Bank Lawyer's Blog

FASB's Big Bad Idea

The stars must be in an unusual alignment, because Bill Issac and Sheila Bair agree on something, and I agree with both of them. Such agreement will come around again when pigs grow wings.

What has united us is the recent FASB proposal to require banks to mark to market all loans it holds, including those classified as "held to maturity." The devotion of mark-to-market fetishists to ideological purity operates like all ideological constructs: damn the real-world consequences.

“This is a terribly destructive idea to even propose,” William Isaac said in a telephone interview today. Just by making the proposal, the Financial Accounting Standards Board will lead banks to quit making loans without an easily discernable market value, and keep the ones they do make to shorter maturities, Isaac said.

Banks would have to report the fair value and amortized cost of loans and some other financial instruments on their balance sheets under the new rules released by FASB for comment on May 26. Changes in fair value would in most cases be recognized in other comprehensive income, the panel said. That could cause swings of billions of dollars in the book values of some of the nation’s biggest lenders.

[...]

The proposal comes “in the face of worldwide condemnation,” Isaac said. It conflicts with the recommendations of the Group of 20 nations, the Basel Committee on Banking Supervision and the International Accounting Standards Board, according to the American Bankers Association, which also opposes the plan.

Mark-to-market accounting destroyed $500 billion of bank capital as traders marked down all assets during the crisis by a total of 27 percent, and many of those values have now returned to near par, Isaac said. “Now FASB is going to spread this disease throughout the system,” he said.

Sheila concurs.

FDIC Chairman Sheila Bair, speaking at a conference in September 2009, said she didn’t agree with the content of FASB’s proposal.

“When a bank is holding a deposit, a loan or a similar banking asset for the long term, it shouldn’t have to mark them to market values that may vary widely over time,” Bair said. “Extending mark-to-market accounting to all banking assets takes a good approach for market-based assets, like securities, but extends this to areas where it doesn’t accurately reflect the business of banking.”

As ABA senior vice president Donna Fisher observed in an article in the American Banker (paid subscription required) late last week, this FASB proposal would be "the biggest accounting event we have ever seen." She didn't intend to convey "big" in the sense of "good," but, rather, "big" in the sense of "colossally bad."

"We've had discussions with them [the FASB] for 20 years now about how accounting should follow the business model, so that if you're buying and selling loans you should mark them to market, but if you're not, having the swings in market value flowing through to your financial statements is misleading," Fisher said.

It will also make earnings more volatile at a time when banking regulators worldwide are trying to make them more stable. It would also motivate banks to no longer make long-term, fixed-rate loans like traditional "safe" 30-year, fixed-rate mortgages, since they would be subject to potential wild swings in valuation over the life of the loan. While banks might originate and sell such loans, that business model is under attack by some regulators like Ms. Bair as a "broken" business model, so I would think it would be more likely that fixed rates would rapidly become a thing of the past for long-term loans.

Other commentators have suggested that regulators might alter the rules for banks in order to lessen the impact of any new FSAB rule on bank capital calculations and earnings. However, inasmuch as banks are required by law to report their financial statements in accordance with GAAP (with some exceptions not applicable to this case), I think decoupling regulatory reporting from GAAP would require Congress to act.

All-in-all, this will be an interesting one to watch, since it has the potential to cause all sorts of unintended consequences, all in the name of making bank financial statements "more transparent."

Pushbacks on Buybacks Getting Stronger

Sunday, we discussed the fact that not only were some big mortgage loan seller/servicers "pushing back" on Fannie Mae and Freddie Mac when those GSEs try to force loan repurchases, but that the Mortgage Bankers Association was holding a series of seminars around the country for bankers on how to fight the repurchase requests. Today, Bloomberg.com reported that the MBA was taking "direct action," talking to both Fannie and Freddie and urging them to "ease back on the buybacks."

While his members “certainly understand” their contracts require repurchases of defaulted loans when faulty appraisals, inflated borrower incomes or missing documentation are discovered, the Mortgage Bankers Association has started to “aggressively” push the two companies and their regulator to ease up, [MBA president John Courson] said.

[...]

“We’re trying to see if we can’t reach some type of a system that says there is a bright line out there, if this loan has been making payments and defaulted for a reason that is neither fraud nor related to the underwriting of the loan, it shouldn’t be subject to a repurchase,” he said.

We warned about these practices five years ago.

In good times, when the percentage of defaults is relatively manageable, the  purchasers of such loans (who customarily bundle and securitize them) tend not to look closely at these representations and warranties; however, in bad times, the holders of the loans have been known to require a second "scrubbing" of the loan files, looking for breaches of representations and warranties that will justify requiring the originator to repurchase the loan. In the last economic downturn, I personally experienced more than one instance of a mortgage lender suffering the infliction of extreme financial and emotional pain caused by buyback demands from secondary market purchasers like FNMA, FHLMC and private institutional investors.

What Courson and others are complaining about are teams of forensic examiners parsing a loan file when a loan defaults, looking for any purported defect that might justify a loan repurchase demand, even if, ultimately, most of the purported "defects" don't support the buyback demand.

“Lenders are getting repurchase requests on the same loan at multiple times for multiple issues, which shows you they’re going from station one, to station two, to station three” as the companies and their contractors “scrub” loan files looking for errors that weren’t material or never occurred, he said.

Unfortunately, as we also pointed out Sunday, the lender ends up paying a lot of money to combat such requests, no matter how tenuous the justifications for the request. Lawyers make money, but the lender loses regardless of whether the loan is ever repurchased. As we all know, paying lawyers ranks right up there with coddling terrorists on a list of what most Americans like least to do.

As if Uncle Freddie and Aunt Fannie weren't generating enough pain through their own efforts, it appears that they're getting help from private mortgage insurers. Bloomberg reports that many of the insurers are picking every nit they can find to deny insurance claim requests, which, in turn, causes a default under Freddie and Fannie guidelines. It's loads of fun out there, isn't it?

The biggest four banks are now the biggest loan servicers. In Fannie's and Freddie's world, a putback is made by the GSE to the servicer, who is liable to the GSE for breaches by its predecessors in title to the loan. The servicers are trying to pass the buck back on down the line. I'm sure that they're finding that's a futile exercise when the loan originator was one of the many independent mortgage "bucket shops" that has gone to the big mortgage banker graveyard.

To loan originators that are still around and still solvent, the world is a scary place.

Repurchases will be “an issue for the next 24 to 36 months for all us,” Steven Jacobson, chief executive officer of Madison, Wisconsin-based Fairway Independent Mortgage Corp., said in a May 24 interview at a conference held in New York by the Washington-based Mortgage Bankers Association. The company last year originated more than $3 billion in mortgages. “Any big bank can put any one of us out of business.”

Guess what: the adage "cleanliness is next to godliness" applies not only to personal hygiene, but, these days, to residential mortgage loan originations, as well.

Y'all have a happy holiday weekend.

Community Banks: Up TARP Creek Without A Paddle

Last year, Jamie Dimon called TARP a "Tarp Baby," which I assume enraged politically correct Uncle Remus haters everywhere. He was talking about the country's biggest banks at the time. In January of this year, we called it a "roach motel" when discussing how federal bank regulators were making it extremely difficult for community banks to pay back TARP capital. Yesterday, the American Banker (paid subscription required) ran a story that alleged that many community banks that took TARP have apparently been sucked into a black hole from which they may never emerge unless they get lucky and the known universe implodes, killing all life on Earth, at which point nobody will be sweating TARP.

Community banks are finding it extremely difficult to check out of the 18-month-old Troubled Asset Relief Program.

While all of the big banks have repurchased or converted preferred stock, and two-thirds of the regionals have followed suit, community banks are expected to hold the vast majority of unpaid Tarp funds on their balance sheets by the program's two-year anniversary.

There's some wailing and gnashing of teeth in the article by commentators (some of whom I actually respect) about how TARP hasn't fulfilled its intended purpose of spurring lending to small businesses. I think that misses the point that one of the original purposes of TARP was to shore up banks' balance sheets so that they didn't fail and drag the entire economy into a hopeless pit of despair. Like the hopeless pit of despair TARP takers now find themselves in. It's continuing to serve that purpose for a number of community banks.

"The initial reason was to promote lending," [Kirk] Bailey (CEO of Magna Bank of Memphis] said. "In hindsight, the Tarp money has become defensive capital … and part of that is protection against something cataclysmic. Things are better, but we're not out of the woods yet."

No, we're not, not by a long shot. As other observers quoted in the article state, commercial real estate has severely punished community banks' balance sheets and will continue to do so in the near future. Thus, those with capital are hanging onto it for deal life and doing everything they can to grab more, which, for community banks, isn't easy.

Although the TARP program has been in existence for 18 months, the portion of the program for community banks has been around for less time than that. It's still in its early stages. The fact that politicians screwed it up after the fact caused banks that could afford to pay back the capital to do so as soon as possible. However, it was designed so that below-market dividend rates on the preferred stock purchased by the government would be payable for five years, so banks would have at least that period of time to work out of their problems and return to a position to raise additional capital and redeem the preferred stock (and warrants). The fact that all of the biggest banks, and two-thirds of the regional banks, have already paid back their TARP capital are events that were not initially expected to occur. The fact that smaller banks, who don't have the same kind of access to capital that the bigger banks do, are sticking with the program is right in line with what was expected to happen and is nothing that should concern, or even surprise, observers.

In that light, the pronouncement by UNC Professor Tony Plath's that "[a]ll we've done is created a bunch of zombie banks" appears to me to be a bit overheated. Not all of the banks who continue to hold TARP capital are "zombies" who won't ultimately survive. I'm sure there are a number of CEOs of such banks who would be pleased to let Tony know that fact, face-to-face (although I'd advise him to wear a catcher's mask). If he keeps spouting that line, he may find himself lumped into the same category with Elizabeth Warren and Nouriel Roubini, a category that engenders eye-rolling instead of rapt attention every time someone opens their mouth.

Another issue not discussed in the article is one we touched on in previous posts and in the opening paragraph of this post. In order to repay TARP capital, banks must receive their primary regulator's approval. Many are not receiving that approval, or are receiving approval only to make partial repayments. Regulators are being as cautious as they can so as not to turn allegedly "zombie" banks into completely inanimate corpses. Expect that caution to continue for near term, as well.

Nouri Bashing Par Excellence

I made a little fun of Nouriel Roubini last week, mostly because he's so unrelentingly downbeat, yet has managed to achieve a kind of "rock star" status among business and economics geeks. It's as if being on the brink of wrapping your lips around the tailpipe of an idling Ford F-150 and inhaling deeply is an American civic virtue.

Yesterday, Tom Brown went to town on Dr. Roubini and made my mild fun-poking look like a virtual love fest.

As the cycle turns higher, Nouriel Roubini is returning to his role as a reflexive, tendentious crank. Dr. Doom was in classic form in BusinessWeek last week in his interview with Charlie Rose. Some highlights, along with some comments from yours truly. [Emph. added]:

What happened to all the toxic assets?

Some of them have been written down, but the policy response has been pray and delay. Many banks are still carrying these assets and loans on their books at face value of a hundred cents on the dollar.

He can’t really believe this. No sane person can. The real estate crackup began in earnest in 2007. Since then, lenders have had to generate audited financial reports three times—for 2007, 2008, and 2009. Does Roubini believe there’s some kind of conspiracy among lenders, auditors, and regulators that’s allowing banks to keep their distressed assets marked at par all this time? That’s not just mistaken, it’s delusional.

Harsh? Surely. Justified? Naturally. Channeling the spirit of Donald Rumsfeld? Yes.

No one who works for or represents commercial banks, especially community banks that have been mowed down by the hundreds in the last couple of years, is going to do anything other than mock someone who states as a matter of fact (not opinion) that "many" banks are carrying "toxic assets" (which are the subject of the question) at original book value. It is simply not within our realm of experience. You can argue legitimately over the issue of whether or not the write downs of troubled commercial real estate loans and other "distressed assets" on the balance sheets of commercial banks have been more or less than is "reasonable," but saying that they haven't been written down at all at "many banks" is worthy of every bit of vitriol that Tom can muster to throw at Nouri. It makes Roubini appear to be, at best, ignorant of the facts on the ground.

As I intuited last week, Roubini thinks too-big-to-fail banks ought to broken up. Tom lambastes Nouri for this view, as well.

I’m no fan of size in the banking business, either, but this notion that systemic risk would somehow be reduced if, say, JPMorgan Chase were broken up into its constituent parts is plain crazy. The company’s derivatives unit, for example, would be “systemically important” whether it’s a unit of mighty Morgan or if it were a standalone boutique.

Tom excoriates Roubini for some of his other views, as well. You should read the whole post, which isn't long, but is entertaining. While I don't have the same feeling that Tom has for every bloviation of Roubini's, I agree with him on enough of them to feel his pain.

The comments section to Tom's post is also amusing, but not in the way many of the commenters, almost all of whom are anonymous, may have intended. As a well-known blogger once declared shortly before shutting down her comments box, "Don't kid yourselves: what we do here does not rise to the level of honest debate."

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It's not too late to take advantage of the $50 discount that we're offering readers of this blog off the price of either the live webinar or live webinar and playback option for tomorrow's Bank Law Stuff webinar, "Strengthening the Balance Sheet: Practical Capital Raising Considerations for Community Banks." In order to take advantage of the discount, you must register by following this link to the special discount registration page. You can register right up the starting time of the webinar, noon Eastern Time.

Pyrrhic Victories

Last week, A Texas bank and a former business customer quietly settled a lawsuit that arose out of the diversion by cyber criminals of over $800,000 from the customer's account with the bank. Although neither side publicly commented about the dispute (obviously, confidentiality provisions were included in the settlement agreement), the business press fired off a closing salvo at the bank by quoting a previous statement made by the customer's co-owner.

“After we were ripped off, PlainsCapital filed suit against us for protection from us getting money back from them.”

As explained in a January post at the excellent Bank Info Security website, the crooks managed to compromise the customer's security system and stole user name and password for the bank account, then used that stolen information to access the account online and direct the bank to wire out $801,495.00. Although there was a dispute as to whether the wire transfers were made from Texas directly to overseas banks or first to banks in the US, the money did wind up in foreign countries. Moreover, the early press reports indicated that notwithstanding the fact that the bank's security procedures required customers to register the IP addresses of computers that they used to access their accounts, the transfers were in initiated by IP addresses in Italy and Romania. Although the bank was able to recover all but $200,000.00 of the diverted funds, when the customer demanded that the bank fork over the remainder, the bank sued its customer and asked the court for a declaratory judgment that the bank's security procedures were "commercially reasonable."

We've discussed the requirements for multi-factor authentication at length (ad nauseam, some might think). It appears that the bank had a multi-factor authentication system in place but, for some reason, it failed to stop this sort of theft. Was someone asleep at the switch? We'll never know.

One thing we do know is that a bank that suffers this kind of loss can win the legal battle and lose the customer relationship war. In the initial press report, the bank comes off looking like it's unsophisticated, if you read between the lines of some of the "experts" who are quoted.

Whatever the outcome of this lawsuit, security experts say that institutions and customers alike must increase their vigilance and strength when securing and authorizing online transactions. "There is a need for transaction verification," says Vatsal Sonecha, vice president at TriCipher, a security vendor. "By making an effort to contact the customer before a transaction occurs, banks are protecting themselves from a faulty transaction. There is a need for communicating the details of each transaction, so that customers have the ability to stop a non-authorized fund transfer."

Fund transfers have the potential for terrible consequences, Vatsal warns. He suggests institutions employ multi-factor authentication and transaction verification, a single-use password sent to a smart phone or mobile device acts as an additional layer of security that customers need.

"As we can see from this case, wire and funds transfers are transactions that can cause quick and devastating results for banks and online bankers," Vatsal says. "Banks need to think about safeguarding the channels that hackers traditionally take to steal sensitive log-in information with strong multi-factor authentication."

Phil Neray, vice president of security strategy for Guardium, an IBM Company, sees the fraudsters winning the battle, as they seem to be targeting the regional banks and community bank commercial customers. "It's a game of catch-up for those institutions that don't have the layered protections and checks and balances across their network," Neray says.

A follow-up article in March of this year presented another opportunity for the customer to bash the bank.

"Our new banking partner asked us not to mention their name, as they would rather not be brought into this whole fiasco," says Troy Owen, a vice president at Hillary Machinery. But he describes the institution as a "large world bank that takes fraud very seriously, as they have much more at risk than a smaller bank."

[...]

"PlainsCapital's decision to deny its inherent responsibility to protect a customer and file a lawsuit is what prompted us to start looking for another bank," says Owen. "PlainsCapital left us little choice. We needed a bank that could protect our deposits."

After researching trends in bank security and due diligence of several financial institutions, Hillary chose a large money center bank to protect its future commercial deposits. "Specifically, major money center banks simply have more resources to dedicate to a defense-in-depth, or a layered security program," Owen says. The selection team sought true two-factor authentication as a first layer, intense fraud controls as a second layer, as well as resources to change as threats evolve. "They also don't simply comply with regulator's expectations," he says. "They do whatever is necessary to protect themselves and their customers."

Ouch!

To me, there are a number of obvious lessons from this unfortunate set of circumstances (and I'm capable of discerning nothing deeper than the most obvious lessons from any set of circumstances). One is that even if you've implemented multi-factor authentication and security guidelines, they won't do you much good if you don't constantly monitor their operation, test them, and make sure that they actually work. Hiring security experts whose job it is to circumvent them and who can tell you where you have holes you need to plug ought to be standard operating procedure for all banks engaged in online banking activities.We don't have enough uncontested facts in this particular case to know whether the bank did or did not follow such practices.

Another lesson is that most customers, whether they are consumers or businesses, are simply not up to the task of covering their own cyber backsides when faced with the intellectual giants who are running these types of criminal enterprises. The banks have got to continue to run hard to try to keep ahead of the bad guys, knowing full well that the race will never end. Banks have to assume that their customers are "challenged" in the online banking security environment and that the security burden falls disproportionately on the banks. That's facing facts, whether the end result is fair or unfair, and whether or not your security procedures would be deemed to be "commercially reasonable" under applicable law.

Yet one more lesson is that when bad things happen, focusing first and foremost on protecting your legal flanks can result in the legal tail wagging the business dog. While suing for a declaratory judgment might have been a smart legal maneuver, how did it work out from a PR standpoint? You be the judge of that. In addition, while banks can craft all the great legal protections they want in their agreements with their business customers, when the crooks come calling and money goes out the bank's door, you may not only have a very upset customer, you may have a reporter sniffing about who would just love to write another "bad bank" story in order to play to a public that currently thinks all banks are lower than pond scum. That simply can't be good for business.

Sunday Night Scattershooting

I'm blogging on the fly while dodging arrows shot by Nouri lovers over last Thursday night's post. So, here are a few disconnected links to items that might be of interest to readers. If not, have a Supercalifragilisticexpialidocious start to your week.

First up is an article from Venable LLP partner Joe Lynyak entitled "The Failing Bank Scenario: An Explanation and Suggested Analysis for a Bank's Board of Directors and Management." It's a reprint of an article in The Banking Law Journal that's a must-read for management and directors of too-small-to-save community and regional banks that may be in danger of imitating The Titanic. In light of the FDIC's new additions to its troubled bank list, I assume that there's an audience out there for this information and that the audience is growing. The latest article by Joe is a companion piece to two other related articles, one on responding to enforcement actions and the other on liability considerations for directors and officers of FDIC-insured institutions (and "institution affiliated parties"). Earlier versions of the latter two articles have been previously discussed on this blog (here and here).

I realize that if there's one thing bankers hate to do, it's to pay a lawyer to do anything. On the other hand, I've seen so many bankers frozen in the glare of the headlights until the nanosecond prior to the collision, at which point they cry "Help!" Too late, Chicken Little, because by that time the lawyer is nothing more than a hospice caregiver. If you're at risk, read the linked articles and hire a knowledgeable counsel of your choice before the Eleventh Hour and Fifty-Ninth Minute.

On a completely unrelated matter, we noted in February that Fannie Mae and Freddie Mac were "in full put-back mode." According to Housing Wire, in the first quarter of 2010, the two broke mortgage giants "forced lenders to repurchase $3.1bn of mortgages out of their securities and off their books in Q110, up 64% from nearly $1.9bn one year earlier." They would have pushed back even more, but according to public filings, some lenders simply didn't have the financial ability to fund the buybacks. In other cases, one of the wards-of-the-state decided that future business considerations outweighed the need for immediate cash.

"Enforcing repurchase obligations with lender customers who have the financial capacity to perform those obligations could also negatively impact our relationships with such customers and ability to retain market share," Freddie said.

There's something odd about a company that is so insolvent, and whose business model is so broken, that its corporate motto ought to be "Epic Fail," worrying about "future market share." The resolution of Fannie and Freddie should have been part of the recent financial reform legislation. Of course, that might have forced the federal government to come even cleaner about its scheme to nationalize the nation's residential mortgage lending business, and goosed the American public out its eyes-glazed-over ennui with respect to the whole "bank bail out thing."

According to Paul Muolo of National Mortgage News, the repurchase "hit" taken during the first quarter by the "Big Four" commercial banks that dominate residential mortgage production in this country was much larger than a paltry $3.1 billion.

...[A]ccording to the latest figures, the "Big Four," combined, were forced to repurchase $8.7 billion of residential loans during the first quarter.

[...]

The buyback issue is now so white hot that the Mortgage Bankers Association is planning a series of seminars around the nation to educate lenders about their rights as seller/servicers. "Our seminars focus on different things," said MBA chief economist Jay Brinkmann. "One key thing we talk about is what type of buybacks are worth fighting for and which ones aren't. There's some lenders out there that have three different repurchase requests on the same loan-all for different reasons."

What's bad news for banks can be great news for lawyers, however (and what else is new).

Law firms are now getting into the buyback game as well. The key question for seller/servicers is how often can they win their buyback battles. One mortgage banker close to the buyback situation said he knows of a lender that recently won 52 out of 55 repurchase disputes. "He had to resubmit documents and it took a lot of time but he won," said the official, requesting his name not be used.

He noted, however, that at some point seller/servicers have to cut their losses. "Rep and warranties can be fought to a degree," he said. "But fraud lives forever. If it's discovered that fraud was involved there's nothing the originator can do."

Yeah, "fraud lives forever." However, some people suffer the consequences and some people don't. For example, how many directors and officers of too-big-to-fail banks will be pursued by the FDIC (or any other federal banking agency) for bad business decisions that have morphed into breaches of fiduciary duty, as opposed to directors and officers of many, if not most, of the too-small-to-save community banks that have failed and will fail? What's your guess?

Doctor Doom Scoffs at Financial Reform

Economist Nouriel Roubini has achieved an almost (or perhaps, actual) cult-like status because he was one of the very few talking heads who consistently called the "Great Recession" before it was apparent to the rest of us mere mortals. He's also got that whole "Vlad-The-Impaler-In-A-Tux" look and funky "Somewhere-Between-Tashkent-And-Turin" accent going for him, and as everyone knows from the latest pop culture fads, chicks dig vampires.Thus, when "Nouri" speaks, people listen. Well, some people don't, but they're not "rad" like "Nouri," so who cares?

A few days ago on CNBC, Roubini laughed in the face of the Congressional folly that is evident in the half-a-loaf financial "reform" legislation that's winding its way through the sausage-making machine commonly referred to as "the U.S. Senate." 

“We need more radical reforms," he added. "The idea that we’ll be able to close down an institution like Goldman (Sachs) in an orderly way—a business that operates in nearly a hundred countries—is absurd.”

So, if it's "absurd" to try to close down a Goldman Sachs in an orderly way, should we just take a lesson from The Joker in the movie "The Dark Knight"?

Do I really look like a guy with a plan? You know what I am? I'm a dog chasing cars. I wouldn't know what to do with one if I caught it. You know, I just... do things.

I'm not sure, because the article that discusses his appearance on CNBC doesn't provide much detail as to what his "more radical reforms" might be. Nevertheless, I think that based upon what was reported, his preferred reforms would be to reinstate the wall between banking and commerce and to break down the "too big to fail" banks into smaller, more manageable pieces. If that's the case, his thinking would be in line with many within the current administration and Congress, although out-of-step with legislators who like big Wall Street banks and the campaign contributions they so generously provide.

On the other hand, I might be wrong. Maybe Nouri wants us to just "do things." I know that very often, that's all I yearn to do. Like score a date with Catherine Zeta-Jones, to pick one random "thing" out of thin air.

Roubini is even gloomier about the heavy weight of sovereign debt.

“There is a risk of ending up in another crisis, as the world found itself in the Depression in 1933.”

The main problem is the huge amount of government debt in many countries around the world. “Debt ratios haven’t fallen yet," he said. "They’re just stabilizing at very high levels.”

He insisted that these deficits were indispensable, however.

“We were on the verge of a great depression," he said. "We needed the stimulus, or the outcome would have been ugly. Some countries can monetize fiscal deficits, others can’t.”

The world is now faced with a choice between default or inflation, according to Roubini.

“If the debt of governments becomes unsustainable, they won’t have the ability to prevent a deeper recession,” he said.

[...]

A fiscal train wreck lies ahead whether governments remove deficits or maintain them, leaving a situation where policymakers are “damned if you do, damned if you don’t,” Roubini said.

 In other words, as I said last week, "we're screwed."

Thanks, Dr. Doom, but many of us have already figured that out. Next time you bloviate on cable television, please give us something useful, like how to dig ourselves out of this hole, or, even better, Catherine Zeta-Jones' private cell phone number.

The Incredible Shrinking Bank Sector

As regular readers know, I've speculated for some time (for example, here) that the FDIC has a not-so-hidden agenda to bring down the number of FDIC-insured banks from 8,000 to 6,000. After a speech last month, I was reminded by legal counsel for a state bank trade association that former Comptroller of the Currency Bob Clarke once publicly stated such a reduction was one of his goals. If, in fact, there is a plan at the federal regulatory level to consciously take down enough small banks to reach 6000, it appears that the regulators will be getting plenty of help from economic and other factors that are driving the downsizing engine full speed ahead.

According to a recent front page article in The American Banker (paid subscription required), experts within and without the regulatory system are telling community banks that the mantra they ought to be chanting is "grow, merge, or die."

Julie Stackhouse,  the senior vice president of supervision at the Federal Reserve Bank of St. Louis, told a gathering of bankers here last week that small banks ought to consider merging with like-minded banks to gain the scale needed to keep pace with technology and handle the burden of regulatory compliance. Merging, especially for those in rural areas, could help diversify a bank's products and geography, she said.

The 200 or so Tennessee bankers at the gathering were asked to raise a hand if they were considering a merger; not a single hand went up. Of course, this may not be something a banker wants to admit in front of his rivals.

"I guarantee there were 50 banks in that room that have had that discussion recently," Sammy Stuard, the president and CEO of F&M Bank in Clarksville, said in an interview after the meeting. "If you can't raise capital, you have to do something — shrink or get out."

Philip K. Smith, the president of Gerrish McCreary Smith, a law and consulting firm in Memphis, predicted consolidation will claim 2,000 to 2,500 banks, bringing the nation's total to 6,000 or fewer.

A great deal of that consolidation will be in the form of mergers, but plenty of banks will fail.

The ever-ebullient Meredith Whitney was her usual slap-happy self. 

"There are going to be a lot of banks that just die," Meredith Whitney, the chief executive of Meredith Whitney  Advisory Group LLC, told the Tennessee bankers. "Some banks are too big to fail while others are too small to matter. For the teeny-tiny banks, there is no place to go."

Whitney's advice tracked Stackhouse's: "Merge with a clean, small bank, and you can raise equity. Get enough scale, and go after the big guys."

Or, you could, you know, always eat the barrel of a gun.

According to community bankers who were interviewed for the story, two of the primary "headwinds" facing community banks are the brutal costs of regulatory compliance and technology. The president of the Tennessee Bankers Association gave the opinion that the regulatory reform legislation moving through Congress might be the final straw that breaks the back of the camel called "community banking."

"There was fear for many years that large banks would be the demise of community banks. I am concerned that Congress could be the demise of community banks."

There's also the added burden of commercial real estate woes that we've been posting about recently. That burden will continue to sink many community banks who fell for the siren call of CRE lending.

As one private equity investor who has been talking with a lot of community bankers told me recently, "There are a bunch of small bank management officials who are telling me that they no longer care about the cheese, they just want out of the trap."

For those community banks that will be the survivors, and, therefore, will grow organically, through acquisitions, or both, the need for capital becomes paramount. One investment banker told the Tennessee conference that the next six months will be critical (as if the last six months weren't). The survivors need to be lining up capital. Of course, that's easier said than done, especially for small banks.

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Speaking of capital raising by community banks, we're offering readers of this blog a $50 discount off the price of either the live webinar or live webinar and playback option for next Wednesday's Bank Law Stuff webinar, "Strengthening the Balance Sheet: Practical Capital Raising Considerations for Community Banks." In order to take advantage of the discount, you must register by following this link to the special discount registration page.

If you're a reader who has already registered for the May 26th webinar and would like to receive the discount, send an e-mail to [email protected], tell her you want the Bank Lawyer's Blog discount for that webinar, and we'll make sure you get the appropriate refund or credit.

And here you thought the only benefit of reading this blog was how good it made you feel about your own levels of sanity and intelligence (as compared to those possessed by this blog's author). If enough readers take advantage of this discount, we may repeat it with select future webinars. If not, please feel free to continue to pay "the full monty."

Sheila Talks Turkey About Derivatives

I assume that no Blue State readers ever watch Fox Business News, and, therefore, as a public service to them, I'm posting an embedded video of a recent interview of Sheila Bair on that cable channel in which she makes some sense about why tearing derivatives trading desks out of banks would be a bad idea. Among other cogent points, she makes the following:

• Derivatives aren't all evil.
• Banks need them to hedge interest rate risk, for themselves and other financial institutions.
• Legislators who say stupid things like "AIG shouldn't be able to use insured deposits" should sit down, shut up, and let the adults talk.

She finishes up by confusing the poor interviewer on the issue of "dressing up the balance sheet" at the end of each calendar quarter. That didn't appear to be an extremely difficult task for her to accomplish, since I assume he was probably day-dreaming about either Angelina Jolie or an ice-cold Bud Light (or both) rather than the calculation of risk-based capital ratios based on average assets.

Enjoy!

The "Inflatable" Charter

Some Denver investors (who, not surprisingly, are former bankers) are in the process of pursuing a game plan that's become increasingly common: buying a relatively small, distressed commercial bank before it fails and using it as a platform to make acquisitions of other solvent banks and/or of deposits and assets of failed banks form the FDIC. The business model is sometimes referred to as "an inflatable charter," because, obviously, you start small but "blow it up." That's "blow it up" in the sense that you blow up a balloon (grow it through acquisitions), not "blow it up" in the sense of the favorite activity of Bruce Willis in the "Die Hard" movie series. At least, the owners' plan is not to intentionally "blow it up" in the latter sense.

I think the reason we're seeing this trend is that garnering a shelf charter has been a tough row to hoe for many who've pursued it. While there have been some winners of failed asset bids from the FDIC among those groups that have acquired a shelf charter, they've been few. Buying an existing bank and using it as an acquisition vehicle gets you in the game more quickly. In addition, as private equity investors who been trying to enter the financial institution business by bidding on failed banks can attest, existing financial bidders have a competitive edge over those outside the system.

Of course, when I use the term "more quickly," I have to put that in context. The Denver investors stated that they'd been working on the acquisition of the small community bank they'd targeted for over a year. And this group includes such credible "players" as the former chairman of the Federal Reserve Bank of Kansas City, so it's obvious that if you don't have a management group in place that has credibility with the regulators, you're wasting your time. According to the linked article, a portion of that delay was due to the difficulty in raising capital to do these types transactions in a depressed economic environment. Although not mentioned in the article, another portion of the delay was likely the result of the regulatory application process. As I repeatedly tell folks, this stuff takes time and the regulators don't give a fig about your "need" to put your capital into productive use as quickly as you can. They're going to cover their posteriors no matter how long that takes. Thus, this is not a game to play if you have a low threshold of boredom or you suffer from ADHD.

Here's another free tip not found in the article. If your business plan involves acquisitions and growth, you better have specifically identified and on board the human and financial resources to support that growth from the get-go. Approval will not be given to acquire the "inflatable bank" unless you can demonstrate that, when "blown up," you'll have everything you need to run the bigger bank. If you think that might be expensive, you're right. Therefore, in addition to time, be prepared to invest plenty of cash.

UPDATE 5/18/10: I've added the missing link to the article at the beginning of this post.