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Board Report:  May 12, 2010

Material Loss Review of San Joaquin Bank


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San Joaquin Bank (San Joaquin) was supervised by the Federal Reserve Bank of San Francisco (FRB San Francisco), under delegated authority from the Board, and by the California Department of Financial Institutions (State). The State closed San Joaquin on October 16, 2009, and the FDIC was named receiver. On November 12, 2009, the FDIC IG notified our office that San Joaquin’s failure would result in an estimated loss to the Deposit Insurance Fund of $90.4 million, or 11.7 percent of the bank’s $771.8 million in total assets.

San Joaquin failed because its Board of Directors and management did not effectively control the risks associated with the bank’s rapid loan growth that led to a high concentration in commercial real estate (CRE) loans and, in particular, construction, land, and land development (CLD) loans tied to the Bakersfield, California, real estate market. The loan growth and high concentrations occurred when the Bakersfield real estate market was experiencing significant price appreciation. A decline in the local real estate market, coupled with the bank’s failure to effectively manage the increased credit risk associated with San Joaquin’s highly concentrated loan portfolio, resulted in deteriorating asset quality and significant losses. Mounting losses impaired earnings, eroded capital, and strained the bank’s liquidity. Efforts to meet a regulatory deadline requiring San Joaquin to be acquired by or merge with another financial institution were unsuccessful, and the State closed the bank and appointed the FDIC as receiver.

With respect to the bank’s supervision, we believe that an April 2007 examination performed by FRB San Francisco provided an opportunity for stronger supervisory action. Examiners noted that San Joaquin’s CRE loan concentration ranked among the highest for state member banks supervised by FRB San Francisco. Examiners also cited management’s plan for additional loan growth, despite signs of a slowing real estate market. In our opinion, these circumstances offered an early opportunity for FRB San Francisco to encourage management to mitigate the risk of asset quality deterioration from further market declines. Further, we believe that the significance of the issues raised during a 2008 State examination warranted a timely enforcement action compelling management to mitigate credit risk management weaknesses and the risks associated with the declining real estate market. 

The State examination report issued in July 2008 noted that San Joaquin’s financial condition had become less than satisfactory. Examiners noted that actual asset growth for 2007 was 16 percent, or double management’s projection. In addition, the bank’s level of construction, residential, and lot development loans had increased notably, yet the sharp decline in the Bakersfield real estate market had not been analyzed by management. According to examiners, despite declining collateral values, San Joaquin continued to grant credit extensions without obtaining updated appraisals or reevaluating borrowers’ creditworthiness. Examiners also questioned whether earnings would remain positive and continue to augment capital. An informal enforcement action in the form of a Memorandum of Understanding developed jointly with the State was issued in December 2008, approximately five months after the State’s examination report was issued. 

While we believe that a stronger supervisory action in 2007 and a more timely enforcement action in 2008 were warranted, it is not possible to determine the degree to which any such actions would have affected the bank’s subsequent decline or the failure’s cost to the DIF. We believe that San Joaquin’s failure pointed to a valuable lesson learned that can be applied when supervising community banks with similar characteristics. In our opinion, San Joaquin’s failure  illustrated that banks with exceptionally high CRE and CLD loan concentrations require a swift and forceful supervisory response when signs of market deterioration first become evident.

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