Bank Lawyer's Blog

Unlike Love, Banks Aren't Lovelier The Second Time Around

The Denver Business Journal's Renee McGaw discusses a quirky result of the recent meltdown in the community banking sector: a number of the banks that have hit the skids and are under regulatory enforcement agreements or orders were started and run by bankers who made a bundle with their first bank and we're trying to replicate their previous success.

An impressive number of the regulatory orders signed so far this year involve second-time-around banks whose founders fared very well with previous banks, in some cases selling them for tens of millions of dollars in the early 2000s. But regulators have signaled concern about their second incarnations.

According to professional recruiter Tim Pendergast, there's a certain irony in all this.

“What’s ironic is that not only did these investors try to duplicate the same business model a decade later, but many hired back the same people and used the same or very similar bank names in round two.”

I don't see it as much ironic as unfortunate. As Ms. McGaw points out, most community banks have traditionally made much of their money in an area where they seem to be able to compete with their bigger brethren: commercial real estate. As some bank consultants have opined with perfect 20/20 hindsight, that made them vulnerable when the subprime mortgage bubble popped and the resulting domino effect cratered all real estate prices, including commercial real estate. If only these bankers had possessed the foresight that so many armchair quarterbacks seem to possess in 2010! If only they had foreseen the inevitability of the worse economic recession since the 1930s, they wouldn't have concentrated so heavily in commercial real estate, but would have diversified into C&I (whoops, also taking a beating) or "safe" investments like FNMA preferred stock (whoops, also the cause of many banks taking it the shorts) or AAA mortgage-backed securities ('nuff said)!

There's no question that a number of banks failed to diversify their asset base suffciiently. It's also true that no one expected the debacle we're now wallowing in, other than a few contrarians who went short and got rich and (according to at least one of my correspondents) regulatory Chicken Little's whose warnings were ignored and/or actively suppressed. The rest of us idiots who were actually in the arena slugging it out might have been uneasy, but never saw the train that hit us.

I'm sure a number of these "replayers" wish they had a chance to "rewind," but that's not how life operates, is it? On the other hand, as Ms. McGaw points out, merely because a bank operates under an enforcement order doesn't mean it's not going to make it out of the swamp and onto dry land eventually. What it does mean is that it won't be repeating its past mistakes. How any of these banks are going to make money in an economy like this one is going to be a challenge, regardless of asset concentration or diversification. "Don't make commercial real estate loans" is the easy part. "What's the alternative in this economy?" is the tough nut to crack, whether or not this is your second time around.

P.S. A community bank CEO lets his inner snark run free.

Overdraft Rules' Impact Overblown?

According to an article in yesterday's American Banker (paid subscription required), both banks and consumer advocates are stunned  (STUNNED I Tell Ya'!) that as banks have been forced to make consumers "opt in" to overdraft protection (as opposed to just automatically signing them up unless they affirmatively "opt out"), it appears that most consumers are choosing to participate in the much-maligned protection. Banks have been fearful, and consumer advocates jubilant, at the prospect that consumers would likely refuse to opt-in, thereby saving themselves (and costing the banks) BILLIONS and BILLIONS of dollars in overdraft fee income.

This may mean that banks have been winning (and consumer advocates losing) the marketing war for the soul of consumers. I guess we'll have to give the devil her due.

The final results are not in yet, but anecdotal reports and data suggest that the expected declines in overdraft business will probably be shallow.

If the final numbers bear out this initial impression, banks can breathe a sigh of relief and keep doing exactly what they did before. They might also take the opportunity to figure out how industry and consumer advocates alike underestimated customer demand for overdraft.

"The American consumer wants overdraft service," said Mike Moebs of Moebs Services, which just released one of the most detailed — and, from banks' point of view, optimistic — studies of overdraft trends to date. "We've had a hard time trying to convince people of that."

The Moebs data, gathered from a survey of almost 2,300 banks, say opt-in rates ranged from 60% to 80%, with nearly all frequent overdrafters — that is, those with 10 overdrafts or more a year — giving their consent.

[...]

Leslie Parrish, the senior researcher at the Center for Responsible Lending in Durham, N.C., noted that neutrally worded surveys by Nielsen Co. and other such firms found greater skepticism toward overdraft coverage than such high enrollment rates would imply.

"I'm a little bit surprised because it runs so counter to what consumers have stated their preferences are," she said. The discrepancy between such surveys and actual opt-in rates may therefore in part be the result of a very hard sell, she said.

While it may be the case that "good marketing" is the cause of this higher-than-expected opt-in trend, it may also be the case that consumers aren't as dumb and helpless as some on both sides of the fence assumed, and that, as I discussed last month, a number of them have intentionally used (and will continue to use) overdrafts as a form of short-term credit. It's expensive credit, but as the American Banker points out, it's a lot cheaper than a payday loan.

"The American consumer, seven times out of eight, if you ask them, will tell you that the overdraft service is not a penalty," Moebs said. "They view it as a service. And they're confused as to why over half the banks and credit unions out there view it as a penalty."

Of course, even if that contention is true, it's also true that banks that offer lower fees will get more business from such consumers. Moreover, even steady users of overdrafts will not "cotton" to the types of "high-to-low" posting that have generated so much bad press (and class-action litigation). Therefore, while this change forced upon banks by the Federal Reserve's changes to Regulation E might be a "marketing opportunity," that opportunity can be squandered by attempts to boost overdraft fee income through "sharp practices" that milk customers for excessive fees.

36% ROE: A Good Year's Work

If eyebrows were raised by last month's news that BankUnited is planning an IPO, those same eyebrows are likely near the top of the forehead with the more recent announcement that the OTS had approved the declaration of a dividend by the bank. The South Florida Business Journal obtained a copy of the bank's dividend application. Unfortunately for the Journal, the amount of the dividend was redacted from the copy the paper obtained through a FOIA request; however, the amount should be revealed when third quarter earnings are announced.

Inasmuch as the Journal's story also notes that the Bank's investors have earned a 36% ROE in a little over a year since they bought the remnants of the failed BankUnited in an FDIC-assisted transaction, some wags have suggested to me that not only will the dividend be hefty, but that the FDIC was "outfoxed" by the investment group's leader, the legendary bottom fisher Wilbur Ross. As I blathered when the IPO was announced, and as I again bloviate now, it's not the size of the return to the investors but the savings to the FDIC fund of doing the assisted transaction as opposed to liquidating the insolvent thrift (or accepting a competing bid) that's the critical consideration in determining whether this was a good deal for the FDIC. The fact that private equity players make a mint on this particular transaction is not that important to me nor should it be that important to bankers. Players like Ross (and his co-investors like Blackstone and Carlyle) win some and they lose some. If they win this one in a big way, good for them, as long as in doing so, they prevented the FDIC from suffering even greater losses on the disposition or liquidation of the "old" BankUnited. Also, they raised $875 million of new capital to dump into the banking system (and they're raising another $500 million in the IPO). The system needs fresh capital and these guys have it. They also saved some banking jobs by buying BankUnited.

Of course, we appear to be living in an era where a number of people think it ought to be illegal for capitalists to prosper, especially in the banking system, and even more especially where the downside risk is covered by the FDIC. I understand the reasons for that sentiment. I simply don't share it.

Fax Machines: A Source of Civil Money Penalties?

Linda McGlasson at The Agency Insider blog had a smart post last week on the recent FDIC guidance on the information security risks of printers, copiers, and fax machines.

It's not about the copies that are made or printed or sent by these machines, (although they can be considered a breach threat too if they fall into the wrong hands) but rather the stored data that poses a problem.

Consider: If you're at an institution that has done any upgrade to its copiers and printers within the last five years, then your current machines most likely are housing the hidden threat underneath the plastic cover -- a hard drive that copies and keeps records of every single copy made on the copier.

Yes, a hard drive can hold a copy of every single copy and the drive continues to write until it is full, and then the new data writes over the old copies. If that hard drive leaves the institution or is accessed, this is a violation of privacy under GLBA. Try explaining how that data made it into the hands of someone who wasn't supposed to see it. Or how after a copier was sent back to the seller for servicing or because its lease was up, a data breach was traced back to your institution -- specifically to that machine.

Banks should have already addressed this issue as part of their information security program that is mandated by the Information Security Guidelines adopted by the FFIEC pursuant to the Gramm-Leach-Bliley Act. The hard drives of these machines should be treated in the same way (and protected and disposed of in the same way) as any other computer hard drive that sits on an employees desktop or is ported about in a laptop, netbook, I-pad, mobile phone, etc. The fact that the FDIC decided that it should issue specific guidance on the topic means that its examiners have discovered a potential "hole" in this respect at more than one bank.

Linda offers some common sense steps that banks should take to address and mitigate these risks:

• change the passwords from the default on copiers and the multi-function printers.
• turn off all the things you don't want and check that the data and fax modems are separate (so you won't run into the problem of having a modem linked in, looking at the records that only a select few are supposed to see in your institution).
• add the manufacturer's security kit that encrypts information on the copier. The kit also shreds each copied document by overwriting the image after it's printed.
• adopt a written policy on the handling of copies, faxes, printed material or stored data, including their secure disposal (if you don't already have one).
• adopt a written policy on the handling and disposal if data on these machines' hard drives.

This is not only good business practice, but, as Linda also discusses, will protect both the institution ad its officers and directors from potential civil money penalties for violation of the requirements of the G-L-B Act.

You may think you've got bigger fish to fry than sweating this "small stuff," but a tiny bump can trip you up. Check your information security policies and make certain this "small stuff" is addressed, whether or not the FDIC is your primary federal regulator.

America's Bank's Bozo Behavior Bites Another Consumer's Behind

I've been blogging about incidents over the last couple of years that demonstrate Bank of America's astounding practice of foreclosing upon and/or seizing homes upon which it has no liens. Of course, this piss-ant blog isn't going to motivate a Mastodon like the mighty B of A to change its ways, but after a while, you'd think all of the bad publicity in the main stream media about this repeated pattern of dysfunctional behavior might motivate even the dull-normals who run the foreclosure arm of the bank that serves the Great Horned God to understand that foreclosing on the wrong homes might not make the bank the poster child for consumer-friendly marketing. Apparently, however, nothing penetrates their armor of ignorance.

In June, we chronicled the sad tale of one Nancy Willmes, who didn't get the bank to back off of its foreclosure on her house (a house she bought for cash and on which Bank of America did not have a line) until a local television station's consumer reporter started pursuing the story. At that point, the bank suddenly blamed the whole affair on a "system error." Yeah, the entire system, apparently. In the June post, we linked to previous stories of Bank of America's foreclosure faux pas that were disturbingly similar. Last week, The Consumerist blog brought to a wider audience another incident in which a cash buyer found his home foreclosed upon by B of A and that proves that bank is still going about its merry way of punishing the innocent. As outlined in a story in the Fort Lauderdale Sun Sentinel, Jason Grodensky of Ft. Lauderdale, Florida bought a house for cash, didn't borrow from B of A, B of A didn't otherwise have a valid lien on the house (in fact, the sale to Mr. Grodensky should have extinguished the bank's lien on the house),  and yet B of A managed to foreclose on the house and transfer tile, all without the owner having any idea what was going on.

Defenders of the bank and similar foreclosing lenders who've made similar mistakes claim the process is complicated, what with the mess the market made of the loan securitization paper trails. Nevertheless, even if you were to concede the lame argument that "mistakes happen," there is no defense to the complete stonewalling and imperviousness to facts that are demonstrated when the errors are pointed out to the bank and its counsel. That stonewalling continues until the main stream press takes an interest.

Grodensky said he spent months trying to figure out what happened but said his questions to Bank of America and to the law firm Florida Default Law Group that handled the foreclosure have not been answered. Florida Default Law Group could not be reached for comment, despite several attempts by phone and e-mail. Grodensky said he has filed a claim with his title insurance company, but that, too, has not resulted in any action.

It wasn't until last week, when Grodensky brought his problem to the attention of the Sun Sentinel, that it began to be resolved.

"It looks like it was a mistake in communication between us and the attorneys handling the foreclosure," said [Bank of America spokeswoman Jumana] Bauwens.

There. Was that so hard? You screwed up. Let's put aside the fact that defense attorneys claim that B of A and other servicers screw up in the same or other ways as often as Mahmoud Ahmadinejad tells a lie. To simply not respond to a homeowner who claims that you foreclosed on a house on which you didn't have a lien and, as was the case with Ms. Willmes, ignore documentary evidence of this fact presented by a reputable title company, is simply wrong from so many perspectives. Moreover, as is evidenced by this blog post and the main stream media stories to which it links, it's the dumbest marketing move this side of Rod Blagojevich's turn on The Apprentice.

This story highlights one the many, many reasons to bank only with community banks. Like Rhett Butler, the bottom line for the big boys is that they frankly don't give a damn.

ICBA Goes Off The Rails

ICBA CEO Camden Fine has finally admitted what many of us have suspected for some time: he's out of his mind.

Albert Einstein defined insanity as doing the same thing over and over again and expecting a different result. Given that definition, to many observers ICBA’s constant calls for more reasonable and balanced field examinations for community banks might appear insane. After numerous and repeated private meetings and public testimony in Washington on this crucial issue over the past three years, community bankers continue to face an overly stringent regulatory environment even as policymakers plead with community banks to boost lending to consumers and businesses.

So what does Camden propose to do now?

You guessed it: keep calling on the regulators to listen up and lighten up.

Einstein also said that the only things that are infinite are the universe and human stupidity, and he wasn’t so sure about the universe. We need a smarter approach to bank exams if we want to keep the fragile economic recovery from reversing course. It doesn’t take an Einstein to figure that out. In a fair exam environment, community banks can give small businesses the loans they need and help America get back to work.

I don't know, Cam. Based upon my own conversations with federal bank regulators, I think that you have as much chance of them heeding your call for "fair exams" as I have of successfully driving the lane on LeBron James.

Then, again, perhaps sanity is grossly overrated.

De Novo No A Go-Go

Over at the Bank Safety & Soundness Advisor (paid subscription required), the experts confirm what the wingnuts at Bank Lawyer's Blog have been blabbing about regarding de novo banks: holding your breath until the FDIC approves your application for insurance of accounts for your de novo bank is a great way to ensure that you pass out.

"Indeed, regulators have been so loathe to approve new charters that most folks stopped applying."

The article quotes D.C. lawyer Robert Freedman, a long-time de novo banking expert, to the effect that he's completely stopped doing de novo applications because he's sick and tired of having been "beaten up" by the regulators. Instead, he's turned to helping investors try to buy failed banks, on the quite reasonable assumption that until the FDIC "clears out the inventory" of failed banks, new charters will be likely a rare sight. Unfortunately, it appears to me that the inventory of failures will be steadily replenished over the near term, so the "clearing" burden is going to be a heavy one.

Peter Weinstock of Hunton & Williams' Dallas office claims that the FDIC has taken the "internal position" that it will approve a new bank charter only "if it won't destabilize any of the other banks in the market." As Weinstock correctly notes, that is a test that is hard to pass.

The example of Lakeside Bank, discussed in a previous post on this blog that is linked above, appears to be a "one-off" situation. That bank had "a good local economy and strong banking competition" that could survive its entry into the local market. The organizers also had the patience of Job, since it took them 2.5 years to make it through the application process. That's too long for most investors, especially when prospects for approval appear so dicey and the costs of the applications, lawyers, consultants, and investment bankers/advisors can be substantial.

Not that the shelf charter route that a number of investment groups have pursued as an alternative appears to be much more promising. Notwithstanding a couple of high profile exceptions, Weinstock claims that the approval process for such charters has turned into a "quasi de novo process," which means the imposition of exacting and difficult-to-meet conditions and covenants on applicants. Other lawyers, like Venable's Ron Glancz, claim that all this is evidence that the regulators really want "qualified investors" (which yesterday's post discussed) to buy an existing bank or buy a failed one rather than start a brand new one. Like a number of us who toil in these fields, Ron thinks the regulators changed the rules without admitting they'd changed the rules, and definitely without going through the rule-making process.

The bottom line: until things loosen up (again, don't hold your breath), the only viable way into the banking game is to find an existing bank and buy it.

Parsing "Private Equity"

Today's American Banker contained a front page article by Rachel Witkowski (paid subscription required) that discussed a very important trend that many interested players have experienced or seen with respect to the acquisition of failed banks from the FDIC: there's "private equity" and then, there's "PRIVATE EQUITY."

Georgia's failed banks are multiplying, but very few homegrown institutions without private-equity backing are buying them.

On Friday, Community and Southern Bank in Carrollton, Ga., reinvigorated by a private equity group and bank turnaround expert Patrick Frawley, acquired three failed banks in the state with a combined $603 million of assets.

Regulators tend to prefer that existing banks, not groups of private investors, acquire failed banks, yet Community and Southern, along with State Bank and Trust Co. in Macon, Ga., has been able to put private-equity money to use in FDIC-assisted deals. Friday's pickups are among five such deals Frawley's bank has completed since a private-equity group revived it in January with an initial investment of $255 million.

We've discussed ad nauseum, legion are the travails of private equity investors who want to get in the game of purchasing broken banks from the FDIC and have been thwarted by what many private equity investors (such as Wilbur Ross and Gerald Ford) believe is an "inexplicable prejudice" by the FDIC (and also by the Federal Reserve) against their brand of dirty, sexy money. Ms. Witkowski parses the nuances of "private equity" and reveals that when it comes to private equity, there are some investors that, to the regulators, give off an aroma of Old Spice and others that give off the aroma of a dead skunk in the middle of the road stinking to high heaven.

Along with capital, regulators also want failed-bank bidders to have significant banking experience. Analysts say Community and Southern has succeeded because Frawley has worked both sides of the table — as a veteran supervisor at the Office of the Comptroller of the Currency and then as a bank turnaround expert.

There area couple of important points here. First, in this context, "experienced management" to the federal banking regulators means not running a regional branch network for Bank of America, but having hands on experience in taking lemons and making lemonade out of them. "Been there, done that" when it comes to building a Phoenix out of the ashes of a burned-out bank (and preferably, a significant number of burned-out banks) is a phrase filled with poetry to the ear of the FDIC. Moreover, it is pure gold if your top dogs have established credibility with the regulators by either previous tenure in their ranks or having successfully interacted with them over the years.

A point not discussed by Ms. Witkowski, but one that I think has an important bearing on private equity's chances of being successful in making it into the bidder's line in the first place and, once there, having a chance of actually succeeding, is that the "private equity investors" need to have a certain mindset and to make a certain positive impression, whether or not a credible management team is on board. Investors who appear to be very likely to rely on credible management (under the guidance of a board of directors that contains truly credible, experienced and independent members) are likely to have a much better chance than a cadre of suspender-wearing, Armani-suit-armored, cigar-smoking, sneer-emoting, thirty-something Masters of the Universe, whose astral auras scream "New Yawk, New Yawk, It's a Wun-a-ful Town," and who convey with every word, tone, and gesture that they're doing the Feds a favor by showing them how it's done "in the real world." The latter will find that their applications find repeated roadblocks springing up like roadside weeds, and that the march to approval is like a death trek through the Gobi Desert where, day after day, the oasis shimmering on the horizon never disappears, yet never grows closer by day's end.

Finally, notwithstanding what kind of private equity player you might be, as Ms. Witkowski rightly observes, if you're bidding against a bank, you'll be starting the match behind the eight ball. The "strategic buyer" will almost always win those contests.

It's Who You Know, Not What You Are

The Senate version of the small business lending bill that passed the Senate last week didn't contain even the watered-down version of the commercial real estate loss amortization provisions that the House version of the bill contained. As I noted in June, banks that would be able to take advantage of the amortization provisions of the House version would have to be banks that are not on the FDIC's troubled institutions list (not rated 4 or 5). In other words, if you were the type of bank that needed the assistance of loss amortization, you wouldn't have been able to receive it.

The Senate version of the legislation never contained the CRE loss amortization provision from the get-go and it was not added by amendment. Although House Democrats are apparently miffed that some of their pet provisions do not appear in the Senate bill, Nancy Pelosi has vowed to adopt the Senate version " because small business can’t wait another day for this legislation to be passed.” Imbuing that phrase with a bit more "truthiness," what Speaker Pelosi meant to say is that Democrats better get something passed that gives the appearance of helping small businesses because the mid-term elections are coming up in another six weeks and things look grim for her party. At least, they appear to be grim for anyone not running against Christine ("Hasn't Everyone Dabbled in Witchcraft?") O'Donnell.

Another potential relief measure for a number of community banks hanging on by their fingernails flushed down the drain. Ah, well, if only you were a bank that got "special treatment." I'll bet any one of the six community banks that bit the dust last Friday wishes they had friends like Barney Frank and Maxine Waters In Congress and that the FDIC had been looking for loopholes to justify their counting prospective capital as capital before it was actually received. Remember when OTS officials were handed their heads for doing just that for IndyMac and some other thrifts that later failed?

It's nice that The Washington Post has brought into the clear this list of banks that might cause "unnecessary press or public relations" problems for the FDIC and how the FDIC acted in this case. Even the FDIC's inspector general wasn't aware of the list. It now "causes him some concern." Apparently, banks on this "double secret probation" list of banks whose failure might cause "adverse publicity" for the FDIC get a helping instead of a boot up the behind like the bad boys in Animal House, who were on a similar list. My response is, so what? Will anything change in our nation's capitol as a result of this "concern"? Will politicians be less corrupt or bank regulators less hypocritical in the future because the FDIC's IG is "concerned"?

[Sound of crickets chirping]

As one long-time banking attorney e-mailed me about this latest revelation, "This is about as ugly as it gets."

Wells, Warren, and the Weekend

A couple of quick hits for those non-government employees who haven't the advantage of "Flex Days" and actually show up for work on Friday to read this blog:

• Baltimore had its latest amended complaint against Wells Fargo dismissed by Judge Motz. He gave them another month to try again, apparently on the theory that the old saw "Third Time's The Charm" might actually be true. The judge keeps narrowing the filed of permissible claims, yet the city can't limbo under the bar no matter how high he raises it. Nevertheless, as I said in January when the initial complaint was dismissed, the city's not likely to quit trying until the contingency-fee trial lawyers that are representing the city run out of gas. The strategy for Wells Fargo has been thus far (and should continue to be) no settlement, not now, not ever. On the plus side (as far as banks are concerned), losses like this bode poorly for the success of similar lawsuits against lenders filed by other cities that followed Baltimore's lead (paid subscription required).
  

  Jeff Taft, a partner at the law firm Mayer Brown LLP in Washington, said the ruling diminishes the chances for similar cases against other banks. "Everybody thought at one point that there might be a lot of these lawsuits," he said. "But the lack of success by those who have brought the lawsuits and the difficulties in making a strong legal case has likely prevented others from bringing similar lawsuits."

• I received inquiries from readers about what I thought of President Obama's decision to appoint Elizabeth Warren as a special adviser to Secretary Geithner with the job of getting the CFPB up and running. He thereby avoided any confrontation with the Senate over her confirmation as director of the CFPB, but that's the position I think she really desires (notwithstanding her protestations to the contrary) and that her supporters wish she'd assume. My initial reaction is that it's a smart move by a crafty politician. He'll get Warren in the de facto driver's seat, which ought to tamp down the heat that's been put on him by liberal and consumer activists. As to making a recess appointment of Warren to officially head the CFPB, I think that what some sources in D.C. have speculated might have some merit. Assuming that Obama's worried about Warren's ability to be confirmed by the Senate, he's likely to make a recess appointment, which will expire at the end of the next session of the Senate after the appointment is made. If he makes the appointment during the next "intersession" recess (for example, right after the end of the second session of the 111th Congress this fall), she could serve only until the end of the first session of the 112th Congress in the fall of 2011. If he waits until the start of the first session of the 112th Congress next January and makes an "intrasession" during one the the first recesses of the the first session of that Congress (say in February or March of 2011), she'd get to serve until the end of the second session of the 112th Congress in the fall of 2012, without the necessity of being confirmed. That would be a slick maneuver politically and one certain to enrage bankers and Republicans (and some moderate Democrats), but that's never been an impediment that's hindered the current administration. This is all idle speculation, of course, but it passes the time. Read more about recess appointments here. President Bush was a big believer in them, by the way, and used them with gusto, even when his party controlled the Senate.

Enough fun for one week. You all have a good weekend.