Bank Lawyer's Blog

Stressing Stress Testing

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

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

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

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

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

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

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

US Justice Department to Banks: SARs May Not Be Sufficient

Most bankers I know always love to receive a helping hand from federal law enforcement officials in making their daily lives just a little bit better. That's why I'm sure that most bankers smiled wide when an Assistant US Attorney General recently told a gathering of bankers that when it comes to reporting suspicious activity, a SAR is often not nearly enough.

“The vast majority of financial institutions file suspicious activity reports when they suspect that an account is connected to nefarious activity,” said assistant attorney general Leslie Caldwell in a Monday speech, according to prepared remarks. “But, in appropriate cases, we encourage those institutions to consider whether to take more action: specifically, to alert law enforcement authorities about the problem.”

[...]

A tip-off from a bank about a suspicious customer could lead law enforcement to seize funds or start an investigation, Ms. Caldwell said.

Sure, that makes sense. Bankers have nothing better to do than to do your job for you, right Leslie? The difference between filing a SAR and picking up the phone and reporting your suspicions to a cop is that the SAR is confidential (the subject of the report should never know one was filed) and applicable law provides for banks that file them a "safe harbor" from a lawsuit by the subject of the SAR (in all but in cases of the most egregiously bad faith filings). Those specific protections do not apply to a phone call or an email to a cop.

As a commenter to the linked article observed, "[i]f the Feds would actually do something about the millions of SARs we (financial institutions) have filed, some of these criminals would be in jail." To "do something," the Feds would have to rip those SARs from the gravitational pull of the black hole into which they're apparently dumped and read them, something that bankers have believed for years rarely happens. On the other hand, as FinCEN's head boasted last year regarding all the Cheech & Chong SARs that banks in Colorado have been filing on "legal" marijuana-related businesses, FinCEN actually read 62% of them. That left 38% to be eventually transformed into goat pellets after being consumed by FinCEN's pet goat.

My guess is that many banks will continue to believe that filing a SAR is a more than sufficient "tip off" for any law enforcement agency that actually is interested in uncovering crime.

FinCEN Consults The Dude For Guidance On Banking Marijuana Businesses

I love some of the headlines I read last Friday and over the weekend on the preposterous "guidance" issued by FinCEN last Friday on the process financial institutions should follow in providing financial services to marijuana-related businesses. The most common (incorrectly used) metaphor was that the guidance "opened the door" for banks to inhale deeply the second-hand smoke of reefer madness. That's either a mighty tiny door or an infinitesimally small opening. As one of the first comments I received (from a skilled financial institutions compliance attorney) put it so well:

This is the biggest joke.  Basically, it tells FI’s that you are finally given the green light to conduct transaction activity for Marijuana Businesses but every time you do, you have to file some form of SAR that might potentially include information from a DOJ memo that you have never read and probably never heard of, all so that you can go out and do the leg work for our investigations.  They should just let FI’s do business with folks on the OFAC list and just make them file lengthy and detailed SARs on those people every single time the conduct any transaction.

Other comments received from financial institution attorneys, especially those who represent either banks or marijuana businesses that want to get together, were equal parts F-bombs and derisive laughter.

Reactions from banks and trade group representatives in Colorado, the state with the most immediate need for action at the federal level, were uniformly negative.

"We're still not going to bank them," said Jim Reuter, executive vice-president of FirstBank, the state's second-largest bank in terms of market share."We are not comfortable taking this guidance alone and on its face," Reuter said. "There's simply too much at stake."

[...]

"They should proceed with maximum caution," CBA president Don Childears said he'll advise its members. "But, honestly, we'll be telling them to not proceed at all."

A FinCEN spokesman tried to put a positive spin on the non-starter.

"This reduces the burden on banks," FinCEN's Shasky Calvery insisted in an interview. "Marijuana under federal law requires a SAR. Now, the necessity is limited, reducing the banks' burden a bit and more importantly clarifies where law enforcement focuses its attention."

"reduces the burden"? Really? It still requires a SAR! In every instance the bank "banks" a marijuana business! The type of SAR may vary, but determining which type of SAR is now required adds to the burden, it doesn't lessen it. As my correspondent above noted, the guidance adds to the already-staggering burden that federal regulators place on financial institutions to do law enforcements "leg work."

CBA's Childears agrees that the burden is not lessened, it's increased.

"It's just bizarre. The threatening language about the liability for prosecution," he said. "Now, not only must we know our customers' business, but our customers' customers' business."

Moreover, under the guidance, the bank is required to refer to "The Cole Memo," a memo that is internal to the US Justice Department and that was not attached to the guidance. The bank has to worry about Mr. Cole's "priorities" of bad-guy behavior and the evil consequences of consorting with Mary Jane in various degrees of seriousness (including harvesting foremen who rely too much on the catch-phrase "Say hello to my little friend"), and also to do all kinds of detailed due diligence, including watching out for a boatload of "red flags," including these two gems:

• The business receives substantially more revenue than may reasonably be expected given the relevant limitations imposed by the state in which it operates.
• The business receives substantially more revenue than its local competitors or than might be expected given the population demographics. It also is still illegal under federal law to service a recreational marijuana business.

That is merely a tiny taste of the problematic nature of the burden imposed by the guidance. We could go on and on, but why bother? The IBC's Barbara Walker said what many of us feel: "Better luck next time."

"The bottom line would continue to be the need for the (banking regulators) to address in writing all of the many issues of concern to the financial services industry," said Barbara Walker, executive director of Independent Bankers of Colorado. "The (Federal Deposit Insurance Corporation, Federal Reserve and Office of the Comptroller of the Currency) are simply asleep at the wheel on the many serious issues posed by Colorado's laws. It's shameful."

"Asleep at the wheel." That sometimes happens when you get to toking when you should not be smoking.

Lesson Not Learned

Once upon a time, we thought that having the Mossad, in league with litigious victims of terrorism, beating you about the head and shoulders in courts foreign and domestic would be enough to deter giant foreign banks from thumbing their noses at UN and US anti-money laundering laws. In the case of HSBC, a sane person might also conclude that paying a fine big enough to choke a Saudi shiek might do the trick. If he or she thought that, he or she would, according to at least one whistle-blower, be dead wrong.

[A] former employee is alleging that the bank continued to break anti-money-laundering rules even as it claimed to be reforming its controls, and he has asked federal authorities to open a new investigation.

Everett Stern, who worked in HSBC Bank USA's anti-money-laundering division in 2010 and 2011, unveiled the allegations Thursday at a protest against the bank in New York. In March, Stern and the law firm Berger & Montague submitted his evidence — which includes internal emails and other documents he collected while working at the bank — to the Securities and Exchange Commission, the Justice Department and banking regulators, claiming that the bank continued to flout money laundering rules while he was employed there.

What's especially surprising is that, as part of its deal with US authorities, HSBC agreed to a five-year deferral of criminal sanctions against the bank and its executives. The deferral is contingent on the bank's good behavior. According to Mr. Stern, the bad boys continued their wrongful ways, evidencing a cavalier attitude toward the prospect of being incarcerated in a minimum security federal country club, where, for an extended period of time, you have to carry your own bag around the golf course. Well, that, and you might be forced to adopt the name "Sweetcakes" by a guy with a bad case of roid rage.

Stern was one of the people hired by the bank to "cure their problem," the "problem" being the laundering of money for terrorist organizations through the bank. Instead of "solving the problem," Stern alleges that the bank adopted a "wink-wink, nudge-nudge" system that, if his allegations are true, was a smoke-and-mirrors attempt to make the regulators think that the bank was trying to comply with AML regulations while allowing hundreds of millions of dollars to be washed, rinsed, and nicely dried by known "financiers of terrorists."

Here's one possible sanction, should Stern's accusations prove to be true: kick the bank out of the United States. If you're going to launder money for people who want to wipe us from face of the Earth (along with all those nasty Israelites), why are we allowing you continue to operate within our borders? Then again, if we start down that path, I suppose we'll have to kick our own big banks out of this country, as well, since other deterrents don't seem to work, and that would never...

Wait a minute! I think that this might be worth further consideration. I'll have a couple more Shiner Bocks and ponder this while watching the latest episode of "Boardwalk Empire" for tips on dealing with this particular brand of bad-boy bankers.

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.

Overdraft Overdependence

Although bankers are pushing back (paid subscription required) on the proposal of the OCC, FRB and FDIC to require banks to break out overdraft fee income on their quarterly CALL reports, the effort is unlikely to stem the continuing crackdown on overdraft fees. That crackdown is not only handwriting on the wall, it's handwriting spray painted in huge block letters on every wall in sight.

Regulators claim that they're primarily concerned about the dependency of individual banks on a source of income "at at a time when stricter regulations appear to be putting pressure on fee-related revenue." Sure they are. There's more to it than that.

They also cited "other public purposes" for wanting the more detailed data, saying the changes "would significantly enhance the ability of the agencies and the [Consumer Financial Protection] Bureau to monitor consumers' behavior."

"Greater understanding of trends in overdraft fees and other deposit service charges is necessary to assess institutional health and enhance understanding of the costs and potential risks financial services pose to consumers," the agencies said.

The latter concern is what consumer advocacy groups are focused on.

"I don't see why the information shouldn't be used by regulators for any of their supervision duties, and consumer protection is related to safety and soundness," said Lauren Saunders, managing attorney with the National Consumer Law Center. "The information is clearly important for regulators to know and banks that are not abusing overdraft fees should have nothing to hide."

You'll notice the use of the term "abusing." That's a favorite term of the CFPB, which always knows what's abusive, even when the consumer does not, and even when the consumer thinks he or she knows exactly what he or she is doing, and even when the consumer would rather have the government not restrict his or her access to overdrafts.

While the regulators may be paying lip service to the issue being all about "safety and soundness," on the theory that what's bad for a subset of consumers (those who "overuse" or are "overserved" overdrafts) is always bad for bank safety and soundness, the actual agenda is the eventual restriction of the ability of banks to charge overdraft fees. That will likely result in severe restriction of ability of the bank customers who rely on the ability to make overdrafts to make ends meet paycheck-to-paycheck, to actually be able to obtain an overdraft (as opposed to having their checks bounce).

Some large banks have been hammered for their overdraft practices, and rightly so. On the other hand, you hate to see babies thrown out with the bathwater, especially when those babies' parents will be turning to alternatives like pawn shops, payday lenders, and a guy named Vito.

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.

Oh Georgia, No Peace, No Peace I Find

It was bad enough when Georgia reached the top of the heap (or bottom, depending on your view) of states in the number of FDIC civil lawsuits against former officers and directors of failed banks. Now, it appears that Georgia may be leading in a race to become the state with the most former bank officers and directors who've been indicted.

The former president and six other officers of First National Bank of Savannah on Friday were indicted by a federal grand jury in Savannah, accused of defrauding First National Bank and other banks out of millions of dollars.

[...]

The indictment comes on the heels of the 2011 prosecution of Savannah real estate developer Richard Guerard for scheming with First National Bank officials and employees to defraud the bank and others to cover loan shortfalls for two of his companies.

He pleaded guilty in May 2011 and was sentenced to 52 months in federal prison in August 2011.

The First National Bank indictments arise out of an alleged scheme by the defendants to hide losses from shareholders, directors, and the regulators that the bank suffered from soured commercial real estate loans through an alleged witches brew of straw borrowers, side deals, "hidden promises," "recruiting other banks to fund non-performing loans based on fraudulent misrepresentations about the quality of the loans," and falsifying and fabricating bank records and other documents. Other than that, everything appears to have been upfront and above-board.

There's a sense of "deja vu" to the allegations, in that other community banks that have failed due to CRE loans that went bad have been alleged by the FDIC to have gone to some lengths to conceal the nature of the losses by the use of similar techniques. Not many of those allegations have resulted in criminal indictments, but these indictments may signal that more of those are on the way.

Of course, indictments present only the government's side of the case. We haven't heard yet from defense counsel. I'm sure their response will paint a different picture.

Nevertheless, lawyers who represent banks that are "in distress" some times find it necessary to point out to bank officers, and occasionally to bank directors, as well, that attempting to mask losses can subject responsible officers and directors to allegations that, among other things, they have filed false financial records, including their quarterly CALL Reports. These types of indictments are a lesson. I hope those who might benefit from such a lesson are paying attention. For some, the time for paying attention has passed. For them, the best approach at this time might be fervent prayer.

SARs: They're Not Just For Goats

We've speculated for years that when a financial institution files a SAR, it's fed to FinCen's pet goat. However, NAFCU Regulatory Compliance Counsel Bernadette Clair reminds us today that a few SARs aren't lodged firmly in a goat's gullet, but actually generate some law enforcement firepower ("Book 'em, Dan-O! Five Counts, Using Campaign Funds To Buy A 'Date'"!). Bernadette lists a representative sampling of criminal actions that resulted from SAR filings, as profiled in FinCen's most recent SAR Activity Report - Trends, Tips & Issues.

My personal favorite? That would be the SAR that led to the smackdown on the illicit importation of human growth hormone. Sure, Ponzi schemes and our old friend, "Mr. Blow," may grab the nefarious glamour, but nothing says "Threat To Western Civilization" more than men and women who look like this:

 

So, keep up the good work, FinCen. We'll all sleep better knowing that our SARs are forcing bodybuilders to make muscles the way they had to make them before HGH ruined the "sport": picking up 98-pound weaklings by their ankles and stuffing them into gym lockers.

A Tale Of Two (Spinning) Tops

A reader who toils in the credit union industry sent me an interesting juxtaposition in spin, one from the NCUA and one from a trade press publication. They both concern recent financial results announced by the NCUA for AEA Federal Credit Union, which was seized by the NCUA in December 2010 and placed into conservatorship. The NCUA injected a $20 million subordinated note that it allows AEA to count as capital. In a press release trumpeting how well AEA is turning things around, the NCUA sounds almost giddy.

AEA Federal Credit Union, which operates under the conservatorship of the National Credit Union Administration (NCUA), posted 2012 year-to-date net income of $839,096. Total assets at the end of the first quarter stood at $245.1 million, up from $230.6 million at year-end 2011. AEA Federal Credit Union’s net worth also improved by 18 basis points during the first three months of 2012, ending the first quarter at 2.85 percent.

[...]

Since Dec. 17, 2010, NCUA, the interim management team, and AEA Federal Credit Union’s employees have worked to dramatically improve the credit union’s financial condition and maintain services for the credit union’s 42,000 members. Deposits at AEA Federal Credit Union remain protected up to $250,000 through NCUA’s National Credit Union Share Insurance Fund.

Sounds like everything is just peachy at the formerly busted credit union, doesn't it?

Here's the take of the Credit Union Journal (paid subscription required) on the same financial results.

NCUA said this afternoon that AEA FCU, the one-time $410 million credit union which was victimized by a massive MBL fraud, continues to operate with zero capital, despite a $20 million emergency NCUA loan it is allowed to count as net worth.

AEA, whose former MBL director William Liddle is headed to jail as a result of the fraud, reported net income of $840,000 for the first quarter of 2012, but is still operating with negative $12 million of its own net worth. A new federal law allows such credit union and bank failures to count regulatory assistance, such as NCUA’s $20 million bailout loan, as regulatory net worth. As a result, NCUA says AEA actually has 2.85% net worth.

Are we talking about the same institution? Counting debt as net worth is a great trick. The FSLIC used it in connection with the Southwest Plan in the late 1980s, which allowed the FSLIC to hide the fact that it was technically insolvent, until Congress finally caught on and punished the FSLIC by merging it out of existence and transforming its operating head, the independent Federal Home Loan Bank Board, into the OTS (recently abolished by Dodd-Frank). Could the NCUA be following down FSLIC's weed-strewn road to perdition?

A couple of months ago, I sat through a presentation by a couple of "big guns" from our nation's capital, both lawyers who do a lot of credit union representation, and one who's a lobbyist for financial institutions. They told us that the NCUA was the reincarnation of the FSLIC and when the extent of its financial troubles came to light, the political fallout might be toxic. I have no idea whether or not this allegation is correct. However, using debt as equity and issuing a press release that trumpets an increase in "net worth" without noting that we're not talking about GAAP net worth, but the often-vilified "regulatory net worth," smacks of slathering not only lipstick, but eyeshadow and rouge, all over a rather corpulent porcine-like slab of flab.

Earlier this year, credit union industry pundits were raising questions about how big the losses might be at the NCUA and how the NCUA was publicly handling the disclosure of its potential problems. It looks like this is an issue that might gain some traction.

Ironically, although the NCUA is allowed to use debt instruments as equity infusions, a simple proposal to permit commercial banks to amortize commercial real estate loan losses over a ten-year period was killed by federal regulatory opposition because it would cause "regulatory accounting" to depart from GAAP and might permit banks to "mask" their "true" financial condition. The depth of cynicism in D.C. is beyond the comprehension of anyone other than professional politicians and members of organized criminal enterprises.