On August 16, 2011, the Financial Institutions and Consumer Credit subcommittee of the House Committee on Financial Services held a field hearing in Newnan, Georgia, with a stated topic of “Potential Mixed Messages: Is Guidance from Washington Being Implemented by Federal Bank Examiners?”
Representatives Shelley Moore Capito, Spencer Bachus, Lynn A. Westmoreland and David Scott each heard testimony from panels of federal banking regulators and Georgian bankers about the condition of banking in Georgia, including the effect that federal banking regulations, guidance, policies and actions have had on community banks. Copies of the written testimony submitted, including that of the FDIC, OCC and Federal Reserve are now available on the Subcommittees website.
Although it is hard to draw any overall themes from the hearings (other than possibly that the issues involved aren’t easily addressed in this format), there were several good points made.
From the FDIC’s written testimony, addressing the challenges faced by Georgia banks:
As the Subcommittee has discussed in previous oversight hearings, the collapse of the U.S. housing market in 2007 led to a financial crisis and economic recession that has adversely affected banks and their borrowers in Georgia and nationwide. Georgia’s economy was hit especially hard following years of strong economic growth characterized by rising real estate prices, abundant credit availability, and robust job creation. Financial institutions, whose performance is closely linked to economic and real estate market conditions, have been significantly affected by a rise in the number of borrowers who are unable to make payments.
Gil Barker, the Deputy Comptroller for the Southern District, specifically addressed many concerns expressed by bankers in his written testimony, including statements of regulators criticizing loans to a particular industry, performing non-performing loans, criticizing loans merely because of a decline in collateral value, and the second guessing of independent appraisers. While one can certainly question whether the interpretations provided by Mr. Barker line up with some of the actions of the on-site examiners, it is definitely a good read for anyone dealing with the OCC in the Southern District.
The loss share method of resolving closed institutions seems to have significant benefits over the FDIC retaining the assets for bulk sale, but there is significant disagreement as to whether the loss share agreements properly incent the acquiring bank with regard to working with borrowers to minimize losses. The representatives seemed particularly attuned to the additional issues related to loan participations where the lead bank has gone through receivership.
The failure of Congress to raise the debt ceiling should have no short-term impact on the ability of the FDIC to cover insured deposits.
The FDIC Deposit Insurance Fund (the “Fund”) is supported by assessments levied by the FDIC on individual banks. After experiencing above normal outflows from the Fund due to the recent spate of bank failures, the FDIC recently required banks to prepay three years’ worth of premiums in order to restore its financial strength. While the Fund has been running a negative balance on an actuarial basis for several quarters, the FDIC projected that the Fund would have a positive balance by the end of the second quarter.
At the end of the first quarter (the last date for which information is currently available), the Fund’s liquid assets, cash and marketable securities, totaled $45.5 billion. In addition, the FDIC has a $100 billion committed line of credit from the US Treasury as a backstop. We do not anticipate that the FDIC will have any problems meeting its obligations to cover any covered losses in insured deposit accounts.
The FDIC is an independent agency of the United States government. Both the FDIC and the Fund are paid for by the banking industry, and not from the U.S. taxpayers. A default by the U.S. government on its obligations will have no impact on the FDIC or the FDIC Deposit Insurance Fund. Since 1933, no depositor has ever lost a single penny of FDIC-insured funds.
In its press release issued on May 4, 2011, Bryan Cave client Brand Group Holdings, Inc. (the “Company”) announced the successful completion of its recapitalization. The total amount raised in the initial phase of this effort was $125 million, and the three largest investors in the recapitalization, affiliates of The Carlyle Group, The Stephens Group, and the Cousins’ family, invested approximately $96 million, with various other investors investing approximately $29 million. The investors have agreements in place with the Company to invest an additional $75 million in capital at a later date.
A unique feature of this transaction is a valuation adjustment that utilizes a stock escrow arrangement. Some of the purchased shares will revert from the new investors to the legacy shareholders if the existing loan portfolio performs better than the investors have projected.
As a result of the recapitalization, the Company is among the best capitalized financial institutions, among those with over $1 billion in assets, in Georgia. The Company’s Total Risk-Based Capital Ratio stands at over 24%. The Company anticipates that its wholly owned subsidiary bank, The Brand Banking Company, will use proceeds from the recapitalization to enhance its current offerings and expand into new banking services.
Treasury is currently recruiting unpaid summer interns to help administer the Small Business Lending Fund (SBLF). Qualified undergraduate and graduate student volunteers “will be working closely with investment managers on the SBLF’s Application Review Team and will be expected to make a meaningful contribution to the program.”
While we are all happy to see Treasury develop talent and conserve its resources, we think this may send the wrong message. At a time when Subchapter S and mutual application guidelines are still unpublished, and over 600 SBLF applicants (all “healthy” and in a position to increase lending to America’s small businesses) are still waiting for disbursement of funds in “early 2011,” we would much rather be hearing about additional paid staffers who can actually get the program implemented. We wonder whether the added responsibility of training and supervising interns will improve existing personnel’s ability to roll out the SBLF.
On the other hand, perhaps the interns can provide the program with the spark it needs. Just don’t tell them about Senator Snowe’s plan to ruin their summer, too.
If there is a partial Federal government shutdown due to a failure to reach a budget agreement, what effect would this have on the four main Federal banking agencies? The short answer: None.
None of the Federal Reserve System, the FDIC, the OCC, or the OTS receives appropriations from Congress. Instead, each of these Federal agencies is funded through various other sources, as described below. Thus, none of the services or responsibilities of these Federal agencies will be affected if a budget agreement is not reached.
However, many other Federal agencies may be significantly affected by a Federal government shutdown, including, notably for financial institutions, the SEC. We would recommend that institutions with on-going matters with the SEC reach out to their contact persons at the SEC to discuss their situations.
Section 165(d) of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires each nonbank financial company supervised by the Federal Reserve and each bank holding company having assets of $50 billion or more (a “Covered Company”) to develop what has commonly become referred to as a “living will,” essentially a plan of orderly liquidation (the “Resolution Plan”). The Federal Reserve and the FDIC published a proposed rule on March 29, 2011, to implement this provision. The proposed rule requires a Covered Company to provide its initial plan within 180 days from the effective date of the final rule or the date the entity becomes a Covered Company. Each Covered Company will then be required to submit an updated plan within 90 days of the end of each calendar year. Interim updates are required if an event occurs that might have a material impact on the Resolution Plan. The Resolution Plan must be submitted the Federal Reserve and the FDIC for their approval. The Plan must take into account what type of distress in the world financial markets might result in failure of the Covered Company and, most importantly, it must assume that the government will not provide any extraordinary support. The Resolution Plan must provide for the “rapid and orderly liquidation” of the Company and should include provisions that protect any FDIC insured institutions from risks created by nonbank subsidiaries of the Covered Company. It should also assess the feasibility of the Covered Company’s plan, including timelines, for executing any sales, divestitures, restructurings or other similar actions.
Editorial Comment: When the credit markets freeze and it is impossible to value financial assets, how exactly will a huge financial company liquidate itself in a “rapid and orderly” manner? A dearth of buyers in such a situation will make the liquidation impossible to accomplish in a short period of time and if it is accomplished it will likely be a very messy affair. An orderly liquidation really presumes that the credit markets are working normally and that the financial distress a large bank is suffering is restricted to it alone. In such a situation there would be willing buyers for the assets and the liquidation would not trigger a broader crisis. One suspects that any Resolution Plan will be much more aspirational in nature than a true blueprint for what to do in a financial panic.
On March 30, 2011, the Treasury announced that the TARP Capital Purchase Program has now generated more money for taxpayers than it originally cost. Through March 30, 2011, the Treasury had collected, on behalf of the U.S. taxpayers, over$251 billion from the financial institutions that Treasury invested in through repayments, dividends, interest, and other income.
This exceeds the original investment Treasury made in these banks by approximately $6 billion, and Treasury currently estimates that the bank programs under TARP will ultimately provide a lifetime profit of approximately $20 billion to taxpayers.
We have attempted to emphasize the investment nature of the Capital Purchase Program since 2008, but the term “bailout” helps sell papers and has generally stuck. As we noted on October 30, 2008:
The emphasis should be on supporting the Government’s program to strengthen the entire banking system in order to enable banks to continue supporting their local community through this economic downturn. The program is designed to earn a return for the Government (and thus the taxpayer), and is thus not a “bail-out” at all.
Perhaps now that the Treasury has already recognized a positive return on its investment, the mainstream press (and the public generally) may begin to accept that TARP should not have been a four letter word.
A Letter to our Clients and Friends in the Financial Institutions Industry
Walt Moeling and Jim McAlpin spoke at the recent Acquire or Be Acquired Conference sponsored by Bank Director Magazine. Their topic was “The Path to Full Profitability by 2013.” In advance of their talk at the conference, Walt and Jim sought input from a group of industry observers on what they foresee as likely developments over the next few years. (A printer-friendly version of the Letter to Clients is also available.)
We thought you would be interested in what we heard in response to these questions, and the following is an excerpt from Walt and Jim’s presentation at the AOBA Conference:
Background
- There are more than 6500 commercial banks in the U.S. Only 500 of these banks have assets of more than $1 billion, and only 110 have assets of more than $10 billion. In other words, over 90% of U.S. banks have assets of less than $1 billion. Also of significance to this discussion, one third of U.S. banks have less than $100 million in assets.
- In connection with this presentation we sent a survey to a number of our contacts at investment banking firms and also to a group of bank consultants. We asked them to look forward over the next few years and project what the landscape will look like in community banking. We received responses from over 30 industry observers from across the country, and our respondents have allowed us to share their comments either with attribution or anonymously.
“What will the ideal community bank look like by year end 2013?”
- Adam Aspes of Sterne Agee provided an answer that sums up most of what we heard in response to this question: “The ideal community bank will either: (i) have a dominant market share in a rural slow growth market, or (ii) if located in an urban market, have enough scale and product offering to compete for deposits with the larger banks.”
- Jennifer Demba of SunTrust Robinson Humphrey responded: “Investors will value concentrated market share community banks, not fragmented networks.”
- One community bank consultant wrote in response “$1 billion in asset size will not be a large bank by 2013.” We consistently heard in response to this question that, in all but rural markets, a minimum necessary asset size will be $500 million.
- Chris Marinac of FIG Partners wrote: “While not universally applicable, in general we think the regulatory costs of operating a bank have increased such that it is difficult to produce adequate long-term returns for a bank below $500 million in assets. There are exceptions, and some private bank investors find a single-digit Return on Equity to be acceptable. However, we think the demands for 11% to 14% ROEs create a $ billion+ size threshold for surviving banks.
- Another investment banker told us that his firm has modeled the impact of increased compliance costs on smaller community banks: “If you assume an increase of [direct and indirect] compliance costs of $100,000, and then factor in growth of only 5% to 8% per year, it is hard for a smaller bank to get to 1% ROA, much less double digit ROE.”
The Senate has acknowledged that the federal banking regulators are sending mixed messages to community banks… but they don’t plan to do anything about it. Section 4113 of the bill to authorize the Small Business Lending Fund adopted by the Senate on September 16, 2010 includes a declaration of Congress regarding the messages being sent by the federal banking regulators.
Sec. 4113. Sense of Congress
It is the sense of Congress that the Federal Deposit Insurance Corporation and other bank regulators are sending mixed messages to banks regarding regulatory capital requirements and lending standards, which is a contributing cause of decreased small business lending and increased regulatory uncertainty at community banks.
Apparently, the Senate doesn’t have any issues with the regulators’ actions, since the bill neither states that Congress believes the regulators are wrong for sending these mixed messages nor includes any requirement that they stop doing so. One might suggest that the regulators are not sending mixed messages… but are sending different messages depending on the audience; the regulators are telling Congress they want banks to lend, while imposing burdens on banks that make new lending practically impossible.
On June 29, 2010, Sarah Wallace, chair of the board of directors of First Federal Savings and Loan Association in Newark, Ohio, authored a passionate opinion piece in the Wall Street Journal titled “The End of Community Banking.” While I agree with many of Ms. Wallace’s points, I do NOT see the end of community banking in the foreseeable future.
I do think that we are going to see tighter regulations and tighter credit than we saw in the five years before the financial meltdown – 2002 through 2007. Those five years were the culmination of a world wide expansion of credit and leverage that began in the US around 1980, so we really had a great run. Nonetheless, by 2002, a good number of observers would argue that credit availability was running somewhat out of control.
As Mrs. Wallace suggests, we will have tighter rules, but they will by nowhere near as tight as those that prevailed until the late 1980′s or early 1990′s. During my career beginning in the late 1960′s, we have done away with limits on interest paid on deposits, most commercial usury limits, limits on branching and cross state expansion, certain caps on real estate lending, and we have expanded the lending limit in many cases from 10% of capital to 25%. Most of these changes will not be reversed, and credit will continue to be available for borrowers who can demonstrate an ability to repay the loan. However, I do not see banks going to the credit excesses of the 2002-2007 period, and there will be people who might have gotten loans then who will not be able to get loans in 2011… and that is probably not all bad.