European Crisis: Should US Banks Be Concerned?


As Europe continues to experience a financial breakdown, there is no doubt that U.S. banks are and should be worried. All banks will be affected, although some more than others, depending on their relationship abroad. Business will be impacted in a number of ways, but according to the attorneys we polled, it’s not all bad.

Should boards at U.S. banks be concerned about the ongoing problems in Europe?

Sara-Lenet.jpgThe boards of U.S. banks that may be affected the most (such as banks that hold a significant amount of European debt, deal in Euros or otherwise engage in business in Europe or with European banks) should be particularly mindful of the situation. On the flipside, in some cases, the problems in Europe may actually open up new opportunities for U.S. banks, which are opportunities that boards of U.S. banks may want to consider. For instance, European banks may begin to lend less in the U.S. and focus on preserving capital and lending in their home countries, which would present increased lending opportunities to U.S. banks (including through loan syndications).

– Doug McClintock & Sara Lenet, Alston & Bird

dwight-smith.pngYes. On an immediate basis, the problems with the calculation of LIBOR will result in a different rate, although how that may be calculated is unclear. Since the rates on many commercial and consumer loans are based on LIBOR, any replacement will at a minimum complicate the lives of both borrowers and lenders. For lending going forward, a bank probably should not use a LIBOR-based rate and may want to consider whether to base lending on any standard rate. More broadly, on a macro basis, problems in Europe inevitably spill over into the United States.

Even though the spill-over seems unlikely to cause a second recession here, any resulting slow down necessarily will have an adverse effect on the U.S. banking industry—a phenomenon we are already experiencing. The macro consequences of the European problems are beyond the control of any bank, but on an individual basis, a U.S. bank should have a deep understanding of its European exposure. This would include not only any direct exposures, for example in the form of bonds, but also exposures to commercial borrowers that may depend to a material extent on their European businesses. A bank should re-visit the use of any foreign instruments that it may use for hedging purposes. The use of foreign exchange also may require more careful monitoring.

– Dwight Smith, Morrison Foerster

Chip-MacDonald.jpgOngoing problems in Europe affect U.S. monetary and fiscal policies, especially in a presidential election year. Concerns over Europe have led to an influx in foreign investment in U.S. Treasury securities as a safe haven investment. This has reduced yields upon Treasury instruments, and TIPs (Treasury Inflation Protected Securities) have even sold at negative rates. Lower Treasury rates adversely affect the yields on bank investment portfolios and compress margins on loans and other credit assets. This makes it more difficult for banks to generate returns on equity and funds available for dividends and repurchases of common stock. Current low interest policies may have created new systemic risks by encouraging investors to “reach” for higher yields in longer maturity securities with riskier credit quality.  

All directors should be concerned about current levels of interest rates, potential future inflation, and interest rate risks resulting from these policies driven by European and domestic U.S. concerns. The regulators are especially concerned about interest rate risks and their future effects on bank balance sheets and earnings.

– Chip MacDonald, Jones Day

john-bowman.pngYes. Boards of banks, regardless of asset size, must understand generally the business of their bank and the environment in which their bank operates. For example, it was not long ago that many bank directors had never heard of or made a subprime real estate loan. They quickly came to appreciate the many challenges to their banks that that loan product presented. The European Union is the largest trading partner of the U.S. Threats and the challenges presented by the second largest economy in the world (the combined economies of the euro zone) cannot and should not be ignored. Problems in Europe could have very real consequences for financial stability in the U.S. in areas such as employment and credit availability.

– John Bowman, Venable

Peter-Weinstock.jpgFortunately or unfortunately, the world in which we live is interconnected. What once appeared to be vast oceans now seem like small ponds (unless one is flying internationally in coach). With the current global economy, it is hard to avoid thinking of the Woody Allen quote, “More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness; the other, to total extinction. Let us pray we have the wisdom to choose correctly.” Unfortunately, there are not many ways to inoculate our economy, and thus, the life blood of community banks from the contagion taking hold in Europe. Only if we as a country can get our own financial house in order will we be in a position not only to withstand, but to help the European economy to grow out of its problems.

– Peter Weinstock, Hunton & Williams

Nonaka_Michael.jpgObviously, boards at U.S. banks with European operations should pay close attention to country developments. However, boards at U.S. banks without European operations also should monitor Europe’s problems, because they have the potential for a major ripple effect if country initiatives are unsuccessful. A board should consider whether its bank has particular exposure to Europe and determine whether special contingency planning is necessary.

 —Jean Veta and Michael Nonaka, Covington & Burling

Bank stocks: “It’s really been a lost decade.”


audit12-hovde.jpgBank stocks rallied earlier this year but then faltered mid-year in the throng of worries about the European debt crisis.

“It’s really been a lost decade,’’ said Steve Hovde, the president and chief executive officer of The Hovde Group, an investment bank that focuses on  the financial services sector. He was speaking at Bank Director’s Bank Audit Committee Conference this month in Chicago.

Looking at bank stocks going back to 2007, when valuations reached their peak, the U.S. SNL Bank and Thrift index was down about 60 percent through May.

The current global outlook has put a good deal of pressure on bank stocks lately, as well. Even banks that don’t have exposure to European debt are feeling the heat, as the crisis will put a drag on the U.S. economy, Hovde said.  And a weak U.S. economy will do nothing for U.S. banks.

“Until we see a healthy economy, we’re not going to have a healthy banking sector,’’ he said. “Until we get employment back, the banking sector is going to have pressure.”

Housing

Housing still is a drag on the economy. Moody’s Analytics has predicted that home values, while improving in some markets, won’t return to pre-crisis levels until 2017. Home prices have lost about one-third of their value since hitting a peak in 2006, according to the Fiserv Case-Shiller composite index.

hovde-chart29.png

Profits

On the other hand, banks have been getting rid of bad loans and improving their balance sheets. On the credit side, net-charge offs of bad loans are declining, and tangible capital ratios are slowly being rebuilt, Hovde said.

Profitability has improved, as well, as banks reduced their loan loss provisions year-over-year in each of the past four quarters.

Return on average assets has risen to an average of 1 percent in the first quarter of 2012, up from .76 percent in the fourth quarter of last year, according to the Federal Deposit Insurance Corp.

M&A

A strengthening bank sector has led to slightly better deal pricing in mergers and acquisitions, but deal volume is still very low.

hovde-chart38.png

Uncertainty about commercial real estate and housing values still is hindering deals, as well as the fact that the stock of many buyers and sellers’ is trading below book value, Hovde said.

The glut of failed banks could also be putting a crimp on deals in some markets, and Hovde predicted that the Chicago area alone will probably have another 10 to 15 bank failures.  Nationwide, there were 403 banks with a Texas ratio greater than 100 percent as of March 31, according to SNL Financial LC. A Texas ratio greater than 100 is an indicator of potential failure. There were 59 banks with a Texas ratio greater than 300 percent, and 36 of them are in the Southeast.

Still, the pace of bank failures has slowed and many buyers are beginning to turn their focus to non-FDIC assisted deals, he said.

“With M&A I think we’ve probably hit the bottom and will probably see it pick up absent another global financial crisis,’’ Hovde said.

Focusing on What’s Important to the Audit Committee: Three Things That Should Be on Everyone’s Mind


magnifying.jpgAfter the passage of the Sarbanes-Oxley Act, audit committee members experienced an increase in the intensity of the spotlight the public and regulators placed on them—and the focus didn’t just affect public companies. The current financial crisis again has put a spotlight on the responsibilities that all boards and audit committee members face. Although audit committees are actively engaged with their management teams and internal and external auditors, it can be difficult to know what should be the focus of those ongoing discussions.

So what are the things that audit committees should be thinking about today? Highlighted here are three of the critical risk areas that audit committees should have on their minds.

1. Earnings and Growth Plans: Early Assessments of the Risks

The credit challenges and related complications of the financial crisis are improving for many banks. Management teams are focused on returning to sustainable profits. Lending groups are actively looking to build their portfolios, and management teams are considering new products and services and expanding existing programs.

Audit committees need to be aware of the strategies their organizations are considering and of the associated risks. Internal audit should be auditing those risks. Whether a bank is considering resurrecting an old lending strategy or launching a new product or service, early action by the audit committee and internal audit will safeguard the organization. Audit committees and internal audit should work to understand their organization’s initiatives, limits and controls, and understand the risk monitoring that exists at their institutions.

2. Compliance: Effective, Efficient, and Critical for Survival

Compliance doesn’t always seem like the most strategic topic, but a lack of compliance can have consequences that quickly become strategic. Consumer regulations have changed significantly over the past few years, and more changes are on the horizon as the regulatory focus on consumer compliance has increased noticeably.

Audit committees should understand not just the details of compliance for individual regulations, but the compliance program itself. Having a robust system in place to identify changes, assess the enterprise-wide effects, and respond effectively is the only way that ongoing compliance can be achieved. Internal audit cannot just rely on management monitoring systems; it must perform independent testing of the compliance program and of compliance risks. Audit committees should understand the risk assessment process and internal audit’s coverage approach with respect to consumer compliance, and they should be comfortable that the compliance program will produce consistent and efficient results across all regulations and lines of business.

3. Enterprise Risk Management: Present, Comprehensive, and Insightful

Enterprise risk management (ERM) has been a topic of conversation for many years, but the level of discussion within banks and regulatory examinations is greater today in light of the financial crisis. Companies need an ERM process that is designed to address all risks across an organization and that provides meaningful information to executive management and the board. In addition, in response to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires a board-level risk committee for firms with more than $10 billion in consolidated assets, examiners sometimes are asking much smaller organizations to put programs in place that include board-level oversight.

Audit committees should understand their bank’s ERM program, and internal audit should evaluate its effectiveness. Questions to consider include: Does a program already exist, and, if so, who owns the program? Are the right people involved? Do the results prompt the right discussions (are the company’s biggest risks part of the conversation)? Do the board and executive management support the process and the outcomes?

The goal of ERM is not to simply to comply with a regulatory mandate, but to establish a disciplined process whereby the most significant risks are summarized for insightful discussion and response. As it does with all critical areas of its bank, an audit committee must make sure that the ERM function exists and that it is operating as intended.

Having confidence in the quality and scope of the internal audit function should be a priority for any bank’s audit committee. Though the three critical areas discussed above are not exhaustive, they represent some of the larger issues facing banks today. Ongoing changes are inevitable. Adding specific consideration of changing risks—and potential changes to audit plans—could be a useful topic for audit committees to add to their agendas.

A Butterfly Flaps Its Wings In Europe


The Opportunities for Community Banks Arising From the European Debt Crisis

butterfly.jpg

Most of the commentary on the financial crisis in Europe has focused on the acute challenges policymakers must address today, an approach that makes sense given the consequences for the global economy if those issues are not addressed adequately.  Less attention has been focused on the opportunity the crisis has created for our own community banks.

The combination of the financial crisis that struck our own country three years ago and the fallout from the European debt crisis may be creating an opportunity for community and regional banks to retake market share lost over the past 20 years.  During that period, community and regional banks lost significant market share in almost every loan class, with the glaring exception of real estate lending.  The resulting real estate dependent business model has now been called into question by both investors and regulators, and it is hard to see growth opportunities or even long-term survival for community banks that do not adapt to the new environment, in which balance sheets saturated with real estate loans are regarded with growing skepticism.

In a silver lining to the European debt crisis, the retreat by many of the world’s largest banks is providing new lending opportunities for those community banks that have steadily grown their capital and liquidity over the past few years, and are contemplating new ways of generating prudent loan growth.

Until recently, European banks have provided credit to American borrowers across a wide range of sectors, including small and medium business enterprises.  Historically, these markets were fertile ground for community banks, but in recent years those banks have seen themselves become less relevant in many of those sectors.  While the ultimate outcome of the European situation is unclear, we can be confident that European banks are going to continue to be severely constrained, with substantially less capital reaching our own lending markets.     

To give some context for the magnitude of this withdrawal, the European Banking Authority last year announced that European banks must reach a 9 percent Tier 1 capital ratio by June 2012. In aggregate, European banks would have to raise over 100 billion euros of new capital to reach this target with their existing balance sheets.  Rather than raise this much equity, however, many European banks have indicated that they intend to reduce their balance sheets to meet the capital target.   Estimates suggest that balance sheet reductions could exceed 1 trillion euros. While we do not yet know how much of that reduction will take place in the U.S., some European banks are already pulling back from our market.

There is no reason for this void to be filled exclusively by the country’s largest banks.  Many, if not most, of these U.S.-based assets and loans are appropriate for banks both large and small.  The challenge for community banks in accessing these loans is two-fold: a question of access and a question of understanding the credits.  As these banks engage in markets they may have exited years ago, they need to ensure that they understand the loans they put on their books, and remember lessons learned from the recent real estate crisis.  In some cases, the move back to traditional commercial (non-real estate) lending may require investing in the education of loan underwriters and credit officers who find their skills outside of real estate lending may have become rusty. 

In order to have access to the best credits surfacing because of this disruption, and to defray the associated sourcing, underwriting and servicing costs, we believe that community banks that choose to work together will be best positioned to compete with their larger brethren.   They will be able to fill lending gaps left by the European banks and take advantage of the tail winds finally blowing in their direction.

The Perfect Storm


Timing is everything. In his short video, Joe Evans, Chairman and CEO of State Bank Financial Corp, shares how he predicted the recession and how his board was ready with a plan.

Over his 30 year career, Joe Evans has run some of Georgia’s beset community banks. In December 2006, Joe Evans sold Atlanta-based Flag Financial Corp. to the U.S. arm of Royal Bank of Canada for $456 million. Since starting State Bank, Evans and his team have acquired several failed banks in the Metro Atlanta area.

In 2011, State Bank was named the top performing bank in the United States by Bank Director magazine in our 2011 Bank Performance Scorecard, a ranking of the 120 largest U.S. publicly traded banks and thrifts.

Watch the below video filmed during Bank Director and NASDAQOMX’s inaugural Boardroom Forum on Lending held last December in New York City.


Survivor Guilt: An Assessment of Financial Crisis Lawsuits


shipwreck.jpgWhat banks have paid the piper from securities fraud lawsuits following the financial crisis?

So far, the biggest losers have been Bank of America Corp. and Wells Fargo & Co. They represent more than half of the $4.4 billion paid in subprime and credit crisis-related settlements, according to Kevin LaCroix, an attorney who writes an extremely well sourced and exhaustive blog on directors and officers (D&O) liability insurance.

But what may be interesting about that fact is not so much that two banking giants have paid the biggest settlements, but that the settlements suggest surviving banks are paying more than the entities that collapsed, notes LaCroix.

Bank of America and Wells Fargo both had bigger settlements than say, Lehman Brothers, whose former executives and underwriters have settled for $507 million. Washington Mutual Inc. became the biggest bank failure in U.S. history when it collapsed into never-never land. The WaMu settlement with investors was $208.5 million, half owed by the directors and officers of the bank but paid by D&O insurance. The other half was owed by the company’s underwriter and auditor, amounting to three separate settlements, according to LaCroix.

Bank of America survived, but paid far more for it. It gobbled up a couple of losers in acquisitions: subprime mortgage aficionado Countrywide Financial and investment bank Merrill Lynch & Co., which was heading toward absolute demise. Settlements stemming from the actions of those two failed entities have amounted to $1.56 billion. Countrywide Financial amounted to the biggest chunk, $624 million in 2010, making it one of the biggest securities fraud settlements ever, according to Stanford University’s Securities Class Action Clearinghouse. The case pitted New York state pension funds and others against the bank for making misleading statements about the quality of its loan portfolio. Bank of America paid $600 million of the Countrywide settlement and Countrywide’s audit firm, KPMG, paid $24 million.

Wells Fargo, another survivor, gets the credit for an even bigger settlement: $627 million in August of last year for the Wachovia Preferred Securities action—$37 million of it paid by, again, KPMG. Wells Fargo bought Wachovia in December 2008 after Wachovia had previously acquired Golden West Financial Corp. and its notorious “pick-a-payment” loans, where the borrowers got to pick how much to pay each month. The loans still drag on Wells Fargo’s portfolio to this day. Wells Fargo’s settlements related to the crisis have totaled $827 million so far.

Of course, there are a lot of complicated factors that go into settlement amounts that have nothing to do with simple guilt. A failed bank like WaMu has insurance proceeds and the personal assets of executives and directors on the table, but that’s about it. A surviving megabank such as Wells Fargo has a lot more assets for plaintiffs to fight over.

Only about 40 cases have settled and 76 dismissed out of about 230 that have been filed relating to the credit and subprime fallout, according to LaCroix.

The years ahead will provide an opportunity to see how much survivors will have to pay for the financial crisis. 

 

Trends in CEO Pay: Work Now, Get Paid Later


The financial crisis has had a huge impact on the way banks pay their executives and even their loan officers, but CEO pay is definitely creeping back upward. The smallest community banks to the international mega-banks have all made changes in the last few years to reduce the likelihood that employees will take big risks that threaten the long-term health of their financial institutions.

Many banks are moving away from short-term incentives, paying smaller amounts in cash bonuses for meeting short-term performance goals, and paying equity gradually over a longer period of time in the form of restricted stock based on performance goals.

One of those banks is First Commonwealth Financial Corp. in Indiana, Pennsylvania, a $6 billion-asset institution with 112 offices.

Bob Ventura, chairman of the board’s compensation and human resources committee, said at Bank Director’s Bank Executive & Board Compensation conference in Chicago recently that the bank has moved from paying a roughly 75 percent/25 percent ratio of compensation in short/long term pay to now using a 65/35 ratio.

Even more changes have been made from a risk standpoint among loan officers.

“We have gotten away from volume goals and put some profitability goals in there,’’ he said, adding that there’s an 18-month time period to get paid the full incentive package.

Even though the bank is not a recipient of Troubled Asset Relief Program money from the federal government, it still follows TARP compensation guidelines. The bank conducts third-party annual reviews of its compensation plans, and has created a position for a chief risk officer who reviews compensation plans and makes recommendations to the risk committee of the board.

 “We have evolved from plans that were primarily paid in cash,’’ he said.

Todd Leone, a principal at McLagan compensation consultants in Minneapolis and a speaker at the conference, laid out some general trends, including:

  • The use of full value equity plans (such as restricted stock) continues to increase.
  • Most banks don’t use stock options as a form of equity compensation, no matter what the bank size is.
  • The larger the bank, the more frequent the use of equity compensation.
  • Banks are increasingly using credit quality measures in performance plans.

Bank CEO pay increased last year as the economy strengthened and bank balance sheets improved, although most of the increases were tied to cash and equity incentives, Leone said. The biggest pay increases were for CEOs at the largest banks, who saw their paychecks drop substantially in 2008 and 2009 following the financial crisis. The median cash compensation for big bank CEOs is now roughly what it was in 2006, $2.3 million, according to McLagan’s analysis of 717 publicly traded bank proxy statements, 41 of them banks with more than $15 billion in assets.

The following table shows the breakdown in CEO pay last year:

Median 2010 CEO Compensation

comp-mclagan.png

*Cash compensation is salary plus all other cash incentives, like bonuses. Direct comp is  cash compensation plus equity. Total compensation adds direct compensation, retiree benefits and all other compensation.

Source: McLagan

Trust in the banking system: How should banks respond to Occupy Wall Street?


occupy-sign2.jpg“The corporations get what they want and the people don’t get anything,’’ says Elizabeth Johnson, with two pieces of duct tape stuck to her shirt with the words “Occupy Nashville” written on them.

She is taking part in Nashville’s version of Occupy Wall Street, where a loose group of protestors hang out on War Memorial Plaza playing the guitar, holding signs, and conducting organizational meetings to plan their marches and policies: keep the plaza clean, be respectful, don’t destroy property.

Johnson says she was originally in favor of the $700 billion rescue of the financial system until she realized the banks “kept that money for themselves.”

Other protestors include a call center worker who says she is disappointed her $100,000 in student loans for a master’s degree in communications landed her in call center doing customer service; a financial planner who says he is concerned about the future of Social Security, low wages and the loss of American jobs to developing countries; and a machinist who disagrees with the Federal Reserve’s control over monetary policy.

Occupy Wall Street’s protests in cities across the world over the weekend unveiled a groundswell of frustration against corporations, political systems, the global economy and the banking system, all rolled into one. Should the banking industry care? If so, what should be done about it?

After all, there doesn’t seem to be a lot of evidence that angry consumers are voting with their feet. The biggest banks in the country control most of the deposits. Account balances in checking and savings accounts are growing, not declining.

Bank of America just reported Tuesday deposits at the bank grew by $3 billion in the third quarter to $1.04 trillion. JP Morgan Chase & Co. reported deposits grew by $44 billion in the quarter to $1.09 trillion.

Still, many people think a bad image for banking isn’t good for business.

In June, GfK Custom Research North America, a division of market research company GfK Group, reported an online survey of 1,000 Americans where the financial services industry ranked third lowest for trustworthiness, ranking above only state and federal governments.

Only 35 percent found financial companies trustworthy. (Retail companies and packaged food manufacturers got the highest marks—71 percent and 65 percent, respectively—out of the 12 public and private sectors in the survey.)

“The fact is that the vast majority of financial services companies still generate substantial profits by fooling customers, or by capitalizing on their mistakes, or by taking advantage of them when they simply aren’t paying attention,’’ says a new report from the management consulting firm Peppers & Rogers Group. The group recommends increased transparency and practices that keep the customers’ best interests in mind, as a way to survive a future where customers can increasingly publicize their frustrations and bad experiences on everything from Facebook to Twitter.

In fact, making consumers happier could do something to push back the tidal wave of increased regulation of the banking industry, some think. Where did the Credit Card Act of 2009 come from, if not consumer frustration?

Plus, the volatile stock market, crashing home values, low wages and high unemployment set the stage for people to be angry at banks, says Gregg Poryzees, vice president, Consulting – GfK Financial Services.

“When the economy takes a hit, people are now unhappier with the financial firms they deal with,” Poryzees says. “This really is an opportunity to rise to the occasion. This is a great time to say ‘What can we do in terms of communication with our customers and designing innovative products, with brand positioning, managing the brand in a volatile market and a volatile consumer market?’”

Another GfK survey in July found that 88 percent of respondents strongly agree or moderately agree that consumers need an agency such as the Consumer Financial Protection Bureau to oversee the practices of banks and other financial institutions.

Waiting for new regulation from the Consumer Financial Protection Bureau is not a plan, Poryzees says. Getting ahead of regulation with consumer-friendly changes is a solution.

 “The implications are that the banking industry can turn this frustration into an opportunity, not so much different fees, but innovations that are more customer focused,’’ he says.

One can only wonder if the recent decisions of some large banks, including Bank of America and JP Morgan Chase to offset new restrictions on debit card interchange fees by charging customers a monthly fee, has further tarnished the industry’s image.

William Mills III, the CEO of Atlanta-based financial public relations firm the William Mills Agency, says bankers should think about how they will respond to the concerns of Occupy Wall Street and others. Community bankers in particular may have an opportunity to differentiate themselves from the bigger banks because they didn’t participate in the marketing and sale of risky bonds, equities and subprime mortgages.

“I hope bankers are thinking about how they would respond if a member of the media calls or a customer asks about it,’’ he says.

Scott Talbott, the senior vice president of government affairs at The Financial Services Roundtable, which represents 100 of the largest financial institutions in the country, says the industry understands the anger reflected in the Occupy Wall Street protests. The financial industry is carrying more capital, is safer, and has eliminated a lot of risky practices, such as subprime lending.

“We are working hard to restore the economy and trust in the banking system,’’ he says.

But the problem lies deeper than trust.

“What am I supposed to tell my children about what their goals should be?’’ says Felisha Cannon, the 33-year-old call center worker, saying she’s not sure there’s a better future for them.  “I can’t tell them to buy a house, because it might not be worth anything. What should they be working for? Should they go to (college) and have $200,000 in debt?”

Opportunity knocks, but there are drawbacks


The mess in banking isn’t over yet.That means hundreds of banks, most of them small, community organizations, likely will fail in the years to come. The flip side of all that carnage is an opportunity for bankers to buy troubled institutions, grow balance sheets during tough economic times and let the Federal Deposit Insurance Corp. take most of the bad assets of the failed bank.
 
The investment bankers and attorneys who attended Bank Director’s May 2nd conference in Chicago agreed on one theme: There are still plenty of deals to be had for banks looking to buy failed institutions from the FDIC, as long as they work hard, fast and smart to do the deals right. 
 
“There is ample opportunity,’’ said Jeffrey Brand, managing director at investment bank Keefe, Bruyette & Woods. “The FDIC will allow you to bid as many times as you like and they will let you be as creative as you like.”
 
There were more than 523 banks with $318.3 billion in assets at the end of last year that had Texas ratios topping 100 percent, said Brand, using SNL Financial data. The Texas ratio is commonly used to predict bank failure, and is the amount of non-performing assets and loans, plus loans delinquent for more than 90 days, divided by tangible equity capital and loan loss reserves. If it’s more than 100 percent, that’s trouble.
 
The number of troubled banks also appears to be increasing. The number of banks with Texas ratios above 100 percent increased 4.5 percent from the third quarter.
 
The FDIC’s “problem” bank list also appears to be growing. It reached a record high for this cycle of 884 banks at the end of last year, more than 10 percent of the total banking system. That number was up from 860 the quarter before.

Louis Dubin, president of Resolution Asset Management Co., said the states with the most number of troubled banks are Georgia, Florida, Illinois and Minnesota.

Troubled Bank Map: 2010 Q4

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TOTAL BANKS: 417
CRITERIA: Texas ratio > 100%, Leverage ratio <9%

Picking up failed banks from the FDIC offers some benefits: the FDIC can take on as much as 80 percent of the failed bank’s losses, using a tranche system based on the size of the losses. Plus, the acquiring bank can cherry pick the assets, locations and employees it wants. The failed bank’s pre-existing contracts are automatically voided on the sale.

And bankers can get creative in terms of how they structure deals. Brand recommended making several bids, including one that follows traditional FDIC deals and one that doesn’t. For instance, banks can price bids to take into account future risk, instead of using a loss share agreement, avoiding the hassles of regular audits from the FDIC to make sure they comply with the loss-share agreement.

“The FDIC is discovering the costs of auditing all these banks to see what their losses are,’’ Brand said. “Now they’re doing deals without loss share (agreements). You don’t need that expensive accounting system. But they are taking away that safety net, too. If losses are worse than estimated, that’s 100 percent coming out of your pocket.”  

One of the drawbacks of FDIC deals is the possibility that the government could change the rules at any time. The loss share agreement lasts a decade for single-family housing assets; five years for commercial properties.

Buyers also don’t have much time to do due diligence. The entire process, from expressing an interest in acquiring a bank, to closing, can take about 90 days, less if the failed bank’s situation is dire.

“They don’t let you wander around the bank talking to all the lending officers,’’ said James McAlpin, an attorney and partner at Bryan Cave in Atlanta.

Bank employees will have to work quickly to make a bid and conduct due diligence. Plus, they must be able to reopen the bank on the Monday after the bank’s Friday closure, and follow timelines to transition the acquired bank and dispose of its assets.

“It is a tremendous strain on your organization,’’ Brand said.

TARP Legacy: Hidden Costs


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.