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Drop in Bank Consent Orders Not (Necessarily) a Sign of Recovery

Regulators are hitting banks with fewer enforcement actions, but don't assume that means the industry's getting healthier.

The decline could merely reflect a shrinking pool of candidates for regulators to flag for errant behavior, some industry observers say.

In May, 10 banks entered into consent orders with the Federal Deposit Insurance Corp. That was roughly half of the monthly average for the prior six months and on par with the number of orders passed out in October 2008, when the financial world was in the midst of a freefall.

Banking lawyers and consultants have a variety of explanations for the drop. A few say it does indeed carry a glimmer of hope for underlying improvement. Others say regulators may be taking a breather.

The prevailing theory, however, is that regulators are just running out of banks to censure.

"I would not view this is as a positive sign. I think we've just reached a saturation point," says Philip Smith, the president of Gerrish McCreary Smith, a consulting and law firm in Memphis, Tenn.

"At this point in the credit cycle, there are just not that many banks left without some kind of an order," Smith says.

Since the beginning of 2008, the FDIC, the largest federal regulator, has issued 851 consent orders, which were called cease-and-desist orders until late 2009, when banking advocates persuaded regulators to adopt the less harsh-sounding term.

The issuances peaked in November 2009 when the FDIC issued 51 consent orders. June data from the FDIC is expected later this month.

An FDIC spokeswoman says it's too soon to speculate on whether May was an anomaly or the beginning of a downward trend. However, the number of troubled banks grew by only four institutions in the first quarter, to 888 banks.

"Overall, things are getting a little better," says Walter Moeling 4th, a partner at the Atlanta law firm Bryan Cave. "There are still banks that are going to fail and there are still banks that are going to go under orders, but I do think it is a good sign" to see consent orders slow.

Moeling adds that orders are often prompted by either a concentration of commercial real estate or instances where classified assets account for more than 135% of capital and reserves. Still, he says that orders given to banks at this stage in the cycle are largely pointless.

"At this point, these banks should be getting a 'Hallelujah' instead of a consent order," Moeling says. "These are the survivors that are making it in a lousy market. It isn't a reflection of the board's performance, it's a reflection of the market."

Other banking observers viewed May's decline in a more pessimistic light, suggesting that regulators may simply be catching their breath.

Christopher Zinski, a partner at Schiff Hardin LLP, says he believes the FDIC is taking a phased approach and the number of consent order might shrink for a few months as the regulator focuses on failing those that are beyond fixing.

"They have this long list and maybe they aren't adding anymore until they clean the chamber," Zinski says. "They need to make room for more. It's a grueling process and they have limited resources."

Zinski is adamant that the reduction in new orders is not a sign of improvement. "I would argue things could get worse as we are getting more clarity that capital is still painfully scarce," he says.

Michael Iannaccone, the president of MDI Investments, a Chicago-area community bank consulting firm, says the number of new orders has slowed as the migration of problem loans has slowed.

"We aren't seeing the increases in nonperforming assets that we were seeing before. It's like we've hit a plateau," Iannaccone says. "I think the regulators would love it if we hit the peak, but it just hasn't happened."

Iannaccone says he expects asset quality to deteriorate again in the second half of this year and that the number of consent orders will trend accordingly. He adds that although the orders are not the death sentence they once were, they are still vexing.

"They are not as meaningful as they were in the past, because these banks are mostly survivors," Iannaccone says. "That doesn't mean they'll stay that way. [Getting an order] is still a negative. You are going to be forced to shrink or find some other solution."

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