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 At a time when Subchapter S and mutual application guidelines are still unpublished, and over 600 SBLF applicants (all “healthy” and in a position to increase lending to America’s small businesses) are still waiting for disbursement of funds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.
We understand that the FDIC is substantially changing the loss share formula structure, applicable to all bids made after March 31, 2010. The material changes include:
- Elimination of the “Stated Threshold” and 95%/5% loss sharing basis. Accordingly, all loss sharing will be at a constant 80%/20% split (FDIC/acquiring bank) for all covered assets and all losses.
- Bidders will now be expected to express the Asset Premium (Discount) component of their bid as a percentage of the book value of assets purchased, rather than a fixed dollar amount.
- The “First Loss Tranche” will now be an element to be bid, rather then an amount calculated based on assets acquired and liabilities assumed. Bidders will be expected to express the “First Loss Tranche” component of their bid as a percentage of the covered assets. The “First Loss Tranche” will continue to represent the amount of losses the acquirer will absorb prior to the commencement of loss sharing. Negative bids for the First Loss Tranche will not be accepted, although zero bids will.
- As the “First Loss Tranche” will now be separately bid, the net equity position of the failed bank may cause an initial payment to be due to the FDIC at closing, particularly when assets passing to the acquiring bank exceed the deposit liabilities. (Previously such an acquiring bank merely assumed 100% of the losses until the amount owed the FDIC was exhausted.)
- The Initial Payment will be the sum of the equity adjustment (assets – liabilities), deposit premium bid (in dollars), and the asset premium bid (in dollars). If the result of the calculation is positive, the acquiring bank will be required to wire the Initial Payment to the FDIC, while if it is negative, the acquiring bank will receive a wire of the Initial Payment from the FDIC.
On February 5, 2010, the federal banking regulators and the Conference of State Bank Supervisors issued an Interagency Statement on the Credit Needs of Creditworthy Small Business Borrowers. The Statement builds upon principles set forth in the October 2009 Policy Statement on Prudent Commercial Real Estate Loan Workouts. After noting the overall decline in loans to small businesses and the reasons for that decline the regulators suggested that lenders may have become overly cautious with respect to small business lending. They encourage lenders to engage in prudent small business lending and that that examiners will not criticize lenders for working in prudent and constructive manner with small businesses.
The decline in small business lending has many reasons, not the least of which is that loan demand is actually down. Lenders are also naturally cautious of lending to those businesses that are reliant solely on cash flow that has slowed due to the slowdown in consumer spending and the decline ion the personal wealth of the owners of the businesses. Despite the assertions to the contrary by the regulators, lenders are concerned that there is a disconnect between statements from Washington, DC and what actually happens in the field when examiners are onsite at financial institutions. Our experience seems to show that local federal regulators do not see any upside in being flexible when faced with making decisions about how to rate credits. Lenders are therefore naturally reluctant to maker decisions based on guidance until they see it actually implemented on the ground.
Short-Term Planning for Recovery and Survival
(This post was authored by Walt Moeling and Dustin Hall. A version of this post originally appeared in the August 2009 issue of the ABA’s Community Banker magazine.)
The grim economic prognoses we continue to hear about have an immediate impact in the bank board room. Boards must think about short-term planning for recovery and survival because virtually no bank is wholly immune from the current recession. Although the problems may have started with residential real estate in the Sunbelt, they have gone much beyond that now, impacting banks throughout the country.
As a director you must plan for both long-term and short-term. Long-term planning is tremendously important, and we hope to make it to the “long-term,” but short-term planning is critical today.
Short-term planning in this context deals with the reality of today’s marketplace. The focus is not on earnings or even stock value, two traditional focal points for planning. Instead, the focus is on capital management, liquidity, and asset quality.
Capital Management
Your short-term capital planning in the face of mounting losses cannot focus on today or yesterday; it must focus on tomorrow. You must ask: Where are we going? What will happen if housing prices drop for another two and a half years, as predicted by some? Can our borrowers sustain a more prolonged recession? If not, where will our capital be three, six, and nine months from now? In essence, you must stress test your bank to see how far it can go.
A real problem for directors is assuming that capital today is as readily available as it has been for the past 15 years, or that they can sell the bank if there is a real problem. Unfortunately, there is no public market, and virtually no private equity, for bank stock. Those sources are presently closed, shall we say, for repair. Instead, short-term capital is likely to be found only within the boardroom and from family and friends.