Bank Lawyer's Blog

Barney Bites Bernie (And Neel)

2016-03-27T22:07:00-05:00

Now that hell has frozen over, I find that all kinds of amazing things are occurring, one of which has created the danger of ripping a huge hole in the space-time continuum: I find myself in agreement with Barney Frank.

While watching the PBS News Hour this past Thursday night, who should pop up but the former House Banking Committee Chair and favorite Bank Lawyers Blog Bullseye, Barney, who was interviewed by Jeffrey Brown about Frank's reaction to statements by Neel Kashkari, currently president of the Federal Reserve Bank of Minneapolis and former Bush Bailout TARP Toolmaker, and the ever-cranky Bernie Sanders, Gen Y's favorite "Democratic Socialist," about "To Big To Fail Banks." Sanders also alleged that the way to break up big banks is to reimpose the Glass-Steagall on commercial banks. Frank, now that he's out of the political arena and no longer feels compelled to be what every politician feels he or she must be, i.e., a caster of shade upon of the truth, was remarkably critical of two gents who are spouting the Democrat Party line about the evils of Wall Street's "TBTF" banks.

Barney may have gained some objectivity, but he's lost none of the pungent-tongued arrows from his verbal quiver.

In the first place, both Senator Sanders and Mr. Kashkari continue to evade the biggest question. That is, how big is too big? The crisis which touched off when Lehman Brothers couldn’t make its payment, Lehman Brothers was about $650 billion in assets. We have banks four and five times that size

And the question is, does everybody have to be smaller than Lehman Brothers is today? But that would have consequences. Getting there would be a problem. By the way, it should be very clear, Glass-Steagall doesn’t do it. There is a disconnect between Senator Sanders insisting that the banks be broken down to the point where they won’t by their own size threaten, if they have too much debt, to undermine it.

And Glass-Steagall — Glass-Steagall would reduce — it wouldn’t do anything to Goldman Sachs and to Morgan Stanley, which are almost Glass-Steagall-ized themselves. But looked at Citicorp, or J.P. Morgan Chase, or Bank of America, Wells Fargo, even if they were subject to Glass-Steagall, they would still be well beyond the size that Lehman Brothers was.

There is just a disconnect between saying we’re going to do Glass-Steagall and getting the banks down to a size where, if there was a complete failure, you would get damaged by it.

The entire response above by Frank is remarkable for the fact that he's right. It's obvious that he's not been spending his time since retirement sampling the wares of Mar Jane-related "legal" businesses in Colorado.

Frank also jumped all over Kashkari's comparison of the 2008 meltdown to the S&L crisis of the 1980s, and Kashkari's statement that the reason the S&L crisis didn't bring the economy down was because none of the S&Ls was "too big to fail." Again, Frank asks why Kashkari won't tell us how big is too big? He also correctly notes that the bailout of the S&Ls cost a lot more than the bail out of big banks in 2008, although he does not also observe that this was because the 2008 TARP allowed the big banks to survive, while the S&L "bailout" allowed them to fail (or most of them, at any rate (outside the Southwest Plan thrifts), and established the Resolution Trust Corporation, staffed by the FDIC, to liquidate their assets. If the politicians, including Frank, had stayed out of it in the 1980s and let the initial bailout template concocted by the former Federal Savings and Loan Corporation play out, there's a chance that the money from that bailout might also have been largely repaid.

Frank says the primary risk is not size but "indebtedness," and on this point he's got a point. However, I disagree with his assertion that his bloated namesake, Dodd-Frank, has dealt successfully with the risk of bank's engaging in excessive borrowing and hinky derivatives that made "The Big Fail" such a hit (his misapprehension of the effect of the Volcker Rule has been lambasted previously), and his assertion that now, no bank is too big to fail.

If a large institution can’t pay its debts, it fails. It is not too big to fail. It is put out of business, by law. No federal official can advance any money to pay its debts under the law until it is dissolved.

TARP also required legislation to create, and the wide-open authority it provided the federal government to bail out banks was induced by panic among folks at the highest levels of the federal government (including Frank) of immanent widespread economic collapse. We'll see how effective Franken-Dodd is when the next crisis hits, as it inevitably will. There's no prohibition on a future panicked Congress changing the rules on the spur of the moment to do what Frank claims can never again be done.

To prove that I haven't completely turned to the dark side, I think his statements about overturning Citizens United are bunk. Nevertheless, all-in-all, startlingly, he makes a lot of sense.

Stressing Stress Testing

2016-03-13T21:29:00-05:00

A recent White Paper from the consulting firm Invictus discusses what those of us who represent community banks have been aware of for some time now: the requirements for "stress tests" that were supposed to apply only to those "Too Big To Fail" banks are "trickling down" to community banks. The buzzwords that apply to banks both large and small are "forward-looking risk analytics." While Invictus notes that bank regulators initially publicly stated that stress testing was only for the Big Guys, their actions belied their words (or, they simply changed their minds).

Regulatory actions in the waning months of 2015 should serve as notice that ignoring forward-looking analytics will lead to lower CAMELS scores, more examiner scrutiny and higher regulatory capital requirements. The new current expected credit loss model (CECL), which is expected early in 2016, is also a forward-looking tool.

Behind the scenes, however, regulators began changing their own methods for examining community banks, relying more and more on forward-looking analytics. In recent months, with signs that community banks are again accumulating higher concentrations of risky commercial real estate loans, regulators are reminding community banks that stress testing is indeed required to manage concentration risk in their portfolios and to develop realistic scenarios for interest rate risk management.
Regulatory actions in the waning months of 2015 should serve as notice that ignoring forward-looking analytics will lead to lower CAMELS scores, more examiner scrutiny and higher regulatory capital requirements. The new current expected credit loss model (CECL), which is expected early in 2016, is also a forward-looking tool.
The large banks have already adopted forward-looking risk analytics and are using the results with regulators. Although community banks are not subjected to the same stress testing requirements as the large banks, the regulatory trend is in the same direction. Those community banks that fail to incorporate new analytics into their risk management systems will find it difficult to communicate effectively with regulators.

The White Paper traces recent public issuances by the FDIC, FRB, and OCC in this direction. A specific red flag is the December 2015 joint agency guidance on CRE concentrations. Those of us who represented community banks and their directors in the aftermath of the last meltdown, when commercial real estate brought a number of community banks to grief, took special note of that guidance. It's "guidance" in the same way vendor management guidance is merely "guidance." Try violating it and see how "sticky" the wicket gets. You'll be up to your eyeballs in MRAs on the your next report of examination...or worse.

Even if you thinkl your CRE isn't all that "concentrated," Invictus thinks that you ought to seriously consider hoping on this forward-looking train.

Even if your bank doesn’t have CRE concentrations, use forward-looking risk analytics to stress test your capital, your strategic plans and any potential acquisition you might be considering. Present the results to regulators. Invictus’ clients that have used stress testing results with examiners have seen their capital requirements decrease, their management piece of their CAMELS composite increase, and their strategic plans win fast regulatory approval.

At the very least, it's worth pausing for a moment and, while you stoop to smell the roses, thinking about whether you might benefit from this approach (if you haven't already adopted it).

Rent-a-Charter vs. Strategic Alliance

2016-02-15T21:58:00-06:00

In June 2004, I wrote a post about schemes by non-bank lenders, especially payday lenders, to "partner" with banks and thrifts in ways that would allow the non-banks to use the bank's or thrift's status to "preemept" "inconvenient state laws, such as those pesky usury limits. As I said at the time:

Apparently, the state-chartered banks involved in this practice are counting on the continued lack of objection by the FDIC, and the continued sympathy of state banking regulators who are eager to increase the number of state-chartered institutions that they regulate. In my opinion, this is a risky course.

I also pointed out at the time that national banks and federal savings banks could rest assured that their primary federal regulator would be scrutinizing their business arrangements with non-banks like Elizabeth Warren looking under her bed every night for a bad banker looking to steal all the cash she has hidden in the sock that she keeps under her pillow.

According to a recent client alert from Chapman and Cutler LLP, this bad old idea not only refuses to die, but has engendered state officials to take action to stop it in its tracks. While the alert discusses the State of Pennsylvania going after payday lenders who've aligned themselves with Native American tribes (which has been a problematic marriage for quite some time), it has wider implications for similar arrangements. In this instance, the Commonwealth of Pennsylvania alleged that the "true lender" for regulatory purposes was not a bank in Delaware that would have been exempt from Pennsylvania usury limits and licensing requirements but the non-bank website "originator" that did most of the origination work and derived most of the economic benefits from the loans. The authors note that in other jurisdictions, the court decisions have not been in lockstep on the issue of preemption, arrangements like the one challenged here are likely always to put the lenders in the regulatory crosshairs.

No clear rule has emerged although regulatory challenges almost certainly are more likely to be made when excessive interest rates and/or abusive sales or collection practices are involved. In this case, the loans imposed interest rates of 200% to 300%.

The alert notes that even though the court's decision involved only a motion to dismiss Pennsylvania's action, and that is a long way from a judgment on the merits, the red flags for financial institutions involved in such relationships are clear "because it demonstrates that plaintiffs will continue to raise the “true lender” theory and courts will not necessarily dismiss at an early stage (for failure to state a claim upon relief can be granted) “true lender” claims solely because a bank is the named lender on the loans, at least where there are allegations that the originating bank does not have substantive duties or an economic interest in the program."

In order to mitigate the risk of claims based on the “true lender” doctrine, companies that engage in internet-based lending programs through an arrangement with one or more banks should consider how the programs are structured. For example, consideration should be given to operations where the bank has substantive duties and/or an economic interest in the program or loans. We are aware that some internet-based lending programs are considering structural changes of this nature.

The firm also advises institutions to make certain that they comply with regulatory guidance governing relationships with service providers. They cite FIL-9-2016 and related FDIC guidance. I'd also suggest taking a look at the OCC's Bulletin 2013-29.

Or, for a change of pace, a bank considering one of these schemes might decide to take its entire capital to The Bellagio in Vegas, walk up to nearest roulette wheel, and lay it all on "00." I mean, if you like dancing along the razor's edge with insured deposits, you might as well go all-in. Plus, you get free booze as long as your money lasts. To hedge your bet, you might want to hold back enough to buy a one-way ticket to Havana (regular flights from the States start soon) just in case that method of income-generation doesn't work out as well as a strategic alliance with a non-bank payday lender.

Activist Investors Betting On Bank Mergers

2016-02-07T22:01:00-06:00

It appears that "activist" investors are turning to banks because they, like many of the rest of us close to the banking sector, think that there will be continued consolidation of the banking industry in the U.S., and what better way to make yourself some hard-earned profits than buying shares in a business and then pushing its board to sell the family farm so you can cash out. Some of you may remember that this model business plan was why the FDIC apparently soured on relying on "private equity" investors to help it clean up the mess after the last banking meltdown.

According to reporters in the St. Louis Post-Dispatch, "[a]ctivist investors are putting the U.S. banking sector in their crosshairs, betting that headwinds whipping through the industry will accelerate consolidation among lenders." The authors cite the rapid uptick in such "activist campaigns" in the financial sector last year, and observe that the "activists" are turning their attention from insurance companies and other non-bank financial businesses to commercial banks.

Hedge funds such as Ancora Advisors, Clover Partners and Seidman & Associates are buying up stakes in lenders across the U.S., from community banks to large regional lenders.

Driving these investments is the view that ultra-low interest rates, lagging returns on equity and tough regulations will push more banks to merge, with buyers willing to pay a hefty multiple to a bank’s tangible book value. Activist investors interviewed by Reuters say another factor is exposure to energy-related loans, which is driving down the valuations of certain banks and making them all the more vulnerable to a takeover.

“Bigger banks are back in the market doing deals,” said Ralph MacDonald, a partner at law firm Jones Day, who specializes in mergers and acquisitions.

U.S. bank mergers and acquisitions volume rose 58 percent last year to $34.5 billion, according to Thomson Reuters data.

The authors think that Zions and Comerica are likely targets. Both "Systemically Important Financial Institutions" had under performing returns on equity last year. That alone makes them prime targets for "activists."

The firm believes that any bank earning a 12 percent or less return on tangible common equity needs to consider whether it can prosper as an independent institution, PL Capital co-founder Richard Lashley said in an interview.

A bank’s exposure to falling energy prices makes it even more vulnerable, he noted. But another key factor is a bank’s ability to maneuver through a climate where low rates are compressing net interest margins, and stricter regulations are increasing costs.

“Management teams and boards are just exhausted,” said Lashley, who is based in New Jersey. “It’s not fun to run a bank anymore.”

However, the article also contains a quote from a community bank chief that indicates that the trend to consolidate is not just for SIFIs.

“My phones are ringing off the hook with calls coming in from banks wanting to sell,” said Pat Hickman, the CEO of Happy State Bank, a lender in the Texas panhandle. “And one of the primary reasons is regulation.”

Yes, it's not fun to run ANY bank anymore, not just the large ones. Whether your a big bank or a small one, publicly traded or privately held, pressured by "activist" investors or simply by the facts of life: as we said a few weeks ago, 2016 will very likely be the year of the bank merger.

De Novo Deep Freeze Thawing? Not So Fast!

2016-01-31T21:54:00-06:00

Although SNL's Nathan Stovall tantalizes readers with the headline "De novo market could be warming up," I think that--reading between the lines--the De Novo Deep Freeze of the past 8 years is not going to be thawing this year.

Stovall cites the recent de novo charter approval of California's Core Commercial Bank. However, that bank's investment adviser's CEO, Edward Carpenter, while stating his belief that "you can expect to see more applications in the relatively near future," warns that the path to approval of a de novo charter is a rocky one.

[T]he application process for de novos is "considerably more difficult" and requires much greater preparation now than before the credit crisis...

[...]

"We believe that a new bank requires more capital than it did in the past. It requires a stronger and deeper management team than it did in the past. And it needs to make a more persuasive case than was often made in the past about community need."

Core Commercial, like the two other most recent de novos, Pennsylvania's Bank of Bird-in-Hand and New Hampshire's Primary Bank, "plans to target a fairly narrow customer base as well, catering to small and medium-sized businesses that might feel disenfranchised by the nation's largest institutions." I assume that the geographic market area is also relatively focused, and that the applicants had to prove with more than lip service that the community was not being adequately served by existing financial institutions.

While Carpenter seems optimistic (and, I'm sure, stands ready to assist other potential clients with their de novo needs), others, including some regulators, are less pie-eyed.

Candace Franks, commissioner of the state banking department in Arkansas, acknowledged that de novo banking activity certainly slows during a recession, but said prior downturns have been followed by a "generous" era of de novo applications. She said that certainly hasn't been the case this time around. Franks, the immediate past chairman of the Conference of State Bank Supervisors, said the lack of de novo activity is "very concerning to us," particularly in rural areas like Arkansas, where community banks serve as the engine of small business activity.

Some observers have argued that regulators were hesitant to grant new charters since many banks that failed during the crisis were de novos formed in early 2000s. The Federal Reserve discussed the issue on a handful of occasions. Robert Mahalik, director of applications at the Federal Reserve Bank of Dallas, said at a conference in April 2014 that he saw no hint that new charter activity or approval would be on the near horizon.

Stoval also discusses other disincentives that may restrain a de novo deluge.

While regulators might be easy to blame for the dearth of de novos, Stevens noted that bankers have not painted a very attractive picture for parties considering entering the industry, often complaining about heightened regulatory burdens. Such rhetoric could serve as a deterrent to potential investors.

Some advisers say there simply are not many investors looking to form new banks. DD&F Consulting Group President Randy Dennis, who has helped launch a number of de novos in his career, said there is a whole new breed of investors that want to put money to work in the banking sector, but some are concerned they will not be able to receive regulatory approval. He further said the higher capital requirements facing de novo banks have limited investor interest.

[...]

...Tom Brown, longtime bank investor and CEO of Second Curve Capital LLC, said at a conference in mid-November that he understood why there is so little investor interest in forming a new bank charter. He believes the capital constraints on de novos make it difficult for investors to earn adequate returns on their capital.

"Who in their right mind would start a bank today? The FDIC requires $35 million in capital to start a bank. And no one can pencil out an annual rate of return on $35 million in the next five years, so you're not seeing new chartered banks," Brown said at the event.

Well, obviously the investors in Core Commercial, who we presume are not insane.

Noted bank attorney Walt Moeling of Bryan Cave also is cautiously optimistic. He thinks the prospects of additional de novo applications is "real," but that there numbers will be far less than in the past.

All the observers seem to agree that the application process will not be easy. The organizers will need to present a convincing case, based on hard data, of the need for the new institution. Capital will be king, and as Tom Brown asserts, the more capital required, the more difficult it is to earn a decent return on equity, especially when private investors have places to place their capital where the returns are larger, quicker. Management will also be critical, with both expertise and probity playing critical roles. Finally, the application process is likely top much more time-consuming and expensive than it ever has been.

And, of course, once the doors are opened, what you have is a community bank, trying to make money in a Post-Franken-Dodd world chock-full of Maxine Waters, Elizabeth Warrens, and other "progressive" ideologues who will look over your shoulder 24/7/365 to "guide" you on the path to righteousness, if not necessarily to profitability.

The Lesser Of Two Evils

2015-11-08T21:53:00-06:00

In a fascinating bit of humbuggery, the US House of Representatives decided last week not to follow the lead of the US Senate and, instead, chose to screw the Federal Reserve rather than the banks who are members of the Federal Reserve System. Of course, both houses of Congress are robbing Peter to pay Paul, his cousin Guido, and their extended family back in Sicily, but that's beside the point. The point is that bank-bashing took a back seat to the realization that next year is an election year, and pissing off bankers might have to take a back seat to fundraising needs until after the first week of November 2016.

Nobody likes the Fed (except when it bails out the world), so messing with that august entity is usually fine and dandy, politically speaking.

The New York Times lays it all out for us.

The banking industry scored a surprise victory on Thursday when the House voted to pay for part of a new highway bill by draining a rainy-day fund at the Federal Reserve rather than cutting federal payments to some of the nation’s largest banks.

The Senate, scrounging for road-building money, voted earlier this year to reduce the Federal Reserve’s annual dividend payments to large commercial banks, saving about $17.1 billion over the next decade. The House was to follow suit, but after loud protests from the big banks, its final version of the highway bill preserves those dividends and instead requires the Fed to provide $59.5 billion over 10 years instead of putting the money into an account intended to cover potential losses.

Now congressional negotiators must decide which to hit, the Fed or the banks.

The Times notes the ultimate injustice of either alternative funding source: funds for highways are supposed to come from the gasoline tax. Naturally, politicians don't want to pass a tax raise that would enrage supporters of both Bernie Sanders and Ben Carson (which covers the political spectrum from coast-to-coast). Moreover, banks are (almost) lower than lawyers in the mind of the average mouth-breathing, knuckle-dragging voter, and bending banks over the back of the sofa isn't generally a risky play. So, whether it's the Fed or its member banks that pay the unjust price of this latest boondoggle, the banking system will pay a price.

If the banks pay the price by being shortchanged, considerably, on dividend income from the Fed, that will hurt their bottom lines. Moreover, Fed Chair Janet Yellen is probably correct in her warning that the Fed will lose members. On the other hand, if the Fed is the direct loser, its surplus will take a hit, which is not something that is in the interest of the financial system. The article points out that the surplus is in addition to capital the Fed raises by selling shares and it may not be needed to bail out the Fed if it goes negative over the next few years as it unwinds the stimulus. It also observes that Congress has tapped the surplus in the past. Setting aside the fact that just because you beat up an old lady and steal her Social Security check one month does not justify making it a habit, this would be the first time since the Fed was created that Congress would completely drain the surplus and prevent it from being refilled.

Other commenters, including some members of Congress, also think either choice is a loser.

"They’re both bad," said Aaron Klein, director of financial regulatory reform at the Bipartisan Policy Center, although he noted Congress has a history of tapping the Fed’s reserves.

Even the author of the House plan sounded apologetic. "This is not perfect policy, but it is much better than the alternative," Representative Randy Neugebauer, a Texas Republican, said on the House floor early Thursday. Mr. Neugebauer said he hoped that future transportation funding "comes from transportation users and not completely unrelated sectors of our economy."

When Porky sprouts wings, Randy.

One silver lining to this dark cloud is that it has upset Maxine ("The Socializer") Waters.

"How many of my colleagues or their constituents have a safe investment that pays this well?" Representative Maxine Waters, a California Democrat, asked on the House floor Thursday morning. "Most of my constituents are lucky to earn a penny a month on their bank accounts."

The fact that the dividend rate paid by the Fed to its members has absolutely nothing to do with the appropriate source of funding for highway construction is beside the point to The Socializer. The money's there, banks are getting it, they're making a better return than me and my friends, the federal government wants the money, so what's the problem? Take it!

I can't wait for either Hillary Clinton or The Greatest Show On Earth (EVER!) to get into the White House in 2017 and set all this right.

Wallison Whales On Dodd-Frank

2015-10-21T22:22:00-05:00

While he'll convince no one in love with Big Government of his thesis, the American Enterprise Institute's Peter Wallison is making the case that recent academic research supports the proposition that Dodd-Frank and other regulatory burdens imposed by the federal government in the wake of the economic recession of 2008 are hampering the economic recovery of the U.S. (hat tip to a community bank CEO and blog reader for sending me the link).

First, a study by Michael Bordo and Joseph Haubrich showed that recoveries after financial crises are actually sharper than other recoveries. After studying 27 recession-recovery cycles since 1882, they concluded that “the stylized fact that deep contractions breed strong recoveries is particularly true when there is a financial crisis.” So we should have expected a steep recovery after the sharp 2008–09 recession rather than the stuttering and stalling economy we have experienced.

Also, studies of Dodd-Frank’s effect have shown that the regulatory burdens imposed by that law have been particularly harsh for community banks. The Fed defines community banks as banks with $10 billion in assets or less; 98.5 percent of all US banks fall into this category. A 2012 Government Accountability Office study showed that 7 of the 16 titles in Dodd-Frank had potential adverse effects for these banks, and studies by scholars at George Mason University and Harvard’s Kennedy School have found significant compliance cost increases attributable to Dodd-Frank. “Since the second quarter of 2010,” said the Harvard study, “around the time of [Dodd-Frank’s] passage, we found community banks’ share of [US banking] assets has shrunk drastically—over 12 percent.”

Of course, the regulatory costs to community banks are not a new story; Congress has been attempting to mitigate these costs for years. What is new is the data that shows the effect of these regulatory costs on small business and hence on economic growth.

Wallison asserts that the vast majority of small businesses (traditionally, the primary drivers of job growth) require bank financing because they do not have the access to capital markets that larger business have. Increased regulatory costs mean less credit. Less credit means slower growth. Slower growth means less job creation.

This is where the costs loaded on small banks begin to affect US economic growth. Regulatory costs affect small banks more than large banks because the costs are largely fixed and large banks by definition have a bigger asset base over which to spread these costs.

When a small bank is required to hire a compliance officer, that is an employee who is not making loans or producing revenue. When the Consumer Financial Protection Bureau—set up by Dodd-Frank and the bane of small banks—sends out a 1,099-page regulation on mortgage lending, that means a community bank must engage a lawyer to interpret the new regulation, a compliance officer to apply the regulation in individual cases, and a tech firm to retool its mortgage underwriting system. All costs, no revenue, and fewer funds to lend. When a bank examiner criticizes a loan because the bank does not have audited financial statements for a customer who has never missed a payment in 20 years, that forces a bank to revise its business model and change its customer relationships. Again, costs for the bank and less financing for the small business.

If the costs Dodd-Frank has imposed on small banks are hurting small business, we should see a significant difference between the growth rates of small and large businesses since 2010. That is exactly what the data shows. In a Goldman Sachs report published in April 2015 and titled “The Two-Speed Economy,” the authors found that firms with more than 500 employees grew faster after 2010—the year of Dodd-Frank’s enactment—than the best historical performance over the last four recoveries. These firms largely had access to the capital markets for credit. However, jobs at firms with fewer than 500 employees declined over this period, although this group had grown faster than the large-firm group in the last four recoveries.

Here, then, is the source of the slow recovery from the 2008–09 recession. Although 64 percent of net new jobs in the US economy between 2002 and 2010 came from employment by small business, this source of growth has disappeared since the enactment of the Dodd-Frank Act. While larger firms have access to credit in the capital markets, millions of small firms, limited to borrowing from beleaguered community banks, are not getting the credit they need to grow and create jobs.

As I said above, Wallison won't convince the Bernie Sanders/Elizabeth Warren crowd with facts. One of the commenters to Wallison's article makes this point ably.

To blame the slow recovery on Dodd Frank is frankly hilarious. It defies logic. Big banks were the major contributors to the 2008 recession and their failure to re-inflate the lending system after the government had made them whole will go down as one the major acts of treachery against small business. Small banks are doing poorly for a far different reason. See the growth of a strong aggressive regional banking structure.

You'll notice that, unlike Wallison, no studies or statistics are cited by the commenter to back up his arguments or even his factual assertions, nor to counter those that support Wallison's arguments. Instead the basic ad hominem attack is made that Wallison's position is "hilarious."

No, it's anything but "hilarious." As people who have actually made a career in the community banking business understand, it is many things, but "hilarious" is not among them.

De Novo Logjam "Open"?

2015-03-25T21:52:00-05:00

No sooner do we post an article about how the dearth of new bank charters appears to be a critical (if not the critical) factor in the phenomenon known as "the incredibly shrinking community banking universe" than out of the chute pops a new community bank (paid subscription required).

Primary Bank is just the second new bank to be approved in more than four years, and charts a potential path for other applicants to follow. The approval, which was reported last week, came more than a year after regulators signed off on Bank of Bird-in-Hand in Pennsylvania in late 2013.

"This does now open the logjam. Now the [Federal Deposit Insurance Corp.] has a process, and as long as future applicants follow that process, they should be in good shape," said Donald Musso, president and chief executive of the consulting firm FinPro, which worked with the new bank's organizers to move the application.

Musso said he is in conversations with four other clients possibly interested in filing de novo applications, although nothing is official yet.

The regulators are "working really hard in trying to open the doors for new de novos to form, but the standards are pretty high," he added. "You need $20 million-plus of new capital, which is a lot of capital. You've got to have enough capital to make it to profitability."

"A lot of capital." Ya' think? When I started working on de novo bank charters, back when Andrew Jackson was trying to bring down the Bank of the United States, you needed a tenth of that amount. Of course, a dollar went a lot farther then, as my buddy Tom Sawyer5 used to say.

American Banker reporter Joe Adler correctly observes that two banks in four years "hardly makes a trend." He also notes that the community in which the new bank is located suffered the sale of local banks, leaving it "local bank free." Also, the new CEO is a heavyweight in the banking industry and a former governor of New Hampshire is a board member. The bank's business plan appears to be conservative, focusing on small business loans, with no home mortgages and, I assume (although the article does not state this), little or no commercial real estate lending and certainly not much acquisition and development lending.

Consultant Byron Richardson also notes that private equity investors do not appear to be chomping at the bit to dive into de novo banks.

Richardson said a critical obstacle to new-bank formations lately has been finding investors willing to earn a slow rate of return in the face of heavy capital requirements and other regulatory burdens.

"A founder or organizer is not just going to put their money in a mattress," he said. "Part of the equation is: How much capital will the regulators require? But then with the cost of complying with the regulatory burden… how much money can the bank itself earn?"

On the other hand, the lead investor in Primary Bank said that he wasn't phased by the "regulatory burden".

"There has obviously been some concern with Dodd-Frank and regulations, and some people say, ‘That's why there's not banking activity,'" [William] Greiner said. "Our going forward is testament to the fact that we can see opportunity. We're not focused on some of the noise per se."

Unless, of course, the "noise" raises to the level of a diving-bombing Stuka. We'll see how the bank continues to ignore the regulatory burden "noise" as time marches on. Focusing on business rather than consumer loans is one way to lower the noise level.

Another factor involved in this de novo that may limit the pool of potential investors is the large number in the group.

"Most banks start with five, eight, maybe 10 individuals…. I felt it was important, given the environment, to have a bigger, broader group. We talked about having potentially 50 investors in that initial round," he said. (They ultimately raised an initial $3 million from 133 individuals.) "I thought if we could get 50 community leaders, business owners, professionals, to come and take a stake in this bank, it would make a statement that it's not a club… but really a community-based initiative," he added.

I agree with Greiner that the FDIC loves that aspect. Broad-based community investment groups tend to be more conservative, more focused on the long-term needs of the local business community that the bank will serve than on using the bank to make profits, ratchet up stock values through growth of assets and ROE, and cashing out in five years or so. If that's going to be a requirement going forward, however, it will dampen the enthusiasm of a number potential capital sources.

While this latest approval may, indeed (as Musso asserts), "open the logjam," we'll see how wide that opening is, and whether it remains open. At present, color me "skeptical." We may see a few more of these in the next couple of years, but I simply don't yet see a wave on the horizon that yet appears to be worth riding.

The Dearth of De Novos

2015-03-08T21:47:00-05:00

Economists Roisin McCord and Edward Simpson Prescott have taken an in-depth look at the rapidly shrinking banking industry (in terms of the number of banks) in the United States since the Great recession of 2007-08 and come to the conclusion that the cause is the unprecedented decline in the creation of new banks since 2010.

From the "Economic Brief" (co-authored with Tim Sablik) that summarizes the more detailed analysis linked above):

The financial crisis of 2007–08 significantly altered the banking landscape. From 2007 through 2013, the number of commercial banks in the United States fell by more than 800, a 14 percent decline. This drop was highly concentrated among small community banks (banks with less than $50 million in assets), which saw their numbers shrink by 41 percent.Although many banks failed during the crisis and its after-math, this decline was driven largely by a lack of new banks. The number of newly formed banks (called de novo banks) has fallen sharply since 2010. In 2012, there were no de novos", and in 2013 there was only one: Bank of Bird-in-Hand,formed in Lancaster County, Pa., to serve the Amish community.

The authors claim that this "collapse in new bank entry" is unprecedented "and could have significant economic repercussions."

In particular, the decline in new bank entry disproportionately decreases the number of community banks because most new banks start small. Since small banks have a comparative advantage in lending to small businesses, their declining number could affect the allocation of credit to different sectors in the economy.

The authors take a look at other financial crises in this country during the past 50 years. While the erosion of interstate branching barriers and the financial impact of previous banking crises had reduced the number of independent commercial banks from between 12,000 and 13,000 in 1980 to less than 7,000 in 2000, each previous economic recession that caused an accelerated reduction in the number of banks through bank failures and mergers was accompanied by the robust creation of new banks to offset the failures. The last five years do not differ markedly from the exit rate of banks in previous years. What is remarkably different about the last five years is the almost complete absence of new bank creation. From 2011 through 2013, only four new banks were created.

The authors discuss the possible reasons for the lack of de novo creation. One explanation is low bank profitability as the result of the Fed's low-interest-rate policies and the resultant anemic net interest margins. However, in discussing another Federal Reserve Board study that takes this position, the Richmond Fed's economists contend that a "literal interpretation of " the FRB's model "would predict that even if the net interest margin and economic conditions recovered to 2006 levels, there still would be almost no new bank entry." They also cite another study, this one by the Federal Reserve Bank of Kansas City, that concludes that while the net interest margin is historically low, it is similar to the net interest margin that followed the 2001 recessions and higher than the net interest margin during the recovery from the 1981-82 recession.

Another potential factor discussed is the high cost of operating a small bank due to the plethora of regulations enacted in the wake of the Great Recession, including those mandated by the Dodd-Frank Act. While the authors note that a recent study found that compliance staffs and costs have risen substantially since 2010, the ratio of non-interest expenses to assets for community banks has not increased significantly. Therefore, regulatory costs, standing alone, may not be a major deterrent to de novo creation, since they may be offset by decreases in other costs.

Another factor, which we also have discussed, involves the time and expense of de novo applications, especially the applications process for insurance of accounts filed with the FDIC. The process is a long and expensive, and there has been a much greater chance than in previous economic cycles that the FDIC will not grant approval. Spending considerable time, money, and brain cells, not to mention the cost of cases of anti-acids to fight the heartburn, with a questionable chance of approval has, in our experience, been a major deterrent.

Once potential deterrent, the 2009 policy of the FDIC to extend the period of time that new banks are subject to greater examination costs and higher capital requirements, was allegedly abandoned by the FDIC within the past year. We think that jury is still out as to whether this abandonment is real or window dressing.

Obviously, the authors of this study, working within the bank regulatory system, are required to be more circumspect and less opinionated. As one living outside that system, and being possessed of a faulty governor of my internal sense of circumspection, I can be more blunt. My personal concern is that I have neither heard nor read anything recently that convinces me that the same regulators at the FDIC who made comments a few years ago that there were too many banks in the United States, and they were in the business of reducing, not maintaining, the total number of banks, have changed their opinion.

Whatever the reasons for the dearth of de novos, the study's authors draw some stark conclusions.

The current decline in commercial banks appears to be driven largely by the complete collapse of new bank entry. If entry remains weak and the exit rate remains constant, the number of banks overall, as well as the number of community banks, will continue to fall.

Julian Is Julienned

2015-02-16T22:03:00-06:00

Juilan Castro, the head of HUD, has taken his lumps lately over his amateur-hour performance on The Daily Show. Apparently, he just can't catch a break. Last week, he had the misfortune to appear before the House Financial Services Committee where he suffered the ultimate humiliation. No, not being grilled by Republican hit man Jeb (Clampett) Hensarling. That's a badge of honor with Castro's crowd. Rather, it was having to listen to Maxine Waters publicly praise him that had to cause him to spit up a little bit in his mouth. I know that she had that effect on me.

U.S. Rep. Maxine Waters, D-Calif., Ranking Member of the Financial Services Committee, was one of the few to praise Castro.

"Secretary Castro, although today you will likely take a fair amount of criticism from my colleagues on the other side of the aisle for your decision, I’d like to take a moment to remind them that when the private sector virtually left our struggling housing market during the worst of the crisis, the FHA stepped up and provided the liquidity that kept it afloat. Despite the steps toward recovery the economy has taken since then, the housing sector continues to suffer from a tight lending environment – and a strong FHA is still very necessary," said Waters.

"I would also note that FHA is far from bankrupt, holding approximately $40 billion in reserves, continuing to generate revenue, and taking critical steps to recover its capital reserves, which are projected to show a positive balance in 2015," she added.

You heard that right: when the private sector collapsed, the FHA hung in there. Of course, the FHA had no choice. It couldn't file "bankruptcy" like a private entity, even though it was insolvent, because its insurance is backed by the full faith and credit of the United States, it is required to fulfill its statutory purpose of providing mortgage insurance to back mortgages to qualified borrowers (many of whom turned out to be unqualified, but that's another story), and it has been used by clowns like (the Bridge Over Troubled) Waters to apportion housing credit to a constituency that appreciates the fact that the FHA being the lender that loans where angels fear to tread and votes accordingly. I think that putting Freddie Mac and Fannie Mae into conservatorship and pumping government money into those giant slush funds for progressive housing policy ("A Chicken In Every Pot and An Illegal Honduran Gardner In Every Malibu McMansion") did more to prop up the housing market than FHA insurance. Then again, who am I to argue with a brainiac like Maxine.

Hensarling and his henchman on the Republican side of the far divide are a bit perturbed with recent actions by the Master of the Selfie Stick in the White House, who reduced the annual mortgage insurance premiums for FHA by 50 basis points, from 1.35% to 0.85%, at a time when the FHA has still not restored its capital reserve ratio to the legally mandated level of 2%. In fact, it's 0.41%. The $40 billion that Maxine crowed about is supposed to over $200 billion.

Castro's response was as dynamic and on point as were his masterful responses to John Stewart. [Editor's Note: The previous sentence was sarcastic, for those readers who seem to take everything I write here in dead earnest.] Castro said that everything's great, we've never been better, nothing to see here, let's all fly to Colorado and score some "Hashey Bars."

Hensarling was not amused.

"With all do respect (Castro), we have heard that before, and you are sincere. But this committee has been told that once, twice, three times, and it hasn’t proven true,” said Hensarling. “Once again, you are in violation of the law and that has got to stop."

Except, Jeb, it won't stop. You know it, and so does everyone else with an IQ above that of a chunk of week-old Limburger cheese. The Republican-controlled house could pass legislation to punish the FHA, perhaps even threatening its funding. Even if the majority in the House did pass such an unpopular measure, Democrats in the Senate would likely thwart its progress in that chamber with procedural maneuvers, and the Perpetual Campaigner would veto it even if both houses pass it. By the time that useless exercise has run its course, there will be a new occupant in the house-is-not-a-home at 1600 Pennsylvania Avenue and Castro will be back to doing what he does best: looking dynamite in Armani formal wear.

Yes, we know: this is all about press releases for 2016. Keep up the good work.