Abstract

Effective asset management and disposition are a crucial aspect of problem bank resolution. The asset disposition department is comprised of all matters that have to do with actual asset liquidation (i.e., loan collection or sale, sale of own real estate owned, etc.). The liquidating authority is expected to maximize the return on the assets of the failed bank and minimize losses related to the failure. The primary goal of this department is to market the bank’s assets, liquidate them, and distribute the proceeds to claimants as prioritized by the law (see the section on claims in Chapter 6). Effective asset management and disposition include proper governance, transparency, and accountability, which can be strengthened with proper delegation of authority and decision-tracking, reporting, and filing systems.

Effective asset management and disposition are a crucial aspect of problem bank resolution. The asset disposition department is comprised of all matters that have to do with actual asset liquidation (i.e., loan collection or sale, sale of own real estate owned, etc.). The liquidating authority is expected to maximize the return on the assets of the failed bank and minimize losses related to the failure. The primary goal of this department is to market the bank’s assets, liquidate them, and distribute the proceeds to claimants as prioritized by the law (see the section on claims in Chapter 6). Effective asset management and disposition include proper governance, transparency, and accountability, which can be strengthened with proper delegation of authority and decision-tracking, reporting, and filing systems.

Following a receivership takeover, debtors almost invariably tend to develop a culture of nonpayment, waiting to see what will happen with the receivership process or what measures will be adopted for the bank’s assets. Speed in resolving this situation is a factor that not only lowers maintenance costs, but also improves the capacity of recovery through the various means employed (direct sale, restructuring, collections, conveyances, etc.).2 See Box 7.1 for guidance in practice.

Many of the examples of assets and collection procedures may not be applicable in all situations. The guidelines can be used as a model, however, to assist the liquidation office in fulfilling its mission. Within the general guidelines, account officers are encouraged to exercise creativity and initiative in the performance of their duties, and especially with regard to the disposition of asset portfolios. The guidelines are meant to provide an overall framework under which flexibility and adaptability can be accommodated in order to foster sound business decisions, while maintaining accountability to the liquidating authority.

As mentioned in Chapter 6, because job titles are subject to change and task assignments vary somewhat, the term “account officer” has been adopted for use in describing duties that may be performed by asset management and other specialists; that is, an account officer is the individual responsible for performing the particular duty.

The 80/20 Rule

The 80/20 rule is a casual concept that illustrates the importance of concentrations. In the context of bank liquidation, the 80/20 rule holds that 80 percent of the value of assets held is concentrated in 20 percent of the assets. Of course, these numbers are not absolute; they merely serve to illustrate the concept. The numbers could as easily be 85/15, 75/25 or an even odder combination. In addition, keep in mind that the value of loans, especially nonperforming, does not necessarily equate to book value.

A bank liquidation operation would do well to consider this theory when analyzing which assets deserve the most attention. Identifying the assets with the most value and focusing collection efforts on them will result in higher recoveries and increased cash flows to distribute to depositors and creditors, as well as help finance the bank liquidation efforts.

The purpose of the asset disposition department is to administer and dispose of assets in a manner that returns the maximum net present value (Box 7.2). (The concept of net present value recognizes the time value of money, justifying the value of collecting a discounted sum immediately over a greater amount of future cash flows or lump sums.) Asset review sheets should be completed for each loan in order to estimate cash recoveries (see Annex 3.19 in Chapter 3).

ASSET DISPOSITION STRATEGIES AND TIMELINES

Failed banks may have homogeneous performing loans (e.g., consumer, mortgages) that can be packaged and sold in bulk to other banks or investors. To the extent possible, this is the preferred method of asset liquidation simply because it is faster. Frequently, however, failed banks have many problem loans (e.g., nonperforming, abusive insider loans, etc.) that will be virtually impossible to sell. The asset collection procedures below deal with the disposition of all types of assets.

Asset Management in a Liquidation Context

The fundamental objectives of asset management in the context of a liquidation procedure are to:

  1. Improve the quality of the assets to be liquidated. This is achieved through various actions, such as:

    • Improving the supporting documentation for those assets

    • Improving the custody and physical maintenance of the assets

    • Taking any legal actions necessary to legally protect the rights over and/or enforceability of the assets

    • Taking actions to recover delinquent assets

    • Facilitating the migration of assets to other financial entities, without losses

    • Attempting to accelerate credit recovery, allowing early payment provided that the amount to be recovered exceeds the estimated value of the credit’s liquidation in auction.

  2. Continue with the administration and collection of the credit assets.

It is important that the majority of debtors be allowed to fulfill their commitments and be encouraged to continue doing so, since that will facilitate subsequent portfolio sales to other “healthy” banks. At the same time, it will reduce the negative financial impact on the proprietor of the assets. Such an approach also contributes to discouraging the development of a culture of “nonpayment,” which invariably arises in the event of a bank receivership and liquidation.1

1

Fernando de Mergelina, Francisco Rivillas, Managing Residual Assets from Banking Liquidations. Operating Manual No. 4 (Inter-American Development Bank, Washington, 2004), pp. 12–15.

For each primary asset type, the asset disposition department outlines the liquidating authority’s primary asset disposition strategies. Account officers should employ these preferred strategies when disposing of assets.

Assets of obvious positive value and collectability should be given prompt attention. Nonloan assets, such as automobiles, furniture, etc., should be converted to cash as swiftly as possible. Loans will require special treatment. Account officers must follow standard practice in working with the debtors of the failed bank. The account officers should emphasize that the failed bank no longer exists and that it is important for the debtor to establish a new banking relationship.

Unless otherwise specified, the primary disposition strategies for each asset type are not listed in any order of preference. In certain circumstances, however, it may be appropriate to employ a disposition strategy for a particular asset or group of assets that is not specified in this manual.

Table 7.1 shows the various asset types along with the primary disposition strategy. Liquidation management should set goals to provide incentives for staff (Box 7.3).

TABLE 7.1

Asset Types and Primary Disposition Strategies

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The asset management and disposition department must be prepared to address loan participations, unfunded loan commitments, and letters of credit in the course of their duties.

ASSET COLLECTION PROCEDURES

As mentioned above, the assets that are not sold to an acquirer at resolution should be given prompt attention. Nonloan assets should be converted to cash according to the procedures set forth above.

Debtors of the failed bank should be encouraged to refinance and establish new banking relationships with healthy banks, so that ongoing and future credit needs can be met. Because not all debtors’ loans can be refinanced, the account officer must decide whether more recovery can be achieved through sale of the loan than other methods. In any case, prompt action will maximize recovery.

Restructuring a loan for a troubled borrower, generally by modifying terms, can sometimes be more productive than foreclosing on collateral or initiating collection lawsuits. Some of these borrowers are operating ongoing businesses. Revenue from these businesses as a loan repayment source must be considered when developing a liquidation strategy. For example, if a business loan secured by the enterprise’s equipment and repayment derives from the continuing business operations, then it would be imprudent to foreclose and repossess the equipment. This would put the firm out of business and curtail further sources of repayment.3 Box 7.4 provides some examples of loan structuring guidelines.

Asset collection is one of the most important but difficult aspects of bank liquidation. Account officers should be aggressive in their collection efforts. Detailed below are examples of step-by-step procedures that must be considered in asset collection (local situations may vary, and the account officer may need to exercise creative collection techniques to achieve the liquidation office’s objectives):

  • Assigning assets

  • Establishing and maintaining asset files

  • Establishing tickler systems

  • Initial notices

  • Borrower communications

  • Good faith negotiations

  • Initial asset review

  • Disposition timelines

  • Applying loan payments

  • Documentation

  • Loan collection

  • Reminder notices

  • Unresolved delinquencies

  • Advances

  • Skip tracing

  • Loan valuation

  • Pooling assets for sale

  • Participations

  • Unfunded loan commitments

  • Judgments, deficiencies, and charge-offs

  • Other real estate owned.

Liquidation Goals1

Effective annual goals can promote successful liquidation procedures. Some examples include the following:

  1. Establish a cash collection target based on aggregate volume of assets available for liquidation as of the commencement of a year. This would be expressed as cash recoveries of 20 percent of booked assets or may be expressed as 35 or 40 percent, etc., of the liquidation appraised value of assets. Since collected interest is a part of cash collections this is not an unattainable objective. The target needs to be high enough to force the liquidator’s strategy to accomplish the total liquidation effort within the maximum number of years for termination of the liquidation activities. A low goal virtually ensures that the liquidation effort will go on for a very long period, thus denying creditors return of their claims for many years into the future.

  2. Establish a book value reduction percentage-of-assets target. Like the cash target this focuses the liquidator’s attention on making considerable progress in reducing the assets of the liquidation on a reasonably aggressive basis. In the first two years a book value reduction goal of 30 percent or more of the initial assets should move the liquidation along at a reasonable speed.

  3. Establish a goal that total expenses of liquidation should not exceed 20, 15, or 10 percent of cash collections. This focuses the liquidator’s attention on not spending substantial resources on low-value assets. It also provides a strong incentive to sell off the very low-value assets quite rapidly to reduce aggregate expenses of their liquidation. Sale of these types of assets very early in the process avoids duplication of these same type expenses for years 2, 3, and 4.

  4. Establish a goal for the disposal rate of any retained banking premises and real estate owned. As a general rule, for example, 75 percent of real estate owned in monetary terms should be disposed of within 12 months of its acquisition.

  5. Establish a goal for the reduction of staff from x level to y level each calendar year. By early sale of a substantial part of the smallest value assets, it makes it easier to reduce staff and simplify accounting and information technology issues.

The types of goals set forth above force liquidation management to avoid holding a significant number of small-value assets that might eventually pay in full but will be very expensive to administer. When proper consideration is made of the cost of excess salaries, unnecessary accounting and data processing services, higher-than-necessary loan servicing costs, distractions of management on marginal value assets, etc., then clearly it is better to sell off marginal value assets at market value, rather than carrying these types of costs described for three to five years (absent a sales strategy for the low-value assets).

It is generally best to simplify and limit the number of goals to ensure that senior liquidation management concentrates on the most important issues, thus making it easier to monitor progress in the most critical liquidation areas.

1

William Dudley, Liquidation Closing Procedures and Liquidation Manual (U.S. Agency for International Development, Washington, July 2003).

Assigning Assets

The first step in effective asset collection procedures is the assignment of responsibility for liquidation (or collection) of assets to an account officer. Different factors may affect the assignment of loans and other real estate owned; however, in general, asset assignment will include the following:

  1. Loan assignments:

    • Loan type (commercial, mortgage, consumer, etc.)

    • Complexity of the asset (legal issues, etc.)

    • Book value of the asset or related line

    • Book value of an account officer’s total portfolio

    • Number of assets or related lines.

  2. Owned real estate assignments:

    • Property type (commercial, vacant land, residential, etc.)

    • Appraised value of the property

    • Appraised value of account officer’s total portfolio

    • Number of properties

    • Property location.

Situations may develop in which a larger number of assets should be assigned to an account officer, including, for example:

  • Many of the borrowers are in bankruptcy

  • Many of the assets have been referred for noncomplex litigation

  • A high percentage of assets are performing.

Similarly, situations may develop in which a smaller number of assets should be assigned to an account officer, including, for example, the complexity of assets or litigation requires a high degree of oversight.

As time goes by, the number and composition of assets will change, and personnel will probably change, so asset assignment will require periodic review and possible redistribution.

Establishing and Maintaining Asset Files

The following are some preliminary procedures that should be performed when account officers are assigned an asset:

  • Verify the existence of the original promissory note and collateral.

  • Review all the documentation in the file.

  • Immediately inform the appropriate supervisor of any missing documents.

The bank file is obtained from the failed bank. Each bank file should be maintained in its original condition. Items may be removed from the bank file for copying, but all original documents must be returned, thereby maintaining the integrity of the bank file. Exceptions are original collateral documents, which should be kept secure in a collateral file. Copies of the original collateral documents should be placed in the bank file. All documentation generated after the bank closing should be kept in an asset file.

Some Loan Restructuring Guidelines

  • If the amortization period is extended, include a shorter call (or balloon) date (three-year maximum).

  • Waive penalty interest for early cash payouts (within 30 days of the first meeting date).

  • Use a generic form restructure agreement for consistency and simplicity.

  • Always try to get more collateral and guarantees, even collateralized guarantees.

  • Require financial statements from the previous three years.

The asset file should:

  • Contain copies of the note and collateral documentation, including any modifications

  • Not be a duplicate of the bank file

  • Be the official record of actions taken on the asset by receivership account officers

  • Contain all agreements made with the borrowers and the results of all meetings and telephone conversations, which must all be properly documented in writing.

The time and duration of meetings and telephone conversations with outside counsel should be recorded. (This information is used in verifying legal fee bills.) If an asset is in litigation, then verify the existence of the original promissory note and collateral securing the note. If important documents from the bank file are copied to the asset file, the account officer will be relieved of retrieving the bank file for future reviews, thereby maintaining the integrity of the bank file.

The account officer should write short notes or memoranda recording the conversations, results of meetings, etc., that occur with the disposition efforts on the asset. These notes should be properly documented, maintained, and included in the asset file. Finally, a copy of all these items and any other related correspondence and memoranda must be included in the appropriate asset file. The asset file is the official record of actions taken on the asset by receivership personnel.

Establishing Tickler Systems

Tickler systems are reminders to perform actions by certain deadlines to protect the receivership’s rights. The deadlines may reflect specific time periods, events, thresholds, etc.

It is the account officer’s responsibility to assure that tickler systems are updated and maintained. Examples of deadlines or thresholds that should be monitored via a tickler system include:

  • Statutes of limitations

  • Expiration of security interest

  • Cross-reference listing co-makers, endorsers, and guarantors

  • Property and life insurance premium due dates

  • Property tax payment due dates

  • Senior lien holders with due dates

  • Other escrow payment requirements

  • Maturity dates on securities

  • Extensions of mortgages

  • Court dates for appearances and filings

  • Tracking pertinent indices for adjustable rate changes

  • Appraisals

  • Any other important time-sensitive matter.

Initial Notices

This section regards sending out initial notices to borrowers and various other parties regarding a bank’s failure.

As soon as possible, account officers should send notices that the liquidation office has assumed responsibility for a closed bank.4 Depending on the specific circumstance, the following should be included as appropriate:

  • Letters to all borrowers, endorsers, and guarantors

  • Notice to all users of bank-owned property, indicating that subsequent rent or lease payments are to be paid to liquidation office

  • Notice to all firms holding securities for the failed bank

  • Notice to all relevant utility, service, and supplier companies

  • Notice to customers leasing safe deposit boxes (if there is no acquirer)

  • Notice to insurers to cancel coverage when the liquidation office has policies in effect

  • Notice to insurers to include coverage as necessary on assets acquired

  • Notice to insurers of collateral to replace loss payee with liquidation office

  • Notice to attorneys, legal firms, and collection agencies engaged by failed bank for collection of debts

  • Notice to all loan participants

  • Notice to all senior lien holders of junior lien positions as the information becomes available.

Borrower Communications

Account officers should make every effort to contact borrowers and guarantors as soon as possible and to develop and maintain lines of communication. Borrowers will be required to provide information essential to the asset collection process. Account officers may need to remind stubborn borrowers that without their cooperation it may be impossible to approve any asset resolution, which could lead to legal action. Although borrowers are entitled to continue making payments and abiding by the terms of the note, it may be prudent to suggest that the borrower attempt to refinance elsewhere, in order to cultivate a new banking relationship.

Good Faith Negotiations

All negotiations with borrowers must be conducted in good faith. Account officers must be very careful to keep all parties involved in any negotiations fully informed. If an asset in current negotiations is under consideration for inclusion in an asset marketing pool of assets, the asset should either be excluded, or notification given to the borrower.

Initial Asset Review

The account officer should quickly become familiar with each asset in his or her portfolio. Whether from the closing of a new bank, or a transfer from another account officer, all available files should be reviewed in order to prioritize their workload.

One logical way to determine workload priorities is to identify those assets that pose imminent financial risk to a liquidating operation. Examples include assets in foreclosure, assets with unfunded commitments, incomplete construction loans, assets in litigation, etc. Assets in these categories have the potential for causing significant losses if timely disposition strategies are not closely monitored. Once priorities are established and portfolios stabilized, the account officer can strategize for the remainder of the portfolio (e.g., address obstacles, anticipate deadlines, and implement disposition strategies).

Disposition Timelines

Timelines for asset disposition were stipulated above; however, very often, an account officer will be successful in disposing of an asset in less time than is indicated in the guidelines. Timely access to meaningful information is key to the speedy resolution of assets. Information that is helpful in the collection of a nonperforming loan, for example, may include appraisals, asset and lien searches, borrower and guarantor financial information, business cash flows and financial data, title reports, and credit reports. Additionally, as appropriate, a representative from the legal division should be included in the process as soon as is practical.

Applying Loan Payments

Unless the note provides to the contrary, loan payments should be applied first to advances (if any); second to accrued interest; and third to the principal balance.

Interest on loans should be computed on a 365-day basis, unless otherwise specified in the note. Indexed interest rates, similarly, should adhere to the stipulations of the note. In cases where the failed bank indexed interest rates according to an internal calculation that cannot be duplicated, the rate should be indexed to the standard prime rate most widely used, with appropriate documentation to that effect.

Late charges, delinquency fees, default rates of interest, and prepayment penalties should likewise be assessed only as permitted by the terms of the note. Account officers should keep in mind, however, that waiver (under proper delegated authority, of course) of some or all of these fees can be an effective tool in negotiating disposition of an asset.

Documentation

To ensure that the portfolio is managed appropriately, each asset should have a disposition strategy. Account officers should maintain complete notes regarding all communication and actions taken concerning the asset in order to provide a clear understanding of the asset, the actions and activities taken to date, and the disposition plan. Any disposition short of full payoff should be properly documented with a case memorandum approved by the proper level of delegated authority.

Loan Collection

Generally, liquidation office policy should be to collect all loans in full; however, in some situations it will be prudent to consider settlements, compromises, modifications, and writeoffs.

Different categories of loans may require slightly different techniques and actions for collection, but the following general guidelines can be applicable for all types. The account officer should be familiar with all loans in his or her portfolio and understand any special collection requirements of each.

After the initial contact letter, borrowers need not be contacted as long as their loans remain current. The closing of a bank does not automatically cause obligations to mature or accelerate; therefore, a borrower cannot be forced to pay a note prior to its maturity unless some act of default has occurred. Current loans should be handled according to the terms of the note, with the account officer ensuring that proper and timely documentation is received.

By emphasizing the benefits of refinancing, however, sizable collections can be accomplished at the outset for loans in disposition. The following are persuasive arguments that encourage loan refinancing:

  • The bank that made the loan is out of business and no longer able to provide extensions of credit and provisions for continuing bank services.

  • The loan may be sold to an out-of-area investor.

  • Interest rates for refinancing may be lower than the rate on the existing note.

Account officers should emphasize that borrowers look for a new bank that can provide continuing service. Sometimes refinancing is done quickly and easily, especially when a borrower has a relationship with a number of banks. More difficult situations involve “one bank” borrowers who have to establish new banking connections, who are marginal credit risks, or who have little to offer in the way of deposit balances.

Prior to maturity and when a borrower is unable to refinance the obligation at another bank, the account officer should attempt to work with a cooperative borrower to extend or modify the loan. The goal of the modification is to have the borrower continue to make payments under the obligation and to create a marketable loan. To the extent necessary and possible, deficiencies in loan file documentation should be addressed and corrected at this time. Foreclosure or seizure of collateral should be undertaken only as a last resort.

Reminder Notices

The account officer should send a reminder notice when a loan is seven to 10 days delinquent. The notice should be polite and short. If a loan becomes 10 to 15 days delinquent, the borrower should be contacted by telephone. The telephone is probably the most effective means of mild collection action. On the initial telephone call, it is a good idea to verify file information and obtain additional information such as nature of employment, payday, etc. Other than verifying information, the account officer should:

  • Identify the borrower.

  • Tell the borrower who is calling.

  • State the purpose of the call.

  • Establish the reason for delinquency.

  • Obtain a commitment to pay by a definite date.

  • Document the information in the asset file.

At this stage, it is appropriate to suggest that the loan be refinanced at another bank. A telephone call should be supplemented with a follow-up letter that recaps the commitments made over the telephone.

Unresolved Delinquencies

When a delinquency remains unresolved for 30 days or longer, a delinquency letter should be sent to the borrower. The letter can be a form letter. It should refer to the delinquency and list the penalties that apply:

  • Repossession of collateral

  • Acceleration of entire debt

  • Legal action to enforce collection.

The letter should be the final step before aggressive collection action is taken. An alternative is to use two such letters before moving to aggressive collection action, one at 30 days, and one at 45 days, with personal contact, if appropriate, between the letters.

At this point, it is advisable to begin preparations for more stringent collection efforts. These actions could include, but are not limited to:

  • Detailed financial analysis of existing financial statements

  • Asset searches

  • Appraisals of any collateral and other assets owned by the borrower that may be attachable in litigation.

When a loan has become 60 days delinquent, the account officer should review the loan file thoroughly in preparation for aggressive collection efforts. Loan and collateral documentation should be checked for completeness. A threat of litigation can be an effective negotiating tool; however, it should not be used lightly. Legal action should be the last resort in the asset disposition process. Consequently, the account officer should review loan modification or settlement alternatives, whenever possible, before legal action is begun. An analysis of the net present value of the various scenarios (loan modification, settlement, foreclosure, litigation, or bankruptcy) often provides the economic justification and substantiation to effectuate a settlement or loan modification.

A final and formal demand letter should be sent to all persons liable for the obligation: borrower(s), co-maker(s), endorser(s), and guarantor(s). The letter should be sent by certified and regular mail. It should describe the delinquency, give a short period of time to cure it, and set forth the intended actions if the delinquency is not cured. This letter should be the final step before repossession of collateral or submission to legal counsel for suit.

If the borrower responds after a referral to legal counsel, but before action has been taken, the attorney should be notified that negotiations are in process and that no further action should be taken until it can be ascertained if the borrower is negotiating in good faith. A short time frame (e.g., 15 days) should be established to make that determination, during which time the account officer should handle negotiations. If the negotiations are not in good faith, litigation should immediately be resumed.

Advances

The account officer may occasionally need to advance funds to pay delinquent property taxes or loss/damage insurance policy premiums. When making such advances, the account officer should always demand immediate repayment from the borrower. If the borrower fails to repay the advance within 30 days, it will be considered a default and the advance should be added to the loan. The account officer should work closely with the accounting department for proper accounting of advances.

Skip Tracing

If a borrower has apparently skipped, or disappeared, a thorough effort should be made to locate the borrower before a decision is made to take no further action on the loan, particularly if collateral or sizable sums are involved.

Loan Valuation

Proper credit decisions require the evaluation of collection alternatives on a comparable basis. Present value techniques can assist in determining the courses of action most advantageous to asset liquidation.

The first step in loan valuation is to determine whether the loan is performing, subperforming, or nonperforming. The following definitions are intended for valuation purposes only, and should not necessarily be used with other collection activities. For example, a subperforming loan, by definition, may actually be currently performing. Also, the nonperforming loan definition includes loans that are past maturity, but with borrowers making ongoing payments. Although the liquidation scenario is used in the valuation methodology for such loans, that may not be an alternative under consideration given disposition guidelines. As with existing loans, contemplated restructures should be classified as performing or subperforming to determine the appropriate valuation method.

A performing loan is defined as a loan that is paying as agreed (less than 60 days past due) and is expected to pay in full under the terms of the note. Past delinquency or file documentation problems do not disqualify a loan as performing (although they may have an effect on the discount rate used to calculate the market value).

A subperforming loan is one where the borrower is making reduced payments consistent with historical financial statements or is presently performing, but projected to ultimately default due to a severe negative event in the future. This event may occur for a variety of reasons, including a known major tenant move-out, a step-up in debt service payment, or a balloon payment coupled with a poor loan-to-value ratio (LTV). If the LTV is greater than the percentages listed in Table 7.2, it is considered poor.

TABLE 7.2

Property Type and Loan-to-Value (LTV) Ratio

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A poor LTV however, does not in itself classify a loan as subperforming. Account officers should also consider whether the borrower has the financial capacity to fund the debt service from sources other than the property.

A nonperforming loan is one that is 60 days or more past due or is past the note (or modification) maturity date, regardless of whether or not ongoing payments are being received from the borrower.

Valuation of Performing Loans

The market value of a performing loan is calculated through a mark-to-market process in which the remaining payments are “present-valued” using current market yield requirements for similar loans. The current market yield is comprised of a base rate, which is the rate for good quality, market-standard loans, and an adjustment for the characteristics of the specific loans.

The base rate may be well defined for some loans, but estimations may be required for loans with more unique terms. The base rate may be determined either through recognized publications that quote comparable rates, or through surveys of local lending banks. A register indicating dates and names of contacts should be maintained as part of the credit file for the latter.

Once the base rate is determined, specific characteristics that affect the required yield should be identified through a review of the loan files and the payment histories. These characteristics include delinquency rates or deficiencies related to missing documentation such as financial statements, the original note or credit agreement, current collateral appraisal, or credit file. A further adjustment may be required for geographic location if the base rate does not reflect local lending practices. The current market yield is the result of adjusting the base rate for any of these characteristics.

Valuation of Subperforming and Nonperforming Loans

The valuation of subperforming and nonperforming loans is based on a net present value of estimated cash recoveries in a liquidation scenario, broadly defined as the cash flows identified with the foreclosure/repossession, holding and sale of pledged collateral, and the collection through litigation from identifiable assets of the borrowers or guarantors. By using a liquidation scenario, decisions regarding a compromise, restructure, or sale of the loan are based on the same established value. It is also useful when the account officer considers other alternatives or to develop a realistic counteroffer to a cash offer by the borrower.

To calculate the net present value of estimated cash recoveries, it is necessary to project all cash flows and discount them. When estimating cash flows, consider all potential sources of recovery, including existing collateral, as well as other attachable assets of the borrower or guarantors. (Recovery may also result from the income of operating properties during the estimated holding period.) Collateral values should be based on current appraisals, while recoveries from other sources require a more subjective analysis based on available information such as financial statements, credit reports, or asset and lien searches. As with collateral, recoveries from other sources should follow a liquidation scenario, such as obtaining and executing a judgment, and not the compromise of a deficiency balance. All analysis regarding the estimated recovery should be fully documented in the file.

Direct cash collection expenses include legal fees, advances, payment of prior liens, foreclosure costs, selling expenses, appraisal fees, operating expenses, management fees, and any other applicable direct cash expense. No deductions should be made for indirect expenses such as internal overhead or the administrative costs of doing business.

The timing of estimated cash recoveries and expenses depends on foreclosure laws, litigation and bankruptcy scenarios, and the estimated selling time for acquired assets. Generally, liquidation accounting is performed on a cash basis, not accrual. Therefore, cash recovery should be listed at the time of sale, not at the time of foreclosure. Similarly, expense for the estimated recoveries should be placed in the periods in which they are expected to occur. For example, payments of prior liens will normally occur at foreclosure, while management fees, appraisal costs, etc., may be incurred before the property is sold.

If a projected recovery is based on the questionable outcome of a court decision, the estimated recovery should reflect the legal department’s assessment of probable success. The percentage provided by the attorney should be applied only to those cash flows resulting from a successful outcome. It would not affect any recoveries or expenses leading, or unrelated, to the court’s decision.

The documentation required in estimating recoveries can vary depending upon the size and type of the loan. For large loans, however, documentation should be adequate to establish the recovery estimate. Whether compromising, restructuring, or selling a loan, every effort should be made to obtain valid appraisals, asset and lien searches, credit reports, and financial statements. The increase in sales price or the ability to negotiate a more favorable disposition usually outweighs the time and costs associated with obtaining the documentation for an accurate valuation.

Discount rates used in present value calculations measure the potential risk associated with sources of recovery and the timing of the projected cash flows as well as an appropriate return on investment. For example, less risk should be associated with estimating recovery on a mortgage loan with a current appraisal on file than with an unsecured loan with an outdated financial statement. Although it is virtually impossible to deal with all categories of estimated cash recoveries, Table 7.3 gives a few examples of how discount rates might be calculated.

TABLE 7.3

Examples of Discount Rate Calculations

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Pooling Assets for Sale

There can be economies of scale, both for the liquidator as well as the purchaser, if assets of a similar nature, such as real estate mortgage loans, commercial loans, and/or installment loans are packaged and sold as a loan pool. In these circumstances loans are often pooled as to specific type, and depending upon the interested parties, the loan pools may also be organized as to duration (maturity), type of collateral, interest rates (fixed/variable), etc.

In order to provide maximum transparency, the liquidator would provide an advertisement/legal notification in a local paper of general circulation and/or perhaps a business journal announcing the proposed auction (sale). It would provide all interested parties with the same set of informational materials, which could include, by loan, the name of the debtor, loan amount, collateral type, interest rate, and payment history. Prospective purchasers would make assumptions about the collectability of the loans and make a sealed bid accordingly.

Participations

Whether the inherited role in a participation loan situation is as lead lender or not, certain responsibilities and risks are assumed. The account officer should review the participation agreement to determine the specific fiduciary responsibilities. Lines of communication with other participants should be opened and maintained.

At a minimum when in the lead position, reasonable care and judgment in collecting the loan, managing the property, and keeping other participants informed should be exercised. When not in the lead position, the account officer should assure that all applicable documentation is obtained. In all cases, complete notes regarding the situation and any actions on the asset should be maintained in the asset file.

Unfunded Loan Commitments

Unfunded loan commitments, such as construction loans with construction activity in progress, land development loans, bridge loans, or letters of credit, may exist when a bank fails. Care must be exercised to ensure that the economic interests of the receiver are not threatened by the curtailment of funding. Prompt communication with the borrower immediately following the bank closing is paramount and should be fully documented in the asset file. Decisions to fund or not fund these commitments must also be fully documented in the asset file along with detailed information supporting the decision.

Clearly, the receiver must not continue financing ventures if no legal liability exists and the economics of the project do not support further advances. However, it is important to support those decisions with the same degree of care exercised when making decisions to continue funding. A decision either way should be clearly documented in a case memorandum reviewed by legal counsel and approved under the proper delegated authority (see Chapter 6).

Judgments, Deficiencies, and Charge-offs

Judgments, deficiencies and charge-offs (JDC) represent assets that may or may not be reflected on a failed bank’s books; however, these assets must be reviewed to determine the appropriate disposition strategy.

Account officers should work JDC assets within the liquidation office under the following circumstances:

  • If legal reasons preclude the sale or transfer of such assets

  • If other compelling business reasons indicate that the asset should be worked in-house. Some examples are if a judgment’s estimated recovery is substantial and is expected within a reasonable time frame, and cases of JDCs related to non-JDC assets where transfer of the JDC asset would be detrimental to a global settlement or other disposition of the combined assets

  • Any newly acquired judgments should be immediately and aggressively pursued. When deemed appropriate, these assets should be sold on the open market.

Otherwise JDCs should be packaged and sold. Because pricing of these assets is often difficult to establish, it may be advisable to enter into a revenue-sharing partnership agreement with an investor. This allows the liquidation office to share in the collections on such assets and mitigates the risk that only the purchaser will benefit from potential collections or settlements that exceed estimates.

Owned Real Estate

A liquidation office acquires real property through various methods, such as from a failed bank, foreclosing on collateral, or as part of a settlement agreement. Since the goal is not to acquire and manage real property, the real property should be promptly disposed of at the highest return possible. Owned real estate property is typically sold “as is,” although repairs may be completed to protect value or to comply with health, safety, or code concerns.

The primary objective in the management of owned real estate properties is to maintain or enhance value while not adversely affecting market stability. Proper management will provide that property does not suffer depreciation from neglect or other controllable causes, and that necessary steps are taken to preserve or enhance marketability.

Any cash flow of the property should not be allowed to deteriorate. Failure to responsibly manage an owned real estate property can directly or indirectly cost significant funds or cause additional loss.

On acquisition of a property, an owned real estate account officer should assess its status and initiate efforts to:

  • Enhance cash flows that may accompany ownership

  • Reduce and prevent hazards to human health and safety

  • Take prudent action to minimize exposure to liability and risk.

Any existing property management contracts involving owned real estate should be reviewed as soon as practical upon acquisition. Evidence of fraud, incompetence, or conflicts of interest should lead to immediate replacement of the contractor. Potential recovery of lost funds should be pursued.

Other issues to be addressed by the account officer include, but are not limited to, the following:

  • Obtaining appropriate property and liability insurance coverage for each real estate asset

  • Obtaining current appraisals

  • Ensuring property taxes are paid

  • Obtaining appropriate approval of an owned real estate budget for the property

  • Arranging for on-site management of the property

  • Developing an appropriate leasing plan for income producing property

  • Developing and implementing an appropriate marketing strategy

  • Updating files

  • Ensuring environmental issues are addressed

  • Making site inspections, including visiting with property managers and tenants, as applicable

  • Preparing the property for sale, including checking status of title, liens, etc.

The responsibility for the management of owned real estate assets should be assigned to knowledgeable staff familiar with the type of property to be managed. For example, management of hotel properties requires extensive knowledge of hotel operations and franchising; large office buildings and retail centers require understanding of commercial lease agreements; and handling of raw land assets is helped by the knowledge of environmental, development, and zoning issues. Therefore, it is highly recommended that a third party with requisite expertise be hired to manage the day-to-day operations of the asset, particularly income producing property. In conjunction with this, account officers should ensure that:

  • All expenditures are properly approved under delegated authority

  • The overall efforts of third-party vendors, such as property managers, appraisers, brokers, site inspectors, and auditors are coordinated and managed

  • There is timely disposition of the asset at current market value.

Subsidiaries

An investment in a subsidiary refers to the ownership that a failed financial institution has in a separate and distinct corporation. The subsidiary may have been formed to insulate the financial institution from liabilities associated with financial, environmental, and construction defects, as well as legal obligations, arising from a particular business venture or asset. Alternatively, it may have been formed when a financial institution wished to expand its operations into areas that were not allowed by law and formed a separate corporation to carry out the particular business activity.

A subsidiary is a legal entity subject to the laws of the country where it is incorporated. Subsidiaries may be:

  • Real estate related

  • Securities firms

  • Real estate development companies

  • Insurance companies

  • Small business investment firms

  • Agricultural credit corporations

  • Other types of lending institutions.

At the heart of the parent/subsidiary relationship is the parent shareholder’s limited liability for the actions taken by the subsidiary corporation. If the law is adhered to, the parent generally will not have liability beyond its initial capital investment in subsidiary stock. This concept of limited liability is often referred to as the “corporate veil,” indicating that the actions of the subsidiary are separate and distinct from those of the parent shareholder through the imposition of a legal barrier.

The court generally recognizes the separate existence of a subsidiary as long as the corporate formalities under applicable law are observed. A parent shareholder may be liable for the debts and liabilities of a subsidiary corporation if a creditor brings a successful legal action to “pierce the corporate veil.” Although there are different legal theories under which the action can be brought, the most common alleges that the parent corporation exerted such pervasive control over the subsidiary’s actions and assets that the court is justified in disregarding the legal barrier between the two entities.

Depending upon the size of the financial institution, there may be multiple or tiers of subsidiaries, meaning subsidiaries that are themselves owned by other subsidiaries; this arrangement is referred to as a multi-tiered subsidiary. Depending upon the number of shares held, a subsidiary may be wholly owned (100 percent), majority-owned (greater than 50 percent) or, in rare instances, minority-owned. Under applicable securities law, the concept of “control” as a shareholder is different from whether the shareholder owns a majority of the shares of stock. Court cases show that a minority interest (less than 50 percent) can still “control” the election of directors and, through them, corporate governance and policies if there are no other large blocks of stock held by any one investor or groups of investors. A “controlling interest” is defined as owning or controlling 50 percent or more of the outstanding voting shares.

The Legal Department should be consulted concerning the rights of minority stockholders before taking any shareholder action. These rights are prescribed by law, articles of incorporation, bylaws, or by contract. Finally, apart from an equity interest, the financial institution also may have been the subsidiary’s lender or served as the guarantor of the subsidiary’s debts. The Legal Department should be consulted so that a strategy can be developed to balance those interests.

Situations may arise when a subsidiary is first acquired or discovered that require immediate or emergency action. Therefore, it may be necessary to seek authorization to take action to ensure that the subsidiary operates legally and in the best interest of the corporate entity and its shareholder(s). Such situations may include electing directors, authorizing emergency funds for operating the subsidiary, or handling litigation.

The objective of the Subsidiary Due Diligence Review Checklist (Annex 3.23 in Chapter 3) is to perform a comprehensive analysis that evaluates all aspects of the subsidiary, including each asset and liability. The due diligence review is critical to the disposition of a subsidiary. Omissions or mistakes in the initial review of a subsidiary’s assets and liabilities can result in significant liabilities being transferred to the receivership. Based on the results of this review, a comprehensive Business and Disposition Plan (Annex 3.24 in Chapter 3) should be prepared for each subsidiary.

The analysis should answer two basic questions: (1) Is the subsidiary corporation necessary? and (2) Can it survive without funding from the parent? If the answer to either of these questions is no, the subsidiary may be a candidate for dissolution. Finally, sound subsidiaries having value as “going concerns” should be kept intact to maximize their disposition value.

DELEGATION OF AUTHORITY

The liquidating authority has a responsibility to provide comprehensive and well-reasoned delegation of authority to conservators or liquidation team directors. This policy can expedite good business decisions while providing for a more timely liquidation of assets as well as operational and administrative decisions. Managers who have demonstrated skill in asset liquidation should be trusted to act within the best interests of the liquidating authority when making decisions regarding settlements, compromises, write-offs, etc. Similarly, experienced operations managers should be empowered to lease office space, award contracts, etc.

The liquidating authority delegates the authority to conduct operational matters and asset management and disposition functions on its behalf to a conservator or a liquidation team director. The conservator or liquidation team director may redelegate authority to various managers and/or committees to allow decisions to be made at the appropriate level in the organization.

The conservator or liquidation team director can establish a credit review committee (CRC) to approve certain matters under delegated authority. The conservator or liquidation team director may delegate any or all of their authority for asset disposition matters, subject to any specific limitations imposed by the delegation of authority. The conservator or liquidation team director (or desig-nee) should serve as the chairman of the CRC. Voting members should be selected from high-level managers of the credit department of the organization, although the conservator or liquidation team director may decide to include additional voting members.

Similarly, an operations review committee (ORC) can be established to de al with operational decisions. Most decisions requiring action under delegated authority, however, are credit-related matters.

The conservator or liquidation team director should have broad delegation of authority for asset disposition and operational matters. Generally, his or her individual approval should be limited to emergency actions. The appropriate committee (CRC or ORC) should approve, reject, or concur in the most significant asset disposition matters.

The CRC should meet often enough to ensure timely action on all asset-disposition-related matters. It is the manager’s responsibility to notify the conservator or liquidation team director of the need for any emergency meetings to expedite critical matters. The CRC that holds the proper level of delegated authority shall be the final authority to approve, reject, or concur on those actions before them. A secretary should be appointed for the CRC meetings and appropriate records (see next section on the case memorandum system) maintained to document all actions. The minutes should reflect the members present and the vote of each member on each case considered at the meeting.

Senior management should review all decisions over a certain amount. Amounts should be high enough that senior management is not swamped with routine decisions. Written procedures should be developed for dealing with delegation of authority violations. Delegation of authority should be periodically reviewed to determine if any adjustments are necessary.

Below are excerpts from a recent example of the FDIC’s delegation of authority. The example may include references that may not necessarily be applicable in other countries (e.g., compliance with U.S. employment legislation), but the framework can provide an excellent pattern for the conservator or liquidating authority to develop customized delegation of authority for the local situation.

The FDIC’s delegation of authority is coded C for conservatorship or liquidation activity and F for legal activity. It usually contains a matrix delegating authority up to a certain monetary amount (usually book value) depending on an employee’s position.

The paragraphs below are selected examples of the delegation of authority that should probably apply in any conservaxtorship or liquidation activity.

C (1) provides for an organization “…to take all other appropriate action with respect to assets…” This language allows the office to use C (1) as a source of authority separate from other delegation if the book value of the asset is less than the stated C (1) authority. In such circumstances, C (1) may be used to authorize certain actions so long as the effect is not to override or render a more specific delegation meaningless.

Additionally, C (1) provides authority to compromise, abandon an asset, and release guarantors, etc., whenever the book value of the asset does not exceed a specified amount. All assets connected to a single borrower (a credit line) must be combined when determining the appropriate level of delegation. The aggregate total of assets owed to a particular failed bank shall be the determining factor. The procedure for determining a credit line will apply to multiple assets connected with a single maker. The credit line should not be inclusive of other debt associated with guarantors that is unrelated to the maker.

Sales of owned real estate and personal property must be approved under C (2).

C (3) is used to approve expenditures in a specific amount per calendar year for the protection of any asset. These disbursements, which must be supported by the proper receipts, invoices, etc., may include appraisals for real and/or personal property, asset searches, title reports and/or searches, environmental reports and checklists, and real property taxes. (Payment arrangements should be implemented in cooperation with the accounting department to allow proper tracking and monitoring of asset-related expenses.)

Loan sales are authorized under C (9) for performing loans, and C (10) for performing or nonperforming loans. Although C (9) authorizes noncompetitive sales, it should not be interpreted as encouraging noncompetitive sales. Non-competitive sales should be limited to sales where it is clear a competitive sale will not improve the price (such as the sale of student loans to the insurer at par). In determining the appropriate level of delegated authority for loan sales, the aggregate book value of all loans being sold is to be used rather than the individual book value of each asset.

If an offer is received to purchase loans of a borrower as a direct result of the borrower’s attempt to refinance or compromise the obligation, there is probably a relationship between the borrower and third-party purchaser. Transactions of this nature should be treated as a compromise under C (1) and should be supported by the required elements of a compromise case (e.g., current financial statements, affidavits, tax returns, etc.).

The write-off of any asset categorized as nondiscretionary is authorized under C (25), regardless of book value, as specified in Table 7.4.

TABLE 7.4

Basis and Requirements for Write-offs by Type of Asset

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Delegation C (26) provides the authorization to fund loan commitments that were originated by the failed bank.

The decision to repudiate a commitment is governed by C (36). Repudiation decisions are based on book value plus the remaining unfunded commitment. In the case of continued funding, however, decisions are based on the remaining amount of the unfunded commitment at the time of acquisition. If multiple commitments have been made to a single borrower, then the aggregate of these commitments should be used for determining the appropriate level of delegated authority.

Delegations F (1), F (2), F (4), and F (5) involve litigation-related actions that require the joint approval of liquidation staff and legal staff with the appropriate delegated authority:

  • F (1) governs the initiation of any litigation arising from liquidation activities.

  • F (2) applies to the settlement of litigation and is referred to as “nonasset” litigation. (The settlement of asset-based litigation is generally accomplished under C (1) with the concurrence of the legal division.)

  • F (5) provides joint authority to settle nonasset litigation against directors and officers and against professionals such as attorneys, accountants, and appraisers.

  • F (4) deals with the dismissal of individual defendants from a lawsuit, as distinct from dismissal of the entire case.

CASE MEMORANDUM SYSTEM

This section sets forth the procedures to take action, whether on an asset or operational matters, under delegated authority. An official paper, known as a case memorandum (or case), should be prepared and submitted to the proper authority to request approval for the proposed action. This document will also serve as a record for action taken under delegated authority. (Of course this documentation should be adapted to the local situation; for example, a bankruptcy court may require different information and/or format from the bankruptcy administrator.)

The case memorandum system provides a consistent method to document the facts and circumstances leading to decisions and actions during the conservatorship or liquidation process. A case memorandum is properly used for operational and asset disposition matters. It should clearly and concisely present:

  • Reference to specific delegation of authority

  • Basic facts, including full asset description as applicable

  • Background information concerning alternatives and options (including any offers made and rejected in the process)

  • Discussion of the merits of the proposed action compared to alternatives

  • Justification

  • Substantiation.

These factors should be carefully evaluated when reviewing a case. The most important function of the reviewer, however, is the evaluation of the business decision.

Cases should be tracked and recorded by assigning a case number to them. The system serves as a record to explain and justify decisions to those who may have an interest in, or a right to know, what is occurring in the bank. It also identifies those persons who have recommended, approved, and reviewed the decisions.

Case memoranda identify decisions clearly and serve as authorizations for subordinates to act. They are the means of initiating the decision-making process under delegated authority. The most knowledgeable functional representatives (of the subject matter) should prepare the case memoranda. The cases should be as complete as possible, providing lucid reasoning to the decisionmakers.

An effective case memorandum should stand on its own merits, written so that individuals without extensive financial training or intimate knowledge of the bank can clearly understand it. Bear in mind that someone who may be acting in the public interest or some other fiduciary capacity may review the document at a later date.

The objective is to provide a logical analysis for decisionmaking, and to produce an understandable audit trail. The case memorandum system is a clear-cut permanent record of the decisions and actions taken during the bank’s rescue or liquidation period.

Some examples of actions or conditions where a case memorandum is appropriate (or required, depending on delegated authority) are:

  • Initial operating budget

  • Staffing cases

  • Engagement of a professional firm or service company

  • Discharge of an employee

  • Monthly budget.

Other examples, depending on the book value of the asset and related lines, are:

  • Sale of an asset

  • Agreement to compromise, settle, or restructure a loan

  • Foreclosure of property.

In summary, any significant action taken by the conservator or liquidation team director during the course of the rescue or liquidation should be recorded in case memorandum form.

The paragraphs below outline a suggested case memorandum format. The format may be varied by policy or by the writer to include additional identifying or statistical information, additional review/concurrence lines, or other modifications for clarification. Whatever changes are made to its format, it should still contain the necessary information outlined below.

Memorandum heading. The heading should reflect a unique case memorandum number and the date the case was completed and ready for signatures. It should identify the bank, also by unique number, and whether the bank is in conservatorship or liquidation. It should be addressed to the lowest-ranking official who has delegated authority for the proposed action. The writer should be identified. The subject line should clearly identify the matter under discussion, including the asset name and number, if applicable.

Proposal. This section should contain the specific action(s) for which authority is requested and should relate solely to the delegation of authority being requested. It should be explained in a concise, direct manner, usually no more than two sentences. It should also identify the individual responsible for carrying out the action and include a completion date.

Executive summary. A concise summary of the proposal that highlights significant issues and provides a brief justification for the action should be presented here. This section may include relevant background information, but only facts that are relevant and necessary to substantiate the proposal.

Legal issues. For cases involving outside counsel, provide the date of referral, legal fees expended to date, projected legal fees, and projected date for completion.

Description. Fully describe the subject matter of the case as comprehensively as possible. For example, if the case concerns deposit payouts, give full information about all the deposits of the bank, by categories, numbers, and balances of deposits. For all cases involving specific assets, provide a detailed description of the asset, including book value, accrued interest, unpaid interest, delinquency, and detailed description of all collateral, as well as legal description, appraised value (and date), unpaid taxes, prior liens, and any environmental problems. Also include information regarding expenses to date and projected.

Background. This section provides detailed information necessary to understand the recommendations and the context for making them. Include the history of the asset, origination date, purpose, description of the borrower, and a concise summary of past actions taken on the asset. Identify any other alternatives or proposals.

Discussion. This section should be limited to relevant facts that substantiate the recommendation and defend it when compared with other alternatives. Information that may be included here would be the financial condition of the borrower, the appraisal of the asset (along with date, name of appraiser, valuation, method of valuation, and any analytical objections to appraisal). Subheadings, such as environmental analysis, legal analysis, and marketing strategy, may be used to keep the case organized and flowing. The positives and negatives of each alternative to the disposition of this asset, including those you are not recommending, should be fully discussed.

Conclusion. A succinct summary of the points covered in the case, which logically proves the good business judgment of the proposed action, should be presented here. Discuss the negative effects of failure to take the proposed action. Show the benefit to the liquidating authority. New information should not be offered in this section.

Date for action to be completed. Specify the date by which the action can be completed and whether or not extensions will be permitted.

Signatures. The writer of the case will sign under a “recommended” heading. All supervisors or representatives of credit committees who are to sign the case under delegated authority should be listed under a “reviewed” or “concur” heading. The lowest level supervisor with delegated authority sufficient to approve the action should sign under an “approved” heading. Finally, there should be a heading for “action completed” where the individual responsible for carrying out the action will sign upon completion.

Generally it should not be necessary to provide attachments to the case. All supporting documentation should be available in the asset file for reference, and it is the responsibility of the first-level supervisor to ensure that all facts are accurate.

Annex 7.1 provides a few sample cases that demonstrate the format and reasoning behind the system.

Case Memorandum Logs (Annex 7.2)

At the institution. A case memorandum log is required to be maintained in the institution. The log should list all case memoranda in numerical order, showing the date submitted, the date approved within the bank, the date the case memorandum was sent to the agency, and the action completed date.

At the liquidating authority. A case memorandum log should be maintained at the liquidating authority, segregated by each institution for which the liquidating authority is responsible. It should list all case memoranda in numerical order (by bank), showing the dates the case memoranda were received, date reviewed, and date approved (as applicable at the liquidating authority).

Case Memoranda Retention

Originals of all cases (including those not approved) on which decisions have been made by the conservator or liquidation team director should remain in the official archives of the institution. Copies of all cases should be sent to the liquidating authority for review and retention. Management of the liquidating authority must establish the method and personnel to be employed in the review of these case memoranda, as they are completed in banks under their control. They will also determine a schedule for the submission of cases, and for notifications to the banks when the reviews have been completed.

REPORTING

The conservator or liquidation team director must maintain an effective reporting system. The liquidating authority’s fiduciary capacity and, in fact, good business sense require it. The conservatorship or closed bank needs to keep track of assets liquidated, creditors paid, and progress on the liquidation.

When compiling a standard report, such as “collections by asset type,” it is important to indicate gross cash receipts, because postings to interest and/or principal can sometimes be very arbitrary. Gross cash receipts generally give a more accurate representation of the effectiveness of the liquidation process.

Information necessary to calculate the expense-to-collection ratio is another important factor for reporting considerations. This measurement should not be relied on exclusively, however, because as long as collections exceed expenses, it is worth doing. Usually, liquidators are guided as to which option of liquidation to use by the concept of maximization of liquidation return, based on a present value calculation. Book value reduction should not be overemphasized because it will often result in more writeoffs than cash collections. Write-offs need to be looked at in conjunction with cash collections in order to gather the clearest picture.

Other reports that may prove beneficial include reports on asset sales, owned real estate sales, actions taken under delegated authority, and assets in litigation. Other nonasset-related reports could include outstanding settlement issues with acquiring banks, claims filed, approved and disapproved, and periodic financial statements from the accounting department.

Additionally, there should be special reports on any very large or sensitive assets from any individual bank. This would include large assets that are in litigation or important settlement or workout negotiations. Sometimes one asset can account for more book value and expense than all the other assets put together, and therefore may deserve the most time and attention, unless it is clearly uncollectible.

Some account officers or contractors will continually work worthless assets until they are told not to. Because of this, staff should make periodic reports regarding the estimated value of the assets. This can range from fairly rudimentary estimates to very technical ones (with computations of internal rates of return, estimating expenses, etc.). But even the best models are very subjective and often overly optimistic. Often, the most worthwhile estimated value report consists of the collector conservatively reporting his best approximation, based on available information.

To estimate the return using different disposition methods, and to track performance during the liquidation process, liquidators use a combination of spreadsheet-based tracking tools. An automated spreadsheet (e.g., Excel, etc.) listing each asset, its estimated liquidation value, the estimated time it will be turned to cash, and the present value based on estimated value and time can be utilized for reporting on a single bank liquidation. A typical spreadsheet would have column titles, resembling those in Annex 7.3. As assets are liquidated, estimated values and dates are replaced with actual dates. A “totals” calculation at the bottom of the spreadsheet summarizes the recovered amount and timing of the entire bank liquidation portfolio.

Similarly, the report can be modified to combine the individual bank’s recovered amounts to generate an aggregate report for all liquidated banks. With this summarization, it is possible to project total recoveries as well as the liquidation balance sheet today and in the future. Actual performance should be tracked against the last quarter’s projection in order to further hone estimated recoveries based on new information.

Sometimes it may make sense to combine assets from different banks in liquidation to assemble a more attractive portfolio for sale (pooling method). And sometimes an outside contractor is hired to liquidate assets from many different banks. In either of these situations it may be impossible to perfectly allocate the proceeds to individual credits or banks. In such circumstances, a proportional allocation is a legitimate method of reporting recoveries.

Monthly reporting on the collection and expense data should be adequate for effective monitoring. Reports containing value estimations can be required less frequently (perhaps quarterly), though direction should be given requiring adjustments whenever a tangible change occurs. A good reporting system should provide necessary information for management, but should not unduly burden the account officers to the degree that their collection efforts are impaired.

FILING SYSTEM

Filing is the systematic arrangement and classification of the information contained in active records for later retrieval. Those responsible for this task represent an important link in the chain of information handling. Without properly filed records, it is difficult and sometimes even impossible to make the decisions required for effective operation.

This section emphasizes the importance of an effective filing system for conservatorships and liquidation operations. It also explains the benefits of an efficient filing system and gives several filing tips.

A well-designed filing system must:

  • Simplify filing and offer quick and easy placement of retrieval of information

  • Assure integrity and continuity of record keeping (anyone must be able to retrieve the information they need at any time)

  • Allow for easy identification of inactive records.

The conservator or liquidation team director is responsible for the organization and maintenance of the files and documents of the conservatorships or liquidations. These files should include all documentation prepared before and during the intervention as well as all documents, including case memoranda reflecting any decisions or actions taken during the conservatorship or liquidation period.

The liquidating authority is also responsible for the retention and security of the files of the bank as found at intervention. This includes but is not limited to:

  • Asset and credit files

  • Financial statements

  • All working papers and other accounting information

  • Personnel records

  • Correspondence

  • Minutes of committees and boards

  • Policy and procedures manuals

  • Contracts for services

  • Leases

  • All other pertinent files of the bank.

The security of electronic files, computer systems, software and hardware, and documentation concerning these systems is also very important. Unless proper backup procedures for all systems in the bank are already in place, the liquidating authority should implement them.

Original documents regarding the analysis and discussion of cases and other actions should remain in the files of the bank under secure conditions. If any original documents must be removed from the bank for legal or supervisory purposes, copies should be made and retained. Individuals removing original documents must sign an official receipt form clearly identifying and itemizing the files being removed.

Keeping financial and business records is important, and having an organized filing system makes the records useful. Setting up a record-keeping system does not have to be a monumental task; it involves development of a policy and adhering to it.

Subject filing offers the most substantial advantages for effectively handling paperwork. Some initial steps are:

  • Develop a list of categories to use

  • Create a file folder for each category

  • Alphabetize the list on a computer file and then label each alphabetically

  • Make sure that documents are filed currently

  • Keep a master list on the file.

Some relevant categories for a bank in conservatorship or a closed bank are likely to be:

  • Chronological file of all correspondence

  • Chronological file of important internal memoranda

  • Notices and legal material from appointment of liquidating authority

  • All Intervention files

  • Media and public relations

  • Agent bank information (receipts, official signers)

  • Pro forma

  • Case management system

  • Committee minutes

  • Facility and equipment leases

  • Accounting records that back up the accounting transactions.

This is not an exhaustive list, but serves to give some examples of what a filing system should consist of.

The records should go into the folder in real time (i.e., as soon as received or, at least, after initial processing). The folder contents then end up in reverse chronological order, oldest at the bottom, newest at top. This standardization will make it easier to find retained documents more efficiently.

Procedures for files that are no longer “active” (i.e., not frequently referred to and not likely to be) are to:

  • Transfer the files to record storage boxes

  • Label the boxes with the contents

  • Store the boxes in a dry storage area.

Audit or other access to archived records is expedited and simplified.

Filing Tips

  • Manila folders, binders, and a 2-hole punch are fundamental filing supplies.

  • Create a file guide with a description of the official filing system along with instructions for users. Then, new personnel can begin and continue to use the filing system easily. This will also avoid the arbitrary creation of new file folders.

  • Create cross-listings to help locate items. Create a file database on a PC using file-folder heading, cross-listing, and location notes.

  • Spell out acronyms and abbreviations.

  • Sort records prior to filing.

  • Use staples rather than paper clips in folders.

  • Bind all documents into the folders. Do not place them in loosely.

  • Discard envelopes if the return address is available on the document itself. Most phone messages, illegible notes, and routine acknowledgments can also be discarded. Important information should be documented on a “memorandum to file” and included in the file.

  • Label and date all file folders. Develop a format for the subject on the tabs.

  • Use “out markers” when removing folders for use. This makes refilling much easier and lets others know that a file exists, ensures that another is not created, and indicates who has the file and when it was checked out.

  • If you must keep your semi-active records somewhere other than your office, keep a complete inventory handy. Include retention dates to keep track of when these records will be eligible for destruction.

  • Do not always save every draft of a document. For most purposes the final version is sufficient.

  • Do not file multiple copies of the same document.

  • Do not file periodicals or newspaper clippings unless you refer to them frequently. It may be more effective to create a library.

  • Some records seem to belong under more than one series or category. To handle this, file the records in one category and place a cross-reference note in the other. It is important to be consistent in deciding where to file records. Once information is filed in a given series and category, it should always be filed there.

  • Some records do not seem to fit conveniently into any series or category. If you need different categories, create them and place them in the appropriate series.

  • Color-coding the different series is a useful tool, especially for refiling folders.

  • Do not overstuff your file folders. If they are overstuffed, divide them into several folders with the same name and roman numerals (e.g., Credit Committee Case Memoranda, 1997, I… Case Memoranda, 1998, II). In cases like this, the file headings may be too broad. Being more specific may help. On the other hand, being too specific may result in one document per folder. Try to find a happy medium.

  • Do not overstuff your file drawers. This can make retrieval of files difficult, as well as create a dangerous work environment.

  • Purge files regularly, using established retention schedules. Send records scheduled for destruction to the records center for storage until their retention requirements expire. Send records scheduled for permanent retention to the archives.

ANNEX 7.1. SAMPLE CASE MEMORANDA

Sample Case Memorandum: Sale of Automobiles

PROPOSAL:

Dispose of the fleet of business automobiles owned and formerly used by the (name of institution). The automobiles will be offered for sale (cash only) as a group to qualified dealers. Three bids must be received or alternative marketing will be undertaken. The most advantageous bid to the Institution will be accepted. The sale will be consummated within 60 days of approval of the case.

DESCRIPTION:

The automobiles are:

The former executives and staff of the institution used these vehicles in the course of business. There is an active automotive market in , and the sale will be consummated in a short period of time. Estimated values have been determined by reviewing records of actual sales in the market in the past several weeks. The institution has the proper ownership documents for these vehicles.

DISCUSSION:

Because the bank has ceased operations, there is no need for these vehicles. In addition, the institution has been paying parking fees of per month at the garage where these vehicles are stored. Licensing fees, insurance, taxes, and other fees are being incurred while the vehicles are under its ownership. (Show as accurately as possible the actual amounts of these items, both here and in the JUSTIFICATION section.)

JUSTIFICATION:

This recommendation is justified because there is no further need for these vehicles in carrying out the business of the institution. They should be liquidated and converted to cash in a competitive bid basis. The cash received from the sale will improve the financial condition of the institution. Assets will have been liquidated and various expenses eliminated.

ACTION COMPLETED DATE:

Action will be completed on this case within 60 days of approval.

Sample Case Memorandum: Payout of Depositors

PROPOSAL:

Pay the deposit liabilities of the bank in accordance with the following payout plan and under the timetable included with the plan:

DESCRIPTION:

The payout plan is based on the following priorities of depositors and priorities as determined by Article of the law.

The payout plan includes the following general provisions:

  • The plan will pay no interest on any deposit or liability until the principal balances of all claims and deposits for all priorities of depositors and creditors have been paid in full.

  • The plan will pay no principal or interest on any deposit or claim to any director, officer, or shareholder or related party of the failed institution until all other deposits and claims have been paid in full, with interest.

  • The plan will disburse funds for each category in sequence. No funds will be disbursed for a category until all amounts specified by the plan for a prior category have been disbursed.

  • Deposits denominated in currencies other than will be disbursed in .

For accounts on which no claim is made prior to the planned payout period, the funds will be retained for a period of during which the claim may be made. If the funds are not claimed by the end of that period, they will revert to the liquidation process of the bank.

DISCUSSION:

The plan follows the law with respect to the categorization and prioritization of the various groups of depositors.

The payout plan includes an outreach effort to contact individuals on the bank’s records who have not yet filed claim forms, using a mailing directed to the last known addresses of the individuals, and including a claim form to be submitted by mail or in person.

The conservator/liquidator will explore whether some arrangement can be made for the payout of deposits to be made through another bank in order to avoid paying out large sums of cash to numerous people in a short period of time. Failing that, the conservator/liquidator will arrange for adequate cash to be on hand and for security to be in place to ensure the safe disbursement of the large amount of cash involved in these payoffs.

JUSTIFICATION:

This plan will distribute the insured deposits of the bank according to the law of banks, and will ensure the most equitable distribution possible under the circumstances.

ACTION COMPLETED DATE:

Action will be completed on this case within five days of approval.

Sample Case Memorandum: Personnel Recommendations

DESCRIPTION:

Prior to the intervention by the regulatory authority, the bank employed individuals in various capacities for a monthly payroll of . The regulatory authority intervened into the affairs of the bank on (date), and appointed as conservator. During the period of his administration has reduced the number of staff members at the bank to , at a monthly salary cost of . A large part of the reduction was directed by in order to reduce expenses, but a significant part of the reduction came about as a result of individuals seeking out and finding new employment opportunities on their own. One result of this exodus is that a number of significant responsible positions, which are necessary to carry out the liquidation process, are unfilled in the bank.

As an example of the shortage of trained personnel to perform vital functions, when the conservator, aware of the need to provide a certain required annual report, reviewed the available staff, he found that no one on the current staff was trained or equipped to produce the statement. Accordingly, he engaged the services of to prepare the statement.

A projection of the work, which must be accomplished in the next several months, includes the following functions, which must be performed:

  • Analysis of the deposit liability of the bank, including a review of the legal requirements, available information in the bank computer systems, and analysis of the public relations aspects of paying off depositors;

  • Analysis of a number of significant assets on the balance sheet of the bank and the preparation of recommendations to resolve issues necessary to increase marketability;

  • Liaison with the teams of auditors and forensic examiners who will enter the bank sometime in the next few weeks seeking information and records only knowledgeable people can generate.

  • Analysis of a number of significant transactions that occurred in the bank prior to intervention, and that have a material effect on the asset and liability sides of the balance sheet.

Accordingly, the conservator has made the recommendation as above to increase staffing in the areas indicated.

A list of personnel and their job titles currently in the bank is Attachment I.

DISCUSSION:

The conservator will continue to monitor staffing levels throughout the bank, and will eliminate positions whenever it is practical to do so. It is clear that increases in staff levels will be met with skepticism from creditors who do not want to see expenditures of funds in a nonfunctional institution. In addition, to attract the types of personnel necessary to perform the necessary functions, it may be necessary to pay a somewhat higher than average salary. The fact remains, however, that the work must be done. A reasonable projection of the net cost of this recommendation is that staffing costs will (increase by ) (decrease by ) (remain the same).

JUSTIFICATION:

The need for trained staff is overwhelming. Unless adequate resources are acquired, the necessary work will not be done. Consequently, asset values may deteriorate, deserving depositors may go unpaid, time will pass without progress toward the goal of resolving the institution, expenses will increase, and the liquidating authority, which has ultimate accountability, will come in for criticism.

ACTION COMPLETED DATE:

Action will be completed on this case within 60 days of approval.

ACTION COMPLETED:

* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *

Sample Case Memorandum: Hire Workout Specialist

PROPOSAL:

Engage the services of as a consultant for purposes of pursuing a settlement of various assets of the institution.

DESCRIPTION:

has written a memorandum offering his services in working out the various elements of the financial structure of the bank. See copy attached.

DISCUSSION:

The memorandum of demonstrates some knowledge of the bank situation, but he very optimistic in his judgments concerning time, and the potential cash flow from these elements. On the other hand, nobody is now actively engaging the debtors and creditors of the institution in the direct manner that proposes. He knows or at least has a good understanding of the roles of the people involved, whereas, almost anyone else would require an orientation period. In our initial meeting, we discussed the liquidation process, the absolute need for cash, the use of present values, and the importance of timing. We do not need to provide with housing or office space and his financial agreement should be heavily weighted toward results, with only a modest retainer up front.

will be instructed on the limits on his ability to negotiate, and that his contact with the bank is through the liquidation team manager.

This is a normal type of consulting contract for an institution in liquidation. Funds are available in the bank to pay the fees.

JUSTIFICATION:

This recommendation is justified because it is low risk and low cost to the institution, with the potential of great reward if is successful. Cash raised through this endeavor will ease the payout situation.

ACTION COMPLETED DATE:

Action will be completed within 60 days of approval.

Sample Case Memorandum: Sale of Computer Equipment

PROPOSAL:

  • Dispose of computer equipment owned and formerly used by the bank. The sale of this equipment will be accomplished using the services of .

  • Retain a small amount of the equipment as needed for the bank’s temporary use.

  • Write off any remaining value for this equipment after the sale. (Present net book value of the equipment is .)

DESCRIPTION:

A list of the equipment is on file at the bank.

DISCUSSION:

The bank has ceased operations and has no need for this equipment. Knowledge of the very limited market for used computer equipment in is essential in packaging the equipment for potential buyers. , through its work with this institution in the past, is familiar with this equipment, and is also familiar with the market. They will prepare the packages most appropriate for the market in . They will be compensated through a commission arrangement to be negotiated. An alternative approach would be to hold an auction or offer the equipment in its entirety for sale on an “as is” basis.

JUSTIFICATION:

This recommendation is justified because there is no further need for this equipment, and the cash from the sale will improve the bank’s financial condition.

ACTION COMPLETED DATE:

Action will be completed on this case within 60 days of approval.

ANNEX 7.2. CASE MEMORANDUM LOG

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CASE MEMORANDUM LOG

CASE MEMORANDUM LOG FOR BANK. (THIS LOG SHOULD BE MAINTAINED FOR EACH BANK UNDER CONSERVATORSHIP OR LIQUIDATION.)

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ANNEX 7.3. ASSET COLLECTION REPORT

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Consolidated Asset Collection Report

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1

The original version of this chapter was published as David C. Parker, Liquidation Operations and Asset Disposition (U.S. Agency for International Development, Washington, 2000).

2

Fernando de Mergelina and Francisco Rivillas, Managing Residual Assets from Banking Liquidations. Operating Manual No. 4 (Inter-American Development Bank, Washington, 2004), p. 2.

3

Federal Deposit Insurance Corporation, Resolutions Handbook (Washington, 1998).

4

This should include the same language regarding the authority for the action as is found in Annexes 3.43.11 in Chapter 3.

Resolution Practices and Procedures