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Bank Regulator Mixed Messages?

Bank Regulator Mixed Messages?

August 16, 2011

Authored by: Robert Klingler

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.

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Federal Bank Regulators Release New Guidance for Management of Interest Rate Risk

On January 7, 2010, the Federal Financial Institutions Examination Council (FFIEC), a collection of federal regulators of financial institutions, issued an advisory on interest rate risk management. This advisory, which was issued as part of an effort to supplement and clarify existing interest rate risk (IRR) guidance provided by individual federal regulators, indicates that federal regulators will have increased expectations during future examinations of a financial institution’s management, modeling, stress testing and documentation of IRR.

In light of the current economic environment in which financial institutions are experiencing downward pressure on capital and earnings, FFIEC has grown concerned with the potential IRR associated with institutions funding longer-term assets with shorter-term liabilities in order to generate earnings. As a result, as part of future federal examinations, IRR assumed by a financial institution will be evaluated relative to the institution’s capital and earnings levels, and management will be evaluated on its efforts to identify, measure, control and document the institution’s IRR.

In particular, FFIEC reiterates its previous position that the ultimate responsibility for the financial institution’s IRR rests with its board of directors; as a result, the board of directors or a specially designated asset/liability committee “should oversee the establishment, approval, implementation, and annual review of IRR management strategies, policies, procedures, and limits.” The board of directors is expected to receive and review regular reports that allow them to accurately assess the IRR sensitivity of the institution to an increasing rate environment and to the important assumptions that underlie management-proposed IRR and liquidity projections. Further, the board of directors is directed to approve comprehensive written policies and procedures in place to monitor and manage IRR continuously. Although the advisory indicates that these processes and systems “should be commensurate with the size and complexity of the institution,” FFIEC indicates that “well-managed institutions” possess IRR management policies that include specific targets under a variety of short and long term scenarios.

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FDIC Issues Final Statement of Policy on Investor Qualifications for Failed Bank Acquisitions

Background

On July 2, 2009, the Board of Directors of the Federal Deposit Insurance Corporation (“FDIC”) issued for public comment a proposed Statement of Policy that sets forth the qualifications for private equity investors in failed bank acquisitions (the “Proposed Policy”).  The FDIC established a 30-day comment period and sought public comment on nine topics:

  • definition of private equity investor and scope of the policy;
  • permissibility of “silo” structures;
  • capital requirements;
  • applicability of the source of strength doctrine;
  • imposition of cross-guarantee liability;
  • restrictions on bidders from bank secrecy jurisdictions;
  • post-investment holding period;
  • possible limitations on 10% investors in failed institutions; and
  • length of restriction period.

On August 26, 2009, the FDIC issued its Final Statement of Policy on Qualifications for Failed Bank Acquisitions (the “Final Policy”).   The FDIC notes that the policy statement is just that—a statement of policy and not a statutory provision imposing civil or criminal penalties and that the requirements it imposes on investors only apply to investors that agree to its terms.

In response to 61 comment letters from a broad variety of interests, in the Final Policy the FDIC reduced the proposed capital requirements, removed the proposed “source of strength” requirement, and increased the ownership threshold for cross-guarantee liability.  These changes are intended to make the failed bank acquisition opportunity more attractive for private equity investors, while retaining many of the other elements of the Proposed Policy that address the FDIC’s apparent concerns about such investors.

The Final Policy is relevant only to bidders for failed financial institutions.  Investors seeking to acquire control of banks that have not failed should refer to the Bank Holding Company Act and the relevant regulations and policy statements issued by the Federal Reserve Board including, but not limited to, the policy statement issued by the Federal Reserve Board on September 22, 2008 that eased certain limitations on private equity investments in banks and bank holding companies.  This policy statement is summarized in our prior client alert on private equity investments generally.    Investors seeking to acquire control of federal savings institutions that have not failed should refer to the Home Owners’ Loan Act and relevant regulations issued by the Office of Thrift Supervision.  These existing holding company statutes and regulations are not replaced or substituted by the Final Policy.  The Final Policy merely adds additional limitations and requirements in the context of acquiring failed financial institutions.

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A New Capital Injection Program?

A New Capital Injection Program?

February 6, 2009

Authored by: Robert Klingler

On February 6, 2009, the Wall Street Journal ran a story indicating that the Treasury Department is shifting away from a “bad bank” concept and towards a second round of capital injections.  This second round of capital injections, according to the Wall Street Journal, would carry stricter terms than the current TARP Capital Purchase program and would be targeted towards weaker banks.

Instead of buying preferred shares, as it did before, the government is discussing taking convertible preferred stakes that automatically convert into common shares in seven years.

To get money, banks would likely have to pay a higher dividend to the government than the 5% rate the government charged in the first round of infusions and agree to a host of new restrictions, such as lending above a baseline level, reporting frequently on their use of the money and curbing executive salaries. While Treasury wouldn’t preclude healthy banks from participating, the stricter terms would likely attract primarily weaker banks in need of capital.

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Interest Rate and Brokered Deposit Restrictions

On January 27, 2009, the FDIC proposed to amend its regulation relating to interest rate restrictions on institutions that are less than well capitalized.  The proposed regulation would tie the interest rate caps to published national interest rates and eliminate the concept of local deposit market areas.

Section 29 of the Federal Deposit Insurance Act places statutory limitations on the ability of any insured depository institution that is not well capitalized to accept funds obtained by or through any deposit broker.  Because of the statutory definition of a deposit broker, these limitations also limit the interest rates which may be paid by insured depository institutions that are less than well-capitalized. In order to be considered well-capitalized, an institution may not be subject to any written agreement or order issued by its primary federal regulatory which requires the institution to meet and maintain a specific capital level for any capital measure.

Under the existing regulations, any institution that is not well capitalized (including any institution subject to a regulatory enforcement action with capital requirements) may generally not pay interest in excess of 75 basis points over the average interest paid for comparable deposits in the institution’s “normal market area.”

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FDIC and Open Bank Assistance

FDIC and Open Bank Assistance

January 12, 2009

Authored by: Robert Klingler

On January 2, 2009, the Wall Street Journal ran a story on the possibility of the FDIC agreeing to assume future losses on the troubled assets of a failed institutions.  The FDIC has used versions of the loss-sharing model several times last year, but with the exception of the initial attempt to rescue Wachovia, only as part of the receivership of a failed institution.

“It is something that we plan on doing in the future where it’s appropriate,” says Herb Held, assistant director in the FDIC’s division of resolutions and receiverships. “I think it’s a good deal for everybody: the FDIC, the acquiring bank and the borrowers. It keeps the assets where they were.”

This leaves open the question of whether the FDIC will begin using a loss-sharing approach to facilitate open bank transactions.  Some advisers believes that the FDIC will use this approach to effectively entice sound financial institutions to purchase struggling banks, or those which may be in imminent danger of failing.  While there is no existing precedent during this period of economic turmoil, open bank assistance was a well regarded and oft used solution in earlier troubled times.  Where FDIC does provide stop loss or other support, it comes ahead of shareholders in the troubled institution, so it does not help shareholders in most instances; however, it does prevent the extra disruption of a failure.  Traditionally, FDIC officials informally estimated the additional loss upon a failure was at least 15% higher than the loss where the troubled bank is acquired by a healthy bank in an open bank transaction.  As a result, properly structured stop loss or other assistance programs should save the deposit insurance fund real dollars.

For now, the FDIC appears tied to the position that it can only offer loss-sharing following receivership and a full auction of the troubled or failing institution in order to comply with its legal obligation to provide the least-costly solution.  If a tangible proposal for a loss sharing were presented to a regional FDIC office, such a proposal would be have to be structured to assure “least costly” status and would be forwarded to DC for review.

Accordingly, we recommend that neither acquiring banks, nor troubled institutions looking to be acquired, put too many eggs in the basket hoping for FDIC loss-sharing assistance.

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FDIC Expands Bidder List for Troubled Institutions

On November 26, 2008, the FDIC issued a press release outlining a new plan to allow parties that do not have a bank charter to bid on failing institutions.  We will keep you up to date as additional details emerge on this new plan.  Below is the complete text of the FDIC’s press release.

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Additional Guidance on Troubled Bank Eligibility

FDIC Chairman Sheila Bair has informed the Florida Bankers Association that higher CAMELS rated banks can apply for the Treasury Capital Program, but it will subject those banks to further regulatory scrutiny.

Another regulator with a federal banking agency informed the Florida Bankers Association as follows:

CAMELS ratings are not the sole determinant and each situation will be looked at individually. Based on what we know thus far, we think many 3-rated banks will meet the standards as long as there are no mounting deficiencies that suggest future prospects are poor or that additional downgrades are likely. Further, it is possible that certain 4-rated banks will qualify, as long as conditions are stable or improving. We also think that a larger number of troubled banks might warrant TARP approval if there is an accompanying injection of private capital.

In addition to the above, banks with less than satisfactory CRA ratings are not likely to be approved. Further, banks with certain risk factors such as high concentrations of construction and development loans will be subject to closer scrutiny, although that will not necessarily disqualify them.

Although ultimate approval for troubled banks remains unlikely, it is very clear that regulators want troubled banks to present proposals for consideration under the TARP Capital plan, and that no regulator wants to be blamed for erroneously pushing a struggling bank out of the program.

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