National Association of Industrial Bankers

From The Horse’s Mouth

One session during the business meeting of the National Association of Industrial Bankers on August 21 consisted of a presentation by local representatives of the FDIC and the Utah Department of Financial Institutions as to their “regulatory hot buttons.” Although certain portions of the conference were “off the record” for legitimate journalists and illegitimate bloggers, this was not one of them. For whatever value it might have to bankers and lawyers out there in the blogosphere, the following is a brief list of those “hot buttons,” with a minimal amount of editorial snark. Most of the issues apply to community and regional banks, as well as to industrial banks.

The FDIC’s Nathan Heizer asserted that the following were the major FDIC concerns at the moment:

The concentration of Risk. This is a problem for industrial banks since most of them are involved in only one type of lending (that’s the reason that they’re owned by companies like Pitney Bowes, Toyota, Harley Davidson, BMW, GE, Target, Sallie Mae, USB, etc.). There’s not much ILCs can do about this other than close their doors. Most, if not all, of the ILCs’ parent companies, could write a check for the full amount of the assets of the bank subsidiary, so capital support shouldn’t be an issue.  Mr. Heizer also said that while the regulators used to think that “geographic diversification” was a risk mitigator, they no longer gave much weight to this factor because, in the current crisis, all areas of the country were hit hard. I found this difficult to believe. If the recently failed Guaranty Bank of Dallas had not focused on California residential construction lending and, instead, stuck closer to home, is the FDIC saying that the end result would have been reached as rapidly, if at all? Geographic diversification must still be of some use in risk management, notwithstanding this “flavor-of-the-moment” change of position by the FDIC.

Capital Is King. You cannot have too much capital in these times. ILCs should seriously consider sacrificing ROE for boosting capital, according to Mr. Heizer. Of course, community banks that seek to raise capital when directed to do so by the FDIC or other federal regulators have a difficult time doing so when they tell potential investors that they can’t achieve an expected return on equity.

Asset Quality will be a critical factor in upcoming exams. The quality of your assets will affect reserves and capital. If you exclude the ILCS (a big exclusion), Utah has the highest ratio of non-performing assets to capital in the nation. That surprised a lot of people but demonstrated to me that doing away with the ILC charters would not only not strengthen the FDIC fund, but would remove strong performers who pay assessments and lend money, leaving the broken to inherit the Earth (until they quickly die).

Aggressive Growth is a no-no. Almost every failure the FDIC has seen has involved “aggressive growth.” He didn’t define “aggressive,” but I would assume that it means any normal bank who grew during the 2003-to-2007 period when times were good. The lesson here is that if you’re trying to enter the banking business, your business plan better not show “aggressive growth.” A better game plan would be “tepid” growth.

Management Quality is a key focus of the FDIC. The FDIC is focusing on management skills in dealing with risk during times such as these. Those who made loans when the living was easy may not have the skillset (or the incentive, if they’re trying to avoid blame) for dealing with troubled assets and positioning the bank in the best manner to survive the current downturn. This may have been directed at board members and CEOs especially, those who need to evaluate the skill set of their management team and “reposition” it accordingly with workout and turnaround talent. Mr. Heizer also said in most insolvent institutions, management did not promptly recognize their problems and deal with them, but waited until the regulators examined them and told them to deal with them, by which time it was often too late. One of the best things you can tell a bank to do is to get the jump on the problem assets before the regulators come in the door. If you wait until you’re “caught,” the regulators will hold it against you and rate management low on the CAMELS rating.

Brokered Deposits are a big problem for the FDIC because they increase the cost of resolving failed banks. On the other hand (as the CEO of an ILC told me) most ILCs rely heavily on such deposits because they can’t take retail deposits. Also, more than one bank official told me that there’s nothing inherently risky about such deposits if you know what you’re doing. Again, as long as you’re well-capitalized and stay that way, your less likely to take heart from the regulators on this issue, although you may have to meet a higher capital ratio to be considered “well-capitalized” than a bank that relies on “core deposits.”

Liquidity Risk is a target of the FDIC, since banks have failed, even though well-capitalized, because they experienced a run on the bank. I chuckled at this risk coming on the heels of the risk of brokered deposits, which are used to deal with liquidity risk. You can’t restrict brokered deposits and expect liquidity risk not to be increased. Even for community banks that can take retail deposits, the big banks are building branches on every corner and taking that business away from the community banks. At any rate, Mr. Heizer pointed to FIL-84-2008 on Liquidity Risk Management for guidance on the issue and bankers would be well advised to make certain that they are familiar with it..

Darryle Rude of the Utah Department of Financial Institutions discussed the following additional “hot buttons”:

Compensation Tied To Volume has been a problem in most failed banks and is frowned upon by the regulators. I guess traditional mortgage brokerage forms of compensation are out the window, eh?

Deceptive Trade Practices is a current focus. As if banks weren’t worried enough about merely surviving. I understand that the regulators are responding to subprime mortgage abuses. On the other hand, to pick this out of all the current concerns for emphasis, especially to a group of survivors who likely haven’t been engaged in widespread practices of such a sort (for the most part) and aren’t likely to be engaged in such practices in the future was, to me, a discordant comment.

New Credit Card Act compliance was also going to be a focus of this regulator, because, I assume, there are large credit card banks among the ILCs (like Target Bank and Advanta). Also, I think that since this is one of the few pieces of financial institution legislation to make it out of the latest Congress, the state regulators are showing the FDIC they know consumer protection as well as does Sheila Bair.

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