Bank Lawyer's Blog

The Unbankable Turn To The Non-Banks

The marijuana banking conundrum in Colorado may be driving banks to distraction, but it's opening up the funding business to high-cost, low-publicity private money sources.

From hard-money lenders — investors who offer short-term, high-interest loans — to publicly traded real estate investment trusts focused on marijuana clients as tenants, the lack of conventional financing has created a sector that's gaining steam and drawing stares.

They are investors with an appetite for high risk and high returns, all of it hinged on an industry that's been around for a few years — retail sale of medical marijuana has been legal since 2009, but the business began to boom Jan. 1, when recreational retail sales began.

What the new breed of lender is doing is focusing on real estate as collateral for the loans it makes to the marijuana business, which theoretically lowers the risk if the marijuana business goes up in smoke. Of course, that assumes that the business operates in accordance with state law and that the federales never exercise their legal right to seize the assets of a drug business that violates federal law. Heightened risk justifies high interest rates.

The higher-risk-higher-rates-and-fees rationale makes sense unless you're in the payday lending, deposit advance, or tax anticipation refund loan businesses where the borrower is a consumer. In that case, the regulators will be all over you for taking advantage of the fog-brained poor consumer. Taking advantage of a smoke-brained Mary-Jane business is just fine, than you very much.

Obviously, there's so much money being made in the state-legal marijuana business that businesses that need the funds can foot the higher bills. On the other hand, what choice do they have? The high-cost private money lenders are the only game in town.

It would be extremely helpful to banks in Colorado if the federal banking regulators would rouse themselves from their torpor and give soem guidance on this business. They've issued guidance in the past on such high-risk, disfavored business as subprime lending, payday lending, third-party payment processors, money services businesses, etc. All we've seen thus far is the extremely problematic FinCen Guidance that raises more issues than it resolves.

The critical risk for bankers at the moment isn't in banking "direct" marijuana businesses. It's in banking the "indirect" marijuana businesses, those that service businesses that are directly involved in the marijuana business. The business that installs and services the drying and heating units. The landscaping business that installs and services the irrigation system. The trucking company that hauls the product. The alarm company that monitors the premises. And on and on.

The FinCen Guidance, in addition to dealing only with BSA issues, mentions "indirect" banking of a marijuana-related business only in a footnote:

FinCEN recognizes that a financial institution filing a SAR on a marijuana-related business may not always be well-positioned to determine whether the business implicates one of the Cole Memo priorities or violates state law,and thus which terms would be most appropriate to include (i.e., “Marijuana Limited” or “Marijuana Priority”). For example, a financial institution could be providing services to another domestic financial institution that, in turn, provides financial services to a marijuana-related business. Similarly, a financial institution could be providingservices to a non-financial customer that provides goods or services to a marijuana-related business (e.g., a commercial landlord that leases property to a marijuana-related business). In such circumstances where services are being provided indirectly, the financial institution may file SARs based on existing regulations and guidance without distinguishing between “Marijuana Limited” and “Marijuana Priority.” Whether the financial institutiondecides to provide indirect services to a marijuana-related business is a risk-based decision that depends on a number of factors specific to that institution and the relevant circumstances. In making this decision, the institution should consider the Cole Memo priorities, to the extent applicable.

Yeah, that clears it up. All any bank needs to do is to determine "the number of factors specific to that institution and the relevant circumstances," then go for it. No problem!

Banks in Colorado need just a wee bit more than that from regulators. Until they get it, any business that even touches a marijuana business is potentially problematic.

Let's Be Reasonable

Attorney Ari Karin has pondered the implications of recent enforcement action by the federal government against large loan servicers, and he's drawn some interesting conclusions. Writing an opinion piece in National Mortgage News, he makes an observation that will ring true with many community bank officers and directors.

Practically, these actions suggest that as opposed to specific standards that must be met, a generalized standard of care is being developed. In other words, up to this point lenders had specific actions and goals that were required. A lender could compare its actions and performance to specific standards to determine its level of compliance.

It appears that we are witnessing the development of a generalized "reasonableness" threshold where lenders will now need to evaluate themselves based upon the processes and procedures of their competition. This obviously creates additional pressures on companies' compliance infrastructures because simply meeting minimum statutory requirements may not be sufficient in the future.

Rather, the more surrounding companies implement practices to protect consumers and avoid defaults and other problems, it could impose liability for companies lagging behind their competition. In that regard, meeting minimum statutory requirements would not be enough—lenders would need to measure themselves against their competition in regards to their compliance performance and review their own conduct from a generalized reasonableness perspective.

Put another way, a lender's compliance would essentially be viewed in hindsight, creating the need to predict possible outcomes and review them in advance to determine that their actions are generally reasonable at the time.

Reasonableness is in the eye of the beholder. When that eye is a jaundiced one, lodged in the skull of a bank regulator, what a lender might regard as "reasonable" is likely to be a world away from what the regulator views as "reasonable." Moreover, Karin's observation that judgments as to "reasonableness" will be made with the benefit of hindsight is chilling, if the judgments made with respect to many officers and directors of failed community banks constitute a taste of what lenders and servicers, bank and non-bank, provide a road map.

Looking at the most recent FDIC lawsuit against former officers and directors of a failed bank, we see that the defendants are typical of a class of unlucky former officers and directors who made commercial real estate loans, especially acquisition and development loans, during the years leading up to the Great Recession: the CEO; the senior executive officer in charge of commercial lending; and two directors who served on the bank's loan committee.

The lawsuit alleges the four recommended and/or approved commercial real estate loans and loans for land acquisition, development and construction that violated “prudent, safe and sound lending practices” and Bradford Bank’s own loan policy. Marsiglia and Mitchell served on the bank’s loan committee.

The lawsuit alleges that in seven loans from July 2006 to October 2007, borrowers were approved for loans they did not have the capacity to repay or were for amounts too high given the value of the underlying real estate. Some borrowers were approved for “speculative” land acquisition, development and construction loans “despite the known economic downturn at the time of loan approval,” the lawsuit said.

"Despite the known economic downturn at the time of loan approval." "Known" with hindsight, of course. At the time the decisions were made, they appeared to the people who made them as "reasonable." Now, we know better, don't we?

Moreover, as the former head of the FDIC during much of this mess, The Care Bair, admitted publicly, even demi-gods residing on the slopes of Mount Olympus failed to anticipate the length or depth of the downturn. Yet, with hindsight, the defendants were negligent and breached their fiduciary duties because their decisions were not "reasonable" in anticipating what "none of us saw coming."

Big loan servicers, welcome to our world. It's located on the far side of the looking glass.

As a side note: any director who decides to serve on a bank's loan committee needs to receive combat pay, a psychiatric examination, or both.

That's A Fact, Jack

It has been a common theme among community bankers and their supporters for the past few years that the crushing regulatory burden in the post-Franken-Dodd era is hurting small banks' bottom lines. Since nay-sayers like the CFPB are allegedly fact-driven, perhaps they'll actually believe that the mantra has a basis in fact now that a university study supports it.

America’s small community banks are reeling under the compliance burdens of the Dodd-Frank Act and the vast majority of them are having to spend more money to comply with the law’s regulations, according to a study by George Mason University.

The study found that 83 percent of the nation’s community banks said that their compliance costs have increased by more than 5 percent because of Dodd-Frank.

Banks have had to hire new employees or outside personnel to help them comply with the law, said the study by the Mercatus Center at GWU.

“The increased regulatory burdens have led small banks to reconsider their product and service offerings, including considering whether to stop providing residential mortgages and overdraft protection. Many small bank customers, who will have difficulty locating convenient alternatives, will feel the indirect effects of Dodd-Frank,” the study said.

“The median number of compliance staff for the banks in our survey increased from one to two, and more than a quarter of respondents plan to add another compliance person.”

The study also cites Franken-Dodd's 850 pages of text and its evil-seed spawning of over 19,000 pages (and counting) of rules as ipso facto evidence of "crushing burden." On the other hand, I suppose bankers who actually read all that wouldn't be staying up all night with worry because the sheer ennui induced by that much sausage ogling would put even the most over-caffeinated banker into a coma.

 The American Banker's Paul Davis thinks that crushing regulatory burden is taking a back seat to community banks worries about being beaten up by their bigger brethren.

Compliance remains a concern, but exemptions and last-minute changes to various rules and regulations have certainly helped to ease the sting at smaller institutions. Numerous attendees at the Independent Community Bankers of America's annual conference here [Honolulu] are expressing more frustration about the pressure they face from their bigger brethren.

Well, if you're going to fret about being stomped on for being tiny, you might as well tremble in Honolulu.

The article cites problems in competing on pricing, with bigger banks buying market share by offering rates that smaller banks can't match. However, it's my view that the economies of scale that benefit big banks are even more critical given the increased costs of compliance. Banks need to combine because it costs too much to operate to be profitable as a small banks, and a large chunk of those costs are compliance costs.

Regulatory burden is driving consolidation.

Bad Banking!

My friend and occasional guest blogger Pat Dalrymple, a former community banker, felt the need to blow off steam again, so I'm indulging him. Actually, he's a lot more optimistic than I am, but that doesn't take much.

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The smart money today is emphatic in advising not to get into banking as a buyer of, or  controlling investor in, a financial institution, especially in a smaller, so-called “community bank”..

The reasons cited are many and cogent:

·         Regulatory restrictions are choking off profitability.

·         There’s a dearth of acceptable assets for investment to soak up the deluge of cash deposits flowing into banks.

·         The Dodd-Frank Act has triggered regulations that make compliance difficult, complex, expensive, and virtually impossible to accomplish.

·         Appreciation in a bank’s market value is minuscule, compared to the windfalls that investors experienced over the past 40 years.

·         Big bank competition makes it impossible for a small bank to thrive

·         The quality of small bank loan portfolios is suspect.

·         Banking isn’t fun anymore.

There are others, but you get the picture.

In fact, every one of the above is true.

Yet, if we’ve learned anything in the last 5,000 years or so of recorded history about war and commerce, when the experts say “do”, don’t.  When the word is “don’t”, seriously consider doing the opposite.

Airplanes could never sink a battleship, submarines were nothing more than toys.  Why would anyone invest in a flying machine, a horseless carriage, or a device that lets people talk on wires?’’

In this instance, we’re not talking about buying stock in a mega-bank.  That’s probably a pretty good bet over the long haul, because the big banks almost can’t help but make money, positioned as they are at the crossroads of global industry and commerce.  The opportunity, if there is one, lies with little banks in relatively small markets: the institutions under, say, $200 million.

Big banking and little banking are two almost completely different businesses that, paradoxically, are governed by the same set of regulations.  Inevitably, these regs are applied differently to the two industries.  Our focus here is on the smaller of the two, but, in terms of the number of individual institutions, and thus in opportunity, much the larger.

So, let’s take a quick look at all of the good reasons not to buy a bank:

Regulatory stifling of profitability:

This  maybe should be first on the list of considerations, and it has to be recognized as a challenge at the outset.  It’s absolutely a fact of modern commercial life that the regs make it difficult to make money the old fashioned way.  Most community bank business models are using pre-crisis blueprints, which may not work in a post meltdown environment.

We’re all products of our training, and bank management teams certainly weren’t conditioned to adust when the basic rules of the game changed.

So, the plan for a purchaser may have to run contrary to a lot of conventional wisdom to thrive in the current economic ecosystem. Fore example,  if the bank isn’t already doing so, become the go to residential mortgage lender for your customers.  When the bank can’t make a loan which could ultimately result in a profitable long term relationship, (which will be often these days) find ways to assist that customer to find alternative financing.  And above all, don’t forget to make money doing it.

Also, carefully look at the cost/benefit equation of paring expenses. All banks, big and little, have been cutting costs for the past several years.  Most community bankers are convinced they’ve cut to the bone, but they’re wrong; they’re running the business that they built and were trained to run, and that model just doesn’t exist in the old format.

For example, small banks that have branches probably shouldn’t.  The deposits accumulated simply  don’t justify the cost. Paradoxically,  management has kept the branches open to “preserve the institution’s franchise value” for potential purchaser.  Ignored is the strong likelihood that, should that buyer come along, the branches will be shuttered soon after the sale closes.

Finally, in viewing a troubled bank, the income statement can tell an interesting story: when all of the expenses attendant to regulatory restrictions and undercapitalization are erased, one often finds that, even with last century’s business model, the bank can be adequately profitable.

Scarcity of good assets:

This phrase merits some redefinition:  There are a lot of quality loan assets around; they just don’t fit the regulators’ discriminatory definition of what’s good.  Of course the result doesn’t change.  If  the regulators classify the loans as second class citizens in the general population of paper, then that’s what they are.

Conventional wisdom says that a lot of bank dollars are chasing few assets, so the big fish will force the little ones out in the feeding frenzy.  But CW, as usual, may have it wrong.  Money center institutions have managed to cinch up  the regulatory bonds past even what the examiners have done to them.  This is because, in response to the post Dodd-Frank regs, they’ve instituted multiple layered internal policies that have destroyed their flexibility.  Good loans often go to big banks to die, especially if they have to move up the approval ladder.  Savvy community banks with good CAMEL ratings are using their huge edge in flexibility and processing time to take high quality business away from the bullies in the high rise offices.

Cost and complexity of compliance:

Nothing causes more angst and molar grinding among bankers than complying with the plethora of consumer laws and regs enacted and promulgated in the wake of the Great Meltdown.  But most of the wailing is done by old duffers like me that have been around banking since way back in the last century.  Fortunately for everybody, we’ll die off, to be replaced by bright young people who will grow up in an over-regulated environment and will opine, “Gee, what’s so hard about that”.  And no matter what us old cowboys tell you, it doesn’t really cost an arm and a leg to accomplish the task.

Minimal appreciation in the bank as a salable asset:

True; you can’t buy a bank and sell it three years later at 3.5 times book.  Putting equity money into a financial institution today is a longer term investment.  But the cash on cash return can be very impressive, which will very nicely enhance book and market value.

Forget about owning a little bank.  Big banks have all of the business:

No businesses are better positioned in their marketplace than community banks.  Few businesses do a worse job of exploiting that advantage.  (See the flexibility factor noted above)  Imitation is the sincerest form of flattery:  the big banks know the advantage of looking little to the home town folks, and often they’re more successful at it than their smaller brethren.

A prospective purchaser of a bank must understand the marketing plum to be acquired that very likely has been woefully underutilized.

Small bank loans are second class paper: 

True for some; at least from the new regulatory perspective.  And almost certainly so for institutions that are the prime targets for investors.  These are the troubled banks that sometimes had to be satisfied with the skim after the cream was scraped off by competitors.

However, any of these loans that are currently performing in a post-nuclear financial landscape are survivors, and have a very good chance of continuing to be.  One of the dichotomies of negotiation for a bank involves the owners touting the net interest margin of the portfolio, while the shopper counters with, “Yeah, but look at the loan quality”. Actually, the quality may be pretty good. The deals have   been through the fire and they’re still anteing up that high interest rate, which can be pretty neat for an investor.

And then there are the non-accrual loans, those gems that you can’t book income from until they go away, one way or another.

What’s weird, is that a lot of these really rotten deals are performing.

My pilot friends tell me that any landing you walk away from is a good one.  My wisest banking friends say that, in the final analysis, a good loan is one that gets paid back.  This bottom line criterion doesn’t necessarily meet 21^st century regulatory discrimination, but, in some instances, it can set up a nice little windfall for an investor, because all of that deferred interest on the loans that continue to perform will ultimately find its way to the bottom line.

That’s about it, so……….

What?  Oh yeah….having fun.  Well, if you’ve been a bank exec for more than ten years, it probably isn’t much fun.  In, say, 2004, the 3-3-3 banking rule didn’t actually prevail (you know, pay 3% for your deposits, mark your loans up 3%, and be on the golf course by 3) but it was a day on the beach compared to 2014.

On the other hand, if you can buy a clean bank, or make sure that the existing owners clean it up before handing over the keys, then you might have a pretty good time, given the potential profit margin.

Regulators Driving Consumers To The Unregulated

As federal regulatory agencies continue to pile regulations onto the backs of the banks, thrifts, and credit unions they regulate, a not-so-funny phenomenon is occurring, according to consultant Susanna Tisa: "all manner of nonbank entities [are] rushing in to offer services that fill the demand – from alternative consumer options like payday loans, online lending and other small-dollar credit to commercial financing provided by business development companies, private investment funds and other shadow bankers."

Over 20% of U.S. households are using alternative financial services such as payday loans at least some of the time. Small and midsize business loan originations from online lenders, merchant cash advance providers and other alternatives have grown a reported 64% in the last four years. The global shadow banking system grew by $5 trillion in 2012, to reach $71 trillion.

Consumers and businesses have turned to these lightly regulated alternatives, usually at much higher cost, as regulated mainstream banks are discouraged from lending to anyone but the most creditworthy. Policymakers say they want to bring "underbanked" young adults, immigrants, entrepreneurs and other groups into the traditional banking system for safer consumer options, small-business growth, a sound banking system and other laudable reasons. But today's rules and aggressive enforcement work against these goals.

Tisa also points out that banks that have attempted to venture into these troubled waters, with such products as "cash advance loans," have been slapped up the side of the head by their primary federal bank regulators. Yet, where there's demand, there will always be suppliers. Tisa's point is that those suppliers are increasingly the "lightly regulated."

She asserts that with the "explosion" of interest by the "lightly regulated," the problem of effective regulation is compounded.

There are simply not enough regulators, examiners or hours in the day to chase down, eradicate or sanction all the abusive practices that can emerge in this exploding market.

Perhaps, but that won't stop the CFPB from giving it the old college try. Expect The Adjustment Bureau to be expanding in years to come like Elvis' waist line in the years immediately prior to his keel-over at Graceland. They may not be able to define "abusive" with Aristotelian precision, but they know it when they see it, and when they see it...well... It. Just. Hacks. Them. OFF!

Tisa does not discuss the fact that in addition to being squeezed out of direct participation in making high-risk loans to high-risk borrowers, regulated financial institutions are being squeezed out of permitting some of the "lightly regulated" with access to the banking system. As we've discussed, if you can't regulate it directly, you can always deny it the ability to exist. That drastically reduces the concern with an insufficient number of regulators. You don't need an examiner to examine a lifeless carcass.

Tisa ends with an appeal to reason.

[T]here must be constructive ways to take some of the pressure off and gradually redirect a portion of the demand back to regulated institutions. Banks and regulators should begin a new conversation, starting from the viewpoint of the disenfranchised consumer and business customer, and factoring in the likely economic scenarios that would unfold if these customers are not served by banks.

A practical conversation could be about setting "safe harbor" parameters that allow banks to design reasonable services for all American consumers and companies – not just the most financially robust – and replacing reactive regulation and "gotcha" enforcement with guided innovation.

In an alternative universe, those intelligent suggestions might have a chance. In the one we inhabit, the chances are slim to none.

A New Game Plan

Long-time mortgage lender and banker (and old friend) Pat Dalrymple, whose guest posts have occasionally graced this blog, wrote a gem recently for his regular column in a Colorado newspaper. Pat provided a real-life example of the consequences of heightened regulatory scrutiny of commercial lending at community banks across the country. As Pat puts it, the scenario is so common that he doesn't even need to worry about the regulators figuring out which bank he might be discussing. I assume that many community bankers (and, unfortunately, many borrowers) recognize themselves.

The worst bank examiner rating for a loan is “probable loss,” which means that the bank has to write off the entire loan, taking the balance out of capital and current income. The next worst is “nonaccrual,” which means that the bank, rather than booking interest income on the loan, must apply the money received to the loan balance on the bank’s books, and realize a profit or (loss) only when the loan is paid off, or the foreclosed property is sold.

But a funny thing may have happened on the way to “nonaccrual”: the loan didn’t turn into a bad loan, it was just called bad by the regulators because, well, the rules changed between exams.

Nonaccrual loans, along with foreclosed collateral, are held to be an indication of a bank’s health. A large percentage of these problem assets in relation to an institution’s capital can mean that the bank is in trouble. However, if one digs into the makeup of these nonaccrual loans, in many cases, a surprising, even shocking, number of them are paying like clockwork. 

[...]

A business owner has been a premier customer of the a bank for, say, 15 years on both sides of the ledger, as depositor and borrower. He comes to the bank president for a relatively small increase in his business operating capital loan; a request that’s been routinely granted for years. The CEO says, “Sorry, we can’t do that. As a matter of fact, we’d like you to move your loan to another lender.”

Of course the guy is ticked off and marches out of the bank vowing never to do business with it again, while figuring that he’s the cream of the crop of bank customers; after all, hasn’t he been told that for 15 years?

Turns out, the rules have changed for everybody. The three banks he subsequently calls on tell him he and his business can’t be accommodated. He then goes back to his old banking partner and announces, “It’s just you and me kid. Looks like we’re stuck with each other.”

And so it goes. Community banks provide the lion's share of the lending to small businesses in this country and small businesses drive job creation. People wonder why the economic recovery has been so prolonged and weak. While there are many culprits, regulators making sure the last war never again breaks out is one of them.

In the meantime, the big boys are doing just fine, thanks for asking.

Blow Banks, Blow

While bank regulators are angst-ridden over the risks banks face from proprietary trading, deposit advance lending, and other forms of outré behavior, there is apparently one lending area into which regulators wish banks would dive more deeply. What area? you may ask. Well, children, according to Point of Law's Heather Pierce, the answer is blowin' in the wind.

Last month,...the Office of the Comptroller of the Currency issued a bulletin encouraging bank investments in wind energy.

Banks are permitted by statute to "make investments directly or indirectly . . . designed primarily to promote the public welfare, including the welfare of low- and moderate-income communities or families (such as by providing housing, services, or jobs)." There are some constraints on these investments, including a prohibition against banks taking on unlimited liability. Certain renewable energy investments qualify as public welfare investments. These investments give banks access to renewable energy tax credits to offset taxable income, allow banks to benefit from renewable energy subsidies, and can be qualified investments under the Community Reinvestment Act.

Last month's OCC fact sheet reminded banks of the benefits of investing in wind projects. One of the two approved projects highlighted by the OCC was a fund that would finance six windmills and thus would purportedly benefit low- and moderate-income "individuals and areas by allowing students at a technical college to pursue careers in the renewable energy sector." The OCC cautions that "the bank should have the requisite expertise and risk management capabilities to make these investments." As the last crisis reminded us, when regulators tip the scale in favor of a particular type of investment, it tends to dull bankers' risk management faculties.

The OCC forgot to mention one additional "benefit" of wind power: killing birds and bats by the flock-load. Where are the storm troopers from PETA and The Audubon Society when you really need them? Nowhere near the OCC, apparently.

Conventional commercial real estate is problematic, but wind turbines are A-OK.

You cannot make this stuff up.

Equal Justice

It's hard to believe that people in the banking business could read a story like this and not be cynical.

ShoreBank, a South Side community bank that won national acclaim for profitably lending in low-income urban neighborhoods before failing in 2010, is setting itself apart again. Its former leaders are dodging the day of reckoning in federal court that has befallen executives at most other failed banks.

On Aug. 16, when the Federal Deposit Insurance Corp. sued the people it said were responsible for improper lending at ShoreBank, it didn't name a single member of the board as a defendant. Among those omitted: the bank's co-founders, Ronald Grzywinski and Mary Houghton, and director Eugene Ludwig, a former head of the U.S. Office of the Comptroller of the Currency and now CEO of Washington-based consultancy Promontory Financial Group LLC.

Instead, the FDIC named five bank lenders as defendants, none of whom had a title more elevated than senior vice president. In contrast, the agency sued at least one director in all but one of the 75 other liability complaints it has filed nationwide since July 2010 seeking damages from leaders of defunct banks. And that suit was a relatively small affair, seeking $8.2 million and involving a single alleged rogue lender (see the PDF).

Likewise, it's all but unheard of for a failed bank's top decision-makers to escape culpability. Mr. Grzywinski and Ms. Houghton led the bank for nearly four decades; Mr. Grzywinski was chairman and Ms. Houghton was president of ShoreBank's holding company until just months before the bank failed.

The two, along with Mr. Ludwig, were known for their unusually good relationships with bank regulators—a status that caused ShoreBank to become the object of right-wing scorn in 2010 as the FDIC helped organize an extraordinary bailout effort that ended up raising more than $140 million from the largest banks on Wall Street and others. The rescue fell short, and the capital instead was injected into newly created Urban Partnership Bank, which took over ShoreBank's branches and adopted its mission of helping low-income neighborhoods, albeit on a far smaller scale.

The story quotes attorneys who represent directors of failed banks who have been sued by the FDIC and other observers to the effect that the failure to sue the "connected" directors looks, walks, and quacks like a duck, and that duck's name is "cronyism." An FDIC spokesperson denies that there's any smoke here, much less a fire.

“This case is no different in the theory that has been applied in our other professional liability cases as to who is named in the suit, meaning the individuals who approved the loans,” a spokesman writes in an email.

The loan committee that approved the "loss loans" upon which the FDIC's damages claims are based were the officers named as defendants. No directors sat of the loan committee. However, that set of facts hasn't stopped the FDIC from alleging in other cases that the non-loan committee directors were grossly negligent for not adequately supervising the officers. That claim should be reinforced by the fact that, according to the linked article, the loss loans received little review from the board and the loan officer in charge was given "virtually unlimited authority." Those facts should enhance a claim of "failure to supervise" against the outside directors. At least, similar facts have formed the basis for such claims against directors who weren't a former Comptroller of the Currency and two fair-haired favorites of the FDIC due to their long involvement with lending in low-income neighborhoods.

The FDIC spokesperson also claimed that a "1992 policy bars the agency from suing officers and directors for general negligence if the loans in question were made while a bank was rated two or better on the FDIC's internal five-point scale for assessing banks. At the time its offending loans were originated ShoreBank was a two." That policy statement (if, in fact, that's the policy statement to which he's referring) has not saved the bacon of other outside directors in similar circumstances, where the FDIC has alleged "gross negligence" (as opposed to "general negligence") in failing to adequately supervise the lending activities of bank officers.

You'd have to have access to the FDIC's investigative file to determine whether there exist facts in this case that logically distinguish it from other cases in which directors have been sued for a breach of their duty to supervise, and that is not going to happen. Therefore, you can't prove that favoritism influenced the FDIC in this case. However, as a defense attorney quoted in the article in effect observes, you just have to wonder.

As in many areas of business, but especially in those that are heavily regulated, who you know seems to make as much, or more, difference than what you know.

Stupefyingly Stupid

New Mexico bank consultant Joe Badal has always had a way with words, and his hot opinions have been blog-worthy in the past. He gave an interview to an Albuquerque reporter a few months ago that many community bankers throughout the country would appreciate.

Community banks in the U.S. will be merging at a frantic pace in the coming years because they can’t afford to keep up with a growing list of federal banking regulations, New Mexico banking consultant and author Joe Badal said Wednesday.

“The big are getting bigger and the small are going away,” Badal said, blasting “stupefyingly stupid” federal regulations at the Economic Forum of Albuquerque breakfast at Hotel Albuquerque in Old Town.

A banker for more than 30 years, Badal noted that a federal appellate court ruled recently that regulators can arbitrarily set capital levels for banks. In other words, they can tell one bank it must have a certain capital level and set a different level for a different bank of the same size.

“What recourse do regulators have against arbitrary and capricious decision by regulators? None. They have no recourse,” said Badal, owner of the Joseph Badal & Associates consulting firm. “Regulators can descend on a bank like storm troopers.”

Yes, they can. And they've got their own Death Star: the FDIC. With no Darth Vaders of their own to throw into the fight, however, many community banks must resort to The Chewbacca Defense.

Badal really gets riled about a failed New Mexico thrift whose fate we chronicled in these pages previously.

The bank was profitable and most of its loans were current, Badal said, but regulators treated it like banks in California, Arizona and Nevada where enormous housing bubbles had burst.

Those regulators assumed what had happened in those three states was going to happen in New Mexico and failed to understand that New Mexico doesn’t have large booms and busts, Badal said. As a result, regulators forced Charter to write down loans they thought would go bad, he said. That forced Charter to increase its loan-loss reserves, which came straight out of its capital reserves, leaving Charter undercapitalized and unable to raise fresh capital, he added.

“They arbitrarily wiped out Charter’s capitalization,” Badal said.

"Arbitrarily" is a loaded term. By insulting the late OTS and, if only by inference, the regulatory shark that swallowed it, Joe might be encouraging cockroach trolls out of their dark corners and into bright daylight long enough to send him hateful "anonymous" email before they scurry back to regions where the Sun don't shine. If that doesn't do it, his novel might.

Badal, who also writes mystery novels, said he wrote his latest book, “Shell Game,” after being outraged by the January 2010 seizure by federal regulators of Charter Bank in Albuquerque.

[...]

“Shell Game” is about a family-owned business that suddenly can’t get credit because federal banking regulators have clamped down on its bank.

While I've got a copy of "Shell Game," I have not had a chance to read it. Once I do, I'll review it. It's the least I can do to bring Joe out of his shell and get him to tell us what he really thinks.

Camden Fine Fires Off A Fine Salvo

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

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

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

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

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

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

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

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

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