Bank Lawyer's Blog

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. 

OTS "Corrects" Me on Charter

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

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

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

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

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

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

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

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

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

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

Community Banks Must Be Invisible

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

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

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

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

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

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

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

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

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

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

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

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

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

Charter Bank Takes A One-Way Trip Through The Looking Glass

Late Friday, the Office of Thrift Supervision shut down, and placed into FDIC receivership, the first bank to fail in New Mexico since 1999. Charter Bank was owned by a company controlled by the Wertheim family, admired philanthropists and supporters of investments in low-income housing in New Mexico. Casual readers who follow such closing through the caustic #bankfailfriday hashtag on Twitter might chalk this up to just another poorly run bank that ran out of gas. However, there's more here than meets the eye.

Charter Bank management and Office of Thrift Supervision examiners argued for months over the quality of Charter's loans.
        The argument ended about 4:30 p.m. Friday when OTS officials arrived at the bank's headquarters in a small shopping mall at Eubank and Spain NE to declare Charter "unsafe and unsound" and appoint the Federal Deposit Insurance Corp. as the bank's receiver.
        The FDIC in turn handed Charter over to a Texas company, Beal Financial Corp., which will keep the Charter name and open for business as usual Monday.
        Charter's management, led since 2001 by bank President Glenn Wertheim, insisted that loans, mostly commercial real estate loans — which OTS said were troubled — were, in fact, being paid on time. OTS disagreed and ordered tens of millions of dollars of those loans to be classified as toxic.
        That classification, recorded as an entry on the bank's balance sheet, on paper lowered Charter's capital (money regulators require banks to make sure their deposits are safe) to levels well below those regulators regard as sound, even though virtually all of Charter's commercial real estate borrowers continued to pay their bills on time.
        "They had one judgment; we had another," Wertheim said in a Journal interview Saturday.

Glenn alleges that the OTS is being overly conservative on loan evaluations, collateral writedowns, and capital requirements because it's fighting for its life. He's not the first to make that allegation, and I think that there's truth in it.

The bone that stuck in my throat was the fact that the OTS ordered massive writedowns on commercial real estate loans that were fully performing. As a reader of Ed Morrissey's blog who calls himself "The Banking Guy" observed, just because a loan's paying now doesn't mean that it's not subject to classification as "troubled." That's a true statement as far as it goes, and without having knowledge of each individual loan, it's difficult to make a definitive judgment. However, another report said 95% of the loan portfolio was fully performing, yet the OTS declared the thrift insolvent and shut it down. That sends a chill through the hearts of community bankers throughout the country.

Those of us who were in the saddle in Texas in December 2005 saw the Federal Home Loan Bank Board ride into Texas and start marking-to-depressed-market the collateral values of commercial real estate, construction, and acquisition and development loans of savings and loans throughout Texas. As a result, Cease and Desist Orders were flying faster than the Roadrunner on crank. It was a tactic used by a regulator responding to political pressure to seize control of a situation. What they did was help accelerate a death spiral that might have been eased had less draconian measures been employed. They proved that they were tough guys, though. They were tough right up until Congress turned on them and put them out of business less than four years later.

If the OTS, the FDIC and the FRB want to do that to every community bank in the country today, they can wreak even more carnage than they did in the late 1980s. That's something to look forward to, isn't it?

There's another thing about this closing that is seldom, if ever, reported upon in the mainstream media. The people who owned this bank weren't a bunch of wheeler-dealers out to loot a bank or take outsized risks in hope of an outsized payday. Instead, they are, by all public reports, good guys. Certainly, the New Mexico Mortgage Finance Authority thought so.

Ed Morrissey, who's a big dog on the right side of the blogging spectrum, thinks that there's something "fishy" with this takeover by the OTS.

...[T]he fact is that the only reason the bank became insolvent is because OTS made the risk look worse on paper last fall.  Their loans were being paid back at a high rate, probably better than most that OTS allows to continue operations.  OTS appears to have set up Charter to fail with its new risk declarations.

Welcome to our world, Ed. It's a trip through the looking glass. The trouble with it is that real human beings, not fictional characters, suffer.

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.

Too Little, Too Late

Experts consulted by Atlanta Business Chronicle reporter J. Scott Trubey tell like it too often is: small banks often wait too long to deal with problem commercial loans and, by the time they do finally address the problem loans, they lack the internal skill set to deal with them properly. Georgia is ground zero for this issue, with 30 banks in the state having already failed and with over a third of the state's banks under regulatory enforcement orders of some sort.

Small lenders, with limited personnel, often do not have talent with the depth of experience to handle the complexity and sheer volume of problems the current financial crisis has thrown at them, experts say.

Some are turning instead to outside consultants who are resorting to creative measures to salvage value out of busted real estate bets.

[...]

“What you’ll find with lenders is they’ll drag their feet and drag their feet until their problems catch up to them,” said Joe Waites, a bank consultant and partner with Minerva Consulting LLC. “[Small banks] don’t have the talent and in most cases they don’t have the right resources.”

Small banks by their nature are deeply embedded in their communities. Often borrowers and bankers go to the same church or golf club and their children play on the same soccer team. They need independent, third parties to make the hard choices, while not breaking those bonds.

“You can’t convert lenders into workout experts,” Waites said. Lenders spend months and years building relationships with borrowers. When the loan starts to sour, the bank itself may not see that the loan is going south until it’s too late.

“Literally the losses get larger and larger,” Waites said.

As commercial real estate problems continue to worsen, the prospects are only going to get bleaker for those banks that play "wait and pray."

The next wave — commercial real estate — will also hit community banks that bet on retail centers and small office buildings.

With vacancy rising and property values falling, many underwater borrowers will need to inject equity to keep projects alive, Waites said.

According to industry sources, many banks have not been proactive and engaging their borrowers to find workout solutions before problems worsen.

This is one area where thinking you can handle whatever comes down the tracks may very well result in you being run over. Even if a community bank with problem commercial loans thinks it can weather the storm without hiring outside help, it might be worthwhile to talk to outside consultants who have a track record of dealing with troubled assets (there are a number of folks who gained much hard-earned expertise during the mid-60-late 1980s and early 1990s and who are still kicking) to see what they have to offer. At the very least, you will be able to say you considered hiring outside help to assist the bank in dealing with its problem loans and rejected that course of action for whatever logical business reasons might be relevant. That's better than facing your board and shareholders with the bank rapidly sliding down the hill into a bottomless pit and admitting (or being forced to admit) that you didn't explore all the alternatives.

Not every consultant will be able to add sufficient value, but it never hurts to turn over all the stones in sight.

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.

Who's Looking Out For The Little Guy?

President Obama has been jawboning the nations largest banks about doing more of that good old small business lending that will pull our economy up by its bootstraps and right out of the deep funk in which it currently wallows. All you have to do is lend, and we shall be saved, is his line, and he's sticking to it. A couple of the big bank executives who weren't "snowed in" and actually made it to last week's meeting at the White House told the president that they'd start taking a harder look at loan applications to make certain that they weren't throwing any wheat away with the chaff. Nobody really believes big bankers when they say things like that, and the president had berated them all as a pack of "fat cats" in a recent "Sixty Minutes" interview, so the entire back-and-forth seemed like so much political theater, designed for public consumption and accomplishing little of practical value.

Today, the president met with representatives of community bankers and his tone was much more conciliatory.

Meeting with 12 executives representing small banks, President Barack Obama vowed Tuesday to press federal agencies to "cut some of the regulatory red tape" that may be limiting the ability of community bankers to lend more as the economy recovers.

"Some small bankers still have some regulatory constraints," Obama explained in remarks made in conjunction with the meeting. "In some ways, the pendulum may have swung too much in the direction of not lending after decades of too much of a focus on getting money out the door."

Alain Sherter of BNet did a good job last week of laying out the case for the importance of community banks and the small businesses they serve. No lap dog of the corporate elite, Sherter called on the White House "to do something" for the little guys after bailing out so many of the "fat cats." On the surface, at least, the White House appears to be concerned about "doing something"

At least the bankers were able to press home to the president (and have reported in the business press) what many of us have been seeing on a daily basis for many moons.

Small bankers discussed concerns that bank examiners are pressuring them to hike their capital, effectively restricting their ability to lend more at the same time that small businesses are cutting back on their borrowing, said Chris Cole, regulatory counsel at the Independent Community Bankers of America.

Cole points out two basic problems with a proposed remedy of "make more loans." First, it's difficult to lend more when you're required by examiners to write down the value of assets (especially commercial real estate loans), increase loss reserves, and increase capital. That's exactly what bank examiners have been doing, which, regardless of your view as to whether that's prudent regulation or counter-cyclical craziness, means that banks who suffer from such regulatory tough loved simply don't have the money to increase lending to small businesses. Second, small businesses are cutting back on their borrowing because their businesses are suffering. Examiners are also "encouraging" bankers to toughen underwriting standards and to dump bad borrowers, neither of which courses of action is a game plan for increasing lending to small businesses.

Many observers are skeptical that meetings like the one today with "The One" will actually change anything. As ABC reported this afternoon, the president claims that his office doesn't necessarily get the respect it thinks it deserves when dealing with the federal banking agencies.

“[W]e don’t have direct influence over our independent regulators.”

Perhaps not "direct influence" (although that is debatable), but certainly while those agencies publicly (and privately) bridle at political pressure, at the same time they factor it into most of the critical decisions they make. If the president is serious about cutting red tape, he can accomplish something. However, don't bet on it. A safer bet is that community banks will continue to suffer under the regulatory lash and lending to small businesses will continue to flounder.

Thank You, Sir! May I Have Another?

While we've previously focused on all the banks that are turning up their noses at the sweet smell of TARP II, we almost missed the fact that there's at least one small bank that scooted back to the trough for another generous helping of TARP Lite.

WashingtonFirst Bankshares Inc. has sold a second round of preferred stock to the Treasury through the Capital Purchase Program, part of the Troubled Asset Relief Program.

On Oct. 30, Reston-based WashingtonFirst got a $6.84 million infusion from TARP, nine months after it got $6.63 million through the program.

MMMMMM, MMMMM! I'll bet that Son of TARP goes great with fava beans and a fine Chianti.

The bank says that it will be using that capital to make loans to debt-deprived borrowers (as required by the terms of TARP II) .

Regulators offered the bank the money and it chose to take it, said Shaza Andersen, CEO. “We have a huge amount of requests for loans right now.”

She said the bank will use the funds primarily to make loans, though it also is in expansion mode. It is hiring for seven new positions and is exploring options for new branches and acquisitions in Maryland and Northern Virginia.

Wait a minute...It's "also in expansion mode." I sure hope none of that fine preferred stock bought by Uncle Sam is used to gobble up fellow banks. That wasn't the announced purpose of either TARP Senior or Junior. The next thing you know, one of these banks might actually use the additional capital to cushion its loan write offs and build its loss reserves. When will the perfidy cease?

As to other banks who gave TARP a cold shoulder, Ms. Anderson thinks their concerns are unfounded.

Many banks didn’t take TARP money because they were unhappy with the frequently changing restrictions and the added scrutiny that came with it — particularly the limits on executive compensation.

Andersen isn’t concerned about the restrictions, and says that WashingtonFirst executives don’t make enough to be affected by the compensation caps.

Those executives may not make enough to meet the caps today, but since there were no compensation restrictions in effect at the time the first round of TARP capital was issued, how can you be assured that Congress won't lower the caps next week, next month, or next year? How can you be assured that Congress won't impose some other restrictions on TARP takers that make it onerous to have received "cheap" TARP capital? Well, of course, you can't be assured. You're betting on a hope and a prayer, otherwise known as the "good faith" of legislators and regulators.

One thing is certain, however: Ms. Anderson is not concerned about surveys like those we discussed last week, that show TARP-takers take it on the PR chin in the eyes of their customers. If Ms. Anderson is correct, and "there are a lot of small businesses" who need the loans that WashingtonFirst will provide "right now," then perhaps her bank will eventually end up a public relations "net winner."

Concentrating on Commercial Real Estate

Reports of increased scrutiny of banks--particularly community banks--because of deteriorating commercial real estate values keep piling on. In Boston, the local business press seized upon the fact that commercial real estate concentrations at several local banks "soared past" the "limit" of 300% of capital set forth in federal bank regulatory agency guidelines. Bank executives tried to put a smiley face on these figures, one even evoking a vision of an empty office tower in Houston and saying "that ain't us." However, I doubt anyone's buying that line. First, Houston circa 1988 is not Houston today. Today, Houston is doing better than just about any other major metropolitan area in the US, thanks in no small part to the fact Texas was hit so hard the last time around the block that Texas didn't have the real estate bubble that has burst all over places like Georgia, Florida, Illinois, Nevada, Arizona, and California. Houston also is home to large oil and gas companies, and those folks are rolling in dough at the present time. Just ask Lexus where it's selling and leasing the most cars in the US. If we're talking "empty office towers" during the current melt down, look at south Florida, not Texas.

In fairness to the banks profiled in the article, they seem to be taking steps to meet regulators' concerns, including "kicking the tires," tightening lending standards, lowering loan-to-value ratios, raising additional capital, and otherwise showing the regulators that they are proactively dealing with the increased risk. Not one of them was mentioned in the article as currently being under any type of formal or informal enforcement action because of their concentration in commercial real estate lending.

Nevertheless, banks like these can certainly expect extra special attention from their primary federal regulator for the foreseeable future. As guest blogger John Walker chillingly pointed out a few weeks ago, "the CRE problem is real." As he also predicted, the problem is going to get worse, maybe a lot worse. As long as that's the case, banks with high concentrations of commercial real estate loans in their portfolio--regardless of their perceived quality and regardless of whatever other arguments the bank makes in the way of risk mitigation--will be in the examiners' cross-hairs.