Dive Brief:

• “Lax lending practices” led to the failure of Sac City, Iowa-based Citizens Bank in November, the Federal Deposit Insurance Corp.’s Office of the Inspector General said in a Friday report.
• Beginning in 2014, Citizens Bank made commercial loans to trucking entities “without sufficient risk management practices, adequate expertise, and sufficient Board oversight,” the report said. By last June, commercial trucking loans made up 43% of the bank’s portfolio.
• The report also called out inaction on part of bank management in addressing issues flagged by regulators in recent years. The estimated loss to the Deposit Insurance Fund was $14.8 million — 23% of the bank’s $65 million in total assets, the report noted.

Dive Insight:

After examiners discovered significant loan losses in the bank’s portfolio, the Iowa Division of Banking closed Citizens Bank and appointed the FDIC as receiver. The bank was then purchased in full by Iowa Trust & Savings Bank.

“Citizens Bank’s failure occurred primarily due to insufficient Board and management oversight of its credit administration practices,” the report determined. 

The bank’s growing exposure to the commercial trucking industry became problematic, as borrowers in that sector, in recent years, experienced worsening financial conditions as the industry grappled with supply chain woes and higher fuel, insurance and repairs costs during the COVID-19 pandemic, the OIG report noted. 

“Citizens Bank compounded these issues by advancing additional funds to problem borrowers through overdrafts, often in excess of the State’s lending limit, and without first obtaining current financial information or conducting proper collateral analysis,” the report said.

Between 2020 and 2023, the bank’s management grew the volume of trucking operation loans within and beyond the bank’s primary market. Historically, agricultural lending within Sac City, Iowa, had been the bank’s leading driver of risk and profits, the report said. “This, coupled with the bank’s poor credit underwriting and administration practices, resulted in significantly increased risks and regulatory concerns,” the report said. 

In March 2020, the FDIC’s examination of Citizens Bank featured recommendations that the bank improve its credit administration policies and practices. State and FDIC examination reports from 2021 and 2022 detailed “repeated instances of inadequate loan underwriting and credit administration deficiencies, in addition to violations of Iowa’s legal lending limits,” the OIG report said. 

By January 2023, the FDIC and Iowa Division of Banking levied a memorandum of understanding, in which the bank agreed to take certain actions to address regulators’ concerns. But during a joint visitation by those regulators last May, the bank was determined to be “critically deficient,” which examiners attributed to “management inaction in addressing previous examination findings, resulting in repeat regulatory criticisms, and apparent violations of laws and regulations,” the OIG report said. 

A consent order was issued last August, requiring the bank to limit overdrafts, restrict credit extension to adversely classified borrowers, and develop risk reduction plans, among other things, the report said. The bank was also told to provide regular progress reports to the FDIC and state regulators. 

However, during a joint examination that same month, the FDIC and Iowa examiners determined that significant loan losses “had eroded the institution’s capital and earnings position,” and the bank “failed to adequately address and respond” to the provisions within the memorandum and consent order.  

The bank’s management and board “failed to complete recommended corrective actions to improve the bank’s safety and soundness,” the report said. The report also noted examiners identified “multiple instances of conflicts of interest in loans administered by the bank Chairman and President.”

“This is a very classic case of bad credit decisions,” not helped by Citizens Bank’s concentration in a particular industry and that it engaged in lending outside its geographic area, said Carl Goss, a Dallas-based partner in the banking area at law firm Hunton Andrews Kurth.

It’s not uncommon for small community banks experiencing lower loan demand in their own communities to consider lending outside of their market areas, Goss said. “The problem with that is, then you start making loans maybe in areas that you’re not familiar with, or geographies you’re not familiar with, and it’s just more risky,” he said.

Despite its small size, the bank’s failure over credit risk is noteworthy, in contrast with last year’s bank failures led by liquidity risks, said Patrick Hanchey, a Dallas-based partner at law firm Alston & Bird. 

“It is a good reminder that asset quality always remains paramount, even in times where there is more focus on liquidity,” Hanchey said in a Monday email.

Similar to the commercial real estate challenges many banks are grappling with now, Citizens Bank’s situation is another example of pandemic-prompted chaos, since it would have been difficult to foresee the resulting supply chain issues that contributed to the bank’s failure, Hanchey added.