The Down and Dirty of Compensation Risk


Recent federal guidance on bank incentive compensation practices, combined with the landmark Dodd-Frank Act, is requiring bank compensation committees and their audit or risk committee counterparts to take a collaborative approach to determining whether their plans pose a material financial risk to the institution. This and other topics were covered at a roundtable discussion on compensation risk that brought together directors and human resources professionals at large, publicly traded banks, representatives of the McLagan consulting firm and the law firm Kilpatrick, Townsend & Stockton. The half-day event was held in late September at the University Club in Washington, DC.

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Released in June 2010, the new rules mandate that banks must review all of their incentive compensation programs annually to make sure they have an appropriate balance of risk and reward, and that the board of directors is providing an adequate level of governance oversight.

Al Moschner, who is chairman of the compensation committee at $13.9 billion-asset Wintrust Financial Corp. in Lake Forest, Illinois, said the compensation committee sponsored a meeting with the chairmen of the other board committees, the chief executive officer, the chief financial officer and the chief risk officer to review the risk profile of the bank in the current environment. A head of the bank’s human resources department also described the various levels of compensation that are being contemplated for the coming year. “And then there was a robust discussion about whether that makes sense from a risk perspective,” Moschner says.

Wintrust also emphasizes an integrative approach to managing compensation risk by having some directors serve on both its compensation and audit committees. “We try to make sure we have some cross-pollination between the two committees,” Moschner explains.

“The compensation committee needs to work collaboratively with the bank’s risk committee,” says Todd Leone, a principal at McLagan. “The risk committee needs to review the goals that drive the bank’s incentive plans. They have to ensure what is being motivated doesn’t have unintended consequences.  The compensation committee drives plan design; the audit/risk committee ensures it is within the bank’s overall risk tolerance.”

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Compensation committees today also face the challenge of developing an appropriate set of performance metrics for long-term incentive plans.
Part of the problem is that federal regulators are now focusing greater attention on compensation risk generally, but fundamental changes that have affected the entire industry add to the challenge. “How banks make money now is now very different and that makes it harder to develop incentive compensation plans,” says Clifford J. Isroff, the lead independent director at $14 billion-asset FirstMerit Corp. in Akron, Ohio, and a member of both the compensation and risk committees.

Wintrust’s long-term incentive plan used to be based on a single metric—annual earnings growth?but the current operating environment has led the bank to build multiple performance metrics into its plan, including return on assets and growth in tangible net assets. 

Another controversial issue that compensation committees are being forced to deal with is the clawback provision in the Dodd-Frank Act. The act requires the Securities and Exchange Commission to direct the national securities exchanges like NYSE Euronext and NASDAQ OMX to prohibit companies from listing their stocks if they have not adopted clawback policies that would allow them to recover incentive compensation that has already been paid to former or current executives if it was based on incorrect data.

Gayle Applebaum, a principal director at McLagan, said many of her bank clients are finding some resistance from their senior managers to the very notion of clawbacks, as well as deferrals that are now being built into many incentive plans. “Oftentimes managers don’t want these things for their people,” Applebaum says. “They are worried about their ability to retain talent.”

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One point that most of the participants agreed on was the importance of having a strong risk culture throughout the organization. Although it will still be necessary to vet the bank’s incentive compensation plans annually to satisfy the new federal requirements, a strong risk culture is every bank’s first line of defense.

“If you manage the risk, I’m not worried about the compensation plan,” said Frank Farnesi, who is chairman of the compensation committee at Beneficial Mutual Bancorp Inc., a $4.7 billion-asset mutual holding company in Philadelphia.

The Dodd-Frank Whistleblower Program: What Publicly-Traded Banks Should Know


whistle.jpgOn August 12, 2011, the Securities and Exchange Commission’s (“SEC”) final rules implementing the sweeping whistleblower program in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) became effective.  Like all entities within the SEC’s jurisdiction, publicly-traded banks and their compliance officials should take the time now to understand the whistleblower provisions and the new challenges they pose.

The Dodd-Frank Whistleblower Provisions

The Dodd-Frank whistleblower provisions are quite broad.  They extend to people who share information with the SEC or the Commodity Futures Trading Commission (“CFTC”) concerning misconduct that falls within the jurisdiction of these agencies — including accounting fraud, insider trading, stock manipulation, and violations of the Foreign Corrupt Practices Act. 

The whistleblower provisions authorize cash rewards to whistleblowers for original information leading to a recovery exceeding $1 million.  A key condition is that the tip is “derived from the independent knowledge or analysis of the whistleblower.”  The SEC and CFTC have discretion to decide the exact amount of the award based on the “significance” of the information and the level of assistance provided by the whistleblower, as long as the award is between 10 and 30  percent of total recovery.

The Final Rules

The SEC’s final rules  exclude certain individuals from receiving awards, including:

  • officers, directors, trustees, or partners of an entity who learn information about misconduct from another person or in connection with the company’s processes for identifying misconduct;
  • employees whose main duties involve compliance or internal audit, or persons associated with a firm hired to perform similar functions; and
  • employees of public accounting firms performing an engagement required by the securities laws, when the information relates to a violation by the client or its officers, directors or employees.

However, these individuals are still eligible for a reward under Dodd-Frank if:

  • they have a reasonable belief that (a) disclosure to the SEC is necessary to prevent the company from engaging in conduct that could cause substantial injury to investors, or (b) the company is acting in a way that would interfere with an investigation of the misconduct; or
  • one hundred twenty days have passed since they escalated the information to their company’s audit committee, legal/compliance officer, or supervisor, or since they received the information and the circumstances indicate that the audit committee, legal/compliance officer, or supervisor was aware of the information.

The Dodd-Frank whistleblower provisions do not impact the obligation of publicly-traded banks under certain circumstances to report suspected wrongdoing, such as in connection with suspicious activity reports or when the bank is notified by its outside auditors under Section 10A of the Exchange Act of a suspected illegal act that has not been adequately remediated.

Although the final rules do not require that employees report suspected wrongdoing through internal corporate compliance channels before disclosing information to the SEC in return for a bounty, the rules do try to encourage internal reporting:

  • A whistleblower who reports wrongdoing to the SEC within 120 days of lodging a complaint internally will be deemed to have reported to the SEC as of the date of the internal disclosure.
  • If a whistleblower reported original information internally before or at the same time that the whistleblower reported it to the SEC, and the company discloses the whistleblower’s information or the results of an investigation initiated by the whistleblower’s information to the SEC leading to a successful enforcement action, the whistleblower will receive credit for the information provided by the company and will be eligible for an award.
  • When deciding whether to increase the amount of a whistleblower’s award, the SEC will consider whether the tipster reported through internal channels and assisted with any internal investigation.

Dodd-Frank prohibits retaliation not only against whistleblowers who provide information under the award program but also against employees engaged in offering consumer financial products who provide information about what they reasonably believe to be a violation of federal consumer protection laws, even if these employees are not pursuing a Dodd-Frank whistleblower award.

Looking Ahead

Beyond enhancing existing internal compliance measures designed to identify potential misconduct (such as employee ethics hotlines), the Dodd-Frank whistleblower rules make it more important than ever for publicly traded banks to promptly review all claims of wrongdoing.  Doing so will increase the opportunity to remediate any problems and self-report the conduct to bank regulators and other authorities before a whistleblower contacts the SEC first.

 

New regulation puts additional burdens on compliance staff


overwhelmed.jpgIn the current economic climate, banks are rightly focusing on safety and soundness issues. Banks must ensure, however, that they also effectively manage their compliance function because banking regulators are increasingly focused on this area in response to the numerous regulatory changes that have recently occurred and are likely to occur in the near future. Even if a bank’s compliance practices have not been criticized in the past, there is no guarantee that they will be approved by regulators at the bank’s next examination. Here are some highlights from a recent report by the Financial Institutions Group of the law firm of Barack Ferrazzano Kirschbaum & Nagelberg LLP, in Chicago:

  • Banking regulators are significantly downgrading many banks’ consumer compliance ratings because they are concerned that their compliance management systems are not equipped to handle the potentially numerous regulatory changes to be implemented by the Consumer Financial Protection Bureau. Banking regulators view violations of recent regulations and/or repeat violations, even if such violations are minimal in number and the bank engages in minimal consumer banking activities, as being especially indicative of an ineffective compliance management system. Importantly, banks with weak compliance systems will likely have their management ratings downgraded as well.
     
  • Banking regulators are conducting in-depth reviews of lending practices and are increasingly referring cases of alleged discrimination by banks to the Department of Justice. Even long-standing lending practices have recently been criticized by examiners. Banking regulators are concerned with:  1. the extent to which banks give their loan officers discretion regarding pricing and underwriting, 2.  whether any pricing variances in any lending activity reflect discrimination against a particular group or in favor of another group, 3. if lending policies or practices may have a disparate impact on a protected class, 4. if assessment areas are appropriate, and the extent to which banks are lending throughout their entire assessment areas, 5. if changes in assessment areas reflect potential redlining, and 6. if banks are steering certain borrowers to particular loan products.
     
  • Section 5 of the Federal Trade Commission Act (the “UDAP law”) prohibits unfair or deceptive trade practices, and the Dodd-Frank Wall Street Reform and Consumer Protection Act expands this area further by prohibiting “abusive” acts or practices. It is increasingly common today for banking regulators to evaluate violations of compliance regulations under the UDAP law as well, and we will now likely see banking regulators evaluate such violations under the new “abusive” standard.
     
  • Banking regulators are delving deeply into mortgage loan originator compensation under the Truth in Lending Act and Regulation Z. Effective for compensation earned on applications received on or after April 1, 2011, a mortgage originator’s compensation cannot, with few exceptions, be based on any factor other than the amount of the credit extended. One general prohibition is the payment of compensation based on the profitability of the branch, division or entire bank.
     
  • Recently, several large banks settled lawsuits with the Department of Justice for allegedly violating the Servicemembers Civil Relief Act (the “SCRA”). These banks allegedly foreclosed on service members without obtaining court orders and/or charged service members interest rates in excess of the 6 percent interest rate cap under the SCRA. These settlements will likely prompt additional service members to file lawsuits against banks, or file complaints with their military offices for improper treatment under the SCRA.

Download the full report in PDF format.

Watch out: Federal Reserve Begins Systemic Reviews of Pending Acquisitions


risk-magnify-article.jpgAt first blush, it might seem strange that the Federal Reserve would be scrutinizing Capital One Financial Corp.’s announced $9 billion acquisition of ING Groep NV’s U.S.-based online banking unit to gauge whether it poses a systemic risk to the financial system. Capital One focuses primarily on retail businesses including credit cards and branch banking, and the operation that it’s acquiring from Dutch banking giant ING is an Internet bank. And when most people think of activities that might entail some element of systemic risk, they probably think of large trading or derivative operations—not consumer banking. 

The Dodd-Frank Act now requires the Fed to review bank mergers to determine whether they pose a systemic risk, so to a certain extent, its review of the Capital One/ING deal might turn out to be a pro forma exercise. Brian F. Gardner, a senior vice president and Washington-based government affairs analyst for Keefe Bruyette & Woods Inc., points out that the combined entity would be “pretty plain vanilla. It won’t be derivatives intensive. It won’t be capital markets intensive.”

“I think [the Fed is] serious about systemic risk, but I don’t think this is a good test case for [the systemic review],” Gardner adds. “I think the deal will go through with few objections from the Fed.”

It will probably take some time before acquirers and their financial and legal advisors understand fully what the Fed is looking for when it does a systemic review of a pending acquisition. Bankers certainly understand the concept of systemic risk including size, inter-connectedness and counterparty risk, to name a few its elements. But as Gardner points out, “It’s a term of art, not a term of science. There’s no clear, bright line definition.”

A recent memo from Wachtell, Lipton, Rosen & Katz, a New York-based law firm with a large M&A practice, does shed some light on what the Fed will be looking at when it performs a systemic merger review. 

According to Wachtell, “(T)he Federal Reserve is focusing on the availability of substitute providers of critical financial services and the interconnectedness of the company post-acquisition and seeking information about each party’s involvement in providing numerous wholesale and institutional (and some consumer) financial services, including repo funding, prime brokerage, underwriting of equity or debt or asset-backed securities, clearing and settlement, asset custody, corporate trust, credit cards and mortgage servicing. The Federal Reserve is also seeking information about market shares and specific competitors in these markets, as well as the dollar volume of overlapping activities. In addition, they are requesting information about each party’s three highest positive and three highest negative counterparty exposures, including information about any collateral or hedges.”

These are some of the things the Fed will be looking at during its systemic reviews, but is there a formula or methodology it will use to decide that one acquisition poses no systemic threat while another one does? Gardner says that even if it does have a specific methodology in mind, he doesn’t expect the Fed to articulate it for the benefit of the M&A market. 

“That preserves as much flexibility for them as possible,” he says. And while that ambiguity leaves potential bank acquirers in large, complex transactions in the dark about what to expect, “Ambiguity is the ally of the regulator.”

Living Wills for Large Banks and Systemically Important Institutions: a Blueprint


BASICS

Each U.S. bank holding company and foreign banking organization with more than $50 billion in consolidated assets and each nonbank financial institution deemed systemically important by the Financial Stability Oversight Council must submit a resolution plan, or “living will” for the “rapid and orderly resolution in the event of material financial distress or failure.” A likely deadline is July 21, 2012.

Each institution required to submit a resolution plan also must submit, on a periodic basis, a credit exposure report. These reports will be critical in the assessment of systemic risk.

The Federal Reserve and Federal Deposit Insurance Corp. have proposed rules with more detailed plan requirements and specifics on credit exposure reports. A final rule is due by January 21, 2012.

The plan must explain:

  • The structures and procedures in place to protect an insured depository institution subsidiary from the risks arising from activities of any nonbank affiliate
  • Ownership structure, assets, liabilities, and contractual obligations
  • Cross-guarantees tied to different securities, major counterparties, and a process for determining to whom the collateral of the company is pledged
  • Reorganization or liquidation in bankruptcy

The plan should anticipate the needs and duties of the Federal Reserve and the FDIC and support two functions:

  • Ongoing supervision

    • Identify material exposures to major counterparties
    • Describe the riskier components of the institution
    • Identify market and liquidity risks
    • Gather information to perform horizontal supervision
    • Develop stress scenarios and potential solutions
  • Resolution planning

    • Describe a hypothetical Chapter 7 and Chapter 11 proceeding
    • Consider which businesses to market pre-liquidation
    • Analyze the usefulness of a bridge bank
    • Assess short-term liquidity needs
    • Identify and prepare for impact of failure on other institutions

CHECKLIST

Planning

  • Appoint full-time living will team
  • Establish a reporting and oversight structure that includes input from enterprise risk management, treasury and finance, and legal
  • Designate board members to monitor process
  • Organize data collection

Major Tasks
Strategic analysis

  • Identify likely stressors
  • Analyze failure of particular entities, and that of the whole institution
  • Assess private sector solutions
  • Devise bankruptcy alternatives
  • Establish methods for protection of the bank

Corporate governance structure for resolution planning

  • Develop central planning function headed by senior management
  • Coordinate communications and reporting to board of directors

Overall organizational structure

  • Describe material entities and core business lines
  • Explain inter-affiliate relationships, including risk transfers
  • Provide financials, including on- and off-balance sheet items 

Management information systems

  • Develop a process for efficient and timely data gathering
  • Determine who will maintain access to specific data

External risks

  • Describe capital and liquidity sources
  • Identify exposures to major counterparties, including short-term funding, derivatives and other “qualified financial contracts,” and collateral arrangements
  • Determine the effect of a failure of a major counterparty

Internal risks

  • Analyze reliance of one affiliate on another for capital, funding, or services
  • Identify cross-guarantees
     

SELECT LEGAL ISSUES

 Bank Regulatory

  • Does the plan sufficiently address management of the institution’s risks, especially liquidity, counterparty, and market risks?
  • How would other supervisory tools affect execution of the plan?
  • How will emerging regulations affect the operations of the institution?
  • Should any restructuring be considered?
  • How will cross-border operations be addressed in the plan?

Bankruptcy and Restructuring

  • How would the institution be liquidated under Chapter 7 or restructured under Chapter 11 of the U.S. Bankruptcy Code?
  • What authority and duties would current directors and officers have?
  • How would counterparty rights in bankruptcy differ from those under Title II of the Dodd-Frank Act?
  • How does the institution avoid a replay of the Lehman bankruptcy?
  • What should the plan include in order to minimize the likelihood that Title II’s Orderly Liquidation Authority will apply?

Capital Markets

  • What are the creditor relationships underlying outstanding debt instruments?
  • Which instruments are realistically available to recapitalize the institution?

Corporate Governance

  • What duties do directors and officers owe in preparing the plan?
  • What duties apply when an institution is failing?

Derivatives

  • What are the material counterparty relationships?
  • Are there unusual considerations in unwinding particular positions?
  • What law governs each of the trading agreements and any credit support arrangements?
  • To what extent are close-out and netting provisions enforceable in the relevant jurisdictions?

Tax

  • What is the effect of a restructuring on deferred tax assets?
  • How do intercompany tax sharing agreements work in stress scenarios?

Technology Transactions

  • Do technology contracts provide maximum protection in a liquidation or restructuring?

© 2011 Morrison & Foerster LLP. All rights reserved.

Compliance Burden Grows Heavier


The Grant Thornton LLP Bank Executive Survey polled nearly 400 bank CEOs and CFOs in April and May about the economy and regulatory reform’s impact. Nichole Jordan, Grant Thornton’s national banking and securities industry leader, talks about some of the highlights, and offers some insights on the new compliance burden.

What did you find particularly significant about the survey’s findings?

Thirty-nine percent of respondents indicated they thought the Dodd-Frank Act would be effective or somewhat effective in preventing or reducing the threat of a future taxpayer-funded bailout.  As we take a look at Dodd-Frank one year later, we’ve been evaluating some of the more positive benefits: having compensation linked more closely to long-term performance with a focus on reducing riskier behavior and having more data transparency with a greater focus on risk management and an emphasis on a culture of compliance.  In addition, living wills create a formal structure that will benefit both those within and outside of the systemically important institution.

What did you think of the more stringent capital requirements in Dodd-Frank?

Internally within an institution, those are heavy demands to meet and it certainly limits growth in certain aspects.  However, the perception externally and in the marketplace is that having increased capital requirements is very important in this environment, especially with what we’ve seen over the last 18 months.

It certainly would seem to put more pressure on management teams.

We are seeing management teams making a shift in focus as they look at how to increase margins and overall, how to improve profitability in the institutions. We’re seeing an emphasis on trying to increase growth, but at the same time, recognizing the challenges associated with that in the current environment. Efficiency initiatives are increasing as well in banks from the standpoint of striving to develop efficiency enhancements into various processes and ensure internal controls are properly in place.

Where do you see the greatest potential for efficiency gains?

There has been a lot of success within certain institutions as they evaluate the centralization of various processes handled in multiple locations.  One example to look at from an accounting standpoint: If there are several individuals at multiple locations handling accounting for a particular branch or the reporting structure at various branches, you could centralize that process, not to reduce headcount, but to centralize by region or even at the headquarter’s location.

In the survey, there was a nearly unanimous agreement that the regulatory burden is the top concern and yet, half feel it won’t be effective at all in preventing the next crisis.

How do you react to that?

It’s difficult for any law to fully reduce the risk of the failures. Dodd-Frank would likely mitigate the risk scenario that we have just experienced, so if the pattern stays the same from what we have had over the past couple of years, Dodd-Frank would have a significant impact in reducing the risk of economic failure.  The likelihood of that same pattern occurring is relatively small, but do I think it will reduce risk? Yes.

What should the banks be doing from a compliance standpoint right now to get ready for Dodd-Frank?

One best practice would be to fully evaluate the impact and develop a timeline and an action plan that will address some of the key areas.  As we have seen, in today’s climate, an enterprise risk management process, a risk management committee and a chief risk officer are the new normal.

How should management decide whether to invest internal resources to handle the increased compliance burden or engage third parties?

Because everything is so new, it lends itself more toward being outsourced and hiring individuals who live and breathe this every day and can share that knowledge gained from serving a variety of institutions.  In future years, the inside management team can then lead the maintenance and compliance effort after the complexities of the implementation phase have been addressed.

Big Challenges, Bigger Opportunities in Bank M&A


Following our 2011 Acquire or Be Acquired conference in Arizona, Nichole Jordan, Grant Thornton LLP National Banking and Securities Industry Leader, Molly Curl, Grant Thornton Bank Regulatory National Advisory Partner, and George Mark, Grant Thornton Audit Partner and New York Financial Institutions Industry Leader, discuss the important issues facing banks today and how those are likely to help drive M&A activity over the next few years.

The issues addressed include:

  • Principal drivers of M&A activity
  • Critical post-acquisition issues
  • Effects of the Dodd-Frank Act
  • Pursuing growth in the year ahead

Download a PDF of the article.

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Bank Stocks Rise as Loan Losses Decline


How do investors see the banking sector right now, and why are they buying bank stocks?

Most of the tone is fairly optimistic and bullish. You want to own bank stocks when you’re going through a credit recovery cycle. Mergers and acquisitions is another big theme that stimulates investor interest.

What are some of the factors that will drive bank stock valuations in 2011?

It’s early yet, but the names that are outperforming so far are those that still are seeing declines in nonperforming assets, declines in reserve levels and net interest margin improvement.

How will M&A drive stock values?

With valuations at trough levels for some decent banks, not specifically broken banks, but banks in good markets, with good deposit share, I think there is a great investment opportunity to own a basket of potential sellers.

How much M&A activity do you expect this year?

I expect considerable amount and even more in 2012 and beyond.  My outlook for the economy is still going to be low growth, especially for the banking sector.  Banks are going to have to grow through consolidation. They’re going to have to grow through collapsing the cost structure.

It’s been a couple of years since we had a strong M&A market.  Do you think investors still remember that not all acquirers are created equal and that an acquisition can destroy value if it’s not executed properly? 

We’re reminding investors about exactly your point. You want to be in a position to own the acquirers that have shown a track record of managing the capital base well, extracting earnings power, getting the costs out, and being mindful of the cultural differences within the banks.  I think this year will be a year where any M&A is almost good M&A, but a higher level of scrutiny will be placed on deals the further we get into this cycle.

How did investors react to the Dodd-Frank Act?

The elevated expense structure is probably going to prevent banks from achieving 15 percent return on equity or 1.5 percent return on assets, which they historically produced. You’re going to get volatility in the near term. Partially, that’s because we don’t really know what the profit model is going to look like for banks.

How do investors feel about the higher capital requirements for the industry?

Investors think the capital levels are too high, and they want to see these banks deploy it or leverage it as much as they can. The investment community has much more foresight and vision than the regulatory community. The regulators are looking in the rearview mirror and saying, “We need to build capital now.”  I think the investors have it right, quite frankly, and the regulators have it wrong.

In an environment like this, I thought we’d see more emphasis on efficiency.  I can remember a time, five to seven years ago, when there was a premium in your stock if you were a low-cost operator. Is this something that investors are focused on?

Banks are not very good in general about finding ways to cut the expense line when they see revenue decreasing. I would argue banks, in general, are still overstaffed. From a technological perspective, they still haven’t embraced efficiencies in processes and procedures. I think that’s a theme that’s not being talked about very much right now, but I think it will emerge as a much more important factor as we continue with low revenue growth.

Are there a couple of banks historically that have a reputation for being good low cost operators?

The one that comes to mind is (Paramus, New Jersey’s) Hudson City (Savings Bank). These guys operate at an 18 to 22 percent efficiency ratio.

Forward-Looking Statement

“With valuations at trough levels for some decent banks—not specifically broken banks—but banks in good markets, with good deposit share, I think there is a great investment opportunity to own a basket of potential sellers.”

Taking the Long View on Regulatory Relations


two-man-facing.jpgWhen 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 the American 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.

Consumer Financial Protection Bureau chief faces Republican critics


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.