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Board Report: March 15, 2010
Community Bank of Nevada (CBON) was supervised by the Federal Reserve Bank of San Francisco (FRB San Francisco), under delegated authority from the Board, and by the Nevada Financial Institutions Division (State). The State closed CBON on August 14, 2009, and the FDIC was named receiver. On September 15, 2009, the FDIC IG notified us that CBON's failure would result in an estimated loss to the Deposit Insurance Fund (DIF) of $766.5 million, or 51.1 percent of the bank's $1.5 billion in total assets.
CBON failed because its Board of Directors and management did not adequately control the risks resulting from its strategy of aggressive growth concentrated in construction and land development (CLD) loans within the local real estate market. A precipitous and unprecedented deterioration of economic conditions within Las Vegas affected the local real estate market, and the bank's CLD portfolio experienced significant losses. Bank management was optimistic that conditions would improve and, therefore, failed to identify and quantify the magnitude of risk within its heavily concentrated portfolio. Mounting losses eliminated earnings and depleted capital, which ultimately led the State to close CBON.
With respect to supervision, we believe that the breadth and significance of issues that examiners encountered leading up to and during the summer of 2008--when an off-site assessment downgraded CBON's CAMELS composite rating to a 3 (fair)--offered an early opportunity for an immediate supervisory response, such as an appropriate enforcement action compelling the bank's Board of Directors and management to mitigate the increasing risks associated with the declining real estate market and previously identified weaknesses in asset quality, earnings, credit risk management, and liquidity.
An examination report issued in May 2008 noted that CBON's overall risk profile was increasing significantly due to what examiners referred to as "rapidly changing market dynamics." In addition, the May 2008 examination (1) identified gaps in CBON's risk management processes for loan review, appraisals, credit underwriting and administrative practices, and liquidity; and (2) noted that the Board of Directors and management should be proactive to address the bank's escalating risks. During a July 2008 meeting with CBON's Board of Directors, examiners noted that the bank's CAMELS composite 2 (satisfactory) rating was supported by the bank's financial results, but that it did not reflect the high level of risk inherent in management's high-concentration strategy. At that meeting, examiners cited the potential for rapid and severe negative shifts in the bank's condition due to its concentration in construction lending and the reliance on wholesale funding.
An August 2008 supervisory assessment revealed that the risks and potential for negative changes to the bank's financial condition previously cited by examiners were actually occurring. Asset quality was downgraded to less than satisfactory due to a substantial increase in classified loans and nonperforming assets. Earnings dropped significantly, and examiners noted that, at current levels, earnings might not fully support operations and be sufficient to replenish capital and the allowance for loan and lease losses given the institution's overall risk profile.
While we believe that an early and forceful supervisory response was warranted as a result of the issues encountered leading up to and during the August 2008 supervisory assessment, in light of the subsequent steep and rapid deterioration of the local real estate market, it was not possible to determine if an earlier enforcement action would have affected CBON's subsequent decline or the failure's cost to the DIF.
CBON's failure offered valuable lessons learned because it illustrated that a bank with a strategy that features a high concentration of CLD loans is extremely vulnerable to changes in the real estate market it serves. In our opinion, CBON's failure also demonstrated that extremely high CLD concentrations can surpass a bank's capability to withstand a sharply deteriorating market and, therefore, pose a substantial risk to the safety and soundness of a financial institution.
The Director of the Division of Banking Supervision and Regulation agreed with our conclusion and concurred with the lessons learned.