Jeff's Soapbox

Comments from a CFPB Speaker

noreply@blogger.com (Jeff Fair) — Tue, 05 Nov 2013 18:20:00 +0000

I just came across some notes I took during a December 2012 presentation to community bankers by a CFPB employee. Some of his comments were worth sharing...

We have a wide range of examiners, some fresh out of college. The young ones have book knowledge, not field knowledge. They are committed to the ideals of CFPB.

You would be surprised at some of the things they will advocate. If you respond affirmatively to their suggestions, you encourage their behavior and they will come up with bigger, better ideas next year.

You, as seasoned industry professionals, need to push back and explain how things work in the real world. I've told examiners that the folks on the other side of the table have been doing their jobs longer than you have been alive. You have to value their experience.

We have lawyers on staff, serving as examiners. They were hired not as lawyers, but as examiners. I tell them that! They are not arguing a case before the Supreme Court. They don't need to be litigious.

We bring enforcement lawyers into exams at the beginning to give thence an understanding of the process. When I was at OCC, they didn't get involved until there was a problem. Then, we had to back up and educate them on the situation. Their presence is not an indication of a problem. They are not meant to intimidate you -- they are there to learn.

Consumers can tell you every detail of their cell phone data plan (which changes every few years), but don't take any time to try and understand their 30 year mortgage. Sometimes, it's the consumer's fault!

Price of Increased Regulatory Burden: Less Time for Customers

noreply@blogger.com (Jeff Fair) — Mon, 23 Sep 2013 14:23:00 +0000

[article from American Banker, April 2013]

Regulatory change is taking increasingly bigger bites out of community banks' bottom lines.

Banks are spending more time and money to follow new regulations. That is problematic, especially when it distracts bankers from other duties, industry observers say.

"Anything that turns the bank's attention away from the customer is detrimental to everyone," says T. Jefferson Fair, president of consulting firm American Planning. Community banks "already know how to take care of customers legally, morally and ethically, so having to comply with regulations that tell them what they already know how to do is frustrating."

A study by Continuity Control, a risk management firm, found that smaller banks spent $250 million and 8.3 million hours complying with regulation implemented in the first quarter. The study, which used public records and data from the firm's clients, looked at banks with an average of $350 million in assets.

Shifting the dialogue from anecdotes to quantifiable data "sends a more powerful message," says Pam Perdue, Continuity Control's chief compliance strategist. "We think it will be welcomed by all of the constituencies. Most importantly, legislatures and regulators will be aware of the impact."

Updating policies and procedures to meet new regulation "is a full time job," says Raymond Altmix, president and chief executive at Bank of Marion in Illinois. He says regulation is changing at a faster pace than what he has ever experienced during his 40 years as a banker.

Bank of Marion, a $332 million-asset unit of Midwest Community Bancshares, has a full-time employee aided part-time by another staffer working on compliance, Altmix says. Continuity Control is helping the bank automate much of the process.

Mixed signals from Washington and field examiners are increasing the financial burden, industry observers say.

Some banks are having "trouble keeping up with what is an actual rule, what is a proposed rule and what is just talked about in the media," Fair says. "Then examiners come in and add a layer of interpretation. It can lead to paralysis."

Banks should act quickly to implement changes as soon as they understanding a rule, observers say. It will be costly; many banks are hiring new full-time employees or outsourcing tasks to outside firms. Hiring workers with regulatory know-how is especially expensive because those people are rare and in high demand.

Meeting regulation can create a "disproportionate burden on community banks because they have less infrastructure," says John Depman, leader of regional and community banking at KPMG. "It can become tough to attract and retain people with the right skill sets in small towns. Those experts have become very costly because of the demand."

Regulators have also been issuing warnings about the use of third-party vendors. Even if a bank outsources some compliance functions, it still must devote internal resources to managing that relationship, Depman says.
Vendor relationships "should be saving you money and not adding to your cost burden," adds Perdue, whose firm provides a compliance platform for community banks. "Compliance needs to stop being a distraction and instead create a competitive advantage."

Banks with a strong compliance management system have an opportunity to reduce the costs of new regulation, Perdue says. Banks should have a system to analyze and assess the risk of new regulations, along with a standardized way to structure policies and procedures, she says.

Automation can also keep costs in check, industry experts say.

Incurring upfront costs to properly address new regulation is less expensive than facing penalties over a lack of compliance, Depman says. Banks that run afoul of regulators also face reputational risk and, in some instances, enforcement actions that can limit expansion efforts.

"There's a balancing act that is going on," Depman says. Regulations for "things like fair lending and anti-money laundering are all good. But you don't want it to be overly burdensome."

http://www.americanbanker.com/issues/178_73/price-of-increased-regulatory-burden-less-time-for-customers-1058355-1.html

Do Examiners Read Their Agency's Publications?

noreply@blogger.com (Jeff Fair) — Fri, 19 Apr 2013 13:51:00 +0000

While responding to an examiner's criticism of a client's Liquidity Policy limits, I rediscovered a very good article from the Fall 2006 FDIC Outlook titled An Assessment of Traditional Liquidity Ratios. One of the authors of the article is Kyle L. Hadley, Senior Capital Markets Specialist, FDIC Division of Supervision and Consumer Protection. I know Kyle and respect his work.

A few of the key comments from the article:

[B]alance sheet ratios can vary widely among institutions with identified liquidity concerns. Consequently, some traditional ratios may not be the most accurate indicators of an institution's true liquidity position, and may be misleading when considered in isolation. In the past, the assumption was that banks with liquidity concerns would have poor ratios and thus would be easily distinguishable from institutions with a more favorable liquidity position. However, given the changing balance sheet structure and uniqueness of individual bank funding strategies, poor ratios do not necessarily mean banks are under liquidity pressures, and favorable ratios do not always depict a strong liquidity position.

[The Non-Core Funding Dependency Ratio] ratio is based on the premise that non-core liabilities are better suited to fund short-term investments rather than long-term assets. In theory, a lower ratio implies that an institution is better able to meet its' liquidity needs. Today there are many concerns with the original premise of this dependency ratio. Highly stable funding items, such as long-term borrowings and long-standing large deposits, are considered non-core, while most highly volatile internet deposits are considered core deposits. Additionally, all loans regardless of time to expected repayment are considered long-term.

[T]he pledged securities-to-total securities ratio could have minimal application under the liquidity management strategies used by some insured institutions.

The relative simplicity of such ratios and the ease by which they can be compared with historical trends at peer institutions increased their attractiveness. However, in today's more complex funding environment, these ratios, while still useful, may not adequately reflect an institution's liquidity position. In fact, ratio-based analysis can hide potential problems and leave a bank unknowingly exposed to considerable liquidity risk.

Despite these relevant and accurate observations made over six years ago, field examiners still focus on on-balance sheet liquidity, non-core funding dependence, pledged securities / total securities and loan to deposit ratios, criticizing banks based on their ratios and policy limits relative to industry or peer norms, often without thinking through the rational bank-specific mitigating factors that reduce perceived risk. Why? I'll allow the article to answer:

The relative simplicity of such ratios and the ease by which they can be compared with historical trends at peer institutions increased their attractiveness. However, in today's more complex funding environment, these ratios, while still useful, may not adequately reflect an institution's liquidity position.

Ratio-based analysis using outdated measures, combined with an examiner's unwillingness to consider the big picture, can make healthy banks look sick, leading to criticism and creating additional work for management. Responding to unnecessary examination criticism is very time consuming, and it diverts community bankers from their most important tasks -- serving their community's financial needs.

My favorite response to examiner criticism is to use their own agency's words against them. I may not win many friends field examiner crowd by doing so, but it will at least make me feel better.

Cyprus, part 3 -- The Butterfly Effect

noreply@blogger.com (Jeff Fair) — Sun, 17 Mar 2013 18:47:00 +0000

For those new to my discussion of Cyprian events, please start here. For the rest of you...

FACT: U.S. banks, large and small, are in much better shape than those in Cyprus. There is plenty of data to support this statement.

OPINION: U.S. depositors should have nothing to worry about come Monday morning.

FACT: People don't always act rationally.

OPINION: U.S. bankers should be prepared to help their customers understand what happened, and why it is not likely to happen here.

In the post-Lehman banking world, regulators and examiners have placed an emphasis on contingency funding plans, liquidity planning and stress testing. If your bank is not up to speed on these topics, it's time to get there, and quickly. I have no reason to expect a panic or bank run in this country, but I wouldn't be surprised if depositors begin to think more about where, and how, their wealth is stored. Some folks are likely to feel that Grandpa's tin can in the back yard and Crazy Uncle Joe's gold and silver in foreign vaults are sounding better each day...

If deposits leave your bank, how will you respond? Cheap deposits have played a crucial role in maintaining net interest margins as assets repriced downward. If deposits become more expensive due to a perceived increase in risk, what shall we do?

Lesson 1: Greece; Lesson 2: Cyprus - Pay Attention

Cyprus, part 2

noreply@blogger.com (Jeff Fair) — Sun, 17 Mar 2013 18:10:00 +0000

As a followup to my post last night, here are updates and additional links to news on the Cyprian meltdown:

President Nicos Anastasiades has warned that "Cyprus's two largest banks will collapse" if the bailout is not ratified by parliament.

Cyprus Parliament To Delay "Rescue" Vote Due To Lack Of Support, Despite ECB Pressure For Pre-Trade Open Decision

The Cypriot cabinet has declared Tuesday a bank holiday, and this may even be stretched to Wednesday.

Cyprus Bank Holiday Extended Through Tuesday As Confusion Spreads

Should Spanish depositors be worried?

EU Passes Law Forcing Countries to Take Bailout; Is Spain the First Target?

And the inevitable comparisons of Cyprus to the US begin...

Could The "Cyprus Fiasco" Occur In The United States?

Did Something Important Just Happen… in Cyprus?

noreply@blogger.com (Jeff Fair) — Sun, 17 Mar 2013 02:19:00 +0000

If you weren’t reading ZeroHedge or wsj.com over the weekend, you might have missed Saturday’s banking news from the tiny Mediterranean island nation of Cyprus. Just five years after joining the Eurozone, Cyprus has accepted a $13 billion bailout from the EU.

So what, you say? No big deal – just another crazy European bailout… Well, unlike the previous bailouts of Portugal, Ireland, Greece and Spain, Cyprus was asked by Germany and the IMF to impose a 40% haircut on bank deposits as part of the bailout. Stop and think about that. What if, despite FDIC insurance, you had to tell your customers that 40% of their money had been confiscated by the government to help keep JPMorgan Chase or Citigroup from failing. Not borrowed, but confiscated. Gone forever.

Now for the good news. Dear customer, our government played hardball with the EU, and you only lost 6.75% of your deposits up to the €100,000 ($131,000) deposit insurance limit, plus 9.9% of all deposits over that limit. That doesn’t hurt nearly as much, does it?

Cypriots (and foreigners with money on deposit in Cyprian banks) lost 6.75% of their insured deposits Friday afternoon. It happened so fast that they had no chance to start a bank run, although things might get ugly on Tuesday morning when the banks reopen (Monday is a holiday in Cyprus).

One of the best questions asked in articles discussing the Cyprian haircut is “After Cyprus, who’s next?” Many large banks in EU countries operate with 150% to 200% loan to deposit ratios, and there are concerns that high asset valuations are the only thing keeping some banks solvent. How ugly would it be if Danes, Swedes, Norwegians or Finns realized that their banks and/or countries were over-levered and could face the same types of haircuts?

The Eurozone financial crisis is far from over, and the Cyprian flu may be highly contagious. Watch the markets this week – we could all be in for a bumpy ride.

For more information, these links are a good place to start:

This Crazy Cyprus Deal Could Screw Up A Lot More Than Cyprus... (Business Insider)

After Cyprus, Who Is Next? (ZeroHedge)

For Everyone Shocked By What Just Happened... And Why This Is Just The Beginning (ZeroHedge)

Cyprus Savings Raid Crosses Financial Rubicon (Ed Conway - Sky News)

The Sun Still Shines!

noreply@blogger.com (Jeff Fair) — Fri, 09 Nov 2012 02:35:00 +0000

The elections are over, and the sun appeared on the horizon Wednesday morning as scheduled. “Status quo” is the phrase being used to forecast the next four years. Unfortunately, the current state of affairs will not continue for that long. Rising taxes, continued implementation of Obamacare, sequestration, shrinking asset yields and international problems could combine to make 2015 very different than 2012.

So what do we, as bankers, do now? My guidance over the last few months has been to wait until the election results were in, and then wait another week to see how the markets react. We’re now in that week of waiting, and waiting is still wise. But at some point, we must set a course for deploying excess funds, either into loans at rates below our traditional comfort level or into securities with huge premiums or painfully low yields (or both).

I have no great wisdom to impart on the asset side of the balance sheet, but I do want to speak forcefully on liability pricing. The Federal Reserve has committed to a Zero Interest Rate Policy for another 30 months, and the troika responsible for that commitment just received a four year contract extension. The old adage “Don’t bet against the Fed” is more appropriate now than ever. Here’s the forceful part:

If you are paying more than 0.50% on a one year CD, stop!

I feel safe predicting that asset yields will continue to fall. Most of our nonmaturity deposit rates are near zero (or should be!). If your market demands CD rates above the cost of replacement funds (FHLB Dallas 1 year bullet advance @ 0.48% this morning, QwickRate 1 year CD offerings in the 0.40% range, brokered CDs priced similarly), shift your funding to the cheaper sources. It’s an easy way to boost a sagging NIM.

When promoting this strategy, I often hear “My regulators don’t like those funding sources.” Perhaps that is true, but the 2010 Interagency Policy Statement on Funding and Liquidity Risk Management states:

“An institution should establish a funding strategy that provides effective diversification in the sources and tenor of funding. It should maintain an ongoing presence in its chosen funding markets and strong relationships with funds providers to promote effective diversification of funding sources.

Funding should also be diversified across a full range of retail as well as secured and unsecured wholesale sources of funds, consistent with the institution's sophistication and complexity.”

If an examiner gives you grief over your prudent use of wholesale funding sources, point them back to their own regs. You should have policy limits in place for each category of wholesale funds, as well as a limit on aggregate wholesale funding. The last four ratios on our monthly Funds Management Report address these items, and there should be no shame in the appropriate use of wholesale funds.

The other response I get sounds something like “But, I’m taking care of my customers” or “I don’t want to lose my customers”. I understand this concern, but the price of taking the “safe” route and paying up on deposits could be huge. If you want to pay a core customer who has large, low-cost deposit balances or large high-yield loan balances a bit more on a CD, no problem. Just don’t overpay for the rest of your CDs. Rate shoppers (local and foreign) should have your bank on their Do Not Call list. Their funds are not core – regardless of the FDIC’s definition – and will rarely be cheaper than wholesale funding sources.

If you have a competitor overpricing his CDs, share this article with him or send me his contact information. I would be glad to help him save some money while normalizing your market’s deposit rates. That’s a Win-Win situation in a Lose-Lose market.

One other parting thought: If you own some of the long MBS the Fed continues to overprice via QEinfinity, take some gains and redeploy the proceeds into products that are not as overpriced. I have seen several recent portfolio restructurings that resulted in minimal change to duration, yield and credit risk while providing a nice pop to current year earnings. I’ll be glad to tell you more if you are interested.

The Sky Isn’t Falling, YET!

noreply@blogger.com (Jeff Fair) — Wed, 13 Jun 2012 01:39:00 +0000

“Don’t worry. Unrealized losses on investment securities are just a book entry. They don’t have any impact on your regulatory capital ratios. You intend to hold the securities to maturity (or call), so you won’t ever recognize the loss.”

“Those silly mark-to-market rules won’t get any tougher. The lessons learned from the Lehman failure will prevent any extensions of mark-to-market accounting.”

Not so fast, my friend. The banking agencies have released a Notice of Proposed Rulemaking addressing implementation of Basel III that includes a summary of the impact of the NPR on community banks. The biggest impact, by far, is the inclusion of Accumulated Other Comprehensive Income (AOCI) in all regulatory capital calculations. For those of you who are more than a few years removed from your last accounting class or Call Report seminar, the biggest component of AOCI for most banks is Unrealized Gain/Loss on Available for Sale Securities.

Under the current proposal, AOCI would be phased into the capital calculations 20% per year beginning in 2014, with complete recognition by 2018. Over that same period, market interest rates are likely to rise, creating a significant unrealized loss in bond portfolios with longer durations. By 2018, then, bankers could find themselves with less regulatory capital than they expect, at a time when regulatory capital minimums are increasing. (The impact of Basel III’s higher capital requirements for the big banks and the trickle-down impact on community bank capital ratios is another concern for another commentary.)

The sky is falling! What do we do!?! Relax. You have options. We can deal with this situation. Here are a few thoughts, assuming that the current NPR survives the onslaught of critical comment letters you and your banker friends will write (you will write them, won’t you?):

We can reclassify some or all of our AFS bonds as HTM and avoid recognizing AOCI
We can sell our most price sensitive bonds (hopefully while they have gains) to avoid the price risk and corresponding capital impact
We can hope that our most price sensitive bonds (Agency Step-Ups, perhaps) are called before the phase-in makes a significant impact on our capital ratios (probably 2015-2016)
We can hold more capital to offset the expected AOCI loss
We can move some of our most price-sensitive bonds to our holding company (this one is tricky – ask me for details if you are interested)
We can adjust our security purchase strategy to avoid making the situation any worse and let the current portfolio roll inward

I expect there will be a lot of discussion of this topic in coming weeks. Creative securities dealers will probably come up with some interesting strategies, so don’t rush to solve tomorrow’s problem, today. Remember – the sky won’t fall until at least 2014 (unless the Mayans were right)…

Observations from the APC Family of Banks

noreply@blogger.com (Jeff Fair) — Sat, 26 May 2012 00:57:00 +0000

I’ve had lots of “What are you seeing in your other banks?” questions from clients recently. Here are a few general observations:

NSF fee incomes are significantly lower than last year. Some of the Q1 weakness may be related to tax refunds, but most of it appears to be driven by the amazing phenomenon of people not spending money they don’t have. This is a good thing for our economy (in the long term), but it slows economic recovery and lowers bank profits. And as an answer to the inevitable follow-up question, I don’t know of any good new sources of fee income.
Loan demand is still soft in most markets, although the I-10 corridor in LA and MS is beginning to show signs of life. There is still too much product (money) chasing too little demand (loans), so price continues to fall. Long term fixed rates (under 5% for 10 years) are being offered in some markets, and I worry a lot about the interest rate risk implications of these products. If you can stay short on balloon date (three to five years, seven at most) on solid credits, the low rate won’t kill you. If you can get an origination fee, even better.
Deposit volumes continue to grow, and most of the growth is in nonmaturity products. This is a good mix trend, but bankers need to make sure their rates are not too high. With overnight funds at 0.25% and extremely low securities yields, why are you paying north of 0.50% on any deposits unless loan demand is strong? If deposit volumes are growing and you don’t have a good plan for deployment, think about lowering rates – again.
Several of our banks are already experiencing earnings and balance sheet performance well above or below plan. If these variances are expected to continue, consider a mid-year plan revision to avoid criticism about the inaccuracy of your plan.

Dealing with Examiners

noreply@blogger.com (Jeff Fair) — Sat, 19 May 2012 01:49:00 +0000

I want you to get up right now, go to your windows, open them and stick your head out and yell ‘I’m as mad as hell and I’m not going to take this anymore!’ Things have got to change. But first, you’ve gotta get mad! You’ve got to say, ‘I’m as mad as hell, and I’m not going to take this anymore!’ Then we’ll figure out what to do about the depression and the inflation and the oil crisis. But first get up out of your chairs, open the window, stick your head out, and yell, and say it: “I’M AS MAD AS HELL, AND I’M NOT GOING TO TAKE THIS ANYMORE!” (Peter Finch as Howard Beale in Network (1976))

OK, so yelling at examiners is not a good idea. I got your attention, though, right? Now, you need to do the same with your examiners. I’ve heard of and read too many off-the-wall statements from examiners lately to hold this in any longer. A few suggestions for you as you prepare for your next exam:

Be prepared. You need to know more about how your bank operates than the examiner. Understand your liquidity, forward liquidity and contingent funding plans. Understand your Earnings at Risk and Economic Value of Equity posture. Call us if you want a refresher course on either one.
Don’t fall prey to the “Gotcha! Game”. If an examiner interrupts your day with a series of rapid-fire questions on a technical topic, delay your response. “I’m right in the middle of something – can I get back to you in 30 minutes?” is an easy escape clause. Then, prepare your response (call in reinforcements as appropriate) and reverse the Gotcha! by catching the examiner off guard when you are ready to talk.
Do not accept inaccurate or unsubstantiated statements. Stand your ground and argue (politely) for your position. If you can’t resolve the issue, ask the examiner to put his concerns in writing (in the Report of Examination) so that you can respond.
Be nice, but be firm. Examiners are people, too. Sometimes, emotions or opinions (or supervisors) override common sense and logical thought. Don’t kill the messenger, but don’t accept the message if it isn’t reasonable.
Respond, in writing, to your Report of Examination. Go on record with your side of the story. The manager of a baseball game doesn’t expect to get a bad call changed by arguing with the umpire. His performance is designed to rally the team and increase his chances on the next close call. The exam is over, and you aren’t going to change the result, but you can make your case for the next exam cycle. I was told recently that a client’s response letter had been widely circulated by examiners and was the “talk of the office”. We would be glad to help you write a measured, appropriate response to your next Report of Examination (or other regulatory communication).

The Fiscal Cliff

noreply@blogger.com (Jeff Fair) — Sat, 12 May 2012 01:46:00 +0000

Fed Chairman Bernanke told a group of senators yesterday that scheduled end of programs including the Bush tax cuts, the payroll tax holiday and extended unemployment benefits, as well as budget cuts that are set to take effect in January of 2013 would have a negative effect on the economy. This statement is similar to one he made at a news conference last month: “It is very important to say that if no action were to be taken by the fiscal authorities, the size of the fiscal cliff is such that there is, I think, absolutely no chance that the Federal Reserve could or would have any ability whatsoever to offset that effect on the economy”. Anyone up for a one year extension on some or all of the Bush tax cuts? Might such an extension become an election year gimmick? Eventually, we must deal with the unholy trinity – tax increases, entitlement reform and a significant reduction in government spending. Or, we can just follow the lead of French and Greek voters and elect anti-austerity candidates. Surely someone will bail us out…

Am I Giving Away My Secrets?

noreply@blogger.com (Jeff Fair) — Thu, 10 May 2012 03:37:00 +0000

I has a client ask if posting my APC Client Commentaries on this blog was equivalent to giving away information to the world instead of sharing it only with paying clients. A good question, I thought, from a financially astute banker who cared about my revenues, his expenses, or both. The short answer is NO. While I do post some good "client only" commentaries here, they are usually uploaded to the blog weeks or even months late (although I do put the original date on the post, for context). And, there is a lot of good info that never makes it onto the blog. So, if you like what you see and aren't a current client, please visit the following websites and learn what we can do for you and your institution.

American Planning Corporation

National Capital, L.L.C.

Curative Advisors, LLC

An Interesting Investment Structure

noreply@blogger.com (Jeff Fair) — Tue, 08 May 2012 23:51:00 +0000

Currently, Qwickrate and other listing services are offering long term CD rates over 2.0%. The top ten 120 month (yes, that’s a ten year maturity) offerings on Qwickrate average 1.97%, meaning you could deploy as much as $2.5 million and pick up 1.75% over Fed Funds. At this point, you should be asking “Why in the world would I want to lock in that low a rate for ten years, Jeff?” The answer: because the early withdrawal penalty is usually only a few months of interest, allowing you to cash in at will without substantial penalty.
When this investment idea first came up, I was uncomfortable with the idea of a banker taking advantage of another banker and breaking the terms of a contract. The more I think about it, however, the more I like it. The counterparty is, through the terms of his contract, selling you a put right as a part of the CD. The cost of the put is the early withdrawal penalty, set by the seller. If you were to employ this investment strategy, you would have to contact each institution to get a copy of the CD agreement, as Qwickrate does not list each institution’s early withdrawal penalty information. I would also recommend making note of your intent to make an early withdrawal in your ALCO minutes to avoid examiner criticism. We will model your embedded put option in our IRR model if you buy any of these long CDs.

Bank Exam Prep

noreply@blogger.com (Jeff Fair) — Fri, 09 Dec 2011 00:59:00 +0000

As LSU’s football players take time out of their BCS Championship preparations to cram for finals (we need them to make their grades so we can beat Alabama again), please take some time to prepare for the liquidity discussions that are likely to occur during your next exam.

The March 2010 Interagency Policy Statement on Funding And Liquidity Risk Management reiterated the importance of cash flow projections, diversified funding sources, stress testing, a cushion of liquid assets, and a formal contingency funding plan as primary tools for measuring and managing liquidity risk. Here are a few ways that you can use your APC reports to show examiners that you are following their guidance. (Before using any of these answers, be sure the facts are appropriate for your institution.)

Examiner Question: Have you stratified the bank’s liquidity / identified the bank’s cushion of liquid assets?
APC Solution: We designed a Forward Liquidity Model in Excel that identifies the types of on-balance sheet liquidity and segregates them into relatively homogeneous pools (“Cash and Cash Equivalents”, “Liquidity Cushion” and “Other”). This spreadsheet, which is designed to be maintained by bank personnel on a monthly or quarterly basis, identifies the bank’s liquidity pools and projects the bank’s future liquidity position. The second page of the Forward Liquidity Model uses the current liquidity volume and projections of future cash flows to estimate the bank’s liquidity over the next year.

Examiner Question: How do you analyze the bank’s future liquidity position? Have you developed cash flow projections (sources and uses of funds model)?
APC Solution: The spreadsheet allows bank personnel to make monthly projections of cash flows for all major balance sheet categories (loans, illiquid assets, deposits, borrowings, capital) to project the net liquidity over the next twelve months. Cash flows into or out of the securities portfolio are not included in the model, as all securities are assumed to be liquid and would not impact the bank’s liquidity position.
Bank’s Response: This is the model (hand over most recent report) that [bank employee] uses to identify our on-balance sheet sources of liquidity and project liquidity over the coming year.

Examiner Question: Tell me about your methods for ensuring diversified funding sources…
APC Solutions: The Deposit Distribution by Type graph on page four of the standard monthly report set shows that you monitor deposit mix on a monthly basis. The CD and FHLB repricing schedules (included in the last 15 pages of the standard report set) show the tenor (remaining maturity) of funding. The Nonmaturity Deposit Rate Projections report (page 10) show your consideration of the behavior of nonmaturity deposits. Our standard Liquidity and Funds Management Policy discusses sources of funding and sets limits on various types of nontraditional funding.
Bank’s Response: We have several reports (point to appropriate pages in the APC monthly report set) that provide insights into funding diversity and behavior. In addition to local deposits, we consider FHLB advances, Qwickrate / National CD Rateline funding and brokered deposits as important tools in ensuring a diversity of source and tenor of funding. Our Funds Management Policy provides guidance on the appropriate use of each nontraditional funding source. We also consider the bank’s interest rate risk position when determining which funding sources to pursue.

Examiner Question: Do you have a formalized contingency funding plan (stressed liquidity model)?
APC Solution: Our standard Liquidity and Funds Management Policy has an entire section dedicated to contingency funding.

Examiner Questions: Do you stress test your liquidity? Do you have a contingent funding model?
APC Solution: We have developed a simple stress model that shows the sources available to fund rapid deposit runoff. Using Call Report information, we run this report quarterly.
Bank’s Response: Our Liquidity Policy addresses contingency funding. (Be sure to read this section of the policy before you discuss it). This model (hand over most recent report) shows how we could fund up to $X million of rapid deposit runoff using a variety of funding sources, including excess cash and overnight funds, liquid securities (that can be sold, pledged or REPO’ed), Fed Fund / Discount Window / FHLB borrowing capacity and loan sales. We also have the capacity to raise funds through Qwickrate / National CD Rateline.

As you cram for your next exam, please call or email if there is anything we can do to help. You have lots of important things to do and lots of customers to care for. So do we! You are our customer, and one of our most important tasks is making your exam experience as good as possible.

Economic Value of Equity Model

noreply@blogger.com (Jeff Fair) — Sat, 01 Oct 2011 02:12:00 +0000

Many of you have heard my soapbox speech about the foolishness of Economic Value of Equity calculations and models. I have recent reports of examiners who acknowledge the minimal value of the models but fall back on the “Washington says we have to check and see if you have one” line. In most examinations, it appears that EVE is a “check the box” issue. If you have an EVE report, the examiners don’t take the time to see what it says or how it was calculated. They are happy to be able to mark it off their list and move on to other tasks.

We have been working on an EVE report worthy of the APC logo, and I think we have come up with
a viable product. I plan to introduce it using September 2011 data and make it a quarterly or annual report (your preference). We will have most of the necessary data in our files but will need a new securities report that provides shocked market values. We will be calling soon to request the data and give you information on acquiring it from your portfolio accounting firm.

Bank Policies

noreply@blogger.com (Jeff Fair) — Fri, 23 Sep 2011 22:10:00 +0000

There are a few field examiners in our area (the gulf south) who have become enamored with reviewing bank policies. In addition to checking the “big three” policies (Loan, Liquidity and Interest Rate Risk), they are reviewing (somewhat randomly) the following: Capital Plan / Policy, Dividend Policy, Transactions with Affiliates Policy, Management Continuity / Succession Policy and Expense Reimbursement Policy. If you don’t have one or more of these on your policy bookshelf, you should adopt one before the next “friendly visit”. We will gladly share samples of some of these policies, so don’t feel like you have to reinvent the wheel or buy a policy from a vendor.

We have made several subtle changes in recent months to our Liquidity and IRR policies to reflect examiner comments and revisions to our reports. If you haven’t updated these two policies in a while, please let us know and we will send you our current templates.

FDIC Insurance Assessment Invoices

noreply@blogger.com (Jeff Fair) — Sat, 17 Sep 2011 02:08:00 +0000

The FDIC sent out second quarter assessment worksheets and invoices this week. This is the first invoice based on the lower rate schedule effective April 1. For those of you in Risk Category I (most CAMELS 1 and 2 institutions), your base annual assessment rate dropped from 12 basis points to 5 basis points (a 59% reduction). The assessment base shifted from Total Deposits (as of the Call Report date) to Average Total Assets less Average Tangible Equity.

The net result for most banks in Risk Category I is a 40-45% expense reduction. If you have not adjusted your daily or monthly accruals in a while, you may be overaccrued. If so, give me a call and let’s talk about a couple of options for making the adjustments.

Rest in Peace, Regulation Q

noreply@blogger.com (Jeff Fair) — Tue, 26 Jul 2011 02:04:00 +0000

I hope you all took time out of your day on Thursday to celebrate the one year anniversary of Dodd-Frank. On this day, the CFPB spread its wings and Regulation Q was repealed. The Durbin Amendment was also scheduled to kick in, but the actual implementation of interchange fee reform has been pushed to October 1.

Over the last few months, the most frequently asked question in my client meetings has been something akin to “What are your other banks doing about commercial interest account pricing?”.

My answer: Most community banks are asking this question but are waiting to see what the big banks do before any major product rollout.

Thursday morning, as I drove to the office, I heard a new Capital One add on the radio. They were promoting their new business checking product. Capital One business customers in all their markets except Louisiana can earn a promotional rate of 1.10% for the first year, but all those loyal Hibernia customers in Louisiana who stuck around after the acquisition only earn 0.50%. I guess that when you already have the state’s largest deposit market share (20% of total LA deposits as of June 2010), you don’t have to pay up for deposits.

As with most highly promoted products, there are lots of strings attached to this account. In case you don’t want to read the fine print on Capital One’s website, here are the details:

25 transactions per month required to earn promotional rate (default rate is 0.05%)
Promotional rate only applies to balances between $10,000 and $100,000.
All other funds earn a tiered promotional rate of 0.05% to 0.50% (0.05% to 0.25% in LA)
$8.00 monthly maintenance fee if you don’t maintain an average daily balance of $10,000
Transactions over 300 per month are charged $0.17 each
Existing customers must deposit $10,000 of new money within 30 days or promotional rates disappear

I haven’t seen any other big banks roll out an aggressive product, yet. If you have, please send details and I will begin compiling a list for future dissemination. In the meantime, be sure you have some sort of product to offer if asked, and make sure your front line team members know about it.

Static Gap - What a Waste of Paper!

noreply@blogger.com (Jeff Fair) — Sat, 11 Jun 2011 02:33:00 +0000

We continue to get reports from clients about examiners who are overly concerned about Static GAP measures in banks that are asset sensitive. The typical Report of Examination comment sounds something like this:

The bank is highly asset sensitive over the next 12 months, with rate sensitive assets exceeding rate sensitive liabilities by $30MM, resulting in a positive gap of 1.85, well above policy parameters of 0.50 to 1.50. In addition, policy limits are overly broad and should be revisited by the board.

If you hear such a comment during an exam, or if you want to head off an examiner before he writes such a comment in his report, try this line of logic:

Our bank’s Static GAP (refer to the RSA / RSL @ One Year Horizon lines on page seven of your monthly APC report set) is between 1.52 and 1.85, depending on the optionality assumptions applied to our securities portfolio. I understand that these numbers seem high relative to examiner expectations and our policy limits, BUT…

Static GAP is an imprecise measurement that looks at a single date in time, 365 days in the future, and does not consider the timing of asset and liability repricing between now and then. We prefer to use a more accurate measurement (APC’s Interest Margin Sensitivity Report) that looks at monthly changes over the same one year period and measures the results in a variety of ways (refer to the Summary of IMSA Results box at the bottom of page eight). We are also at a unique point in the history of interest rate risk, where the potential for material rate decreases is very tiny. We are comfortable with a large positive GAP, as it should result in stronger earnings when rates rise.

If the examiner continues to fixate on Static GAP, consider this angle:

My ALCO and my board understand that we could reduce our GAP position in several ways, but we are not comfortable with any of them. Which of the following would you recommend, in light of the current economic situation?

Making fixed rate loans with longer maturities at the bottom of the interest rate cycle? (decreasing liquidity and possibly taking excess credit risk to acquire the loans)

Increasing my security portfolio’s price risk by purchasing fixed rate securities at the bottom of the interest rate cycle?

Encouraging customers to shorten their CD maturities such that I will have to reprice them sooner if rates rise?

When responding to examiner concerns, please don’t say “we’ll change our limits” or “we’ll lower our GAP” unless you fully understand the implications. Instead, say something like “I’ll bring your concerns to ALCO and the board”. Once the examiner writes “President Johnson committed to tighten the bank’s GAP limits”, it’s hard to do anything but comply, even if that’s not what you said.

I’ll close this commentary with two final stabs at the adequacy of Static GAP calculations:

Barron’s Banking Dictionary notes: “By itself, interest rate gap is an imprecise measurement…”
Investopedia explains: “Simple static gaps are inherently imprecise measurements…”

Don’t take my word for it – the Internet says it’s true!

Wednesday Night's Perfect Game

noreply@blogger.com (Jeff Fair) — Thu, 03 Jun 2010 15:29:00 +0000

Dear Mr. Selig,

We all make mistakes. Mr. Joyce is a good umpire who made a mistake. After realizing his mistake, he did what he could to make amends. Mr. Selig, please don't compound his mistake by leaving the record books as they stand now.

A calm, polite young pitcher threw a perfect game last night. History needs to reflect that fact. In addition to shutting down 28 straight batters, Armando Galarraga did something else last night that was equally surprising and almost as rare. After the blown call, he didn't throw a tantrum like many of today's "role models" regularly do. Standing almost face to face with Mr. Joyce after being denied his 27th out, he chose to walk away. He quietly went back to work and finished his perfect game.

The youth of America can learn from Mr. Galarraga. Please let them learn from you as well. When mistakes are made, we all should do our part to make things right again.

IRR: Much Ado About Nothing?

noreply@blogger.com (Jeff Fair) — Fri, 09 Apr 2010 22:11:00 +0000

Our country and our industry continue to sail uncharted waters. We are now in our 17th month of a “zero to 0.25%” Fed Funds target, and the FOMC continues to indicate a prolonged period before upward adjustments begin. In January, regulators issued new guidance on interest rate risk and indicated a concern about the positions some institutions were taking in this low rate environment that could lead to significant IRR once rates rise.

Some level of heightened concern over IRR exposures is definitely warranted. Unfortunately, recent regulatory guidance is akin to building a Rube Goldberg contraption to open a jar of peanut butter.

Of all the risks inherent in banking, Interest Rate Risk is one of the most talked about yet least dangerous. Credit Risk, Liquidity Risk and even Reputational Risk play much larger roles in the success or failure of an institution. While it is possible for IRR to cause an institution’s failure, I have seen no evidence to suggest that IRR was the primary or secondary cause of any of the over 200 failures since September 2007.

Most community banks operate with a minimal level of interest rate risk. I make this statement based on 17 years of analyzing, on a monthly basis, the IRR positions of over 70 institutions. One needs only to look at the stability of these institutions’ net interest margins across interest rate cycles to see that a combination of the banks’ static IRR exposures and management’s responses to market rate changes minimizes true IRR exposures without the use of sophisticated models. NOTE: This statement does not apply to banks that go wild with callable securities, complex derivatives or other nonstandard assets in an attempt to shore up sagging earnings or deploy excess liquidity. Be smart – some of today’s decisions can have long-lasting consequences.

Whether you use a simple method or Rube Goldberg contraption to open your jar of IRR peanut butter, the stuff inside is still rather sticky. The harsh reality of IRR is that none of the models are right. You can’t model IRR without making assumptions, and none of us are omniscient. Our assumptions, whether few or numerous, introduce error into the system. As the old saying goes, Garbage In, Garbage Out.

Perhaps the greatest problem in the IRR equation is that, in an effort to get a more accurate answer, we must increase the number of assumptions. More assumptions = more chances for error. I can think of a few assumptions that, if made incorrectly, can completely reverse a bank’s apparent IRR sensitivity. If a model is hypersensitive to a necessary assumption that cannot be made with certainty, the result of the model is only as good as the assumption itself.

Assumptions about nonmaturity deposit behavior quickly corrupt both Earnings at Risk (EaR) and Economic Value of Equity (EVE) models. Some of the assumptions answer questions like:

Ø How quickly will we have to increase our NOW, MMSA and Savings rates once market rates begin to move?

Ø Does current pricing include a virtual floor (e.g.: Savings rate currently at 0.50%, even though it would normally price below the Fed Funds target rate) that will protect the bank from increasing cost during the first 50-100BP rise in rates?

Ø Once the virtual floor is cleared, will these rates increment in lock step or at some fraction of market rates?

Ø Will there be a repricing lag?

Ø What do we do with Demand Deposit balances? (Answering this question could take several pages and bore all but the most academic among us…)

Similar questions can be asked of other balance sheet sections (cash flows on loans, optionality of securities, etc.). The short version of this long story is that we make educated guesses that build upon each other until the system resembles a house of cards (covered with peanut butter). When our friendly examiners come to visit, they look at our house of cards and suggest that adding some jelly to the mix might make the output more accurate.

Yes, dear friends, I realize that my analogy has become somewhat silly. So have some of the expectations of our regulators in the IRR arena. Please remember: we are in uncharted waters (sailing beyond the edges of the mapped IRR landscape), and most IRR models do not behave well “way out here”. We continue to use our IMSA model for EaR estimations and the RiskExpert system for annual EVE estimations, but recognize, as should you, that these are estimations made with assumptions. Therefore, they are probably wrong, just like everyone else’s models. The good news is that it doesn’t really matter, as IRR is, for most banks, Much Ado About Nothing.

One piece of advice, which I intend to repeat often, is to set the IRR tone carefully with your Examiner in Charge at the outset of your next exam. “We are a noncomplex institution” is a good way to start the conversation, and be prepared to explain why. Complexity = Risk, and we don’t want to look risky if we aren’t.

The Regulatory Mindset

noreply@blogger.com (Jeff Fair) — Fri, 13 Nov 2009 23:08:00 +0000

Where the FDIC once gave broad latitude to the OCC, OTS and state chartering agencies, now everyone else is expected to take a back seat to the almighty insurer. In the eyes of some field examiners (FDIC and others), anything abnormal is bad. If your bank is funded from nontraditional sources or invested in nontraditional assets, the presumption is that you have taken on excessive risk. Don’t let examiners make sweeping assumptions and penalize you for the way your bank is structured. Choose which battles are worth fighting, then stand up and defend your position. If the worst case is a 2 or 3 rating in liquidity and a composite 1 or 2, consider swallowing your medicine with a smile. If the concern might result in a composite 3 rating (which will result in a regulatory order) that you feel is undeserved, fight to the last man. You should know your bank better than someone who comes in for two weeks every 18 months. A disagreement, handled professionally, is an opportunity to show just how well you know how your bank behaves.

Will the real Core Deposits please stand up?

noreply@blogger.com (Jeff Fair) — Mon, 31 Aug 2009 14:44:00 +0000

The FDIC and other regulators had a favorite phrase in this era of excessive bank growth leading to explosive bank failure: CORE DEPOSITS. The idea is as old as the hills. Banks have three types of funding sources -- capital, core funds and non-core funds. Nothing wrong with that statement, right?

The problem shows its face when you try to define Core Deposits. The FDIC created its definition decades ago, when the FDIC insurance limit was $100,000 and there were no material non-deposit sources of funding other than capital. This decrepit definition of core deposits includes all nonmaturity deposits (regardless of balance) and certificates of deposit under $100,000. [$100,000 in 1980 dollars (the year the FDIC insurance limit was raised to $100K) = over $250,000 in 2008 dollars.]

Fast forward to the 21st century, where $100,000 just doesn't buy as much as it used to. I walk into my local Bank A with $150,000 and open one certificate of deposit, which is not counted as a core deposit due to its size. If, however, I open two CDs for $75,000 each, they are both counted as core deposits. Or, if I open a Money Market account with the $150K, the whole balance is treated as a core deposit. Whichever account type I choose, all of my $150K is covered by FDIC insurance at its new $250K level.

If I am a retiree on a budget, who relies on interest income to buy groceries, I may watch rates like a hawk, moving my money often to get the best rates in town. In that case, my $150K is not really a core deposit, as it will stay at Bank A only as long as it offers the best rate. On the other hand, if I am a small business owner, the $150K may be a small portion of a bigger financial picture, and my relationship with Bank A may include personal and business deposit and loan accounts. I may even be an investor in Bank A or sit on its board of directors. All of this suggests that my $150K may be a very solid core deposit, regardless of balance.

Why does all this matter? It matters because the FDIC uses Core Deposit data (and a variety of ratios that include Core Deposits) as benchmarks when examining banks. A bank that has too many non-core funding sources (jumbo CDs, FHLB borrowings, brokered deposits, etc.) will be criticized harshly, even if the bank exhibits a well-developed ability to operate safely with its particular funding mix. With expanded deposit insurance in place, there have been many calls for the FDIC to revise its definitions of Core Deposits. The agency has, so far, been unwilling to do so, partly because it uses the current definition to its advantage when it needs leverage against a bank that it doesn't like.

I don't have a Pulitzer-winning close to this post, and I do have to get back to the paying work. Let's just close with the thought that the FDIC is in many ways a dinosaur that is unable or unwilling to keep up with changing banking structures. Of course, this should be obvious to anyone who has been watching the bank failure count grow every Friday. The scary part is that the FDIC is spending much of its energy these days fighting for more regulatory authority, instead of addressing some of the fundamental weaknesses in its existing regulatory framework.

Appropriate Measurement of Earnings at Risk in Community Banks

noreply@blogger.com (Jeff Fair) — Wed, 05 Aug 2009 16:01:00 +0000

Recent regulatory thought on interest rate risk has been divided into two primary areas of concern: Earnings at Risk (EaR) and Economic Value of Equity (EVE). EaR addresses the short term IRR concern, while EVE addresses the long term aspects of IRR. For the rest of this discussion, let us focus on Earnings at Risk.

Recently, we have had several clients report negative exam comments surrounding the lack of RSA / RSL(rate sensitive assets / rate sensitive liabilities) parameters in the banks’ interest rate risk policies. The comments read something like:

The bank’s IRR policy establishes adequate parameters for post-shock changes in ROA but does not establish parameters for the RSA / RSL position or changes to the Net Interest Margin. Management should update the IRR policy to provide operating parameters for RSA / RSL and the Net Interest Margin.

These examiner comments about RSA / RSL expose a lack of understanding about how interest rate risk measurement works and incorrectly imply a regulatory requirement to measure by antiquated standards.

An example of the weakness of RSA / RSL relative to Change in ROA: Consider two banks (A and B), each with total assets of $100 million. Bank A has $30 million of loans that adjust immediately with a change in NY Prime. Bank B has $30 million of loans that reprice annually, with repricing dates spread evenly across the coming year. The two banks are identical in all other respects.

The RSA / RSL ratio at the one year horizon is identical for the two banks, as each bank’s $30 million in loans will reprice within the first year. The banks’ changes in ROA are very different, however, due to the timing of the repricing. If Bank A’s interest rate risk position as measured by Change in ROA is completely neutral, Bank B would be very liability sensitive due to the slower repricing of its loan portfolio in a rising rate environment.

If you are feeling the heat from examiners who seem unable to break free from antiquated measurement systems, send me an email (jfair@americanplanning.com) and let's talk about how we can help.

Another Friday, Another Failure (or Seven)

noreply@blogger.com (Jeff Fair) — Fri, 03 Jul 2009 19:47:00 +0000

With the 4th of July holiday looming, Black Friday came early this week -- the FDIC shuttered seven banks at the close of business Thursday. Six of these failures were in Illinois, bringing the state's total to 12 since January 2008 and moving the Land of Lincoln into second place behind Georgia (14) in the failure race.

The story behind this week's Illinois failures is that all six banks were controlled by the same family and had purchased huge volumes of trust preferred securities. The failures were a result of the forced writedown of the investments and the family's inability to raise enough outside capital to prop up the banks. Three other banks owned by the same family are struggling to stay afloat.