Bank Lawyer's Blog

Cashing Out on BankUnited

The recent news that the original private equity funds that backed one of the FDIC-assisted broke-back-bank deals of the latest banking "crisis" are finally, after five years, cashing out the last of their remaining ownership may fill the FDIC with even more "seller's remorse" than it allegedly experienced previously when it decided that it had been way too generous with the buyers of BankUnited. As I discussed four years ago, some wags complained that the assistance deal was too lucrative for the acquirers, due, the wags surmised, because the crafty Wilbur Ross and his fellow PE all-stars "outfoxed" their FDIC counterparts.

I don't think that the FDIC was "outfoxed." Rather, Ross and his compatriots (led on the management side by John Kanas, who will remain at the helm of the the bank after the original investors leave the stage) were into the game early, when the risks were high, the rules flexible, and the FDIC uncertain as to where the sweet spot might be between giving away just enough to entice buyers to buy, but not so much that critics in the peanut gallery would do what the FDIC does to officers and directors of the failed banks: second-guess them with the benefit of hindsight. As a result, Ross and his fellow investors negotiated better terms than those who came later. As the FDIC became more comfortable with its understanding of the field of potential bidders and what they would or would not accept, the deal terms negotiated became less lucrative for the acquirers.

An unfortunate consequence of this criticism of the FDIC, as well as of public bragging by some notable PE investors who also got into the game at the beginning (not Ross) about the sweet deals they'd swung, was that the FDIC decided to clamp down on private equity bidders for failed banks, making the conditions on PE bidders onerous enough that Ross and others simply opted out of the process and turned their attention to other investments. That eliminated competition for other assisted transactions and may have ended up costing the FDIC money in the long run. That's pure speculation, but not unreasonable speculation.

There will be some who will sneer at the fact that Ross and company are making more from the deal than they originally expected. As I said four years ago,

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.

I still don't share it. Risk takers recapitalized a broken bank, turned it from a high-flying outlier into a solid franchise, saved the jobs of many workers who otherwise would have been hitting the pavement, and performed in accordance with the deal they cut with the government. The FDIC experienced a substantially lower loss than it would have if it had not done the deal. The investors made out well. So, let's all criticize both parties for not doing a deal that wouldn't have been done at the time it was done. That makes sense.

My only regret is that the FDIC didn't do more BankUnited-like deals. Then again, as I've said before on this blog, I sustain myself not by eating solid food, but by taking a straw and sucking the sweat from the brow of the proletariat. Of course I'd feel that way.

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.

Ben Knows Best

When you read news like the recent reports that Benjamin Lawsky, superintendent of the New York Department of Financial Services, asserts that "[n]onbank mortgage servicers are growing too fast and regulators need to protect homeowners by making sure these companies can handle the volume of business they are taking on," you assume that Lawsky must have a great grasp of the mortgage servicing business, information technology systems, staffing, business growth, mergers and acquisitions, personnel management, and, in a business environment, how to do it right and, most important, how to avoid doing it wrong. You'd think that. Of course, if you did, you'd be sucking wind.

According to his official biography, Lawsky is a lawyer. As anyone who reads this blog knows, that qualifies you for...the practice of law...maybe. It also likely means that you're adept at opening your pie hole and emitting various loud intonations about a myriad of subjects about which you have little, if any specific knowledge. All that goes with the job description.

Lawsky's bio also touts the following mortgage servicing specific job experience:

• Governor Andrew Cuomo's Chief of Staff.
• Deputy Counselor and Special Assistant to then-Attorney General Cuomo.
• Assistant United States Attorney in the Southern District of New York, "where he prosecuted white collar crime, organized crime, and terrorism cases."
• Chief Counsel to Senator Charles Schumer on the Senate Judiciary Committe.
• Trial Attorney in the Civil Division of the Department of Justice.

So, when Lawsky shoots down Ocwen's purchase of Wells Fargo's servicing rights on the grounds that he's concerned about Ocwen's ability to handle the increased volume, you can see how his background has made him uniquely qualified to second-guess Ocwen on that matter. After all, when it comes to private business acquisition decisions, Lawsky's job experience has provided him valuable insight's into such matters as which way Andy Coumo's wind is blowing on Tuesday morning, does Chuck Schumer take his grande chai latte with one lump or two, and which upstate village mayor needs to be kneecapped for not supporting the boss in the last general election.

Ocwen may or may not be able to adequately handle the Wells Fargo servicing business. Homeowners may, in fact, need protection in this or some other similar instance. However, why would we believe Lawsky on this specific issue? Why, instead, does he appear to be the second coming of The Spitz (absent, we hope, the "crossing-state-lines-to-visit-Ashley" issue)?

We'll see how all this shakes out. Perhaps it's not merely one more political grandstanding stunt by a New York pol on the make, and is based upon hard evidence. If it's based upon industry-specific expertise, we assume someone other Lawsky is supplying it.

One Banker Who's Learned The Lesson Of Chase

U.S. Bancorp's Richard Davis, a man never to be confused with the likes of Charlie Sheen when it comes to self-preservation and the exercise of plain old prudence, was quoted not long ago in an article in the American Banker (paid subscription required) to the effect that it would be a frosty day in the land of Beelzebub before his bank ever ventured where Chase is sorry it ever went.

"In the old days it was about credit risk, and uncertainty about who you would acquire as it relates to long-term, systemic credit surprises," Davis said at the Bank of America Merrill Lynch Banking & Financial Services Conference in New York on Tuesday.

"But it is all about compliance now and as you've seen in this environment, you will be held accountable from day one for the company you buy," says Davis, who is U.S. Bancorp's chairman and chief executive. "And you can be held accountable for things up to 10 years in the past, even if they were approved back in the old rules that have changed."

[...]

"Anyone who is going to do a deal needs to be very careful that they are not bringing a virus into a healthy room," Davis says.

While the article notes that Davis has long been cautious about the unintended consequences of acquisitions (a virtue not possessed by our federal legislators), he believes that the "little guys" will be engaging in M&A.

"You might see a 10 and a 10 trying to get to 20, or a 10 and a 15 thinking about 25," Davis says. "You'll see a lot of fours and twos getting to six."

Obviously, he's talking about the billions of dollars in assets possessed by the banks who will be merging.

I think that he's right. The biggest will grow organically, but the less-than-behemoths will grow by devouring both compatriots and their children. It's not a question of "if," it's only a question of "when."

The Long-Range Consequences Of Adopting The Mating Habits Of A Praying Mantis

The Boston Business Journal's Matthew L. Brown articulated the thoughts of many banking executives and attorneys when the news broke last week that JPMorgan Chase had agreed to pay the US Government a whopping $13 billion to settle claims arising, principally, if not exclusively, out of the steaming heap of goat custard that lay beneath the surface of Wamu and Bear Stearns. Chase bought those gems at the behest of the US Government in 2008 as part of the efforts of the governemt to prevent a meltdown of the US economy over the subprime mortgage securitization crisis and its consequences. As we discussed a few years ago, in the case of Wamu, Chase and the FDIC have been locked in mortal combat over whether the less-than-clear acquisition agreement and related documents required Chase to assume the liabilities related to that custard or whether it stayed with the FDIC as receiver for the Wamu. That battle continues and may be impeding the finalization of settlement documents.

Brown's point is more general and far-reaching. He claims that by asking Chase to step in and rescue the government from the consequences of those two entities going down in flames, and then beating Chase about the head and shoulders with a hockey stick for sins committed by those two entities prior to Chase's purchase of them, the government is jeopardizing the chances that any major players will ever step into the breach again in such a fashion, at least without a lot of belt-and-suspenders language i the acquisition documents that makes it perfectly clear, particularly to a federal court, exactly what liabilities are being assumed and what liabilities are not.

However, Brown argues that going after Chase for the liabilities of Bearn Stearns and Wamu is also egregious because of the respective responsibility of the two combatants in this aftermath--Chase and the US Government--for the losses.

Big banks’ mortgage securitization and credit derivatives practices in the years before the collapse were reckless, self-serving and parasitic. We’ve also learned — from books like Charles Morris’ "The Trillion Dollar Melt Down," published in March 2008 — that they were decipherable and predictable.

Regulators didn’t bother to decipher or predict the meltdown. And in the case of Bear Stearns and WaMu, they didn’t seem to do much regulating, either.

A $13 billion settlement will only sting JPMorgan Chase a bit. The more fervent feelings appear to be on the government’s side as it hustles for little bits of cash to cover for its own ineptitude.

"Hustles for little bits of cash." He's right, of course. Compared to the total amount of money and asset value lost by the perfect storm of stupidity, incompetence, greed, and venality by so many players in the game, including the executive and legislative branches of the US government, $13.1 billion is a pittance. Still, it's a lot of money to most bankers, and Brown's parting shot sounds prophetic: "It’ll be a long time, indeed, before a big bank answers the federal help line."

Hating A Hate Crime Torpedoes A Bank Bailout

Recently, a too-small-to-save community bank in Bridgeport, Connecticut failed. So far, so what? If it's not run by the likes of Jamie Dimon, you know it's not going to get a bailout. In fact, the bank had been denied TARP capital. What's an interesting wrinkle in this sob story is that the bank. the state's only minority-owned bank, had lined up a White Knight, one Donald J. Vaccaro, who had the cash to buy and recapitalize the bank and was raring to go. Unfortunately for him, the state and federal banking regulators determined that he just couldn't pass the "integrity test."

Did he machine-gun a busload of nuns? Strafe an orphanage? Break wind in the vicinity of an open flame? No, something much worse: he was arrested (but never convicted) of a "hate crime." The "crime" was uttering a racial epithet.

State and federal regulators got stuck on Vaccaro's arrest, which happened in 2012 at an Oscar party in Hartford, on the felony charge and four misdemeanors. He allegedly was bounced out of Real Art Ways when he allegedly grabbed one woman's breasts. He later allegedly told the bouncer, "You never should have touched me, you black mother-[expletive]," according to police.

Vaccaro has consistently denied that he touched anyone or used any racial slurs.

He was granted accelerated rehabilitation by the courts, a special form of probation that would erase the record of the arrest if probation is successfully completed. The probation period has been shortened once, and is now set to end in February.

Let's leave aside the First Amendment implications of the entire concept of "hate crimes." There's no sense in opening up that can of worms. If Vaccaro in fact uttered such a racial slur, it certainly would not make him the preferred provider to capital to Connecticut's only minority-owned bank, would it? Yet, here was the bank's founder seeking his capital. Not only that, the NAACP publicly gave Vaccaro a clean bill of health reputation-wise and supported his proposed acquisition of the bank. In light of that, you'd think that the regulators' fears of "reputational risk" (cited by the state banking authorities) would be assuaged. If he'd insulted Norwegians ("You never should have touched me, you pasty-faced mother-[expletive]," of course, then I doubt he could have effectively marshaled a respected Scandinavian-American advocacy group to come to his aid. But in this case, the premier advocacy organization for the minority group he'd allegedly insulted told the world that the guy was not a "hater."

In addition, it seems to me that the accelerated probation is indicative of the fact that the local authorities did not consider him a serious offender. Once probation was completed, which was to be in less than six months, the crime would be expunged from the record. It would have been as if it had never happened. So, doesn't it seem a tad unfair to base your decision primarily on an arrest for a crime that will, shortly, have never existed? I realize that bank regulators regularly time travel through worm holes, so everything that has ever happened or will happen is, for them, occurring right now, but still...

The bank's founder and CEO, Peter Hurst, put it poignantly.

"It was one bad night in February 2012," Hurst said. "Should that be enough to let a bank fail? I just don't get it. I don't think I ever will."

In the interest of fairness (which is seldom a concern on this blog), the linked story discusses the Federal Reserve Board's "stinging" letter of rejection of Vaccaro's application, delivered after the bank failed, which cites other "unexplained" past arrests of Vaccaro and investigations of Vaccaro-related enterprises. None of those incidents appeared to present hurdles that could have not been leaped, however. In addition, the state banking commissioner's comments make clear that the primary factor in the rejection of Vaccaro's application was the hate crime arrest.

To cut the chase, the regulators didn't think that Vaccaro was their kind of guy. Which, in a sane world, might be a reason to praise Vaccaro, not to bury him.

Where's Snowden When You Really Need Him?

In a performance worthy of Dean Wormer's Double Secret Probation, the US Treasury Department gave a classic runaround to St. Louis Business Journal reporter Greg Edwards when he had the temerity to ask Treasury why it is keeping the names of bidders in its auction sales of "TARP stock" a big fat secret.

Originally the Treasury spokesman, who identified himself as Adam, said he would get the answer from the department’s lawyers. Having received no response by Thursday, we called again. The inquiry was duly noted, I was told.

Today I made another effort, aware of the three-day weekend’s approach. The line rang and rang before I got a voicemail recording that told me public affairs was “not available.” Perhaps the weekend already has begun for taxpayer-funded government workers.

Edwards relates an email from a reader (I assume a banker) who was also being stonewalled.

“I have called and emailed the U.S. Treasury several times to try to find out when certain auctions would occur and who had won auctions I read about after they took place. I have never heard back from anyone.”

As one outraged St. Louis banker reminds us, this is taxpayer money we're talking about.

Yes, well, so it is. As if that ever meant a thing to the people who play with it. File a FOIA request, Greg. Then pull out a pillow, a blanket, and a quart of Ripple, and settle in for a long and peaceful slumber while you wait for denials, the redaction of all critical information, and a Westminster Abbey-sized load of smoke to be blown up your nether regions. After all, this is your federal government at work, and accountability to the taxpayer is definitely NOT its long suit.

Now You See Them, Now You Don't

The American Banker's Alan Kline wrote a very interesting article last week (paid subscription required) about a subject we've been focused on for the last several years: the incredible shrinking banking business.

Since mid-2010 the total number of banks has fallen by 11.4%, by far the largest three-year drop since the mid-to-late 1990s, according to data from the Federal Deposit Insurance Corp.'s most recent Quarterly Banking Profile.

Failures, mergers and charter consolidations have all played a role in the decline, but less so than in the prior three-year cycle. Twenty-three fewer banks failed between June 2010 and June 2013 than in the three years prior, and there were 107 fewer mergers in the most recent three-year span.

What's really driven down the numbers of late is the lack of startups. No new banks have opened for business since mid-2011 and only 23 have come online since 2008, according to the FDIC. Contrast that with the five years leading up to the financial crisis, when an average of 156 new banks opened each year — or roughly one bank for every two that failed or were merged out of existence.

The unacknowledged "war on de novos" by the FDIC and other federal banking regulators has been a hot topic on this blog for some time. The effects of the undeclared "moratorium" on de novo bank approvals are manifesting themselves. While many observers expected the number of banks to decline due to mergers, it turns out that the lack of de novos is as much, if not more, at fault.

Other experts interviewed by Kline state that the industry will continue to shrink for the oft-cited reasons of regulatory burden costs, a lousy yield curve, higher capital requirements, tepid loan demand, and the reluctance, or sheer inability, of smaller banks to invest in the technology needed to compete. None of those factors is exactly an incentive to start a new bank from a business perspective, even if the regulators were eager to grant new charters. Thus, there is nothing on the horizon to suggest that the number of banks will not continue to decline.

Which, according to those in love with the Canadian model, is a great prospect.

Reading Between The Lines

Kevin LaCroix commented last week on the recently released FDIC Quarterly Banking Profile for Q2 2013, and had some cogent observations. While the FDIC tried to put a positive face on the statistics, namely that things aren't as bad as they have been, both the agency and LaCroix also drilled down a little deeper and what they saw is disconcerting.

The press release accompanying the report quotes the agency’s Chairman as saying “overall these results show a continuation in the recovery in the banking industry.” However, the Chairman is also quoted as saying that “industry revenue growth remains weak, reflecting narrow margins and modes loan growth.” In addition the current low interest rate environment “creates an incentive for institutions to reach for yield, which is a matter of ongoing supervisory concern.”

[...]

The number of problem institutions is down by over 40 percent from the high quarter-end number of 888 problem institutions at the end of the first quarter of 2011. The quarterly decline in the second quarter represented the ninth consecutive decline in the number of problem institutions.

One of the more noteworthy effects of the crisis in the banking sector has been the dramatic shrinkage in the number of banks. At the end of 2007, there were 8,534 banking institutions, meaning that between December 31, 2007 and June 30, 2013, 1,584 banks went out of existence, representing a decline of over 18.5%. Yet despite that substantial decrease (resulting from closures, mergers and so on), there are still 553 problem institutions in the industry, as of June 30, 2013.

With the declining number of banks, the percentage of banks that are rated as problem institutions still remains high, despite the decline in the absolute number of problem banks. The 553 problem institutions at the end of the second quarter still represent nearly eight percent of all reporting institutions (down slightly from the 8.7% of all banking institutions at the end of the first quarter of 2013). . In other words, roughly one out of twelve of every bank in the United States is still regarded by the FDIC to be a “problem institution.”

 And not only that – banks are continuing to fail...While it seems likely that the number of banks that fail in 2013 will be below the 51 that failed in 2012 and a far cry from the 157 that failed in 2010, the fact is that banks are continuing to fail. Even at this late date, five years after the peak of the financial crisis.

There are two trends here, neither of them good. One is that unlike any other economic recession I have experienced in the nearly 40 years I've been practicing law, the banking industry (along with the rest of the economy) is coming out of this downturn much, much more slowly than ever before. The pain continues, and there is the unpleasant feeling among many bankers and business people in general that the recovery is fragile and could be derailed by a less-than-robust shock. We're simply not coming back from this last one like we have from all the others since the Great Depression.

The other trend is one we've been harping on for some time: the number of banks in this country is trending downward and the only questions in the mind of those of us who represent community banks is how low will the number go and how fast will the shrinkage occur. The "merger tsunami" that many have predicted has not (yet) occurred, but the pace seems to be picking up. These trends have implications not merely for banks, but those service providers, like law firms, that work with community banks. The business will shrink, and the competition for the survivors will increase. Expect not only the number of banks to decrease, but the number of bank lawyers and law firms to decrease also. Competition will be fierce, not only in terms of expertise, but in terms of pricing, as well. The expense side of the P&I statement will be as important for banking law firms as it will for their clients. As is true of most business sectors in a "free" market, those with foresight and the ability to adapt quickly will be the likely survivors.

Community Bank Consolidation: Over-Hyped?

I've been traveling on business this week and have missed posting the past couple of days, but I couldn't let the week end without commenting on a story in yesterday's American Banker, the tone, and much of the substance, of which, was that bank merger activity is stagnant and is not likely to improve in the near term. I'm not as gloomy.

Aside from the fact that our boutique firm is currently involved in a half-dozen deals, I attended a banking conference last Friday in Dallas (actually, the Four Seasons Resort in Las Colinas) hosted by Commerce Street Capital, in which that firm's head of M&A, former OTS Western Regional Director C.K. Lee, circulated some interesting statistics. One was that the total number of M&A transactions last year nation-wide was 230, the highest since 286 in 2007, before the crash. 39 of those were in the Southwest. In the first quarter of this year, there were 44 transactions, 8 of them in the Southwest. I was in Denver the last few days, and had lunch yesterday with an investment banker whose firm is heavily involved in M&A activity in Colorado and surrounding states, and he's also currently juggling a handful of deals at the moment.

While all of this is not exactly a raging inferno of M&A, it's not as depressing as the folks the American Banker interviewed made it out to be. There's no question that potential buyers who feasted on FDIC loss-sharing and the cheap prices they paid for failed banks are not enamored of sellers who want an actual premium over tangible book value. It's also true that, in some areas of the country, the bid/asked gap between sellers and buyers is wide. However, in some areas of the country, deals are getting done and there are more in the hopper.

Therefore, while I agree that the predictions of some pundits that there would be a "tsunami" of community bank consolidation this year will not prove to be true, I also think that as agencies like the CFPB continue to work their magic on the psyches of community bank owners, directors, and senior managers, and as the ownership of many closely-held community banking organizations continues to age, there will be more mice who decide that they no longer want the cheese, they just want out of the trap.

Then again, as Dennis Miller would put it, that's just my opinion. I could be wrong.