C'mon! Give the Regulators a Break!

Much is being written in the press about the regulators, especially the FDIC, allowing banks to “extend and pretend” because of the October 30, 2009 “Policy Statement on Prudent Commercial Real Estate Loan Workouts.” Comments in online articles and blogs state, “Bank examiners have guidelines to follow when they review bank’s books, but none of the guidelines forces banks to ultimately resolve problem loans”
and, “Rather than foreclose, banks were guided to extend and amend loans.”

While the Youtube video on CRE posted below is hilarious, it accuses the FDIC of amnesty during bank examinations and I don’t see this being the case in any way.



The guidance that was released is simply a reiteration of policies that have been in effect for many years. Assistant examiners are taught these policies during training classes at the FDIC’s training facility in Virginia and while on the job from more seasoned examiners. The same is true for the other regulators. For lenders who have lived and worked through the last banking crisis, this is not new material. For bankers who have worked in this industry for shorter time periods, some of this material may be an education. During the conference call on December 3, 2009, Darrin Benhart, Director of Commercial Credit at the Office of the Controller of the Currency, stated, “I want to emphasize that there's no change to the definition or the process for analyzing credit in determining the classification.” The transcript for the call can be found at
http://www.fdic.gov/news/news/financial/2009/fil09068.html.

What the guidance does do is clarify the aspects of a loan credit that an examiner evaluates while reading the loan during an onsite examination. The guidance also discusses in detail the benefits of restructuring a note using an A and B note structure. In reality, many of a bank’s borrowers want to remain in good standing with their bank, especially if they have long-term established relationships with their community bankers. By restructuring a loan into two notes, the bank has the ability to structure the A note according to their institution’s board approved lending policy and eventually return this note to accrual status without an adverse classification. This scenario benefits everyone. The B note is typically charged off but the bank has the opportunity to recover if the situation presents itself.

By following this methodology, a bank will take a loss, but the loss will not be as severe. In my opinion this is not the regulators' way of saying not to recognize the loss, but a better way to estimate the actual loss. If this can be accomplished while banks are starting to realize increased earnings, more banks can be saved and the customer/banker relationship can be maintained. More importantly, the property will not have to be foreclosed upon, thus avoiding additional legal expenses for the bank and stemming the flow of distressed real estate in the market.

It is in no one’s best interest to have as many failures as the last banking crisis. During that crisis, the Resolution Trust Corporation was created in 1989 to facilitate the sale and disposition of bad assets, mostly consisting of real estate and securities, from failed thrifts. The RTC dealt with 747 thrifts with assets totaling over $394 billion. The assets were sold for cents on the dollar to investors. If they could make good on the loans, they were rewarded handsomely. Former FDIC Chairman William Isaac estimated that some funds who were organized by Wall Street investment banks earned annual returns of 40-50% on their investments.

While the ultimate cost to the taxpayer was not quite as large as originally estimated, the loss in the banking industry was huge. Efforts to contain this crisis and return the banking system to health is well worth the effort.

In My Humble Opinion

Federal Reserve Chairman Ben Bernanke is being nominated for a second term by President Obama. The hearings were televised on CSPAN and are available on the Senate’s website. It was interesting to hear individual Senators’ opinions on the job performance of Chairman Bernanke. Some Senators praised him for his decisive and effective efforts to prevent the collapse of the global banking system last fall. Some Senators acknowledged these efforts but were critical of other decisions while Senator (R) Bunning from Kentucky blamed Chairman Bernanke for everything since the Civil War.

Chairman Bernanke will surely serve another term during a critical time in our nation’s history. There are several major propositions that Congress is considering.

• First - The possible consolidation of the federal financial regulators. This, in my opinion, would be the worst possible outcome. The federal thrift charter remains an important mechanism in this country to finance residential mortgages by an insured depository institution. Many consumers are wary of obtaining financing through mortgage brokers and they should be. Also, there is the possibility that the Federal Reserve should not have direct supervisory responsibility over member banks. In my opinion this would also not be a beneficial change to the regulatory structure. Federal Reserve examiners provide valuable insight and direct access to banking issues during their examination processes.

• Second - The possible oversight of the Federal Reserve’s monetary policy function. This is also an area that should not be tampered with. Monetary policy is a long-term objective and should be conducted by individuals independent of political functions. There is plenty of transparency of the Federal Reserve board who issue the minutes of their meetings and frequently testify before Congress during hearings. The most successful countries are ones that allow monetary policy to be independent of the legislative or executive branches of government. 

• Third –Addressing the “too big to fail” concept. Never in this country’s history has this concept been more evident than over the last two years and if Congress can accomplish only one objective it should be this one. The nation’s largest institutions took on tremendous risk by filling their balance sheets with subprime and high risk/high LTV loans and the taxpayers subsidized this risk. The subsidy allowed these institutions to write off these bad loans and now bounce back to profitability from income streams derived from their nontraditional banking activities. Chairman Bernanke is in favor of empowering the FDIC with the authority to “wind down” the resolution of failed large institutions. This is a suggestion Congress should act on because the FDIC clearly has the infrastructure and experience to assume this new and incredibly important responsibility.

The nation is recovering from a large financial disaster, although the recovery is a shaky one. Many Americans are out of work, the credit markets are still not lending to their full capacity, and delinquencies and defaults on commercial real estate loans are rising. Because of this, the FDIC continues to close failed institutions and incur losses to the deposit insurance fund. Hopefully, we as a nation, and bankers especially, have learned valuable lessons from this economic recession. Going forward, better risk management practices are in everyone’s best interest.