Bank Lawyer's Blog

The Incredible Sinking Deficit

The word from the Treasury confirms something we've believed for a long time: the cost of TARP to the American tax payers will end up being small potatoes.

The Congressional Budget Office says TARP’s subsidy cost to the government – including grants for mortgage aid initiatives – currently stands at $21 billion, down $3 billion from the last estimate of $24
billion.

Remember when everyone was moaning about a price tag that appeared to be 700 billion dollars? That was when many of us thought that the sky was falling. Of course, it might have, and if it had, the free market purists would have felt vindicated, while battling their fellow citizens for crusts of bread and potable water. The intervention was unusual, made only because the prognosis was dire and the geniuses in D.C. were tying to ward off a complete meltdown. In retrospect, I think it was necessary to avert a lot of pain and suffering.

Not that we didn't experience a lot of pain and suffering in any event.

Among the most interesting facts cited in the latest disclosures is the portion of the bailout funds that was intended to help hapless homeowners. HAMP helped 1.1 million homeowners receive a loan modification, which sounds like a god thing at first blush. However, the report also indicates that 300,000 of those modifications later went into default. That's a nearly 30% re-default rate, which is, no matter how you look at it, an arguably bad investment. On the other hand, it also means that over 70% o the borrowers were "saved," so there's "the glass is half-full" view of the matter.

Consumer activists would likely say that even more should have been done for more homeowners. Others would say that with that default rate, throwing more money down that rabbit hole would have been a bad idea.

I feel strongly both ways.

[REVISED 07.12.13 TO CHANGE "30,000" TO "300,000" AND TO MAKE OTHER MINOR CORRECTIONS]

 

Camden Fine Fires Off A Fine Salvo

In  recent opinion piece for Bloomberg News, ICBA CEO Camden Fine was in fine fettle, ranting about his favorite topic: new regulatory burdens are strangling community while the largest banks are doing just fine, thank you very much. Among his salient points are the following:

The megabanks are benefiting from what Bloomberg View calculated is an $83 billion annual taxpayer subsidy, the value of implicit guarantees by the U.S. Treasury. Bloomberg View was correct to characterize the too-big-to-fail subsidy as “a major driver of the largest banks’ profits.”

Perversely, Federal Deposit Insurance Corp. data show that large banks have both the lowest credit quality and the lowest cost of funds in the industry. Community banks rank the highest in both categories even though they have had to compete for years against the megabanks’ access to cheaper money in pricing loans. In addition, community banks must compete against the big lenders’ lower comparative costs in handling regulatory paperwork.

While Cam complains that this is "morally wrong," I suspect that in a nation overrun with Pontius Pilates who sneer in the throes of their born-again relativism "What is 'truth'?," appealing to "morality" as a behavior influencer will have as much impact on Congress as a stern talking to by Pope Francis would have on Charlie Sheen. More effective on the morally challenged is likely to be his economic arguments.

Community banks should be putting their capital to work in the small towns, rural communities and middle-class urban enclaves they know well. Instead, they are focusing too many of their precious human resources on onerous paperwork and time-consuming compliance measures.

Community banks are the source of almost 60 percent of all small-business loans of less than $1 million, as well as mortgage and consumer loans tailored to the needs of their local communities. Large banking organizations with more than $50 billion in assets hold almost 40 percent of outstanding small loans to businesses, according to the Federal Reserve, but loans to small businesses aren’t a significant portion of large-bank lending. Small-business loans represent less than 5 percent of the large banks’ total domestic lending.

Cam outlines five specific steps Congress and the federal regulators could take to help community banks (and credit unions, for that matter, although Cam would choke on his own tongue before admitting it). They include:

• Easing up on some of the more onerous residential mortgage lending and servicing rules.
• Eliminating the requirement that community banks report on every new small business loan application.
• Requiring a cost-benefit analysis for all new regulations and prohibiting the issuance of any regulation where the cost exceeds the benefit.
• Raising the threshold to $350 million in assets for the requirement for an audit of a bank's internal controls.
• Eliminating the annual requirement for sending no-change privacy policies.

These are all helpful suggestions, but  I'm frankly surprised that he didn't also call for the carpet bombing of CFPB's D.C. headquarters and insist that Jamie Dimon's king-size bed be short-sheeted. Oh well, the year is not even half over. There's still time to get down to the really important stuff.

Charlie Munger: A Favorite Curmudgeon

Warren Buffet's long-time running buddy, Charlie Munger, agrees with Cam Fine about one thing: it's time to break up (or at least "simplify") the big banks.

In an interview with CNN at Berkshire Hathaway's annual meeting, Munger, who is Warren Buffett's chief lieutenant, said he thinks the big banks are still too complicated and dangerous for the economy. But he doesn't think a recently proposed bill by Senators Sherrod Brown and David Vitter, which has gotten praise from others who want to rein in big banks, is the answer.

"I think if you increase the capital requirements and let them do what they want, they will just get in trouble again," says Munger.

Munger's preferred prescription sounds like a stricter version of the Volcker Rule, which was meant to limit risky trading at the banks and was included in Dodd-Frank, but has yet to be implemented. He would force the banks to get out of their business of underwriting and trading derivatives, financial contracts that allow you to speculate, some say hedge, on commodities, interest rates, and other things. About a year ago, JPMorgan Chase (JPM) announced it had lost billions on a credit derivative hedge that had not worked out as expected.

As CNN reporter Stephen Gandel notes, Munger's words carry additional weight, because he's calling for action against banks like Wells Fargo and Bank of America, institutions in which Berkshire Hathaway has sizable investments.

Munger thinks that big banks should be more heavily regulated, and that more regulation will be just what the profit doctor ordered. "By getting out of risky businesses, banks may end up giving back much less of their bull market gains in the down years" He thinks that banks should stick to their knitting, lending. "The ideal bank is pretty boring." I agree.

Gandel thinks that if Munger actually believes that more regulation and smaller size lead to greater profits, then he has a fiduciary duty to Berkshire's shareholders to press banks like Bank of America to pare down their size and accept tighter regulation (instead of unleashing the lobbyists on Congress).Munger thinks that's the job of the regulators. I'd argue it's the role of Congress, but I'd also agree with Munger that Berkshire Hathaway isn't going to persuade Bank of America to accept being broken up or buried under an avalanche of more regulation.

Munger said he and Buffett make investment decisions based on the world they are in, not what they wished it to be, which is fair.

Like Buffet, Munger has always pretty much said what he thinks. As he ages, he's not becoming any less candid. It makes for an interesting interview.

Refraining From Punching The Punching Bag

A regular reader sent me a link to a video of a recent interview of Sheila Bair by Bill Moyers. Bair plus Moyers equals big bank bashing, and you know going in what you're going to hear. For those who expect me to do my usual double-tap to Bair's forehead, I'm sorry to disappoint you. I didn't think she was that far off base.

Moyers tried to serve her some softballs that she could stroke into the far left-hand corner of the outfield, but to me, Sheila seemed, for the most part, to resist the temptation to play to Moyer's typical crowd (take a look at the comments box for a sampling). She let it be known that while she's no fan of the management of the largest banks, and she believes that the federal bank regulators have suffered "cognitive capture" by those banks, she also thinks that trying to modify Dodd-Frank to add more specific provisions regarding breaking up the big banks is a fool's errand. Not only is it impossible to effect in the current political environment, but the regulators already have the tools to accomplish what they need to accomplish regarding mitigating the risk of the "Too-Big-To-Fail" institutions. That's the theory, at any rate, and I don't find it to be an unreasonable one.

Of course, the regulators had all the tools they needed to prevent the latest financial disaster and didn't use them effectively. Yet, we can always have hope, can't we?

I do find her purported amazement at the fact that banks use their own internal models to assign risk weights to certain held-for-trading assets to be, itself, amazing. As Dealbreaker's Matt King observed not too long ago, the banks base their models on public information and that information is, to put it mildly, "opaque." I doubt that the regulators would have much more success in assigning across-the-board risk weights to such assets in the same manner that they can assign risk weights to single-family mortgage loans. Moreover, the regulators have not been clamoring to usurp the banks' internal models with spiffy new and improved models of their own, have they? Maybe they have and I've simply missed the clamor.

I also found amusing her contention that Congress could have been more "prescriptive" in Dodd-Frank, contrary to the wishes of the regulators, who wanted to retain more discretion to set the rules. Leaving aside her own position on this issue in the formulation of Dodd-Frank, that act was drafted so hastily and rammed down the throats of the opposition so quickly that the very idea that the folks who wrote it could have nailed down "prescriptions" in any coherent fashion is implausible. On the other hand, as we've found in many of the lawsuits that the FDIC has filed against former officers and directors of failed community banks, hindsight is amazingly clear-eyed and Sheila has the benefit of 20/20 hindsight.

All-in-all, however, Sheila is sounding almost reasonable these days. Or, perhaps, I'm merely mellowing.

TARP Paybacks Continue To Roll In

Although I’ve beaten this drum for the last four years, I’m going to continue to rip flamadiddles on the same theme until my hinged wrists get tired. TARP, when it stuck to its intended purpose (before it became a slush fund to bail out the auto unions), not only saved many deserving community banks, it has ended up making a net profit for the US government. One more example is a recent auction of TARP preferred stock of a "saved" Texas community bank.

The U.S. Treasury said Friday it expects to recoup $19.8 million in proceeds from the public auction of FC Holdings Inc.’s Troubled Asset Relief Program debt.

The Treasury priced 21,042 TARP shares of the Sugar Land-based bank holding company’s TARP at $897 per share, which would ring up at $18.8 million. Another 1,052 TARP shares are expected to be sold for $955 per share, totaling $1 million, according to the Treasury.

FC Holdings, the bank holding company for Sugar Land-based First Community Bank, originally received $21 million in TARP in 2009. The Treasury said it has gotten back about $268 billion from its TARP investment in the U.S. banking industry, which was $245 billion.

Unfortunately, the hard-core critics of TARP will never admit that there might have been some good done for some banks, along with all the evil visited upon pure free market principles. The facts keep rolling in like waves onto the shore, and many refuse to acknowledge the error of their ideological ways. It's tough to prove a negative, namely, the proposition that if TARP had not been created, the economy would have tanked a lot worse than it did in 2008-2009.

It's a question of judgment. On this matter, I choose to trust my own. Of course, I'm leaving AIG out of the calculations. That organization wasn't among the "banks" TARP was originally designed to bail out. Nor, for that matter, was Chrysler.

The Curious Case Of Charter Bank

The FDIC's first lawsuit of 2013 against former officers and directors of a failed FDIC-insured financial institution involved a former thrift that was the subject of a number of blog posts over the past several years, Charter Bank of Santa Fe, New Mexico. In one post, I recounted how I was taken behind the woodshed by OTS personnel and supporters for questioning the severity of that agency's writedown of the value of collateral securing commercial real estate loans in the bank's portfolio. Most of the discussions at that time (and since that time) that I have had with folks on all sides of that bank's failure and subsequent "resolution" have focused on the commercial real estate loans, especially acquisition and developments loans.

Given that focus, I was surprised to read that the claims against the former board and certain executive officers of Charter involved not commercial real estate loans, but a subprime residential mortgage operation that the bank established in Denver at perhaps, with hindsight, was one of the worst possible times to do so: 2006. It's been more common during the latest wave of lawsuits that involve a failed community bank that concentrated on commercial real estate lending, for the FDIC's complaint to allege negligence, gross negligence, and breach of fiduciary duty arising out of excessive growth, concentrated in CRE, funded by "hot money," without adequate capital in light of the risk, and without proper risk management policies, procedures, and/or practices for that type of lending concentration. Usually, the FDIC selects a portfolio of CRE loans where they think they can prove the allegedly wrongful acts and omissions caused identifiable monetary losses, totals the aggregate amount of losses on those loans, and sues for that amount.

In this case, I guess the FDIC chose what it thought was the "lower hanging fruit": losses related to the bank's subprime lending unit. The three-year statute of limitations has expired, and the FDIC's lawsuit made it under the wire, so unless there was a tolling agreement signed by potential defendants (unlikely), this is likely to be the only claim against the former officers and directors of the bank that the FDIC pursues. I simply find it unusual that, after all the allegations and "controversy" concerning CRE loan losses at that institution, it was subprime lending that caught the FDIC's eye.

Curious.

The 10th Circuit Shoves The Fifth Amendment Under A Rug

The 10th Circuit Court of Appeals issued a ruling a couple of weeks ago that has received scant attention, but merits close scrutiny. Cutting through all the "mumbo jumbo" (a hat tip to some of my lawyer-bashing clients), the court found that when it comes to determining a bank's capital levels, the bank's primary federal regulator can set it at any level it chooses, and the decision is not subject to judicial review. "Arbitrary and capricious"? The courts don't recognize the concept when it comes to capital levels. The sky's the limit.

The case arose out a "borrow-short-invest-long" strategy employed by Oklahoma-based Frontier Bank, whose primary federal regulator is the FDIC. The FDIC was concerned with the riskiness of the strategy. The bank and the FDIC negotiated a memorandum of understanding that, among other things, required the bank to maintain a 7% leverage ratio. In 2008, the FDIC determined that such a ration was not high enough and that the strategy was "unsafe and unsound," and when  the bank resisted the FDIC's demands, the FDIC filed a notice of charges and the parties were off to the races in an administrative hearing setting.

The administrative law judge who heard the case sided with the FDIC and proposed an order that would require the bank to maintain a 10% tier 1 leverage capital ratio. The FDIC adopted the ALJ's recommendation and the bank appealed to the 10th Circuit, alleging that the FDIC's decision was "arbitrary and capricious" for (among other things) lacking adequate support for the 10% capital ratio requirement. Those are, of course, the magic words under applicable law for providing a basis for appealing such an order.

The Court had the following to say about its ability to review the FDIC's determination of appropriate capital levels of the institutions it supervises.

Congress left the setting of capital levels exclusively to the FDIC’s discretion because there is no “meaningful standard against which to judge the agency’s exercise of discretion.” See Heckler v. Chaney, 470 U.S. 821, 830 (1985); see also 5 U.S.C. § 701(a)(2). Since there is no such standard,
there is no way for us to discern whether the FDIC abused its discretion or acted arbitrarily and capriciously in establishing minimum capital levels for Frontier, regardless of the enforcement procedure the FDIC employed.

[Applicable statutory law] vests this court with jurisdiction to review cease-and-desist orders. But it also explicitly incorporates the APA’s standards for judicial review. Id. While the APA embodies a presumption of judicial review, “[t]his is just a presumption, however, and under § 701(a)(2) agency action is not subject to judicial review ‘to the extent that’ such action ‘is committed to agency discretion by law.’” Madigan, 14 F.3d at 1449 (quoting Lincoln v. Vigil, 508 U.S. 182, 190-91 (1993)). As § 701(a)(2) makes clear, judicial review is not available in those circumstances where the relevant statute “is drawn so that a court would have no meaningful standard against which to judge the agency’s exercise of discretion.” Heckler, 470 U.S. at 830; see Madigan, 14 F.3d at 1449. “In such a case, the statute . . . can be taken to have ‘committed’ the decisionmaking to the agency’s judgment absolutely.” Heckler, 470 U.S. at 830; see Lincoln v. Vigil, 508 U.S. 182, 191 (1993).

Because the International Lending Supervision Act of 1983 vested in each federal banking agency the "ability to set authority to establish such minimum level of capital for a banking institution as the appropriate Federal banking agency, in its discretion, deems to be necessary or appropriate in light of the particular circumstances of the banking institution," the court ruled that the agencies had "sole discretion" to set such levels and, moreover, held that the law gave the court no standard to use to review an agency's determination. Given the lack of a standard for judicial review, the court determined that it had no power to review the decision.

The court further held that the fact that the decision of the regulator was made in the course of a cease-and-desist proceeding, as opposed to a capital directive, is meaningless. Either way, it's up to the sole subjective discretion of the regulator and the court cannot review the regulator's determination.

I found the following passage especially ironic.

The amount of capital a bank needs to weather uncertainty is a subjective judgment
dependent on an informed analysis of the magnitude and likelihood of the attendant risks...Reasonable minds will differ as to appropriate capital levels because they reasonably differ on their assessment of the attendant risks.

What has the concept of "reasonable minds" got to do with the discussion? The court has determined that the decision as to appropriate capital levels for each bank is within the sole discretion of the the bank's primary federal regulator regulator and that the decision is entirely subjective. Whether the capital level determination is based on "my mother made me do it," "Lord Zardoz of the Planet Mongo commands it," or "Simon Says," it's not up for any stinking Monday morning quarterbacking by any two-bit appeals court on the basis that it was "arbitrary and capricious," "without a reasonable basis," "as loony as a fruitcake," or any other rationale employed by those interested in providing a modicum of due process to banks in such matters.

While the opinion addresses several other points of contention between the bank and the FDIC, and slaps the bank down on all of them, the sticking point for those of us daydreaming about the Fifth Amendment is the absolute discretion of the FDIC (and, of course, the OCC, FRB and NCUA) to set capital levels without any ability to challenge those decisions in court. Bankers are used to the fact that challenging regulatory decisions is an uphill battle. What they're not usually expecting is a ninety degree incline.

Unless the bank successfully takes this up to the SCOTUS, I think this might just take a legislative fix.

TARP Profits Continue To Grow

Back in February, I noted that TARP had yielded a profit for the US Treasury of $20 billion. Notwithstanding the fact that the program is now down to the "harder-to-exit" smaller banks that might not be as attractive to potential purchasers of the preferred stock that the Treasury still holds, the profit figure is now up to $23 billion. While that's a drop in an ocean of federal debt, it's nothing to sneeze at. What I said earlier, I'll say again:

Opponents of the original TARP will never admit that they might have been wrong about the need for the program to save the economy from ruin. The fact that the Treasury has already made a profit on its original TARP investments ($20 billion so far, according to the linked article) is meaningless to them. I guess they wanted to let the "creative destructive" forces of a "pure market system" work their magic on all of us, and if we ended up standing in bread lines, they'd say that was a hard lesson learned and that we're all the better for it. I don't have the energy to tell them that not only is God dead, but so is Ayn Rand.

Even if the remaining $8 billion is written off (it won't be), the program still ends up in the black. Not bad for a much-maligned "bailout."

Of course, the Treasury may have a problem getting potential investors to pay as much as they might have in future TARP stock auctions now that one bank has stiffed an investor on TARP stock dividends (paid subscription required). The fact that those dividends are noncumulative makes it risky when small banks decide that, while it was their patriotic to pay the US Treasury, it's perfectly fine not to pay investors who bought their TARP stock from the Treasury Department.

"This is a good lesson as to what risks buyers need to be aware of with small banks," said Doug Faucette, a lawyer at Locke Lord. "That's why they call it stock."

I think that's an astute observation. However, I wish that bank the best of luck if it ever finds itself in need of capital from private equity investors in the future. PE hates it when Main Street starts acting just like Wall Street.

Hoenig and the Senate Agree: Basel III Bites

FDIC Director Thomas Hoenig, a regulator who "gets it" when it comes to the value of community banks, has been all over the country recently blasting the proposed Basel III capital standards. He's now all over the world trumpeting the same tune.

Federal Deposit Insurance Corp. Director Thomas Hoenig believes his call to reject the implementation of Basel 3 bank capital standards in the United States is "realistic," and that such an outcome is "possible" as long as the proposals are not adopted.

During an interview with MNI, the former Kansas City Federal Reserve Bank president also noted "there is momentum to change" Basel 3. "And I think we should not ignore that momentum going forward."

Hoenig said he envisioned a transition period of five to ten years to implement his alternative standard.

The FDIC director, who also argues in favor of breaking up banks in order to remove riskier activities from insured institutions, urged international regulators in a Sept. 14 speech to rethink the Basel 3 capital standards -- which he considers complex, flawed and backward looking.

He stressed the need to return to the "basics," and urged a delay of Basel 3 implementation. "Absent that, the United States should not implement Basel III, but reject the Basel approach to capital and go back to the basics," he said in his speech.

Hoenig proposed instead a "tangible equity to tangible assets ratio" as a better measure to assess capital adequacy.

Such an alternative is "realistic" and would strengthen the U.S. system and global financial markets globally, Hoenig told MNI. "Therefore it's important that it be considered."

Hoenig think there's still time to derail Basel III capital standards. I hope he's right.

One hopeful (if mostly symbolic) sign is that a bi-partisan group of 53 senators recently sent a letter to the FRB, OCC, and FDIC that opposes the new capital rules. To get bi-partisan support for anything favorable to community banks in this election year is a cause for some amazement. On the other hand, a letter is a long way from legislation.

“Community banks have little or no access to capital markets,” the letter states. “In most cases, they must rely on the bank's officers, directors and shareholders to raise additional capital. Raising capital for community banks in the best of times is challenging and nearly impossible in times of economic stress. We are concerned that the proposed capital rules could exacerbate these funding challenges.

"Experts" quoted in the linked article think it's highly unlikely that the regulators will change course. Let's hope that in this case, they're wrong.

Unnecessary Outreach

The FDIC is trying to tickle private equity's funny bone. At least, we assume that's the FDIC's intention in recently announcing a series of "outreach shops" to assist private investors who want to buy assets that the FDIC has acquired from the hundreds of banks that have failed in the past four years.

The goal of the series is to reach out to individuals and firms that may have a desire to invest in these types of assets, but lack the know-how or experience to do so.

"We believe that expanding the investor pool will assist in minimizing losses to the Deposit Insurance Fund," said Pamela Farwig, deputy director of the division of resolutions and receiverships.

The workshops will run a half day and are slated to take place in Chicago, Los Angeles and New York.

Those in attendance will learn more about structured sales and the pre-qualification process used to acquire assets from failed banks.

The FDIC wouldn't have to put on series of "outreach shops" to "expand the pool of private investors" for assets the FDIC has been mismanaging if they hadn't decided that private equity was evil because it was driven by the profit motive, and discouraged so many potential investors from acquiring whole failed banks, albeit with loss sharing. That negative attitude drove potential investors like the legendary Wilbur Ross to decide to take his investment capital to more hospitable climes.

If there's a way to maximize losses and minimize returns, you know which sector of the economy you can always turn to. No, it's not the private sector.

On the other hand, many investors did very well in the 1990s buying assets of failed savings and loans from the RTC. Those buyers didn't have to do their buying in the midst of the economic malaise and political and regulatory uncertainty that currently afflicts the nation; however, if profiting at the expense of a government agency revs your engine, I encourage you to give it a go. Let the "someone" the FDIC reaches out and touches be you.