Monthly Archives: June 2010

Appraisals need to reflect current condition of collateral

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When should a banker get a new appraisal on collateral? That question came up at the regulator panel hosted by the Minnesota Bankers Association earlier this month in Duluth. James LaPierre, the FDIC Director of the Kansas City Region offered guidance.

“The expectation is that you will have a current appraisal,” LaPierre said. “The most likely need for an appraisal less than annually is if the existing appraisal does not show what is happening in the project.”

LaPierre suggested an example of a condominium project in which the bank loaned the developer money based on a business plan to sell each of the condos. Mid-project, the developer decides to rent the condos. In that situation, “we would expect a new appraisal,” he said.  

“The more likely scenario is we will simply adjust the appraisal. If we see a project where the business plan says we are going to sell eight units a month for 10 months and the sales level is actually four units a month with the sales price $25,000 per unit less than anticipate, that will be an adjustment — assuming you are down to a collateral bases where the loan has become collateral dependent,” LaPierre said.

“If it is not collateral dependent and the borrowers continue to make payments, it is a much more difficult thing because the question becomes ‘does that borrower have both the capacity and the willingness to continue?’ We have seen cases where borrowers had significant other assets, but they get to the point where they realize that it is no longer a good economic decision for them to continue to pay, and if they are paying it is very difficult to look forward and say they are going to get to that point.”

Blake Paulson of the Office of the Comptroller of the Currency, had this to say: ”On appraisals, it is very important that you have done your analysis. And if it is a severe problem loan, I would expect every quarter that you have done you analysis of what that collateral is worth, given recent information. If the examiners see that you have done that analysis and it is reasonable, they are much more likely to accept that than if they open the loan file and there is no appraisal and it looks like the economics have changed. You are much better off doing the analysis yourself and let the examiners validate that, versus forcing the examiners to do their own analysis.”

Look for in-depth coverage of the regulatory panel in the July 15 edition of NorthWestern Financial Review magazine.

Tomorrow likely to be like today

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As an English major in college who needed a science credit, I took a course in meteorology. I remember the professor telling us that if you simply predict that the weather tomorrow will be the same as it is today, you will be correct about 70 percent of the time.

That statistic came to mind recently while I was listening to a panel of regulators discuss local conditions. The Minnesota Bankers Association hosted the regulators during a session of its annual convention two weeks ago in Duluth.

James LaPierre, the head of the FDIC’s Kansas City Region, commented on CAMELS ratings. He said if you want to predict what composite rating regulators will assign your bank after an examination, you should expect the rating to be the same as the one you had before.

“Across our region, from 1-rated banks to 5, by far the most likely rating if you were rated 1 last time, by far you are most likely to be rated 1 this time. And that is across all five rating bands. If you are examined again, your most likely rating is the same one you had last time,” LaPierre said.

However, if your rating changes, he said, in the current environment you are twice as likely to be downgraded as your are to be upgraded.

Ron Feldman, senior vice president at the Federal Reserve Bank of Minneapolis, also participated in the panel discussion. He noted that every quarter, the Fed runs a predictive model to calculate the likelihood of a CAMELS downgrade at each bank in its district. He said that for Minnesota banks in the first quarter, “It was the first time that I have seen a decrease in the likelihood of downgrades across each of the rating categories. The chance of being downgraded has gone down in virtually all of the categories.”

LaPierre reported that as of June 4, twenty-seven percent of the banks in the country have a CAMELS rating of 3, 4 or 5.

Kevin Murphy, the deputy commissioner of commerce for the state of Minnesota, who also participated in the panel discussion, indicated 200 of Minnesota’s 306 state chartered banks have a rating of 1 or 2.

Congratulations to bank champ, Tim Meininger

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Congratulations to Tim Meininger, who won the Minnesota Bankers Association’s “Bank Champion” award two weeks ago. The annual honor is presented at the MBA’s convention, this year conducted in Duluth.

Meininger is president of the Beacon Bank office in Duluth. Beacon Bank, based in Shorewood, Minn., is run by its founder, Bob Weiss. Bob came to know Tim through the Minnesota Bankers Association. Both had served as president’s (now called chairman) of the association, Bob in 1998-99 and Tim in 2000-2001. In 2002, when Tim separated from Republic Bank in Duluth, where he had worked for years, he and Weiss began talking about opening a new shop in Duluth. In December 2002, Beacon Bank Duluth opened with Meininger at the helm.

Here are excerpts from the MBA press release announcing Meininger’s selection:

The MBA Bank Champion award recognizes a banker who has been an outstanding champion of banking by demonstrating proactive leadership that supports the best interests of Minnesota’s banking community through lobbying, education and community service.

 The judges evaluating Tim’s application were especially impressed by the support letters that were submitted by community leaders and bank staff. Quotes from just a few of the letters included:

 Duluth Area Chamber of Commerce President, David Ross, wrote:

“Tim Meininger has been the most influential volunteer leader I have had the good fortune of working with in my thirteen years as president of the Duluth Area Chamber of Commerce. What sets Tim apart from other community leaders is his sincere commitment to his leadership responsibilities, his humor, his empathy, and the kindness and genuineness he exhibits in every interaction.”

 Duluth Greater Downtown Council President, Kristi Stokes wrote:

“One of the key components of community leadership is utilizing your social capital.

Tim’s network of friends and colleagues is far-reaching. He has tapped into this network to help the ODC accomplish many successful initiatives, from membership recruitment to creating a Special Service District which further enhances and strengthens the central core of our community.”

 Letter from Beacon Bank President & CEO, Bob Weiss:

Tim has been an extraordinary Community Banker for over 36 years. During that time, Tim has served as a community leader in every community he has served.

 I have always known that Tim is a pillar of the Duluth community, but this became more apparent to me when Tim joined Beacon Bank as the President of the Duluth market. I was amazed at his level of community involvement, his knowledge of the Duluth market and his interest in its future. Community leaders listen to what Tim has to say, are interested in his insight and respect his involvement.

 A Letter from Beacon Bank Staff:

The “door is always open” to Tim’s office. He is always ready with an encouraging word, finds satisfaction in the accomplishments of employees and customers and values the success they achieve and whatever role he played in that success.

 Tim is a role model and mentor to all of us. He knows all our customers by name and takes time to visit with them when they come into the bank. He knows their businesses. He empowers us, his employees, to make our own decisions and then stands behind us. Tim Meininger is our ‘beacon.’

 

Conference committee passes reform bill

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A House-Senate conference committee passed financial regulatory reform legislation this morning, just about the time I was finishing up a bowl of Wheaties for breakfast. Here is how the Huffington Post covered it. Although CNBC published this before the committee finished its work, I thought this comment from Sen. Judd Gregg was interesting.

Here is the statement issued by the American Bankers Association:

“The American Bankers Association remains strongly opposed to the legislation agreed to by the House and Senate conferees today. 

 “Bankers have supported key reform principles since the beginning of this debate.  Creating a systemic risk council, creating a robust method for handling the failure of large institutions, ending the concept of too-big-to-fail, closing gaps in regulatory oversight, and enhancing consumer protection are all laudable goals that the industry supports. 

 “But these important provisions are overshadowed by a number of other provisions in the bill that run far afield from Wall Street reform and will ultimately harm Main Street.  The consequences involved are very real and will have a very negative impact on traditional banks, on consumers and on the broader economy.  This bill will, in the end, add well over a thousand pages of new regulations for even the smallest bank.  As a result of this volume and the new restrictions, many small banks are telling us they will simply have to sell out to larger institutions that have the staff to deal with the massive volume of new reports and rules. Above all, the capability of traditional banks to provide the credit needed to move the economy forward has been undermined in numerous ways.

 “We have worked tirelessly to ensure that members of the House and Senate understand and recognize these concerns.  While we have had some success in this regard, in the final analysis, the legislation in question simply does more harm than good and will make it exceedingly difficult for banks to be the drivers of economic growth and recovery going forward.”

Here is the press statement issued by ICBA:

“Congress has nearly completed work on the most monumental financial regulatory overhaul legislation since the Great Depression.  This financial and economic crisis has clearly demonstrated that reform of Wall Street is needed to safeguard our financial system, the nation’s taxpayers and our communities from a future catastrophe. ICBA has grave concerns with some sections of the final bill and opposed them throughout the process, but we are pleased that the bill also includes many other provisions that we have long advocated.

“While the bill could go further to restructure megafirms and hold nonbanks that were the root cause of this crisis accountable, it does include powerful language that will help rein in these culprits from their excessive size and risks they pose to our financial system.   In particular, ICBA is pleased that Congress adopted a version of the Volcker Rule that will bar megabanks from propriety trading and investing in or sponsoring a hedge fund or private-equity fund. Ultimately, this will help prevent major financial firms from putting customers, taxpayers and the financial system at risk by conducting risky activities solely for their own profit.

“ICBA also appreciates that Congress recognizes the differences between Main Street community banks and Wall Street by ensuring megabanks pay their fair share for the risk they pose to the FDIC’s Deposit Insurance Fund (DIF), and ultimately our entire financial system.  The change in the deposit insurance assessment base, which ICBA advocated, will save community banks roughly $4.5 billion over the next three years—capital that will be reinvested in the communities they serve.  ICBA is pleased that other measures such as the permanent increase in the FDIC insurance limit to $250,000 and the extension of the Transaction Account Guarantee (TAG) program for an additional two years were also included in the bill.  Many other sections of the bill recognize the value of a tiered regulatory system that differentiates between small and large banks.  Additionally, ICBA is pleased that conferees modified an amendment that would have prevented all financial institutions from including trust-preferred securities in their Tier 1 capital.  With the modification, bank holding companies with less than $15 billion in assets, and institutions organized as mutual holding companies, will be able to grandfather the TruPS they issued before May 19, 2010.  These provisions will go a long way to help community banks continue to do what they do best—serve the needs of their local communities. 

“However, ICBA is gravely disappointed that debit interchange language was included in the bill.  This ‘compromise’ proposal will only compound the harm to consumers and Main Street by imposing new and onerous burdens on debit card issuers, and will fail in any way to adequately account for the significant operational costs and losses incurred by community banks due to fraud and merchant data breaches. Now is not the time to change a proven interchange system just so big-box merchants can reap higher profits and pass their costs of doing business on to America’s consumers.  Consumers have already suffered enough thanks to this economic crisis that was triggered by too-big-to-fail.

“ICBA also continues to have serious concerns about a separate Consumer Financial Protection Bureau (CFPB).  While we appreciate that community banks will have some exemptions from the proposed CFPB, we fought hard for further changes and are disappointed that further changes were not included in the legislation.  Community banks have always viewed consumer protection as a cornerstone to their business model, so it makes sense that the CFPB focus on those too-big-to-fail and shadow institutions that were at the heart of the financial crisis.” 

The House and the Senate will vote on the conference committee bill next week and get it to the president for him to sign into law .

My sense is the bill will mean a lot of new jobs for regulators, but I am skeptical it will do much to prevent another financial crisis.

Mark to market and college hockey

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FASB announced last month that it wants banks to mark loans to market. This is the disaster that industry observers had been expecting for years. FASB has been moving in this direction for a long time, but some of us hoped they would never actually go all the way and demand mark to market accounting on loans.

Mark to market accounting works for investment managers, who buy assets to sell them. It does not work for bankers, who lend money with the idea of recovering it over time. A banker sells some loans, particularly home loans, but commercial loans and small business loans are typically held to maturity. Valuing these kinds of loans to current market conditions serves no useful purpose.

Rich Clayburgh, president of the North Dakota Bankers Association, had an interesting comment about FASB and bankers. He compared FASB’s interest in mark to market on loans to college hockey. “If you follow college hockey,” he explained, “you know that you can ice the puck when you are killing a penalty. You can’t ice the puck when both teams are at full strength.

“Well, the rule-makers at the NCAA wanted to make it illegal to ice the puck during a penalty. When they proposed that, all the coaches, and many players and fans, argued against it. They were adamant about needing the opportunity to ice the puck during a penalty.

“That was a classic situation where the people playing the game, the people in the trenches who have to live with the rules, know what’s best for the game, while officials in a distant office make up rules for them, and they don’t have a clue because they are not the one’s who have to live by those rules. Their livelihood is not impacted by their own rules.

“It is exactly the same thing with FASB and the banking industry,” Clayburgh continued. “FASB wants mark to market on loans and the people who would actually have to live with that are vehemently against it.”

Let states decide their own lending limits

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One of the biggest problems with the financial reform bill, now officially called the “Wall Street Reform and Consumer Protection Act of 2010,” is section 611, which would prevent state regulators from setting lending limits for the banks they supervise. It would require all banks, regardless of charter, to abide by the lending limit established by the OCC.

This would be a huge blow to the dual banking system. Twenty states currently have lending limits higher than the OCC limit.

Lending limits, of course, are much more important for smaller banks than they are for larger banks. Forcing all banks to abide by the OCC limit shifts tremendous competitive advantage to larger banks. Currently, smaller, state chartered banks can accommodate more local customers with a loan limit that reflects local conditions. A national loan limit — equally applied to all banks regardless of location — would mean only big banks could make larger loans. A national limit would significantly reduce the loan market for a lot of state chartered banks. And it means many borrowers would have fewer options. They would be forced to go to larger banks, where the service would most likely be less individualized.

Tim Karsky, the Commissioner for the North Dakota Department of Financial Institutions, put together an interesting list of the state’s 77 state chartered banks. (There are 92 banks total in N.D.) North Dakota currently has a lending limit for its state chartered banks that is more generous than OCC limits. The list shows each state bank’s current lending limit and the limit that would be in place if OCC rules applied to them. The average reduction in lending limit (expressed in terms of actually dollars that could be lent) at each of the individual banks is about 35 percent. At eight banks, the reduction in lending limit exceeds 40 percent, including one bank, where it exceeds 50 percent.

Some might argue that higher loan limits mean riskier banking, but that is completely false. In North Dakota, there have been no bank failures during the financial crisis of the last few years.

OCC lending limits are always going to be lower than state limits. If you have to come up with a one-size-fits all rule, as the OCC has to do, then you are going to be conservative to manage the riskiest parts of the country. This is wise, but it is bad for people who live in states where the economy is strong. A national rule forces everyone to live as if conditions are equally difficult in all parts of the country. That is ridiculous. Why punish states that diversified their economy, managed their public budgets well, and created the right environment for local businesses to flourish? Also, state regulators can respond to changing local conditions much quicker than a regulator who has to implement a national rule.

Applying one national lending limit to all banks is an incredibly bad idea. I hope the conference committee figures this out and corrects the legislation before it gets to the president’s desk.

Traditional bank or investment fund?

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I had an interesting conversation with Kevin Murphy, the deputy commissioner of commerce for the state of Minnesota, shortly after he presented some industry numbers at the Minnesota Bankers Association convention in Duluth last week.

He talked about the difficulty of gathering core deposits. He said that many of the banks that have gotten in trouble recently have relied heavily on brokered deposits and wholesale money to fund their loans. Banks have to pay up for this money, so the margins are thinner at banks that depend on brokered and wholesale money compared to those with healthy core deposits. That works fine in a good economy, but when things get tough, the thinner margins just don’t produce the earnings necessary to cover loan loss reserves. Also, brokered money is more volatile, so it is much more likely to leave a bank just when the bank really needs it.

He said that when a bank relies mainly on brokered funds, the financial institution becomes much more of an investment fund than a traditional bank. I think it is an interesting distinction. There is an important difference between lending money and investing money. Part of the difference has to do with the expectation of the person providing the funds. In the case of a bank, the customers who provide the funds are generally looking for safekeeping; in the case of the investment fund, the customers are generally looking for return.

It is one thing for a financial institutions professional to make a conscious decision to change from a banker to an investor, but it is quite another thing for the financial professional to subtly morph from one to the other due to market forces. Core deposits are getting harder and harder to come by. What does that reality mean for you? Is it making you into something you are not prepared to be?

In the past, much of the industry talk has been on lending, that is, the asset side of the balance sheet. But going into the next few years, my sense is much of the industry talk will be about deposits and funding, that is, the liabilities side of the balance sheet.

Progress on CRE loss amortization concept

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While everyone is watching the House-Senate conference committee work through the 2,000-page financial reform bill, one of the most significant developments for community banks took place in the House on a different bill — the Small Business Lending Fund Act of 2010 (H.R. 5297). This is the bill that would create a $30 billion fund to help banks make small business loans.

Much more important than the main bill, however, is an amendment the House approved by voice vote to allow banks with fewer than $10 billion in assets to amortize losses or write-downs on commercial real estate loans over a 10-year period. I have written about the need for such a thing. U.S. Rep. Ed Perlmutter of Colorado authored the amendment. Read the details here.

The House passed the bill, with the Perlmutter amendment, on Thursday, by a vote of 241-182. The Senate is expected to consider the bill after the Independence Day recess. I hope they move on it quickly and this bill gets signed into law by Labor Day.