The Rescue of Troubled Banks: Consequences for Corporate Strategies to Deal with Financial and Operating Stress

A rapidly growing literature on the financing of distressed companies finds that troubled firms often secure relief from stress through asset restructuring, capital restructuring, or both. However, none of the earlier corporate distress restructuring studies have focused on the centrally important commercial banking industry which has been one of the most financially distressed industries of the past decade. In this study financial and operating changes experienced by nearly 730 U.S. insured banks that experienced at least two years of negative earnings and then returned to positive profitability were examined using both univariate and joint tests. The study finds that troubled banking corporations displayed evidence of both financial and operating problems simultaneously, so that financial distress appears to be linked to operating stress in the majority of instances observed. However, operating problems (as reflected, for example, in production inefficiencies and expense-control problems) tended to be of longer duration than corporate financial problems, suggesting that either financial stress tends to be easier to address or is subject to more rapid resolution than are corporate operating problems. Relief from corporate stress in the banking sector appears to be accompanied by accelerated growth in total assets, reduced debt financing costs, a strengthening of liquid asset positions, strengthening of customer loan performance, greater employment of junior-priority and shorter-term debt, and reduced dividends on common stock.