Comments from a CFPB Speaker

I just came across some notes I took during a December 2012 presentation to community bankers by a CFPB employee.  Some of his comments were worth sharing...

• We have a wide range of examiners, some fresh out of college.  The young ones have book knowledge, not field knowledge.  They are committed to the ideals of CFPB.

• You would be surprised at some of the things they will advocate.  If you respond affirmatively to their suggestions, you encourage their behavior and they will come up with bigger, better ideas next year.

• You, as seasoned industry professionals, need to push back and explain how things work in the real world.   I've told examiners that the folks on the other side of the table have been doing their jobs longer than you have been alive. You have to value their experience.

• We have lawyers on staff, serving as examiners. They were hired not as lawyers, but as examiners. I tell them that!  They are not arguing a case before the Supreme Court.  They don't need to be litigious.

• We bring enforcement lawyers into exams at the beginning to give thence an understanding of the process. When I was at OCC, they didn't get involved until there was a problem. Then, we had to back up and educate them on the situation. Their presence is not an indication of a problem.  They are not meant to intimidate you -- they are there to learn.

• Consumers can tell you every detail of their cell phone data plan (which changes every few years), but don't take any time to try and understand their 30 year mortgage.  Sometimes, it's the consumer's fault!

 

Price of Increased Regulatory Burden: Less Time for Customers

[article from American Banker, April 2013]

Regulatory change is taking increasingly bigger bites out of community banks' bottom lines.

Banks are spending more time and money to follow new regulations. That is problematic, especially when it distracts bankers from other duties, industry observers say.

"Anything that turns the bank's attention away from the customer is detrimental to everyone," says T. Jefferson Fair, president of consulting firm American Planning. Community banks "already know how to take care of customers legally, morally and ethically, so having to comply with regulations that tell them what they already know how to do is frustrating."

A study by Continuity Control, a risk management firm, found that smaller banks spent $250 million and 8.3 million hours complying with regulation implemented in the first quarter. The study, which used public records and data from the firm's clients, looked at banks with an average of $350 million in assets.

Shifting the dialogue from anecdotes to quantifiable data "sends a more powerful message," says Pam Perdue, Continuity Control's chief compliance strategist. "We think it will be welcomed by all of the constituencies. Most importantly, legislatures and regulators will be aware of the impact."

Updating policies and procedures to meet new regulation "is a full time job," says Raymond Altmix, president and chief executive at Bank of Marion in Illinois. He says regulation is changing at a faster pace than what he has ever experienced during his 40 years as a banker.

Bank of Marion, a $332 million-asset unit of Midwest Community Bancshares, has a full-time employee aided part-time by another staffer working on compliance, Altmix says. Continuity Control is helping the bank automate much of the process.

Mixed signals from Washington and field examiners are increasing the financial burden, industry observers say.

Some banks are having "trouble keeping up with what is an actual rule, what is a proposed rule and what is just talked about in the media," Fair says. "Then examiners come in and add a layer of interpretation. It can lead to paralysis."

Banks should act quickly to implement changes as soon as they understanding a rule, observers say. It will be costly; many banks are hiring new full-time employees or outsourcing tasks to outside firms. Hiring workers with regulatory know-how is especially expensive because those people are rare and in high demand.

Meeting regulation can create a "disproportionate burden on community banks because they have less infrastructure," says John Depman, leader of regional and community banking at KPMG. "It can become tough to attract and retain people with the right skill sets in small towns. Those experts have become very costly because of the demand."

Regulators have also been issuing warnings about the use of third-party vendors. Even if a bank outsources some compliance functions, it still must devote internal resources to managing that relationship, Depman says.
Vendor relationships "should be saving you money and not adding to your cost burden," adds Perdue, whose firm provides a compliance platform for community banks. "Compliance needs to stop being a distraction and instead create a competitive advantage."

Banks with a strong compliance management system have an opportunity to reduce the costs of new regulation, Perdue says. Banks should have a system to analyze and assess the risk of new regulations, along with a standardized way to structure policies and procedures, she says.

Automation can also keep costs in check, industry experts say.

Incurring upfront costs to properly address new regulation is less expensive than facing penalties over a lack of compliance, Depman says. Banks that run afoul of regulators also face reputational risk and, in some instances, enforcement actions that can limit expansion efforts.

"There's a balancing act that is going on," Depman says. Regulations for "things like fair lending and anti-money laundering are all good. But you don't want it to be overly burdensome."

http://www.americanbanker.com/issues/178_73/price-of-increased-regulatory-burden-less-time-for-customers-1058355-1.html

Do Examiners Read Their Agency's Publications?

While responding to an examiner's criticism of a client's Liquidity Policy limits, I rediscovered a very good article from the Fall 2006 FDIC Outlook titled An Assessment of Traditional Liquidity Ratios.  One of the authors of the article is Kyle L. Hadley, Senior Capital Markets Specialist, FDIC Division of Supervision and Consumer Protection.  I know Kyle and respect his work.

A few of the key comments from the article: 

[B]alance sheet ratios can vary widely among institutions with identified liquidity concerns. Consequently, some traditional ratios may not be the most accurate indicators of an institution's true liquidity position, and may be misleading when considered in isolation. In the past, the assumption was that banks with liquidity concerns would have poor ratios and thus would be easily distinguishable from institutions with a more favorable liquidity position. However, given the changing balance sheet structure and uniqueness of individual bank funding strategies, poor ratios do not necessarily mean banks are under liquidity pressures, and favorable ratios do not always depict a strong liquidity position.

[The Non-Core Funding Dependency Ratio] ratio is based on the premise that non-core liabilities are better suited to fund short-term investments rather than long-term assets. In theory, a lower ratio implies that an institution is better able to meet its' liquidity needs. Today there are many concerns with the original premise of this dependency ratio. Highly stable funding items, such as long-term borrowings and long-standing large deposits, are considered non-core, while most highly volatile internet deposits are considered core deposits. Additionally, all loans regardless of time to expected repayment are considered long-term.

[T]he pledged securities-to-total securities ratio could have minimal application under the liquidity management strategies used by some insured institutions.

The relative simplicity of such ratios and the ease by which they can be compared with historical trends at peer institutions increased their attractiveness. However, in today's more complex funding environment, these ratios, while still useful, may not adequately reflect an institution's liquidity position. In fact, ratio-based analysis can hide potential problems and leave a bank unknowingly exposed to considerable liquidity risk.

Despite these relevant and accurate observations made over six years ago, field examiners still focus on on-balance sheet liquidity, non-core funding dependence, pledged securities / total securities and loan to deposit ratios, criticizing banks based on their ratios and policy limits relative to industry or peer norms, often without thinking through the rational bank-specific mitigating factors that reduce perceived risk.  Why?  I'll allow the article to answer:

The relative simplicity of such ratios and the ease by which they can be compared with historical trends at peer institutions increased their attractiveness. However, in today's more complex funding environment, these ratios, while still useful, may not adequately reflect an institution's liquidity position.

Ratio-based analysis using outdated measures, combined with an examiner's unwillingness to consider the big picture, can make healthy banks look sick, leading to criticism and creating additional work for management.  Responding to unnecessary examination criticism is very time consuming, and it diverts community bankers from their most important tasks -- serving their community's financial needs.

My favorite response to examiner criticism is to use their own agency's words against them.  I may not win many friends field examiner crowd by doing so, but it will at least make me feel better.

Cyprus, part 3 -- The Butterfly Effect

For those new to my discussion of Cyprian events, please start here.  For the rest of you...

FACT:  U.S. banks, large and small, are in much better shape than those in Cyprus.  There is plenty of data to support this statement.  

OPINION:  U.S. depositors should have nothing to worry about come Monday morning.

FACT:  People don't always act rationally.

OPINION:  U.S. bankers should be prepared to help their customers understand what happened, and why it is not likely to happen here.

In the post-Lehman banking world, regulators and examiners have placed an emphasis on contingency funding plans, liquidity planning and stress testing.  If your bank is not up to speed on these topics, it's time to get there, and quickly.  I have no reason to expect a panic or bank run in this country, but I wouldn't be surprised if depositors begin to think more about where, and how, their wealth is stored.  Some folks are likely to feel that Grandpa's tin can in the back yard and Crazy Uncle Joe's gold and silver in foreign vaults are sounding better each day...

If deposits leave your bank, how will you respond?  Cheap deposits have played a crucial role in maintaining net interest margins as assets repriced downward.  If deposits become more expensive due to a perceived increase in risk, what shall we do?


Lesson 1: Greece; Lesson 2: Cyprus - Pay Attention

Cyprus, part 2

As a followup to my post last night, here are updates and additional links to news on the Cyprian meltdown:

President Nicos Anastasiades has warned that "Cyprus's two largest banks will collapse" if the bailout is not ratified by parliament.

Cyprus Parliament To Delay "Rescue" Vote Due To Lack Of Support, Despite ECB Pressure For Pre-Trade Open Decision

The Cypriot cabinet has declared Tuesday a bank holiday, and this may even be stretched to Wednesday.

Cyprus Bank Holiday Extended Through Tuesday As Confusion Spreads

Should Spanish depositors be worried?

EU Passes Law Forcing Countries to Take Bailout; Is Spain the First Target?

And the inevitable comparisons of Cyprus to the US begin...

Could The "Cyprus Fiasco" Occur In The United States?

Did Something Important Just Happen… in Cyprus?

If you weren’t reading ZeroHedge or wsj.com over the weekend, you might have missed Saturday’s banking news from the tiny Mediterranean island nation of Cyprus.  Just five years after joining the Eurozone, Cyprus has accepted a $13 billion bailout from the EU.

So what, you say?  No big deal – just another crazy European bailout…  Well, unlike the previous bailouts of Portugal, Ireland, Greece and Spain, Cyprus was asked by Germany and the IMF to impose a 40% haircut on bank deposits as part of the bailout.  Stop and think about that.  What if, despite FDIC insurance, you had to tell your customers that 40% of their money had been confiscated by the government to help keep JPMorgan Chase or Citigroup from failing.  Not borrowed, but confiscated.  Gone forever.

Now for the good news.  Dear customer, our government played hardball with the EU, and you only lost 6.75% of your deposits up to the €100,000 ($131,000) deposit insurance limit, plus 9.9% of all deposits over that limit.  That doesn’t hurt nearly as much, does it?  

Cypriots (and foreigners with money on deposit in Cyprian banks) lost 6.75% of their insured deposits Friday afternoon.  It happened so fast that they had no chance to start a bank run, although things might get ugly on Tuesday morning when the banks reopen (Monday is a holiday in Cyprus).  

One of the best questions asked in articles discussing the Cyprian haircut is “After Cyprus, who’s next?”  Many large banks in EU countries operate with 150% to 200% loan to deposit ratios, and there are concerns that high asset valuations are the only thing keeping some banks solvent.  How ugly would it be if Danes, Swedes, Norwegians or Finns realized that their banks and/or countries were over-levered and could face the same types of haircuts?

The Eurozone financial crisis is far from over, and the Cyprian flu may be highly contagious.  Watch the markets this week – we could all be in for a bumpy ride.

For more information, these links are a good place to start:

This Crazy Cyprus Deal Could Screw Up A Lot More Than Cyprus... (Business Insider)

After Cyprus, Who Is Next? (ZeroHedge)

For Everyone Shocked By What Just Happened... And Why This Is Just The Beginning (ZeroHedge)

Cyprus Savings Raid Crosses Financial Rubicon (Ed Conway - Sky News)

The Sun Still Shines!

The elections are over, and the sun appeared on the horizon Wednesday morning as scheduled.  “Status quo” is the phrase being used to forecast the next four years.  Unfortunately, the current state of affairs will not continue for that long.  Rising taxes, continued implementation of Obamacare, sequestration, shrinking asset yields and international problems could combine to make 2015 very different than 2012.

So what do we, as bankers, do now?  My guidance over the last few months has been to wait until the election results were in, and then wait another week to see how the markets react.  We’re now in that week of waiting, and waiting is still wise.  But at some point, we must set a course for deploying excess funds, either into loans at rates below our traditional comfort level or into securities with huge premiums or painfully low yields (or both).

I have no great wisdom to impart on the asset side of the balance sheet, but I do want to speak forcefully on liability pricing.  The Federal Reserve has committed to a Zero Interest Rate Policy for another 30 months, and the troika responsible for that commitment just received a four year contract extension.  The old adage “Don’t bet against the Fed” is more appropriate now than ever.  Here’s the forceful part:

If you are paying more than 0.50% on a one year CD, stop!

I feel safe predicting that asset yields will continue to fall.  Most of our nonmaturity deposit rates are near zero (or should be!).  If your market demands CD rates above the cost of replacement funds (FHLB Dallas 1 year bullet advance @ 0.48% this morning, QwickRate 1 year CD offerings in the 0.40% range, brokered CDs priced similarly), shift your funding to the cheaper sources.  It’s an easy way to boost a sagging NIM.

When promoting this strategy, I often hear “My regulators don’t like those funding sources.”  Perhaps that is true, but the 2010 Interagency Policy Statement on Funding and Liquidity Risk Management states:

“An institution should establish a funding strategy that provides effective diversification in the sources and tenor of funding.  It should maintain an ongoing presence in its chosen funding markets and strong relationships with funds providers to promote effective diversification of funding sources.

Funding should also be diversified across a full range of retail as well as secured and unsecured wholesale sources of funds, consistent with the institution's sophistication and complexity.”

If an examiner gives you grief over your prudent use of wholesale funding sources, point them back to their own regs.  You should have policy limits in place for each category of wholesale funds, as well as a limit on aggregate wholesale funding.  The last four ratios on our monthly Funds Management Report address these items, and there should be no shame in the appropriate use of wholesale funds.

The other response I get sounds something like “But, I’m taking care of my customers” or “I don’t want to lose my customers”.  I understand this concern, but the price of taking the “safe” route and paying up on deposits could be huge.  If you want to pay a core customer who has large, low-cost deposit balances or large high-yield loan balances a bit more on a CD, no problem.  Just don’t overpay for the rest of your CDs.  Rate shoppers (local and foreign) should have your bank on their Do Not Call list.  Their funds are not core – regardless of the FDIC’s definition – and will rarely be cheaper than wholesale funding sources.

If you have a competitor overpricing his CDs, share this article with him or send me his contact information.  I would be glad to help him save some money while normalizing your market’s deposit rates.  That’s a Win-Win situation in a Lose-Lose market.

One other parting thought:  If you own some of the long MBS the Fed continues to overprice via QEinfinity, take some gains and redeploy the proceeds into products that are not as overpriced.  I have seen several recent portfolio restructurings that resulted in minimal change to duration, yield and credit risk while providing a nice pop to current year earnings.  I’ll be glad to tell you more if you are interested.