Bank Lawyer's Blog

Gimme A Break! Nobody Actually Believed Us!

To answer a reader's question, yes, I did get a kick out of the argument by S&P's lawyers (paid subscription required) that statements by S&P "about independence and objectivity are 'puffery' and were never meant to be taken at face value by investors."

Standard & Poor's responded formally on Monday to the civil lawsuit that the Justice Department filed against the company on Feb. 4 in U.S. District Court in Los Angeles.

The federal government says that the rating firm committed fraud when it allegedly misrepresented its ratings as independent and objective.

In its formal defense filed Monday, S&P pointed to two earlier court decisions where judges ruled that such statements by the firm were puffery and therefore can't form the basis for a fraud claim.

[...]

"Even if it's a viable legal argument, it's a pretty unattractive argument for S&P to be putting forward since they're basically in the business of charging clients for their reputation," said Samuel Buell, a law professor at Duke University and a former federal prosecutor. "What they're saying here is, 'When we're talking to investors about our own reputation, we're engaging in meaningless puffery.' "

"That's the whole point of the rating agencies, their seal of approval," Mr. Buell said.

It's hard to argue with Professor Buell about that.

Predictably, this all drove Larry Doyle over the edge.

In conclusion, the statement made by S&P’s lawyer is the equivalent of throwing another log on the fire that is incinerating any sense of meaningful integrity within the Wall Street-Washington conspiracy.

Puff . . . puff . . . up in smoke!

You may want to do the same with any credit ratings that cross your desk from S&P and its industry brethren at Moody’s and Fitch.

As hard as this is to believe, I'm going to say that the provision of Dodd-Frank that requires the regulators to figure out an alternative to the rating agencies is justified, not merely by the facts, but by the damning words flowing from the rating agencies and their mouthpieces. The problem is, thus far, no one has figured out what that alternative might be.

One option on the table is a proposal by Sen. Al Franken (D., Minn.) to create a board that would assign rating firms to rate deals. "As this lawsuit unfolds, it only becomes more clear that the credit rating industry is in need of serious reform, and that the American people and our economy are still at risk as a result of the conflict of interest in the industry," Mr. Franken said in a statement.

Wait a minute: I just agreed with Al Franken. Don't tell anyone. This moment may pass.

Uh, oh. I think Hell just froze over.

M&A Litigation's Logical Consequences

Last week, we discussed a recent study that had shown that nearly every merger or acquisition transaction involving a publicly traded company last year had resulted in a lawsuit by class action attorneys aggrieved shareholders. Yesterday, the American Banker (paid subscription required) ran a story about one of the consequences of this litigation-by-the-numbers: increased underwriting scrutiny from D&O insurance carriers.

"With a pickup in M&A activity, it is the one thing that we are asking about in every meeting," Heather Hill, a regional underwriting officer in Zurich North America's Chicago office, said during a panel discussion in Greensboro, N.C., hosted by the North Carolina Bankers Association last week.

"We'd want to know about the types of banks they want to buy, the condition of those banks and the loan portfolios" that would be acquired, Hill said in an interview following the discussion. "A one-off situation is different from [acquisitions becoming] a strategic way for a client. Transparency is the overarching theme."

For instance, banks owned by private-equity firms can expect "significantly higher requirements" for liability coverage, Eric Marshall, the managing director for financial institutions at Travelers, said during the panel discussion.

Other consequences include higher deductibles and higher premiums.

This increased scrutiny and expense comes on top of increases caused by FDIC claims against former shareholders and directors of failed banks.

Bankers have endured several years of increased premiums to insure directors and officers because of the financial crisis and a high rate of bank failures in 2009 and 2010. A heightened risk of litigation from the Federal Deposit Insurance Corp., which has a three-year window to pursue claims against managers of failed institutions, has continued to drive rates higher, panelists said.

I suppose this is looked at as simply another cost of doing business by those banks that are aggressive acquirers. For more conservative potential acquirers, it’s another potential downside to doing a deal.

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.

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.

Justice

ICBA's Cam Fine is shocked ("Shocked, I tell you!") to discover that another giant bank (in this case, the bank America hates less than all the rest) is getting off the hook when it comes to the imposition of regulatory sanctions. Cam is referring to a recent New York Times article that discussed Citigroup's settlement with the SEC over securities fraud allegations, in which the SEC extracted a promise by Citigroup that it would never again violate securities laws. Citi also promised that it would never again visit a strip joint, drink hard liquor, or call another banker "gay" just because he went to the opening night of the Broadway revival of "Oklahoma." Unfortunately, Citigroup's a repeat offender, and, according to the Times, so are a scad of other large financial institutions. In no case in the last ten years has the SEC sanctioned one of the big boys for violating a C&D imposed by the SEC. Talk about a wimpy deterrent effect.

Any community banker or director reading the article should be outraged. There are no consequences for senior officers and boards of these systemically dangerous financial firms. However, community bankers and directors who, in good faith, sat on the boards of failed community banks are routinely pursued individually and collectively by bank regulators both civilly and, in some cases, criminally.

Cam shouts that this isn't "equal application of the laws." Of course, he's right. But the cold, hard fact is, nobody gives a rip. They're too busy being pepper-spayed in the face while rioting over the "disrespectful" manner in which the beloved Joe Paterno has been dismissed at Penn State for the minor infraction of not calling the cops when his valued defensive coordinator was caught "coordinating" with a ten year-old boy in a shower. We have to get our priorities straight, and if the dissing of "Joe Pa" trumps pedophile rape, it's sure as shooting going to trump the unequal treatment of little banks versus big banks by federal regulators.

We'll get back to you, Cam, as soon as the bowl season's over.

Dimon In The Rough

With fringe elements of Occupy Wall Street and The Tea Party currently spazing out so far into the ether of the opposite ends of the political spectrum that they are likely to join hands on the far side of the moon, I think it's safe to say that for vast segments of the American public, when Jamie Dimon talks, nobody listens, especially when what he's talking about is how the Volcker Rule "might" make the largest American banks less competitive with their foreign counterparts. He could be right, he could be wrong (he could have sworn he saw a light coming on*), but I guarantee you that most people reading that interview at this moment in time don't care. They may in a year or two, but today they simply can't work up an ounce of concern that JPMoragan Chase's trading profits were down $900 million for the quarter and that the Volcker Rule might exacerbate that problem.

Also lost in the overriding barrage of white noise emanating form the fringes of inner space is Dimon's very sound admonition about unintended consequences (a topic near and dear to our black and withered hearts).

“Maybe excessive risk was taken by some people,” Dimon said, but added that regulators and the government shouldn’t do things without understanding the full implications.

Sorry, Jamie, that train left the station a long time ago and has been in run-away mode for a while.

Strangely (or not-so-strangely, for those who consider Dimon a thoughtful man), he feels the pain of the people who think he and his ilk deserved to be shot down without being given a running head start.

When asked about the Occupy Wall Street protests that have grown from a few citizens to a global movement, Dimon said he could understand why everyday Americans are upset.

“You have to be looking at Washington and the big banks and asking what is going on,” he said, adding that job creation is key to getting the economy back on track.

It's not merely that "everyday Americans" are looking at Washington and the big banks and asking "what's going on?" It's that they're looking and asking "Where'd I put that cattle prod and my box of spare of RPGs?"

*obscure reference to Radiohead's "I Might Be Wrong"

The Big Dog Always Gets The Bone

Proving once again that when it comes to the federal government, Too Big To Fail banks get a backrub while Too Small To Save banks get a backside paddling. Yesterday, we discussed how so many of the community banks who received a TARP investment a few years ago are stuck with TARP with no way out. On the other hand, according to TARP's special inspector general, the biggest 17 TARP banks were coddled by Congress and the regulators, including by special interest legislation and relaxed requirements by the banking regulators, and allowed to exit the program before the IG thinks they should.

The quick exit was motivated in part by the executive compensation restrictions that Congress enacted after the banks were already in the TARP, so you can't blame the banks for wanting to back out of a program where Congress changes the rules ex post facto. Also, the Fed and the OCC have pushed back hard against the IG's criticism, claiming that the government wanted the early exit as much as the banks, and that the banks were able to raise Tier 1 capital through private sources more easily with the loosened restrictions. Certainly, none of the banks that exited was unstable without the TARP capital.

Nevertheless, it's galling that special action was taken at the highest levels to accommodate the fat cats, while providing any TARP for the little guys was at first an afterthought, and that now that many of the small banks took that capital, no one in Congress or the federal banking agencies is falling all over themselves to relax any rules (e.g., amortization of CRE losses) to help them exist before the dividend rates rise.

Help: I've Fallen (Into A TARP Pit) And I Can't Get Out!

In a very revealing article in last Thursday's American Banker (paid subscription required), reporter Kevin Whack let's us know that the recently closed Small Business Lending Fund was a bust at helping most banks, and most of all, at helping those small community banks that are still sitting on a pile of TARP to exit that sorry state of affairs.

The SBLF generally offered a cheaper alternative to Tarp, but the banks that were able to take advantage are in the minority.

Out of at least 319 Tarp recipients that applied for SBLF funds, only 137 eventually received the money.

In addition to the banks whose applications were denied, other Tarp banks were discouraged from applying because the SBLF's rules made clear that they would not qualify.

As a result, the prospects for many small banks in Tarp, which already looked bleak when the SBLF began a year ago, seem even darker today.

At least 170 of them have missed two or more of the quarterly dividend payments they owe to the Treasury Department. Such payments are set to jump to 9% from their current rate of 5% in two more years.

Each bank's primary federal banking regulator had to approve them for SBLF capital, and it appears that the regulators were shooting down applicants faster than Dick Cheney can blow a shotgun load of buckshot into a lawyer's face.

Overall, more banks were rejected by the SBLF than were approved, according to Paul Merski, executive vice president and chief economist for the Independent Community Bankers of America. The available data suggests that the same trend holds for Tarp banks.

One commenter to the article alleges that the FDIC ought to be sliced and diced for nixing so many potential recipients of SBLF capital for fear they'd be too aggressive in their lending. I don't know why the FDIC and other federal regulators discouraged so many applicants, but if it was based on fear of "aggressive lending," that would be the kind of dysfunctional analysis would not exactly shock me.

As another commenter complains, "just $1.33 billion of the $30 billion SBLF fund was new money given to banks that will help the economy. Treasury only used 4.3% of the funds they could have used to help create jobs in the economy. Geithner needs to be fired for this." That's a legitimate complaint, but it misses the larger problems that $30 billion is too little, too late, and that without a robust economy creating robust borrowers, banks who received SBLF capital would be doing what banks who are still stuck in TARP are doing with such capital: sitting on it. To echo the old Clinton campaign mantra: "It's the economy, stupid."

Two observers cited toward the end of the article, Christy Romero, the acting inspector general for TARP and Neil Barofsky, the original IG for TARP, make a good point about what the end game might be for many of these small, privately owned banks who can't raise capital from other sources to pay off the TARP preferred stock, and are waiting for the dividend rate to escalate from 5% to 9% in a couple of years.

"I think they really need to be talking to these banks, and talking to the observers that they're sending, and determining how to give these small banks a clear exit path," Romero says.

She also notes that in some instances the Treasury has restructured its Tarp investments, taking a partial loss in order to avoid a total loss.

"So that same kind of consideration needs to go into, 'What's the ultimate strategy to get small banks out of Tarp?' " Romero says.

Barofsky predicts that as the eventual rise in Tarp's dividend rate approaches, the Treasury Department will agree to take partial losses on its investments in small banks as part of sales and merger deals.

"You're going to see mergers, you're going to see acquisitions," he says.

That conforms to our recent experience. In the right case, Treasury is willing to take a haircut, sometimes a substantial haircut, on its TARP investment in connection with an acquisition or recapitalization transaction. Realists understand that 20% of your investment is a lot better return than no return. Don't be surprised to more instances of this type of "exit strategy" being employed as 2013 looms closer and sellers become more "realistic" about what's a "market" price for their stock.

Bank of America Must Whistle Up A Million Bucks

The poster child for Big Bad Bank Haters can't buy good news lately, can it? The latest public whipping came this afternoon, when the story broke that Bank of America has been ordered by the U.S. Department of Labor to pay a former employee $930,000 as damages for firing her when she "blew the whistle" on fraud within B of A's Countrywide unit (whose motto was: "If it walks like a duck and quacks like a duck, we'll still insist it's Scarlett Johansson.").

(An aside: that Countrywide purchase might have helped bail out the FDIC, but for the bank, it sure as heck has been a Pandora's Box, filled with horrors and plenty of pain.)

The employee was terminated soon after the Charlotte, North Carolina-based bank took over Countrywide in 2008, the agency said today in a statement. The worker, who must also be reinstated, led internal investigations that found “pervasive wire, mail and bank fraud involving Countrywide employees,” according to the release.

“It's clear from our investigation that Bank of America used illegal retaliatory tactics against this employee,” said David Michaels, assistant secretary of the Labor Department's Occupational Safety and Health Administration, in the statement. “This employee showed great courage reporting potential fraud and standing up for the rights of other employees.”

Unsurprisingly, the bank begs to differ with the DOL.

“The bank's actions in dismissing this associate were solely based on issues with her management style and in no way related to the complaints and allegations she made,” [bank spokesman Dan] Frahm said in an e-mail. “Bank of America encourages associates to raise issues they see. We take such escalations seriously and investigate them thoroughly.”

"And then we fire the troublemaker," I'm sure Frahm didn't say, but would have if he'd had a belt or two of sour mash in his belly before he wrote his e-mail.

A management style issue, huh? It's always a bitch when some employee insists on adopting a management style that screams "integrity" and "truth" when you're trying to put lipstick on a pig, call it Miss America, and use it to securitize some kosher mortgage-backeds you plan to unload on a fishing village in Lapland. I can see how that might be as annoying as all get-out.

As the article notes, both parties have a right to appeal. Therefore, don't be surprised if the trial-lawyer-rich bank drags this controversy out and that the discharged employee is a resident of a rest home somewhere in the Inland Empire by the time she sees any of that $930,000.

Omaha's White Knight Rides To The Rescue Again

Today's news that Warren Buffet's Berkshire Hathaway was investing a cool $5 billion in Bank of America's preferred stock came as a shock to this blogger. I realize that Buffet had previously come to the rescue of the great vampire squid wrapped around the face of humanity, i.e. Goldman Sachs, with an investment in its preferred stock that also paid a 10% dividend, so rescuing "the bank that can't foreclose straight" isn't a stretch. I mean, a yearly yield of $500,000 million sure beats what the average retiree gets on Bank of America's crappy CD interest rates (an APY on a 5-year CD currently being in the neighborhood of 1.5% to 1.6%), so it's a good deal for Berkshire Hathaway and a public confidence boost for B of A. For Buffet and the bank, a win-win.

No, it wasn't the terms of the deal that shocked me. It was the fact that I thought that Warren had immolated his entire fortune earlier this month just because he's getting old, his kicks are getting harder to find, and he thought he'd do something really loony that would get him some quality air time before he sucked the tailpipe.

I guess the press reports I read were mistaken.

 

On a grimmer note for America's favorite bank, as well as for other large loan servicers, a panel of advisors assembled last week by Bloomberg Television confirmed JPMorgan Chase's Jamie Dimon's prediction that we discussed yesterday, that "the ongoing litigation between banks and their investors in soured mortgage-backed securities sold during the housing boom...will go on for years." The experts also concluded that "most of the pressure will land on Bank of America" because of the tons of toxic waste it inherited from Countrywide. Thus, while big bankers can expect years of misery, their litigation defense counsel can expect years of billable hourly bliss. It looks like BofA has been hit by that ancient gypsy curse, "May you be buried by a blizzard of barristers."