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Board Report:  September 30, 2010

Review of the Failure of Marco Community Bank

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Marco Community Bank (Marco) was a de novo bank supervised by the Federal Reserve Bank of Atlanta (FRB Atlanta), under delegated authority from the Board, and by the Florida Office of Financial Regulation (State). The State closed Marco on February 19, 2010, and named the FDIC as receiver. The FDIC IG estimated that Marco’s failure would result in a $36.9 million loss to the DIF, or 29.1 percent of the bank’s $126.9 million in total assets. While the loss did not exceed the materiality threshold  established in the Dodd-Frank Act, we conducted an in-depht review after determining that Marco’s failure presented unusual circumstances because (1) during its second year of operations, tier 1 capital dipped beneath the minimum required by regulatory guidance, and (2) the bank relied heavily on its holding company to augment the bank’s capital throughout Marco’s limited history.

Marco failed because its Board of Directors and management did not provide adequate oversight of the bank’s lending activities. Following its inception, the bank operated with a weak internal control environment due, in part, to frequent management turnover, vacancies in key positions, and inadequate staff expertise. The bank grew more quickly than management anticipated in its business plan and relied on capital injections from its holding company to sustain operations. The growth resulted in Marco developing high concentrations in (1) the CLD component of the bank’s CRE loan portfolio, and (2) home equity lines of credit. Also, in 2006 and 2007, the bank executed management’s strategic decision to supplement its declining loan production by purchasing a pool of short-term acquisition and renovation loans on properties primarily located in two counties in Florida. These loan pools created an additional concentration risk for Marco.  As the real estate market in Marco Island weakened, the bank’s asset quality deteriorated significantly and resulted in large provision expenses that eliminated earnings and depleted capital.

Our analysis of FRB Atlanta’s supervision of Marco revealed that FRB Atlanta did not fully comply with the Board’s supervisory standards for de novo banks. Specifically, FRB Atlanta did not comply with examination frequency guidelines and put Marco on a standard examination cycle despite noting issues that should have raised concerns about the bank’s ability to operate on a sound basis—a consideration when determining if a de novo bank should be transitioned to a standard examination frequency cycle. We believe that FRB Atlanta should not have transitioned Marco to the standard examination cycle after FRB Atlanta and the State had only conducted two full scope examinations. In hindsight, we believe that many of the issues noted during these first two examinations foreshadowed the bank’s future problems. Nevertheless, it was not possible to determine the degree to which strict adherence to the supervisory guidelines for de novo banks may have altered the course of the bank’s financial decline or affected the failure’s cost to the DIF.

We believe that Marco’s failure pointed to valuable lessons learned that can be applied when supervising de novo banks with similar characteristics. First, Marco’s failure underscored that de novo banks require close supervision and that examiners should only implement the standard examination cycle when—consistent with regulatory guidance—the bank’s corporate governance, financial condition, and internal controls warrant the transition. Second, this failure highlighted the importance of examiners closely monitoring a de novo bank’s performance when, as was the case with Marco, there are significant deviations from the business plan submitted as part of the application to become a state member bank.

The Director of the Board’s Division of Banking Supervision and Regulation concurred with our conclusion and lessons learned.