BankThink

FDIC Stuck in Crisis Mode, Hurting Banks’ Recovery

I believe that this will be the first year of a slow transition back to normal banking.  The economy is improving and asset problems are beginning to decline for most banks.

It is understandable that the Office of the Comptroller of the Currency, the Federal Reserve Board, and in particular the Federal Deposit Insurance Corp. had to impose draconian policies that affected the capital and asset valuations of the banking industry beginning in 2008. These policies were necessary and prudent because asset values were in a steady decline, no one knew how long the recession would last, and many bank employees and directors did not recognize the extent of the damage incurred by their banks. 

However, in this improving economy, many of the policies and procedures that were imposed on banks in 2008 by the regulators have become counterproductive, and are hurting rather than helping the banking industry. 

Loss provisions have begun to decline, as have nonperforming-asset ratios. More banks returning to profitability. In view of the advent of these positive signs, the FDIC should acknowledge that the banking industry is finally improving rather than getting worse. Policies that were appropriate in the dark days of 2008, 2009, and 2010 no longer are, and we suggest that existing policies should be reviewed to determine if they are still applicable. 

The following policies, in particular, should be modified as doing so would immediately help the banks and the economy:

Inordinate Time for Decision Making and Lack of Written Policies

Perhaps the most frustrating policy of the FDIC is its unpredictable and time consuming practice of delayed decisions concerning bank applications involving mergers, asset sales, new capital, etc., and the absence of clearly written policies concerning these issues. The FDIC has apparently elected not to delegate decision making to its regional and local staffs, but to restrict most decisions to its office in Washington. Restricting decision making to a relatively few people requires an inordinate amount of time to make decisions, and this process also implies that very few members of the FDIC staff know what the FDIC policies are.  

Delaying decisions for unreasonable periods of time has hampered reasonable planning by bank presidents and their directors, and has resulted in a high level of frustration and mistrust on the part of the banking industry and its investors.

Policies That Discourage Capital Raising

Many banks need to raise equity to comply with regulatory capital ratios which have recently been increased. Because of the severity of the industry’s losses and the number of failing banks, it has been difficult for smaller community banks to raise new capital as traditional bank stock investors already own depressed bank stocks and/or their personal net worth has declined significantly. However, there are many situations where banks could raise the needed capital if they could offer a more attractive security than common stock. Convertible preferred shares or subordinated debentures provide investors with a senior position vis-à-vis the common shares and a cash dividend or interest payment while they wait for better times. The FDIC has discouraged the issuance of preferred shares that require cash dividends, apparently because the payment of future cash dividends on the preferred shares would reduce the bank’s capital. The fact that a successful offering of preferred shares would generate far more capital apparently is given little consideration by the FDIC.

Approval of M&A Transactions

Florida has about 225 community banks, and an estimated 50% of them are subject to restrictive agreements and are likely to be classified as CAMELS 3 or possibly CAMELS 4 banks. (The CAMELS system grades banks on a scale of 1 to 5, 1 being the best rating. The term is an acronym for the six areas where banks are evaluated: capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk.) These banks are likely so classified because of inadequate capital ratios, high levels of nonperforming assets, or both, but many have positive core earnings, established businesses, and a high level of core deposits. They can be attractive acquisitions as part of a larger bank.

The average asset size of most community banks is $250 million, and in view of the ongoing increases in fixed costs for compliance, technology, and staffing, smaller banks must get bigger to achieve a sufficient level of profits to attract capital. Mergers of equals are the best solution for most banks to achieve the increased size required to be adequately profitable and competitive, and these transactions offer many operational benefits as well as scales to the merged banks. A merger of equals allows both parties to participate in the management of the merged bank and provide continued ownership and upside potential for both banks’ shareholders. The mergers are typically structured as an exchange of common shares at an exchange ratio determined by the relative contribution of earnings, capital, etc. by each bank to the merged entity.

Mergers of equals also offer operational advantages, not the least of which is that the larger, more efficient merged banks will have a better chance of capital than either bank would have with a “survival offering,” which many of the unsuccessful offerings for small community banks have been.

As asset values start to stabilize this year, these deals will become more feasible, and one would think that the FDIC would encourage mergers of equals rather than discouraging them. Yet the FDIC has indicated that it will only approve mergers involving CAMELS 2 banks or those mergers where the merged banks can be classified as a CAMELS 2 bank. This policy will leave a large number of CAMELS 3 banks in limbo. 

The FDIC, in discouraging mergers of equals, is ignoring the possible consequences of its actions, because this policy could result in a higher level of failed banks, higher costs to the FDIC deposit insurance fund, and higher future premiums for the banking industry. The FDIC’s decision concerning mergers of equals should be based on the viability of the merged banks, their business plan, their management team, and their pro forma capital – not their pre-merger CAMELS ratios.

Treatment of Restructured Loans

In working with borrowers who are having difficulty in meeting the debt service requirements of commercial real estate loans, banks often need to modify the terms of the loans, such as by lowering interest rates or extending maturities. Since these modifications hurt the fair market value of the loan, the bank either must write the loan down to its new market value or establish an appropriate reserve. Apparently, these two methods for recognizing the lost market value are not sufficient as the FDIC requires that the modified loan must also be adversely classified as a troubled loan even after a reasonable period of debt service coverage has been demonstrated. This requirement made sense when the economy was declining, as it did from 2008 to 2010.  Even in an improving economy, the FDIC continues to adversely classify the reworked loans, and in doing so, lowers the regulatory capital of the bank. A modification of this policy would make more capital available to support new lending and to comply with capital ratios.

The regulators had a thankless job of stabilizing the banking industry from 2008 to 2011. Now, with an improving economy, they are in a position to help deserving banks raise capital and enter into mergers.

These suggested changes in regulatory policies for the country’s 7,000 banks would not only create jobs, but they may do so quicker and at a lower cost than the various programs being considered by Congress or the Administration.

Benjamin C. Bishop, Jr. is the chairman of Allen C. Ewing & Co., an investment banking firm in Jacksonville, Fla., that caters to financial institutions in the Southeast. This article is adapted from a letter he sent to regulators and members of Congress. 

For reprint and licensing requests for this article, click here.
Community banking Law and regulation M&A
MORE FROM AMERICAN BANKER