Thursday, December 20, 2012

Taking A Holiday Break
 Best Wishes for Yours!

from the First National Community Bank of New Richmond, Wisconsin

I won't be posting commentary for the next two Mondays in order to enjoy the holidays with family.  Best wishes to all of you for a terrific holiday season!  And remember, when old Uncle Charlie plants himself on the couch in front of you and starts rambling on endlessly about how wonderful things were in the good old days, it's an opportunity for you to tune out and grab your iPad.  Take a look at some of the older posts on The National Bank Examiner.  Some topics are timely, some are timeless, and because they are free, all are priceless.

Monday, December 17, 2012

 Community Bank M&A Tipping Point?

The latest FDIC quarterly banking profile shows that the banking industry continues to get back on its feet.  More than half of all institutions showed improvements in their quarterly net income from a year ago, driven largely by improving credit quality.  Headwinds are becoming tailwinds and the downward spiral in credit quality seems to have stabilized.

One gets the sense, from the industry dialogue, that merger and acquisition (M&A) activity at the mid-size and community bank level is poised to increase significantly in 2013.   With recent news stories indicating that the mega-banks have been sidelined by the Fed with regard to M&A activity, the M&A focus moves to the mid-size and community bank segments of the industry.

Three reasons contribute to this hunch.  The first is the program of financial repression created through the Federal Reserve zero interest rate policy and its efforts to push down long-term rates.  A community bank, in particular, has to have a reasonably wide positive carry (net interest margin) to cover its overhead.   Fee income helps, but with what looks like a public jihad against banking fees (think overdraft and interchange fees), there are limits to flexibility on that front.

With loan demand lethargic, options to offset financial repression are few.  Many community bankers are seeing the present Fed zero interest rate policy remaining for years to come.  This is pushing some to pursue classic “down and out” banking - moving down the scale of credit quality and out along the yield curve to squeeze out a few more basis points of yield.  But those practicing “down and out” banking know, in the back of their minds, that a reasonable buyout offer tomorrow would be preferable to the risky, and potentially mortal, balance sheet positions they are building out of necessity and desperation today.

The second is the escalation in the average community bank cost structure. Community bank cost structures are creeping up faster than technology can lower them.   Technology is a great way to lower unit costs of production, but diminishing returns appear to be kicking in.  The cost reduction curve is being slowed by increased expenditures for cyber-security and privacy protection.

Then add in to the community bank cost structure increases in personnel expenses associated with the implementation of the Affordable Care Act, compliance costs associated with the ongoing implementation of the Dodd-Frank Act, Consumer Financial Protection Board regulations in the pipeline, and the increased regulatory agency fondness for “guidelines” (which appear to be recommendations, but are enforced as obligatory through the examination process).

Not helping the cost structure situation either, is the emotional attachment to lightly-trafficked brick-and-mortar branches as monuments to territorial conquest and icons to the exercise of superior generalship in days gone by.  Cede turf to a competitor? Never!

Third, battle fatigue is showing up in more and more community bank CEOs and boards of directors.  Not only is this economic recovery so frustratingly long and slow, but many of the true joys of community banking are being overshadowed by the aforementioned frustrations and obstacles.  The familiar five stages of adaptation are at work: denial, anger, bargaining, depression and acceptance.   This process tends to soften opposition to market value buyout offers.   Stock swaps may also become more popular, as many shareholders may think that buying a ticket on a winning horse may be preferable to being passengers on a foundering vessel.

Monday, December 10, 2012

An Appealing Option

OCC Ombudsman Larry Hattix

Former Comptroller of the Currency, Eugene “Gene” Ludwig, created the OCC's Ombudsman's Office in 1993.  The effectiveness of this program led to a statutory requirement for all federal bank regulatory agencies to establish an independent intra-agency appellate process, including a requirement for each agency to appoint an ombudsman (Section 4806 of the Regulatory Improvement Act of 1994).  Almost 20 years later, the OCC Ombudsman's Office remains in very capable hands, led by a veteran national bank examiner, Larry Hattix.  The current appeals guidance, for national banks and thrifts, is contained in OCC Bulletin 2011-44 – Bank Appeals Process –Guidance for Bankers.

The guidance outlines two tracks for the review of matters that qualify for a bank or thrift appeal.  For the purposes of this article, the term “bank” will mean a national bank or federal savings association.

Using the case of a community bank, the bank's board of directors has the choice to submit the matter directly to the Ombudsman or to the bank's OCC district deputy comptroller (or in the case of an extremely troubled bank, the Deputy Comptroller for Special Supervision in Washington, D.C.).   I've recently been asked how a community bank's board of directors might choose one path for appealable matters over the other.  Here is my advice:

First, for any preliminary examination determination that may ultimately become an appealable matter, work with your examiner-in-charge and the Assistant Deputy Comptroller of your local OCC field office to try to resolve the matter. Working things out before an examination report is submitted for processing is the best and least costly step, in time and effort, for all concerned.

When a final examination report is rendered and decisions have become final, the community bank's board of directors may continue to feel that it wants to pursue an appealable matter.   In that case, my advice is that they initially go through the bank's district deputy comptroller only if their bank is a CAMELS Composite 1- or 2-rated community bank without an informal or formal enforcement action. Otherwise, take the matter directly to the Ombudsman's Office.

Here is the logic:  If your community bank is CAMELS Composite 2-rated with an informal or formal enforcement action (in place or pending), or 3-rated, or 4-rated under $1 billion in assets, the final decision regarding your bank's examination results and CAMELS ratings was made by the district deputy comptroller, through the mechanism of a District Supervision Review Committee (DSRC).  The same decision-making authority, for extremely troubled banks (4-rated over $1 billion in assets or any 5-rated), is vested in the Deputy Comptroller for Special Supervision in Washington.

OCC Bulletin 2011-44, Bank AppealsProcess – Guidance for Bankers, has this important provision: “Recusal of the Deputy Comptroller: If the Deputy Comptroller directly or indirectly participated in making the decision under review, he or she must transfer the appeal to the Ombudsman after advising the appellant.”

Taking either appeals route, through the appropriate supervisory office or through the Ombudsman, a community bank board of directors will find seasoned and experienced professionals who want to be open, reasonable and equitable.  

And remember, though some decisions are not appealable as outlined in OCC Bulletin 2011-44, the building blocks that led up to the final decisions, and now support those decisions, may themselves be appealable.  

Monday, December 3, 2012

Full TAG Extension - A Contrary View

It's interesting to see the banking trade associations, who normally rail and fulminate at government intervention in the marketplace, madly try to protect the government special favors or munificence already bestowed... I'm talking about the Transaction Account Guarantee Program (TAG).  TAG was an emergency measure, taken at the depths of the 2008 financial crisis, to manage systemic liquidity fears and maintain financial system stability. It granted unlimited FDIC deposit insurance protection to non-interest bearing transaction accounts.  Its latest extension expires on December 31, 2012.  The banking trade associations are lobbying for an additional extension.

In Economics 101, we were taught about the workings of Adam Smith's invisible hand. What we are seeing play out with the TAG extension, is Adam Smith's other hand at work... his visible hand.  The pursuit of self-interest to gain or maintain government largesse.

I'm reminded of an earlier government financial emergency measure, the 1933 Glass-Steagall prohibition on paying interest on demand deposits and the establishment of government-administered ceilings on the maximum rates of interest that could be paid on savings and time deposits. Congress wanted to avoid a repeat of the speculative banking behavior that culminated in the 1929 financial crisis, and that eventually brought on the Great Depression. The idea behind the measure was a sense that excessive competition for deposits (some characterized it as "destructive competition") created an undesirable narrowing of bank net interest margins. This narrowing, in turn, resulted in an anxiety for income that was thought to have promoted risky bank lending and investment practices.

These price controls remained in effect until the 1980 Depository Institutions Deregulation and Monetary Control Act established a six-year phaseout of the maximum rates of interest that could be paid on savings and time deposits in Regulation Q, the Federal Reserve regulation through which these price controls were administered . Even though government-determined interest rates on savings and time deposits went away in 1986, it wasn't until the passage of the Dodd-Frank Act that the last vestige of these measures was repealed. The payment of interest on business demand deposits was allowed as of July 21, 2011. On that day, an amazing 78 years after these emergency measures were first enacted by Congress, Regulation Q, was finally consigned to the ash bin of history.

Even if the extreme hypotheticals advanced by the trade associations for TAG extension  have some kernels of validity, a weaning off of government support is in order. A step-down approach to the normal deposit insurance limit of $250,000 would allow us to examine the true nature of the funds flows, instead of our fears.

Monday, November 26, 2012

OCC Matters Requiring Attention (MRA) 
Reference Guide Revealed!

On November 15, before a meeting of the The Clearinghouse Association, Comptroller Curry referred to the OCC's adoption of “heightened expectations for corporate governance and oversight” for large national banks.   Among those heightened expectations was this statement: “We are no longer willing to accept audit and risk management functions that are simply satisfactory.... Our expectation now is that large institutions will meet the standard of “strong” for audit and risk management functions.”

What has not received much current attention, but which merits recognition, are the fruits of an earlier, parallel effort by the OCC's Midsize and Community Bank Supervision (MCBS) department to become more anticipatory in the supervision of midsize and community banks by identifying and dealing with unsatisfactory bank risk-taking practices before the consequences of those risk-taking practices escalate into significant problems.

Many of the OCC's internal lessons-learned reviews and external material loss reviews, from bank failures and "near-misses" from the most recent financial crisis and the resulting economic downturn, had a common theme:  In many instances, examiners, and their supervisory offices, could have done more earlier to address inappropriately-managed bank risk-taking behavior.  What was missing from many reports of examination was a clear description of the inappropriate risk management practices, their causes and their consequences coupled with an insistence that those unsatisfactory practices be corrected in a timely manner.  It also became apparent that this needed to be back-stopped by requirements for strong, frequent, and effective followup on the status of the bank's MRA corrective actions by the OCC examiner-in-charge and the local supervisory office.

A team of seasoned OCC examiners, managers, and executives prepared updated guidance for examiners called the “MCBS MRA Reference Guide”.  A really excellent piece of work that focuses on dealing with unsatisfactory risk management practices that have been identified during the course of the examiner's ongoing supervision of the bank and also sets explicit communications and follow-up standards.   All with the goal of dealing with unsatisfactory bank risk management practices early before they escalate into intractable problems.

Having referred to the document frequently as an Assistant Deputy Comptroller of a local OCC field office, I was always puzzled by the admonition on the Table of Contents page: “This document is created for internal use. It may not be shared with any party outside the OCC.”   The puzzling part was that it had no otherwise confidential bank-specific supervision information in it.  So in order to bring this document into the public domain, I made a request to the OCC under the Freedom of Information Act.  The OCC graciously released it unredacted.  Here is a link to the document:

MCBS MRA Reference Guide

[Editor's Note:  Some people have been experiencing trouble with this link.  If you have difficulty accessing the document, please email and we will forward a .pdf copy]

This document should be very beneficial to national bank and thrift CEOs and their boards of directors.  Now they know the rules and standards surrounding the citation of MRAs in their reports of examination.  That knowledge can improve their understanding of how the OCC expects MRAs to be handled by the bank and also has the potential to improve the quality of the dialogue between the bank or thrift CEO and the examiner-in-charge of the examination.  Particularly in the wrap-up stage of an examination, when “must fix” items, like MRAs, need to be separated from “nice to do” items, like best practice recommendations, before the draft report of examination is submitted for final processing.

Monday, November 19, 2012

A License to Heal

In the mid-1990's, shortly after the 1994 arrival of Chief Counsel Julie Williams to the OCC, the representative of the Comptroller's licensing function was toppled from the Olympian heights of the Comptroller's Executive Committee and quietly tucked away into the organizational structure of the Chief Counsel's office.  The Senior Deputy Comptroller for Corporate Activities took on the more modest, slightly humbler, title of Deputy Comptroller for Licensing.  That position, along with its staff, has been sequestered in the Chief Counsel's Office ever since.

In the campaign to champion national bank preemption and increase the value of the national bank charter, consolidating and unifying OCC's legal forces and its licensing forces was a very effective way to fortify the “surge”.  Post Dodd-Frank, however, the borders have been established and the battle has now largely been decided.   The prevailing and retreating forces have been pretty well sorted out.   It's another world now.

With no permanent Chief Counsel at the moment, Comptroller Curry has the opportunity to curb the out-sized influence of the Chief Counsel's Office among his circle of closest advisors.  The OCC's Annual Report breaks OCC mission-centric activities into three broad programs: Supervise, Regulate (Rulemaking), and Charter.   These are three broad line functions around which all other OCC staff functions are arrayed to support.   Given this established organizational framework, it is also an opportunity to rationalize the role of the Chief Counsel's Office as more of an advisory and supporting staff function, rather than an organization with multiple line responsibilities.

The national bank charter has now been joined by the federal thrift charter, making the OCC this nation's sole Federal financial institution chartering authority, with the exception of federal credit unions.  Multiple forces, including global financial integration, evolving Dodd-Frank requirements, and rapid changes in bank technology, will not only create their own unique impacts on the structure and operations of federally-chartered banks and thrifts, but also on the structure of the financial services industry generally.  New policy questions, including the inevitable unintended consequences of the new federal regulatory architecture, will need innovative regulatory responses.  These high visibility issues will impact OCC licensing decisions and establish precedents for decades to come.

The restoration of licensing to Executive Committee status would give the function direct access to the Comptroller and provide an additional voice at the table. This may have more advantages than disadvantages.

Monday, November 12, 2012

The Bluebird (Card) of Happiness:
 Synthetic Banking, Walmart-Style

Credit: Gary Larson- The Far Side

Students of regulatory policy, and any parents of teenagers, are well aware of the maxim “Any artificial impediment to a natural inclination breeds circumvention”.

Take a look at the Walmart Money Center ( ).  A street-level, customer-facing synthetic bank is being created through the bundling of individual third-party financial services providers. The bundler itself, Walmart, while subject to state-level regulation as a money services business, enjoys total freedom from the costly overhead of Federal prudential bank regulation and supervision that is applied to all chartered banks.  It therefore gains a competitive cost advantage.

Scroll down that same screen a tad and look at the “Money Services” being offered without a bank charter. If Walmart linked up with a mortgage originator, like maybe a PHH or Quicken Loans, the menu of street-level, customer-facing retail “banking” offerings would be substantially complete.

Walmart, of course, does not call what it does “financial services bundling”, they call it “retailing”, and retailing is something Walmart has always done and done exceedingly well.   Take a look at this fascinating interview with Daniel Eckert, head financial services executive at Walmart, done recently by Sean Sposito, Technology Reporter at the American Banker:

Bankers and banking regulators have always closely followed the evolution of the money services at Walmart, but the recent addition of the American Express Bluebird Checking and Debit Alternative seems to indicate that we have crossed the Rubicon in the construction of a synthetic bank.  If financial services bundling becomes popular with other providers, we could be looking at a parallel retail banking system someday.

The English-parsing wizards in the American Express legal department did a commendable job, in the Member Agreement, navigating around any terminology that could create an actionable banking nexus for Bluebird by using terms of art like “Adding Funds” and “Remote Check Capture” and assiduously avoiding the word "deposit" when possible.  But the fact is that this prepaid card product is being marketed as the functional equivalent of a bank account.

The Amex marketing department, on the other hand, apparently didn't get the memo.... like most marketing departments, the legal niceties are, well, the fine print, right?   So in the single minded pursuit of luring account relationships, the marketing materials use the terms “deposit money”, “direct deposit”, and “deposit checks”.   Check it out:

Several bank regulatory policy issues need to be dealt with, in addition to the often discussed issue of the lack of Federal deposit insurance for funds in these prepaid accounts. State banking supervisors need to consider the question... At what point do enhancements to state-supervised money services business products trigger a requirement for a bank charter?  In addition, there is the broader financial regulatory policy question of how to treat financial services bundlers, like Walmart, who, by creating synthetic banks, could end up creating a parallel retail banking system, out of reach of Federal prudential banking supervision.

In retrospect, maybe best day that Walmart ever had, was the day it pulled its industrial bank charter application in March 2007 after realizing that the FDIC was not inclined to approve it with a banking industry foaming at the mouth in opposition.  The worst day for the banking industry and the FDIC was that same day.  Because on that day they lost an opportunity to draw Walmart into the hot steamy bosom of Federal prudential banking regulation.

Given the subsequent payment system benefits clawed back to retailers by the Dodd-Frank Durbin Amendment and the upcoming benefits from the pending Swipe Fee Settlement (even though Walmart opposes it for being insufficient and for its waiver of future liability), and then combine those benefits with the ability to create a synthetic bank, and you can understand why Mr. Eckert of Walmart is emphatic about no longer seeking a bank charter.

Thursday, November 1, 2012

Sandy, meet DIDRA

 "Boat-Thru Banking" - Associated Press

In  1992, in the aftermath of the devastation wreaked by Hurricanes Andrew, Iniki, and the Los Angeles riots, Congress passed, and the President of the United States signed, the “Depository Institutions Disaster Relief Act of 1992 (PL 102-485)”.   DIDRA, as it was labeled, provided time-limited regulatory relief from some FIRREA appraisal requirements, certain Truth in Lending Act (TILA) and Expedited Funds Availability Act (EFAA) provisions, and also set up a process for individual bank relief from Prompt Corrective Action (PCA) leverage ratio requirements because of temporary leverage ratio distortions caused by bank customers depositing disaster-related property/casualty and flood insurance proceeds as well as government assistance payments.  The FIRREA appraisal relief can be invoked for any Presidential declared emergency in the future, subject to a duration limit of 36 months each time.  The TILA, EFAA, and PCA capital leverage ratio flexibilities were strictly limited to reasonable periods subsequent to the occurrence of the specific disasters listed above. 

Another DIDRA (PL 103-76) was passed in 1993 for the massive Mississippi River floods with certain provisions applied later to the 1994 California earthquakes.  It contained all of the previous flexibilities with the exception of the FIRREA appraisal relief which, after DIDRA 1992, is a continuously available tool.  In 1997, another DIDRA (The Depository Institutions Disaster Relief Act of 1997 (PL 105-18)” was passed to deal with the devastation related to the flooding of the Red River in the Dakotas and Minnesota.  It too reiterated and granted relief related to certain FIRREA appraisal requirements, TILA, EFFA, and PCA capital leverage ratio requirements. The TILA, EFAA, and PCA capital leverage ratio flexibilities were likewise time-bound and geographically limited to the specific declared disaster. 

Additional efforts were later attempted for Hurricanes Katrina, Wilma, and Rita.  Although I believe that only regulatory relief for Katrina may have been successful, when language was inserted into a Katrina Emergency Supplemental Appropriations Bill and subsequently signed into law.

With the costly devastation that has accompanied Hurricane Sandy estimated in the tens of billions of dollars, it is highly likely that some similar temporary regulatory flexibilities will be needed by banks located in the areas declared by the President of the United States to be emergency disaster areas under the Stafford Act.  Moreover, additional flexibilities may need to be incorporated to account for germane changes in the legislative and regulatory landscape since 1997, not the least of which may be the 2010 Dodd-Frank Act.

Since periodic natural disasters are a fact of life, Congress should also consider allowing the Federal bank regulators the ongoing ability to exercise these flexibilities and regulatory relief options anytime the President of the United States declares an emergency under the Stafford Act.  This would avoid the need to pass new legislation for subsequent major national disasters and thereby speed regulatory relief to banks in affected communities.

Once the full operations of the Federal Government resume this week, it would be helpful to those banks adversely affected by Hurricane Sandy for Senate Banking Committee and House Financial Services Committee staff to consult with the banking trade associations and the community of Federal banking regulators, and begin drafting the “Depository Institutions Disaster Relief Act of 2012”.  With earnest efforts by both political parties, this could be passed during the upcoming lame duck session of Congress.