WASHINGTON — The scope and depth of the housing crisis is fueling fears among industry observers that federal banking regulators are overtaxed and underprepared to handle problems at financial institutions.
While regulators argue they are up to the challenge, industry watchers point to some deficiencies, including retirements and downsizings that have left a relatively untested examiner force in a rapidly changing environment.
"If we have anything approaching what we hit in the early '90s, I think the agencies are going to be woefully undermanned," said Nicholas Ketcha Jr., a former director of supervision at the Federal Deposit Insurance Corp. and now the managing director of FinPro Inc., a consulting company in Liberty Corner, N.J.
The agencies have "let attrition take care of staff because there weren't problems in the industry," Mr. Ketcha said. "If problems do surface next year, I think they're all going to be scrambling for people."
What is already clear from interviews with regulators, bankers, and industry representatives is that examiners have changed how they operate in response to the current crisis, giving new priority to institutions with significant subprime lending and, at least according to anecdotal evidence, giving more leeway to more traditional and less complicated institutions.
Regulators say it is standard practice to assign attention to where there is the greatest risk — and right now, that is subprime lending portfolios. That has sometimes meant other items get put on the back burner. Some less complicated institutions report their exam teams have shrunk, while others have to wait longer for exam reports.
"I've noticed some recently good-sized clients — especially thrifts — have received some very small exam teams, particularly in the West Coast," said Kip A. Weissman, a partner at Luse Gorman Pomerenk & Schick PC in Washington. "What does that mean? To me that means there's a large group of examiners examining Wamu … or Countrywide or you name it.
"They're putting … [examiners] on special projects with subprime."
Officials with the Federal Deposit Insurance Corp. and the Office of Thrift Supervision said that practice makes sense given the recent problems.
"We have done some targeted reviews on institutions that, based on off-site data that we had or prior examination data, we knew that they might have above-normal exposure to either the liquidity issues in the mortgage market, or with respect to credit quality should they be holding these loans on their books," said Serena Owens, an associate director with the FDIC's division of supervision and consumer protection.
"I don't know that you'd specifically say it's because of the mortgage market itself," she said. "It has more to do with what the risk in the industry is as a whole, and right now that of course would include the fallout from the mortgage market."
Regulators deny, however, that the reallocation is more extensive than normal, or that it has left gaps.
"From a risk-focused perspective, we're going to look at the risk profile of an institution, and if the institution has a low risk profile, there may be some work that we don't do at that institution that we would indeed do at an institution with a higher risk profile," said Scott M. Polakoff, the OTS' deputy director. "That's the right way to run an agency, and that's the right way to run a regulatory process."
But that does not mean examiners are ignoring other areas, he said. "It's the responsibility of our management team not to allow that to happen," Mr. Polakoff said. "It's not an either-or. We as an agency … can't focus on one at the expense of the other."
E. Wayne Rushton, the chief national bank examiner at the Office of the Comptroller of the Currency, said the added demands of the mortgage mess have not hurt the agency's supervision capabilities.
"It hasn't slowed anything down," he said. Challenges may emerge if problems were to dramatically worsen — to the magnitude of the 1980s S&L crisis — but, "We are nowhere near that," he said.
But others are concerned the potential is there for regulators at both the state and federal levels to overreact while stretched thin — especially in light of criticism of regulators for not doing enough to prevent problems in the subprime market. "There are a number of states where they're understaffed, and where the average age is going up because they're not adding new examiners," Mr. Weissman said. At federal agencies, "they've got to get [examiners] from somewhere. We've seen a few places where they've had very large exams. No one's surprised at that. Where did the examiners come from? Sooner or later, they get them from institutions that don't have the subprime problems.
"If they're spending all their time in a troubled neighborhood, then maybe things might slip in the better neighborhood where they're not visiting as much," he said.
An issue for all agencies is responding to the new risk environment with turnover in their examiner force. The baby-boom generation hitting retirement age has made maintaining staff levels challenging, and some agencies — such as the FDIC and OTS — recently hit peaks in post-S&L-crisis downsizings.
As a result, the examiner force is getting increasingly younger, and some question whether newer examiners are up to the task of attacking the current credit issues with an appropriate level of vigilance.
Under prior FDIC leadership, "there was a big push for early retirement and retirement buyouts, and they lost some really, really top-drawer regulators, … people who have been through downturns," said Randy Dennis, the president of DD&F Consulting Group Inc. in Little Rock. With the current credit trouble, "you need people that are seasoned in understanding these issues, and won't overreact or under-react. We don't have that right now. You have a lot of young examiners."
The FDIC and OTS, as examples, have gone about adding manpower differently. The FDIC has sought to rehire some of its retirees on a part-time basis to supplement bank teams and help train younger examiners. The agency also has attempted in recent years to cut down on unneeded time an examiner spends in an institution, both to maximize resources and cause less burden to bankers.
"All the stuff that we can do off-site, we do it off-site," Ms. Owens said. "I wouldn't say that necessarily translates to 'we spent less time on the exam.' "
The OTS had 3,379 employees in 1989, 1,282 in 1999, and has a little over 1,000 now. It added roughly 150 employees in the last two fiscal years to supplement exam staff.
Mr. Polakoff said the agency plans more hiring, but acknowledged many of the new hires, while qualified, still need experience. "These folks, incredibly intelligent, still need to go through some on-the-job training, as well as some formal training," he said.
Despite efforts by the agencies to manage resources, observers see difficulties. The FDIC's efforts to make safety and soundness exams more efficient — the Merit program started in 2002 tailors examinations for smaller banks with high Camels ratings that have not changed management — was criticized by the agency's own examiners.
In a recent employee survey conducted by a consultant to address morale issues at the agency, nearly half of examiners responding said the program allows them insufficient time to examine banks, and 67% said the program is an overall detriment to the effectiveness of the exam process. The agency will not comment on the survey, conducted by Hay Group, until the firm releases a more detailed report of its findings later this month.
But Mr. Ketcha said a strain on the agency's resources is evident.
"What we're hearing from the banks … is regulators are telling them, 'It's going to take us longer before we get the report back to you,' " he said. "Now, every time I call for someone" at the FDIC, "they're on detail or on cross-training somewhere else. … It's causing a real morale problem as people are being bounced around so much. They're shuffling people around like crazy."
Mr. Polakoff acknowledged that a less experienced exam staff could be prone to overreaction, but said his agency's examiners are trained not to jump to conclusions.
"I'm concerned that less experienced examiners could overreact in this situation," he said.
But others disagree there are problems. FDIC officials say a shifting of resources is to be expected with every cycle in the industry, and the recent downturn is no exception.
"Have we spent some time focusing" on credit problems "and making sure we've identified … [institutions] that have some exposure? Yeah, I think that's correct. … But I don't think we'd characterize it as a really significant, massive reallocation of exam resources," said Steve Fritts, also an associate director in the same FDIC division as Ms. Owens.
Bankers, meanwhile, report they have noticed a change in how exams are being carried out, with a particular emphasis on subprime issues. Examiners in the past took a more big-picture approach to reviewing institutions' lending procedures. Now agencies are giving individual loan transactions more scrutiny. "We are taking a look at the actual products themselves now," Ms. Owens said.
Joe Pierce, the president and chief executive of the $455 million-asset Farmers State Bank in Lagrange, Ind., said his bank's recent safety and soundness exam by state regulators revealed a fresh strategy that regulators are taking.
"They wanted to know if we were a participant in subprime lending activities, and, after assuring them we were not, they proceeded with a fairly normal exam," Mr. Pierce said. "This is a new question. … My guess is they're seeking to focus their examination"
Preston Kennedy, the chief executive at the $150 million-asset Bank of Zachary in Louisiana, heard a similar message. At a recent banker roundtable for institutions examined by the FDIC's Memphis office, officials prepared the participants for a new focus in their exams, he said.
"They were letting us know, … if you're doing any subprime lending or you're having any problems in your community, No. 1, they're offering their services to help in any way they can as an adviser," Mr. Kennedy said.
"The other thing was," they said, " 'If you do have any of this kind of lending that might be considered subprime or predatory, we're going to look at that pretty closely.'"
