New Regulatory Orders Fell in '11 — Is it a Good Thing?

Regulators are doling out fewer new enforcement actions, but is it really an indication of returning health in the banking industry? Or have so many banks already been flagged for shortcomings that precious few remain to implicate?

A number of industry observers prefer to take the glass-is-half-full approach in assessing the decline.

"The banks are cleaning things up themselves, or the regulators are forcing them to do it," says Kevin Jacques, a finance professor at Baldwin-Wallace College in Berea, Ohio, and a former Treasury Department economist. "Either way, there will come a natural improvement."

In 2011, the total number of new cease-and-desist orders and consent orders fell 33% from a year earlier, to 286, according to data from Trepp LLC. Issuance of prompt corrective actions fell 32% last year, to 50. Regulators also eased up on new formal and written agreements, which declined 57%, to 166.

Written agreements are noticeably declining. Regulators reached 13 such agreements during the fourth quarter, or roughly a third of volume from a quarter earlier.

A drop in the number of new enforcement actions shouldn't be surprising, says Tim Yeager, a former economist with the Federal Reserve. Broad improvements in the U.S. economy are giving banks a boost, and those institutions are continuing an ongoing purge of delinquent assets, he says.

"Bank performance is significantly better this year than last year," says Yeager, a finance professor at the University of Arkansas.

"Asset quality is getting better and inflows of nonperformers are going down and home prices are stabilizing," says Marty Mosby, an analyst at Guggenheim Partners LLC and a former chief financial officer at First Horizon National Corp. "Those things that were causing the biggest pressures are getting to a point where banks can manage it better."

The positive spins don't rule out the fact that a dwindling supply of ailing banks means there are fewer institutions to receive regulatory orders, adds Mosby, a former chief financial officer at First Horizon National Corp.

When regulatory orders began to slow earlier this year, skeptics argued that the banking industry had simply reached a point of saturation, as 2,130 enforcement actions had been issued since early 2007. That was in a universe of about 7,500 institutions. Other observers suggested that regulators were only catching their breath as they dealt with problems already in the queue.

In 2011, bank failures fell 41% from a year earlier, to 92, according to the Federal Deposit Insurance Corp.

Nevertheless, Mosby says he believes that a smaller supply of struggling banks is only a contributing factor to the overall decline in new orders. Mosby says it took many months for the number of new regulatory orders to fall, suggesting the reason is because state and federal regulatory agencies are undermanned

Regulators "only had so much manpower to cover the banks," Mosby says. "They worked through the banks that were out there and so they're now wrapping up the process."

The shockwaves that permeated the financial system from 2008 to 2010 exposed banks' internal weaknesses that had been masked by profits, says Jacques, who also worked at one time at the Office of the Comptroller of the Currency.

"Banks that were not operating as they should have been — they didn't have the risk-management systems in place they needed, a lot did not have enough capital," Jacques says. "Regulators responded to that and we naturally would expect it to get better."

Of course, regulators are going to continue to issue and terminate orders against banks as they endure — and hopefully overcome — their challenges.

The Fed, for instance, on Tuesday disclosed a new prompt corrective action and a written agreement.

Community West Bank in Goleta, Calif., disclosed on Wednesday that the OCC had hit it with a consent order. As part of the Jan. 26 order, the $633 million-asset bank must beef up capital levels and improve oversight of its loan portfolio.

Cortland Bancorp in Ohio said on Wednesday that regulators had notified the $498 million-asset company that it had fulfilled the terms of "informal assurances" given to regulators in 2009, when Cortland was hit with a memorandum of understanding.

Regardless of the reasons, industry observers say that a decline in new enforcement actions should be viewed favorably.

"Either way it's good news," Mosby says. "You have already churned through a subset of banks that have issues and we're not seeing further deterioration in that."