Though the banking industry continues to labor under the weight of billions in nonperforming assets and the list of problem banks reached a new high at the end of 2009, we have spotted early signs of stabilization.
We expect more than 200 bank failures in 2010, but it is encouraging that 45% of banks showed improved asset quality in the fourth quarter. Capital raises are becoming more common. If the FDIC is successful in auctioning off "clusters" of failed banks, we could see the number of problem banks actually begin to decrease in the second half of 2010.
With these signs of stabilization, why would bank regulators decide that now is the time to increase required capital levels? The industry needs capital forbearance, not higher requirements. The uncertainty created by an uneven regulatory response to the issue of capital is having a paralyzing effect.
Thousands of banks with the requisite capital and management to help clean up the current mess by acquiring problem banks are unwilling to move forward with a merger until they are certain they will have capital sufficient to meet any new standards after the merger. In addition, private-equity firms and others with capital are poised to pour billions of new capital into the industry once it can be determined what the new standards will be.
It is important to note that the problem at failing community banks during this cycle was not a lack of adequate capital. The problems had more to do with lax regulatory oversight of lending (loan concentrations, outsize bets on home prices and out-of-market loans) and of excessive reliance on wholesale funding magnified by a prolonged period of unrealistically low interest rates.
The median bank that failed in 2009 had positive equity the quarter before failure. More banks in 2009 were closed over liquidity and funding concerns than an absence of capital. One of the costliest failures, Guaranty Federal, a thrift with branches in Texas and California, was allowed to stay open for months while operating with a negative capital ratio in excess of 5% of assets while the OTS shopped for a buyer.
Bank failures over the past 18 months have cost the U.S. taxpayer zero! All the losses the FDIC incurred in cleaning up the current problems are being financed by banks out of their current capital through FDIC assessments. Community banks have not been bailed out! The Tarp dollars that flowed into banks and thrifts will be fully repaid to the Treasury at a net profit to the taxpayers. However, it appears that the desirability of a "capital cushion" afforded by Tarp to the nation's largest banks has somehow found its way into proposed regulatory reform for community banks.
The current standards for capital in community banks are perfectly adequate. Raising capital requirements for community banks is the wrong response to this crisis. In the last banking crisis, over 20 years ago, banks with good management were given forbearance and were required to submit a "capital plan" that would demonstrate how they could return to required levels of capital through earnings retention and managed growth. Cease-and-desist orders were given only to those banks with owners and management that refused to cooperate with regulators as a form of punishment for bad behavior.
In the current cycle, "prompt corrective action" is the charge, and C&Ds are given based on a formula without the exercise of any professional judgment on behalf of the regulators. We continually hear from bankers throughout the country that the opinions of their regional regulator are arbitrarily overridden by superiors at headquarters in Washington. Clear, consistent regulatory guidance is lacking, causing banks to control balance-sheet growth and risk, which has the effect of reducing profitability and returns on capital. This restricts capital growth in two ways by lowering internally generated capital and driving external capital to industries with better risk/reward profiles. Banks with good management should be given time to work through asset-quality issues or to acquire problem banks under current capital standards. Until this issue is resolved, community banks across the country cannot assume their usual role as the wellspring of economic growth.