Banking Law

On the first working day of the new year, FinCri Advisor (free registration required) sets an ominous tone by opining that 2010 is likely to be the year of the "take-no-prisoners" bank examination.

Look for much deeper and more critical safety and soundness exams in 2010, as regulators significantly beef up their risk management staffs - the FDIC's alone will grow 31% - and more quickly issue enforcement orders. Examiners' marching orders start with two big issues: CRE and liquidity risk.

An anonymous federal bank examiner warns that examiners will be "grading banks more closely." This means a number of things, foremost among them that many banks, especially community banks, should expect 2010 to be a "year of living dangerously," where the arrival of a bank examination team will be, in many cases, the starting point of a painful process that will lead to downgrades of CAMELS ratings, enforcement action, requirements that banks write down asset values, increase capital levels and reserves, improve management, operations, systems, and risk management, lower dependence on non-core funding sources, and otherwise jump through flaming hoops held higher and higher from the surface of the ground until bankers either flame out or sell out. Other than that, it sounds like the next twelve months should be a lot of fun.

One of the critical problems with upcoming examinations is that the federal regulatory agencies have been expanding their examination staffs substantially. Unfortunately, they don't appear to be bringing old hands out of retirement, but adding wet-behind-the-ears, fresh-faced youngsters. Former OCC examiner Robert Ziner asserts that this lack of experience will exacerbate the pain for banks.

Although examiners have more focused time in each bank, their lack of experience means there is less nuance and flexibility in the exam process...This manifests itself in several ways. Supervisory guidance gets interpreted as rules, Ziner says - such as the view regulators first issued in 2006 that a bank should keep its commercial real estate loan (CRE) concentrations below 300% of total capital. "Human nature tends to take a guideline and make it a hard and fast rule because it's easy to support," he says. "Your boss isn't going to tell you you've done something wrong by enforcing the guidelines. You don't have to take a risk."

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Younger examiners also are much less likely to agree to informal understandings or permit forbearance, says former Fed examiner Pat McElroy Jr. of Risk Management Partners in Dallas. "Examiners have had more of a hair-trigger on enforcement actions," he says. "We've seen that a lot lately. They are not as negotiable as they used to be."

Note to bankers: Telling a young bank examiner who lacks the "nuance" that comes with experience that you'll "tear him a new one" is not likely to help your case. You know who you are. I'm merely pointing out the obvious. Just because it feels good to vent doesn't make it the right way to go.

According to FinCri Advisor, the two biggest issues for examiners will be asset quality and liquidity. Those certainly have been high on the list of issues we've seen in 2009, and I expect that they will cause even more headaches in 2010, especially for banks with heavy commercial real estate loan portfolios, which, unfortunately, includes many community banks, as well as those banks who rely on brokered depsoits and similar non-core funding sources.

I was especially amused (with only a tinge of bitterness) about the new emphasis on "enterprise risk management." That's one check box item on an inexperienced bank examiner's list that is bound to be as baffling to many of examiners as it is to the small bank executives that have to answer their questions on the subject.

One community bank says the most surprising question asked at its recent exam was how it handles enterprise risk. "The examiner had no idea what he was really asking," says a respondent to the FinCri Advisor survey. "But it was clear that he was supposed to start asking it. It isn't a tough question, per se, but it sends a signal to bankers of what to expect coming down the road."

Another thing to expect is that bank management and board quality will be under the examination microscope. The skill set requires for managing in good times is not the same as that required for managing in bad times. Dealing with problems when your world is going to hell in a hand basket requires management that is able to roll up its sleeves, get its hands dirty, and deal with troubled assets by doing something more proactive than putting lipstick on pigs. As galling as it may be to have some freckle-faced youngster questioning your expertise, community bankers should be prepared to restrain their "fists of death" and deal with it.

In light of these disconcerting prospects, some bankers (and those who deal with them) may find one or more of the upcoming Bank Law Stuff webinars useful, whether it's Venable LLP partner Joe Lynyak's January 5th webinar on responding to enforcement actions, or later presentations on today's hot buttons for bank examiners and/or the onrushing commercial real estate freight train, what it means to banks, and what banks need to do about it. Regardless, fasten your seat belts, because 2010 is bound to be a bumpy ride.