Financial leaders are facing major headwinds this year. Declining net interest margins, loan growth and regulatory challenges are top concerns for banking leaders, according to the results of an audience survey at Bank Director’s Acquire or Be Acquired conference in Arizona in January. Jordan discusses the top concerns and what to do about them.
Few pieces of legislation in recent years have riled up the financial services industry as thoroughly as the Dodd-Frank Act. And the white hot center of that controversial law is probably the new Consumer Financial Protection Bureau (CFPB), which the Act created to police the marketplace for personal financial services. If you’ve been reading the news lately, you know that the CFPB has a new director—former Ohio Attorney General Richard Cordray—who received a sharply-criticized recess appointment recently from President Obama. Senate Republicans had refused to hold confirmation hearings on Cordray until certain changes were made to the agency’s organizational structure, and Obama finally lost his patience and made Cordray’s appointment official while Congress was in recess.
If you have been paying attention, you also know there’s a difference of opinion between Senate Republicans like Majority Leader Mitch McConnell (R-Kentucky) and the White House over whether Congress was technically still in session, so the legality of Cordray’s appointment might be challenged in court. It’s also entirely possible—perhaps even likely—that the CFPB will be legislated out of existence should the Republican Party recapture the White House and both houses of Congress this fall. No doubt many bankers, their trade associations and the U.S. Chamber of Commerce would like to see that happen.
On the other hand, if the president wins reelection, I am sure he would veto any such bill that might emerge from a Republican controlled Congress, should the Republicans hold the House and retake the Senate this fall, which is possible but by no means assured. And if you give Obama a 50/50 chance of being reelected—which is my guess at this point having watched the Republican presidential race closely—then you can reasonably assume the CFPB has a 50/50 chance of surviving at least until January 2016.
And I think that’s a good thing.
This probably puts me at odds with most of Bank Director magazine’s readers. There’s no question that Dodd-Frank, combined with a variety of recent initiatives that have come directly from agencies like the Federal Reserve, will drive up compliance costs for banks and thrifts. And the CFPB‘s information demands alone will be a component of those higher costs. However, I have a hunch that what scares some people the most is the specter of a wild-eyed liberal bureaucrat imposing his or her consumer activist agenda on the marketplace. I don’t think Cordray quite fits that description, based on what I’ve read about him, but obviously we won’t know for sure until he’s been in the job for a while, so the naysayers’ apprehension is understandable. At the very least he seems determined to get on with the job, so we should know soon enough what kind of director he will be.
Here’s my side of the argument. Among the primary causes of the global financial crisis of 2008, which was precipitated by the collapse of the residential real estate market in the United States, were some of the truly deplorable practices that occurred during—and contributed to—the creation of a housing bubble. Chief among them were the notorious option-payment adjustable rate mortgages and similar permutations that allowed borrowers to pay less than the amortization rate that would have paid down their mortgages, which essentially allowed them to buy more house and take out a bigger mortgage than they could afford to repay. Some of these buyers were speculators who didn’t care about amortization because they planned on flipping the house in two years. But many of them were just people who wanted a nicer, more expensive house than they could afford and figured optimistically that things would work out. And the expansion of the subprime mortgage market brought millions of new home buyers into the market just when housing prices were becoming over inflated.
I’m not suggesting that the CFPB, had it been in existence during the home mortgage boom, could have single-handedly prevented the housing bubble. The causes of the bubble and the financial panic that eventually ensued were many and varied, including the interest rate policies of the Federal Reserve, the laxness on the bank regulatory agencies when it came to supervising the commercial banks and thrifts, the laxness of the Securities and Exchange Commission when it came to supervising the Wall Street investment banks and the fact that no one regulated the securitization market. But an agency like the CFPB, had it been doing its job, would have cracked down on dangerous practices like the so-called liar loans, or loans that didn’t require borrowers to verify their income. It would have put an end to phony real estate appraisals that overstated a home’s worth, making it easier for borrowers to qualify for a mortgage. And it would have been appropriately suspicious of option-ARMs if a super-low teaser rate and negative amortization were the only way that a borrower could afford to buy a home.
The CFPB is not a prudential bank regulator and will not focus on bank safety and soundness like the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. But in cracking down on some of these dangerous marketplace practices, the CFPB might have reigned in institutions like Wachovia, Washington Mutual, IndyMac and Countrywide that ultimately failed, or were forced to sell out, because it would have discouraged many of the shenanigans that helped feed the housing bubble.
Of course, many of the unsound practices that helped inflate the bubble were widespread outside the banking industry, and one of the CFPB’s principal—and I would say most important—duties will be to regulate the mortgage brokers and nonbank mortgage originators who accounted for a significant percentage of origination volume during the housing boom. Banks and thrifts should benefit greatly from this effort if it leads to the creation of a level playing field where nonbank lenders can no longer exploit the advantages of asymmetrical regulation.
A truism of our financial system is that money and institutional power will always be attracted to those sectors that have the least amount of regulation. For all intents and purposes, both the gigantic secondary market and the large network of mortgage brokers and nonbank mortgage lenders went unregulated during the boom years, and this is where the greatest abuses occurred. (Dodd-Frank also addressed the secondary market, although the jury is out whether its prescribed changes will work. Indeed, at this point it’s unclear whether the secondary market for home mortgages will ever recover.)
In hindsight, having two mortgage origination markets—one highly regulated, the other unregulated—was asking for trouble. And that’s exactly what we got.
When FDIC Chairman Sheila Bair gave a speech last month at the American Bankers Association’s Government Relations Summit in Washington, D.C., she got into what theAmerican Banker newspaper characterized as some “testy” exchanges with the audience while taking questions after her prepared remarks, particularly on topics like the Dodd-Frank Act and a proposed reduction in interchange fees.
Given the tone of the Q&A session, one could reasonably conclude that the state of “government relations” between bankers and the federales smells like sour milk right now. Certainly, banking regulators have been playing hardball over the last two years with institutions that are dangerously undercapitalized or have been slow to address their deteriorating asset quality. If the regulators were asleep at the switch during the real estate bubble in the mid-2000s, they probably overcorrected once the bubble burst.
To paraphrase Claude Rains in “Casablanca,” regulators were shocked – shocked! – to discover that highly leveraged banks were piling up concentrations in commercial real estate loans that turned out to be extremely dangerous.
But this is not the first time in my memory that federal banking regulators have cracked down hard on financial institutions after a period of, shall we say, benign supervision. Back in the late 1980s, after the so-called thrift crisis, Congress passed the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) that among things abolished the old Federal Home Loan Bank Board – the thrift industry’s prudential regulator – and replaced it with the Office of Thrift Supervision. FIRREA was detested nearly as much as the Dodd-Frank Act is today, and the OTS used the law’s higher capital requirements to put a lot of highly-leveraged thrifts out of business. It struck many people back then as an example of frontier justice with the OTS playing the roles of sheriff, judge and hangman.
The point is, what’s happening today isn’t new. If you watch the banking industry long enough, you’ll see everything at least twice, including things that everyone swore the first time would never happen again.
Like it or not, the regulators have a job to do. Many banks became too reliant on real estate lending during the bubble, and once it popped they needed to raise capital so they could afford to charge off their worst loans. Based on what I have heard from bankers, lawyers and investment bankers, the regulators haven’t been willing to allow marginal institutions to earn their way out of their asset quality and capitalization problems, but have been forcing the issue in many instances. As much as they dislike Dodd-Frank or the proposed limits on interchange fees, I believe that much of the tension between banks and their regulators derives from regulatory activism at the grass roots level.
It won’t always be this way. The industry’s asset quality will gradually improve as the economy strengthens, most undercapitalized banks will either figure out a way to raise capital or will sell out to a stronger competitor, and the regulators will ease up. CEOs and directors may not like this oscillation between supervision sometimes being too soft and sometimes being too tough, but it seems to be a normal phenomenon in banking.
After living through one of the worst financial crises since the Great Depression, I am sure that all of federal banking regulatory agencies have felt pressure to tighten up their supervision. And while privately they might chafe against the heightened scrutiny, smart CEOs and their boards don’t go to war with their institution’s regulators. Instead, they consult with them frequently, communicate regularly and take a proactive approach to problem solving.
Smart bankers take the long view of regulatory relations. And that certainly doesn’t include picking a public fight with the chairman of the FDIC.
Congress created the $30 billion fund to provide capital to banks and increase lending to small business, but as of Monday, a little more than 600 banks applied for only $8.6 billion, according to Treasury spokeswoman Colleen Murray.
Those numbers disguise the fact that about 2,000 banks are S corporations or mutual companies and haven’t had a chance to apply yet because the Treasury hasn’t given them a term sheet.
So as the Wall Street Journal reported last week, the fact that only 7 percent of all banks actually applied by the end of March deadline is not as pathetic as it looks.
The U.S. Treasury has extended the deadline for banks to apply from the end of March to May 16 and will issue term sheets within weeks for S corporations and mutuals, Murray said.
She said the Treasury expects applications for the program to start flowing in, and there’s a real need for capital on the part of small business.
Still, there’s a lot of hesitancy among banks. Those that have Troubled Asset Program Relief capital can refinance into the Small Business Lending Fund and potentially save money on dividends to the government, as long as they increase lending.
But for banks that didn’t have TARP money, there is less of an incentive to apply.
Banks that have CAMELS 4 or 5 ratings aren’t eligible, either.
Plus, “many banks concluded there wasn’t sufficient enough growth opportunities to warrant taking on that type of capital,’’ said Richard Maroney, co-head of investment banking for Austin Associates. Although the dividends banks must pay on the capital start low, they can rise as high as 9 percent for banks that don’t increase small business lending after four and a half years (although banks can repay the capital and avoid the higher dividend).
Plus, bankers are wary the federal government could change the rules on them. There is, indeed, a good amount of political pressure surrounding the program.
Congresswoman Sen. Olympia Snowe, R-Maine, for example, introduced a bill last month saying the program lacked “transparency and accountability.” The bill would make it impossible for the fund to give money to banks that had TARP money.
“I think there is still a taint from TARP,’’ Maroney said. “I had a number of clients who said they were hesitant to deal with the government.”
Neil Barofsky stepped down this week as the official watchdog for the $700 billion Troubled Asset Relief Program, a safety net for just about everyone during the financial crisis, from banks to car companies to homeowners. As the special inspector general for the Troubled Asset Relief Program (STIGTARP), Barofsky has done a great deal to highlight problems and pinpoint areas for improvement.
He has repeatedly criticized the U.S. Treasury, for example, for its handling of the TARP Home Affordable Modification Program, which failed to live up to its lofty goal of saving three million to four million households from foreclosure.
But in one respect, Barofsky takes a little too much credit.
He said in its last quarterly report to Congress in January that his organization had 142 ongoing criminal and civil investigations, resulting in 13 criminal fraud convictions.
But none of the law enforcement investigations described in the report relate to any taxpayer dollars stolen. Two of the companies mentioned, The Shmuckler Group and Residential Relief Foundation, were accused of swindling homeowners by promising to modify mortgages in exchange for fees. (The Home Affordable Modification Program does try to help struggling homeowners modify mortgages through their banks, but without any upfront fees for homeowners).
Another case is the prosecution of bank officers for Colonial Bank and mortgage lenders Taylor, Bean & Whitaker. Prosecutors believe Colonial Bank tried to obtain $550 million in TARP program money using fraudulent mortgages cooked up by officers at Taylor, Bean & Whitaker, according to The New York Times. (The case is ongoing). Again, no TARP money was obtained by the bank, but The New York Times says the case got started when STIGTARP became suspicious of the size of the bank’s TARP application.
In another case, Gordon Grigg, who is now serving a 10-year prison term, was convicted in Nashville, Tennessee, of stealing at least $6 million from investors. Grigg promised at least one investor he could invest in TARP-related debt, although no such investment opportunity exists. I was a reporter covering a press conference in Nashville in 2009 when Barofsky flew in from Washington, D.C. to join federal and local law enforcement officials announcing the charges against Grigg. It was advertised as the first TARP-related fraud case, and it got national media attention.
Again, no actual TARP money was involved.
Still, the law enforcement end of STIGTARP presses on. The watchdog agency has 45 armed officers and 27 vehicles equipped with lights and sirens, and recently asked Congress for additional money to upgrade vehicles, according to a recent CNBC story.
A spokeswoman for STIGTARP, Kris Belisle, confirmed that report and said the agency has been successful in stopping people from using TARP money fraudulently. That may be the case. But after more than two years of TARP, it’s surprising the lack of fraud using taxpayer dollars disclosed so far by all these armed investigators. Is that because none exists, or is that because we haven’t found it?
The U.S. Treasury reported this week that taxpayers will make a $20 billion profit from the Troubled Asset Relief Program for banks, the government’s emergency support during the financial crisis.
That’s because banks have been paying dividends to the government on what was essentially borrowed capital and now 99 percent of the funds have been paid back.
The latest banks to pay back TARP, as announced this week, were Cincinnati’s Fifth Third Bancorp; Boyertown, Pa.’s National Penn Bancshares; Rapid City, South Dakota’s Stockmens Financial Corp.; San Jose, California’s Bridge Capital Holdings; and Norfolk, Virginia’s Heritage Bankshares.
Separately, the Congressional Budget Office has brought down its estimate of the total cost of TARP to taxpayers, which included investments in automobile manufacturers and insurer AIG, down to $25 billion, must less than the $356 billion the budget office previously estimated.
Winding down its work this week, the Congressional Oversight Panel for TARP released its final report on the program, saying TARP helped avert an even worse financial meltdown, which has become a pretty standard line for economists on both sides of the political aisle.
The Congressional Oversight Panel said: “The TARP does not deserve full credit for this outcome, but it provided critical support to markets at a moment of profound uncertainty. It achieved this effect in part by providing capital to banks but, more significantly, by demonstrating that the United States would take any action necessary to prevent the collapse of its financial system.”
The report goes on to criticize TARP as well, saying part of the reason the program has cost so little is because some of it didn’t work. For instance, the home affordable modification program (HAMP) was designed to lose money and benefit three to four million homeowners, but the U.S. Treasury hastily crafted it, and relied on voluntary participation from mortgage servicers.
“The program now appears on track to help only 700,000 to 800,000 homeowners,’’ the Congressional Oversight report says.
Also, TARP probably cost less than expected because of other government aid to the economy, the report says.
Plus, TARP leaves an even bigger problem on the table: the problem of moral hazard, the report says.
“By protecting very large banks from insolvency and collapse, the TARP also created moral hazard: very large financial institutions may now rationally decide to take inflated risks because they expect that, if their gamble fails, taxpayers will bear the loss. Ironically, these inflated risks may create even greater systemic risk and increase the likelihood of future crises and bailouts.”
The Congressional Oversight Panel is not the only one to bring up this problem. Many economists have been calling attention to the same issue. Whether the topic will resonate with the American public, still reeling from high unemployment, remains to be seen.
Elizabeth Warren, the special advisor setting up the new Consumer Financial Protection Bureau, fought back challenges from Republicans during a subcommittee hearing Wednesday of the House Financial Services Committee.
Warren, who declared that the foreclosure crisis would not have occurred if the Consumer Financial Protection Bureau had been in place six years ago, kept her poise during a barrage of questions from Republican lawmakers concerned about her authority and the potential impact on banks.
“You are directing perhaps the most powerful agency that’s ever been created in Washington,’’ said Rep. Spencer Bachus, R-Alabama, who is chairman of the House Financial Services Committee, saying Warren or the person ultimately appointed to head the agency will get to decide what’s an abusive practice in financial services and what’s not.
“We almost have to have good faith in your integrity and judgment,’’ said Bachus, who introduced legislation today that would create a five-member bipartisan commission to run the bureau instead. “That’s quite a burden for you and quite a burden for us.”
He pointed out that the agency has a $300 million annual budget, about the size of the Federal Trade Commission.
Other Republicans questioned why Warren was involved in discussions with the U.S. Department of Justice and 50 states attorney generals about a possible settlement over mortgage fraud accusations with mortgage servicers, even though the Consumer Financial Protection Bureau doesn’t have enforcement powers yet.
Warren defended her actions, saying she had been asked for advice by the Department of Justice and the U.S. Treasury, and she was simply giving her advice, although she declined to divulge details of the conversations.
She also said the Congress set up the Consumer Financial Protection Bureau to be headed by one person, instead of a board, to increase efficiency.
It is crucial, she said, that “we have a real cop on the beat.”
She said the consumer protection authority of the Federal Reserve and other banking regulators will be transferred to the Consumer Financial Protection Bureau on July 21.
In answer to a question about current financial regulators efforts to protect consumers, she said: “The evidence is fairly clear that they did not do their job.”
She also sought to emphasize that the agency’s goal was to make financial products’ pricing and risk clear to consumers; and that her agency didn’t have the authority to regulate financial products such as mutual funds.
“There are many people who have figured out how to return incredible profits and revenues, into the tens of billions of dollars, selling products, car title loans, remittances, we could go on and on, without making the risks and pricing clear upfront,’’ she said, “making it impossible to compare one product with two or three others.”
Republican Steve Pearce, from New Mexico, lambasted her for not giving the straightforward and clear, concise answers to the committee members she was demanding of financial companies.
“What damn business is it of yours if I want to borrow $100 and pay back $120?” he asked.
The Small Business Lending Fund may be that gift from Congress to bankers they never expected.
After months of gridlock, legislators passed a small business bill last September that included $30 billion for small business loans.
Banks with less than $10 billion in assets can apply to the U.S. Treasury for the capital, and then use the money to lend to small businesses, as a way to generate relief for the economy. The reason it is so great for banks is that many of them still are saddled with Troubled Asset Relief Program money (TARP) and they are having a tough time raising capital, especially smaller, community banks.
This new fund will give them a chance to refinance out of TARP, save money in dividends paid to the government, and have the new money count toward Tier 1 capital to satisfy regulators. Even banks without TARP money can apply.
“It’s a no brainer,’’ said Christopher Annas, the president and chief executive officer of Meridian Bank in Devon, Pennsylvania.
His $400 million-asset bank would reduce dividends from $600,000 to $125,000 per year, by refinancing out of TARP into the small business fund.
The dividend rate on the new fund is from 1 percent to 5 percent, depending on how much the bank increases lending to small business. Banks that increase lending by less than 2.5 percent will pay 5 percent dividends on the fund. Banks that increase lending by more than 10 percent pay 1 percent. In contrast, banks must pay TARP dividends of 5 percent, no matter how much they increase lending.
Even the potential drawbacks of the new program seem hard to find. For instance, banks have two years to increase their lending to small businesses before they start paying penalties. With penalties, the rate is no more than 7 percent or 9 percent—and the higher amount is if lending doesn’t increase after four and a half years.
The banks are free to pay back the Small Business Lending Fund money at any time, without penalty.
So if it doesn’t work out, no worries.
“If you don’t need the capital right now, take it, you can use it next year,’’ Annas said.
If a bank is having trouble raising capital, the fund could equate to “deferring your capital raise for two or three years,’’ said Richard Maroney Jr., who co-manages the investment banking division of Austin Associates in Toledo, Ohio, and spoke at Bank Director’s Acquire or Be Acquired conference in Scottsdale, Arizona recently.
With 1 percent to 5 percent dividend rates, “over time, you could say that’s a pretty good cost of funds,’’ he said.
For instance, if a bank takes $10 million in small business lending money, refinances out of TARP and reduces its dividend from 5 percent to 1 percent, that’s a savings of $400,000 per year, Maroney said.
There are some requirements though:
Any bank, thrift or bank holding company applying for the funds must have assets of less than $10 billion.
The deadline to apply is March 31. However, there is no obligation to take the funds if applying.
Each loan commitment can’t be more than $10 million.
The loans must be given to businesses that make annual revenues of less than $50 million. Commercial and industrial loans are included. So are owner-occupied real-estate backed commercial loans and agriculture loans. SBA and other government-backed loans are excluded (no double dipping allowed).
Reporting requirements include quarterly confidential statements to the U.S. Treasury and a two-page report to the primary regulator.