The State of Banking
By: KAREN L. GRANDSTRAND
On April 16, 2012, Karen Grandstrand co-chaired the 9th Annual Banking Law Institute. The following are excerpts from her introductory remarks.
Welcome to the 9th Annual Banking Law Institute.
We hope that today’s session will provide relevant and timely updates, as well as be thought provoking. We have representatives from Congress, state and national bank trade associations, the new Consumer Financial Protection Agency, all of the federal bank regulatory agencies, banking organizations, and law firms.
To begin our program, I will set the stage with some facts and figures on the industry, as well as observations on recent examination findings and ratings.
As of the end of 2011, there were 6,290 commercial banks and 1,067 savings institutions in the U.S. This compares to roughly 10,000 in 2000 and 15,000 in 1990. As of December 31, 2011, the FDIC considered 813 of the current 7,357 institutions to be problem institutions. This compares to 884 in 2010 and 702 in 2009. In Minnesota, there are 387 banks; about 30 percent are on regulatory watch lists.
So, are things improving? Yes; but slowly. Ratings have started to improve, at least certain of the CAMELS component ratings. Significant progress, however, will take more time. First, banks continue to have troubled loans and foreclosed properties on their balance sheets. Accordingly, a key ratio that determines bank ratings—the classified to Tier 1 Capital and Reserves ratio—remains elevated at many banks, although not because banks have failed to take actions to improve loan portfolios. Rather, as long as bank customers are experiencing financial stress due to the economy and there continues to be a less than robust market for foreclosed property, banks will have a difficult time improving the classified ratio -- it takes time and it takes a strong economy unless a bank pushes weaker customers out the door.
A second reason why ratings have not all returned to CAMELS 1s and 2s is due to new downgrades based on regulators’ findings that bank risk management systems must be more robust. Regulators are emphasizing that they have carefully studied the cause of the financial crisis and recent bank failures and determined that banks must do a better job of identifying, mitigating and monitoring risks. In my experience, this has created an environment where many are trying to eliminate all risks from the banking system. However, the elimination of all risk creates another risk -- if the benchmarks against which banks can make loans and charge fees are too stringent and capital levels and compliance costs are too high, banks will not make money, thereby impeding the health of the industry. Nevertheless, regulators are pressing for stronger credit administration, and more robust capital plans and liquidity contingency plans, all of which must be stress tested. Further, there is an intense focus on, and expectation of, meticulous compliance with an ever increasing number of laws and regulations.
Because ratings are slowing improving, the number of new public formal enforcement actions have declined. Newly issued public enforcement actions peaked in the first half of 2010 when 221 actions were issued in the first quarter and 220 in the second quarter. By comparison, the last half of 2011 saw only 134 public actions. Despite this decrease, 1,007 banks and thrifts are still operating under severe enforcement actions issued after 2007. Also, while we are starting to see the termination of formal actions, in many cases banks are not totally free of actions. When formal actions such as consent orders and written agreements are lifted, they are often replaced with confidential informal memorandums of understanding or, in the case of national banks, with individual minimum capital ratio (IMCR) letters.
Consistent with this trend, bank failures have slowed. In 2009 there were 140 failures (6 in Minnesota); in 2010, failures peaked at 157 (8 in Minnesota); in 2011, there were 92 failures nationally (2 in Minnesota). As of this past Friday, there have been only 16 failures across the country in 2012, including two in Minnesota. Thus, supervisory/FDIC M&A activity is down, resulting in an uptick in private sector M&A. There is much pent up demand by the industry on both the buy and sell sides. Whether this will translate into completed deals over the next year depends on first, whether buyers and sellers can reach agreement on pricing; second, whether buyers can find the capital needed to do acquisitions given the trust preferred market is gone and bank stock loans are more difficult to come by; and third, whether and under what parameters regulators will approve deals.
Now more than ever, as we are hopefully moving beyond the worst of the financial crisis, bankers and regulators must engage in constructive dialogue and communications to improve relations and try to have more certainty in the supervisory process. Relations are strained, and a significant number of new regulations as well as a changed regulatory structure given creation of the CFPB, have caused uncertainty.