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.

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. 

The Silver Lining

President Obama's big bank bashing bonanza rolled on today with his announcement that he's going to crack down on the proprietary trading activities of "Big Banks" and otherwise pin their ears back. The major stock indexes went into a funk as Big Bank stocks took a hit. On the other hand, one man's beat-down is another man's pick-me-up. In a video posted today by Fox News, a reporter whose voice could peel the paint from the hull of a guided missile cruiser interviewed Steve Trager, the CEO of regional bank Republic Bank of Kentucky, and Steve was honest in his appraisal that what's bad for giant banks might actually be good for community banks. On the other hand, Steve's comments about his fear of any new regulations applied poorly and how they helped drive all but the biggest banks and a plethora of mortgage brokers "with no skin in the game" out of the residential mortgage market are on the mark.

Also worth a listen is a brief segment of an interview with Warren Buffett on risk management (also posted today by Fox News). His assertion that every CEO ought to be the firm's chief risk officer ought to be stamped on the foreheads of every bank CEO in the country. On the other hand, as Buffett has so aptly demonstrated in his career, eliminating risk is not a reasonable goal, but managing it is. That is, you can't eliminate it entirely if you expect to make any money. That's something the politicians would be well served to keep in mind as they, once again, embark on the Quixotic adventure of making sure that financial failure "never happens again."

Treasury Claims It Took Big Banks To The Cleaners

One of the most popular games in Washington, D.C. these days is poking fingers in the eyes of big banks to show "The Peeps" what a populist can do to a rootless cosmopolitan capitalist oppressor of the working man (and womyn). In that vein, the US Treasury Department today crowed about how it drove a hard bargain with the big banks who repaid TARP CPP money on the purchase price of the warrants those banks bought back.

The Obama administration said Wednesday it's increased the investment return to taxpayers by pushing banks to pay higher prices to repurchase stock warrants given to the government during the financial crisis.

[...]

The Treasury said the $2.9 billion it received in the repurchase transactions exceeded estimates it and others had made. Those estimates had put the value of the warrants at between $2.6 billion and $2.7 billion. Treasury said the initial bids from the banks, which it rejected, totaled $1.7 billion on this group of warrants.

"This report makes clear that Treasury's process for selling these warrants has been consistent, transparent and has delivered strong returns for taxpayers," Herb Allison, the head of Treasury's financial rescue program, said in a statement.

What Treasury didn't crow about was the fact that if the federal government hadn't engaged in bad faith after-the-fact changing of the CPP terms, the banks might not have paid back the CPP funds yet and those warrants would be increasing in value instead of being converted into cash which may very well be flushed down those TARP rat holes called "General Motors," "AIG," Freddie Mac," and "Fannie Mae," entities which will be paying back the money invested in them by the US Treasury when Porky flies over the White House and does a victory roll. But hey, that's just my take on the matter and as every reader of this blog knows, I'm just another bourgeois exploiter of the proletariat, a lickspittle idler and a kulak parasite, a Bonapartist pig, a Trotskyite fascist hyena, a revanchist, and a class traitor, who deserves to be gulaged.

Also getting a lot less public yodeling by Secretary Geithner and his merry band of warrant regulators is a plaintive cry last week from the Conference of State Bank Supervisors for a continuing taste of TARP to be served up for community banks to dine upon. The CSBS wants Geithner to take some of that TARP money that's been repaid and institute a program for community banks that (a) permits banks to qualify for TARP CPP if they can show that they'll be viable after receiving the CPP injection (as opposed to the previous requirement that they must be viable without the CPP), and (b) establishes a "functional and attractive small business lending program" that community banks can use to make loans to those small businesses that drive the economy. Our inside sources tell us that Treasury Secretary Geithner was so impressed with CSBS CEO Neil Milner's request that he personally dialed him up and quoted this famous of line of Jack Handy's: "It take a big man to cry, but it takes a bigger man to laugh at that man."

Frankly, I think Mr. Milner would have made more headway if he'd sent the letter to Ariana Huffington.

The Myth of Charter Shopping

A couple of months ago, we highlighted Fin Reg 21's Darrell Delamaide's assertion that Chris Dodd's charge that we need a single federal bank regulator in order to prevent the kind of "charter shopping" that helped to cause the great financial meltdown we're currently wading through was devoid of any evidence to support it.Today (again thanks to FinReg 21), we discovered that Philadelphia Inquirer reporter Harold Brubaker has gone one step further than Darrell by showing that the facts that do exist rebut Dodd's charge.

Banking law allows institutions to choose national or state charters, to be a savings bank or a commercial bank, and to deal more closely with the Federal Reserve or with the Federal Deposit Insurance Corp. as a regulator.

There is little evidence, however, that large-scale charter-switching has happened generally, or that the Office of Thrift Supervision, the alleged weak link in banking regulation, attracted large numbers of banks to its supposedly more lenient regulatory oversight.

From 1999 to 2008, 45 more institutions dumped the savings bank, or thrift, charter than adopted it, according to congressional testimony in August by John E. Bowman, acting director of the OTS. Thrifts, by definition, are supposed to focus on collecting deposits and making mortgages. Overall, just a tiny fraction of banks switch charters each year, according to data from the FDIC.

It's not easy to find a pattern in the charter "flips," as regulators call them, other than the particular needs of the institutions.

It's a terrible thing for a politician (or a trial lawyer, for that matter) with a story to spin when the facts get in the way. Nevertheless, that has stopped few of them from spinning until they--and the voters--are dizzy.

Let's hope that as more time elapses and more stories like these are written, the rush to "do something, anything" to "reform" and "restructure" the financial system is blunted and that what emerges from Congress is something based more on facts than on folk tales.

Bank of America's Galveston Fish Story

I realize that whenever a bank (or any other business entity) is sued these days the standard public response  is some variation of "the lawsuit is without merit and we intend to vigorously defend," but occasionally, you wonder why the bank didn't simply settle the dispute short of letting it get to the point where a lawsuit is initiated. Some claims are just public relations losers regardless of the legal issues involved. Take the case of the Galveston, Texas, homeowner who discovered that his vacation home had been seized by Bank of America, which thought it was taking control of a home on which it had foreclosed and which proceeded to change the locks on the house and turn off the power by throwing the main power switch.

Unfortunately, at the time the power was cut off, there was 75 pounds of  Alaskan halibut and salmon sitting in a freezer. The homeowner, a retired professor, and his wife were planning to throw a party for 30 guests. Instead, after entering the house a week after the power was turned off, they, and the police officers who responded to their call that their home had been invaded, were poleaxed by the overpowering stench of rotting fish. I assume it will take more than a single air freshener to police up the atmosphere in that dwelling.

“It was the most unbearable stench,” [homeowner Dr. Alan] Schroit said. “It was so unbearable the police officer asked if we could leave the house so he could take the report; it was absolutely horrible, a gooey mess.”

Needless to say, the fish fry was canceled.

The problem for Bank of America is that it seized the wrong house. The professor thinks the bank might have been looking for a house on another street with the same house number. However, he and his wife don't have a loan with Bank of America. I assume they're not likely to apply for one in the near (or distant) future. Whatever the reason for the error, that was a major "oops" moment for the nation's biggest bank.

The professor and his wife apparently are claiming that substantial damages were incurred as a result of the power being cut off, in addition to the rotting fish odor issue.

“The property sustained water damage, potential mold contamination arising from the standing freezer residue, water, heat and high humidity conditions during the time the electrical power was off,” according to the lawsuit.

Schroit said he kept doors and windows open for days to try to rid the house of the foul odor. Cleanup efforts were substantial, he said.

The floors had to be cleaned, as did the joists of a lower-level ceiling, through which fish blood seeped, and some painting had to done to get the house back to a “preinvasion” state, according to the lawsuit.

Perhaps the bank thinks the plaintiffs' monetary demands exceed the bounds of reasonableness. At this point, the bank isn't saying much other than it is familiar with the claims and "we do not believe the case will show merit.”

Maybe it does, maybe it doesn't. You can't determine that from the press report, although it does seem that because the plaintiffs are doing most of the talking, and that big banks aren't exactly admired by the reading public these days, the bank's image is taking a hit. Therefore, you'd think that unless the plaintiffs were trying to extract a windfall, the bank would want to avoid the bad publicity. After all, these stories give reporters a chance to publicize the fact that this isn't an isolated case for Bank of America.

According to an Oct. 30 article in the Floyd County Times, a Wheelwright, Ky., man filed a lawsuit against Bank of America for repossessing his home by mistake and refusing to pay for damages other than replacing the locks.

“Christopher Hamby arrived home on Oct. 5 to find the locks on his doors changed and winterization chemicals placed in the plumbing and various lines cut at the residence,” according to the article.

Hamby also did not have a mortgage with Bank of America, according to the article.

Leap First, Look Later

Tomorrow morning, our very own Truth Commission starts hearings into the causes of the financial crisis in which we wallow and how best to ensure that it all "never happens again." You might think that a deliberative body like the U.S. Congress might want to await the findings and recommendations of the "Financial Crisis Inquiry Commission," which is allegedly bi-partisan, before actually enacting legislation to "reform" the financial system. That would be the prudent course. That might help to ensure that our legislators don't screw up a flawed regulatory system even worse than it already is by the brutal application of the law of unintended consequences, by fixing what doesn't need to be fixed, and by either not fixing what does need fixing or fixing it in a way that turns what's "fixed" into a malfunctioning mess of goo.

Yeah, that would be the smart way to do it.

Which is why the House passed a massive regulatory reform act last year and Senate Democrats are hell-bent-for-leather to make sure that something just as poorly thought through makes it through the Senate this year. Doing it the right way takes time, and time works against the panic purveyors who see their shot to stampede a p.o.ed public into looking the other way while the federal government grows even bigger and extends it tentacles into every nook and cranny of the financial machinery so that it works in a fair and balanced fashion, as determined by bureaucrats and politicians, those best suited by intellectual endowments and actual, hands-on experience, to ensure that a bubble never gets blown so big again. Human nature reigned in and re-engineered by financial gurus like Barney Frank and Chris Dodd. That's the ticket!

The Commission itself appears to be something of a boondoggle. While appointed in July, it's only recently started to staff up. However, it looks like it will keep some staffers paying the rent and buying groceries until it issues its final report, due in December of this year.

It has new offices in downtown Washington, a few blocks northeast of the White House. Funded to the tune of $8 million, it aims to employ between 40 and 50 investigators and other staffers.

Look, at least it should be entertaining. We can also hope that when people are grilled, there won't be the idiotic political posturing that goes on in Senate and House committee hearings. Commission members also promise that they won't sugarcoat the role that politicians played in fomenting the crisis, which we've seen in congressional hearings that paint everyone but the politicians as "evil doers." 

Lawmakers say the commission was modeled after the Pecora Commission, a panel that was convened after the 1929 Wall Street crash and other events leading to the Great Depression.

The Pecora panel's findings led to an overhaul of federal banking laws, including the creation of the Glass-Steagall Act of 1933. Glass-Steagall divided investment banking from government-insured commercial banking; ending that separation in the 1990s was seen by some critics as contributing to the current crisis.

It's modeled after a commission that held hearings, conducted investigations, made findings, and made recommendations to Congress, after which Congress enacted "game-changing" legislation. Not in this case, however. This time around, Congress is shooting from the hip, then asking questions. We'll have to see if Congress shoots itself (and the country) in the foot by trying to be so quick on the draw. What's your guess?

The Lesson of Baltimore: Never Settle

A few weeks ago, we discussed doubts raised by federal district court judge J. Frederick Motz about the viability of a lawsuit filed by the City of Baltimore against Wells Fargo, that alleged that Wells Fargo's predatory and discriminatory lending practices ("reverse redlining") are the root cause of the nuclear winter wasteland that Baltimore's inner city has become. Last week, Judge Motz ended those doubts by dismissing the lawsuit. He also had some harsh words for the plaintiff about the "real causes" of the deterioration of Baltimore and the "implausibility" of attempting to pick Wells Fargo's deep pockets as a quick fix by blaming it all on them.

"The alleged connection is even more implausible when considered against the background of other factors leading to the deterioration of the inner city," U.S. District Judge J. Frederick Motz explained in a six-page memorandum opinion accompanying the dismissal order. He pointed specifically to Baltimore's "extensive unemployment, lack of educational opportunity and choice, irresponsible parenting, disrespect for the law, widespread drug use, and violence."

Motz did allow that the City of Baltimore could refile a complaint that might survive dismissal if it "could restrict its claims to specific damages allegedly suffered because of actual houses made vacant by Wells Fargo's lending practices." What fun is that? If you're going to try to steal money from the private sector, you want to go for the really big payday by concocting a story that makes a well-capitalized defendant the Great Satan, then spinning it non-stop to the press and to a jury of the bad bank's "peers." Having to confine your self to "actual damages" and "the facts" is for chumps. There's no future in the facts for politicians. They spend their lives doing to the facts what dogs so to fire hydrants.

Besides, the "facts" will show that Wells Fargo isn't responsible for enough to fund even one municipal pol's PAC.

Baltimore has as many as 30,000 vacant homes, according to the original complaint, but so far, the city has identified only 80 vacancies related to Wells Fargo in African-American neighborhoods. "Thus, using the City's own figures," Motz wrote, "Wells Fargo is responsible for only a negligible portion of the City's vacant housing stock."

The American Banker (paid subscription required) discussed the approach taken by Buffalo as having more staying power, although perhaps not any more merit. As we discussed a year ago, Buffalo tried to make lenders who chose not to foreclose on vacant homes the "de facto" owners for purposes of city code violations and was handed its head by the trial court. Buffalo's still trying to squeeze lenders who take title through foreclosure to vacant homes whose condition violates the city's ordinances out of money for  the cost of each such home that the city is forced to raze. The damages in such cases aren't exactly pocket change but they aren't the gazillions and bazillions that cities would like to extract from lenders to replace their decimated tax bases.

However, as the article's author, Jeff Horwitz, observes, most of these municipal suits are being taken on a contingency basis by firms that defense attorney Andrew Sandler claims are "running around the country trying to persuade city councils to file these cases." Thus, the law firm, not the city, is fronting the lion's share of the fees, and, therefore, the city has no immediate financial incentive for dropping the cases. On the other hand, if the lenders all hang tough and keep fighting these lawsuits (and continuing to win), the "betting-on-the-come" trial lawyers will eventually fold. The danger lies in some lenders settling cases simply to be shed of the litigation.

Howard Cayne, a partner in Arnold & Porter's Washington office who represents banks, suggested that municipalities, even if they cannot win in court, could still "hope that the imposition of legal costs will force banks to settle." Anything other than a united front would be a disaster, he added, as any significant settlement would invite further litigation.

In other words, lenders, in this arena, "no quarter, asked or given," is the only way to fight.

Chris Dodd: Man On A Mission?

Chris Dodd's pending retirement from the US Senate (and the leadership of the Senate Banking Committee) is causing some proponents of banking reform to begin singing (well, not full-throatedly, more like humming) the blues. Alain Sherter, a man who yearns for banks to be put on "a short leash" (which I think is appropriate only for use at a leather convention, and even then, only when held by a dominatrix named "Lady Inamorata"), focuses on Dodd's likely successor among Senate Democrats. He's not happy about the prospect that any of them will be as tough on banks as Christopher ("Friend of Angelo") Dodd. He's most likely correct.

Taking a more hopeful line, though, is Stacy Kaper at the American Banker (paid subscription required). She's zeroed in on the fact that Chris has the whole of this year to do his voodoo, and that he's focused on his legacy (other than having "dated" Carrie Fisher and gotten a sweet home loan deal from the late, great Countrywide). The various yapping heads she's spoken with speculate that Dodd will push reform and, freed from political pressures imposed by a re-election bid, will be willing to engage in the horse trading that traditionally has been the way to get legislation moved through the more deliberative body of our esteemed Congress. While folks like Alain might be disappointed with any major compromises that Dodd might make to get a bill through Congress before he rides off into oblivion, folks like me (a minion of the evil banking empire) are worried that whatever passes will be screwing the goose that lays my golden eggs (and not in a pleasurable way, either). Odds are that if Dodd is serious about working out a compromise, he can push something through that will disappoint everyone, which is what Congress does about as well or better than any other public institution we have and which should allow him to echo another giant of the past decade: "Mission Accomplished."

Bank Exams in 2010: Step Aboard The Pain Train

On the first working day of the new year, FinCri Advisor (free registration required) sets an ominous tone by opining that 2010 is likely to be the year of the "take-no-prisoners" bank examination.

Look for much deeper and more critical safety and soundness exams in 2010, as regulators significantly beef up their risk management staffs - the FDIC's alone will grow 31% - and more quickly issue enforcement orders. Examiners' marching orders start with two big issues: CRE and liquidity risk.

An anonymous federal bank examiner warns that examiners will be "grading banks more closely." This means a number of things, foremost among them that many banks, especially community banks, should expect 2010 to be a "year of living dangerously," where the arrival of a bank examination team will be, in many cases, the starting point of a painful process that will lead to downgrades of CAMELS ratings, enforcement action, requirements that banks write down asset values, increase capital levels and reserves, improve management, operations, systems, and risk management, lower dependence on non-core funding sources, and otherwise jump through flaming hoops held higher and higher from the surface of the ground until bankers either flame out or sell out. Other than that, it sounds like the next twelve months should be a lot of fun.

One of the critical problems with upcoming examinations is that the federal regulatory agencies have been expanding their examination staffs substantially. Unfortunately, they don't appear to be bringing old hands out of retirement, but adding wet-behind-the-ears, fresh-faced youngsters. Former OCC examiner Robert Ziner asserts that this lack of experience will exacerbate the pain for banks.

Although examiners have more focused time in each bank, their lack of experience means there is less nuance and flexibility in the exam process...This manifests itself in several ways. Supervisory guidance gets interpreted as rules, Ziner says - such as the view regulators first issued in 2006 that a bank should keep its commercial real estate loan (CRE) concentrations below 300% of total capital. "Human nature tends to take a guideline and make it a hard and fast rule because it's easy to support," he says. "Your boss isn't going to tell you you've done something wrong by enforcing the guidelines. You don't have to take a risk."

[...]

Younger examiners also are much less likely to agree to informal understandings or permit forbearance, says former Fed examiner Pat McElroy Jr. of Risk Management Partners in Dallas. "Examiners have had more of a hair-trigger on enforcement actions," he says. "We've seen that a lot lately. They are not as negotiable as they used to be."

Note to bankers: Telling a young bank examiner who lacks the "nuance" that comes with experience that you'll "tear him a new one" is not likely to help your case. You know who you are. I'm merely pointing out the obvious. Just because it feels good to vent doesn't make it the right way to go.

According to FinCri Advisor, the two biggest issues for examiners will be asset quality and liquidity. Those certainly have been high on the list of issues we've seen in 2009, and I expect that they will cause even more headaches in 2010, especially for banks with heavy commercial real estate loan portfolios, which, unfortunately, includes many community banks, as well as those banks who rely on brokered deposits and similar non-core funding sources.

I was especially amused (with only a tinge of bitterness) about the new emphasis on "enterprise risk management." That's one check box item on an inexperienced bank examiner's list that is bound to be as baffling to many of examiners as it is to the small bank executives that have to answer their questions on the subject.

One community bank says the most surprising question asked at its recent exam was how it handles enterprise risk. "The examiner had no idea what he was really asking," says a respondent to the FinCri Advisor survey. "But it was clear that he was supposed to start asking it. It isn't a tough question, per se, but it sends a signal to bankers of what to expect coming down the road."

Another thing to expect is that bank management and board quality will be under the examination microscope. The skill set requires for managing in good times is not the same as that required for managing in bad times. Dealing with problems when your world is going to hell in a hand basket requires management that is able to roll up its sleeves, get its hands dirty, and deal with troubled assets by doing something more proactive than putting lipstick on pigs. As galling as it may be to have some freckle-faced youngster questioning your expertise, community bankers should be prepared to restrain their "fists of death" and deal with it.

In light of these disconcerting prospects, some bankers (and those who deal with them) may find one or more of the upcoming Bank Law Stuff webinars useful, whether it's Venable LLP partner Joe Lynyak's January 5th webinar on responding to enforcement actions, or later presentations on today's hot buttons for bank examiners and/or the onrushing commercial real estate freight train, what it means to banks, and what banks need to do about it. Regardless, fasten your seat belts, because 2010 is bound to be a bumpy ride.