On March 3, 2009, the FDIC published Financial Institution Letter FIL-13-2009 on the use of volatile or special funding sources by financial institutions that are in a weakened condition.  The guidance generally suggests that banks should be run safely and soundly.

Directors and officers of institutions that are in a weakened financial condition are expected to oversee the operations of these institutions in a way that stabilizes the risk profile and strengthens the financial condition. Actions taken by a weak financial institution to increase its risk profile are inconsistent with this expectation.

While the guidance is overly broad, we believe the FDIC guidance may be focused on two practices:

First, during the Savings & Loan crisis, many thrifts adopted a high-growth strategy to try to dig themselves out of the problem.  It didn’t work then, and we think the FDIC is saying that they don’t believe it will work now either.

Second, the FDIC may be targeting certain tactics such as the pre-funding of maturing brokered deposits and the movement of funds (such as director’s personal funds) from CDARS or non-insured accounts to (fully guaranteed) non-interest bearing demand deposit accounts as a play to increase liquidity in the short term without a capital injection.  The FDIC concern is that this “increases the exposure of the insurance fund” even if it improves the ability of the institution to avoid receivership (and thus any loss to the fund).  Even before the issuance of this Financial Institution Letter, some of our clients had begun receiving letters from the FDIC requiring approval before any change in business plan or material (5%) change in any aspect of the balance sheet, including funding sources.