Bank Lawyer's Blog

It's About Interests, Stupid – Not Positions

Another guest post by my Bank Business Advisors colleague John M. Walker, Jr. He's not happy.

 It’s time for those in Washington to take off their current, collective Chapeau de Derriere and get serious about solving the growing crisis among community banks in this country.As someone who’s spent more than 30 years as a “solver of other people’s problems,” a lesson I was fortunate to learn early in my career is that one first must identify the problem and then must “focus on interests, not positions” in order to solve the problem. It appears that no one in Washington was as fortunate as I in getting such an education.

Getting to Yes, a magnificent book about negotiating by Roger Fisher, William Ury, and Bruce Patton of the Harvard Negotiation Project, says it well – interests define the problem.  Interests motivate people – interests are one’s needs, desires, concerns, and fears. Positions are something upon which one has decided.  Focusing on positions hides the fact that there well may be interests in common upon which a solution to a problem may be found. But, to focus on interests, the interests must be identified – which means they must be discussed openly, honestly, and frankly. And, once interests are identified and discussed, problem-solving requires - among other things – that options for mutual gain be identified.

Here’s the problem facing community banks:  they’re being force-fed a capital starvation diet; and, many of the community banks will die as a result if a solution isn’t found quickly. As best I can tell, there’s little “interest focusing,” but there’s a whole lot of “positioning,” going on in Washington – and that ain’t solving the problem.

It’s bad enough that the banks are suffering malnutrition under the burden of troubled commercial real estate (CRE) loan portfolios.  But, to make matters worse, “tales from the crypt” describe regulatory exams now being conducted from a newly staked-out “position” of “I need to prove I’m the toughest regulatory SOB on the block.”  The result is an almost Sherman-like march through local communities that is wiping out community banks’ capital based on the marking-to-market of illiquid CRE collateral.  Assumptions made in valuing any asset are critical and inherently are subject to human bias; and, overly conservative assumptions that may be used in these exams that shorten the time periods for loss history used as a guide and that also forecast an overly bleak future can make bank death seem pre-ordained - or at least a self-fulfilling prophecy – when current loss recognition is required.  At the same time, now “positioned” with his new found, politically-attuned populist religion and small business fervor, President  Obama appears to be putting $30 billion of capital into a pants pocket of the community banks with his recently trumpeted loan program.  But, just as it goes into one pocket, the capital is being taken out of the community banks’ other pocket at least as quickly and likely in far greater amounts by current loss recognition exacerbated by the exam process.  The death spiral for the community banks continues and will continue unabated absent a problem solving approach based on interests, not positions.  

People who work at or who are invested in these banks will continue to lose their jobs and invested capital.  Communities often also will lose a major source of support for local community projects such as low income housing. Why is this community bank death spiral permitted to continue?  We have an environment today where unemployment hovers around 10%, there appears to be general agreement that the greatest generators of jobs are small businesses, small businesses need capital, and community banks likely are the greatest source of small business capital.  Why aren’t the interests affected by the community banks’ capital starvation first being identified and then discussed openly, honestly, and frankly so that options for mutual gain can be developed?  How does one slow, stop, or reverse the community banks’ capital starvation so that these interests can be served?  What “mutual gain” will be created by the competing positions that already are staked out within the executive branch in Washington - positions that will operate at cross-purposes and thus prevent the problem from being solved? 

I wish I had all the answers – to the shock of those who know me, I must admit that I don’t.  But, it does seem to me that one way to retard the march of this capital starvation is to take action that will reduce the impact of immediate loss recognition generated by the short-term, capital-threatening pressure of illiquid collateral/assets being marked-to-market in the midst of this financial melt-down.  Although not a panacea for all that may ail the banks, why not let the losses incurred over a defined period of time related to this financial crisis be amortized over, say, a 10-year period instead of being recognized currently?  Don’t tell me it can’t be done – having Washington actually focus on interests instead of positions and solve a problem as a result is no less bizarre than some of the other things we’ve seen from Washington in the last year.

The Proletariat's Getting Peeved

When you think of New Mexico, I'll bet that the first word that does not pop into your mind is "grass" (unless it's some of that fine New Mexico Feathergrass). You'd better get used to it, because it appears that the recent seizure of Charter Bank (a subject about which my recent blog posts ruffled some feathers) is in danger of igniting a "grass roots movement" that has nothing to do with tea baggers, birthers, or that politician from Alaska who keeps ripping off Tina Fey's act.

Realtor Peter Parnegg pulls no punches when it comes to his opinion of the Jan. 22 federal seizure and sale of Albuquerque’s Charter Bank to a Texas-based bank.

“This is as absolute a heinous crime as there is. They stole that bank – the government stole that bank from its rightful owners,” said Parnegg, CEO of Coldwell Banker Legacy, the largest residential real estate firm in New Mexico.

So Parnegg, whose Albuquerque firm did lots of business with the locally-owned Charter, is out to try to get the sale of Charter to Beal Financial Corp. reversed, or to at least let the Office of Thrift Supervision and the Federal Deposit Insurance Corporation know that many Albuquerqueans are angry about the seizure and sale of the 30-year-old community bank.

“I’m trying to get a grass roots, groundswell of support for Charter and see if I can get 10,000 to 20,000 people to write or call our senators and congressmen to express their dismay and outrage,” Parnegg said. “This is an injustice and an absolutely misguided policy.”

As far as getting the seizure overturned, that's a pipe dream. With all apologies to Tim Geithner, "that will never happen." On the other hand, as the facts play out in the aftermath of the seizure, it will be interesting to see how the regulators react to this type of popular and political anger and whose ox ends up being gored. I had a client whose thrift was seized in the early 1990s by the OTS, and when the RTC investigators finished their last interview with the owner, they asked him why he didn't sue the OTS? Even with that shocking bit of encouragement, he decided that he had better things to do than dance with a bear for the next 15 years. While I always thought he had a heck of a case, it was one of the very few I've seen in over 35 years of swimming in this cesspool.

At best, the owners might win some money damages, but the discretion the law and the courts afford the regulatory agencies in these cases make winning even that a long shot. In addition, I've heard noises from various quarters, none of which wish to be identified, that there's more to the case of Charter Bank than meets the public eye. Inasmuch as the regulatory examination reports are confidential and the contents can't be disclosed (legally) at this point by those "in the know," I take all intimations of "if only we could tell the entire story" with a grain of salt. I've seen too many examination reports filled with distortions and inaccuracies to consider them anything other than somebody's opinion. It may take a lawsuit or two (or three) in any of these cases to get close to "The Truth," and as we all know, when trial attorneys get their hands on the "facts" the spin doctoring can make you too dizzy to sort fact from well-told fiction.

In the meantime, it will be interesting to see how long the public anger stays stoked, how far this "grass roots movement" spreads beyond Albuquerque, and whether it successfully utilizes the only method of recourse that's likely to have much practical effect: politics. Immediately, it seems that path may show some promise.

Meanwhile, U.S. Rep. Martin Heinrich, D-NM, said he will start looking at how Congress can change banking regulations. Heinrich met with three Albuquerque community bankers on Feb. 1 in his Downtown office. Those bankers told him that the OTS was going after community banks after getting criticized for failing to spot and stop the problems in large national banks that led to the nation’s financial meltdown.

“Local community banks did not get us into the economic mess we are in,” said Main Bank President and CEO Ron Shettlesworth. “It’s the top 15 to 20 banks versus the rest of us.”

Shettlesworth said that big banks should be broken up into smaller ones so they are not considered too big to fail.

Union Savings Bank President and CEO Sam Collins said the “regulatory pendulum has swung too far” in terms of punishing community banks.

Heinrich seemed to agree.

“I think the OTS is part of the pendulum swing on not enforcing regulations on big institutions,” Heinrich said. “And now they are taking it out on smaller banks. It’s an easier nut to crack. We need to get to the heart of the problem.”

"Get to the heart of the problem." That's something we'd all like to get to. Good luck.

Memo To Arianna Huffington: It's The Capital, Not The Liabilities

I have an idea for Arianna Huffington. Over the holidays, the liberal blog-maven and media pundit took up a populist cause to have ordinary Jacks and Jills move their money from Big Bad Banks to community banks because, she says, she likes the little guys and doesn't like Wall Streeters or Big Bankers. More recently, her Huffington Post brought to light the fact that Sheila Bair got over $1 million in loans from Bank of America under some circumstances that raised a few eyebrows and launched a pissy little response from an FDIC toady or two. In my opinion, that last dog wont hunt. Sheila has too many friends in high places to take a bullet from anything other than a smoking gun of a caliber that even Dirty Harry would have trouble lifting, much less firing

Here's a better campaign, Arianna: save community banks not by loading them up with consumer deposits (although they'll take them, thank you very much) because they can't put them to good use. One reason that they can't put them to good use is because the bank regulators are (as my good friend and partner John Walker puts it) "laying waste to community bank capital like Sherman marching to the sea." They're doing it by aggressively writing down the collateral values of individual commercial real estate loans and by requiring community banks to make assumptions concerning future losses that are often "worst case." Talk to community bankers, Arianna. They'll tell you the horror stories.

Community and small regional banks have traditionally provided the lion's share of financing to small business. Small businesses are the source of well over half (some "experts" allege "almost all") of the new job growth in this country (other than federal government jobs, of course, which are growing at a nice clip). The commercial real estate meltdown that has flowed from the current recession is killing many community banks. Federal banking regulators appear to be in a competition to see who's the "weak sister" and who's the "hard guy" and every one of them is trying to outdo the others in "hardness."

Sheila Bair is setting the tone, Arianna. Two weeks ago she made it clear in a speech that she wants community banks to take their losses on CRE loans and she wants them to do it NOW! She understands that means hundreds of community banks (maybe over a thousand) will fail, but that's alright with her because, you see, we need to clear out the bad loans (modify them, of course, “if you can”) or take the property into foreclosure and then get the CRE back into private hands at depressed current market rates so the system can recover more quickly. According to the FDIC (and other federal banking agencies), we also need to stop using historical loss experience longer than the past twelve-to-eighteen months when setting general loss allowances, because to do otherwise wouldn't be "prudent." Of course, doing that increases the bank's losses and its hits to capital, and ultimately, its chance to fail. What happens to small businesses who lose their lenders and try to get loans from survivors hanging on by a thread and who are desperately trying to build capital and loss reserve levels, which, of course, constrains their ability to lend, is not being discussed.

On the other hand, Ms. Bair is all for preventing banks from facing reality on the residential loan side as long as that means more loan modifications for borrowers, many of whom will never be able to afford the homes they bought because they’re unemployed or underemployed, a condition that won’t be remedied until small businesses have access to financing to support their business needs, financing which community banks have traditionally provided, but which they won’t be able to provide because Sheila and her minions are killing them in droves and hamstringing many of the survivors through mark-to-market CRE valuations and Armageddon-like levels of general loss reserves.

We've heard from more than one source that the FDIC believes that there are too many insured banks in the country, and that taking the number from 8,000 down to 6,000 would be "a good thing." Yep, consolidation and the lessening of competition is a good thing, right? I guess it is when you're engaged in a government-planned economy. Some of us who favor just a wee bit freer economy (or, if we're going to have a "philosopher king," that it be someone who's actually run a bank) might disagree, but, then, we're not in charge.

So, Arianna, if you wish every American used a community bank, then how about insuring that more of them survive the devatation of their capital? By all means, if you're determined to save residential mortgage borrowers by kicking the can down the road through loan modifications, please do so. Nothing's stopped that freight train yet and nothing we can think of will stop it in the future, other than the cold, hard fact that ultimately, it won't work. However, while you're at it, how about urging Congress to come up with something more useful than a drop-in-the-bucket $30 billion TARP program that won't address the real problems? We've got ideas on how to address the real problems, and so do community bankers. If regulators are hot to have all banks "face up to their CRE problems," write down those bad CRE collateral values, and get aggressive about loss reserves, then how about amending current law to allow banks to amortize the resulting capital hits over an extended period of time, say ten years? There's precedent for it this, and these are, after all, extraordinary times that call for extraordinary measures. Yes, we know that we're proposing kicking the can down the road, just like we're already doing on the residential mortgage side (albeit we're doing it poorly).

If that's too controversial at the moment, Arianna, how about we at least start with leashing the examination hounds so we can talk about the alternatives without being drowned out by all the baying and barking and the agonized screams of the victims? Whatever bright ideas reasonable people can concoct to save the community banking industry, there must be something preferable to the slash-and-burn tactics employed thus far. That is, there must be if you're not hell-bent on taking down twenty-five percent of the existing community banks.

If you love those community banks like you say you do, Arianna, show the George Baileys of the world that love by taking up the cause of something more critical than "Move Your Money."

In the meantime, we'll be feeding the homeless at soup kitchens and helping old ladies cross the street. 

Mama Like

I've only got time tonight for a quick post that brings to the attention of those two of you who might not have seen last Saturday night's "Saturday Night Live" skit with actor John Hamm spoofing Senators Scott Brown, Harry Reid, Nancy Pelosi, Barbara Boxer, and Robert Byrd, and one of Bank Lawyer's Blog's favorite buffoons, House Banking Committee Chairman Barney Frank. For certain hypersensitive blog readers who feel compelled to hector me for my politically incorrect sensibilities, you can now add the writers and performers of SNL to your list of known homophobes, sexists, ageists, and bozo bigots.

For the rest of you, enjoy a light moment. I'll see you next week. Or not.

More Charter Bank

A few more interesting aspects of the Charter Bank deal that got the OTS on Defcon 1 PR alert last week showed up late last week in New Mexico Business Weekly.

The story shows that in many cases, the community banks that are being closed down are, in fact, "community" banks, relatively smaller institutions that are performing vital work for their local communities. In Charter Bank's case, it was acting as the primary originator and master servicer of loans for the New Mexico Mortgage Finance Authority, which provides financing assistance to low income home buyers in New Mexico. The buyer of Charter Bank's insured deposits and most of its assets (a good portion of which are covered by a loss sharing agreement with the OTS) isn't interested in fulfilling that public service role. The MFA needs to find a new master servicer and a new loan originator. According to its spokesman, its not exactly sure yet which institutions will take up the burden previously borne by Charter Bank.

The new Charter might be vastly different from the old one, said MFA Executive Director Jay Czar.

“From what I understand, they are going to be a depository bank and they are not going to do loan servicing,” Czar said. “They are not going to do any of the work that [the old] Charter did with the MFA.

“There is going to be another group to take over their service component. No one [as of yet] is taking over their loan origination side, and so somebody else is going to end up having to do that work.

“The current Charter employees will continue doing it for a period of about three months and then there will be a transition.”

Czar said he could not yet release the name of the group that would be taking over the MFA’s loan servicing duties. He also said that the agency has not yet found an institution or group to take over the loan origination services. Charter employs about 90 people to service those contracts, Czar said.

The last sentence discloses another consequence of the loss of this community bank. What are those 90 employees going to do? It's not likely that they'll be working for the new, improved Charter Bank. How many more of their fellow employees will be cashiered? They'll all be more folks added to the unemployment rolls. Multiply that by hundreds of banks that have failed, then increase that number five fold or more, and you get a sense of the human pain and suffering involved in these dry statistics and what the callous make sport of with "Bank Fail Friday" and other humorless "games" on social media forums.

When I wrote my first post about Charter Bank, I didn't intend to get into Ed Morrissey's contention that something was "fishy" about the write downs, although I'm glad I did because it highlighted a problem with zealous regulators laying waste to community banks' capital due to aggressive CRE collateral value writedowns and Armageddon-like loan loss reserve assumptions at a time when politicians are yapping and yipping at banks to lend more to small businesses. What I intended to focus on that behind all the back-and-forth on public policy and, often, ideological, issues, is that the death of community banks affects real human beings. They're no less "real" than the residential loan borrowers over whom Sheila Bair sheds tears. I suppose most people don't give a damn about that fact. When bank haters express glee over big, bad fat cat bankers "getting theirs" when a bank fails, they don't seem to understand the fact that the collateral damage can be widespread, and very few of the community banks that have gone down in flames, and will continue to go down in flames as a result of economic woes they did not cause, are "fat cats." For the most part (with some exceptions, as is always the case) they're people who are standing in front of a steam roller and get flattened.

When I toiled as a partner for a large national law that represented banks and thrifts in the late 1980s and early 1990s, I grew tired of a particular attorney with a bank regulatory agency kicking my ass. So, I hired her as an associate. I put her to work representing thrifts, the owners and senior management of one of which which soon grew close to her and she to them on a personal level. She fought hard for them, and we did what we could to keep them alive, but when commercial real estate loans in Texas, including the land acquisition and development loans in which this thrift specialized, went down the tubes, so, eventually, did the savings institution. On the day that institution failed and was crammed into a Southwest Plan receivership, she bawled her eyes out. Not unkindly, I told her "Now you know how it feels on the other side of the table."

Many observers (our Care Bair among them) rightly feel for residential loan borrowers caught in the downside of the current economic cycle and want to help them. I think that compassion is well placed (if poorly executed), however hard that assertion might be for some readers to believe. On the other hand, what I wish some regulators (including Chair Bair) would also keep foremost in their minds as they rush to close down community banks by the hundreds, is that there are actual human beings involved, no less worthy of compassion.

Fannie and Freddie In Full Put-Back Mode

The country's largest commercial banks have become the largest originators of residential mortgage loans. Unfortunately for them, they're also becoming the recipients of knuckle massages lovingly administered by those "instruments of public policy," Fannie Mae and Freddie Mac. As we've long noted, the major risk in being a mortgage originator and seller is the risk of the buyer doing everything it can when default rates rise to force the seller to buy back the loans that don't perform well. According to The Wall Street Journal, Fannie and Freddie, who now account for 70% of the market for residential mortgage loan purchases, are doing precisely that.

It is payback time for Fannie Mae and Freddie Mac on some mortgages sold to the finance companies by lenders.

Stuck with about $300 billion in loans to borrowers at least 90 days behind on payments, Fannie and Freddie have unleashed armies of auditors and other employees to sift through mortgage files for proof of underwriting flaws. The two mortgage-finance companies are flexing their muscles to force banks to repurchase loans found to contain improper documentation about a borrower's income or outright lies.

The result: Freddie Mac required lenders to buy back $2.7 billion of loans in the first nine months of 2009, a 125% jump from $1.2 billion a year earlier. Fannie Mae won't disclose its figure, but trade publication Inside Mortgage Finance said Fannie made $4.3 billion in loan-repurchase requests in the first nine months of 2009.

Community bankers have watched the big banks dominate the residential mortgage origination business, especially following the collapse of the large independent mortgage originators over the last few years. It's very difficult for community banks to compete with the large boys in a business where profit margins are thin and compliance and technology investments can be heavy. Therefore, it brings a little tear of joy to the corner of the eye of many small bankers when they see who's taking it on the chin from the punches thrown by Uncle Freddie and Aunt Fannie.

The biggest losers are likely to be Bank of America Corp., J.P. Morgan Chase & Co. and other mortgage lenders when the housing bubble burst. Such lenders also are being deluged with loans kicked back to them by holders of mortgage-backed securities who uncover deficiencies with loans bundled into the pools. One common example: a borrower who said the loan was for an owner-occupied home but used it for a second house.

Overall, banks repurchased about $14.2 billion in loans from holders of mortgage-backed securities in the first nine months of last year, up from $3.6 billion a year earlier, according to Barclays Capital. The figures are based on data reported to regulators by federally insured banks and savings institutions.

Forced loan buybacks threaten to "wipe out a significant portion of the [loan] origination profits…made in the last year," said Nicholas Strand, a Barclays analyst.

I went through this on a much milder scale for a large client that bought the large servicing platform and a bundle of servicing rights from the RTC. The platform and servicing rights had previously belonged to a large savings bank that had bitten the dust in the early 1990s. Unlike a private seller, the RTC sold servicing rights without the ability to put them back if there were defaults under Fannie Mae's or Freddie Mac's seller/servicer guides prior to the date of sale. When problems later cropped up with loans in the portfolio, which, as might be expected, arose when borrowers started defaulting, Fannie and Freddie looked to the current servicer (my client) and told it to buy the loans back. In a perfect world, the current servicer then passes the loan back down the line until it reaches the originator. When my client turned around to pass off the loans, it was looking in the mirror. It's tough being the last solvent man standing when the repurchase arrows start flying. You better hope the relatively cheap price you paid the RTC makes up for the fact that you're stuck in the mud with no way out.

Today, the problem is much, much worse.

Fannie reported Thursday that borrowers of 5.29% of the loans it guarantees were at least 90 days behind as of November, up from 2.13% a year earlier. Fannie guarantees $2.9 trillion in loans.

At Freddie, such delinquencies reached 3.87% at the end of December, up from 1.72% a year earlier.

While growth in subprime defaults is slowing, defaults on prime loans are accelerating. Such loans account for 90% of all mortgages guaranteed by Fannie and Freddie.

"Delinquency rates are up, so it's not surprising" that buyback demands are up, said Brad German, a Freddie Mac spokesman. "Consequently, the number of loan put-backs will reflect that."

As an American taxpayer, I can't say I'm displeased that the two publicly-owned mortgage securitizers are scouring loan files looking for ways to lower their losses. Then again, I don't own stock in Bank of America, J.P.Morgan Chase, or Wells Fargo. If I did, I wouldn't be quite so sanguine.

And You Don't Even Own Clubs

Great news: "[T]op investment banks are now intending to hire one-third more graduates this year than last. Their remarkable resilience to the downturn, and this year's strong recovery in the financial markets, mean that opportunities still exist in banking for those with the skill and tenacity to get them."

That sure warms the cockles of my heart. How about you?

What they don't tell recruits, however, is that the world of investment banking is full of hidden perils, not the least of which is the risk of a broken heart. From Columbia Business School's Follies of 2006 comes a trailer for a movie about the dangers of office romance in a business that broke the back of the American economy.

Note to politically correct hypersensitive readers: if you're offended, take it up with CBS. Don't hate the playa, hate the game.

OTS "Corrects" Me on Charter

My post of last Monday caused some people to sit up and growl, including current and former OTS employees. Not only the OTS wrote me, but also a number of others, including a member of the Wertheim family, and a few tin foil hat wearers convinced the entire affair was further evidence of socialist creep. A PR employee of the OTS even sent me links to "facts from public documents," for which I thanked him, even though those of us at Bank Lawyer's Blog prefer to wallow in the soothing, tepid waters of our prejudices and regard one man's facts as another man's damned lies.

Although I haven't spent a great deal of time following up on this, having to actually make a living from something other than blogging, here are some conclusions I've reached since my previous post:

• The former owners of the failed thrift, the Wertheims, seem like very decent people. They've done a lot of good for New Mexico, and it's sad to see their bank steamrolled by this crisis in real estate values, which is only getting worse, notwithstanding Panglossian blatherings by some snake oil salesmen in D.C. Also, "shoulda', woulda', coulda'" regarding real estate lending is a game for second-guessers who've never actually run a bank. Unfortunately, the Wertheims and the other directors and senior officers of the bank better be prepared for that game, because that's one the FDIC loves to play.

• An allegation made by more than one reader (all of them pro-OTS) was that the real estate assets couldn't have been worth what the Wertheims claimed because no other investors stepped in to buy the thrift before it failed. No acquirer in the current environment is going to buy a thrift the size of Charter Bank in the situation that Charter Bank was in after OTS-directed writedowns, when they know they can get a relatively risk-free deal if they just wait until the FDIC receivership and, if they win the bid, get loss coverage from the FDIC. As Bruce Hornsby sings, "That's Just The Way It Is." Given the the current paradigm (including the fact that open bank assistance for too-small-to-bailout community banks will never happen outside of that wonderfully unsuccessful TARP CPP), private investors who buy from the FDIC don't need to take any practical risk on future losses of commercial real estate assets compared to the risk they face if they acquire the same bank without the loss coverage on commercial real estate, even if they think that the OTS was overly aggressive in writing down the collateral values of those assets.

• The September 2009 Thrift Financial Report to which I was linked by an OTS representative support the OTS in countering Ed Morrissey's contention that at the time the thrift failed, the loan portfolio was substantially performing. Morrissey's article is wrong to imply that. The delinquency rates cited by Ed at the end of his article are not applicable to September 2009, when, as the OTS PR person pointed out to me, "Charter Bank had high levels of loan delinquencies, particularly in construction loans (single family and commercial) and loans for land: 19.48 percent of gross outstanding construction loans were at least 30 days delinquent and 22.88 percent of gross mortgage loans for land were at least 90 days delinquent." That's correct, a year after the OTS required massive write downs of the the value of real estate loans that were, at that time, substantially performing, the thrift was in trouble. How much of that trouble, particularly in the construction loans specifically cited by the OTS, was caused by overly aggressive writedowns and loss reserves with respect to loans whose history did not reflect the need for such levels of reserves and devaluations? For example, since a federal savings bank can't have more than 400% of its capital in nonresidential real estate loans, does it seem possible that a sudden deduction to capital might impair the thrift's ability to loan funds needed to keep particular projects or borrowers alive? Also, since the maximum loan-to-value ratio of residential construction loans is 85% and of nonresidential construction loans is 80%, do you think it might cause a problem with continuing to fund such a loan if the collateral value of that loan is suddenly whacked by a substantial percentage? Although thrifts have implied "salvage powers" to exceed such limits to salvage their investment, bank attorneys have seen cases recently where the regulators have ignored such implied powers and have required banks to stop funding loans or to start liquidating assets where regulatory limits would be exceeded. I'm not saying any of these events occurred at Charter Bank or contributed to the high delinquencies because I don't have personal knowledge, but I am saying that because you take a snap shot on September 30, 2009 and say on that date the financial condition of the thrift is X, that doesn't tell you why the thrift arrived at that point. The contention of former Charter Bank CEO Glenn Wertheim, as set forth in the press accounts quoted in last week's post, is that the relevant date to look at is a year earlier than September 2009, when the OTS made aggressive valuation allowance and collateral devaluation demands on loans that were performing. He claims that the OTS made this situation much worse than it had to be by taking such actions.  The "facts" sent by the OTS do not refute that allegation.

• The act of appraising a piece of real estate is as much art as it is science. An appraisal arrives at an individual's "opinion" of fair market value. Reasonably knowledgeable people can disagree on value, which happens all the time. In its order appointing the FDIC as receiver, the OTS claims that even accepting both management's analysis and a third party appraisal report (which the OTS rejected), the thrift was still "undercapitalized." That's like saying that even if we hadn't shot you in the head, you would have still had the flu. "Undercapitalized" means you're severely ill but salvageable. "Critically undercapitalized" means you're dead. Given the stakes, wouldn't a third valuation have been something the OTS could have found acceptable, using a mutually acceptable appraisal group? Why the rush to accept the worst-case appraisal, that of the OTS? Why the rush to close this bank down?

• Some readers objected to Ed Morrissey's blaming all this on CRA. I, too, thought that was Kool Aid drinking on Ed's part, which is why, if people had bothered to read my post, I didn't mention it. As I've said before, in my opinion, CRA was not responsible for the subprime mortgage credit meltdown and wingnuts who keep ranting about it condemn themselves as rebels without a clue. Thus, please stop setting up straw men to knock me down. My bloviations always have sufficient legitimate holes in them without manufacturing false ones. That said, Morrissey has a large readership on the right, and the fact that he's on the case of the OTS at all does nothing but add to the woes of a federal agency that needs not a single additional one.

• The OTS is not alone in its aggressiveness on real estate valuations and loss reserves. To me, it's no more aggressive than the FDIC, OCC or FRB (Barney Frank's letter notwithstanding). Community banks of all charter types are finding this out. Therefore, trying to single out the OTS as a renegade in this respect is a fool's errand. On this issue, charter flipping is not an answer.

• A colleague told me that the fact that I got so much feedback, especially from the OTS, is somehow complimentary of me. I disagree. I'm just some solo practitioner with a background in this area who fires off a rant four or five times a week at most, usually off the top of my head and with a beer in one hand (as evidenced by several typos in the first version of this post). I enrage as many as (or more than) I interest. Instead, I think it shows the defensiveness of the OTS to criticism from any quarter. As I reminded one of my OTS correspondents, the agency would have been better advised to simply ignore a crank like me. After all, I'm not a reporter, I'm one of those pajama-wearing "blogger" nutjobs.

A final observation. When Glenn Wertheim says that his family, like The Terminator, will be back--perhaps even back in the banking business--I believe him. His family's track record would certainly support that contention. I started working with the predecessor to the OTS (the Federal Home Loan Bank Board) when I joined the legal staff of a large savings and loan association in February 1977, and I've dealt with them for over three decades now. During that time, I've heard repeated calls for their demise, and generally discounted those calls. This time, however, I believe that the agency's days are numbered. Notwithstanding some brave talk from its Acting Director, I think people within the agency also believe it. Even with a dwindling assessment base, they appear to be aggressively eating their young, which is not a plan for long-term survival. This year or next, Congress is going to put a bullet in its head (although I think the federal thrift charter will live on for awhile). It may very well be that while the OTS won this "battle," the Wertheims will eventually dance on its grave.

Bashing Bankers to Push Brew

Obama's recent bout of banker bashing didn't originate in the fertile minds of his brain trust. No, it's been a time honored tactic of brew sellers in the UK. Witness last year's Strongbow Beer ad where a chorus of workers gathered for battle in a formation reminiscent of the movie "Braveheart" tells bankers to "Sod Off."

You've got to admire the crusty elan of the oldest banker flipping the bird to his critics on his way out of the scrum, though. You couldn't pull that one off on US broadcast networks. Thank god it's flex day Friday, when readers are scarce.

Community Banks Must Be Invisible

Tonight's post is another guest post by one of my partners at Bank Business Advisors, LLC, John Walker. John's worked up about commercial real estate and its past, present and, most disconcerting, future effects on community banks. He's also not thrilled about either the lack of a plan by the federal government to honestly deal with this train wreck or its lack of transparency in telling us the hard facts about the plan he suspects they might have in mind. But I'll let him tell his story in his own words. John, bank consultant Larry Martin, and banking accounting expert Dan McDonald have a lot more to say about commercial real estate lending, community banks, and related regulatory and accounting issues in their upcoming webinar for Bank Law Stuff.

As I’ve watched the public “goings-on” over the last 12-18 months with community banks generally, I’m struck by how invisible community banks seem to be to those responsible for stopping the hemorrhaging in our financial system.  You’d think the banks collectively were Burt Campbell (Richard Mulligan’s character) in the long-running tv series Soap, who concluded he was invisible because whenever he’d walk into a room, try to engage in conversation, or otherwise come into contact with other people, no one would acknowledge his presence.

We’ve heard Fed Chairman Ben Bernanke (September 2009) and the President’s top economic advisor Larry Summers (December 2009) announce that the recession’s over.  We’ve heard Treasury Secretary Tim Geithner (September 2009) say that he didn’t think that commercial real estate (CRE) loans would set off a new banking crisis.  We’ve even heard Jamie Dimon say that CRE is a train wreck that’s already happened (January 2010).

But that’s little solace to the community banks.  Deutsche Bank, in it’s quarterly CRE Outlooks published over the last several quarters, provides some perspective about the CRE market that paints a disturbingly different picture for community banks.

• Commercial MBS growth during 2004 – 2007 came at the expense of banks, particularly regional and community banks, as CMBS offered lower costs and higher leverage for higher quality properties with stable cash flows.

• Unlike residential real estate debt, banks hold the riskiest CRE debt, as banks became more concentrated in riskier CRE loans (e.g., construction, condo development, and land loans) with the better lending opportunities going to CMBS.

• Over $2 trillion in CRE loans mature between now and 2013 and a majority of those lack the equity to qualify for loans sufficient to pay-off the existing debt.

• Of those banks in the Deutsche CRE Outlooks’ bank universe that have assets of $25 billion or less (what the Outlooks label smaller regional banks and the community banks - 7,493 of them), they have 27.43% of their aggregate assets in CRE loans, while the larger banks (greater than $25 billion in assets) have only 6.05% of their assets in CRE loans.

• Deutsche Bank expects 1,853 of the smaller regional banks and community banks (collectively with $1.096 trillion in assets) to suffer $72 billion (6.56% of total assets) in CRE loan losses.

• From its total universe of banks in the Outlooks (7,542), Deutsche Bank expects 1,592 banks, collectively holding $1.531 trillion in assets, to lose 50% or more of their Tier 1 capital as a result of CRE loan losses.

Most experienced business executives understand the importance of having a plan with goals or objectives that are clearly communicated, reinforced not only by words but also by deeds daily, and against which all future actions are judged for comparison, particularly when dealing with problems that threaten survival. The plan should incorporate an understanding of the environment in which it’s being implemented and should address the problem, not simply the symptoms.  Commercial real estate loans generally are no better than their collateral, which is not liquid – notwithstanding the efforts of financial engineers to attempt to dress the illiquid wolf in sheep’s mortgage-backed securities clothing – and, in an environment where unemployment is greater than 10%, there appears to be general agreement that the greatest generators of jobs are small businesses, small businesses need loans, and politicians are screaming at banks to make loans, it seems fair to ask what’s the plan to save these community banks.

Railing against “Wall Street banks” with populist fervor isn’t much of a plan to save community banks.  Neither is marching Sherman-like through local communities, wiping out banks’ capital based on a regulatory-based drive effectively to mark-to-market illiquid collateral – especially when value recovery will take time as a number of smart people (including Bill Gross and the McKinsey Global Institute) believe asset value growth in the future will revert back to tracking closely GDP growth as it historically did until the leverage orgy that began in the 1980s.  Issuing updated loan modification guidelines (Fed’s press release) isn’t much of a plan or goal either – as a road to survivability, it doesn’t even rise to the level of rearranging the deck-chairs on the Titanic; at best, it’s mopping the Titanic’s deck before the chairs are rearranged.  If there is a plan for the community banks, it’s not been clearly communicated and present actions make it appear to be one of surreptitiously effecting a banking industry consolidation.

On the other hand, one might excuse a cynic for thinking that in a job-thirsty environment where credit remains tight and small businesses need credit, and where “creative” minds have fashioned “survival” plans that involved shoving aside bankruptcy law precedents for creditor class treatment in order to reorganize forcefully the auto industry, the granting of effective blank-check writing authority to Fannie and Freddie, and the willful granting of huge-dollar special deals to entice favorable votes on legislation, someone could do some unconventional thinking and come up with a plan to cover a defined period of time during which the short-term, capital-threatening pressure of illiquid collateral/assets held by the community banks is alleviated in order to ensure their long-term viability.