WASHINGTON — "Oppressive." "Harsh." "Micro-managing."

These were some descriptions community bankers were using in congressional hearings last year to describe their safety and soundness exams.

But in interviews with two dozen bankers, regulators and other experts, it appears the bank-examiner relationship has started to change dramatically. While any consensus in a nation of more than 7,000 banks, which generally avoid talking about exams, is challenging, it seems that the strong criticism that bankers felt in safety and soundness reviews—while not vanished entirely—has subsided.

"I'm hearing generally they're fair and generally they're working with bankers as opposed to coming in locked and loaded with the safety off," said Salvatore Marranca, president and chief executive of the $189 million-asset Cattaraugus County Bank in Little Valley, N.Y.

Explanations for that vary greatly, but most point to the industry's recovery as the primary factor.

"It reflects relative stability in the institution" being examined "and in the banking sector," said Christopher Spoth, a former Federal Deposit Insurance Corp. official who helped oversee the agency's exam process.

Others also cite "sincere" outreach efforts by the agencies while some also say institutions hit hard by the crisis — that saw once-revered credits falter — are now more open to tougher scrutiny of their books.

They "began to see that aggressively grading their loans made sense, in that the earlier you find the problem the easier it is to fix it," said Karl Nelson, chief executive of KPN Consulting. "Bankers and regulators had to get on the same page about what a substandard loan was."

Bankers' feelings about the relationship between them and their examiners was very different in early and mid-2011.

"Almost every decision that we were making was being second-guessed," Paul Reed, who testified last year about his 2011 FDIC exam at the $256 million-asset Farmers Bank and Savings Co. in Ohio, said in an interview.

But whether criticism of exams in the wake of the crisis was widespread or just anecdotal was always hard to gauge. While many bankers complained, others said their exams were smooth. Several experts, meanwhile, said tougher assessments following the 2008 crisis were inevitable. At the end of March 2011, nearly 12% of the industry was still on the FDIC "problem" list.

"It is a normal tendency as the economic scenario darkens to see the regulators tighten up," said Steve Scurlock, the executive vice president of the Independent Bankers Association of Texas.

The improvement described by some bankers contrasts with some banking industry trade groups, which have maintained there is a problem. Speaking in private, some bankers say they never saw a concern.

"I've not really had a problem with our exams, but we've run a good shop here," said one community banker who asked not to be identified. "The exams have always been fair. Our last exam was very thorough, and their criticisms were things that we needed to correct anyway."

Still, claims of overreaching mounted. The outcry sparked industry steps to gain banker feedback about exams — accompanying surveys done by the regulators — which are just starting to produce numbers. Lawmakers proposed bills to allow banks more options to appeal exam findings.

With 772 institutions still on the problem list, exams can still produce tension, and some bankers continue to object to the aggressiveness in recent compliance exams, which, separate from safety and soundness reviews, monitor banks' adherence to consumer laws.

"There seems to be improvement" but "it's still a very strange relationship," said Nicholas Ketcha, a former FDIC head of supervision and now a consultant at FinPro. "To be fair, things have gotten better, but they're still not where they used to be in terms of a more active dialogue between examiners and the bankers that existed before the crisis."

But Nelson, who was the head of industry and government relations at Atlanta-based Silverton Bank, which failed in 2009, says both regulators and bankers "were caught off guard" by the crisis. He said part of the difficulty in adjusting to the new environment was how lenient some exams were pre-crisis.

"There was abuse in the worst of the crisis where examiners perhaps were too joyous over seeing a bank fail. But I think it was not the norm," he said. "It's normal for regulators to be adversarial toward the group that they regulate. That is the situation that will be the norm for many years to come.

"I don't think it was a wise idea for regulators to get too close to the banks that they regulate."


John Weier, the chief for emerging issues in the FDIC's risk management supervision section, sees examination results — and perceptions of them — as tied to banking performance.

"We've taken action to make sure we understand" banks' "concerns. But in terms of how exams are conducted, our processes have not materially changed," he said. "I believe that weakening or improvement in safety and soundness examination ratings is more closely related to how banks have been affected by changing economic conditions."

Weier said the crisis put examiners in the tough position of alerting banks — including highly rated ones — to problems with loans that had looked strong.

"A banker may say, 'I've been making a loan to the same borrower for the last five years. It's always been a good loan.' But that borrower's condition may have changed, because conditions on the ground have changed," he said. "When an examiner goes in and recognizes that change in condition, one of the things a banker may say is, 'You're looking at me differently now because I had that same loan to that same borrower the last time you were here and you didn't criticize it then.'

"Even at 1- or 2-rated institutions, the downturn is going to have an impact on individual borrowers. If the examiner identifies those problems, and is the first person to do so, that can be a difficult conversation."

Others said the rapid stream of new information coming during the crisis, as well as concerns about potential next shoes to drop, complicated the dialogue between executive and their regulators.

"It's the difference of being able to examine in a period where we have a little more stability in the financial system than in a period when you don't know what you're dealing with," said Michael Stevens, executive vice president for the Conference of State Bank Supervisors. "The industry didn't know what was ahead of them in the economic environment, and the examiners didn't. That was a recipe for a very challenging relationship."

But observers say those types of disagreements have diminished.

"What's happened is everybody has a better handle of the rules and what we all are going to be operating under," said Joe Brannen, president and chief executive officer of the Georgia Bankers Association.

"Early in the cycle, the regulators were identifying problem assets that the banks didn't feel were going to be a problem. They were working with borrowers that they had long relationships with, which the regulators didn't have to think about. Over the cycle, a lot of those relationships did go sour, and those projects that no one expected wouldn't make it, didn't make it. Anything that's coming in now this late in the cycle, it's not a surprise to anybody."

Tracy Fitzgerald, an examination specialist for large institutions based in the FDIC's Tulsa office, said as concerns about credit quality turned into losses, banks have become more accepting of the higher level of scrutiny.

"As the conditions deteriorated, we did have professional disagreements. Sometimes it took a little time before they were ready to accept it," he said. "At first bankers have an opinion, and examiners have an opinion. When examiners' opinions are right often enough, examiners do tend to gain credibility."

Executives agree that early criticism of portfolio credits can help a bank address asset quality issues.

"I always look at the examination process as, we're paying for them to come in and find problems. I want the regulators, when they come in, to tell me every problem that they can find, so we can correct them," said John Evans Jr., the president and chief executive officer of the $952 million-asset D. L. Evans Bank in Burley, Idaho.

"Early on, I think they were a little tougher than they needed to be. They've loosened up a little bit" since then.


But separate from improved earnings results and awareness about credit quality, bankers say they also just notice examiners' tone easing.

"They really care about getting it back where there is a mutual level of respect that we're all on the same cause, to make our banks better," Reed, of Farmers Bank and Savings in Ohio, said about the FDIC.

That is likely not an accident, as all the federal agencies — hearing the criticism from earlier in the cycle — have significantly expanded industry outreach efforts.

"Outreach helps promote consistency and provides a basis for examiners to better understand some of the more-nuanced issues that we're encountering," said Maryann Hunter, a deputy director in the Federal Reserve Board's bank supervision and regulation division.

Bert Otto, deputy comptroller for the Office of the Comptroller's central district said "it is no question that it is both" improvement in banking performance and outreach contributing to better interactions.

The OCC has done a series of five CEO outreach meetings, Otto said, including three in his district. "Anytime the industry is improving, people feel better. There is less stress in every bank that you go into. But I believe it's also a lot of outreach," he said.

"I'm a big believer in outreach, because that's where we can get the expectations out on the table, what are we expecting of bank management in this current cycle. What are we expecting of examiners during this time period."

The FDIC, the federal regulator with by far the most community banks under its watch, has been the most aggressive in reaching out to the industry. A new initiative this year to focus on the community-bank sector — launched by Acting FDIC Chairman Martin Gruenberg — included a large conference at the agency's Washington headquarters, followed by regional roundtables around the country attended by Gruenberg and community bankers. The agency says it will also review regulatory policies to explore ways to tailor oversight to smaller institutions.

On Thursday, the agency's risk management supervision division, in its periodic "Supervisory Insights" journal, published an article focused on effective communications between banks and examiners. The article laid out the importance of communications from both parties, included examples of good communications strategies and summarized the key steps of the exam process — from the pre-exam planning to when findings are presented to a board of directors and then to the final examination report.

"Banks should expect our examination findings to be fair, fact-based, and consistent with FDIC policies and procedures. The FDIC prefers to have an ongoing dialogue during examinations to discuss preliminary findings and allow management to respond," the article said. "Although there may be cases when regulators and bankers 'agree to disagree,' the FDIC wants to ensure our position considers all perspectives."

Marranca, who was previously the chairman of the Independent Community Bankers of America, said at the group's last national conference Gruenberg "really sincerely said the right things about the future of community banking.

"I don't think as a community banker one has to be paranoid that the regulators are out to get them," said Marranca, a former FDIC bank examiner. "The head of the FDIC has made a clear statement about the positive influence of community banks and the positive future of community banks. That has an effect over time; they're trying their absolute best to be fair and consistent across the board with community banks. You throw in the factor of modest but positive trends … in the economy — all of these factors add up to a different environment than we were in in the heat of the battle a couple of years ago."

But bankers were sounding much different about the relationship only a year ago.

At a hearing before the Senate Banking Committee last June, Marranca — while not complaining about his bank's own exams — said examiners had become too resistant to listening to an institution's point of view when finding problems. "Generally speaking, there is no compromise. There is no discussion," he told lawmakers.

Looking back, Marranca says the pressure regulators were under during the crisis led them to act more aggressively. "People didn't know what was going on with appraisals, and falling prices and where it was going to end," he said. "In the middle of a crisis, one reacts differently than one does when you're not on the front line of a battle."

The legislative framework put in place following the thrift crisis of the eighties and nineties does not allow the regulators much flexibility when dealing with a troubled institution. Under "prompt corrective action," federal supervisors must stick to a formal schedule for forcing an undercapitalized bank to repair itself or else close its doors, not leaving a lot of room for conversation.

Spoth, formerly of the FDIC, who now is a director for the banking arm of Deloitte & Touche LLP, said institutions were likely not prepared for that framework — enacted 20 years earlier — to be put in action.

"Particularly in 2009, the decline in bank conditions was precipitous and highly volatile. In that cycle, for the banks that were most affected, they were subject to mandatory PCA restrictions and brokered deposit restrictions," Spoth said. "That was an experience that would have been new to institutions that had historically been well-capitalized."

Now, the environment is much calmer.

Marranca was recently surprised when the FDIC's regional ombudsman contacted him out of the blue, asking for a meeting at his bank on the western edge of New York state just to hear the executive's feedback about the regulatory process.

"This is not somebody just taking a 15- or 30-minute drive," the banker said.

"For the first time ever, the ombudsman said, 'I want to come out to the bank and visit with you and talk.' … There is no specific issue with our bank, but it sounds like they just want to hear from us. That never happened before. It was from the standpoint of communication."

Reed, who also testified last year following a safety and soundness exam that he described as "nasty", said he has seen a similar shift, with the FDIC softening its tone during a more recent compliance examination.

"I don't know that any exam is a breeze, but it was refreshing to see the change in attitude over the last 18 months," he said.

Industry surveys suggest simply the demeanor of examiners during the actual review goes a long way toward making bankers feel better about the process.

About a year ago, several state banking associations launched an effort — spearheaded by the Utah Bankers Association, with participation from the American Banker Association — to allow executives to assess their exam experience through anonymous surveys.

In general, the Regulatory Feedback Initiative — established by the Alliance of Bankers Associations — found that 70% of respondents over the past year found their exams to be fair, while 30% had complaints. (Over 1,200 bankers nationwide participated.)

But the data also showed bankers reacted more positively as the year progressed.

Howard Headlee, head of the Utah Bankers Association, said the surveys suggest the biggest drivers of a better reaction to exams are improvements in overall Camels ratings, as well as bankers finding that regulators are listening more.

For both overall exam ratings as well as components of the exams, the survey listed satisfaction ratings of 1 to 5, with 5 being highest. Through the third quarter of 2011, the average overall rating was 3.26. But from the fourth quarter through the second quarter of this year, that average rose 12 basis points to 3.38. The rate of agreement with one's Camels rating improved 18 basis points to 3.47. The average extent to which bankers felt examiners were "open to the exchange of views with my staff" increased 18 basis points to 3.62.

"The first is fairly obvious — it is the level to which the banker agrees with their Camels rating," Headlee said. "The second is a bit more surprising — it is the level to which the banker feels that the examination staff is flexible and open to the exchange of information with his staff.

"The good news is that being open and flexible to the exchange of information is that something the examiners have control over, regardless of the economic environment."

A substantial piece of a bank examiner's training focuses on how to comport oneself in what can be a potentially tense exchange.

"It really is important, you have to realize when you're an examiner and you're delivering bad news, that you do in fact have to put yourself into someone else's shoes and experience what they're feeling," said Bruce Peters, a former FDIC examiner who teaches classes in the agency's Corporate University. "You just can't be a plastic person and spit out some facts and figures and move on from there."

Examiners, who at the end of each examination present comprehensive results of the exam to the bank's board of directors, say the tenor in those meetings runs the gamut from gratitude to anger. Bank examiners receive training before going into any institution on how to act in either scenario.

"We've had … board members at the end of the exam come up to us and thank us for bringing … issues to the board so that they can address them, because the board is ultimately responsible for that bank," said Michael Loewe, a field supervisor for the FDIC in Albany, Ga.

"On the other side of the spectrum, we've had directors accuse us of just being out to get the bank. Some stand up, say a few choice words and just leave the meeting. We don't take those kinds of things lightly at all. We want to understand their frustration so we can try to address that."


As hundreds of troubled banks still try to improve their situations, it is clear that not all institutions report positive exam experiences, and some believe the regulators are still overreaching in certain cases.

"Most exams are doing what they're supposed to do. The problem is that a high enough — and I think a third of the exams is high enough to cause question — are not doing what they're supposed to do," Wayne Abernathy, the ABA's executive director of financial institutions policy and regulatory affairs, said in reference to the industry survey results. "They're not identifying genuine problems, or leaving the banks better off than before the exam.

"I think 30% is still a big problem. … It's still a high level of dissatisfaction with the process. Our point is that we don't have a system that's broken. But we have a system that's in need of fixing and improving."

(Of the industry surveys, an FDIC spokesman said, "While the FDIC welcomes input from the industry on the examination process, we would note that this questionnaire has inherent limitations based on geography, sample size and other methodological issues.")

While most institutions report a favorable assessment of safety and soundness exams, compliance exams now draw the most concern, with bankers worried about an expanded focus on fair lending and other consumer issues.

Martin Cole, president and chief executive officer of the $331 million-asset Andover Bank in Andover, Ohio, said community banks are now feeling pressure to step up their internal controls to ensure more systematic compliance with consumer laws.

"It's becoming increasingly difficult to keep with up with the compliance changes that are coming," Cole said. "In our particular bank, we haven't had any direct issues related to safety and soundness. We are seeing an increased emphasis in the compliance area of regulation and the administration of it. We feel that there is certainly an increased interest in things like deposit accounts, overdraft, pricing on lending and fees, which were areas that were never a problem before."

But similar to the safety and soundness exams, it is unclear whether the industry at large has objected to recent exams, or rather that banks fear a perception of tougher assessments.

"Some banks have had a difficult time on the compliance front. … But I would think that not every bank has been through that cycle yet. I've talked to a lot of banks who haven't had their compliance exams, but they're afraid of what they've heard," said the CSBS's Stevens. "We'll have to see how this plays out, in terms of: Is this all banks, or do some banks actually go through this and say, 'It wasn't quite what I thought it would be?'"

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