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Banks, Small Business and Risk

Posted by Wendell Brock on Thu, Sep 16, 2010

In the recently passed legislation, the Dodd Frank Law, the FDIC is given the mandate to change the way it assesses deposit insurance premiums from banks, mostly based on risk. This will greatly impact small businesses, by limiting their access to capital through loans. Perhaps as much or more than the recent health care bill will.

First the Law

The law “defines a risk-based system as one based on an institution’s probability of causing a loss to the Deposit Insurance Fund (the Fund or the DIF) due to the composition and concentration of the institutions assets and liabilities, the likely amount of any such loss, and the revenue needs of the DIF. …allowing the FDIC to establish separate risk-based assessment systems for large and small members of the Deposit Insurance Fund.

“Over the long-term, institutions that pose higher long-term risk will pay higher assessments when they assume those risks. …should provide incentives for institutions to avoid excessive risk.” (the information quoted is found in the following paper about the new score card produced by the FDIC located at: http://www.denovostrategy.com/new-fdic-score-card/)  The new assessments will be based on a performance score, which will be comprised of three main elements: 1) CAMELS Score, 30%; 2) Ability to withstand asset-related stress, 50%; and 3) Ability to withstand funding-related stress 20%. It is the asset-related stress that has the regulators concerned and if an institution has too much risk in that category, it will also affect the CAMELS rating, as the regulators will perceive that management is not doing their job – that of taking care of the bank.

The banker’s number one job now it to make sure that the bank never becomes a problem bank, that may cause the regulators to pay on deposits; everything else is now ancillary to that goal.

Small Businesses

All small businesses are risk rated, based on their credit score, (or the owners credit score), which becomes the basis for easy or difficult access to credit at a financial institution. At times bankers make loans to small businesses, because they understand the business, the risk associated with the business and they know the owner, even though the credit may be simply o.k. (not great, but not terribly bad either).

This new way of assessing deposit insurance will now cause the banker to ask the question – how will this loan affect the bank’s portfolio and ultimately it’s DIF assessment? As bankers ask this question more loans will be turned down. This is not to say, that all loans should be written as applied for, but as the bell curve moves towards safety, it will certainly leave a larger percentage of good small business loans unfulfilled and business owners without the much needed capital to continue in business or to grow. And we all know that when small businesses don’t continue, or fail to grow, then lay-offs occur and unemployment lines increase.

Did Congress and the regulators think this one through completely? Is there a better way to asses risk?

Topics: Bank, FDIC, banks, Regulations, FDIC Insurance Fund, Loan Grading, Risk Management, Bank Regulations, Growth, small business

Loan Portfolio Regulatory Requirements - Intense Portfolio Analytics

Posted by Wendell Brock on Fri, Apr 23, 2010

As the financial crisis deepened, regulatory requirements for financial institution's loan portfolios, both banks and credit unions, are much more stringent.  The thought is that institutions can no longer book loans and forget about them; they must go back regularly and revisit the value of the asset backing the loan and the credit worthiness of the borrower as well as other items that may change.  Considering the national financial crisis, many people have experienced changes in their personal and business finances.

As financial institutions prepare for or respond to an examination, questions around the loan portfolio are asked: what are the examiners asking for? How deep do they want the bankers to drill to find issues with the loan portfolio? What kind of data do they want from the institution? You may say, "but my institution is clean with very few problem loans, I won't need to do any of this research" - think again. They are also looking for loans that could go bad or the data to defend a clean portfolio.

Below are a few items taken from a regulatory agreement between a financial institution and their regulator, these are by no means comprehensive, nor are they the same for each regulatory agency, but each is similar in their requests:

"The Board shall develop, implement, and thereafter direct the Bank's management to ensure the Bank's adherence to systems which provide for effective monitoring of:  

(a) early problem loan identification to assure the timely identification and rating of loans and leases based on lending officer submissions;

(b) statistical records that will serve as a basis for identifying sources of problem loans and leases by industry, size, collateral, division, group, indirect dealer, and individual lending officer;

(c) adequacy of credit and collateral documentation"

The regulators are asking for probable loss modeling of the loan portfolio, which loans are likely to go bad based on objective statistical data. Along with stratification analysis based on loan officer, industry, size, collateral, division, group, indirect dealer; additionally the institution may need to show the stratification of loan grading, FICO scores, FICO migration, zip code, branch office, loan size, or any other important data point. The institution should know its loan migration, how many "A" grade loans in a portfolio have shifted over time to "B" or "C" or lower grade loans.

They also want the assets backing the loans reanalyzed to make sure there is still enough value behind the loan if a foreclosure or repossession is necessary. Real-time asset valuations combined with stress testing the portfolio will be the key; how does the financial institution get objective real-time values on the assets that back a diverse loan portfolio that includes consumer, residential and commercial real estate for thousands of loans? 

The Agreement goes on to state that the financial institution will...

"The Board shall within sixty (60) days employ or designate a sufficiently experienced and qualified person(s) or firm to ensure the timely and independent identification of problem loans and leases.

"The Board shall within sixty (60) days ensure that the Bank's management is accurately analyzing and categorizing the Bank's problem loans and leases.

"The Board shall establish an effective, independent and on-going loan review system to review, at least semi-annually, the Bank's loan and lease portfolios to assure the timely identification and categorization of problem credits. The system shall provide for a written report to be filed with the Board after each review and shall use a loan and lease grading system consistent with the guidelines set forth in "Rating Credit Risk" and "Allowance for Loan and Lease Losses" booklets of the Comptroller's Handbook. Such reports shall include, at a minimum, conclusions regarding:

(a) the overall quality of the loan and lease portfolios;

(b) the identification, type, rating, and amount of problem loans and leases;

(c) the identification and amount of delinquent loans and leases;

(d) credit and collateral documentation exceptions;

(e) the identification and status of credit related violations of law, rule or regulation;

(f) the identity of the loan officer who originated each loan;

(g) loans and leases to executive officers, directors, principal shareholders (and their related interests) of the Bank; and,

"The Board shall ensure that the Bank has processes, personnel, and control systems to ensure implementation of and adherence to the program developed pursuant to this Article.

In addition to the above requirements, this will require stress testing of the portfolio across several data points including, loan to value compression, FICO score movement, as well as interest rate adjustments. How will each type of loan portfolio respond to multiple, simultaneous stresses?

The board of directors has a lot of work to do in assisting the management team of the institution. The regulators are asking for more involvement with the institution and its problem loans requiring, objective defensible grading and stratification analysis, along with probable loss modeling, stress test simulations, and real-time asset valuation, of 100 percent of the portfolio. Moreover, if you think that your institution is completely clean - you are not on a problem list or don't have very many problem loans - well now you will have to prove it to the regulators.

Real, defensible, comprehensive portfolio analytics will be the solution - it will take a banker/CFO weeks or months to develop such a custom model for your institution in an excel spreadsheet. Or will it require anew strategy?

Topics: Interest Rates, regulators, stress tests, Regulations, Loan Grading, Asset Valuation, Stress Test Simulation, Portfolio Analytics, loan portfolio

New Rules for Deposit Insurance Assessments Based on Bank Risk

Posted by Wendell Brock on Wed, Apr 14, 2010

Yesterday the FDIC announced that the formula for how they assess deposit insurance would be changed for large banks (those with $10 billion of assets or more). Below is the notice with the links to the summary and the full document.  While this rule makes changes for "large banks" eventually this methodology will trickle down and become practice for smaller banks too.

Each bank, no matter the size, will need an objective, defensible methodology for analyzing, grading and stratifying their loan portfolio. They will also need the ability to stress test the portfolio beyond the typical raising or lowering of interest rates. Probable loss modeling will become the norm as bankers and examiners look deeper for risks in the portfolio. It will be important for bankers to have this information updated regularly based on current estimates of value of the assets backing the loans.

It is no longer simply how much the bank has on deposit that determines the banks deposit premium, it is centered on the risk the bank is to the bank insurance fund - how likely will the FDIC have to pay out to cover deposits. The loan portfolio that the bank is creating and servicing is where the risks are, which must be fully analyzed, using an objective, defensible method.

As you read this notice of what the regulators are going to start requiring from banks, you will realize that the questions will get tougher and the answers more complex. We are happy to help provide strategies and solutions to some of the tough questions banks will face.

Assessments
Notice of Proposed Rulemaking
On April 13, 2010, the FDIC Board of Directors (Board) adopted a notice of proposed rulemaking (NPR or proposal) and request for comment that would revise the assessment system applicable to all large insured depository institutions. The NPR would: (1) eliminate risk categories and the use of long-term debt issuer ratings in calculating risk-based assessments for large institutions; (2) use two scorecards -one for most large institutions and another for large institutions that are structurally and operationally complex or that pose unique challenges and risks in the event of failure (highly complex institutions)-to calculate the assessment rates for all large institutions; (3) allow the FDIC to take additional information into account to make limited adjustments to the scores; and (4) use the scorecard to determine the assessment rate for each institution.

The NPR would also alter assessment rates applicable to all insured depository institutions to ensure that the revenue collected under the new assessment system would approximately equal that collected under the existing assessment system and ensure that the lowest rate applicable to small and large institutions would be the same.

On September 29, 2009, the Board adopted a uniform increase in assessment rates effective January 1, 2011. As a result of the Board's earlier action, assessment rates in effect on January 1, 2011, will uniformly increase by 3 basis points.

FOR MORE INFORMATION:

In less time than you take for a lunch break Silverback Portfolio Analytics can show you how to, analyze your loan portfolio with real-time asset valuations, use objective loan grading, provide stratification analysis, probable loss modeling and stress test simulations.

The full summary: http://www.fdic.gov/news/news/financial/2010/fil10014.html

The full text of the proposed rule: http://www.fdic.gov/news/board/april06.pdf

Topics: Loans, Regulations, FDIC Insurance Fund, Loan Grading, Asset Valuation, Probable Loss Modeling, Stress Test Simulation, Portfolio Analytics, Bank Risk

Bank Portfolio Management - Solve the Problems

Posted by Wendell Brock on Wed, Mar 10, 2010

It's a tangled mess in the financial jungle. In order to navigate the issues of portfolio management and compliance while still staying profitable and able to weather the market's unpredictable trends, financial institutions must arm themselves with the best information and resources. Yet many don't have either the knowledge or analytical resources to not only stay abreast of changing trends but also act on them in a timely and profitable manner. We have solutions.

New Rules, Economic Trends

A financial planner I know is now telling his older clients that the stock market is so volatile that it cannot be relied on as a stable platform for long term investing. Thus, the age-old saying that "assets are soft and debts are hard," has never been truer. In these difficult economic times, financial institutions need reliable information about their asset portfolio, including how the loans are matching up with the current value of the assets supporting the loans, along with the borrower's strength, all at a simple click of a mouse. 

By the time the CFO, CCO, CLO, CEO or any other member of the management team assembles enough information about the portfolio in a spreadsheet to make decisions, it seems the market may have changed enough to make the choice more difficult.  The analytics we can provide at a simple click of the mouse gives you 100 percent loan penetration and enough analytical information about your assets that your institution will have an objective defendable system to help manage the portfolio.  

Regulatory Requirements

The frequency and breadth of audits are increasing; requiring financial institutions to stay in a mode of continuous compliance, in one year's time they could be subject to internal and external loan review, IT audit, financial audit, CRA exam, and regulatory exams. Compliance is mandatory and with RiskKey, staying in continuous compliance is much easier.   

Industry Standards

There is a paradigm shift coming to financial institutions. Because lending is often formula driven, bankers need aggressively take on the roll of being asset managers. In addition to managing the loans in the portfolio, they need to manage the assets that support the loans. The tools and knowledge to help actively manage your portfolio are available with a simple, cost effective, mouse click!

Evaluate

With forward-thinking analytics, you can determine your portfolio's risk. These analytics provide a defensible probability of default within the portfolio, you can also stress test the portfolio along several different data inputs, including, percent of asset recovery, interest rate, fico score, and others. This basis can provide a direction as to the quality of the overall portfolio, all the while allowing the banker to zero in on the individual problem loans and assess their grade based on the institution's custom grading scale.

Act

Armed with a new, comprehensive understanding of your portfolio's risk, the analytics will subsequently locate the most pressing issues and provide options.

Assess

Finally, with your portfolio's risk evaluated and acted upon, you will have the tools and resources needed to clearly and concisely report your findings, to loan committees, the board of directors, and regulators.

Easy, Secure & Forthright

Working with us is simple. We take care of merging your data into a single platform. Your data will be protected and your analyses kept completely confidential. Our pricing is straightforward and simple.

People, Time & Action

Your employees should be generating revenue and managing accounts, not gathering statistics.  De Novo Strategy will allow your people to get back to profitable work. Our innovative practices are well beyond spreadsheets and simplistic reports. There's no laborious compiling of figures or making difficult assessments across a range of formats. Integrated reports and analyses mean less lag time between making a decision and executing it.

To learn more about Silverback Portfolio Analytics click and let us know. This will help you Build a Smarter Bank!

Topics: Bank, Bank Risks, regulators, Bank Regulators, Bank Asset, Regulations, Bank Policies, Compliance, Growth, real estate, Commercial Bank

Next-generation Compliance for Banks

Posted by Wendell Brock on Wed, Feb 17, 2010

Compliance. An issue most bankers don't relish. Often times it is explained away as a necessary evil! This approach makes difficult for the bank to stay on top of compliance issues and often leads to problems with examiners. This leads to compliance waves where the compliance officer works to get things ready for an exam or audit then the work load relaxes until the next exam or audit.

Based on the current state of affairs, most banks' find themselves overwhelmed with compliance workloads; they have limited staff and schedules, along with the increase demands from examiners, who want more risk management. Internal audits are conducted by just a few people, typically, they are reactionary, and they utilize outdated technology, if any technology at all. The workload is not slowing down anytime soon-if anything it is increasing.

What we propose is a complete rethinking of compliance-to what is called "Next-generation Compliance"-this is where banks are proactive with compliance rather than reactive. It smoothes out the waves and distributes the work throughout the organization, which makes the compliance load much lighter and much easier to manage. Such a change must happen on three levels: a bank's operational culture, their level of collaboration, and the technology used in audits.

I. Culture

  1. 1. Devise a compliance strategy
  2. Get executives onboard with the strategy
  3. Promote all team members to be proactive
  4. Create metrics to quantify the value of proactive compliance
    • Does compliance result in an increased speed of reporting?
    • Quality compliance management response?
    • The larger scope includes overall compliance simplicity?
    • Money and time saved?

 II. Collaboration

  1. 1. Include people from multiple departments in compliance audits
  2. Standardize process across all areas of compliance audits
  3. Be flexible, and have reasonable expectations
  4. Make your auditors business-focused, independent, strategists
    • They shouldn't be on an island
    • Promote productivity
  5. Communication with regulators
    • Involve them in the process early so they understand the improvements from the positive changes

III. Technology

  1. 1.Reassess your current compliance tools
    1. Is technology working efficiently for you?
    2. Break from the spreadsheet! You can't properly collaborate from a spreadsheet - there are easier ways
  2. Increase use of collaboration tools to centralize the compliance audit workflow
    1. With them, everyone can discuss and facilitate improved risk management
  3. Track the use of audit recommendations
    1. What good are recommendations if they aren't used?
    2. Provide continuous up-to-date analysis/status of risk management

Compliance and Banking

Regulators are asking for more risk management and compliance, but banks aren't able to address this increased workflow with more manpower. With tighter operating budgets, the solution is working smarter. Often times when a bank is not able, to deliver properly on compliance issues it results in the issuance of an MOU or a C&D to the bank. Restoration plans and strategies may be implemented and managed through continuous compliance.

If you're buying a bank, the regulatory hurdles are less. But modifying an existing bank's compliance processes requires a team effort; it's all about building a smarter bank!

If you're starting a bank, a culture of compliance can be built from the ground up as your institution evolves. A blank slate is easy to work with. But at the same time, new banks are subject to harsher regulatory scrutiny, which means compliance has to be a priority.

To learn more about Next-generation Compliance, click the link for more information. 

Topics: Buy a bank, Bank Risks, regulators, Bank Regulators, Bank Regulation, Regulations, Bank Policies, Risk Management, Bank Regulations, Building Smarter Banks, Start a bank, Smarter Banks, Restoration Plan, distressed banks, Compliance, Next-generation Compliance

The FDIC’s NEW Advisory Committee on Community Banking

Posted by Wendell Brock on Fri, Oct 16, 2009

In May of 2009, the FDIC authorized the creation of an Advisory Committee Community Banking with the purpose that this committee would help the FDIC understand the particular issues that small rural and urban community banks face in the ever-changing financial landscape.

The committee is consists of no more than 20 volunteer members from the community banks around the country along with small business, education, non-for-profit organizations and other individuals that use the services of these community banks. It is expected that the committee will have an annual budget of $300,000 and two full time FDIC staff people committed to serving their needs. The committee charter will last for two years unless it is renewed by the FDIC. The committee will also report directly to the Chairman of the Board of Directors of the FDIC.

The committee's first meeting was this week and below is the press release from that meeting. At the bottom is a link to the FDIC website where more information may be obtained about the meeting. We hope this positive for the community banking sector as they struggle under the weight of very difficult regulations, limited budgets, and with razor thin margins. They are scheduled to meet twice a year, so the next meeting should be in April.

Press Release from the Advisory Committee on Community Banking

At its first meeting since being established by the FDIC Board in May, the FDIC's Advisory Committee on Community Banking today discussed the impact of the financial crisis on community banks. Other issues addressed were regulatory reform proposals under consideration by Congress and their effect on community banks, the impact of FDIC supervisory proposals on these banks, and community banks' perspectives on funding the FDIC's Deposit Insurance Fund.

"I was extremely pleased with the robust discussion among our committee members on issues that are so critical to both the FDIC and our nation's community banks," said FDIC Chairman Sheila C. Bair. "The committee members voiced a number of interesting ideas that they will pursue."

The Advisory Committee was formed to provide the FDIC with advice and recommendations on a broad range of policy issues with particular impact on small community banks throughout the nation, and the local communities they serve. The committee is comprised of 14 community bankers from across the country, and one representative from academia.

"We are fortunate to have so many highly respected professionals who are willing to volunteer their time and talents to help the FDIC analyze the issues most important to community banks," said Paul Nash, Deputy to the Chairman for External Affairs, and the Designated Federal Official for the Advisory Committee on Community Banking.

The members' opinions on the FDIC's proposed rulemaking to prepay three years of deposit insurance assessments will be included in the public comment file.

For more information on the Advisory Committee on Community Banking please visit http://www.fdic.gov/communitybanking/index.html.

Topics: FDIC, Community Bank, Banking industry, Bank Regulators, Commercial Banks, Regulations, Bank Regulations, FDIC Advisory Committee

Bank Regulators Propose Liquidity Risk Managements Guidelines

Posted by Wendell Brock on Wed, Jul 22, 2009

Bank Regulators Solicit Comments on Proposed Liquidity Risk Managements

The U.S. federal bank regulators (OCC, FRB, FDIC, OTS) along with the National Credit Union Association (NCUA) have collectively produced a set of guidelines regarding liquidity risk management for financial institutions. The agencies are soliciting public comments on these guidelines through September 4.

The proposed guidelines define a framework for the identification, measurement and monitoring of funding and liquidity risk; they include specific recommendations for:

  • corporate governance
  • risk mitigation
  • management of intraday liquidity

The responsibility of board members

Under the proposed guidelines, an institution's board members are ultimately responsible for managing liquidity risk. The board must therefore establish an appropriate level of risk tolerance for the institution, and then communicate that risk tolerance profile to the internal management team. At least annually, the board should revisit the liquidity strategy to ensure that:

  • current liquidity risks are understood
  • the liquidity policy is still relevant and appropriate
  • the policy is being enforced
  • it is clear internally which senior managers are responsible for making liquidity risk decisions

Key aspects of an institution's liquidity plan

The institution's liquidity management plan should:

  • be appropriate given the complexity of the institution's structure and activities
  • identify primary funding sources, both for daily needs and seasonal or cyclical needs
  • define acceptable liquidity strategies, both for expected and unexpected business scenarios
  • address liquidity management in terms of separate currencies and/or business lines, where appropriate
  • address how the liquidity management practices dovetail with broader business strategies and contingency planning

The plan should establish liquidity projection assumptions and a periodic review process, to ensure that those assumptions continue to be valid over time. Qualitative targets and quantitative objectives should be clearly defined. Examples include:

  • Unpledged liquid asset reserve targets
  • Funding diversification targets
  • Contingent liability exposures
  • Desired asset concentrations
  • Activity exposures
  • Targeted level of unencumbered assets to serve as liquidity cushion

The guidelines also recommend that senior managers receive liquidity reports at least monthly, or more often when economic conditions are severe. Board members should be evaluating the institution's liquidity position at least quarterly.

It is also advised that complex institutions make efforts to build liquidity costs into internal product pricing and performance measurement.

Risk measurement and reporting

Institutions are expected to measure ongoing liquidity risk with short- and long-term cash flow projections that consider both on- and off-balance sheet items. As part of this process, the institution should have measures in place to ensure the appropriate valuation of assets. Other key components of an appropriate liquidity monitoring strategy include:

  • regular stress testing
  • collateral position management
  • procedures to monitor liquidity across business lines and legal entities
  • procedures to monitor and manage intraday liquidity position

The report also addresses liquidity risk management practices for holding companies. Read the Proposed Interagency Guidance here and (http://www.fdic.gov/news/news/press/2009/pr09107a.pdf ) let us know what you think. Are these recommended procedures detailed enough to head off unexpected liquidity crises when economic conditions sour? Have the agencies overlooked key liquidity management tactics? Or are these guidelines too much?

Topics: Bank Regulators, Bank Regulation, Regulations, Bank Policies, Bank Regulations, Bank Liquiditity

Proposed Changes to Regulation D

Posted by Wendell Brock on Wed, May 21, 2008

New opportunities for Raising Capital for Bank Holding Companies

Regulation D, which was adopted in 1982, contains several different exemptions for private or limited offerings. Regulation D was designed to facilitate capital formation while protecting investors by simplifying and clarifying existing exemptions for private or limited offerings, expanding their availability, and providing more uniformity between federal and state exemptions.  An offering under one of the exemptions in Regulation D can be beneficial for a bank holding company because the offering does not have to be registered with the SEC, which can be expensive and time consuming. However, an offering under Regulation D may not be right for all bank holding companies due to the specific requirements that must be met in order to fall under the various exemptions from registration contained in Regulation D.

On August 3, 2007, the SEC issued a release that proposed certain revisions to Regulation D. The comment period ended on October 9, 2007, and the SEC is expected to release the final revisions soon. The objective of the proposed revisions is to modernize and clarify Regulation D to bring it more in line with the modern market and communications technology, while still providing protection for investors. The focus of this article is to discuss the proposed changes to Regulation D and the impact the proposed changes may have on offerings for Release No. 33-6389 (Mar. 8, 1982). Release No. 33-8828 (Aug. 3, 2007). bank holding companies. The proposed changes include the following:

  • revising the definition of "accredited investor";
  • creating a new exemption for limited offers and sale to "large accredited investors";
  • shortening the integration safe harbor for Regulation D offerings from six months to 90 days; and
  • applying uniform disqualification provisions to all Regulation D offerings.

For a complete copy of the white paper titled Proposed Changes to Regulation D - click on this link Bank Capital.

Hunton & Williams
Dallas office
1445 Ross Avenue, Suite 3700
Dallas, Texas 75202-2799
(214) 979-3000
(214) 880-0011 fax
Jacquelyn Bateman Kruppa
214-468-3347
jkruppa@hunton.com

Topics: Bank Capital, De Novo Bank Capital, Regulations, Reg. D Stock

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BankNotes© is published by De Novo Strategy as a service to clients and other friends. The information contained in this publication should not be construed as legal, accounting, or investment advice. Should further analysis or explanation of the subject matter be required, please contact De Novo Strategy at subscribe@denovostrategy.com.