FINANCIAL INSTITUTIONS

Causes and Consequences 

of Recent Community Bank

Failures

Statement of Lawrance L. Evans, Jr., Director 

Financial Markets and Community Investment

Testimony 

Before the Committee on Banking, 

Housing, and Urban Affairs, U.S. Senate

For Release on Delivery 

Expected at 10 a.m. EDT

Thursday, June 13, 2013

GAO-13-704T

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-13-704T, a testimony 

before the Committee on Banking, Housing 

and Urban Affairs, U.S. Senate

June 13, 2013

FINANCIAL INSTITUTIONS 

Causes and Consequences of Recent Community 

Bank Failures 

Why GAO Did This Study

Between January 2008 and December 

2011—a period of economic downturn 

in the United States—414 insured U.S. 

banks failed. Of these, 85 percent 

(353) were small institutions with less 

than $1 billion in assets. Small banks 

often specialize in small business 

lending and are associated with local 

community development and 

philanthropy. The failures of these 

banks have raised questions about 

contributing factors. Further, the 

failures have raised concerns about

the accounting and regulatory 

requirements needed to maintain 

reserves large enough to absorb 

expected loan losses (loan loss 

allowances)—for example, when 

borrowers are unable to repay a loan 

(credit losses).

 

This statement is based on findings 

from GAO’s 2013 report on recent 

bank failures (GAO-13-71) required by 

Pub. L. No 112-88. This testimony 

discusses (1) the factors that 

contributed to the bank failures in 

states with the most failed institutions 

between 2008 and 2011; (2) the use of 

shared loss agreements in resolving 

troubled banks; and (3) the effect of 

recent bank failures on local 

communities. To do this work, GAO 

relied on issued report GAO-13-71 and 

updated data as appropriate.

What GAO Found

Ten states concentrated in the western, midwestern, and southeastern United 

States—areas where the housing market had experienced strong growth in the 

prior decade—each experienced 10 or more commercial bank or thrift (bank) 

failures between 2008 and 2011. The failures of small banks (those with less 

than $1 billion in assets) in these states were largely driven by credit losses on 

commercial real estate (CRE) loans, particularly loans secured by real estate to 

finance land development and construction. Many of the failed banks had often 

pursued aggressive growth strategies using nontraditional, riskier funding 

sources and exhibited weak underwriting and credit administration practices. The 

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

on Loss Provisioning observed that earlier recognition of credit losses could have 

potentially lessened the impact of the crisis. The accounting model used for 

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

prefinancial crisis years. In part due to these accounting rules, loan loss 

allowances were not adequate to absorb the wave of credit losses that occurred 

once the financial crisis began. Banks had to recognize these losses through a 

sudden series of increases (provisions) to the loan loss allowance that reduced 

earnings and regulatory capital. In December 2012, the Financial Accounting 

Standards Board issued a proposal for public comment for a loan loss 

provisioning model that is more forward looking and would incorporate a broader 

range of credit information. This would result in banks establishing earlier 

recognition of loan losses for the loans they underwrite and could incentivize 

prudent risk management practices. It should also 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 281 of the 414 bank failures during the recent financial crisis to 

minimize the impact on the Deposit Insurance Fund (DIF). 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. FDIC compared the 

estimated cost of the shared loss agreements to the estimated cost of directly 

liquidating the failed banks’ assets and estimated that the use of shared loss 

agreements saved the DIF over $40 billion. 

GAO analysis of metropolitan and rural areas where bank failures occurred and 

econometric analysis of bank income and condition data suggested that the 

acquisitions of failed banks by healthy banks mitigated the potentially negative 

effects of failures on communities. However, the focus of local lending and 

philanthropy may have shifted. Also, bank officials whom GAO interviewed noted 

that in the wake of the bank failures, underwriting standards had tightened. As a 

result, credit was generally most available for small business owners with good 

credit histories and strong financials. Further, the effects of bank failures could 

potentially be significant for communities that had been serviced by only one 

bank or where only a few banks remain.

View GAO-13-704T. For more information, 

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

4802 or evansl@gao.gov.
Page 1 GAO-13-704T 

441 G St. N.W.

Washington, DC 20548

Chairman Johnson, Ranking Member Crapo, and Members of the 

Committee:

I am pleased to be here today as you examine lessons learned from 

recent community bank failures. Between January 2008 and December 

2011, 414 insured U.S. commercial banks and thrifts (banks) failed. Of 

these, 85 percent (353) were small banks with less than $1 billion in 

assets. Banks of this size tend to be community banks with a relatively 

limited geographic scope of operations and often specialize in providing 

credit to local small businesses. Typically these banks are also 

associated with local community development, leadership, and 

philanthropy. The failures of these community banks, which were largely 

concentrated in certain parts of the country, occurred against the 

backdrop of the worst financial crisis since the Great Depression and 

raised a number of questions. Among these are the role played by local 

market conditions and related economic factors; the application of fair 

value accounting under generally accepted accounting principles (GAAP); 

and the potential effect on the communities where the banks were 

located, particularly in terms of credit availability, income and 

employment, and philanthropic activity.1 In addition, these failures raise 

questions about the impact of the Federal Deposit Insurance 

Corporation’s (FDIC) methods for resolving failed banks on the Deposit 

Insurance Fund (DIF).

My remarks today are based on our January 2013 report on the impact of 

bank failures.2 My statement will address (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 FDIC’s choice of resolution method 

and the costs that the DIF incurred as a result of these methods; and 

 

1

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.

2

GAO, Financial Institutions: Causes and Consequences of Recent Bank Failures, 

GAO-13-71 (Washington, D.C.: Jan. 3, 2013). This report was mandated by Pub. L. No. 

112-88, § 3, 125 Stat. 1899, 1902 (2012). As part of this act, the FDIC Inspector General 

(IG) was also required to conduct a separate study on the impact of bank failures.

 
 

Page 2 GAO-13-704T 

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

address these issues, we analyzed bank income and condition data (call 

report data); reviewed inspectors general (IG) reports of individual bank 

failures; conducted econometric modeling; and interviewed officials from 

federal and state banking regulators, banking associations, banks, and 

market experts. We also coordinated with the FDIC Inspector General on 

its study. 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.

Ten states concentrated in the western, midwestern, and southeastern 

United States—all areas where the housing market had experienced 

strong growth in the prior decade—experienced 10 or more bank failures 

between 2008 and 2011 (see fig.1). Together, failures in these 10 states 

accounted for 72 percent (298), of the 414 bank failures across all states 

during this time period.

Background 
 

Page 3 GAO-13-704T 

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. Twelve percent (36) 

were 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 4 GAO-13-704T 

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 commercial real estate (CRE) loans, in particular the 

subset of acquisition, development, and construction (ADC) loans, and 

with inadequate management of the risks associated with these high 

concentrations.3 Our analysis of call report data found that CRE (including 

ADC) lending increased significantly in the years prior to the housing 

market downturn at the 258 small banks that failed between 2008 and 

2011. This rapid growth of failed banks’ CRE portfolios resulted in 

concentrations—that is, the ratio of total CRE loans to total risk-based 

capital—that exceeded regulatory thresholds for heightened scrutiny 

established in 2006 and increased the banks’ exposure to the sustained 

downturn that began in 2007.4 Specifically, we found that CRE 

concentrations grew from 333 percent in December 2001 to 535 percent 

in June 2008. At the same time, ADC concentrations grew from 104 

percent to 259 percent. The trends for the 36 failed medium-size banks 

were similar over this time period. In contrast, small and medium-sized 

banks that did not fail exhibited substantially lower levels and markedly 

slower growth rates of CRE loans and as a result had significantly lower 

concentrations of them, reducing the banks’ exposure.

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

began to rise, as did the level of subsequent net charge-offs, leading to a 

 

3

Regulators define CRE loans to include 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 

because of their long development times and because they can include properties (such 

as housing developments or retail space in a shopping mall) that are built without firm 

commitments from buyers or lessees. By the time the construction phase is completed, 

market demand may have fallen, putting downward pressure on sales prices or rents, 

making ADC loans more volatile.

4

Guidelines issued by federal banking regulators in 2006 described characteristics that 

would subject banks to greater regulatory scrutiny. These included an ADC concentration 

of more than 100 percent or a CRE concentration of more than 300 percent when there is 

an increase in the outstanding balance of the CRE portfolio of 50 percent or more during 

the prior 36 months. Concentrations in Commercial Real Estate Lending, Sound Risk 

Management Practices 71 Fed. Reg. 74,580 (Dec. 12, 2006).

Bank Failures Were 

Largely Related to 

Nonperforming Real 

Estate Loans, but Also 

Highlighted the 

Impact of Impairment 

Accounting and Loan 

Loss Provisioning
 

Page 5 GAO-13-704T 

decline in net interest income and regulatory capital.5 The rising level of 

nonperforming loans, particularly ADC loans, appears to have been the 

key factor in the failures of small and medium-size banks in the 10 states 

between 2008 and 2011. For example, in December 2001, 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 2011.6 As banks began to designate nonperforming loans or 

portions of these loans as uncollectible, the level of net charge-offs also 

began to rise. In December 2001, net charge-offs of ADC loans at small 

failed banks were less than 1 percent. By June 2008, they had risen to 2 

percent and by June 2011 to 12 percent.

CRE and especially ADC concentrations in small and medium-size failed 

banks in the 10 states were often correlated with poor risk management 

and risky funding sources. Our analysis showed that small failed banks in 

the 10 states had often pursued aggressive growth strategies using 

nontraditional and riskier funding sources such as brokered deposits.7

The IG reviews noted that in the majority of failures, management 

exercised poor oversight of the risks associated with high CRE and ADC 

concentrations and engaged in weak underwriting and credit 

administration practices. Further, 28 percent (84) of the failed banks had 

been chartered for less than 10 years at the time of failure and appeared 

 

5

Net charge-offs are the total amount of loans that are removed from the balance sheet 

because they are uncollectible, less amounts recovered on loans previously charged off. 

Net 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.

6

Nonperforming 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.

7

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

through the mediation or assistance of a deposit broker. The broker pools largedenomination 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.
 

Page 6 GAO-13-704T 

in many cases to have deviated from their approved business plans, 

according to FDIC. Large bank failures in the 10 states were associated 

with some of the same factors as small bank failures—high-risk growth 

strategies, weak underwriting and risk controls, and excessive 

concentrations that increased these banks’ exposure to the real estate 

market downturn. The primary difference was that the large banks’ 

strategies generally relied on risky nontraditional residential mortgage 

products as opposed to commercial real estate.

To further 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 to 2011. Our econometric 

analysis suggests that across the country, riskier lending and funding 

sources were associated with an increased likelihood of bank failures. 

Specifically, we found that banks with high concentrations of ADC loans 

and an increased use of brokered deposits were more likely to fail from 

2008 to 2011, while banks with better asset quality and greater capital 

adequacy were less likely to fail.8 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. Among other things, the IG 

found that these banks exhibited strong management, sound credit 

administration and underwriting practices, and adequate capital.9

 

8

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. We collected data on characteristics that described a bank’s capital 

adequacy; asset quality; earnings; liquidity; ADC lending; multifamily real estate lending; 

nonfarm, nonresidential real estate lending; commercial real estate lending not secured by 

real estate; brokered deposits funding; and size. We then estimated the likelihood of 

failure as a function of these characteristics, controlling for factors that affected the 

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

and overall economic conditions.

9

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

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

2012).
 

Page 7 GAO-13-704T 

We found that losses related to bank assets and liabilities that were 

subject to fair value accounting contributed little to bank failures overall, 

largely because most banks’ assets and liabilities were not recorded at 

fair value. Based on our analysis, fair value losses related to certain types 

of mortgage-related investment securities contributed to some bank 

failures. But in general fair value-related losses 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 more than two-thirds of the assets of 

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

classified as held-for-investment (HFI) loans, which were not subject to 

fair value accounting.10 For example, small failed commercial banks held 

an average of 77 percent of their assets as HFI loans in 2008. At the 

same time, small commercial banks that remained open held an average 

of 69 percent in such loans. Failed and open small thrifts, as well as 

medium-size and large commercial banks, had similar percentages.

Investment securities classified as available for sale (AFS) represented 

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

over the 5-year period we reviewed. 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, but the changes in fair value impact 

earnings or regulatory capital only under certain circumstances.11 While 

several other asset and liability categories are recorded at fair value and 

 

10Generally, HFI loans are recorded at amortized cost, net of an impairment allowance for 

estimated credit losses. Essentially, amortized cost is outstanding principal adjusted for 

any charge offs, deferred fees or costs, and unamortized discounts or premiums.

11Some assets and liabilities, such as securities designated for trading, are measured at 

fair value on a recurring basis (at each reporting period), where unrealized gains or losses 

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

However, for certain other assets and liabilities that are measured at fair value on a 

recurring basis, such as AFS securities, 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, unless the institution determines that a decline in fair value below amortized cost 

constitutes an other-than-temporary impairment, in which case the instrument is written 

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

Credit Losses and Chargeoffs from Nonperforming 

Loans Contributed 

Significantly to Bank 

Failures Nationwide, but 

Losses Due to Fair Value 

Accounting Did Not
 

Page 8 GAO-13-704T 

impact regulatory capital, 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, trading assets, nontrading assets 

such as nontrading derivative contracts, and trading liabilities at small 

failed banks ranged from 0.00 to 0.03 percent of total assets.

As discussed earlier, declines in regulatory capital at failed banks were 

driven by rising levels of credit losses related to nonperforming loans and 

charge-offs of these loans. For failed commercial banks and thrifts of all 

sizes nationwide, 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’ earnings and regulatory capital levels than those 

recorded at fair value.

During the course of our work, 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 in those areas where real estate assets 

prices declined severely—drove both credit losses and charge-offs and 

resulted in reductions to regulatory capital. 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. Data are not publicly 

available to analyze the extent to which declines in the collateral values of 

impaired collateral-dependent CRE or ADC loans drove credit losses or 

charge-offs at the failed banks. However, state banking associations said 

that the magnitude of the losses was exacerbated by federal bank 

examiners’ classification of collateral-dependent loans and evaluations of 

the appraisals banks used to support the impairment analyses of these 

loans. Federal banking regulators noted that regulatory guidance in 2009 

directed examiners not to require banks to write down loans to an amount 

less than the loan balance solely because the value of the underlying 

collateral had declined. The regulators added that examiners were 

generally not expected to challenge the appraisals obtained by banks 

unless they found that any underlying facts or assumptions about the 
 

Page 9 GAO-13-704T 

appraisal were inappropriate or could support alternative assumptions.12

The guidance also stated that in making decisions to write down loans, 

bank examiners were to first focus on the adequacy of cash flows to 

service the debt. If the sources of cash flows did not exist and the only 

likely repayment source was the sale of the collateral, then examiners 

were to 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 official told us that some failed banks 

were extending ADC loans 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. Under these circumstances, absent any evidence that the 

borrowers could pay through other means, the examiners would require a 

write-down.

 

12FDIC, Federal Reserve, OCC, OTS, the National Credit Union Administration (NCUA), 

and the Federal Financial Institutions Examination Council (FFIEC) State Liaison 

Committee, Policy Statement on Prudent Commercial Real Estate Loan Workouts (Oct. 

30, 2009) (see for example, Federal Reserve SR 09–07 and FDIC FIL-61-2009). We 

reported in 2011 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. GAO, Banking Regulation: Enhanced Guidance on Commercial Real Estate Risks 

Needed, GAO-11-489 (Washington, D.C.: May 19, 2011).
 

Page 10 GAO-13-704T 

A loan loss provision is the money a bank sets aside to cover potential 

credit losses on loans.13 The Department of the Treasury (Treasury) and 

the Financial Stability Forum’s Working Group on Loss Provisioning 

(Working Group) have 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. 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 

estimates of losses incurred as of the balance sheet date. 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 most recent downturn, historical 

loan loss rates would typically be low. As a result, justifying significant 

loan loss provisioning to increase the loan loss allowance can be difficult 

under the incurred loss model.

Treasury and the Working Group noted that earlier recognition of loan 

losses could have reduced the need for banks to recognize increases in 

their incurred credit losses through a sudden series of loan loss 

provisions that reduced earnings and regulatory capital. Federal banking 

regulators have also noted that requiring management at the failed banks 

to recognize loan losses earlier could have helped stem losses. 

Specifically, such a requirement might have provided an incentive not to 

concentrate so heavily in the loans that later resulted in significant losses. 

To address this issue, 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. This 

proposal would allow banks to establish a means of recognizing potential 

losses earlier on the loans they underwrite and could incentivize prudent 

risk management practices. Moreover, the proposal is designed to help 

address the cycle of losses and failures that emerged in the recent crisis 

 

13GAAP 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.

Current Accounting 

Practices for Loss 

Provisioning May 

Have Delayed 

Reporting of Credit 

Losses during the 

Recent Crisis
 

Page 11 GAO-13-704T 

as banks were forced to increase loan loss allowances and raise capital 

when they were least able to do so (procyclicality). We plan to continue to 

monitor the progress of the ongoing activities of the standard setters to 

address concerns with the loan loss provisioning model.

FDIC is required to resolve a bank failure in a manner that results in the 

least cost to the Deposit Insurance Fund (DIF). FDIC’s preferred 

resolution method is to sell the failed bank to another, healthier, bank. 

During the most recent financial crisis, FDIC facilitated these sales by 

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

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

January 2008 through December 31, 2011, FDIC was appointed as 

receiver for the 414 failed banks, with $662 billion in book value of failed 

bank assets. FDIC used purchase and assumption agreements (the direct 

sale of a failed bank to another, healthier bank) to resolve 394 failed 

institutions with approximately $652 billion in assets. As such, during the 

period 2008 through 2011, FDIC sold 98 percent of failed bank assets 

using purchase and assumption agreements. However, FDIC only was 

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. FDIC officials said that at the height of the financial 

crisis in 2008, FDIC sought bids for whole bank purchase and assumption 

agreements (in which the acquiring bank assumes essentially all of the 

failed bank’s assets and liabilities) 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. 

Acquiring bank officials that we spoke to said that they would not have 

purchased the failed banks without FDIC’s shared loss agreements 

because of uncertainties in the market and the value of the assets.

Because shared loss agreements had worked well during the savings and 

loan crisis of the 1980s and early 1990s, FDIC decided to offer the option 

of having such agreements as part of the purchase and assumption of the 

failed bank.

Shared loss agreements provide potential buyers with 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. Under the agreements, FDIC generally agrees to pay 80 

percent for covered losses, and the acquiring bank covers the remaining 

20 percent. From 2008 to the end of 2011, FDIC resolved 281of the 414 

failures (68 percent) by providing a shared loss agreement as part of the 

purchase and assumption. The need to offer shared loss agreements 

FDIC Used Shared 

Loss Agreements to 

Attract Bidders at 

Least Cost to the 

Deposit Insurance 

Fund 
 

Page 12 GAO-13-704T 

diminished as the market improved. For example, in 2012 FDIC was able 

to resolve more than half of all failed institutions without having to offer to 

share in the losses. Specifically, between January and September 30, 

2012, FDIC had agreed to share losses on 18 of 43 bank failures (42 

percent). Additionally, some potential bidders were willing to accept 

shared loss agreements with lower than 80-percent coverage. As of 

December 31, 2011, DIF receiverships had made shared loss payments 

totaling $16.2 billion. In addition, future payments under DIF receiverships 

are estimated at an additional $26.6 billion over the duration of the shared 

loss agreements, resulting in total estimated lifetime losses of $42.8 

billion (see fig. 2).14

Figure 2: Shared Loss Agreements Entered into by Year, 2008-2011

By comparing the estimated cost of the shared loss agreements with the 

estimated cost of directly liquidating the failed banks’ assets, FDIC has 

estimated that using shared loss agreements has saved the DIF over $40 

billion. However, while the total estimated lifetime losses of the shared 

loss agreements may not change, the timing of the losses may, and 

payments from shared loss agreements may increase as the terms of the 

agreements mature. FDIC officials stated that the acquiring banks were 

being monitored for compliance with the terms and conditions of the 

shared loss agreements. FDIC is in the process of issuing guidance to the 

 

14FDIC reported that, as of December 31, 2012, DIF receiverships made shared-loss 

payments totaling $23.3 billion and are estimated to pay an additional $18.1 billion over 

the duration of the shared loss agreements, resulting in total lifetime losses of $41.4 

billion. These data included shared-loss agreements associated with both the bank 

failures that occurred between 2008 and 2011 as well as the additional banks that failed in 

2012.
 

Page 13 GAO-13-704T 

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 appear to have 

mitigated the potentially negative effects of bank failures on communities, 

although the focus of local lending and philanthropy may have shifted. 

First, 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, by, for example, raising prices or 

reducing the availability of some products and services. But, we found 

that a limited number of metropolitan areas and rural counties were likely 

to have become significantly more concentrated.

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. We calculated 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. The HHI is 

measured on a scale of 0 to 10,000, with values over 1,500 considered 

indicative of concentration.15 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 

that indicate significant competitive concerns. Similarly, 5 of the 68 rural 

counties affected by bank failures during the same time period met the 

criteria. The relatively limited number of areas where concentration 

increased was generally the result of acquisitions by institutions that were 

not already established in the locales that the failed banks served. 

However, the effects could be potentially significant for those limited 

areas that had been serviced by one bank or where only a few banks 

remain.

 

15The 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. According to the Department of justice 

and the Federal Trade Commission, 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.

The Impact of Bank 

Failures on Local 

Communities Was 

Mixed 
 

Page 14 GAO-13-704T 

Second, our econometric analysis of call report data from 2006 through 

2011 found that failing small banks extended progressively less net credit 

as they approached failure, but that acquiring banks generally increased 

net credit after the acquisition, albeit more slowly.16 Officials from 

acquiring and peer banks we interviewed in Georgia, Michigan, and 

Nevada agreed.17 However, general credit conditions were generally 

tighter in the period following the financial crisis. For example, several 

bank officials noted that in the wake of the bank failures, underwriting 

standards had tightened, making it harder for some borrowers who might 

have been able to obtain loans prior to the bank failures to obtain them 

afterward. Several banks officials we interviewed also said that new 

lending for certain types of loans could be restricted in certain areas. For 

example, they noted that the CRE market, and in particular the ADC 

market, had contracted and that new lending in this area had declined 

significantly.

Officials from regulators, banking associations, and banks we spoke with 

also said that involvement in local philanthropy had declined as small 

banks approached failure but generally increased after acquisition. State 

banking regulators and national and state community banking 

associations we interviewed told us that community banks tended to be 

highly involved in local philanthropic activities before the recession—for 

example, by designating portions of their earnings for community 

development or other charitable activities. However, these philanthropic 

activities decreased as the banks approached failure and struggled to 

conserve capital. Acquiring bank officials we interviewed told us that they 

had generally increased philanthropic activities compared with the failed 

 

16We 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; nonfarm, nonresidential 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 

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 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.

17We chose to focus on these three states because they reflect the three major areas 

where the bank failures were concentrated—the southeast, southwest, and midwest. They 

reflect 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.
 

Page 15 GAO-13-704T 

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 the acquiring bank 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.

Finally, we econometrically analyzed the relationships among bank 

failures, income, unemployment, and real estate prices for all states and 

the District of Columbia (states) for 1994 through 2011. Our analysis 

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

estate sector than its labor market or broader economy. In particular, this 

analysis did not suggest that bank failures in a state—as measured by 

failed banks’ share of deposits—were associated with a decline in 

personal income in that state. To the extent that there is a relationship 

between the unemployment rate and bank failures, the unemployment 

rate appears to have more bearing on failed banks’ share of deposits than 

vice versa. In contrast, our analysis found that failed banks’ share of 

deposits and the house price index in a state appear to be significantly 

related to each other. 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 less likely to appear in the overall labor market or in the 

broader economy.18 However, we note that these results could be 

different at the city or county level.

 

18We measured bank failures in a state as the fraction of deposits in a state that were in 

banks that failed during the past year. This measure 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 measured income in a 

state using state personal income, adjusted for inflation. We measured unemployment in a 

state using the unemployment rate. We 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 controlled for timeinvariant characteristics of states and features of the national economy that affected all 

states at the same time and that allowed for the possibility that all four variables were 

jointly determined and affected by each other. We then used Granger causality tests to 

estimate the likelihood that the past values of each variable helped explain the current 

values of the other variables.
 

Page 16 GAO-13-704T 

Chairman Johnson, Ranking Member Crapo, and Members of the 

Committee, this concludes my prepared statement. I would be happy to 

answer any questions that you may have at this time.

If you or your staff have any questions about this testimony, 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 testimony include Karen Tremba, Assistant 

Director; William Cordrey, Assistant Director; Gary Chupka, Assistant 

Director; William Chatlos; Emily Chalmers, Robert Dacey; Rachel 

DeMarcus; M’Baye Diagne; Courtney LaFountain; Marc Molino, Patricia 

Moye; Lauren Nunnally; Angela Pun, Stefanie Jonkman; Akiko Ohnuma; 

Michael Osman; and Jay Thomas.

Contacts and 

Acknowledgments 

(250740)
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