Regulator’s View of Banking in the Current Market
CCRMA was delighted with the fantastic turnout at the Regulator Panel held on 5/23/07 at the exclusive Center Club in Baltimore. After a delicious crab cake luncheon, the attendees were treated to an informative panel discussion.The presenter’s at the panel discussion included: Moderator: Mary Jo Taylor, Senior Vice President, Northwest Savings Bank Panelists: Steven Bareford, Assistant Vice President, Banking Supervision and Regulation, Federal Reserve Board
Maryann Kennedy, Assistant Deputy Controller, Office of the Controller of the Currency
Robert Mitchell, Assistant Regional Director for the Southeast Region, Office of Thrift Supervision
Bill Spangler, Assistant Bank Commissioner, State of Maryland
James Watkins, Deputy Regional Director (Risk Management), Federal Deposit Insurance Corporation David Miller, the programming co-chair of CCRMA and a Senior Vice President at Sandy Spring Bank, kicked off the event with a welcome message. David thanked his co-chairs on the Programming Committee, Vicki Tillman from LaSalle Business Credit, and Jennifer Kissner, AVP with Provident Bank who were also instrumental in planning and organizing the event. David was followed by Bill Githens, Director of Member Relations (at national level) for RMA who noted the importance of the chapter network for the success of RMA and more specifically some of the accomplishments of the Chesapeake Chapter including their success with local programming and open enrollment events. Mr. Githens also noted the numerous national leadership positions held by Chapter members, most notably, Glenn Wilson, President & CEO of Citizens National Bank who is the current Chair of RMA at the national level. After the initial introductions, Mary Jo Taylor started the panel discussion off with the first of a series of questions. The questions and responses are paraphrased below: - How are the banks that you supervise doing in terms of “Safety and Soundness”?
- Exam Trends?
- Exam Trouble spots?
Bob Mitchell, OTS:
Mr. Mitchell reported that the Thrifts in Maryland, Virginia, and D.C. are generally in sound condition. However, he stated they continue to have allot of Commercial Real Estate in their portfolios. He noted some complaints from the thrifts about competition for residential mortgages from mortgage brokers and large scale builders that have captive financing.
Underwriting remains strong, but noted some weakness in monitoring. Monitoring is an issue of increasing importance especially with the recent CRE guidance. The CD market remains competitive and some thrifts are experiencing difficulty generating favorable yield loans. These two factors are contributing to the interest margin compression. James Watkins, FDIC:
Mr. Watkins reported that from his observations, the banking industry is doing well. Most banks are maintaining high levels of capital. However, net interest margin compression remains a threat. The asset quality in general remains strong. Approximately 92% of banks are rated 1 or 2. However, there have been some downgrades in the earnings component of the rating. Steve Bareford, Federal Reserve
Mr. Bareford stated that there has not been much slippage in the banks in his region. Under the CAMELS rating system, only 8% are rated unsatisfactory. However, he noted that risk management practices have not necessarily kept up with growth. Net interest margin pressure was noted again. However, Mr. Bareford qualified the comment by stating that larger banks were handling the pressure better than community banks. Some minor slippage was noted in asset quality. Increased reliance on non-core deposits was noted. Overall, however, the exams have remained pretty good. Maryann Kennedy, OCC
Ms. Kennedy noted concern over net interest margin compression particularly for community banks. She noted that efficiency ratios are already low and that she has concerns on how much additional overhead cost reductions can be made without negatively impacting risk management. Three areas of particular concern were that: - 30% of banks have over 300% capital in CRE loans
- Housing price volatility may negatively impact retail credit quality
- In some pocket markets, banks are forced to chase deposits
Bill Spangler, State of Maryland
Mr. Spangler started by stating that there was greater competition for funds. Asset quality remained strong. Loss reserves remained adequate at 2 times non-performing loans. All Maryland banks had well capitalized status. ROA was still strong for Maryland banks at 1.28%, but below a high of 1.40% in 2005. However, net interest margin compression was noted.- There was a question from the audience about BSA / AML, which led into the next question.
What are the “hot” buttons regarding compliance? - Bank Secrecy Act
- Anti-Money Laundering
- Adherence to appraisal and flood regulations
- CRE concentration proposal
- Recommendations
Maryann Kennedy, OCC
Ms. Kennedy stated the OCC is fairly satisfied with the efforts on BSA / AML compliance, despite some continued letters of understanding. Areas of weakness still being observed are: - Board of Director Oversight – Not enough involvement by the Board
- Management Support – BSA officers not empowered
- Audit – Weaknesses in testing and inadequate documentation in work papers
- Training
- Consistency
- Weak Internal Controls
- Weak Risk Assessments – Static assessments opposed to dynamic
Bill Spangler, State of Maryland
The risk assessment portion of BSA was a hot button on recent exams. He indicated that although there are more assessments being completed, they are not being incorporated into BSA procedures. Steve Bareford, Federal Reserve
Mr. Bareford made the analogy of a lawyer “practicing” law because one is never “perfect” at law and compared that to the role of the BSA officer. There has been improvement in BSA compliance but there is still room for improvement. BSA risk assessments were again noted as an area of concern. Smart cards were also noted as an area of risk in BSA / AML. There are different levels of risk based upon the bank’s role in the issuing of smart cards. However, notable abuses of smart cards have been noted. Mr. Bareford also discussed flood insurance as a hot topic. FEMA has been making payments because adequate flood insurance is not in place. The purpose of flood insurance is to protect the government, not the bank or borrower. Mr Bareford further indicated fines are being assessed for non-compliance in this area. He noted three steps and potential sources of errors for flood insurance (1) determining the need for insurance, (2) determining the correct amount of the insurance, and (3) making sure it is in place prior to settlement. Bob Mitchell, OTS
Mr. Mitchell acknowledged that banks had worked hard on BSA / AML and that most have done a good job. However, BSA / AML compliance remained the easiest place to get into trouble. Fair Lending was noted as another hot topic for the OTS. Mr. Mitchell suggested that all Banks should complete self assessments that are more than statistical. In particular, matched pair testing was recommended. Match pair methodology should take the least credit worthy non-minority applicant that was approved and compare that to the most credit worthy minority that was declined. There should be a notable difference in the credit worthiness of the two applicants. Any discrepancies or outliers should be thoroughly explained. Flood insurance also continues to be a hot topic and could move even more to the forefront if there are more significant storms this year. - Could you please provide some insight into how banks are collecting data for CRE, particularly if the information is not on a mainframe operating system? How will you be monitoring this going forward; are there any changes contemplated?
James Watkins, FDIC
On the surface it appears as if many banks have concentrations, but when they drill down into owner occupied vs. non-owner occupied, it brings many banks under the 300% threshold. The most important factor for banks is to understand their systems and its capabilities and to code correctly.- In regard to the recent ALLL guidance, how does it differ from the methodology guidelines most recently in place?
Bill Spangler, State of Maryland
As with most policy statements, the new ALLL guidance was intentionally vague to encompass all institutions. There is no uniform “one size fits all” solution. The new guidance is not significantly different than the prior guidance. The consistent application of procedures remains the focus. The most significant difference in the new guidance was the greater expansion of FAS 114 and subjecting more of the portfolio to FAS 114 procedures. There was also an increased emphasis on qualitative factors. Qualitative factors remain a critical part of the ALLL calculation but must be well documented. There continues to be a struggle between the SEC (GAAP) and the banking regulators (RAP). The regulators still prefer higher reserves.Steve Bareford, Federal Serve
Mr. Bareford joked that he has never asked any bank to take money out of its reserves. Maryann Kennedy, OCC
Ms. Kennedy agreed there was not much change in the guidance. One point that she noted was portfolio segmentation and analysis was stressed more heavily in the new guidance. - Regulatory exams seem to have a much greater emphasis on overall risk management and the risk assessment process. Could you please explain which risk factors you think most critical and why?
Steve Bareford, Federal Reserve
Credit Risk was ranked as the number one risk followed by operations risk. The lack of workout experience by younger bankers was also noted as a risk.Maryann Kennedy, OCC
Ms. Kennedy agreed that credit risk was number one risk. As effective risk management tools, the April RMA Journal Artice “Portfolio Management for Community Banks” was cited. The seven elements deemed critical in the article were (1) board oversight, (2) portfolio management, (3) management information systems (4) market analysis, (5) credit underwriting, (6) stress testing and sensitivity analysis, and (7) risk review. Fraud was listed as another key risk area especially with mortgages and insiders. Bill Spangler, State of Maryland
Mr. Spangler also listed credit risk as number risk. Headline risk was also noted as a risk. As an example of headline risk, the sub-prime lending problem was noted. Although this had a greater impact on the mortgage industry, the public perception was that it was caused by the banking industry. Bob Mitchell, OTS
Credit risk was again noted as the number one risk. In particular, Mr. Mitchell noted the 2nd mortgage portfolios as an area concern because the second mortgage lenders do not understand the terms of the 1st mortgages ahead of them. These mortgages could be interest only or option ARMs, which could have negative implications on LTVs and the ability to repay after repricing. Low Doc and No Doc mortgages were also listed as areas of concern. James Watkins, FDIC
Noted the risk associated with the number of publicly traded banks. Adverse stockholder reaction to news must be mitigated through effective public and shareholder relations. Adverse stock price movements could prohibit access to market capital and cause liquidity crunches. - What do you see as being the “hot” exam/compliance topics in the upcoming year?
Bob Mitchell, OTS
BSA, Fair LendingMaryann Kennedy, OCC
BSA, Fair Lending, Overall Compliance Risk Management (BSA focus has created other holes) - What keeps you awake at night?
James Watkins, FDIC
Fraud is primary concern because even pristine banks can be surprised.Bob Mitchell, OTS
The possibility of a pull back in the housing market was the primary concern. Bill Spangler, State of Maryland
Fraud and the housing markets were the primary concerns. It was noted that banks have many of the tools already to minimize fraud; however, the checks and balances are not fully implemented or monitored as they should be. Maryann Kennedy, OCC
Ms. Kennedy repeated fraud and the housing market as the primary concerns. She also noted the need for robust systems to prevent insider fraud. Steve Bareford, Federal Reserve
Fraud was listed as primary concern especially on the mortgage side. A personal concern was the legislative reaction (or possible over reaction) to the sub prime leasing problems. This was the conclusion of the formal program; several of the panelists were available afterward for individual questions. The local Chapter looks forward to offering this event annually, your suggestions and input are welcomed!
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