset qualitya, capital adequacya 3 

Asset qualityb, capital adequacya 2 

Asset qualityc, capital adequacya 1 
Appendix III: GAO Analysis of Bank 

Characteristics and the Likelihood of Failure 

Page 72 GAO-13-71 Recent Bank Failures 

Bank size

Lagged factors that increase the likelihood 

of failure in the current quarter

Lagged factors that decrease the likelihood 

of failure in the current quarter

Number of lags 

(quarters)

Small banks (average assets less than $1 billion)

ADC loansa Asset qualityb 8 

ADC loansa Asset qualityb 7 

ADC loansa Asset qualitya, capital adequacyc 6 

ADC loansa Asset qualitya, capital adequacya 5 

ADC loansb Asset qualitya, capital adequacya 4 

Asset qualitya, capital adequacya 3 

Asset qualityb, capital adequacya 2 

Capital adequacya 1 

Medium-sized banks (average assets $1-10 billion)

ADC loansb 8 

ADC loansc 7 

6 

5 

4 

Capital adequacyb 3 

Capital adequacyb 2 

Capital adequacyb 1 

Source: GAO analysis of data from FDIC and the Federal Financial Institutions Examinations Council.

a

Significant at the 1 percent level. 

b

Significant at the 5 percent level. 

c

Significant at the 10 percent level. 

Our results likely reflect both factors that are generally correlated with the 

likelihood of failure and factors that are specific to the particular time 

period we analyzed. Thus, the extent to which our results can be 

generalized to other time periods is limited. Furthermore, our results 

reflect average relationships between bank characteristics and the 

likelihood of failure for all of the observations we used. As such, they may 

not reflect the particular circumstances of any one bank. Finally, we note 

that the list of characteristics we analyzed is meant to highlight important 

characteristics of banks that are related to the likelihood of failure, but 

many other factors play a role in whether or not a bank fails and our list of 

characteristics is not exhaustive.
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 73 GAO-13-71 Recent Bank Failures 

We analyzed bank call reports from 2007 through 2011 for failed and 

open commercial banks to identify and compare trends in (1) the use of 

historical cost accounting and fair value accounting and (2) the extent to 

which losses were credit-related for small, medium-size, and large 

institutions. We define small failed banks as those that had $1 billion or 

less in assets at the time of failure, medium-size failed banks as those 

that had between $1 billion and $10 billion at the time of failure, and large 

failed banks as those that had over $10 billion in assets at the time of 

failure. Overall our analysis showed that fair value-related losses 

contributed very little to the decline in net interest income and regulatory 

capital experienced by failed commercial banks of all sizes (small, 

medium-size, and large) once the financial crisis began in 2007. Similarly, 

fair value losses at open commercial banks of all sizes were also limited. 

Instead, this analysis showed that the commercial bank failures were 

driven by rising levels of credit losses related to nonperforming loans held 

by the banks. Further, these losses had a greater negative impact on 

institutions’ net interest income and regulatory capital levels than those 

recorded at fair value. We analyzed failed thrifts separately. (See app. V.)

U.S. generally accepted accounting principles (GAAP) establish the basis 

on which items reported on a bank’s balance sheet should be measured. 

Currently, assets and liabilities are reflected in the balance sheet at fair 

value, historical cost, or another basis, such as lower-of-cost or fair value.

• Fair Value: Fair value is the price that would be received to sell a 

asset or paid to transfer a liability in an orderly transaction between 

market participants at the measurement date. Fair value accounting 

standards under GAAP establish a standardized framework for 

Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial 

Bank Failures

Fair Value, Historical Cost, 

and Impairment 

Accounting
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 74 GAO-13-71 Recent Bank Failures 

measuring the fair value of an asset or liability.1 According to the 

Securities and Exchange Commission, fair value is most prevalently 

used to measure “financial” assets and liabilities, such as investment 

securities and derivative instruments. Fair value measurements that 

are required on a quarterly basis (or each reporting period) are often 

referred to as “recurring.” Fair value measurements that are not 

required on a regular basis are often referred to as “nonrecurring.” For 

some assets and liabilities that are measured at fair value on a 

recurring basis, such as securities designated for trading, unrealized 

gains or losses flow through the bank’s earnings in the income 

statement and affect regulatory capital. For other assets and liabilities 

that are measured at fair value on a recurring basis, such as 

securities designated as available for sale, unrealized fair value gains 

and losses generally do not impact earnings, and thus, generally are 

not included in regulatory capital calculations. Instead, these gains or 

losses are recorded through other comprehensive income (OCI), 

unless the institution determines that a decline in fair value below 

amortized cost constitutes an other than temporary impairment (OTTI) 

in which case the instrument is written down to its fair value, with 

credit losses reflected in earnings.2

 

1

In 2006, the Financial Accounting Standards Board issued Statement of Financial 

Accounting Standards (SFAS) No. 157, Fair Value Measurements, which defined fair 

value, established a framework for measuring fair value under GAAP, and required 

expanded disclosures about fair value measurements. SFAS No. 157 became effective in 

2008. Prior to its issuance, fair value measurement principles were not consistently 

defined and codified in a single accounting standard, which led to the potential for 

disparate fair value measurement practices under different accounting standards. SFAS 

No. 157 was intended to provide a single set of measurement principles to be uniformly 

applied for fair value measurement when GAAP requires or permits reporting entities to 

measure or disclose the fair value of an asset or liability. However, SFAS No. 157 did not 

change which asset and liabilities are subject to fair value accounting or when fair value 

should be applied, as other previously existing accounting standards provide the 

requirement or permission to measure assets and liabilities at fair value. SFAS 157 was 

subsequently codified as ASC 820 and amended, and additional staff guidance was 

issued on the application of fair value accounting.

The OTTI decision for a given 

2

OCI refers to revenues, expenses, gains, and losses that are included in comprehensive

income but excluded from net income. Comprehensive income is the total non-owner 

change in equity for a reporting period. An other-than-temporarily impaired instrument is 

one whose fair value has fallen below its amortized cost and its value is not expected to 

recover to its amortized cost through the holding period. As a result of an April 2009 

change to the relevant GAAP standard, an OTTI of either a debt security classified as 

available-for-sale or held-to-maturity in certain circumstances in separated into the (1) 

credit loss amount recognized in earnings and (2) the amount related to all other factors

(non-credit loss) recognized in OCI, net of applicable taxes. 
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 75 GAO-13-71 Recent Bank Failures 

asset is a judgmental decision of the bank, considering various factors 

related to the severity and duration of the decrease in the value of the 

asset. Unrealized changes in fair value and OTTI-related write-downs 

that are recognized in earnings in the income statement directly 

impact regulatory capital levels.

• Historical Cost: Measurement using historical cost can be done in 

several ways, but the general concept is to record items on the 

balance sheet using the original amount paid or received, with 

adjustments when appropriate in subsequent periods for depreciation, 

amortization, principal pay downs, or impairment. Generally, loans 

that a bank holds for investment (HFI), for example, are recorded at 

amortized cost, net of an impairment allowance for estimated credit 

losses.3

• Loan Impairment Accounting: GAAP requires financial institutions to 

maintain an allowance for loan losses (loan loss allowance) at a level 

that is appropriate to cover estimated credit losses incurred as of the 

balance sheet date for their entire portfolio of HFI loans. Under GAAP, 

institutions must recognize impairment on HFI loans when credit 

losses are determined to be probable and reasonably estimable, that 

is, when, based on current information and events, it is probable that 

an institution will be unable to collect all amounts due (i.e., both 

principal and interest) according to the contractual terms of the 

original loan agreement. An increase in the loan loss allowance 

results in a charge to expenses, termed a provision for loan losses. 

Impairment accounting standards under GAAP set forth the 

measurement methods for estimating the credit losses attributable to 

individually impaired loans. Regulators generally require institutions to 

establish policies and procedures for determining the loan loss 

allowance based on GAAP requirements.

 Such loans typically comprise the bulk of assets held by 

FDIC-insured banks.

4

 

3

Essentially, amortized cost is outstanding principal, adjusted for any charge-offs, deferred 

fees or costs, and unamortized discount or premium.

4

Section 121 of the Federal Deposit Insurance Corporation Improvement Act requires that 

the accounting principles used for regulatory reporting should be no less stringent than 

GAAP in order to facilitate prompt corrective action to resolve failed banks at the least cost 

to the DIF. 
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 76 GAO-13-71 Recent Bank Failures 

During the period of our study, loans HFI represented on average over 

two-thirds of most commercial banks’ total assets (table 1). HFI loans are 

not measured at fair value, but instead are measured on an amortizedcost basis, net of an impairment allowance for estimated credit losses. 

Table 6 indicates that small and medium-size commercial banks generally 

had slightly higher percentages of loans classified as HFI loans than large 

commercial banks. Also, compared to open commercial banks, failed 

commercial banks held a higher percentage of HFI loans.

Table 6: HFI Loans as a Percentage of Total Assets for Failed and Open Commercial Banks, 2007-2011

Asset size Description 2007 2008 2009 2010 2011

Failed banks 

< $1 billion HFI loans 78.30% 77.48% 74.25% 70.73% 68.38%

>$1 billion, <$10 billion HFI loans 72.46% 73.01% 69.90% 69.20% 77.39%

>$10 billion HFI loans 60.80% 56.25% 58.85% 77.20% __a

Open banks 

< $1 billion HFI loans __b 69.47% 67.68% 65.11% 62.47%

>$1 billion, <$10 billion HFI loans __b 68.62% 66.89% 63.64% 61.95%

>$10 billion HFI loans __b 52.72% 50.99% 51.30% 49.63%

Source: GAO analysis of FDIC call report data.

a

No large commercial banks failed in 2011. 

b

Pub. L. No.112-88 requires us to analyze bank failures that occurred since 2008. As such, we 

analyzed trends for both failed banks and open banks from 2008 through 2011. For failed banks, we 

also obtained 2007 data to determine any additional trends prior to the failures. 

Most Assets and Liabilities 

at Failed and Open 

Commercial Banks Were 

Not Measured at Fair Value 

between 2007 and 2011

Assets Measured at Amortized 

Cost
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 77 GAO-13-71 Recent Bank Failures 

Assets measured at fair value through earnings on a recurring basis 

comprised mainly trading assets, nontrading derivative assets, and 

nonfinancial assets such as servicing rights for mortgages for which the 

fair value option has been elected.5

Trading Assets

Trading assets generally include both debt and marketable equity 

securities bought and held primarily to be sold in the near term. Trading 

activities typically involve active and frequent buying and selling to 

generate profits on short-term movements in market prices. Trading 

assets also include derivative contracts held for trading purposes in gain 

positions. Table 7 shows that trading assets did not represent a 

significant percentage of failed commercial banks’ assets from 2007 

through 2011. Table 7 also indicates that failed commercial banks held 

fewer trading assets than open commercial banks. Large open 

commercial banks in particular tended to have larger percentages of 

trading assets than failed commercial banks of similar size.

Table 7: Trading Assets as a Percentage of Total Assets for Failed and Open Commercial Banks, 2007-2011

Asset size Description 2007 2008 2009 2010 2011

Failed banks 

< $1 billion Trading assets 0.05% 0.03% 0.00% 0.02 0.00%

>$1 billion, <$10 billion Trading assets 0.17% 0.14% 0.03% 0.01% 0.00%

>$10 billion Trading assets 0.04% 0.04% 0.05% 0.11 __a

Open banks 

< $1 billion Trading assets __b 0.06% 0.04% 0.02% 0.02%

>$1 billion, <$10 billion Trading assets __b 0.27% 0.16% 0.28% 0.19%

>$10 billion Trading assets __b 9.76% 7.82% 7.22% 7.03%

Source: GAO analysis of FDIC call report data.

a

No large commercial banks failed in 2011. 

b

Pub. L. No.112-88 requires us to analyze bank failures that occurred since 2008. As such, we 

analyzed trends for both failed banks and open banks from 2008 through 2011. For failed banks, we 

also obtained 2007 data to determine any additional trends prior to the failures. 

 

5

ASC 825 (formerly FAS 159), “The Fair Value Option for Financial Assets and Financial 

Liabilities,” (February 2007) allows a one-time election to report certain financial 

instruments at fair value. At initial recognition for certain financial assets and liabilities, an 

entity may irrevocably elect fair value as the initial and subsequent measurement attribute, 

with changes in fair value included in current earnings.

Assets and Liabilities Measured 

at Fair Value Through Earnings 

on a Recurring Basis 
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 78 GAO-13-71 Recent Bank Failures 

Nontrading Assets

Nontrading assets measured at fair value on a recurring basis include, 

among other things, nontrading derivative contracts in gain positions. 

Most commercial banks did not have any significant holdings of such 

nontrading assets (table 8). Even for open commercial banks that have 

relatively more of such nontrading assets than failed institutions, the level 

of these assets is less than 0.15 percent of their total assets.

Table 8: Nontrading Assets Measured at Fair Value Through Earnings on a Recurring Basis as a Percentage of Total Assets 

for Failed and Open Commercial Banks, 2007-2011

Asset size Description 2007 2008 2009 2010 2011

Failed banks

< $1 billion Nontrading assets 0.00% 0.00% 0.00% 0.00% 0.00%

>$1 billion, <$10 billion Nontrading assets 0.00% 0.00% 0.00% 0.00% 0.00%

>$10 billion Nontrading assets 0.00% 0.00% 0.00% 0.00% __a

Open banks 

< $1 billion Nontrading assets __b 0.03% 0.01% 0.00% 0.00%

>$1 billion, <$10 billion Nontrading assets __b 0.03% 0.04% 0.05% 0.06%

>$10 billion Nontrading assets __b 0.13% 0.02% 0.02% 0.01%

Source: GAO analysis of FDIC call report data.

a

No large commercial banks failed in 2011. 

b

Pub. L. No. 112-88 requires us to analyze bank failures that occurred since 2008. As such, we 

analyzed trends for both failed banks and open banks from 2008 through 2011. For failed banks, we 

also obtained 2007 data to determine any additional trends prior to the failures. 

Nonfinancial Assets

Nonfinancial assets measured at fair value through earnings on a 

recurring basis consist of mortgage servicing rights (MSR) for which a fair 

value option has been elected. Failed commercial banks did not have 

significant amounts of such nonfinancial assets (table 9). Failed 

commercial banks also had fewer such nonfinancial assets than open 

commercial banks, particularly large open commercial banks.
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 79 GAO-13-71 Recent Bank Failures 

Table 9: Nonfinancial Assets Measured at Fair Value Through Earnings on a Recurring Basis as a Percentage of Total Assets 

for Failed and Open Commercial Banks, 2007-2011

Asset size Description 2007 2008 2009 2010 2011

Failed banks

< $1 billion Nonfinancial assets 0.00% 0.00% 0.00% 0.00% 0.00% 

>$1 billion, <$10 billion Nonfinancial assets 0.00% 0.00% 0.00% 0.00% 0.00%

>$10 billion Nonfinancial assets 0.00% 0.00% 0.00% 0.00% __a

Open banks

< $1 billion Nonfinancial assets __b 0.05% 0.09% 0.08% 0.07%

>$1 billion, <$10 billion Nonfinancial assets __b 0.24% 0.34% 0.27% 0.23%

>$10 billion Nonfinancial assets __b 1.08% 1.31% 1.19% 1.08%

Source: GAO analysis of FDIC call report data.

a

No large commercial banks failed in 2011. 

b

Pub. L. No. 112-88 requires us to analyze bank failures that occurred since 2008. As such, we 

analyzed trends for both failed banks and open banks from 2008 through 2011. For failed banks, we 

also obtained 2007 data to determine any additional trends prior to the failures. 

Liabilities 

Liabilities measured at fair value through earnings on a recurring basis 

include trading liabilities such as securities an institution sold but did not 

own and therefore is obligated to purchase at a future date (short 

positions), derivative contracts held for trading purposes in loss positions, 

nontrading derivative contracts in loss positions, and those liabilities for 

which a bank elects to measure at fair value on a recurring basis under 

the fair value option. Failed commercial banks did not have a significant 

amount of such liabilities (table 10). Failed commercial banks also had 

fewer such liabilities than open commercial banks, particularly large open 

banks.
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 80 GAO-13-71 Recent Bank Failures 

Table 10: Trading Liabilities Measured at Fair Value Through Earnings on a Recurring Basis as a Percentage of Total Assets 

for Failed and Open Commercial Banks, 2007-2011

Asset size Description 2007 2008 2009 2010 2011

Failed banks

< $1 billion Liabilities 0.00% 0.00% 0.00% 0.00% 0.00%

>$1 billion, <$10 billion Liabilities 0.01% 0.00% 0.00% 0.00% 0.00%

>$10 billion Liabilities 0.01% 0.02% 0.03% 0.06% __a

Open banks

< $1 billion Liabilities __b 0.00% 0.00% 0.00% 0.00%

>$1 billion, <$10 billion Liabilities __b 0.06% 0.05% 0.04% 0.06%

>$10 Billion Liabilities __b 4.61% 3.43% 3.33% 3.37%

Source: GAO analysis of FDIC call report data.

a

No large commercial banks failed in 2011. 

b

Pub. L. No. 112-88 requires us to analyze bank failures that occurred since 2008. As such, we 

analyzed trends for both failed banks and open banks from 2008 through 2011. For failed banks, we 

also obtained 2007 data to determine any additional trends prior to the failures. 

Securities Held to Maturity

Investments in debt securities classified as held-to-maturity (HTM) are 

measured at amortized cost, but if any decline in fair value below 

amortized cost is other than temporary, credit losses are recognized in 

earnings. The HTM category includes only debt securities that 

management has both the positive intent and ability to hold until maturity. 

As illustrated in table 11, investment securities accounted for as HTM 

represented less than 2 percent of assets held for failed banks with less 

than $10 billion in assets. For failed banks with more than $10 billion in 

assets, HTM ranged between 3 percent and 14 percent, particularly 

because of one large bank with a high percentage of HTM securities. On 

average, open banks held about 3 percent of HTM securities.

Assets Measured at Fair Value 

on a Nonrecurring Basis

Through Income
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 81 GAO-13-71 Recent Bank Failures 

Table 11: HTM Securities as a Percentage of Total Assets for Failed and Open Commercial Banks, 2007-2011

Asset size Description 2007 2008 2009 2010 2011

Failed banks 

< $1 billion HTM securities 1.17% 1.14% 0.63% 0.32% 0.43%

>$1 billion, <$10 billion HTM securities 0.82% 1.38% 1.09% 0.14% 0.00%

>$10 billiona HTM securities 13.60% 5.04% 2.80% 4.88% __b

Open banks

< $1 billion HTM securities __c 2.51% 2.37% 2.22% 2.17%

>$1 billion, <$10 billion HTM securities __c 2.63% 2.56% 2.97% 3.10%

>$1 0 billion HTM securities __c 0.69% 1.12% 0.84% 1.02%

Source: GAO analysis of FDIC call report data.

a

One large bank with a high percentage of HTM securities accounted for most of the HTM securities. 

Excluding this bank, the percentages ranged from x to x. 

b

No large commercial banks failed in 2011. 

c

Pub. L. No.112-88 requires us to analyze bank failures that occurred since 2008. As such, we 

analyzed trends for both failed banks and open banks from 2008 through 2011. For failed banks, we 

also obtained 2007 data to determine any additional trends prior to the failures. 

Securities Available for Sale

Investments in debt securities that are not classified as trading securities 

or as HTM securities are classified as available-for-sale (AFS) securities. 

AFS securities also include equity securities that have readily 

determinable fair values and are not classified as trading securities. If the 

fair value of an AFS security declines below its amortized cost, and the 

decline is other than temporary, credit losses are recognized in earnings.

As illustrated in table 12, AFS securities represented the largest 

percentage of assets held after HFI loans. For failed banks, AFS assets 

ranged between 9 percent and 18 percent of total assets compared to 12 

percent and 20 percent for open banks. On average, open banks with 

less than $10 billion in total assets held the highest percentages of AFS 

securities.
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 82 GAO-13-71 Recent Bank Failures 

Table 12: AFS Securities as a Percentage of Total Assets for Failed and Open Commercial Banks, 2007-2011

Asset size Description 2007 2008 2009 2010 2011

Failed banks 

< $1 billion AFS securities 10.51% 10.15% 9.61% 9.47% 9.50%

>$1 billion, <$10 billion AFS securities 15.56% 11.97% 10.92% 13.22% 10.01%

>$1 billion AFS securities 9.94% 16.47% 18.31% 12.52% __a

Open banks

< $1 billion AFS securities __b 16.16% 16.47% 17.68% 19.79%

>$1 billion, <$10 billion AFS securities __b 15.59% 16.19% 17.06% 18.83%

>$10 billion AFS securities __b 12.68% 15.91% 17.94% 18.28%

Source: GAO analysis of FDIC call report data.

a

No large commercial banks failed in 2011. 

b

Pub. L. No. 112-88 requires us to analyze bank failures that occurred since 2008. As such, we 

analyzed trends for both failed banks and open banks from 2008 through 2011. For failed banks, we 

also obtained 2007 data to determine any additional trends prior to the failures. 

As a result of an April 2009 change to the relevant GAAP standard, an 

OTTI loss of either an AFS or HTM debt security, in certain 

circumstances, is separated into (1) the credit loss amount, which is 

recognized in earnings and (2) the loss amount related to all other factors 

(noncredit loss), which is recognized in OCI, net of applicable taxes. We 

discuss the impact of this change later on in this appendix.

Loans Held for Sale

Under GAAP, loans originated with the intent to sell in the secondary 

market to government-sponsored entities and other investors (including 

other FDIC-insured institutions) are carried at the lower of cost or fair 

value, unless the institution has elected to account for the loans at fair 

value under the fair value option. Institutions can transfer loans into or out 

of the HFS classification as a result of changes in intentions regarding 

whether the loans will be sold or held for investment. Transfers between 

Assets Measured at the Lower 

of Cost or Fair Value
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 83 GAO-13-71 Recent Bank Failures 

the HFS and HFI categories, however, are recorded at the lower of cost 

or fair value.6

As indicated in table 13, HFS loans did not represent a significant percent 

of assets held by commercial banks. On average, failed banks with less 

than $10 billion in assets held less than 2 percent of HFS loans with small 

banks accounting for less than one-half of 1 percent of such assets. 

Large failed banks have a higher percent of HFS loans than open large 

banks. In 2007 and 2008, a few large banks started transferring HFS 

loans into their HFI portfolios as a result of the 2007 contraction in the 

secondary mortgage market. Appendix VI provides further analysis of 

these transfers.

Table 13: HFS Loans as a Percentage of Total Assets for Failed and Open Commercial Banks, 2007-2011

Asset size Description 2007 2008 2009 2010 2011

Failed banks 

< $1 billion HFS loans 0.42% 0.22% 0.26% 0.29% 0.26%

>$1 billion, <$10 billion HFS loans 1.17% 1.36% 1.35% 0.73% 0.05%

>$10 billion HFS loans 3.08% 4.19% 3.01% 0.65% __a

Open banks

< $10 billion HFS loans __b 0.32% 0.47% 0.54% 0.53%

>$1billion, <$10 billion HFS loans __b 1.34% 0.83% 0.93% 0.96%

>$10 Billion HFS loans __b 1.52% 1.58% 1.45% 1.21%

Source: GAO analysis of FDIC call report data.

a

No large commercial banks failed in 2011. 

b

Pub. L. No. 112-88 requires us to analyze bank failures that occurred since 2008. As such, we 

analyzed trends for both failed banks and open banks from 2008 through 2011. For failed banks, we 

also obtained 2007 data to determine any additional trends prior to the failures. 

Other Real Estate Owned

Other Real Estate Owned (OREO) usually includes assets repossessed 

through a foreclosure process for defaulted loans. Generally, assets 

 

6

The OCC Bank Accounting Advisory Series states that a bank should transfer loans from 

the HFI category to the HFS category when it no longer has the intent and ability to hold 

the loans for the foreseeable future or until maturity or payoff. However, such changes in 

intent followed by subsequent sales of the loan in the near term would likely cause 

increased skepticism and scrutiny by the auditor and examiner, especially if the sale or 

transfer occurs during the period the bank originally considered its foreseeable future. 
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 84 GAO-13-71 Recent Bank Failures 

acquired through, or in lieu of, loan foreclosure are held for sale and are 

initially recorded at the estimated fair value of the collateral less costs to 

sell at the date of foreclosure, establishing a new cost basis. Subsequent 

to foreclosure, periodic valuations are performed and the assets are 

carried at the lower of their cost basis or estimated fair value less cost to 

sell.7

Table 14 shows that early in 2007 and 2008, commercial banks had little 

exposure to foreclosed assets. However, as the crisis deepened and the 

real estate downturn became more severe, delinquencies increased 

rapidly and banks foreclosed more properties, particularly smaller 

institutions. Compared to open banks, failed banks had a larger share of 

OREO assets.

Table 14: OREO Assets as a Percentage of Total Assets for Failed and Open Commercial Banks, 2007-2011

Asset size Description 2007 2008 2009 2010 2011

Failed banks

< $1 billion OREO 0.36% 1.35% 2.88% 5.13% 7.78%

>$1 billion, <$10 billion OREO 0.26% 0.83% 2.10% 2.61% 2.30%

>$10 billion OREO 0.04% 0.39% 0.63% 0.78% __a

Open banks

< $1 billion OREO __b 0.37% 0.71% 0.98% 1.05%

>$1 billion, <$10 billion OREO __b 0.26% 0.55% 0.78% 0.80%

>$10 billion OREO __b 0.10% 0.15% 0.24% 0.22%

Source: GAO analysis of FDIC call report data.

a

No large commercial banks failed in 2011. 

b

Pub. L. No. 112-88 requires us to analyze bank failures that occurred since 2008. As such, we 

analyzed trends for both failed banks and open banks from 2008 through 2011. For failed banks, we 

also obtained 2007 data to determine any additional trends prior to the failures. 

 

7

See, for example, FDIC Financial Institution Letter 62-2008 Guidance on Other Real 

Estate. 
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 85 GAO-13-71 Recent Bank Failures 

The reduction in capital for small failed commercial banks was driven by 

increases in their provisions for loan losses. As the financial crisis that 

began in 2007 progressed, the levels of nonperforming loans rose from 

an average of less than 2 percent of total loans in 2007 to over 6 percent 

in 2008, and to nearly 20 percent in 2011 (see fig. 9).

Figure 9: Nonperforming Loans as a Percentage of Total Loans for Small Failed and 

Open Commercial Banks, 2007-2011

Declines in Regulatory 

Capital at Failed 

Commercial Banks Due to 

Rising Levels of 

Nonperforming Loans and 

Resulting Increased Credit 

Losses

Small Commercial Banks
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 86 GAO-13-71 Recent Bank Failures 

The rising levels of nonperforming loans appear to be the key factor 

driving the increases in provisions for loan losses and the resulting 

reduction in net interest income and regulatory capital. For small failed

banks, credit losses were by far the largest contributor to these 

institutions’ losses relative to any other asset class. For example, from 

2008 through 2011, credit losses accounted for on average over 140 

percent of net interest income while net losses from the sale of OREO 

averaged about 15 percent of net interest income (see fig. 10). During 

that same period, net losses from the sale of AFS and HTM securities 

averaged less than 4 percent. Net losses from recurring fair value 

measurements were less than one-tenth of 1 percent.

Figure 10: Income Categories as a Percentage of Net Interest Income for Small 

Failed Commercial Banks, 2007-2011
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 87 GAO-13-71 Recent Bank Failures 

a

Net interest income is reported in the call report, schedule report of income. We show net interest 

income as 100 percent and for each income category calculate its percentage of net interest income. 

b

Credit losses are based on provisions for loan and lease losses as reported in the call report, 

schedule report of income. 

c

The impact on income of other real estate owned is based on net gains (losses) on sales of OREO 

as reported in the call report, schedule report of income , which includes gains and losses recognized 

upon sale of foreclosed property and fair value losses recognized prior to sale. 

d

The impact on income of HFS loans is based on net gains (losses) on sales of loans and leases as 

reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale and fair value losses recognized prior to sale. 

e

The impact on income of AFS and HTM securities is based on realized gains (losses) on AFS and 

HTM securities as reported in the call report, schedule report of income, which includes impairment 

losses recognized. 

f

The impact on income of recurring fair value measurements is based on trading revenues and net 

gains (losses) on assets and liabilities accounted for under the fair value option as reported in the call 

report, schedule report of income. 

The level of nonperforming loans experienced by small failed banks far 

exceeds the levels of nonperforming loans experienced by open banks of 

similar size (see figs.10 and 11). Also, the magnitude of the credit losses 

experienced by open banks is significantly less than what the failed banks 

have experienced.
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 88 GAO-13-71 Recent Bank Failures 

Figure 11: Income Categories as Percentage of Net Interest Income for Small Open 

Commercial Banks, 2008-2011

a

Net interest income is reported in the call report, schedule report of income. We show net interest 

income as 100 percent and for each income category calculate its percentage of net interest income. 

b

Credit losses are based on provisions for loan and lease losses as reported in the call report, 

schedule report of income. 

c

The impact on income of other real estate owned is based on net gains (losses) on sales of OREO 

as reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale of foreclosed property and fair value losses recognized prior to sale. 

d

The impact on income of HFS loans is based on net gains (losses) on sales of loans and leases as 

reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale and fair value losses recognized prior to sale. 

e

The impact on income of AFS and HTM securities is based on realized gains (losses) on AFS and 

HTM securities as reported in the call report, schedule report of income, which includes impairment 

losses recognized. 

f

The impact on income of recurring fair value measurements is based on trading revenues and net 

gains (losses) on assets and liabilities accounted for under the fair value option as reported in the call 

report, schedule report of income. 

The high levels of nonperforming loans experienced in 2009 and 2010 

drove the extent of credit losses during those years for medium-size failed 

banks. The levels of nonperforming loans for these banks went from less 

Medium-Size Commercial 

Banks
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 89 GAO-13-71 Recent Bank Failures 

than 2 percent in 2007 to over 6 percent in 2008 and to over 14 percent in 

2010 (see fig. 12). During that same time frame, nonperforming loan 

levels for open banks of similar size were about one-third.

Figure 12: Nonperforming Loans as a Percentage of Total Loans for Medium-Size 

Commercial Banks, 2007-2011

The large credit losses generally drove the failed commercial banks’ 

decrease in earnings and regulatory capital. For example, from 2007 to 

2011, credit losses averaged over 181 percent of net interest income 

while net losses from the sale of OREO averaged close to10 percent of 

net interest income (see fig. 13). During that same period, net losses from 

the sale of AFS and HTM securities, as well as losses from trading 

(recurring fair value) averaged about 9 percent and 0.09 percent of net 

interest income, respectively. Sales of HFS loans, on the other hand, had 

a positive impact on net interest income.
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 90 GAO-13-71 Recent Bank Failures 

Figure 13: Income Categories as a Percentage of Net Interest Income for Mediumsize Failed Commercial Banks, 2007-2011

a

Net interest income is reported in the call report, schedule report of income. We show net interest 

income as 100 percent and for each income category calculate its percentage of net interest income. 

b

Credit losses are based on provisions for loan and lease losses as reported in the call report, 

schedule report of income. 

c

The impact on income of other real estate owned is based on net gains (losses) on sales of OREO 

as reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale of foreclosed property and fair value losses recognized prior to sale. 

d

The impact on income of HFS loans is based on net gains (losses) on sales of loans and leases as 

reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale and fair value losses recognized prior to sale. 

e

The impact on income of AFS and HTM securities is based on realized gains (losses) on AFS and 

HTM securities as reported in the call report, schedule report of income, which includes impairment 

losses recognized. 

f

The impact on income of recurring fair value measurements is based on trading revenues and net 

gains (losses) on assets and liabilities accounted for under the fair value option as reported in the call 

report, schedule report of income. 

In contrast, medium-size open banks experienced far fewer credit losses 

during the 2008-2011 time period (see fig. 14).
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 91 GAO-13-71 Recent Bank Failures 

Figure 14: Income Categories as a Percentage of Net Interest Income for Open 

Medium-size Banks, 2008-2011

a

Net interest income is reported in the call report, schedule report of income. We show net interest 

income as 100 percent and for each income category calculate its percentage of net interest income. 

b

Credit losses are based on provisions for loan and lease losses as reported in the call report, 

schedule report of income. 

c

The impact on income of other real estate owned is based on net gains (losses) on sales of OREO 

as reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale of foreclosed property and fair value losses recognized prior to sale. 

d

The impact on income of HFS loans is based on net gains (losses) on sales of loans and leases as 

reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale and fair value losses recognized prior to sale. 

e

The impact on income of AFS and HTM securities is based on realized gains (losses) on AFS and 

HTM securities as reported in the call report, schedule report of income, which includes impairment 

losses recognized. 

f

The impact on income of recurring fair value measurements is based on trading revenues and net 

gains (losses) on assets and liabilities accounted for under the fair value option as reported in the call 

report, schedule report of income. 

Nonperforming loans for the three large commercial banks that failed 

between 2008 and 2011—United Commercial Bank (UCB), Colonial Bank 

(Colonial), and Westernbank Puerto Rico (Westernbank) also far 

Large Failed Commercial 

Banks
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 92 GAO-13-71 Recent Bank Failures 

exceeded the levels of nonperforming loans experienced generally for 

open banks of similar size (fig.15).

Figure 15: Nonperforming Loans as a Percentage of Total Loans for Large Failed 

Commercial Banks, 2007-2011

Note: For each large failed commercial bank, we provided data for 2007 and for the following years 

until the bank failed. UCB and Colonial failed in 2009 and Westernbank failed in 2010. 

UCB

In 2007, UCB had less than 1 percent of nonperforming loans. However, 

in 2008, the levels of nonperforming loans rose rapidly to almost 4 

percent, and nearly tripled in 2009 (see fig. 15). In its 2008 Form 10-K, 

UCB disclosed that it recorded a net loss of $68 million in 2008 compared 

with a net income of $102 million in 2007. The decline was primarily the 

result of an increase in the provision for loan losses of about $263 million 

for 2008, compared to $20 million for 2007. The increased provision for 

loan losses was the result of increases in classified residential 

construction loans and specific allowances on individually impaired 
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 93 GAO-13-71 Recent Bank Failures 

residential construction loans located in distressed areas of California and 

Nevada.

UCB’s credit losses were by far the largest contributor to the bank’s 

overall losses relative to any other asset class (fig.16). For example, from 

2007 through 2009, credit losses accounted for on average over 123 

percent of net interest income.

Figure 16: Income Categories as a Percentage of Net Interest Income for United 

Commercial Bank, 2007-2009

a

Net interest income is reported in the call report, schedule report of income. We show net interest 

income as 100 percent and for each income category calculate its percentage of net interest income. 

b

Credit losses are based on provisions for loan and lease losses as reported in the call report, 

schedule report of income. 

c

The impact on income of other real estate owned is based on net gains (losses) on sales of OREO 

as reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale of foreclosed property and fair value losses recognized prior to sale. 

d

The impact on income of HFS loans is based on net gains (losses) on sales of loans and leases as 

reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale and fair value losses recognized prior to sale. 
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 94 GAO-13-71 Recent Bank Failures 

e

The impact on income of AFS and HTM securities is based on realized gains (losses) on AFS and 

HTM securities as reported in the call report, schedule report of income, which includes impairment 

losses recognized. 

f

The impact on income of recurring fair value measurements is based on trading revenues and net 

gains (losses) on assets and liabilities accounted for under the fair value option as reported in the call 

report, schedule report of income. UCB did not report any losses in this category during this period. 

Colonial 

In 2008 Colonial had less than one-half of 1 percent of nonperforming 

loans (fig. 15). However, in 2008, nonperforming loans had jumped to 

nearly 3 percent of total loans, reflecting rapid deteriorations in the quality 

of its loan portfolio. By 2009, the level of nonperforming loans had more 

than doubled again to 7.23 percent. In its material loss review, the 

Treasury IG found that from 2006 through 2009, Colonial charged off 

$998 million of loans, of which $752 million (75 percent) were losses 

within the acquisition, development, and construction (ADC) loan 

portfolio. In addition, loan delinquencies significantly increased and, as of 

June 2009, 25 percent of the ADC loan portfolio was 90 days past due or 

in nonaccrual status. During that same quarter, Colonial also had $377 

million in unrealized securities losses in its other mortgage-backed 

securities portfolio.

By and large, Colonial’s credit losses were the primary drivers of the 

decline in net interest income (see fig. 17). For example, from 2007 

through 2009, Colonial’s credit losses accounted for on average over 110 

percent of net interest income, while net losses from the sale of OREO 

averaged about 6 percent. During that same period, net losses from the 

sale of AFS and HTM securities averaged less than 2 percent of net 

interest income and the bank’s fair value losses were less than 1 percent 

of net interest income, whereas HFS loan sales generated income.
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 95 GAO-13-71 Recent Bank Failures 

Figure 17: Income Categories as a Percentage of Net Interest Income for Colonial 

National Bank, 2007-2009

a

Net interest income is reported in the call report, schedule report of income. We show net interest 

income as 100 percent and for each income category calculate its percentage of net interest income. 

b

Credit losses are based on provisions for loan and lease losses as reported in the call report, 

schedule report of income. 

c

The impact on income of other real estate owned is based on net gains (losses) on sales of OREO 

as reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale of foreclosed property and fair value losses recognized prior to sale. 

d

The impact on income of HFS loans is based on net gains (losses) on sales of loans and leases as 

reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale and fair value losses recognized prior to sale. 

e

The impact on income of AFS and HTM securities is based on realized gains (losses) on AFS and 

HTM securities as reported in the call report, schedule report of income, which includes impairment 

losses recognized. 

f

The impact on income of recurring fair value measurements is based on trading revenues and net 

gains (losses) on assets and liabilities accounted for under the fair value option as reported in the call 

report, schedule report of income. 

Westernbank

In 2007, Westernbank was already experiencing significant levels of 

nonperforming loans, which approached 10 percent of its total loans (fig. 
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 96 GAO-13-71 Recent Bank Failures 

15). According to the Treasury IG’s material loss review, Westernbank’s 

board and management’s lending strategy focused on growth in CRE, 

ADC, and asset-based lending (ABL) portfolios without mitigating controls 

in place to keep pace with the changing loan portfolio. The IG noted that 

as Puerto Rico’s economy sank into recession, ABL, CRE and ADC loans 

that were originated and renewed based on weak loan underwriting 

practices and deficient credit administration practices caused the 

precipitous deterioration of asset quality and increasingly high levels of 

adversely classified assets.

During the period 2007 through 2010, Westernbank’s credit losses 

contributed the most to the bank’s overall losses relative to any other 

asset class (fig. 18). For example, from 2007 through 2010, credit losses 

accounted for, on average, over 125 percent of net interest income while 

net losses from the sale of OREO averaged over 7 percent of net interest 

income. During that same period, revenues from the sale of AFS and 

HTM securities, HFS loans, and assets measured at recurring fair value 

had a positive impact on net interest income. However, the credit losses 

Westernbank sustained necessitated a large increase in provisions for 

losses, which stressed earnings and eventually eroded the bank’s capital.
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 97 GAO-13-71 Recent Bank Failures 

Figure 18: Income Categories as a Percentage of Net Interest Income for 

Westernbank, 2007-2010 

a

Net interest income is reported in the call report, schedule report of income. We show net interest 

income as 100 percent and for each income category calculate its percentage of net interest income. 

b

Credit losses are based on provisions for loan and lease losses as reported in the call report, 

schedule report of income. 

c

The impact on income of other real estate owned is based on net gains (losses) on sales of OREO 

as reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale of foreclosed property and fair value losses recognized prior to sale. 

d

The impact on income of HFS loans is based on net gains (losses) on sales of loans and leases as 

reported in the call report, schedule report of income, which includes gains and losses recognized 

upon sale and fair value losses recognized prior to sale. 

e

The impact on income of AFS and HTM securities is based on realized gains (losses) on AFS and 

HTM securities as reported in the call report, schedule report of income, which includes impairment 

losses recognized. 

f

The impact on income of recurring fair value measurements is based on trading revenues and net 

gains (losses) on assets and liabilities accounted for under the fair value option as reported in the call 

report, schedule report of income. 
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 98 GAO-13-71 Recent Bank Failures 

In April 2009, the Financial Accounting Standards Board (FASB) 

amended the GAAP standard on OTTI to modify when charges stemming 

from declines in the fair value of debt securities classified as AFS and 

HTM below amortized cost are recorded in earnings.8 Under the previous 

standard, an entity was required to consider relevant factors in 

determining whether an impairment of a debt security was other than 

temporary, in which case the entire loss was recognized in earnings.9

Figure 19 shows total OTTI losses and the breakdown of the noncreditrelated portion recognized in OCI and the credit-related portion 

recognized in earnings. Although the changes were adopted in April of 

2009, the changes were not captured in bank call reports until the first 

quarter of 2010, as a result, no data on OTTI are available prior to first 

quarter of 2010. Also, because most of the large banks that failed did so 

prior to the first quarter of 2010, there were no OTTI data recorded for the 

large banks past that date. Nevertheless, based on the limited reported 

data on OTTI, the results of the analysis show that generally OTTI losses 

recognized in earnings accounted for less than 2 percent of net interest 

income in 2010 and 2011 at failed and open banks of all sizes.

However, some critics of this standard believed that during the recent 

financial crisis banks were recording significant OTTI losses to their 

earnings, and thus regulatory capital, to account for impaired assets, such 

as mortgage-backed securities that they had no immediate intention of 

selling and on which they expected the fair value would recover in the 

future when the financial markets improved. Under the new standard, if 

(a) the entity does not intend to sell a debt security and (b) it is not more 

likely than not that the entity will be required to sell the debt security 

before recovery of its amortized cost basis less any current-period credit 

loss, the amount of the OTTI representing the credit loss is recognized in 

earnings and the amount related to all other factors is recognized in OCI. 

In contrast, the amount of OTTI recorded in earnings for a debt security is 

the entire difference between the security’s amortized cost basis and its 

fair value if the entity intends to sell the security or it is more likely than 

not that the entity will be required to sell the debt security prior to recovery 

of its amortized cost basis.

 

8

Financial Accounting Standards Board Staff Position No. FAS 115-2: “Recognition and 

Presentation of Other-Than-Temporary Impairments,” (April 9, 2009).

9

ASC 320 (formerly FAS 115): “Accounting for Certain Investments in Debt and Equity 

Securities,” May 1993. 

OTTI Losses on HTM and 

AFS Debt Securities as a 

Percentage of Net Interest 

Income
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 99 GAO-13-71 Recent Bank Failures 

Figure 19: OTTI Losses on HTM and AFS Debt Securities as a Percentage of Net 

Interest Income for Failed Banks

Goodwill refers to the excess of the cost of an acquired entity over the net 

of the amounts assigned to assets acquired and liabilities assumed. 

Goodwill is tested for impairment on an annual basis with any impairment 

charge recognized in net income and therefore decreasing equity capital. 

Generally, one trigger for assessing goodwill and other intangibles for 

impairment is if the fair value of the business unit acquired falls below its 

carrying amount. As figures 20 and 21 show, goodwill and other 

intangible expenses, on average, represented less than 2 percent of 

equity capital for failed institutions, compared to less than 1 percent for 

open institutions. For large failed banks, the ratio of goodwill and other 

intangible expenses to capital showed higher levels in 2008 and 2009 

mainly because of two institutions, UCB and Colonial Bank. These two 

banks recognized higher than expected goodwill expenses in 2008 and 

2009. For example, in December 2008, Colonial recognized a goodwill 

and other intangible expense totaling over $579 million, and in September 

of 2009, UCB recognized a similar noncash charge totaling $433 million. 

Without the goodwill impairment transactions of these two institutions, the 

ratio of goodwill and other intangible expenses to capital would have been 

0.13 percent and 0.88 percent in 2008 and 2009, respectively.

Impact of Goodwill and 

Other Intangible Assets on 

Equity Capital
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 100 GAO-13-71 Recent Bank Failures 

Figure 20: Goodwill and Other Intangible Expenses as a Percentage of Equity 

Capital (Failed Banks), 2007-2011

Note: The ratio of goodwill and other intangible expenses to capital showed higher levels in 2008 and 

2009 mainly because of two institutions, UCB and Colonial Bank. These two banks recognized higher 

than expected goodwill expenses in 2008 and 2009 because of 2007 bank mergers and acquisitions 

in Florida and Nevada that later became impaired primarily due to declining bank market valuations 

and increased credit costs. For example, in December 2008, Colonial recognized a goodwill and 

other intangible expense totaling over $579 million, and in September of 2009, UCB recognized a 

similar noncash charge totaling $433 million. Without the goodwill impairment transactions of these 

two institutions, the ratio of goodwill and other intangible expenses to capital would have been 0.13 

percent and 0.88 percent in 2008 and 2009, respectively. 
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 101 GAO-13-71 Recent Bank Failures 

Figure 21: Goodwill and Other Intangible Expenses as a Percentage of Equity 

Capital (Open Banks), 2008-2011

As discussed earlier, the accumulated OCI includes the unrealized fair 

value gains and losses on AFS securities (including fair value losses 

unrelated to credit factors). In addition, when a debt security is transferred 

from AFS to HTM, the unrealized holding gains or losses continues to be 

reported in this account, and it is amortized over the remaining life of the 

security as an adjustment of yield. We determined the extent to which 

negative changes in OCI impacted institutions’ equity capital.

As table 15 shows, for small failed and open banks, the year-to-date 

(YTD) and accumulated OCI decreases were smaller than for mediumsize and large failed and open banks. Generally, larger banks had larger 

decreases in 2008 and 2009, principally due to two large banks, Colonial 

and Westernbank. Colonial had a YTD OCI of over $(318) million during 

the fourth quarter of 2008, and $ (200) million during the first quarter of 

2009, while Westernbank had a YTD OCI of over $ (100) million during 

Impact of Other 

Comprehensive Income on 

Equity Capital
Appendix IV: Analysis of the Impact of Fair 

Value Accounting on Recent Commercial Bank 

Failures 

Page 102 GAO-13-71 Recent Bank Failures 

the second and third quarters of 2008. These unrealized fair value losses 

had a slightly larger impact on larger banks with more than $10 billion in 

assets. Larger failed banks had larger negative changes in OCI, hence 

larger negative impact on equity than open institutions of similar size.

Table 15: YTD and Accumulated OCI as a Percentage of Equity Capital

Asset size Description 2007 2008 2009 2010 2011

Failed banks 

< $1 billion YTD OCI -0.05% -1.92% -0.21% 0.53% 15.17%

>$1 billion, <$10 billion YTD OCI 0.10% -1.81% -0.06% 2.58% 1.83%

>$10 billion YTD OCI 0.48% -5.77% 5.57% 4.25% __a

< $1 billion AOCI -0.57% -2.15% -2.70% -0.06% 11.17%

>$1 billion, <$10 billion AOCI -0.93% -2.50% -6.56% -1.61% -2.25%

>$10 billion AOCI -1.00% -6.32% -3.69% 0.18% N/Aa

Open banks 

< $1 billion YTD OCI __b -0.70% 0.54% 0.59% 1.90%

>$1 billion, <$10 billion YTD OCI __b -1.12% 0.66% 0.65% 1.09%

>$10 billion YTD OCI __b -2.96% 2.54% 1.51% 0.71%

< $1 billion AOCI __b -0.39% 0.46% 1.43% 1.99%

>$1 billion, <$10 billion AOCI __b -1.42% -0.94% 0.48% 0.91%

>$10 billion AOCI __b -4.64% -3.41% -0.67% -0.15%

Source: GAO analysis of FDIC call report data.

a

No large commercial banks failed in 2011. 

b

Pub. L. No. 112-88 requires us to analyze bank failures that occurred since 2008. As such, we 

analyzed trends for both failed banks and open banks from 2008 through 2011. For failed banks, we 

also obtained 2007 data to determine any additional trends prior to the failures. 
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 103 GAO-13-71 Recent Bank Failures 

We analyzed thrifts financial reports from 2007 through 2011 for failed 

and open thrift institutions to identify and compare trends in (1) the use of 

historical cost accounting and fair value accounting and (2) the extent to 

which losses were credit-related for small, medium-size, and large 

institutions. We define small failed thrifts as those that had $1 billion or 

less in assets at the time of failure, medium-size failed thrifts as those that 

had between $1 billion and $10 billion at the time of failure, and large 

failed thrifts as those that had over $10 billion in assets at the time of 

failure. Overall we found that fair value-related losses contributed very 

little to the decline in net interest income and regulatory capital 

experienced by failed thrifts of all sizes (small, medium-size, and large) 

once the financial crisis began. Similarly, fair value losses at open thrifts 

of all sizes were also limited. Instead, we found that the thrift failures were 

driven by rising levels of credit losses related to nonperforming loans held 

by the thrifts. Further, these losses had a greater negative impact on thrift 

institutions’ net interest income and regulatory capital levels than those 

recorded at fair value. We analyzed failed banks separately. (See app. 

IV.)

U. S. generally accepted accounting principles (GAAP) establish the 

basis on which items reported on a financial institution’s balance sheet 

should be measured, including a thrift. Currently, assets and liabilities are 

reflected in the balance sheet at fair value, historical cost, or another 

basis, such as lower-of-cost or fair value.

• Fair Value: Fair value is the price that would be received to sell an 

asset or paid to transfer a liability in an orderly transaction between 

market participants at the measurement date.. Fair value accounting 

standards under GAAP establish a standardized framework for 

Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Fair Value, Historical Cost, 

and Impairment 

Accounting
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 104 GAO-13-71 Recent Bank Failures 

measuring the fair value of an asset or liability.1 According to the 

Securities and Exchange Commission, fair value is most prevalently 

used to measure “financial” assets and liabilities, such as investment 

securities and derivative instruments. Fair value measurements that 

are required on a quarterly basis (or each reporting period) are often 

referred to as “recurring.” Fair value measurements that are not 

required on a regular basis are often referred to as “nonrecurring.”For 

some assets and liabilities that are measured at fair value on a 

recurring basis, such as securities designated for trading, unrealized 

gains or losses flow through the thrift’s earnings in the income 

statement and affect regulatory capital. For other assets and liabilities 

measured at fair value on a recurring basis, such as securities 

designated as available for sale, unrealized fair value gains and 

losses generally do not impact earnings, and thus, generally are not 

included in regulatory capital calculations. Instead, these gains or 

losses are recorded through other comprehensive income (OCI), 

unless the institution determines that a decline in fair value below 

amortized cost constitutes an other than temporary impairment 

(OTTI), in which case the instrument is written down to its fair value, 

with credit losses reflected in earnings.2

 

1

In 2006, the Financial Accounting Standards Board issued Statement of Financial 

Accounting Standards (SFAS) No. 157, Fair Value Measurements, which defined fair 

value, established a framework for measuring fair value under GAAP, and required 

expanded disclosures about fair value measurements. SFAS No. 157 became effective in 

2008. Prior to its issuance, fair value measurement principles were not consistently 

defined and codified in a single accounting standard, which led to the potential for 

disparate fair value measurement practices under different accounting standards. SFAS 

No. 157 was intended to provide a single set of measurement principles to be uniformly 

applied for fair value measurement when GAAP requires or permits reporting entities to 

measure or disclose the fair value of an asset or liability. However, SFAS No. 157 did not 

change which asset and liabilities are subject to fair value accounting or when fair value 

should be applied, as other previously existing accounting standards provide the 

requirement or permission to measure assets and liabilities at fair value. SFAS 157 was 

subsequently codified as Accounting Standards Council (ASC) 820 and amended, and 

additional staff guidance was issued on the application of fair value accounting.

The OTTI decision for a given 

2

OCI refers to revenues, expenses, gains, and losses that are included in comprehensive 

income but excluded from net income. Comprehensive income is the total non-owner 

change in equity for a reporting period. An other-than-temporarily impaired instrument is 

one whose fair value has fallen below its amortized cost and its value is not expected to 

recover through the holding period. As a result of an April 2009 change to the relevant 

GAAP standard, an OTTI of either a debt security classified as available-for-sale or heldto-maturity in certain circumstances in separated into the (1) credit loss amount 

recognized in earnings and (2) the amount related to all other factors (non-credit loss) 

recognized in OCI, net of applicable taxes.
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 105 GAO-13-71 Recent Bank Failures 

asset is a judgmental decision of the thrift, considering various factors 

related to the severity and duration of the decrease in the value of the 

asset. Unrealized changes in fair value and OTTI-related write-downs 

that are recognized in earnings in the income statement directly 

impact regulatory capital levels.

• Historical Cost: Measurement using historical cost can be done in 

several ways, but the general concept is to record items on the 

balance sheet using the original amount paid or received, with 

adjustments when appropriate in subsequent periods for depreciation, 

amortization, principal pay downs, or impairment. Generally, loans 

that a thrift designates as held-for-investment (HFI), for example, are 

recorded at amortized cost, net of an impairment allowance for 

estimated credit losses.3

• Loan Impairment Accounting: GAAP requires financial institutions to 

maintain an allowance for loan losses (loan loss allowance) at a level 

that is appropriate to cover estimated credit losses incurred as of the 

balance sheet date for their entire portfolio of HFI loans. Under GAAP, 

institutions must recognize impairment on HFI loans when credit 

losses are determined to be probable and reasonably estimable, that 

is, when, based on current information and events, it is probable that 

an institution will be unable to collect all amounts due (i.e., both 

principal and interest) according to the contractual terms of the 

original loan agreement. An increase in the loan loss allowance 

results in a charge to expenses, termed a provision for loan losses. 

Impairment accounting standards under GAAP set forth the 

measurement methods for estimating the credit losses attributable to 

individually impaired loans. Regulators generally require institutions to 

establish policies and procedures for determining the loan loss 

allowance based on GAAP requirements.

Such loans typically comprise the bulk of 

assets held by thrifts.

 

3

Essentially, amortized cost is outstanding principal, adjusted for any charge offs, deferred 

fees or costs, and unamortized discount or premium.
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 106 GAO-13-71 Recent Bank Failures 

During the period of our study, HFI loans represented on average over 

two thirds of most thrift institutions total assets (table 1). HFI loans are not 

recorded at fair value, but instead are measured on an amortized-cost 

basis, net of an impairment allowance for estimated credit losses. Table 

16 indicates that small and medium-size thrifts generally had slightly 

higher percentages of loans classified as HFI loans than large thrifts. 

Also, compared to open thrifts, failed thrifts held a higher percentage of 

HFI loans.

Table 16: HFI Loans as a Percentage of Total Assets for Failed and Open Thrifts, 2007-2011 

Asset size Description 2007 2008 2009 2010 2011

Failed thrifts

< $1 billion HFI loans 77.67% 77.62% 73.65% 66.80% 70.20%

>$1 billion, <$10 billion HFI loans 81.24% 83.02% 78.27% 65.43% 69.56%

Open thrifts

>$10 billion HFI loans 68.91% 75.42% 72.19% __a __a

< $1 billion HFI loans 70.69% 71.65% 69.91% 67.20% 64.87%

>$1 billion, <$10 billion HFI loans 71.12% 68.61% 63.41% 59.82% 61.01%

>$10 billion HFI Loans 65.25% 67.03% 60.85% 58.47% 55.51%

Source: GAO analysis of FDIC thrift financial report data.

a

No large thrifts failed in 2010 or 2011. 

Most Failed Small and 

Medium-Size Thrifts Did 

Not Measure a Significant

Percentage of Assets at 

Fair Value over the 2007-

2011 Period

Assets Measured at Amortized 

Cost
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 107 GAO-13-71 Recent Bank Failures 

Assets measured at fair value through earnings on a recurring basis 

comprised mainly trading assets, nontrading derivative assets, and 

nonfinancial assets such as servicing rights for mortgages for which the 

fair value option has been elected.4

Trading assets generally include both debt and marketable equity 

securities bought and held primarily to be sold in the near term. Trading 

activities typically involve active and frequent buying and selling to 

generate profits on short-term movements in market prices. Trading 

assets also include derivative contracts held for trading purposes in gain 

positions. Table 17 shows that trading assets did not represent a

significant percentage of failed thrifts’ assets from 2007-2011.

Table 17: Trading Assets as a Percentage of Total Assets for Failed and Open Thrifts, 2007-2011

Asset size Description 2007 2008 2009 2010 2011

Failed thrifts

< $1 billion Trading assets 0.00% 0.00% 0.00% 0.01 0.00%

>$1 billion, <$10 billion Trading assets 0.00% 0.13% 0.20% 0.05% 0.00%

>$10 billion Trading assets 1.28% 0.35% 0.00% __a __a

Open thrifts

< $1 billion Trading assets 0.19% 0.12% 0.04% 0.01% 0.01%

>$1 billion, <$10 billion Trading assets 0.56% 1.53% 1.68% 0.89% 0.03%

>$10 billion Trading assets 0.52% 0.37% 0.43% 0.11% 0.17%

Source: GAO analysis of FDIC thrift financial report data.

a

No large thrifts failed in 2010 or 2011. 

Nontrading Assets

Nontrading assets measured at fair value on a recurring basis include, 

among other things, nontrading derivative contracts in gain positions. 

Most thrifts did not have any significant holdings of such nontrading 

 

4

ASC 825 (formerly FAS 159), “The Fair Value Option for Financial Assets and Financial 

Liabilities,” (February 2007) allows a one-time election to report certain financial 

instruments at fair value. At initial recognition for certain financial assets and liabilities, an 

entity may irrevocably elect fair value as the initial and subsequent measurement attribute, 

with changes in fair value included in current earnings. 

Assets and Liabilities 

Measured at Fair Value 

Through Earnings on a 

Recurring Basis through 

Income

Trading Assets
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 108 GAO-13-71 Recent Bank Failures 

assets (table 18). Even for open thrifts that have relatively more of such 

nontrading assets than failed thrifts, the level of these assets is less than 

2.75 percent of their total assets.

Table 18: Nontrading Assets Measured at Fair Value Through Earnings on a Recurring Basis as a Percentage of Total Assets 

for Failed and Open Thrifts, 2007-2011

Asset size Description 2007 2008 2009 2010 2011

Failed thrifts

< $1 billion Nontrading assets 0.33% 0.26% 0.28% 2.94% 14.68%

>$1 billion, <$10 Billion Nontrading assets 0.02% 0.30% 0.50% 0.03% 0.01%

>$10 billion Nontrading assets 0.87% 1.24% 1.15% __a __a

Open thrifts

< $1 billion Nontrading assets 0.80% 0.76% 0.41% 0.29% 0.48%

>$1 billion, <$10 billion Nontrading assets 0.34% 1.32% 1.68% 1.40% 1.03%

>$10 billion Nontrading assets 1.76% 1.71% 2.10% 2.71% 2.34%

Source: GAO analysis of FDIC thrift financial report data.

a

No large thrifts failed in 2010 or 2011. 

Nonfinancial Assets

Nonfinancial assets measured at fair value through earnings on a 

recurring basis consist of mortgage servicing rights (MSRs) for which a 

fair value option has been elected. Failed thrifts did not have significant 

amounts of such nonfinancial assets (table 19). Failed thrifts also 

generally had fewer such nonfinancial assets than open thrifts. However, 

large failed thrifts generally had larger levels of such nonfinancial assets 

than most of the open thrifts because Washington Mutual, the largest 

thrift institution that failed, had a sizable level of mortgage servicing rights 

on its books.
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 109 GAO-13-71 Recent Bank Failures 

Table 19: Nonfinancial Assets Measured at Fair Value Through Earnings on a Recurring Basis as a Percentage of Total 

Assets for Failed and Open Thrifts, 2007-2011 

Asset size Description 2007 2008 2009 2010 2011

Failed thrifts

< $1 billion Nonfinancial assets 0.04% 0.04% 0.08% 0.14% 0.37%

>$1 billion, <$10 billion Nonfinancial assets 0.25% 0.27% 0.34% 0.21% 0.19%

>$10 billion Nonfinancial assets 2.21% 1.18% 1.28% __a __a

Open thrifts

< $1 billion Nonfinancial Assets 0.19% 0.19% 0.18% 0.20% 0.26%

>$1 billion, <$10 Billion Nonfinancial Assets 0.29% 0.28% 0.42% 0.33% 0.42%

>$10 billion Nonfinancial Assets 0.86% 0.84% 0.39% 0.31% 0.29%

Source: GAO analysis of FDIC thrift financial report data.

a

No large thrifts failed in 2010 or 2011. 

Liabilities 

Liabilities measured at fair value through earnings on a recurring basis 

include trading liabilities such as securities an institution sold but did not 

own and therefore is obligated to purchase at a future date (short 

positions), derivative contracts held for trading purposes in loss positions, 

nontrading derivative contracts in loss positions, and those liabilities for 

which a bank elects to measure at fair value on a recurring basis under 

the fair value option. Failed thrifts did not have a significant amount of 

such trading liabilities (table 20). Failed thrifts also had fewer such trading 

liabilities than open thrifts, particularly large open thrifts.

Table 20: Liabilities Measured at Fair Value Through Earnings on a Recurring Basis as a Percentage of Total Assets for Failed

and Open Thrifts, 2007-2011 

Asset size Description 2007 2008 2009 2010 2011

Failed thrifts

< $1 billion Liabilities 0.01% 0.01% 0.00% 0.01% 0.02%

>$1 billion, <$10 billion Liabilities 0.00% 0.05% 0.04% 0.12% 0.30%

>$1 billion Liabilities 0.04% 0.15% 0.13% __a __a

Open thrifts

< $1 billion Liabilities 0.26% 0.19% 0.00% 0.00% 0.00%

>$1 billion, <$10 billion Liabilities 0.30% 1.87% 2.41% 1.69% 1.53%

>$1 billion Liabilities 1.06% 0.48% 0.15% 0.76% 0.76%

Source: GAO analysis of FDIC thrift financial report data.

a

No large thrifts failed in 2010 or 2011. 
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 110 GAO-13-71 Recent Bank Failures 

Securities Held to Maturity

Investments in debt securities classified as held to maturity (HTM) are 

measured at amortized cost but if any decline in fair value is other than 

temporary, credit losses are recognized in earnings. The held-to-maturity 

category includes only debt securities that management has both the 

positive intent and ability to hold until maturity.

As illustrated in table 21, investment securities classified as HTM

represented less than 4 percent of assets held for failed thrifts with less 

than $10 billion in assets. For failed thrifts with more than $10 billion in 

assets, HTM securities ranged between 2 percent and 5 percent. HTM 

securities for open thrifts were not available.

Table 21: HTM Securities as a Percentage of Total Assets for Failed Thrifts, 2007-2011Failed thrifts 

Asset size Description 2007 2008 2009 2010 2011

< $1 billion HTM securities 2.08% 1.16% 1.32% 1.71% 0.33%

>$1 billion, <$10 billion HTM securities 2.8% 3.1% 2.7% 3.5% 0.2%

>$10 billion HTM securities 1.79% 4.94% 3.01% __a __a

Source: GAO analysis of FDIC thrift financial report data.

a

No large thrifts failed in 2010 or 2011. 

Securities Available for Sale

Investments in debt securities that are not classified as trading securities 

or as HTM securities are classified as available-for-sale (AFS) securities. 

AFS securities also include equity securities that have readily 

determinable fair values and are not classified as trading securities. If the 

fair value of an AFS security declines below its amortized cost, and the 

decline is other than temporary, credit losses are recognized in earnings.

As illustrated in table 22, AFS securities represented the largest 

percentage of assets held after loans HFI. For failed thrifts, AFS 

securities ranged between 6 percent and 10 percent of total assets 

compared to 12 percent and 20 percent for open thrifts. On average, 

large open thrifts held the highest percentages of AFS securities.

Assets Measured at Fair Value 

on a Non-Recurring Basis 

Through Income
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 111 GAO-13-71 Recent Bank Failures 

Table 22: AFS Securities as a Percentage of Total Assets for Failed and Open Thrifts, 2007-2011 

Asset size Description 2007 2008 2009 2010 2011

Failed thrifts

< $1 billion AFS securities 8.36% 7.63% 7.88% 9.65% 7.87%

>$1 billion, <$10 billion AFS securities 5.60% 5.28% 4.99% 8.52% 8.47%

>$10 billion AFS securities 8.44% 6.29% 7.88% __a __a

Open thrifts

< $1 billion AFS securities 11.50% 10.96% 11.05% 11.66% 12.74%

>$1 billion, <$10 billion AFS securities 12.11% 12.48% 15.50% 19.05% 19.62%

>$10 billion AFS securities 14.56% 13.92% 14.85% 19.32% 20.20%

Source: GAO analysis of FDIC thrift financial report data.

a

No large thrifts failed in 2010 or 2011. 

As a result of an April 2009 change to the relevant GAAP standard, an 

OTTI loss of either an AFS or HTM debt security, in certain 

circumstances, is separated into (1) the credit loss amount, which is 

recognized in earnings and (2) the loss amount related to all other factors 

(noncredit loss), which is recognized in other comprehensive income, net 

of applicable taxes.

Loans Held for Sale

Under GAAP, HFS loans originated with the intent to sell in the secondary 

market to government-sponsored entities and other investors (including 

other FDIC-insured institutions) are carried at the lower of cost or fair 

value, unless the institution has elected to account for the loans at fair 

value under the fair value option. Institutions can transfer loans into or out 

of the HFS classification as a result of changes in intentions regarding 

Assets Measured at the Lowerof-Cost-or-Fair-Value
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 112 GAO-13-71 Recent Bank Failures 

whether the loans will be sold or HFI. Transfers between categories, 

however, are recorded at the lower of cost or fair value.5

HFS loans did not represent a significant percentage of assets held by 

thrifts. On average, failed thrifts with less than $10 billion in assets held 

about 5 percent of their assets in HFS loans (table 23). With the 

exception of 2007, the percentage of HFS assets are generally lower for 

failed thrifts with over $10 billion in assets compared to open thrifts of 

similar size. In 2007 and 2008, a few large thrifts started transferring a 

significant amount of HFS loans into their HFI portfolio as a result of the 

tightening in the secondary market for nonagency mortgage loans. 

Appendix VI provides further analysis of these transfers.

Table 23: HFS Loans as a Percentage of Total Assets for Failed and Open Thrifts, 2007-2011 

Asset size Description 2007 2008 2009 2010 2011

Failed thrifts

< $1 billion HFS loans 2.82% 2.55% 1.95% 2.18% 0.18%

>$1 billion, <$10 billion HFS loans 3.45% 1.60% 2.36% 5.13% 1.12%

>$10 billion HFS loans 6.81% 1.26% 1.05% __a __a

Open thrifts

< $1 billion HFS loans 1.07% 1.13% 1.20% 1.28% 1.02%

>$1 billion, <$10 billion HFS loans 2.07% 2.13% 2.61% 2.19% 1.38%

>$10 billion HFS loans 5.30% 2.29% 1.47% 0.96% 2.41%

Source: GAO analysis of FDIC thrift financial report data.

a

No large thrifts failed in 2010 or 2011. 

Other Real Estate Owned

Other Real Estate Owned (OREO) usually includes assets repossessed 

through a foreclosure process for defaulted loans. Generally, assets 

acquired through, or in lieu of, loan foreclosure are held for sale and are 

initially recorded at the estimated fair value of the collateral less costs to 

 

5

The OCC Bank Accounting Advisory Series states that a bank should transfer loans from 

the held-for-investment category to the HFS category when it no longer has the intent and 

ability to hold the loans for the foreseeable future or until maturity or payoff. However, 

such changes in intent followed by subsequent sales of the loan in the near term, would 

likely cause increased skepticism and scrutiny by the auditor and examiner, especially if 

the sale or transfer occurs during the period the bank originally considered its foreseeable 

future. 
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 113 GAO-13-71 Recent Bank Failures 

sell at the date of foreclosure, establishing a new cost basis. Subsequent 

to foreclosure, periodic valuations are performed and the assets are 

carried at the lower of their cost basis or estimated fair value less cost to 

sell.6

In early 2007 and 2008, thrift institutions had little exposure to foreclosed 

assets (table 24). However, as the financial crisis deepened and the real 

estate downturn became more severe, delinquencies increased rapidly 

and thrifts foreclosed more properties, particularly smaller thrifts. 

Compared to open thrifts, failed thrifts had a larger share of OREO 

assets.

Table 24: OREO Assets as a Percentage of Total Assets for Failed and Open Thrifts, 2007-2011

Asset size Description 2007 2008 2009 2010 2011

Failed thrifts

< $1 billion OREO 0.33% 1.16% 2.34% 4.16% 6.07%

>$1 billion, <$10 billion OREO 0.18% 0.84% 1.73% 1.81% 2.47%

>$10 billion OREO 0.26% 0.96% 4.19% __a __a

Open thrifts

< $1 billion OREO 0.17% 0.34% 0.69% 0.91% 0.95%

>$1 billion, <$10 billion OREO 0.11% 0.32% 0.54% 0.47% 0.42%

>$10 billion OREO 0.14% 0.30% 0.33% 0.41% 0.35%

Source: GAO analysis of FDIC thrift financial report data.

a

No large thrifts failed in 2010 or 2011. 

For small failed thrifts, as the financial crisis that began in 2007 

progressed, the levels of nonperforming loans rose from an average of 

 

6

See, for example, FDIC Financial Institution Letter 62-2008: Guidance on Other Real 

Estate. 

Declines in Regulatory 

Capital at Failed Thrifts 

Due to Rising Levels of 

Nonperforming Loans and 

Resulting Increased Credit 

Losses

Small Failed Thrifts
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 114 GAO-13-71 Recent Bank Failures 

less than 2 percent of total loans in 2007 to over 13 percent in 2011 (fig. 

22).

Figure 22: Nonperforming Loans as a Percentage of Total Loans for Small Failed 

Thrifts, 2007-2011

The rising levels on nonperforming loans appear to be the key factor 

driving the increases in provisions for credit losses and the resulting 

reduction in net interest income and regulatory capital. For failed small 

thrifts, credit losses were by far the largest contributor to these 

institutions’ losses relative to any other asset class. For example, from 

2007 to 2011, credit losses accounted for on average over 130 percent of 

net interest income while net losses from the sale of HFS assets 

averaged about 2 percent of net interest income (fig. 23). During that 

same period, net losses from recurring fair value measurements were 

less than 4 percent.
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 115 GAO-13-71 Recent Bank Failures 

Figure 23: Income Categories as a Percentage of Net Interest Income for Small 

Failed Thrifts, 2007-2011

a

Net interest income reported in the thrift financial report, schedule statement of operations. We show 

net interest income as 100 percent and for each income category calculate its percentage of net 

interest income. 

b

Credit losses are based on provisions for losses on interest bearing assets as reported in the thrift 

financial report schedule statement of operations, which includes fair value losses recognized on 

foreclosed property and impairment losses recognized on debt and equity securities. 

c

The impact on income of losses on HFS loans is based on the lower-of-cost-or-fair-value 

adjustments made to HFS assets as reported in the thrift financial report schedule statement of 

operations of the thrift financial report, which does not include gains or losses recognized upon sale. 

d

The impact on income of gain/loss on sales is based on the sale of HFS assets and AFS securities 

as reported in the thrift financial report schedule statement of operations, which does not include 

impairment losses. e

The impact on income of servicing income is based on mortgage loan servicing fees and servicing 

amortization and valuation adjustments as reported in the thrift financial report schedule statement of 

operations. 

f

The impact on income of recurring fair value measurements is based on gains and losses on 

financial assets and liabilities carried at fair value as reported in the thrift financial report schedule 

statement of operations. 
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 116 GAO-13-71 Recent Bank Failures 

In contrast, the magnitude of credit losses experienced by small open 

thrifts from 2007 through 2011 was significantly less than what the failed 

thrifts experienced (fig.24).

Figure 24: Income Categories as a Percentage of Net Interest Income for Small 

Open Thrifts, 2007-2011

a

Net interest income reported in the thrift financial report, schedule statement of operations. We show 

net interest income as 100 percent and for each income category calculate its percentage of net 

interest income. 

b

Credit losses are based on provisions for losses on interest bearing assets as reported in the thrift 

financial report schedule statement of operations, which includes fair value losses recognized on 

foreclosed property and impairment losses recognized on debt and equity securities. 

c

The impact on income of losses on HFS loans is based on the lower-of-cost-or-fair-value 

adjustments made to HFS assets as reported in the thrift financial report schedule statement of 

operations of the thrift financial report, which does not include gains or losses recognized upon sale. 

d

The impact on income of gain/loss on sales is based on the sale of HFS assets and AFS securities 

as reported in the thrift financial report schedule statement of operations, which does not include 

impairment losses. 
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 117 GAO-13-71 Recent Bank Failures 

e

The impact on income of servicing income is based on mortgage loan servicing fees and servicing 

amortization and valuation adjustments as reported in the thrift financial report schedule statement of 

operations. 

f

The impact on income of recurring fair value measurements is based on gains and losses on 

financial assets and liabilities carried at fair value as reported in the thrift financial report schedule 

statement of operations. 

The level of nonperforming loans for medium-size failed thrifts grew from 

less than 2 percent in 2007 to over 9 percent in 2009 (fig. 25). As with the 

small failed thrifts, the rising levels of nonperforming loans appear to be 

the key factor driving the increases in credit losses for medium-size failed 

thrifts.

Figure 25: Nonperforming Loans as a Percent of Total Loans for Medium-Size 

Failed Thrifts, 2007-2011

The large credit losses largely drove the failed thrifts’ decrease in 

earnings and regulatory capital. For example, from 2007 through 2009, 

credit losses accounted for on average over 133 percent of net interest 

income of medium-size failed thrifts while net losses from HFS assets 

averaged less than one half of 1 percent of net interest income (fig. 26).

Medium-Size Thrifts
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 118 GAO-13-71 Recent Bank Failures 

Figure 26: Income Categories as a Percentage of Net Interest Income for Mediumsize Failed Thrifts, 2007-2011

a

Net interest income reported in the thrift financial report, schedule statement of operations. We show 

net interest income as 100 percent and for each income category calculate its percentage of net 

interest income. 

b

Credit losses are based on provisions for losses on interest bearing assets as reported in the thrift 

financial report schedule statement of operations, which includes fair value losses recognized on 

foreclosed property and impairment losses recognized on debt and equity securities. 

c

The impact on income of losses on HFS loans is based on the lower-of-cost-or-fair-value 

adjustments made to HFS assets as reported in the thrift financial report schedule statement of 

operations of the thrift financial report, which does not include gains or losses recognized upon sale. 

d

The impact on income of gain/loss on sales is based on the sale of HFS assets and AFS securities 

as reported in the thrift financial report schedule statement of operations, which does not include 

impairment losses. 

e

The impact on income of servicing income is based on mortgage loan servicing fees and servicing 

amortization and valuation adjustments as reported in the thrift financial report schedule statement of 

operations. 

f

The impact on income of recurring fair value measurements is based on gains and losses on 

financial assets and liabilities carried at fair value as reported in the thrift financial report schedule 

statement of operations. 
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 119 GAO-13-71 Recent Bank Failures 

During that same time frame, the magnitude of the credit losses 

experienced by open medium-size thrifts was significantly less (fig. 27).

Figure 27: Income Categories as a Percentage of Net Interest Income for MediumSize Open Thrifts, 2007-2011

a

Net interest income reported in the thrift financial report, schedule statement of operations. We show 

net interest income as 100 percent and for each income category calculate its percentage of net 

interest income. 

b

Credit losses are based on provisions for losses on interest bearing assets as reported in the thrift 

financial report schedule statement of operations, which includes fair value losses recognized on 

foreclosed property and impairment losses recognized on debt and equity securities. 

c

The impact on income of losses on HFS loans is based on the lower-of-cost-or-fair-value 

adjustments made to HFS assets as reported in the thrift financial report schedule statement of 

operations of the thrift financial report, which does not include gains or losses recognized upon sale. 

d

The impact on income of gain/loss on sales is based on the sale of HFS assets and AFS securities 

as reported in the thrift financial report schedule statement of operations, which does not include 

impairment losses. 

e

The impact on income of servicing income is based on mortgage loan servicing fees and servicing 

amortization and valuation adjustments as reported in the thrift financial report schedule statement of 

operations. 
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 120 GAO-13-71 Recent Bank Failures 

f

The impact on income of recurring fair value measurements is based on gains and losses on 

financial assets and liabilities carried at fair value as reported in the thrift financial report schedule 

statement of operations. 

The large failed thrifts’ decrease in earnings and regulatory capital also 

was mostly driven by the rising levels of nonperforming loans. For 

example, in 2007 large thrifts’ nonperforming loans averaged about 2 

percent of their total assets compared with 7.36 percent in 2008, when 

WaMu, IndyMac, and Downey failed (fig.28). However, from 2008 through 

2009, nonperforming loans for AmTrust, BankUnited, and Guaranty, the 

large thrifts that failed in 2009, grew from an average of almost 7.36 

percent to over 10 percent.

Figure 28: Nonperforming Loans as a Percent age of Total Loans for Large Failed 

Thrifts, 2007-2009

The large credit losses largely drove the failed thrifts’ decrease in 

earnings and regulatory capital. For example, from 2007 to 2009, credit 

losses accounted for on average close to 300 percent of net interest 

Large Failed Thrifts
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 121 GAO-13-71 Recent Bank Failures 

income while net losses from HFS assets and recurring fair averaged 

about 2 percent and 4.5 percent, respectively. During that same time 

period, the magnitude of credit losses at open thrifts of similar size 

averaged only about 33 percent (figs. 29 and 30).

Figure 29: Income Categories as a Percentage of Net Interest Income for Large 

Failed Thrifts, 2007-2009

a

Net interest income reported in the thrift financial report, schedule statement of operations. We show 

net interest income as 100 percent and for each income category calculate its percentage of net 

interest income. 

b

Credit losses are based on provisions for losses on interest bearing assets as reported in the thrift 

financial report schedule statement of operations, which includes fair value losses recognized on 

foreclosed property and impairment losses recognized on debt and equity securities. 

c

The impact on income of losses on HFS loans is based on the lower-of-cost-or-fair-value 

adjustments made to HFS assets as reported in the thrift financial report schedule statement of 

operations of the thrift financial report, which does not include gains or losses recognized upon sale. 

d

The impact on income of gain/loss on sales is based on the sale of HFS assets and AFS securities 

as reported in the thrift financial report schedule statement of operations, which does not include 

impairment losses. 

e

The impact on income of servicing income is based on mortgage loan servicing fees and servicing 

amortization and valuation adjustments as reported in the thrift financial report schedule statement of 

operations. 
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 122 GAO-13-71 Recent Bank Failures 

f

The impact on income of recurring fair value measurements is based on gains and losses on 

financial assets and liabilities carried at fair value as reported in the thrift financial report schedule 

statement of operations. 

Figure 30: Income Categories as a Percentage of Net Interest Income for Large 

Open Thrifts, 2007-2011

a

Net interest income reported in the thrift financial report, schedule statement of operations. We show 

net interest income as 100 percent and for each income category calculate its percentage of net 

interest income. 

b

Credit losses are based on provisions for losses on interest bearing assets as reported in the thrift 

financial report schedule statement of operations, which includes fair value losses recognized on 

foreclosed property and impairment losses recognized on debt and equity securities. c

The impact on income of losses on HFS loans is based on the lower-of-cost-or-fair-value 

adjustments made to HFS assets as reported in the thrift financial report schedule statement of 

operations of the thrift financial report, which does not include gains or losses recognized upon sale. 

d

The impact on income of gain/loss on sales is based on the sale of HFS assets and AFS securities 

as reported in the thrift financial report schedule statement of operations, which does not include 

impairment losses. 

e

The impact on income of servicing income is based on mortgage loan servicing fees and servicing 

amortization and valuation adjustments as reported in the thrift financial report schedule statement of 

operations. 
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 123 GAO-13-71 Recent Bank Failures 

f

The impact on income of recurring fair value measurements is based on gains and losses on 

financial assets and liabilities carried at fair value as reported in the thrift financial report schedule 

statement of operations. 

IndyMac 

The recognition of incurred credit losses and losses recognized for the

decrease in fair value of its portfolio of HFS loans, investment securities, 

and derivatives contributed to the decline in regulatory capital at IndyMac 

(fig. 31). According to its 2007 Form 10-K, IndyMac was severely 

impacted by worsening credit conditions as home prices and home sales 

declined. As a result, it experienced a significant increase in 

delinquencies in many products, and thus recorded significant charges, 

related to credit risk in its HFI portfolio and other construction portfolios. In 

addition, IndyMac recorded significant fair value losses in its loans held 

for sale, investment- and noninvestment-grade securities and residual 

securities. Offsetting these decreases in fair value was an increase in fair 

value of the bank’s MSRs.

IndyMac also recognized its largest write-downs for its noninvestment 

grade securities in 2007 and attributed a significant portion of these writedowns to incurred credit losses embedded in these securities. During 

2008, IndyMac recognized additional charges for credit losses and related 

write-downs.
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 124 GAO-13-71 Recent Bank Failures 

Figure 31: IndyMac Income Categories as a Percentage of Net Interest Income, 

2007-2008 

a

Net interest income reported in the thrift financial report, schedule statement of operations. We show 

net interest income as 100 percent and for each income category calculate its percentage of net 

interest income. 

b

Credit losses are based on provisions for losses on interest bearing assets as reported in the thrift 

financial report schedule statement of operations, which includes fair value losses recognized on 

foreclosed property and impairment losses recognized on debt and equity securities. 

c

The impact on income of losses on HFS loans is based on the lower-of-cost-or-fair-value 

adjustments made to HFS assets as reported in the thrift financial report schedule statement of 

operations of the thrift financial report, which does not include gains or losses recognized upon sale. 

d

The impact on income of gain/loss on sales is based on the sale of HFS assets and AFS securities 

as reported in the thrift financial report schedule statement of operations, which does not include 

impairment losses. 

e

The impact on income of servicing income is based on mortgage loan servicing fees and servicing 

amortization and valuation adjustments as reported in the thrift financial report schedule statement of 

operations. 

f

The impact on income of recurring fair value measurements is based on gains and losses on 

financial assets and liabilities carried at fair value as reported in the thrift financial report schedule 

statement of operations. 
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 125 GAO-13-71 Recent Bank Failures 

Downey

According to regulatory filings, credit losses were the most significant 

cause of decline in income at Downey, and there were no losses 

recognized for recurring fair value measurements (fig. 32).

Figure 32: Downey Income Categories as a Percent of Net Interest Income, 2007-

2008 

a

Net interest income reported in the thrift financial report, schedule statement of operations. We show 

net interest income as 100 percent and for each income category calculate its percentage of net 

interest income. 

b

Credit losses are based on provisions for losses on interest bearing assets as reported in the thrift 

financial report schedule statement of operations, which includes fair value losses recognized on 

foreclosed property and impairment losses recognized on debt and equity securities. 

c

The impact on income of losses on HFS loans is based on the lower-of-cost-or-fair-value 

adjustments made to HFS assets as reported in the thrift financial report schedule statement of 

operations of the thrift financial report, which does not include gains or losses recognized upon sale. 

d

The impact on income of gain/loss on sales is based on the sale of HFS assets and AFS securities 

as reported in the thrift financial report schedule statement of operations, which does not include 

impairment losses. 

e

The impact on income of servicing income is based on mortgage loan servicing fees and servicing 

amortization and valuation adjustments as reported in the thrift financial report schedule statement of 

operations. 
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 126 GAO-13-71 Recent Bank Failures 

f

The impact on income of recurring fair value measurements is based on gains and losses on 

financial assets and liabilities carried at fair value as reported in the thrift financial report schedule 

statement of operations. 

Washington Mutual

Figure 33 shows that credit losses were the most significant cause of 

declines in income at WaMu. Although WaMu recognized fair value 

losses during the review period, these losses were significantly less than 

the credit losses recognized during the same periods. In its 2007 Form 

10-K, WaMu disclosed that it recorded a net loss for 2007 of $67 million 

compared with net income of $3.56 billion in 2006. It noted the decline 

was primarily the result of significant credit deterioration in its singlefamily residential mortgage loan portfolio and significant disruptions in the 

capital markets, including the sudden and severe contraction in 

secondary mortgage market liquidity for nonconforming residential loan 

products. Based on disclosures made it its 2007 annual regulatory filing, 

during 2007 WaMu recognized approximately $500 million of fair value 

losses for trading securities, which primarily consisted of below 

investment grade retained interests in credit card securitizations, and 

$200 million of losses for fair value write-downs of nonconforming 

residential mortgage loans HFS. In contrast, it recognized $3.1 billion of 

credit losses during that year.

According to its first and second quarter 2008 Forms 10-Q, during the first 

quarter of 2008, WaMu recognized approximately $600 million of fair 

value gains due to derivatives that economically hedged the fair value of 

MSRs, which were partially offset by fair value declines in the related 

MSRs. During the second quarter of 2008, WaMu recognized losses on 

the derivatives it used to economically hedge the fair value of MSRs, 

which again were partially offset by gains in the fair value of its MSRs. In 

addition to the fair value effects of hedging activities, WaMu recognized

approximately $500 million of fair value losses for credit card retained 

interests and securities backed by Alt-A loans that were accounted for as 

trading securities during the first 6 months of 2008, which was 

significantly less than the $9.4 billion of credit losses recognized during 

the same period.
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 127 GAO-13-71 Recent Bank Failures 

Figure 33: Washington Mutual Income Categories as a Percentage of Net Interest 

Income, 2007-2008 

a

Net interest income reported in the thrift financial report, schedule statement of operations. We show 

net interest income as 100 percent and for each income category calculate its percentage of net 

interest income. 

b

Credit losses are based on provisions for losses on interest bearing assets as reported in the thrift 

financial report schedule statement of operations, which includes fair value losses recognized on 

foreclosed property and impairment losses recognized on debt and equity securities. 

c

The impact on income of losses on HFS loans is based on the lower-of-cost-or-fair-value 

adjustments made to HFS assets as reported in the thrift financial report schedule statement of 

operations of the thrift financial report, which does not include gains or losses recognized upon sale. 

d

The impact on income of gain/loss on sales is based on the sale of HFS assets and AFS securities 

as reported in the thrift financial report schedule statement of operations, which does not include 

impairment losses. 

e

The impact on income of servicing income is based on mortgage loan servicing fees and servicing 

amortization and valuation adjustments as reported in the thrift financial report schedule statement of 

operations. 

f

The impact on income of recurring fair value measurements is based on gains and losses on 

financial assets and liabilities carried at fair value as reported in the thrift financial report schedule 

statement of operations. 

Credit losses resulting from increased nonperforming loan levels were the 

main driver for the decline in income at AmTrust (fig. 34). In 2007, 

AmTrust’s nonperforming loans were already over 3 percent of its total 

loans and had more than doubled in 2008. In 2009, AmTrust’s 

AmTrust
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 128 GAO-13-71 Recent Bank Failures 

nonperforming loans climbed to over 12 percent. The Treasury IG’s 

material loss review for AmTrust identified significant losses in AmTrust’s 

loan portfolio associated with its high concentrations of ADC loans and 

high-risk residential mortgage loans, including interest-only, reduced 

documentation, and subprime loans. As the levels on nonperforming 

loans increased rapidly in 2008 and 2009, AmTrust’s net losses exceeded 

$513 million and $308 million, respectively. From 2007 to 2009, 

AmTrust’s credit losses averaged close to 250 percent of net interest 

income. The substantial credit losses associated with AmTrust’s growing 

nonperforming loans eroded the bank’s earnings and capital. On 

November 4, 2009, OTS notified AmTrust that it had become significantly 

undercapitalized and required AmTrust to file a capital restoration plan by 

November 30, 2009. On December 1, 2009, AmTrust informed OTS that 

its efforts to raise capital were unsuccessful, and that there were no 

known near-term investors or acquirers.

Figure 34: AmTrust Income Categories as a Percentage of Net Interest Income, 

2007-2009
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 129 GAO-13-71 Recent Bank Failures 

a

Net interest income reported in the thrift financial report, schedule statement of operations. We show 

net interest income as 100 percent and for each income category calculate its percentage of net 

interest income. 

b

Credit losses are based on provisions for losses on interest bearing assets as reported in the thrift 

financial report schedule statement of operations, which includes fair value losses recognized on 

foreclosed property and impairment losses recognized on debt and equity securities. 

c

The impact on income of losses on HFS loans is based on the lower-of-cost-or-fair-value 

adjustments made to HFS assets as reported in the thrift financial report schedule statement of 

operations of the thrift financial report, which does not include gains or losses recognized upon sale. 

d

The impact on income of gain/loss on sales is based on the sale of HFS assets and AFS securities 

as reported in the thrift financial report schedule statement of operations, which does not include 

impairment losses. 

e

The impact on income of servicing income is based on mortgage loan servicing fees and servicing 

amortization and valuation adjustments as reported in the thrift financial report schedule statement of 

operations. 

f

The impact on income of recurring fair value measurements is based on gains and losses on 

financial assets and liabilities carried at fair value as reported in the thrift financial report schedule 

statement of operations. 

Credit losses resulting from increased nonperforming loan levels were the 

main driver for the decline in income at BankUnited. In 2007, BankUnited 

nonperforming loans were just below 2 percent of its total loans. 

However, by December 2007, BankUnited’s payment option adjustable 

rate mortgages increased to $7.5 billion, comprising 52 percent of its total 

assets. The rapid decline in real estate market resulted in the 

deterioration of the thrift’s asset quality and a rise in nonperforming loans, 

which led to significant credit losses that diminished earnings. For 

example, in 2007, BankUnited’s credit losses averaged about 27 percent 

of net interest income, but in 2008, BankUnited’s credit losses 

substantially increased to an average of 1,000 percent of net interest 

income (fig.35). BankUnited’s losses during the first quarter of 2009 

almost reached 14,000 percent of net interest income. The increase in 

BankUnited’s nonperforming real estate loans in all categories, totaling 

$1.8 billion as of March 31, 2009, resulted in increases in its loan loss 

allowance and large losses that significantly diminished the thrift’s 

earnings and capital.

BankUnited
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 130 GAO-13-71 Recent Bank Failures 

Figure 35: BankUnited Income Categories as a Percentage of Net Interest Income, 

2007-2009

a

Net interest income reported in the thrift financial report, schedule statement of operations. We show 

net interest income as 100 percent and for each income category calculate its percentage of net 

interest income. 

b

Credit losses are based on provisions for losses on interest bearing assets as reported in the thrift 

financial report schedule statement of operations, which includes fair value losses recognized on 

foreclosed property and impairment losses recognized on debt and equity securities. 

c

The impact on income of losses on HFS loans is based on the lower-of-cost-or-fair-value 

adjustments made to HFS assets as reported in the thrift financial report schedule statement of 

operations of the thrift financial report, which does not include gains or losses recognized upon sale. 

d

The impact on income of gain/loss on sales is based on the sale of HFS assets and AFS securities 

as reported in the thrift financial report schedule statement of operations, which does not include 

impairment losses. 

e

The impact on income of servicing income is based on mortgage loan servicing fees and servicing 

amortization and valuation adjustments as reported in the thrift financial report schedule statement of 

operations. 

f

The impact on income of recurring fair value measurements is based on gains and losses on 

financial assets and liabilities carried at fair value as reported in the thrift financial report schedule 

statement of operations. 

Large credit losses resulting from increased nonperforming loan levels 

coupled with significant losses in nonagency mortgage-backed securities 

Guaranty
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 131 GAO-13-71 Recent Bank Failures 

were the main drivers for the decline in income and resulting failure at 

Guaranty. Guaranty held a substantial level of nontraditional mortgage 

loans with option ARM features concentrated in volatile real estate 

markets such as California, Florida, and Arizona. In its regulatory filing for 

third quarter 2008, Guaranty disclosed that credit losses for 

nonperforming loans increased from $33 million in December 2007 to $58 

million in March of 2008, and to $99 million in June of 2008. From 2008 to 

2009, Guaranty’s credit losses averaged 181 percent of net interest 

income (fig.36). In 2008, Guaranty also sustained a $1.2 billion loss in the 

value of its $3.5 billion nonagency mortgage backed securities portfolio. 

The mounting losses depleted its capital.

Figure 36: Guaranty Income Categories as a Percentage of Net Interest Income, 

2007-2009

a

Net interest income reported in the thrift financial report, schedule statement of operations. We show 

net interest income as 100 percent and for each income category calculate its percentage of net 

interest income. 

b

Credit losses are based on provisions for losses on interest bearing assets as reported in the thrift 

financial report schedule statement of operations, which includes fair value losses recognized on 

foreclosed property and impairment losses recognized on debt and equity securities. 
Appendix V: Analysis of the Impact of Fair 

Value Accounting on Recent Thrift Institution 

Failures 

Page 132 GAO-13-71 Recent Bank Failures 

c

The impact on income of losses on HFS loans is based on the lower-of-cost-or-fair-value 

adjustments made to HFS assets as reported in the thrift financial report schedule statement of 

operations of the thrift financial report, which does not include gains or losses recognized upon sale. 

d

The impact on income of gain/loss on sales is based on the sale of HFS assets and AFS securities 

as reported in the thrift financial report schedule statement of operations, which does not include 

impairment losses. 

e

The impact on income of servicing income is based on mortgage loan servicing fees and servicing 

amortization and valuation adjustments as reported in the thrift financial report schedule statement of 

operations. 

f

The impact on income of recurring fair value measurements is based on gains and losses on 

financial assets and liabilities carried at fair value as reported in the thrift financial report schedule 

statement of operations. 
Appendix VI: Analysis of HFI Loans Compared 

to HFS Loans of Large Banks

Page 133 GAO-13-71 Recent Bank Failures 

Loans held for investment (HFI) recorded at amortized cost represent for 

most banks the largest proportion of their assets between 2007 and 2011. 

Conversely, loans held for sale (HFS) represented a much smaller share 

of assets for most of the larger banks and thrifts. However, as a result of 

severe contraction in the secondary market for mortgage-backed 

securities in 2007, several of the large banks and thrifts that failed 

between 2008 and 2011 determined that a significant amount of real 

estate loans that had been designated as HFS prior to the market 

disruption were no longer held for sale and transferred the loans to HFI. 

HFI loans are those loans that the bank has the intent and ability to hold 

for the foreseeable future or until maturity or payoff.1 Failed institutions’ 

primary reason for reclassifying HFS loans to HFI was to better reflect 

their prevailing intentions in light of the severity and duration of 

unfavorable secondary market conditions that existed during the crisis, 

especially if they did not anticipate liquidity to return in the foreseeable 

future. In addition, HFS loans are more susceptible to earnings volatility 

particularly when real estate values are falling because the accounting 

standards require that these loans be carried on the balance sheet at the 

lower of cost or fair value, with any declines reflected in current earnings.2

From the first quarter of 2007 to the first quarter of 2008, AmTrust’s HFS 

loans ranged between about 12 percent to 21 percent of its total assets 

(fig. 37). In July 2008, AmTrust began curtailing the volume of its HFS 

Loans held for investment, by contrast, are reported on the balance sheet 

at amortized cost, net of an impairment allowance for estimated credit 

losses (loan loss allowance). Impairment on HFI loans must be 

recognized when credit losses are determined to probable and estimable. 

An increase to the loan loss allowance results in a charge to expenses, 

termed a provision for loan losses, which reduces current earnings. We 

discuss five large commercial banks and thrifts that failed between 2008 

and 2011 that reclassified significant amounts of HFS loans to HFI during 

the financial crisis: AmTrust Bank (AmTrust); IndyMac Bank (IndyMac); 

Washington Mutual Bank (Wamu); Downey Savings and Loan, FB 

(Downey); and United Commercial Bank (UCB).

 

1

Call report instructions, schedule report of income RI-C. 

2

FASB Statement No. 65, Accounting for Certain Mortgage Banking Activities (SFAS 65), 

Paragraph 6, states that a mortgage loan transferred to a long-term investment 

classification shall be transferred at the lower of cost or fair value on the transfer date. Any 

difference between the carrying amount of the loan and its outstanding principal balance 

shall be recognized as an adjustment to yield by the interest method.

Appendix VI: Analysis of HFI Loans 

Compared to HFS Loans of Large Banks

AmTrust
Appendix VI: Analysis of HFI Loans Compared 

to HFS Loans of Large Banks

Page 134 GAO-13-71 Recent Bank Failures 

loans, which included a large volume of acquisition, development, and 

construction loans.

Figure 37: Amtrust Volume of HFI Loans Compared to HFS Loans as a Percentage 

of Total Assets

IndyMac was the failed bank with the largest share of HFS loans as a 

percent of its total assets. From the first quarter of 2007 to the third 

quarter of 2007, IndyMac’s HFS loans ranged between about 36 percent 

to 42 percent of its total assets (fig. 38). However, as of the fourth quarter 

of 2007, it started curtailing the volume of its HFS loans, which included 

significant amounts of payment option adjustable rate mortgage loans. In 

its regulatory filing with the Securities Exchange Commission (SEC), 

IndyMac reported that in the fourth quarter of 2007, it transferred HFS 

loans with an original cost basis of $10.9 billion to HFI loans as it no 

longer intended to sell these loans given the extreme disruption in the 

secondary mortgage market.

IndyMac
Appendix VI: Analysis of HFI Loans Compared 

to HFS Loans of Large Banks

Page 135 GAO-13-71 Recent Bank Failures 

Figure 38: IndyMac Volume of HFI Loans Compared to HFS Loans as a Percentage 

of Total Assets

From the first quarter of 2007 to the fourth quarter of 2007, WaMu’s HFS 

loans declined from 8.5 percent to 1.7 percent of its total assets (fig.39). 

The company reported in its regulatory filings with the SEC that it 

transferred $17 billion of real estate loans designated as HFS loans to its 

HFI loan portfolio, which represented substantially all of its loans 

designated as HFS prior to the market disruption.

WaMu 
Appendix VI: Analysis of HFI Loans Compared 

to HFS Loans of Large Banks

Page 136 GAO-13-71 Recent Bank Failures 

Figure 39: WaMu Volume of HFI Loans Compared to HFS Loans as a Percent age of 

Total Assets

From first quarter of 2007 to third quarter of the same year, Downey’s 

volume of HFS loans declined from 1.8 percent to 0.6 percent (fig.40). 

Downey disclosed in a regulatory filing dated August 2007 that total loans 

and mortgage-backed securities, including those designated HFS, 

declined $818 million during the second quarter of 2007to a total of $12.4 

billion. The company also disclosed in regulatory filings that during the 

third quarter of 2008, loans HFI increased $119 million while loans HFS 

declined $78 million.

Downey
Appendix VI: Analysis of HFI Loans Compared 

to HFS Loans of Large Banks

Page 137 GAO-13-71 Recent Bank Failures 

Figure 40: Downey Volume of HFI Loans compared to HFS Loans as a Percentage 

of Total Assets

From first quarter 2007 to first quarter of 2008, UCB’s HFS loans ranged 

between 0.9 percent and 1.7 percent of total assets (fig. 41). In the 

second quarter of 2008 it began curtailing its HFS portfolio.

UCB
Appendix VI: Analysis of HFI Loans Compared 

to HFS Loans of Large Banks

Page 138 GAO-13-71 Recent Bank Failures 

Figure 41: UCB Volume of HFI Loans Compared to HFS Loans as a Percentage of 

Total Assets
Appendix VII: GAO Analysis of Net Credit 

Extended by Failing Banks and Acquiring 

Banks 

Page 139 GAO-13-71 Recent Bank Failures 

To analyze the impact of bank failures on credit availability, we estimated 

net credit extended by failing banks in the quarters leading up to failure 

and by acquiring banks in the quarters following acquisition of a failed 

bank. We used the change in the size of a bank’s loan portfolio over a 

quarter to measure the net amount of credit it extended over that quarter.

Several factors affect the size of a bank’s loan portfolio. It grows when the 

bank makes new loans or purchases existing loans. It shrinks when the 

bank charges off a delinquent loan; when the bank forecloses on a 

delinquent real estate loan, charges off the difference between the market 

and face values of the loan, and reclassifies the collateral as “other real 

estate owned;” and when a the bank sells or securitizes a loan. It also 

changes when loans are paid down, extended, or repurchased. Thus, the 

change in the size of a bank’s loan portfolio is a measure of the net effect 

of increases in the amount of credit a bank is extending (e.g., from 

making new loans or purchasing loans) and reductions in the amount of 

credit a bank is extending (e.g., from charging-off delinquent loans or 

selling loans).

We used FDIC and Federal Financial Institutions Examination Council 

(FFIEC data on FDIC-insured commercial banks and savings banks 

(banks) over the period from 2006 through 2011. We first used an 

econometric model to estimate the relationship between net credit 

extended by banks and the characteristics of banks associated with the 

likelihood of failure—capital adequacy; asset quality; earnings; liquidity; 

ADC lending; nonfarm, nonresidential real estate lending; commercial real 

estate lending not secured by real estate; multifamily real estate lending; 

brokered deposits funding; and size. We included indicators for each 

quarter to control for factors affecting net credit extension that are 

common to all banks at the same time, such as the regulatory 

environment, the state of the market for bank products and services, and 

the condition of the overall economy. We have observations on each 

bank over one or more quarters (a panel) so we also included indicators 

for each bank to control for unobserved characteristics of banks that do 

not change over time. We estimated the parameters of the model using 

observations on all banks. We then used the estimated parameters along 

with observations on failed banks and acquiring banks to predict net 

credit extended by failing banks over the 2 years preceding failure and to 

predict net credit extended by acquiring banks over the period from one 

quarter preceding acquisition of a failed bank to six quarters following the 

acquisition of a failed bank. To examine the robustness of our results, we 

repeated our analysis separately for small and medium-sized banks. The 

number of large failed banks was not large enough for us to separately 

analyze large banks. We used this approach because it allowed us to 

Appendix VII: GAO Analysis of Net Credit 

Extended by Failing Banks and Acquiring 

Banks 
Appendix VII: GAO Analysis of Net Credit 

Extended by Failing Banks and Acquiring 

Banks 

Page 140 GAO-13-71 Recent Bank Failures 

connect net credit extended by failed and acquiring banks to the 

characteristics of the balance sheets, rather than just their status as failed 

or acquiring banks, as these categories may not fully reflect the factors 

associated with net credit extension. In addition, our approach allowed us 

to improve our estimates by incorporating banks that neither failed nor 

acquired a failed bank as a control group since they may have had 

balance sheet characteristics that were similar to the characteristics of 

failed or acquiring banks for a period of time.

As shown in table 25, our econometric model suggests that many of the 

characteristics that help explain the likelihood of failure also help explain 

net credit extended by banks. Our estimates suggest that capital 

adequacy and asset quality were associated with more net credit, while 

ADC lending was associated with less net credit, all else being equal. In 

addition, higher earnings, nonfarm, nonresidential real estate lending, 

multifamily real estate lending, and size were also associated with less 

net credit, all else being equal.

Table 25: Estimated Effect of Bank Characteristics on Net Credit, 2006-2011

Characteristic All banks Small banks

Medium-sized 

banks

Capital adequacy 2.005a 2.119a 0.221

(0.0720) (0.0729) (0.289)

Asset quality 0.76a 0.738a 0.617a

(0.0493) (0.0503) (0.176)

Earnings -4.168a -4.407a 0.376

(0.314) (0.336) (0.644)

Liquidity 0.0133 0.0215 -0.0706

(0.0199) (0.0213) (0.0565)

ADC lending -0.467a -0.489a -0.0203

(0.0358) (0.0378) (0.0878)

Non-farm, non-residential real estate 

lending

-0.555a -0.549a -0.170

(0.0339) (0.0342) (0.153)

Multifamily real estate lending -0.818a -0.854a -0.339

(0.133) (0.141) (0.425)

Commercial real estate, construction, 

and land development loans not 

secured by real estate

-0.327 a -0.315a -0.228

(0.0844) (0.0817) (0.619)

Brokered deposits 0.0208 0.00301 0.111

(0.0301) (0.0254) (0.0707)
Appendix VII: GAO Analysis of Net Credit 

Extended by Failing Banks and Acquiring 

Banks 

Page 141 GAO-13-71 Recent Bank Failures 

Characteristic All banks Small banks

Medium-sized 

banks

Size -6.046a -3.926a -13.70a

(0.941) (0.979) (2.302)

Observations 168,225 155,664 10,520

R-squared 0.336 0.406 0.060

Number of banks 8,307 7,644 548

Source: GAO analysis of data from FDIC and the Federal Financial Institutions Examinations Council.

Notes: This table shows the estimated parameters and standard errors for a regression of net credit 

extended by banks on capital adequacy, asset quality, earnings, liquidity, ADC lending, nonfarm, 

nonresidential real estate lending, multifamily real estate lending, commercial real estate lending not 

secured by real estate, brokered deposits, size, indicators for each quarter, and indicators for each 

bank. Parameters were estimated separately using observations on all banks, on small banks only, 

and on medium-sized banks only. Parameters for quarter and bank indicators are not reported. We 

used t-tests to determine statistical significance. 

a

Significant at the 1 percent level. 

Our analysis of small banks produced estimates that are generally similar 

to the results of our baseline analysis of all banks. For medium-sized 

banks, our estimates suggest that net credit was positively associated 

with asset quality and negatively associated with size, but it was not 

significantly associated with any other characteristics.

We used the estimates from our econometric model to predict net credit 

extended by failing banks in the eight quarters preceding failure and by 

acquiring banks from the quarter preceding failure to six quarters 

following the acquisition of a failed bank (table 26). To do so, we first 

calculated the predicted value of net credit for every bank in every quarter 

using the actual values of the independent variables for each observation 

and the parameters we estimated with our baseline econometric model 

for all banks. Next, we calculated the average of the predicted values for 

observations on failed banks in the last quarter prior to failure to produce 

the average net credit extended by failing banks in the last quarter prior to 

failure. Similarly, we calculated the average of the predicted values for 

observations on failed banks two quarters prior to failure, the average of 

the predicted values of the observations on failed banks three quarters 

prior to failure, and so on up to eight quarters prior to failure. We also 

calculated the average of the predicted values for observations on 

acquiring banks one quarter prior to acquisition of a failed bank, the 

average of the predicted values for observations on acquiring banks the 

quarter they acquired a failed bank, the average of the predicted values 

for observations on acquiring banks the quarter after they acquired a 

failed bank, and so on up to six quarters after acquiring a failed bank.
Appendix VII: GAO Analysis of Net Credit 

Extended by Failing Banks and Acquiring 

Banks 

Page 142 GAO-13-71 Recent Bank Failures 

Finally, we calculated the average of the predicted values for 

observations on open, nonacquiring banks to produce average predicted 

net credit for these banks for all quarters. We repeated these steps using 

only observations on small banks along with the estimated parameters for 

small banks and also using only observations on medium-sized banks 

along with the estimated parameters for medium-sized banks.

Table 26: Estimated Net Credit Extended by Failing, Acquiring, and Nonfailing, Nonacquiring Banks, 2008-2011 

Failing banks, quarters prior to failure (percent)

Average net credit extended by nonfailing, non-acquiring banks (percent)

8 7 6 5 4 3 2 1 —- 

All banks 3.6 2.2 0.9 -0.4 -2.1 -4.4 -6.3 -8.4 2.8

Small banks 3.6 2.2 0.8 -0.5 -2.2 -4.6 -6.8 -8.8 2.8

Medium-sized 

banks

3.9 3 1.9 1.1 -0.3 -1.2 -3.5 -4.2 2.5

Acquiring banks, quarters following failed bank acquisition 

(percent)

-1 0 1 2 3 4 5 6 —- 

All banks 5.2 5.0 0.1 1.9 1.3 0.8 1.3 0.9 2.8

Small banks 7.0 6.4 -1.4 1.5 1.5 1.4 1.6 1.2 2.8

Mediumsized banks3.3 3.6 2.2 1.4 0.0 -1.4 -0.8 -1.7 2.5

Source: GAO analysis of data from FDIC and the Federal Financial Institutions Examinations Council.

Note: Table cells contain average predicted net credit extended by failing banks in quarters prior to 

failure and by acquiring banks in quarters following acquisition of a failed bank. We used an 

econometric model to estimate the relationship between net credit extended by banks and the 

characteristics of banks associated with the likelihood of failure—capital adequacy, asset quality, 

earnings, liquidity, ADC lending, nonfarm, nonresidential real estate lending, commercial real estate 

lending not secured by real estate, multifamily real estate lending, brokered deposits funding, and 

size. We included indicators for each quarter to control for factors affecting the likelihood of failure 

that are common to all banks at the same time and we included indicators for each bank to control for 

unobserved characteristics of banks that do not change over time. We estimated the parameters of 

the model using observations on all banks. We used the estimated parameters along with 

observations on failed banks and acquiring banks to predict average net credit extended by failing 

banks over the two years preceding failure and to predict net credit extended by acquiring banks over 

the period from one quarter preceding to six quarters following the acquisition of a failed bank. We 

used the estimated parameters along with observations on open, non-acquiring banks to predict 

average net credit extended by these banks in all quarters. We repeated this procedure using only 

observations on small banks and using only observations on medium-sized banks. 

Our estimates suggest that, on average, net credit extended by banks 

that failed in the period from 2008 through 2011 decreased continuously 

over the eight quarters prior to failure and actually became negative about 

five quarters prior to failure, indicating that failing banks were contracting 

the sizes of their loan portfolios and reducing the overall amount of credit 

they were providing. Our estimates also suggest that net credit extended 
Appendix VII: GAO Analysis of Net Credit 

Extended by Failing Banks and Acquiring 

Banks 

Page 143 GAO-13-71 Recent Bank Failures 

by banks that acquired failed banks during the same period generally 

decreased immediately after the acquisition and then partially recovered, 

but remained positive. Acquiring banks continued to expand the amount 

of credit they were making available, albeit more slowly than they did prior 

to the acquisition of the failed bank.

The results of our separate analysis of small and medium-size banks are 

broadly similar to the results of our baseline analysis of all banks, with the 

exception of medium-size acquiring banks. On average, net credit 

extended by both small and medium-size failing banks declined 

continuously in the quarters preceding failure and became negative 4-5 

quarters prior to failure. On average, net credit extended by small 

acquiring banks declined immediately following the acquisition of a failed 

bank and then partially recovered, but remained positive except in the first 

quarter following the acquisition. For medium-size acquiring banks, on 

average, net credit appears to have declined more slowing following the 

acquisition of a failed bank, remaining positive for several quarters but 

actually becoming negative around a year after acquiring the failed bank. 

Overall, however, our estimates suggest that failing banks extended less 

and less credit as they failed and that that acquiring banks continued to 

extend additional credit after they acquired failed banks.

The results of this analysis are subject to several limitations and should 

be interpreted with caution. As discussed above, we used the change in 

the size of a bank’s loan portfolio over a quarter to measure the net 

amount of credit it extended over the quarter. This measure reflects the 

net effects of new loan originations, loan purchases, charge-offs, loan 

sales and securitizations, and other factors, and does not reflect only the 

extension of new credit. Our results likely reflect both factors that are 

generally associated with net credit extended by banks and factors that 

are specific to the particular time period we analyzed. Thus, the extent to 

which our results can be generalized to other time periods is limited.

Furthermore, our results reflect average relationships between bank 

characteristics and net credit extended by banks for all of the 

observations we used. As such, they may not reflect the particular 

circumstances of any one bank or local community. Finally, we note that 

the list of characteristics we analyzed is meant to highlight important 

characteristics of banks that are related to the provision of credit, but 

many other factors—including demand for credit by borrowers— play a 

role in the amount of credit a bank extends and our list of characteristics 

is not exhaustive.
Appendix VIII: GAO Analysis of the Effect of 

Bank Failures on State Economic Conditions 

Page 144 GAO-13-71 Recent Bank Failures 

To assess the relationship between bank failures and overall economic 

conditions in a state, we used an econometric model to analyze the 

relationship between bank failures, income, unemployment, and real 

estate prices for U.S. states and the District of Columbia (states) using 

data for the period from 1994 through 2011. That is, we estimated four 

sets of relationships: (1) the relationship between personal income and 

past values of personal income, past values of the unemployment rate, 

past values of the house price index, and past values of failed banks’ 

share of deposits; (2) the relationship between the unemployment rate 

and past values of the unemployment rate, past values of personal 

income, past values of the house price index, and past values of failed 

banks’ share of deposits; (3) the relationship between the house price 

index and past values of the house price index, past values of personal 

income, past values of the unemployment rate, and past values of failed 

banks’ share of deposits; and (4) the relationship between failed banks’ 

share of deposits and past values of failed banks’ share of deposits, past 

values of personal income, past values of the unemployment rate, and 

past values of the house price index.

The results of our analysis are limited by several factors and thus should 

be interpreted with caution. First, we used the concept of Granger 

causality to determine the extent to which variables are associated with 

each other. However, Granger causality only measures whether the 

current value of one variable is correlated with past values of another 

variable and it does not imply that one variable is the result of or the effect 

of another variable. In addition, our results likely reflect factors specific to 

the time period we analyzed and may not apply to other time periods.

Second, our results likely reflect relationships among the variables at the 

state level and may not generalize to other geographic units—either 

larger units, such as a nation, or smaller units, such as cities or counties.

Furthermore, our results reflect average relationships among the 

variables and thus may not apply to the specific circumstances of any one 

state. Finally, the specific group of variables we analyzed was chosen to 

highlight particular relationships and may not contain all of the variables 

that contribute to explaining personal income, unemployment, house 

prices, or failed bank deposits in states.

We measured bank failures in a state as the fraction of deposits in a state 

that were in banks that failed during the past year. We measured income 

in a state using state personal income, adjusted for inflation. We 

measured unemployment in a state using the unemployment rate. We 

Appendix VIII: GAO Analysis of the Effect of 

Bank Failures on State Economic Conditions

Limitations

Analysis
Appendix VIII: GAO Analysis of the Effect of 

Bank Failures on State Economic Conditions 

Page 145 GAO-13-71 Recent Bank Failures 

measured real estate prices using house price indices for single-family 

detached properties with conventional conforming mortgages. For each 

variable, we estimated the relationship between the variable, its past 

values, and past values of the other three variables. We used a technique 

that controls for time-invariant characteristics of states, that controls for 

features of the national economy that affect all states at the same time, 

and that allows for the possibility that all four variables are jointly 

determined and affected by each other. We then estimated the likelihood 

that the past values of each variable help explain current values of the 

other variables.

We used data on the price level, state gross domestic product, and state 

personal income from the Bureau of Economic Analysis; on state 

unemployment rates from the Bureau of Labor Statistics; on deposits and 

failures of commercial banks, savings banks, savings associations, and 

insured branches of foreign banks (banks) from the Federal Deposit 

Insurance Corporation (FDIC); and on house prices in states from the 

Federal Housing Finance Administration (FHFA) for the period from 1994 

to 2011 for U.S. states and the District of Columbia (states).

We used linear dynamic panel models to estimate relationships among 

bank failures, income, unemployment, and house prices in states. Linear 

dynamic panel models are appropriate for analysis of panels with a large 

number of cross-section units and a small number of time periods, 

dynamic dependent variables that depend on past values of themselves, 

potentially endogenous explanatory variables, fixed cross-section effects, 

and heteroskedasticity and autocorrelation within cross-section units but 

not across them. We separately estimated the parameters of four 

equations—one each for failed bank deposits, personal income, 

unemployment, and house prices—in which the dependent variable is a 

linear function of past values of itself, as well as past values of the other 

three variables, indicators for each state, and indicators for each year. For 

example, for the personal income equation, personal income was the 

dependent variable and was a linear function of past values of personal 

income, past values of unemployment, failed bank deposits, and house 

prices, indicators for each state, and indicators for each year. Then, we 

used Granger causality tests to assess the extent to which the dependent 

variable is “Granger caused” by the other three variables in the sense that 

past values of the other three variables help explain the current value of 

the dependent variable. For example, for the personal income equation,

we used Granger causality tests to assess whether past values of 

unemployment, failed bank deposits, and house prices help explain the 

current value of personal income. We chose the number of past values by 
Appendix VIII: GAO Analysis of the Effect of 

Bank Failures on State Economic Conditions 

Page 146 GAO-13-71 Recent Bank Failures 

starting with six past values and then using F-tests to determine if fewer 

past values were appropriate. We also examined our models for the 

presence of first-order autocorrelation. Linear dynamic panel models use 

lagged values of variables as instruments. However, instrument 

proliferation can overfit endogenous variables and fail to expunge their 

endogenous components. To address this limitation, we examined 

specifications with the default number of instruments and with a severely 

reduced number of instruments.

In general, our results suggest that bank failures in a state were more 

likely to affect its real estate sector than its labor market or overall 

economy (table 27). We did not find evidence of a significant relationship 

between personal income in a state and failed banks’ share of deposits in 

a state. Our results suggest that failed banks’ share of deposits in a state 

did not “cause” personal income in a state in the sense that past values of 

failed banks’ share of deposits do not help explain the current level of 

personal income. Similarly, past values of personal income do not help 

explain the current value of failed banks’ share of deposits.

Table 27: Granger Causality Tests for Personal Income, Unemployment, House Price, and Failed Bank Deposit Equations, 

1994-2011

Panel A. Default number of instruments

Granger causality test

Equation Personal income Unemployment House prices Failed bank deposits

Personal income

(4 lags, 323 instruments)

—- 33.44

(0.00)

32.33

(0.00)

0.90

(0.93)

Unemployment

(4 lags, 323 instruments)

12.63

(0.01)

—- 36.93

(0.00)

7.07

(0.13)

House prices

(6 lags, 250 instruments)

15.85

(0.02)

15.17

(0.02)

—- 31.71

(0.00)

Failed bank deposits

(6 lags, 241 instruments)

8.90

(0.18)

15.28

(0.02)

27.46

(0.00)

—- 

Panel B. Restricted instrument count

Granger causality test

Equation Personal income Unemployment House prices Failed bank deposits

Personal income

(3 lags, 60 instruments)

—- 9.45

(0.02)

4.70

(0.20)

4.11

(0.25)

Unemployment

(4 lags, 56 instruments)

12.69

(0.01)

—- 3.14

(0.54)

1.54

(0.82)
Appendix VIII: GAO Analysis of the Effect of 

Bank Failures on State Economic Conditions 

Page 147 GAO-13-71 Recent Bank Failures 

House prices

(4 lags, 56 instruments)

7.10

(0.13)

15.00

(0.01)

—- 12.86

(0.01)

Failed bank deposits

(2 lags, 65 instruments)

2.27

(0.32)

6.55

(0.04)

12.4

(0.00)

—- 

Source: GAO analysis of data from the Bureau of Economic Analysis, the Bureau of Labor Statistics, FDIC, and FHFA.

Notes: Cells contain the chi-squared statistics and p-values (in parentheses) of F-tests of the null 

hypothesis that the lagged values of the variable in the column header are jointly equal to zero in the 

regression of the variable in the row header on lagged values of itself and the other three variables. 

The lag length for each equation is determined by starting with a model with 6 lags and then using Ftests to identify the highest order lags that are not jointly significant at the 10 percent level. 

To the extent that there was a relationship between the unemployment 

rate and failed banks’ share of deposits in a state, it appears that the 

unemployment rate had more bearing on failed banks’ share of deposits 

than vice versa. Past values of unemployment appear to partially explain 

the current value of failed banks’ share of deposits, but failed banks’ 

share of deposits did not help explain the current value of unemployment.

Finally, failed banks’ share of deposits and the house price index in a 

state appear to be significantly related to each other. Past values of failed 

banks’ share of deposits appeared to help explain the current value of the 

house price index in a state, and vice versa. Altogether, these results 

suggest that the effects of bank failures on a state’s economy were more 

likely to appear in the real estate sector and less likely to appear in the 

labor market or in the broader economy.
Appendix IX: GAO Contacts and Staff 

Acknowledgments

Page 148 GAO-13-71 Recent Bank Failures 

Lawrance L. Evans, Jr. (202) 512-4802 or EvansL@gao.gov

In addition to the contact named above, Karen Tremba, Assistant 

Director; William Cordrey, Assistant Director; Gary Chupka, Assistant 

Director; William Chatlos; Robert Dacey; Rachel DeMarcus; M’Baye 

Diagne; Courtney LaFountain; Patricia Moye; Lauren Nunnally; Stefanie 

Jonkman; Akiko Ohnuma; Michael Osman; and Jay Thomas made key 

contributions to this report.

Appendix IX: GAO Contacts and Staff 

Acknowledgments 

GAO Contact 

Staff 

Acknowledgments 

(250660)
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