Bank Lawyer's Blog

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.

The Tough Sledding Will Get Tougher

When H. Rodgin Cohen speaks, bankers listen. At least, they ought to listen if they want to learn something.

Bank Lawyer's Blog favorite Cohen gave a speech last week in New York City in which he dropped a few pearls of wisdom concerning why he thinks an already tough regulatory environment for banks is going to only get tougher. Among the reasons are the following:

• "The lingering public perception that banks got off too easy after the financial crisis could color regulators' mindsets." Cohen thinks that regulators will be especially tough on anti-money laundering and consumer law violations. He also believes that federal regulators may be motivated to pursue criminal penalties because of the perception among bankers that since recent criminal penalty settlements have not resulted in any individual bankers serving jail time, the risks of pleading guilty to crimes has somehow lessened. On the other hand, the long-time banking attorney thinks that banks have no one to blame but themselves for continuing to violate laws that they should, by now, know how to comply with.
• New OCC risk management standards for board members will provide a basis for new enforcement actions. In this area, Cohen thinks the regulators are being unrealistic. "I do worry that there is a point at which boards just cannot perform all of these tasks. You can only do so if you are prepared to have directors who really have no other significant occupation. … The cost would be to lose an incredible inventory of valuable directors." Amen, Brother Cohen!
• A recent FRB proposal that attempts to assert increased US control over foreign banks could hurt the US economy, Cohen worries. It also might have "an adverse impact on international trade and effective resolution."
• Too big to fail bank resolution procedures continue to be a preoccupation of the regulators and will continue to motivate regulatory actions. Cohen does think that effective too big to fail processes are "within reach" if the will exists to enact them. I consider Mr. Cohen to be an optimist on that issue, but he's smarter and closer to the throb of the power center in D.C. than I am, so I'll defer to his judgment.

Speaking of optimists, Cohen's partner, Michael Wiseman, gave an upbeat view about what all this increased regulatory pressure means for lawyers.

"It is an intellectually fascinating time to be a banking lawyer," he said. "When I started out, it was a relatively boring job."

"Intellectual fascination" will be (correctly) interpreted by banking clients to mean "higher legal fees." That's the silver lining that bankers always have a hard time seeing.

Logjam Not Broken By Bird-in-Hand

Back in January, I expressed the hope that the FDIC wouldn't smack down the only de novo bank application that a chance in a thousand of being approved, simply because the applicants included, and intended to serve, members of the Amish community, a band of renegades well-known for international unpasteurized milk trafficking. We understand that when it comes to asking the question "Got Milk?" even the Colombians and the Mexicans ask it with an air of humble supplication.

Well, the FDIC let this one pass on by (the first in three years) and that makes the folks at Bank of Bird-in-Hand as happy as if they had Two-in-Bush (yes, I broke my previous promise to leave that one alone). The organizers indicated that their experience may be a template for the process that other successful de novo applicants will have to follow, including:

• Board members who not only had previous experience as company directors, but experience specifically as a bank director.
• A "thorough" application process (an eighteen-inch thick application, versus a three-inch thick application for a de novo twenty years ago);
• A review process akin to an 18-month long proctoscopy, only without the pleasant chit-chat with your doctor's nurse.
• A business plan that will be scrutinized with an electron microscope by Olympic-caliber second guessers unhindered by the burden of actual private sector banking experience.
• 8% leverage capital ratio's maintained not for the first three years, but for the first eight (making it extremely difficult for all but those who deal "sub rosa" in illegal milk products to make a decent ROE).
• Sacrificing your first born male child to Moloch.

Look, this approval is not a harbinger that the de novo floodgates are opening. Rather, it's evidence of how tough it will be for de novo applications to be approved, and how unique the circumstances of the individual de novo banks will be that are eventually approved. If you're spending into seven figures (or, at the very least, high six figures) on a process that's "iffy," you have to have the mentality of a riverboat gambler, a saint, or a blithering idiot to go through it when recent history demonstrates that many may feel that they are called, but few are actually chosen.

The linked article discusses a letter of protest about the de novo application and approval process, and requirements, from the IBCA and the American Association of Bank Directors. Those organizations decry the difficulties strewn in the path of such applications, and claim that it's depriving smaller communities to access to needed credit. If so, the arguments are falling on deaf ears. The attitude won't change without legislation, and how likely is that to happen in the frozen tundra of D.C.?

[Sound of crickets chirping]

As the American Banker's Alan Kline asserted several months ago, the decline in the number of banks in this country (the overwhelming majority of them community banks) since the onset of the last economic meltdown has been dramatic. It's also due as much or more to the lack of de novo charter approvals as it is to mergers and acquisitions. It's a trend that will continue and one to which those of us who serve that industry had better either adapt or find something better to do. Like heckling Liz Warren for a living, or something equally as emotionally satisfying, if not as lucrative. Whatever we do, accepting reality is not really an option for those who want to survive.

OCC Ups The Ante On Third Party Relationships

The OCC issued new guidance on third party relationships last Wednesday. The new guidance, found in Bulletin 2013-29, rescinds and replaces OCC Bulletin 2001-47, which many banks have used as the "template" for structuring their vendor management programs and as a checklist for what they need to address in their contracts with third party vendors. While I haven't had a chance to absorb all aspects of the revised guidance, I have a couple of quick impressions. The first is that by including an extensive section toward the latter part of the guidance that includes specific duties for a bank's directors, as well as "senior management" and "business line management," the OCC is sending a message to banks that it expects third party relationships and vendor management to ultimately be the responsibility of the bank's board of directors. While, strictly speaking, this was always the case (see, for example, the statement on page 1 of Bulletin 2001-47 as to the responsibility of the board of directors and management to "properly oversee and manage" such relationships), by going into detail as to the specific duties of the directors and senior management in the latest guidance, the OCC is making it clear that (1) it expects banks to be "drilling down" in terms of due diligence and management, both upfront and ongoing, on the risks of third party relationships, and (2) that if those relationships cause loss to the bank of any type (reputational, operational, and strategic risks are all discussed), then the OCC will be looking all the way up the food chain at the bank to assess blame and, if warranted, impose penalties.

Here's a telling line: “A  bank’s failure to have an effective third-party risk management process that is commensurate with the level of risk, complexity of third-party relationships, and organizational structure of the bank may be an unsafe and unsound banking practice.” The emphasis is the OCC's, not mine.

There will be a lot of commentary on the new guidance in the near future. Banks of all kinds, not merely national banks, ought to pay attention to it. The OCC (and the other federal banking regulators, in our view) mean business. Vendor management, and third party relationships generally, must be addressed at the highest levels of the bank, because if a relationship turns "sour" and the bank suffers adverse consequences (even a "hit" to its public image), you can bet your bottom dollar they'll be assessing responsibility and consequences from the top down.

More Pertinent Than The Three Rs

In a recent article in the ABA Banking Journal, attorney Harold P. Reichwald advises directors who are serious about responding to the banking regulators' emphasis on enterprise-wide risk management to pay attention to what he calls "the five C’s of board governance:  Competency, Collegiality, Confidentiality, Communication, and Culture."

As Howard warns, these aren't the only principles of board governance with which directors should be concerned. On the other hand, "they are a set of principles that must be present, lest the bank inevitability suffer unanticipated losses." And if the bank suffers unanticipated losses that are serious, the directors may anticipate that the bank's primary regulators will take note and may even sanction the bank, and the directors, for such losses. If the bank fails, the FDIC may eventually come calling, and it won't be to have friendly chat.

Although all five points are worth noting, one struck home with me in light of what I, and colleagues with whom I work, have learned from our representation of management and boards of failed banks. That point is the second C, Collegiality.

Here's what Howard has to say about that.

Collegiality stresses the importance of trust among the board members and the encouragement of board members to voice their opinions fully, including expressions of differing points of view.

It encourages respect for all views expressed by individual directors and discourages attempts at private decision-making or influencing management away from the boardroom.

It demands that the board be seen as acting with one voice in making decisions—even when there are dissenting views expressed in deliberations prior to a vote.

Those of us who have been around the banking business through many business cycles have seen the negative consequences that can result when dissent at the board level is suppressed. There is nothing more detrimental to the health of a community bank (and to the health of its directors' pocketbooks) than a "strong" majority shareholder/director or board Chair who runs meetings like a religious revival, with only one preacher preaching and the rest of the attendees screaming "Amen!" I've talked about the dangers of this personality type in previous posts.

I understand Howard's point about the Board "speaking with one voice" even when there is dissent. However, it is also important that legitimate dissent (as opposed to the never-ending nay-saying of a professional gadfly who could stand in the middle of the Gobi dessert at high noon and argue that he's in Antarctica at midnight) be reflected in the board minutes, as well as the response to that dissent, and also an articulation of the reasons why a majority of the board decided to vote contrary to the opinion of the dissenter (if that is the board's decision). The board should be able to show that it considered the pertinent information and issues, pro and con, and made its decision in a disinterested manner after due deliberation. The goal of this process is to satisfy the requirements of the business judgment rule, not necessarily to prove that the decision was "right" in hindsight. As one federal district judge noted in ruling in favor of directors of a failed bank, the business judgment rule protects directors even when they might be inept.

Therefore, "collegiality" as proposed by Howard is an attitude that fosters respect for the opinions of all borad members so that they feel free to voice contrary views. It does not mean that everyone "goes along to get along." 

2013: The Year of The Lawsuit

Not long ago, The Washington Post ran an article that discussed how the FDIC has filed "a flurry of lawsuits" against officers and directors of failed banks. The recent "flurry" is due to the fact that the three-year statute of limitations is running out on banks that failed in 2010, a "banner year" for bank failures. Obviously, the FDIC doesn't want to let that limit expire without preserving its right to squeeze some blood out of the turnips.

As The Post points out, filing the lawsuit is not the end of the game. The cases can drag on for years.

There have been repeated delays as defendants seek to have cases thrown out and argue that their bank was the victim of a bad economy — not negligence.

[...]

“We generally don’t have people come in saying, ‘We’re really sorry we caused the bank to fail, here’s a check,’ ” said Richard Osterman Jr., acting general counsel at the FDIC. “We have to investigate, uncover information, subpoena records, do depositions and often file actions.”

Osterman was the head of the "bad bank" side of the FDIC prior to becoming acting general counsel, so his wry observation is spot on.

Alston & Bird's Mary Gill also states an obvious truth about litigation of all types.

“Federal litigation is inherently a slow process,” said Mary Gill, a partner at Alston & Bird, who specializes in director and officer, or D&O, litigation. “There have been discovery disputes that have arisen in many of the cases, which has somewhat slowed the pace of the litigation.”

And we can't forget the unstated truth that when attorneys bill by the hour, many hours must be spent. I believe that's a law of nature.

As the article also observes, the longer these cases drag on, the lower the FDIC's ultimate recovery may be. That's due to the fact that the D&O insurance policies (in most cases, the major "fund" out of which FDIC recoveries will be paid) cover litigation costs and litigation costs are applied against the policy limit. While the personal assets of the defendants can theoretically be tapped, in reality many of those defendants don't have the net worth to pony up much, or the net worth they have is ensconced in exempt assets. 

A couple of knowledgeable attorneys, Chris Cole and David Baris, are correctly quoted as observing that (1) unlike the S&L meltdown of the 1980s, there's less blatant fraud this time around the horn and a much better basis for arguing the the officers, and certainly the outside directors, could not have anticipated the steamroller that started flattening the economy in 2008; and (2) the practice of many of many community banks of having directors sit on the bank's loan committee and approve commercial loans is going the way of the passenger pigeon. Also, although Osterman correctly states that the fact that bank examiners did not criticize (and often praised) directors and officers credit practices that are not being severely criticized (in hindsight) by the FDIC, does not give the directors an automatic pass on a negligence or breach of fiduciary duty claim, it is a hurdle for the FDIC to jump.

Nowhere in the article is there any discussion that the overwhelming majority of the officers and directors being sued served community banks. The big boys were bailed out. The little guys were too small to save. But, apparently, not too small to second-guess and to sue.

A Good Policy Is (Sometimes) Hard To Find

A number of readers, all banking law attorneys  with experience in the subject matter ranging from a dozen to fifty years, wrote or called me to discuss my post of last week on the refusal of the FDIC to sue "favored sons and daughters" who served on the board of directors of a failed bank. None of my correspondents had ever heard of the FDIC policy that was quoted by an FDIC spokesperson in the newspaper story to which I linked in that post. According to that FDIC official, 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." The only published FDIC policy I could find from 1992 on the subject does not discuss the "2" rating aspect at all. Some of us assume that the FDIC official might be referring to an internal interpretation of that published policy or, perhaps, to another internal policy that has never been published.

More than one correspondent floated the possibility that the spokesperson, or someone else with whom he spoke at the FDIC, simply made the whole thing up. We would never suggest that, and assuming that is not the case, you still have to wonder what policy is being discussed. The reason for the astonishment of many of us who represent, and have represented for decades, directors of failed banks is that we find it hard to believe that there have not been instances over te past 22 years where "loss loans" that have formed the basis for claims by the FDIC against those directors were made when the bank was CAMELS-rated 1 or 2. Thus, the "policy," if it exists, may not have been applied consistently. If it has not applied consistently, why not? Political connections or an inside connection with the FDIC or a sister agency couldn't play any part in the decision, could they? None of us are saying that they did in this case or in any other case. What we are saying is that what appeared to at least one business reporter to be suspicious appears to many of us who work in this area  to be worthy of two raised eyebrows.

Until the actual policy is made publicly available, the questions raised by the reporter and others will linger. The FDIC might do itself a favor by either disavowing what its spokesperson said about the existence of such such a policy (and explain the actual reason the FDIC decided not to sue the directors of the failed bank) or produce an actual 1992 policy to that effect and explain why it was not made public.

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.

Dancing With The Bear: The Softshoe Shuffle Continues

My posts concerning former bank CEO Patrick Adams and his long, hard, expensive fight to clear his name encouraged one reader to send me a copy of a decision from a couple of months ago that involved another bank officer (actually, the Chairman of a bank) who has been slugging it out with the OCC (and in this case, the Fed) four the last four years over an attempt by the regulators to oust him from his position with the bank. The D.C. Circuit Court of Appeals held in his favor and sent the case back to the banking agencies with some pretty caustic comments.

The entire opinion is an interesting read, but here's a synopsis, paraphrased from one prepared by my correspondent.

Louis DeNaples, was a director and controlling shareholder of a national bank and two bank holding companies.  In 2008, Pennsylvania state prosecutors charged him with perjury.  But the charges were later withdrawn pursuant to an agreement in which Mr. DeNaples agreed, among other things, to release claims against the state based on irregularities in the underlying grand jury proceeding.  Thereafter, the state court expunged the entire prosecution.  The Comptroller of the Currency and the Federal Reserve Board, however, concluded that Mr. DeNaples had violated Section 19 of the Federal Deposit Insurance Act, which prohibits a person from participating in a regulated financial institution after entering into a “pretrial diversion or similar program” with respect to certain criminal offenses, including perjury.  The agencies thus issued cease-and-desist orders directing Mr. DeNaples to resign from his positions, and to divest his shares, in the regulated institutions.

Mr. DeNaples appealed, arguing, among other things, that (1) his agreement for withdrawal of the perjury charges was not a “pretrial diversion or similar program,” and in any event (2) Section 19 does not apply to expunged convictions.  A three-judge panel of the D.C. Circuit unanimously agreed on both counts.

First, the Court held that the banking agencies’ interpretations of Section 19 are not entitled to Chevron deference.  The panel adopted DeNaples' argument that no deference is warranted for any part of the Federal Deposit Insurance Act because multiple agencies enforce it, creating the potential for inconsistent agency interpretations, as occurred in this case.

Next, the Court held that the agencies had applied inconsistent and overbroad definitions of the term “pretrial diversion or similar program,” essentially capturing any situation where a person supplies a “quid pro quo for the prosecutor’s withdrawal of charges.”  The panel explained that pretrial diversion generally refers to a discrete program that seeks some offender- or community-oriented outcome such as treatment, rehabilitation, or restitution.  The Court, moreover, adopted the argument of DeNaples' lawyers that the agencies on remand must consider the meaning of “pretrial diversion” under state law, which they adamantly refused to do in the earlier cease-and-desist proceedings.

Finally, the Court agreed with DeNaples that the OCC’s and the Board’s positions on the impact of expungement were both internally inconsistent and at odds with a published FDIC policy statement.  In a stunning rebuke of the agencies, the panel criticized their positions as “bizarre,” “untenable,” “unpredictable,” and a “scattergun approach,” and said that reconciling their views “is like trying to draw a two-dimensional shape on the surface of a grapefruit.”

Trying to draw a two-dimensional shape on the surface of a grapefruit. For four years. A worthy endeavor, no?

Incidentally, the lead counsel for DeNaples (at leas, the lawyer named in the opinion) is Howard Cayne, a well-known D.C. banking law litigator who, like your trusty bloviator, has "danced with the bear" on previous occasions. The man must have a high tolerance for pain. As must Mr. DeNaples.

 

The Not-So-Secret Facts of Life

The LA Times obtained a bunch of documents from the FDIC pursuant to a FOIA request and uncovered some startling news: the FDIC is settling lawsuits against those it alleges caused banks to fail. Worse than that, the FDIC is agreeing not to issue press releases regarding many of the settlements. This earth-shattering news is labeled a "major policy shift" from the way the FDIC handled failed bank litigation that arose out of the last big bank meltdown, "when the FDIC trumpeted punitive actions against banks as a deterrent to others."

Before I address that last point, let's listen to some more suspicious minds support the Times theme that all of this "secret settlement" skulduggery smacks of some kind of plot to let evil-doers escape the lynch mobs that surely would have strung them up if only the FDIC had set public outrage en fuego by  trumpeting these settlements from the top of the Rocky Mountains.

Critics fault the government for going easy on banks in the aftermath of the financial crisis. At a Feb. 14 hearing, Sen. Elizabeth Warren (D-Mass.), founder of the Consumer Financial Protection Bureau, criticized FDIC Chairman Martin J. Gruenberg along with other bank regulators for their reluctance to make examples of Wall Street firms by taking them to trial.

Quoting "The Founder" is a go-to proposition for the Times, and one that lacks the punch that soundbites from other less usual suspects bring to the table. In addition, the Times' accusations range far beyond Wall Street banks. It's mostly (if not entirely) the little guys that are being pursued. God forbid they should get a break today from anyone other than MacDonalds.

Attorneys who have represented bank officials and the FDIC said regulators are now far likelier to settle cases before filing lawsuits than after the last spate of failures, when more than 2,300 institutions collapsed in the 1980s and early 1990s, bankrupting a fund that insured savings and loan deposits. That crisis grew out of Reagan-era deregulation, which allowed thrifts already hurting from 1970s inflation to make riskier investments, including commercial real estate deals that soured en masse during the second half of the 1980s.

Critics describe the FDIC's current practice of low-profile deal-making as a major departure from the S&L crisis.

"In the old days, the regulators made it a point to embarrass everyone, to call attention to their role in bank failures," said former bank examiner Richard Newsom, who specialized in insider-abuse cases for the FDIC in the aftermath of the S&L debacle. The goal was simple: "to make other bankers scared."

Newsom said he couldn't understand the shift, unless the agency doesn't "want people to know how little they are settling for."

The FDIC should disclose as much as it can, said Lauren Saunders, managing attorney at the National Consumer Law Center in Washington. "Transparency is always better, and serves as a deterrent to future misconduct."

Yes, let's deter the future conduct of owning, managing, and directing a community bank that concentrates on loan products that the regulators find are being originated and managed within the parameters of safety and soundness guidelines until, within a few months, the world falls apart in the greatest economic collapse since the Great Depression. Thereafter, although we feel compelled to go after many failed bank officials, directors, and third parties because we've got an obligation to recover whatever losses to the fund we are able whenever we can do so without being laughed out of court, we understand, in our heart-of-hearts, notwithstanding the posturing we might do for political or litigation purposes, that these times are different than late 1980s.

This is what neither the Times nor its talking heads understand (or, if they do understand, will admit): the facts are different this time. In the 1980s, there were a number of outright crooks involved in the banking and, especially, the thrift business in certain parts of the country, some wearing stetsons and cowboy boots, others clad in three-piece Armani suits. There were fraudulent appraisals, my-dead-cow-for-your-dead-horse swaps, 100 percent loan-to-value ADC loans on raw dirt, rapid multiple flips that would have taxed Shawn Johnson, and similar shenanigans. The damages were also limited to certain regions of the country where real estate bubbles were exploited (or partially created) by financial institutions who engaged in outright speculation until those bubbles burst. Also, many of the worst players were (relatively) smaller players.

In the latest debacle, the causes of losses are more complicated and the resulting economic consequences much more devastating and widespread. Many of the hundreds of banks that failed collapsed because they were steamrolled by the swiftness of the onset, and the depth, of the economic collapse triggered, in large part, by subprime residential mortgage loans, the complex web of securities they spawned, and the resulting residential real estate inflation. Commercial real estate wasn't the primary cause of the collapse this time, it was a casualty of the collapse. You can argue until you're blue in the face about the nuances of fiduciary duties and CRE concentrations, but in all but the low hanging fruit cases, the FDIC doesn't have smoking guns laying in plain sight to use to extract huge settlements or litigation awards out of either defendants or, more importantly, their insurance companies, who are fighting back.

As to the lack of a "deterrent" to future potential wrongdoers that allegedly results from not making settlements public, I wouldn't be concerned that "silent settlements" are encouraging prospective bank officers and directors to do anything. Those who haven't said "screw it" and opted to sip mai-tais in Cabo until they need their livers "Rolfed," or are seriously considering an alternative exit strategy, aren't chomping at the bit to jump feet-first back into subprime anything or to make CRE or any other product or service their concentration-of-choice, and their primary regulatory supervisors wouldn't let them go there even if they yearned to do so. "Other bankers" are plenty scared Mr. Newsome, without the need to read about FDIC settlements. At least, that's the story with the vast number of smaller banks in this country.

I suppose there might be some deterrent effect if the FDIC announced settlements against the officers and directors of the large Wall Street banks that helped create the mess we're in and which then failed, so that future Wall Street bankers would...oops...none of them failed. That's right: they were bailed out. My bad!

Buried in the story is the rationale for keeping mum (until FOIA forces disclosure) about settlements.

Defendants benefit by settling because they can avoid admitting guilt and limit the damages they might face in court. The FDIC benefits by collecting money without the hassle and expense of litigation. The no-press-release arrangements help close those deals.

Those are valid reasons, and they make sense for both parties.

Let's hope the Times drills a little deeper next time and strikes oil instead of gas.