[Senate Hearing 112-172]
[From the U.S. Government Publishing Office]
S. Hrg. 112-172
ENHANCING SAFETY AND SOUNDNESS: LESSONS LEARNED AND OPPORTUNITIES FOR
CONTINUED IMPROVEMENT
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
FINANCIAL INSTITUTIONS AND CONSUMER PROTECTION
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
ON
EXAMINING OPPORTUNITIES FOR CONTINUED IMPROVEMENT IN THE SAFETY AND
SOUNDNESS OF OUR BANKING SYSTEM
__________
JUNE 15, 2011
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.fdsys.gov /
U.S. GOVERNMENT PRINTING OFFICE
71-700 WASHINGTON : 2012
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing Office,
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center, U.S. Government Printing Office. Phone 202�09512�091800, or 866�09512�091800 (toll-free). E-mail, [email protected].
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia MARK KIRK, Illinois
JEFF MERKLEY, Oregon JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
Dwight Fettig, Staff Director
William D. Duhnke, Republican Staff Director
Dawn Ratliff, Chief Clerk
Levon Bagramian, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on Financial Institutions and Consumer Protection
SHERROD BROWN, Ohio, Chairman
BOB CORKER, Tennessee, Ranking Republican Member
JACK REED, Rhode Island JERRY MORAN, Kansas
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey MIKE JOHANNS, Nebraska
DANIEL K. AKAKA, Hawaii PATRICK J. TOOMEY, Pennsylvania
JON TESTER, Montana JIM DeMINT, South Carolina
HERB KOHL, Wisconsin DAVID VITTER, Louisiana
JEFF MERKLEY, Oregon
KAY HAGAN, North Carolina
Graham Steele, Subcommittee Staff Director
Michael Bright, Republican Subcommittee Staff Director
(ii)
?
C O N T E N T S
----------
WEDNESDAY, JUNE 15, 2011
Page
Opening statement of Chairman Brown.............................. 1
Opening statements, comments, or prepared statements of:
Senator Corker............................................... 2
WITNESSES
Michael R. Foley, Senior Associate Director, Division of Banking
Supervision and Regulation, Board of Governors of the Federal
Reserve System................................................. 4
Prepared statement........................................... 31
Responses to written questions of:
Senator Reed............................................. 59
Senator Merkley.......................................... 59
Christopher J. Spoth, Senior Deputy Director, Division of Risk
Management Supervision, Federal Deposit Insurance Corporation.. 6
Prepared statement........................................... 34
David K. Wilson, Deputy Comptroller, Credit and Market Risk,
Office of the Comptroller of the Currency...................... 8
Prepared statement........................................... 39
Responses to written questions of:
Chairman Brown........................................... 61
Senator Reed............................................. 63
Senator Merkley.......................................... 64
Salvatore Marranca, Director, President, and Chief Executive
Officer, Cattraugus County Bank, Little Valley, New York....... 19
Prepared statement........................................... 52
Frank A. Suellentrop, Chairman and President, Legacy Bank,
Colwich,
Kansas......................................................... 21
Prepared statement........................................... 56
Additional Material Supplied for the Record
Statement submitted by the American Bankers Association.......... 68
(iii)
ENHANCING SAFETY AND SOUNDNESS: LESSONS LEARNED AND OPPORTUNITIES FOR
CONTINUED IMPROVEMENT
----------
WEDNESDAY, JUNE 15, 2011
U.S. Senate,
Subcommittee on Financial Institutions and
Consumer Protection,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee met at 10:04 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Sherrod Brown, Chairman of the
Subcommittee, presiding.
OPENING STATEMENT OF CHAIRMAN SHERROD BROWN
Chairman Brown. The Subcommittee on Financial Institutions
and Consumer Protection will come to order. I will do a brief
opening statement, call on the Ranking Member, Senator Corker
from Tennessee, and then I think Senator Reed and I believe
Senator Moran will be here for opening statements, and Senator
Moran wants to introduce somebody in the second panel.
From 1999 to 2007, Wall Street in many ways was a big party
without adult supervision. Mortgage originators, investors, and
investment banks all made money. Large megabanks made lots and
lots of money. Citigroup's CEO, Chuck Prince, famously asked
Treasury Secretary Hank Paulson, ``Isn't there something you
can do to order us not to take all of these risks?'' The answer
was, ``Yes, but no one did.'' And so Prince concluded, ``As
long as the music is playing, you have got to get up and
dance.''
As a former Fed Chairman once said, ``The Fed's job is to
take away the punch bowl just as the party gets going.'' So
where were the regulators? One Fed supervisor told the
Financial Crisis Inquiry Commission, ``Citigroup was earning $4
to $5 billion a quarter. When that kind of money is flowing out
quarter after quarter, it is very hard to challenge.''
While the securitization machine was in full swing, Wall
Street basically wrote its own rules. Banking regulators relied
on Wall Street's own internal risk models and allowed the banks
to hold no capital buffer against their subprime securities
while these securities were rubber-stamped as AAA by the rating
agencies. The OCC's head of large bank supervision has
acknowledged that they did not have enough information about
market risk and failed to intervene before the crisis.
According to a 2009 evaluation, the New York Fed's
supervision of Citigroup ``lacked a disciplined and proactive
approach in assessing and validating actions taken by the firm
to address supervisory issues.''
The former head of the Office of Thrift Supervision
compared its ability to regulate AIG to that of a gnat on an
elephant. With supervision like this, the party was sure to end
in financial disaster.
Now there is a constant drumbeat on Wall Street and in
Washington that focusing on safe and sound financial practices
will hold back our economic recovery. Wall Street and my
conservative colleagues in Washington have a bad case of
amnesia. They have forgotten that poor safety and soundness
oversight helped push us toward a fiscal crisis and a disaster
in our economy. The Congressional Budget Office projects the
financial crisis will increase Federal debt held by the private
sector by 40 percent of GDP. Standard & Poor's estimates that
another financial sector bailout could have up-front costs as
high as $5 trillion.
These are not the only costs. We know home prices have
fallen by more than they did during the Depression; 28 percent
of homeowners are currently underwater, owing more on their
house than their house is worth. Reports of foreclosure fraud
and mortgage-backed security failures are all too commonplace.
Lax supervision also makes it harder to hold wrongdoers
accountable because law enforcement agencies rely only on
referrals too often only from bank regulators. As the New York
Times noted in April, the Office of Thrift Supervision has not
referred a single case to the Justice Department since 2000 and
the OCC has referred only three. When laws can be ignored, then
property can be taken from its rightful owners, homeowners and
investors, and given to servicers and originators. A safe and
sound banking system should attract capital from investors and
provide it to borrowers to finance productive economic
activity.
Guided by clear-cut, sensible rules, our banking system for
over five decades has been a model of safety and security for
the world, yet it is clear that we forgot the lessons learned
in prior bank crises at home and abroad that an unsafe and
unsound banking system destroys wealth and drains resources
from the rest of the economy. I am afraid that American
families and investors, simply put, have lost faith in our
financial system.
So my question to the witnesses is: What are you doing--and
those questions will be more specific from all of us after
statements from us and you. What are you doing to restore Main
Street's confidence? What have you learned about sound bank
regulation? How has your approach changed? And what is being
done right now before all the provisions of Dodd-Frank take
effect to prevent another collapse of our banking system?
Senator Corker.
STATEMENT OF SENATOR BOB CORKER
Senator Corker. Thank you, Mr. Chairman. That was quite a
statement.
I want to thank each of you for coming and thank you for
what you do. I will say that there is no question that I think
people on both sides of the aisle would agree that we have to
figure out a way to keep regulation from being procyclical
where, when things are really good, people loosen up, and when
things are really bad, we create a self-fulfilling prophecy by
overregulating. And I think probably everybody would agree that
that is a problem that we have got to keep from happening.
But I have to tell you, I think I am amazed. Congress
certainly was part of the party and was pouring some of the
alcohol in the punch bowl, and, you know, I look at Dodd-Frank
as an incredible exercise of laziness by Congress where
basically Congress punted all the tough decisions to
regulators, trying to act like it had done something great. And
I think the Financial Times had the best summary of it about a
week after they had an analysis, and it said, ``So many pages,
so little content.'' And I find it hilarious--it would be
hilarious except for the damage that it is doing to our country
right now.
You know, Dodd-Frank was basically put in place and rushed
the way that it was to create clarity in the markets, and
anything but that has happened. The fact is that, you know,
Congress punted all tough decisions to regulators, did not give
the clarity. Then I find it, again, hilarious except for the
damage that is being done that we now have Senators on both
sides of the aisle acting as supplicants to regulators, begging
them not to do certain things because we have turned over all
of the power as it relates to these financial institutions to
regulators without really giving the type of direction that we
should have given.
So I think over time historically, looking at Dodd-Frank,
people are going to look at it as a minor disaster as it
relates to our economy. I do wish we had taken more time to do
the work we needed to do to understand the issues instead of
just, as Congress typically does, acting like we did something
great but basically have asked the regulators to make hundreds
and hundreds of rules in a short amount of time. I mean, that
alone we all know is going to lead to all kinds of unintended
consequences.
So as we are pointing fingers, I certainly hope fingers
will be pointed, as they should be, at the U.S. Senate and
Congress for not doing the oversight that it should have done
while the party was going on, for basically fueling it with
much of the housing policies, and then now basically punting
much of our responsibilities to regulators, creating a
tremendous lack of clarity out there. And I do hope while the
regulators, in my opinion, have made some bad decisions over
the course of the last couple months, several months, this last
year, the fact is that we are all in this together, and I think
we all do want a sound financial system with appropriate
reserves and all of those types of things.
So I think the pendulum has swung too far. I think
Congress, just like regulators do, on a procyclical basis, the
regulators overregulate during the bad times. We are seeing it
throughout our country, especially with community banks. I
think Congress has done the same thing, and instead of
surgically looking at the problems and prescriptively trying to
deal with those, we wrote this massive, massive, massive bill
that has given the regulators tremendous powers, many of which
the regulators do not want.
You know, we complain about regulatory overreach, and in
the case of Dodd-Frank, I think the regulators are saying,
``Please, do not ask us to do all these things in the short
amount of time that you have given us.''
So, with that, I look forward to your testimony, and I do
that with a smile, and I thank you for being here.
Chairman Brown. Senator Reed.
Senator Reed. Thank you, Mr. Chairman, for convening this
hearing.
Chairman Brown. Good statement. Thank you.
Michael Foley is a Senior Associate Director of the Federal
Reserve Board with responsibility for large bank supervision.
In that role he cochairs a system-wide multidisciplinary
committee that is responsible for implementing a coordinated,
comprehensive supervisory program for large complex banking
organizations overseeing horizontal examinations and evaluating
the findings from key supervisory activities. He has served in
that capacity since the formation of this group in mid-2010.
Previously, he was senior adviser to the Director of Banking
Supervision and Regulation beginning in late 2008.
Christopher Spoth is Senior Deputy Director of the FDIC's
Division of Risk Management Supervision. His responsibilities
include oversight of the FDIC's supervisory programs for safety
and soundness and bank secrecy, antimoney laundering. Prior to
his current appointment, Mr. Spoth was regional director of the
FDIC's New York Region. Welcome.
David Wilson was appointed Deputy Comptroller for Credit
and Market Risk at the Office of the Comptroller of the
Currency in June 2010. In this role Mr. Wilson is a key adviser
to OCC's senior management on evaluating credit risk. He also
provides expertise on other major policy matters affecting
national bank lending activities. Mr. Wilson cochairs OCC's
National Risk Committee and supplies executive direction in
analyzing emerging risks to the financial banking system and
establishing bank supervisory policy.
Mr. Foley, if you would begin.
STATEMENT OF MICHAEL R. FOLEY, SENIOR ASSOCIATE DIRECTOR,
DIVISION OF BANKING SUPERVISION AND REGULATION, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Foley. Thank you, Chairman Brown, Ranking Member
Corker, and other Members of the Subcommittee. I appreciate the
opportunity to testify today regarding the Federal Reserve
Board's supervision of financial institutions and, in
particular, changes that we have made and are in the process of
making to enhance our supervisory opportunities over these
firms. As you mentioned, I am a Senior Associate Director at
the Federal Reserve. I am responsible for the largest banking
institutions.
The financial crisis revealed a number of vulnerabilities
in the financial system and in the regulatory framework in the
United States. Many of those have been addressed by the Dodd-
Frank Act, but in addition, the Federal Reserve has taken a
number of steps to strengthen our oversight of the largest,
most complex financial institutions and to broaden our
perspective to include a more macroprudential approach to
supervision.
To that end, as you mentioned, we have established a new
governance structure for large bank supervision. This was led
by a number of senior officials from across the Federal Reserve
System with expertise in a number of areas--macroeconomics,
capital markets, payment systems--in addition to bank
supervisors.
This committee is responsible for helping us to identify
potential threats both to individual firms and to the system
more broadly, to set supervisory priorities and strategies for
the largest institutions, and to review the findings and the
work of the examiners on-site at these institutions.
The Supervisory Capital Assessment Program, which was led
by the Federal Reserve in early 2009, helped to stabilize the
U.S. financial system, but also demonstrated the feasibility
and the benefits of employing an across-firm macroprudential
approach to the supervision of the largest firms. As a result,
our examiners are making greater use of these horizontal
assessments. The most recent example of this is the
Comprehensive Capital Analysis and Review, or the CCAR, which
we completed earlier this year in cooperation with our
colleagues from the OCC and the FDIC.
The CCAR also, very importantly, represented a substantial
strengthening of previous approaches by supervisors to ensure
that large firms themselves have robust internal processes for
managing their capital resources, that resulted in a forward-
looking assessment of capital adequacy, both for individual
firms and also for a majority of the assets of the U.S. banking
system.
We also are strengthening our firm-specific supervisory
techniques. We are using more detailed data, more frequent and
more granular collection of data, and improved quantitative
methods and models in analyzing that data.
I would like to add that while many of our recent actions
have been focused on enhancing the supervision for the largest
institutions, we also have been making adjustments to our
oversight for community and regional banks. As liquidity
strains developed during the course of the crisis, we adjusted
our focus to place greater emphasis on evaluating liquidity
contingency funding plans at those organizations. And as
commercial real estate began to deteriorate and affected the
performance of those firms, we conducted reviews of the
implementation of the 2006 interagency guidance addressing
commercial real estate concentrations. And as a result of those
reviews, we identified a number of issues for which examiners
and bankers needed clarification. That contributed to the 2009
interagency guidance aimed at facilitating prudent workouts of
commercial real estate loans and prudent modifications of those
loans.
So while the crisis made it clear that tightening of
supervisory expectations and our processes was needed and
appropriate, we are also mindful of the importance of
maintaining banks' ability and willingness to lend to
creditworthy small businesses and consumers. Consequently, we
have worked hard to ensure that our examiners employ a balanced
approach when they are reviewing banks' underwriting and when
they are reviewing banks' risk management and mitigation
practices. We expect our examiners to strive for consistency in
the examination process throughout the business cycle.
I would add that credit markets have been recovering slowly
since the financial crisis. Recent measures of aggregate credit
outstanding that have shown some signs of improvement. But,
clearly, the residential and commercial real estate lending
sectors remain lagging. They are going to continue to present
challenges for banks and supervisors for quite some time to
come. With housing values flat or deteriorating in many
markets, there are renewed concerns about the health of the
mortgage market in general, and home equity loans and the
activities of firms in that regard.
So with residential and commercial property values still
under strain, heightened reserve levels at banks remain
appropriate. We expect that banks will continue to incur
higher-than-historical losses in these sectors for some time to
come, certainly through the remainder of this year and beyond.
In conclusion, the Federal Reserve has made significant
enhancements to our supervisory process, and those
enhancements, coupled with the Dodd-Frank Act, support enhanced
regulation and supervision of large complex firms, but we have
also enhanced our supervision of regional and community banks,
placing greater emphasis on sound risk management practices. In
so doing, we have been mindful of the need to ensure that bank
supervision is scaled to the size and the complexity of the
supervised firm, and that bank management and examiners take a
balanced approach to ensuring the safety and soundness of the
banking system and also serving the credit needs of their
communities.
Thank you for inviting me to appear before the Committee
today on these important issues. I would be pleased to take any
questions that you may have.
Chairman Brown. Thank you, Mr. Foley.
Mr. Spoth.
STATEMENT OF CHRISTOPHER J. SPOTH, SENIOR DEPUTY DIRECTOR,
DIVISION OF RISK MANAGEMENT SUPERVISION, FEDERAL DEPOSIT
INSURANCE CORPORATION
Mr. Spoth. Chairman Brown, Ranking Member Corker, Members
of the Committee, thank you for the opportunity to testify on
behalf of the FDIC about our supervisory process. As Senior
Deputy Director, Division of Risk Management, I oversee our
nationwide safety and soundness examination program.
As the primary Federal supervisor of most community banks,
the FDIC seeks to maintain a balanced approach to bank
supervision, regardless of economic conditions. In our unique
role as deposit insurer, we have a vital interest in assessing
risks to the Deposit Insurance Fund posed by all FDIC-insured
institutions.
Overall, we are cautiously optimistic regarding the current
condition and trends in banking. The number of institutions on
the FDIC Problem List is leveling off, and the number of failed
insured financial institutions appear to have peaked in 2010.
However, the number of problem institutions remains high at 12
percent of all insured institutions, indicating that a portion
of the industry continues to struggle with lingering credit
quality issues. These issues limit the ability of some
institutions to grow their lending activity.
We identify four broad factors that led to the financial
crisis: excessive leverage, misaligned incentives, regulatory
gaps, and weak market discipline. Much of the risk centered on
poorly underwritten mortgage loans originated for
securitization in the so called shadow banking system.
Structured financial activities that generated the greatest
losses were undertaken at the intersection of the lightly
regulated shadow banking system and the more heavily regulated
traditional banking system. This experience motivated
legislative reforms and supervisory improvements.
The establishment of the Financial Stability Oversight
Council, the designation of systemically important financial
institutions, or SIFIs, and the heightened supervision of
systemic institutions along with other regulatory changes will
help restore market discipline to our financial system. At the
FDIC we established the Office of Complex Financial
Institutions to continuously monitor and, potentially, resolve
SIFIs. Among other requirements the office will review SIFI
resolution plans which must demonstrate that the firm is
resolvable under the Bankruptcy Code.
With respect to community banks, they were generally not
involved in the mortgage-related issues that were at the center
of the financial crisis, but they were impacted in the fallout.
Hit first was construction and development lending. Credit
losses subsequently spread across all loan types. Further, home
prices continued to fall because of several factors, including
the foreclosure inventory.
Growth in well-underwritten loans is essential for bank
revenue growth and for our economy to grow. However, recent
independent surveys and some bankers indicate that borrower
demand remains sluggish. Despite the challenges, community
banks continue their vital role as lenders. In fact, they have
increased their loan balances since the second quarter of 2008.
To address the significant challenges faced by banks and
their borrowers, we continue our active engagement with banks.
For example, 2 years ago the FDIC established its Advisory
Committee on Community Banking. The committee provides the FDIC
with advice on a broad range of policies. In addition, bank
CEOs received a letter reiterating various channels, including
confidential ones, for bankers to raise any concern about an
examination.
The FDIC continues to work on eliminating unnecessary
burdens on community banks whose structure and business lines
are relatively noncomplex. As noted in my written testimony and
appropriate for the causes of the crisis, much of the Dodd-
Frank Act should not directly impact community banks, and
certain provisions of the act provide some benefits.
We will continue to pursue methods to streamline our
supervisory process using technology and other means to reduce
disruption associated with examinations. We strive to be
efficient in our work while also conducting effective
examinations. Having our office locations in numerous
communities across the country helps our examiners be
knowledgeable about community banks in their areas and about
local conditions.
The FDIC has been incorporating lessons learned into our
examination program. We are encouraging banks to make loans to
creditworthy borrowers, and we recognize their important role
in the economy.
Thank you. I would be pleased to take your questions.
Chairman Brown. Thank you, Mr. Spoth.
Mr. Wilson.
STATEMENT OF DAVID K. WILSON, DEPUTY COMPTROLLER, CREDIT AND
MARKET RISK, OFFICE OF THE COMPTROLLER OF THE CURRENCY
Mr. Wilson. Chairman Brown, Ranking Member Corker, and
Members of the Subcommittee, I appreciate the opportunity to
discuss the OCC's perspectives on lessons learned from the
financial crisis and our ensuing approach to bank supervision.
While not covered in my remarks, pursuant to the Subcommittee's
request, my written statement does provide an update on the
current state of small business and real estate lending,
mortgage servicing, and trading lines of business.
The financial crisis underscored the importance of prudent
underwriting practices, adequate loan loss reserves, strong
capital cushions, and it also highlighted the need for
supervisors to develop better tools to evaluate and address
emerging risks across the system. The OCC has taken action to
strengthen our supervision and practices of the banks we
supervise in each of these areas.
The primary driver of the financial crisis was the
progressive slippage in underwriting practices that occurred as
banks responded to competitive pressures from the shadow
banking system. We closely monitor national bank underwriting
and have directed our banks not to compromise their
underwriting standards due to competitive or other pressures,
and as well, we have strengthened our analytical tools to help
monitor for slippage in loan quality so we can intervene at an
earlier stage. This includes granular loan-level data on major
credit portfolios that we are collecting from the largest
national banks that allow us to conduct forward-looking
analysis under varying economic scenarios.
The financial crisis also highlighted that risk management
is and must be much more than simply a collection of policies,
procedures, limits, and models. Effective risk management
requires a strong corporate culture and corporate risk
governance. This culture must be set, embraced, and enforced by
the bank's board of directors and its senior management, and it
must permeate through all the bank's activities. This is a
point of emphasis in all of our meetings with senior management
teams, directors, and senior management at large, midsized, and
community banks.
We have also updated our risk assessment system that we use
as a part of our examinations at each national bank to reflect
and incorporate lessons learned from the financial crisis and
have directed examiners to be more forward-looking when they
assess and assign these risk assessments. Given the importance
and role of large national banks and the importance they play
in the financial stability of the U.S., we have made it clear
that these firms should not operate without strong risk
management and audit functions. Anything less would not be
sufficient.
Further, we are directing large banks to incorporate
robust, enterprise-wide stress testing as a part of their
ongoing risk management. We are also working with smaller banks
to improve their ability to assess potential concentrations in
key portfolios, most notably commercial real estate, so they
can address potential problems before they occur.
To improve our ability to identify emerging systemic risks,
we have established a financial markets group to monitor and
gather market intelligence, and we developed a system of early
indicators that signal a buildup of risk within the system.
Under this system warning signals across a number of measures
will trigger a more formal review and assessment of the risk
and the need for a supervisory response.
The OCC has worked with supervisors across the globe to
enhance and strengthen capital and liquidity standards. These
efforts culminated in Basel III. These reforms tighten the
definition of what counts as regulatory capital, expand the
type of risk captured within the regulatory capital framework,
increase overall capital requirements, establish an
international leverage ratio, and introduce global minimum
liquidity standards for large banks.
The OCC has also been a vocal advocate with the accounting
standard setters to revise the current accounting model for
loan loss reserves to make them more forward-looking.
In closing, the financial crisis exposed fundamental
weaknesses in risk management and supervisory practices across
the financial industry and the supervisory community. The OCC
has taken numerous steps to enhance its supervision programs.
As we implement these changes and those mandated by the Dodd-
Frank Act, we are cognizant of the need to tailor our
expectations to the scope and complexity of each bank's
activities. We must also avoid wringing all risk out of the
banking system. Banks' fundamental role is risk intermediation,
and financial innovation and expansion of credit are important
drivers of our economy. Banks must be able to respond to
customer and investor demand for new and innovative products
and services, and in this respect our overarching goal and
mission remain the same: to assure banks conduct their
activities with integrity and in a safe and sound manner, and
that our supervision remains balanced and fair.
Thank you, and I would be happy to take questions.
Chairman Brown. Thank you, Mr. Wilson. I do not think
anybody wants, to your last comment, wring all the risk out of
the financial system. I do not think that is where anybody is
going in this.
Last week the Treasury Department--and this question will
be for you, Mr. Wilson, but anybody can weigh in--announced it
was withholding payments from three servicers due to poor
performance in the HAMP program. We do not always in these
hearings and in our deliberations think about human beings and
the consequences of all of these actions.
I want to tell a quick story about Frank Vance from Medina
County, an exurban county just south of Cleveland. He worked at
the Arcelor Mittal Steel Plant as a railroad engineer. He and
his wife bought their dream house in Chatham, Ohio, with a
Countrywide mortgage. The financial crisis hit. The plant
closed. The plant laid him off in 2009. He went to his lender,
now Bank of America, entered into a trial modification that
lowered his monthly payment by extending the loan 12 years.
When a paper bill came in the mail showing the old payment
amount, Frank called his bank. They told him not to worry, to
keep making his payments, that no negative reports were being
made to the credit bureaus. The bank did not approve a
permanent modification until August 2010 when his payments
increased by $200 a month. He later discovered that all his
payments for a period of 13 months were sitting in an escrow
account, and his credit report made it appear as if he was not
making any payments over that year. In addition to placing his
home in jeopardy, it is now more expensive for him to make the
second biggest purchase in his life--his car.
My question for the regulator is: What is the OCC doing to
scrutinize these loans? What are you doing to help the Frank
Vances of the world?
Mr. Wilson. Yes, Senator, HAMP is a Treasury program, but
these problems are indicative of our findings of the reviews
that we did late last year. They are the subject of the consent
orders that we issued in April. Those consent orders get to the
heart of, you know, where consumers were harmed because of
foreclosure management practices. The consent orders
specifically talk about dual-track processing and things like
that. It is, unfortunately, not something that can be corrected
overnight. But one of the reasons that the OCC and my colleague
agencies moved forward with consent orders is to get them
corrected as quickly as possible.
Chairman Brown. Anyone else want to weigh in?
[No response.]
Chairman Brown. Let me go somewhere else. National City
Bank in Cleveland was a huge regional bank founded in Cleveland
in 1845. As recently as 2007, it was the ninth largest U.S.
commercial bank with $140 billion in assets. It was sold to PNC
a year later during this terrible crisis. It is a case study in
regulatory failure.
After buying subprime lender First Franklin in 1999, the
bank's mortgage annual profits grew 20-fold in 4 years from $50
million to $1 billion. These volatile, unpredictable mortgages
eventually did in National City. National City executives
started talking about selling First Franklin in early 2005. It
took until late 2006 for them to sell it. They were forced to
retain $10 billion of the riskiest loans, half of the loans
that ultimately brought National City down.
In the summer of 2006, their chief economist wrote a
research report arguing that the housing market was headed for
collapse. That report was ignored by the bank's own executives.
A few months later, the bank spent 42 billion buying two
Florida banks, a market that has been crushed by declining
property values and foreclosures.
In early 2007 the bank bought back $3 billion of its own
stock. A year later it was forced to raise a very expensive $7
billion from private investors. National City wound up losing
$6 billion in 2008 and was bought by PNC for only $2.23 a
share. The company and its regulators--the Fed and the OCC had
known for almost a year the bank was in trouble.
What have we learned from this? What would you do
differently? What are you doing now to prevent failures such as
National City? And understanding that bank still exists as part
of PNC, they still have a lot of employees in my State, but
they have significantly fewer employees, and a whole lot of
stockholders in National City lost a lot of money.
Mr. Wilson. I will refer back to some of the comments about
when do you take away the punch bowl. That is one of the most
difficult things that regulators and supervisors have. And I
referred to it in my testimony. We have developed a number of
tools and indicators that really indicate when times are too
good. For example, the best loans are often made during the
worst of times and vice versa. So the worst loans are made
during the best of times. Being able to identify that and flag
it early and take early action I think is the key to preventing
your description of National City.
Chairman Brown. And you are capable of that, and the other
regulators are now capable of that?
Mr. Wilson. We have a renewed emphasis, and we are going to
do the best we can.
Chairman Brown. Mr. Foley.
Mr. Foley. From our perspective the first step is to go
back and consider the lessons learned in the crisis. The very
situation you talked about really describes a collective
failure of imagination by the banks and by the regulators
themselves. Of course, this is in the context of very strong
economic growth, a long benign economic environment, strong
profitability from firms, and exceptionally low losses on
mortgage lending.
But against that backdrop, bankers and supervisors did not
consider the potential for a significant decline in house
prices. We did not consider the potential that what were
assumed to be stable sources of funding could go away in that
type of environment. The result was that these firms were
undercapitalized, and they were not prepared for the liquidity
strains that they saw in the crisis.
One of the appropriate responses, we think, is that bankers
themselves need to have stronger risk management in place and
supervisors have to have better tools to assess the potential
for low profitability, but high-impact stress events. Stress
testing is one effective way to do that. That is required under
the Dodd-Frank Act. That is reflective of the activities
undertaken in the SCAP and the CCAR process. But one important
element of this is the need for a forward-looking assessment of
the potential risks of the firms. We need to consider more
extreme economic events and idiosyncratic risks that can affect
individual firms and relate that back to potential future
losses, the ability to earn and supplement their capital base,
and evaluate their need for capital and liquidity under those
types of adverse circumstances.
Mr. Spoth. Senator, I would only add, the one thing FDIC
has done with the other regulators is reframe our back-up
examination activities to protect the insurance fund wherein we
adopted a new memorandum of understanding to engage in back-up
activities where necessary.
Chairman Brown. OK. Thank you. Senator Corker, before you
begin, in light of your opening statement, I hope there are
some statutory issues that maybe with Dodd-Frank we can work
together on to help us with that. Thank you.
Senator Corker. I appreciate that. As a matter of fact, I
think there are, and I think that a lot of us are seeing a lot
of unintended consequences and I think a lot of folks wanted to
see appropriate financial regulation, so I hope we can do that.
As I go through our State, people from all kinds of
backgrounds and persuasions politically that are in community
banking come up to me and say, ``You know, Corker, I am
beginning to think that the Federal Government just really does
not want community banks in the number that they have today,
that they really want to force consolidation, that they really
are doing everything they can to keep us from being
successful.''
And I guess my question to each of you, without being too
elaborate with your answers, is what is happening right now
throughout community banks, the banking system? Is it a result
of procyclicality, where, in essence, we are clamping down more
than we should at a time when the economy is slow and creating
a self-fulfilling prophecy? Is it that Dodd-Frank is forcing
you to do things that you were not doing before? Or is it some
other answer? But I really do believe that amongst community
bankers in our country, there is a belief that the Federal
Government really has stacked the deck in a way that makes it
very difficult for them to compete.
Mr. Spoth. I might touch on that first, Senator, as
principally we are the regulator for most of the community
banks. I think with respect to Dodd-Frank, the burden falls, as
it should, on the largest financial institutions and we should
work in that regard for implementation.
I hear the same things that you do when I am talking with
bankers about burden. I am optimistic that the community bank
franchise is a strong one and a valuable one and will continue
to be so for our country. Looking at the numbers, I know that
of all the 7,500 insured banks in this country, 90 percent of
them are community banks serving their communities well. They
have under a billion dollars in assets each, but they have a
disproportionately large share of the commercial loans in their
markets.
Mr. Wilson. At the OCC, we respect and support the role of
community banks and have no intention of trying to reduce the
number of community banks or anything like that. In addition to
what Chris said, community banks are under a lot of pressure
right now because they tended to be overly concentrated in
commercial real estate, and commercial real estate,
particularly income-producing commercial real estate, has
lagged the recovery. A lot of banks are continuing to struggle
with those concentrations and working through those
concentrations. We are doing the best we can, and I know my
colleagues are, as well, to make sure that we are fair and
balanced in allowing the banks to work through those. But in
some cases, it is just not possible.
Senator Corker. Yes. We kind of forced them out of
residential into commercial due to our policies here, and that
is one of the problems that we, Congress, helped create.
The one thing I would say, Mr. Spoth, I know you mentioned
that, somehow or other, this is tilted toward the large
institutions. The fact is, that is not the case. I mean, the
big just get bigger when we regulate the way that we have, and
what has happened is with the community banks, their back
offices now are much, much, much larger and are getting larger
just to deal with all the things that are in Dodd-Frank. So I
would just say your statement is just categorically untrue,
because larger institutions have the ability to absorb
regulations in a much more efficient way. They can spread it
over a larger mass than community banks do. So that is just
categorically an incorrect statement. And you can go talk to
any community bank in our country and they will tell you that
the burden per asset base that they have is much larger on a
community bank than it is on something that is much larger.
Let me ask another question. The risk retention piece, I
thought, was ridiculous, and I think it is going to have
tremendous effects on our securitization market. So, again,
Congress punted and basically said, oh, well, we do not really
want to get--we do not know how this works, really, so set up a
Qualified Residential Mortgage. You guys have, in your wisdom,
come up with a 20 percent downpayment and now Congress, being
the supplicants that we now are in this process--everybody is
writing letters to say, well, we really--oh, gosh, we wish you
had not done that. Would you all like to respond to the
Qualified Residential Mortgage and just the whole risk
retention piece and how you guys, in your wisdom, have come up
with a 20 percent downpayment that now Senators who punted
their responsibilities are trying to keep you from doing.
Mr. Wilson. Of course, Senator. That rule is out for
comment and we have invited comments on that very issue,
especially the 20 percent downpayment. I think the policy
makers looked at the rule as primarily a risk retention rule.
The intent of the rule is that the securitizer would retain
risk. It did allow, as you mentioned, the option of designing a
very, very high quality asset that would be exempt from that
risk retention rule. So the design of it was very conservative,
not only in residential real estate, but in the other asset
classes that are mentioned in the proposed rule. And, again,
the intent of the law was risk retention, and so the exceptions
to risk retention should be narrow.
Senator Corker. So, basically, this is--for those out in
the real estate world that are slightly upset, if you can
imagine, about a 20 percent downpayment, what you would say is
that is exactly what the U.S. Senate told you to do.
Mr. Wilson. We believe that there are many, many good
mortgages, we would hope, that would still be made that are
outside of QRM if you include----
Senator Corker. But the institutions would have to hold
risk against those.
Mr. Wilson. But they would have to hold----
Senator Corker. And so that means that no community bank--
let me just go back to the other statement--no community bank
could possibly, possibly be in that world. It means that, now,
home mortgages will be concentrated in the JPMorgans and the
Citibanks and the Bank of Americas because nobody else has the
ability to hold risk on their balance sheet, is that correct?
Mr. Wilson. We have tried to design the rule to not have
that happen. The risk retention is the primary responsibility
of the securitizer, not the originator. So under the current
model where you have a community bank that will originate a
handful of loans and then sell them to a securitizer, the
community bank does not have to retain the risk. It is the
securitizer that has to retain that risk.
Senator Corker. But will it not concentrate that market
when you have to have a large balance sheet like that to hold
the risk?
Mr. Wilson. To the extent that the community bank decides
to sell that loan, that would be the model that existed before
Dodd-Frank. So if the community bank decides to hold the loan
on the books, then risk retention does not come into play. But
we consciously tried to consider this factor when we debated
whether we would make the originator retain the risk versus the
securitizer themselves, and it was this consideration that went
into that debate.
Senator Corker. Listen, thank you. I know I have taken over
my time. Thanks for having the hearing. I would just close by
saying that I know you guys have 300 rulemakings to make, and I
know in many cases you feel like you are making them too
quickly, trying to meet deadlines. And I do know for a fact
that it is creating tremendous lack of clarity out in the
financial markets and people have no idea what the rules of the
road are and I know that is hurting our economy. I know that. I
do not know many things, but I know that.
I do hope that as you move along, if you see things that
you feel like you are rushing, that you will not be cowered by
those people who just want to see Dodd-Frank pushed through
regardless, but that you will tell us that you need more time,
and I thank you very much for what you do and appreciate the
opportunity to be with you today.
Chairman Brown. Thank you, Senator Corker.
Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman.
Just to follow, a point of clarification, Mr. Wilson. The
20 percent downpayment is not specified--I do not believe it is
specified in Dodd-Frank in terms of qualifying. Is it
specified?
Mr. Wilson. No, the 20 percent down is not specified.
Senator Reed. Yes. In fact, the agencies have the
flexibility to design a rule which would reflect an appropriate
downpayment, but 20 percent is something you are proposing now.
Mr. Wilson. That is correct.
Senator Reed. Thank you. Mr. Wilson, I am still, as you are
probably aware, awaiting questions, or responses from the May
12 hearing from the OCC and I would appreciate very much if
those responses would be forthcoming. I know my staff has
talked to you. I appreciate that. But they are important
questions and I would like answers. Any idea when we are going
to get them?
Mr. Wilson. Senator Reed, we understand that. We are well
along on answering those questions and I would hope it would be
very soon.
Senator Reed. Thank you.
Mr. Wilson. We take it very seriously.
Senator Reed. Thank you. You have mentioned the OCC consent
order. At the heart of it seems to be the requirement that the
banks engage an independent consultant to look back at their
servicing processes, which begs a couple of questions. First,
why was the OCC looking at these processes? And then a related
question is at what point did the OCC become aware of what
appears to be, and Senator Brown's example is just one of
thousands, hundreds of thousands, serious deficiencies, in
fact, deficiencies that appear to be violating law? So could
you respond to those two issues?
Mr. Wilson. Yes, sir. We become aware, not really until it
became public with the Allied Bank publicity, but we jumped in
very quickly after that with horizontal examinations on an
interagency basis.
As to why were we not looking at before, this is another
lesson learned, but we do look at mortgage servicing
operations. We do look at modification procedures, the basic
transaction of the notary signing and affidavits, and things
like that traditionally was a low-risk business. We did not
have any indicators from internal audit or other risk
management functions around the bank. We did not pick up any
complaints in our consumer complaint process. So it was not
something that we had a big focus on until we understood the
nature of the problems.
Senator Reed. Let me--just two points. One, I presume based
on not only the response to this question but your previous
responses that you have taken corrective action with respect to
these issues in terms of your examination procedures, the
training of examiners, and I would also sort of emphasize the
consumer complaint process, because, frankly, our offices are
deluged by consumer complaints. If you were getting a quarter
of the complaints which were originating two or 3 years ago
that I think some of them are also getting, then you have to
look very carefully at your consumer relations and how you
identify complaints and follow them up, because there was a lot
of noise out there in terms of consumers, frustrated consumers
literally banging down our doors, and I think I speak for
everybody on this Committee and in every part of the country.
Let me shift gears briefly, and still in the context of
this process of mortgage foreclosures. Yesterday, 11 of my
colleagues, including the Chairman of the Committee, Chairman
Brown, Chairman Leahy of the Judiciary Committee, sent a letter
to the Comptroller asking the Comptroller to work very closely
with the States' Attorneys General, with the Department of
Justice, with the Department of Housing and Urban Development,
to produce a comprehensive solution to this foreclosure crisis,
not just rectifying the robosigns, et cetera. And I think at
the heart of it is the notion that we have--until we stabilize
the housing market, which we have not, we will not have any
economic growth of consequence nor will the safety and
soundness of banks begin to be self-sustaining and something
that you have to worry about.
So let me just specifically ask, can you describe your
proposed collaboration with the Attorneys General at all?
Mr. Wilson. I will try. I will say, number one, we agree
with the letter. We agree that not only should we fix what is
wrong with the foreclosure process, provide restitution to
consumers that have been harmed, but then also address the
broader issue of servicing and servicing standards and some of
the things that got us to this place in the first place.
In terms of cooperation, we went forward with the consent
orders to do that first piece of the two-piece puzzle, but we
were very careful not to interfere with ongoing negotiations
from the Department of Justice and the State AGs, and, in fact,
we are trying to coordinate. We just announced that we delayed
the responses back from the banks by 30 days at the specific
request of the Department of Justice, and so we do look forward
to going forward. There are a number of groups working on
national servicing standards and we all agree that we need to
get to a commonplace at some point.
Senator Reed. Let me, again, in the context of a
comprehensive approach, I think--and the letter indicates
this--there is also the possibility of modification, including
principal reductions, in terms of terms, extensions of
mortgages, so that we avoid foreclosures, basically. I think
simply getting the foreclosure process correct, then go out and
foreclosing more homes is not going to help anybody. And, in
fact, in talking to the Attorneys General, this modification
process is one of the things that was used in the Iowa farm
crisis of the 1980s in terms of trying to correct similar
situations. So I would presume that you would be working as
best you can along with the Attorneys General in this regard,
too, is that correct?
Mr. Wilson. That would be correct. I mean, the devil is in
the details, but yes.
Senator Reed. Thank you very much. Thank you, Mr. Chairman.
Chairman Brown. Thank you.
Before turning to Senator Merkley and Senator Moran, we
will also in a moment introduce one of the members of the next
panel. A couple of questions before Senator Merkley.
For you, Mr. Wilson, brief questions. As Dodd-Frank in the
Senate and the House worked together on sort of, obviously,
reconfiguring the regulatory agencies with OCC and FDIC and the
Fed and the new CFPB, I have two brief questions for you, Mr.
Wilson, just so I understand, so we understand the structure
better as we move forward. Does the OCC have a single head or a
board? I understand they have a single head, correct?
Mr. Wilson. We have a single head, yes.
Chairman Brown. OK. And the OCC is subject to the
appropriations process or not?
Mr. Wilson. They are not, no.
Chairman Brown. They are not. OK. It is important to make
that clear.
Senator Merkley.
Senator Merkley. Thank you, Mr. Chair, and thank you all
for your testimony.
I wanted to get a better sense of the contrast between the
strategies used for overseeing or supervising or auditing the
large, complex financial institutions as compared with
community banks. Certainly in a smaller institution, the FDIC
as it supervises community banks can go in and basically look
at every loan file. In large, complex institutions, the
strategy is more on the side of having, as I understand it, a
staff member on-site working with the risk management staff of
that institution.
I would like to get a sense of whether that embedded risk
management approach is the best strategy. What have we learned
from this financial crisis? Do we need to have kind of some
more, if not loan level, but more deeper understanding or
inspection of what is going on in the guts of complex
institutions? And Mr. Wilson and Mr. Foley, if you could share
your thoughts on that, it would be helpful.
Mr. Wilson. I will start. We do have a significant
difference between the way we supervise large institutions and
community banks. Community banks tend to be more of a point in
time examination where we go in periodically. In our large
banks, we have core staffs--some of them can be quite large--
that are resident in the bank at all times. And you are right.
We try to work with risk management, audit, some of the risk
functions. But to say that that is all we do is not correct. We
do a lot of transaction testing, especially looking at
individual loans, sampling individual loans. Every spring, we
do a Shared National Credit Program, which is where we review
all the big shared credits in the country that are significant.
So that testing is there.
I think the question is, do we need to do more? I think in
some cases we should. And in products that were homogeneous, we
may have become a little more comfortable with the process and
did not call a residential mortgage and say, how is this thing
actually being underwritten. I think it is a lesson learned for
the future.
Senator Merkley. Well, you are talking about transaction
testing. Are you randomly selecting a few out of, of course, a
very large volume of transactions to see kind of just what you
find, whether, one, it was real, and two, presented to reflect
the reality of the transaction and so forth?
Mr. Wilson. For things like credit, structural products,
bonds, things like that, we would do a random selection. For
example, in CMBS for commercial real estate, we will look at
the quality of the loans that are going into those structures.
Senator Merkley. And before we shift over, is there
anything that you feel has really been a modification of your
strategy based on the lessons learned from the 2008-2009
crisis?
Mr. Wilson. Yes, as I said in my testimony, we are doing a
lot more data collection from the banks, the large banks
themselves. This is loan level data collection which started in
2008 and we have expanded it to additional asset classes to the
point now where we are collecting on almost all major asset
classes. We are doing a lot more modeling on that.
From our core staffs on our large banks, we have
significantly ramped up our expectations for risk management in
those institutions. I think before we were somewhat OK if we
rated the risk management functions as satisfactory. We have
communicated to our banks that that is no longer the grade.
They have to be strong and we are working toward getting to
strong risk management.
Senator Merkley. So are you designing any independent risk
models or utilizing just simply kind of following what the bank
itself is using?
Mr. Wilson. We do both, but on the loan level data
collection that I was talking about, those are independent.
Senator Merkley. Mr. Foley.
Mr. Foley. Thank you, Senator. I think, again, part of this
is looking at the structure in place before, and I think there
were a number of limitations, many of which have been addressed
by the Dodd-Frank Act. But the Federal Reserve, for example, by
statute, was very narrowly focused to consider nonbank
subsidiaries and the impact they could have on depository
institutions. Primary and functional regulators were very
focused on the particular legal entities they were responsible
for. But no Federal regulator had sufficient authority to
consider those risks across the entire organization, and for
very large, complex firms. For example, they may have a client
in Asia that enters into a contract that is booked in the U.S.,
with the risk on that contract hedged in the U.K. Therefore the
supervisory approaches that we take have to recognize the
underlying business approaches that these firms use.
Transaction testing is a key element of that, but we are
increasingly using techniques such as the SCAP, which involve a
broader horizontal assessment. The nature of that exercise is
to have the firms consider, for example, a particular stress
situation. That could be an economic stress. That could be an
idiosyncratic stress particular to the businesses that firm is
engaged in. We collect extensive information from the firm to
understand the impact of a stress on each of their loan
portfolios, to understand the impact on their profitability
going forward, to understand the impact on their liquidity.
It is important for the firm to be able to demonstrate they
can collect data across the entire consolidated organization,
that they can aggregate their risk exposures, that they can
understand the potential impact on their profitability going
forward and be able to translate that into what their capital
and liquidity needs might be, not just as a point in time, but
under a more stressful scenario going forward.
Those approaches are much more sophisticated. They allow us
as supervisors to collect extensive, robust data on these firms
that permits us to independently validate the firms'
suggestions in their models. Additionally, we are able to run
scenario analysis on any range of scenarios that we may have to
consider beyond what the firms are focused on.
Senator Merkley. Thank you.
Chairman Brown. Thank you, Senator Merkley.
Thank you very much for joining us. We very much appreciate
it.
I call the second panel forward, Salvatore Marranca and
Frank Suellentrop, and Senator Moran, as you get situated--he
can wait a moment if he wants--but introduce Mr. Suellentrop.
Senator Moran. Mr. Chairman, thank you very much. Thank you
for accommodating our desire to have a Kansas community banker
testify before this Subcommittee, and I appreciate your
cooperation in that regard.
Frank Suellentrop is a fourth generation banker. The bank
has been in his family for four generations and his bank is
outside of Wichita, Kansas. He is an active member of the
Kansas Bankers Association as well as the independent community
bankers. Like community bankers across the country, he is so
actively engaged in his community.
You have heard me say many times in this Subcommittee and
more so in the full committee about my concern about the
potential demise of community banking because of the regulatory
environment. I do not know exactly what Mr. Suellentrop will
testify to, but I am anxious to hear his and our other
witness's testimony in regard to the regulatory environment and
the changes that have occurred since Dodd-Frank, and I thank
you for allowing this Kansan to join us today.
Chairman Brown. Thank you, Senator Moran, and welcome, Mr.
Suellentrop.
Salvatore Marranca is Chairman of the Independent Community
Bankers of America, the only national trade organization that
exclusively represents community banks. He is Director,
President, and CEO of Cattraugus County Bank in Little Valley,
New York. He has served the community banking industry in many
leadership positions.
Mr. Marranca served in the U.S. Army with a tour of duty
during the Vietnam War. Thank you for your service to our
country, Mr. Marranca. He is the past Board President of the
New York State Banking Department, Director and Past President
of the Independent Bankers Association of New York State.
Welcome to both of you. Mr. Marranca, if you would begin.
Thank you.
STATEMENT OF SALVATORE MARRANCA, DIRECTOR, PRESIDENT, AND CHIEF
EXECUTIVE OFFICER, CATTRAUGUS COUNTY BANK, LITTLE VALLEY, NEW
YORK
Mr. Marranca. Thank you. Chairman Brown, Senator Moran,
Senator Merkley, I am Sal Marranca, Director, President, and
CEO of Cattraugus County Bank, a $174 million community bank
founded in 1902 in Little Valley, New York. I am pleased to be
here today as Chairman of the Independent Community Bankers of
America, the ICBA.
The safety and soundness of our banking system is a
significant concern to the nearly 5,000 community bank members
of the ICBA. Early in my banking career, for more than a
decade, I was a senior bank examiner with the FDIC. The
commitment I made then to safety and soundness is still
ingrained.
The recent financial crisis was fueled by high-risk lending
and speculation by the megabanks and Wall Street firms.
Significant harm was done to taxpayers and the economy.
Community banks, too, were harmed. The economic decline
retracted consumer spending and dramatically reduced the demand
for credit. Residential and commercial real estate markets
remain stressed in some areas. Still, the community banking
industry remains well capitalized and, because we take a
conservative, common sense approach to lending, has fewer
problem assets than any other segment of the industry.
We must ensure this crisis never repeats itself and
appropriate supervision of all financial services providers is
a key component of that effort. However, the way safety and
soundness is achieved is also very important. Misguided, though
well intentioned, efforts could be very economically damaging.
Frankly, many community bankers are deeply frustrated with the
current exam environment.
I am fortunate to enjoy a cooperative and constructive
working relationship with my regulator, the FDIC. Having been a
bank examiner, I have been on both sides of the table and
appreciate the concerns and the challenges examiners face. It
is a difficult job with a great deal at stake. The stakes were
raised sharply after the financial crisis.
The pendulum has swung too far in the direction of
overregulation. As a community banker, I have met with
thousands of bankers from every part of the country in recent
years and I can tell you there is an unmistakable trend toward
arbitrary, micromanaged, unreasonable examinations that have
the effect of suffocating lending. What is more, these exams--
in fact, all regulatory compliance--are more costly and a
burden to small banks because we have a smaller asset base and
staff over which to spread the costs.
ICBA supports bringing consistency to the examination
process. Arbitrary loan classifications are a particular source
of frustration to community bankers. ICBA strongly supports
legislation recently introduced in the House by Representative
Bill Posey, the Common Sense Economic Recovery Act. This
legislation would help establish conservative common sense
criteria for determining when a loan is performing and provide
more consistent classifications. We are hopeful a Senate
companion bill will soon be introduced and considered by this
Committee.
ICBA also supports House legislation introduced by
Representative Blaine Luetkemeyer, the Communities First Act,
the CFA. This bill contains many reforms that would improve the
regulatory environment and community bank viability to the
benefit of our customers and communities. To cite just a few
examples, this bill would raise the threshold number of bank
shareholders that triggers costly SEC registration, from 500 to
2,000. Another provision would extend the 5-year net operating
loss carryback provision to free up community bank capital,
when it is needed most. Again, ICBA hopes to see a companion
bill introduced in the Senate.
The greatest threat to safety and soundness remains the
too-big-to-fail institutions that dominate the financial
services sector. The financial crisis has, in fact, accelerated
industry concentration. Today, the ten largest banks hold 77
percent of all bank assets. A more diverse financial system
would reduce risk and promote competition, innovation, and
access to credit. This is why ICBA generally supports the too-
big-to-fail measures in the Dodd-Frank Act.
Finally, I would note that some of the housing finance
reforms being considered by the agencies and by Congress, if
not done carefully, could have the unintended effect of driving
further industry consolidation and jeopardizing safety and
soundness. For example, the Dodd-Frank risk retention rule on
securitized mortgages should include a fairly broad exemption
for Qualified Residential Mortgages.
Thank you again for convening this hearing and giving ICBA
the opportunity to testify. We share your commitment to
enhancing the safety and soundness of our financial
institution. I look forward to your questions. Thank you.
Chairman Brown. Thank you, Mr. Marranca, and thanks to the
Independent Community Bankers.
Mr. Suellentrop, welcome.
STATEMENT OF FRANK A. SUELLENTROP, CHAIRMAN AND PRESIDENT,
LEGACY BANK, COLWICH, KANSAS
Mr. Suellentrop. Thank you, Mr. Chairman, Senator Brown,
Ranking Member Corker, and Members of the Subcommittee. Thank
you for the opportunity to testify before you today regarding
lessons learned and opportunities for continued improvement.
My name is Frank Suellentrop. I am President and Chairman
of Legacy Bank in Colwich, Kansas. We are a $250 million
closely held community bank providing banking services to the
area of Sedgwick County, Kansas. We have five branch locations,
our charter bank location in Colwich, Kansas, population 1,400,
and four branch locations in the Wichita, Kansas, community.
Our bank was established in 1886, which means we are
celebrating our 125th year in banking this year. I am fourth
generation President of our bank since 1991. From that
experience, I have seen the beginning of the consumer
regulation in the early 1970s, the agriculture and real estate
crisis of the 1980s, and now the Wall Street-induced real
estate crisis of 2008.
Legacy Bank is significantly involved in residential
development, residential construction, and commercial property
lending, therefore, greatly impacted by the economic slowdown
and depressed real estate market values. Fortunately, the
economy in Wichita, Kansas, has fared reasonably well
throughout the current crisis relative to other markets,
primarily due to the fact that Kansas, specifically Wichita,
had not experienced inflated real estate values of the past
decade.
I would like to preference my comments regarding recent
examination by saying that I understand examiners are charged
with a difficult task. On one hand, they are expected to
protect against bank failures, ensure consumer compliance and
regulations are adhered to, to satisfy community groups and
organizations' demand for fair banking practices, and heed
Congressional demands for banking or financial oversight. On
the other hand, regulators should be tasked with not
interfering with the bank's corporate mission of creating value
for its shareholders. Legacy Bank is a for-profit corporation.
Our most recent 2010 examination revealed stark differences
from prior exams: Expectations of higher capital and liquidity
standards, more demanding asset loan quality evaluations,
expectations for higher allowance for loan and lease loss
reserves, increased focus on management assessment and
compensation practices. Comments made by regulators during our
last exam include, ``We do not like your risk profile,'' and
``We are not going to bat for you in Washington.''
To put the first comment in context, our bank has been a
lender to residential real estate developers, home builders,
and commercial property owners since the late 1980s. We feel
our lending staff has the knowledge and experience to manage
our loan portfolio composition. Examiners were significantly
more aggressive compared to prior examination observations. Due
to recent failures of problem banks in other areas of the
country, our lending risk profile is now unacceptable.
In addition to the standard underwriting criteria of
evaluating a borrower's capital, collateral, and capacity to
repay, and market conditions, our loan committee has added a
new component to our loan approval discussion: Will the loan
pass examiner review and approval? This component should not be
a part of the loan approval process. A customer's loan request
should be based on its viability and productive value. With
respect to the latter comment, it illustrates the regulatory
attitude that banks in real estate lending may be unsafe and
unsound in their practices.
Banks are evaluated on a CAMELS component rating, which
measures a bank's capital, asset quality, management, earnings,
liquidity, and sensitivity to market risk. My comments on each
of those follows.
Capital standards are being dictated above the levels for
regulatory defined well capitalized banks and those standards
that are required for our Nation's largest institutions.
Regulators quite often use discretionary capital standards to
demand higher capital levels for community banks--than those at
large banks. Capital below the mandated Tier One risk-based
levels are likely to receive a lower capital component rating
in an examination, which may subject the bank to troubled bank
status. The discretionary capital standards create a difficult
moving target for community banks as we seek to achieve an
acceptable capital component rating.
Asset quality loan evaluations have become more critical.
Examiners are slow to recognize when a credit risk has been
mitigated and classifications can be inconsistent.
Community banks' management compensation is being reviewed
by examiners by suggesting potential negative impact to
earnings and capital. Without a significant discussion,
examiner comments dictated that we justify management
compensation benefits by use of an outside source. Somehow,
Wall Street excesses on executive pay have crept into the
regulators' view of Main Street banking compensation practices
when there is no valid comparison to Wall Street compensation
abuses.
Earnings were reviewed and projected to be half by
examiners of what actual 2010 actual earnings were for our
bank, causing concerns for our earnings component.
In summary, micromanaging community banks is unproductive.
Examiners should expect results, but if capital is solid and
management is capable, then overregulation is unnecessary.
Regulatory burden and examiner expectations are
disproportionate in their impact on community banks versus the
largest banks.
I appreciate the opportunity to comment and am open to your
questions. Thank you.
Chairman Brown. Thank you very much, Mr. Suellentrop and
Mr. Marranca. Thank you very much.
I think that across the political spectrum and across both
parties and everyone on this Committee is supportive of efforts
to work with community banks, one, to help community banks deal
with the difficulties of Dodd-Frank. I think that all of us
want to see community banks succeed. I think all of us
understand that the guilty parties on Wall Street caused--as
Mr. Suellentrop said, the Wall Street-caused debacle to our
financial system and to our economy had little to do with
community bank practices, and all of us I think are disturbed--
I can just talk for myself, but I think we all are. Mr.
Marranca, your comments that the ten largest banks today hold
77 percent of all U.S. bank assets, I am quoting you, compared
with 55 percent of total assets in 2002. We know what that bank
crisis, what the disaster on Wall Street, we know what it did
to community banks as we have seen more concentration just in
that 9-year period. We know what it has done to our economy. We
also know how it has made regulation more difficult. When you
put up the OCC or the Office of Thrift Supervision or any of
these regulatory--the FDIC, any of these regulatory bodies
dealing with the sophistication and the resources of the
biggest banks, it obviously is too often a mismatch.
The former head of the OTS said an organization like OTS
cannot supervise AIG, Merrill Lynch, or entities that have
worldwide offices. There is no way. And that makes all of this
more difficult.
But shifting, Mr. Marranca, to your comments and
understanding that megabanks were rewarded so often for the
regulatory failures with bailouts while community banks too
often are being shut down and the concentration of the larger
banks gets greater and greater, talk to me specifically--and I
like the thoughts of--and your testimony was helpful in this
way from both of you. Talk about the costs and burden and
supervision for your bank as compared to a too-big-to-fail
bank. Put that in context, if you would, with your bank
personally or with some of your member banks, but obviously you
know yours best.
Mr. Marranca. Yes, sir, Senator, and I would confidently
say that my experience is the same as the vast majority of
community banks across the country, and I will give you an
example. I received an email 2 days ago that we would be--that
soon an upcoming compliance examination by the FDIC would occur
in my bank and that it would have a minimum of two people in my
bank for a minimum of 4 weeks. That is just one compliance
examination. I should add that at the current time I have the
New York State Banking Department in my bank for a compliance
examination.
The point is we have a small shop, approximately 30 people.
There is an opportunity cost for all the time, attention, and
energy let alone what I feel is there could be a better
utilization of the resources of the examiners.
Again, this is just specialized compliance. In addition to
compliance, we have a CRA examination, which is a separate
examination. In my particular case, in New York State, I have a
separate CRA examination by the State and by the FDIC.
In addition to that, I have a BSA examination. I have an
IAT or ADP examination. I just completed an examination by the
Federal Home Loan regarding our secondary mortgage market. We
just completed--the IRS just left our bank.
There are very few times in my small, one-light town in
Little Valley, New York, that I do not have examiners in my
bank, and we are a 109-year-old institution, highly rated, low
risk profile, and not a complex organization. It seems to me
there is a better way to allocate the resources of examination.
And this takes me away from lending and away from my consumers
and away from my customers.
Chairman Brown. You are a $174 million bank.
Mr. Marranca. Yes, sir.
Chairman Brown. Your comments about that, if you would, Mr.
Suellentrop.
Mr. Suellentrop. Thank you, Senator. Truth be known, we
actually started an examination on Monday, so I should probably
be there. We have, I believe, 17 examiners at our bank for
probably a period of 2 to 3 weeks. We will review safety and
soundness, information technology, BSA, and I am sure I am
forgetting something, but it will take the time of the majority
of our staff to accommodate getting their information and
support, the bank's practices.
Our bank is fortunate in that we are of the size where we
have a sufficient number of employees where those efforts can
be delegated amongst a number of our staff, although it is
still a tremendous burden. We have many banks in the State of
Kansas and throughout the Nation, substantially smaller than we
are, who those burdens fall on one or two individuals and can
be tremendous in terms of their cost to the bank as well as the
time that it takes away from serving their customers and their
community.
So that is just the examination part. That does not take
into account the daily routines of going through processes to
ensure compliance and ensure safety and soundness and bank
secrecy and the like. So it is a tremendous burden for
community banks, and hopefully there are some alternative
options to reducing that burden.
Chairman Brown. You expressed, Mr. Suellentrop, you are
reflecting, I think, what many community bankers, at least in
my State and the conversations I have, and I think what you
seemed to say of anger at what Wall Street did and the damage
it caused to the economy, writ large, but obviously the damage
it did to community banks, and the added scrutiny and pressure
and costs to community banks.
Do you think regulators are doing enough to oversee the--
understanding that you do not want it to spill on you in terms
of more regulation, but do you think the regulators are doing
enough to oversee these trillion-dollar banks? The last
question for each of you.
Mr. Marranca. I would be happy to jump in there. The answer
is no. I am held accountable for--my board and I are held
accountable for what we do at our bank. We have skin in the
game. We take care of our communities, we take care of our
customers, and we take care of our employees. To bail out the
largest banks because of their failures, and in some cases
borderline criminal behavior, I think goes against the
capitalistic ways of this country and I think has done great
harm.
I have a tremendous competitive disadvantage when the 20
largest banks in this country are too big to fail, and my
customers know that.
Are they held accountable? No. Are they scrutinized to the
degree that we are? No. Should they be? Yes.
Chairman Brown. Mr. Suellentrop, your comments on that?
Mr. Suellentrop. Thank you, Senator. Probably examiners'
efforts with the largest banks is above my pay grade in making
that determination, but I can tell you from sitting in our bank
and the impact that we feel from recent economic problems and
the conditions we have today, it certainly feels like we are
receiving the brunt of the examination overload.
What additional regulation and examination is needed for
the largest banks? I do not pretend to know that, but I know
that for community banks the overload is significant, and they
are certainly not slowing down. As the gentleman before us
noted, there is a myriad of rules and regulations that are
forthcoming.
Chairman Brown. Thank you. And then a last comment. It
seems that some in this town have been sort of lobbying the
press and the media, and the agencies are using your situation
to weaken the rules on some of the big banks, and I just do not
want that ever conflated, that while virtually all of us I
think here want to see the regulatory burden lifted from
community banks and the banks in towns like where I grew up in
Mansfield, Ohio, we do not want to see that as an excuse to
weaken rules and further deregulation and weaken the Dodd-Frank
implementation of the big banks that Mr. Marranca referred to.
Senator Moran.
Mr. Moran. Mr. Chairman, thank you very much. I thank both
witnesses for their testimony.
Let me ask in this case both of you, you heard--let me
start with you, Mr. Suellentrop. You heard the previous panel
in which we had representatives from the Federal Reserve, the
Office of the Comptroller of the Currency, and the FDIC. Did
you hear anything there that you would like to comment on as--
at least it has been in my experience in every conversation I
have had with regulators at the table that you are seated at,
they all indicate to me they make special consideration for
community banks, they understand the challenges they face, they
have task forces that have been created to make sure that
community banks are not overregulated. There is the whole list
of disclaimers about all the things we are doing to address the
concerns that we are talking about, overregulation of community
banks. And yet it never seems to me in my conversations with my
bankers that there is any consequence to that constant effort
that is claimed by the regulators to avoid overregulation. And
I wondered if you heard anything from the witnesses today that
did or did not make sense to you.
Mr. Suellentrop. No, I cannot say that I did hear anything
that would change my perspective on how community banks are
going to be regulated or examined going forward. I would say
that there is a significant persuasive attitude that an
examiner in the field would be the same as the examiner in
Washington, that they are not interested in having a problem
bank or a failure on their watch. In other words, the comment
was also made, ``We are going to err on the side of caution,''
in the first part of our examination in 2010. And I do not
think that is going to change. I think they have a significant
interest in protecting their reputation, and one way to do that
is to be aggressive and to be thorough in their examinations.
We are not suggesting they should not be thorough. We just ask
that they are equitable.
Mr. Marranca. Senator Moran, I would just ask--and the word
that comes to my mind is--and it has been used often--is the
``disconnect'' between Washington and the examiner in the
field. Again, the examiner in the field has a difficult job,
but yet they are out there and, generally speaking, there is no
compromise, there is no discussion, there is no ``Let us get
this fixed now, and we will take care of this.'' The way it--
ancient history now. The way it used to be in the examination
field was a more cooperative basis and working together with
the banker. Today's world--and I understand the world has
changed. In the last 29 years that I have been CEO at
Cattaraugus County Bank, every regulation that has landed on
Wells Fargo or Bank of America has landed on my desk. There
needs to be some type of tiered regulation. There needs to be a
function where the examiners realize a difference between my
risk profile and my business model and my relationship banking
and the way that a $2 trillion bank does business. They do not
have the flexibility to do that right now, so there is a real
disconnect.
Senator Moran. So the common conversation that we have that
community banks, by regulators headquartered here in
Washington, DC, their leadership tells us that community banks
are treated differently. But your statement, your sentence
stands out to me about what happens to Wells Fargo--every
regulation that has been imposed upon them is imposed upon a
community bank. Is that true?
Mr. Marranca. That is true. And I look around, and Wells
Fargo, or whoever it may be, has X number of attorneys and X
number of resources that they can allocate toward that new
regulation. And, again, over 30 years they have built up and
built up and built up. Every time I get that regulation, I look
out of my office, and I am looking at Sue or Mary or Bob and
trying to figure out how are we going to do this. In some
cases, it does not relate to my market or my business model in
a very rural part of New York State.
Senator Moran. Any sense of the qualifications, the
background, and experience of the examiners that are in your
banks today as compared to what they were in the past? Is there
a change in the personnel that are examining your banks and
their qualifications or characteristics? You mentioned in a
sense the good old days, but is there a change in who is in our
banks today as far as ability?
Mr. Marranca. My perspective would be--and these are
extremely sharp, smart, intelligent young people in many cases.
In many cases--I do not know the average age of the examiner
today, but the old corps, if you will, is gone, and the new
youth is there. They are very smart. They are very intelligent.
Do they have experience in banking? Not specifically.
Also, I do want to add, in today's world when you have an
ADP specialist, a compliance specialist, a BSA specialist, a
CRA specialist, none of those examiners have a holistic
approach to the bank as a whole. They are not in any way
concerned about my capital, my 100-year-old history, even my
CAMELS rating or my profits. They are only concerned with their
very narrow point of view of their expertise. So they are
smart, they are intelligent, they are experts. But in my humble
opinion, they need to broaden their holistic approach to the
bank as a whole. We are not a risk to the FDIC fund, nor are we
a risk to the economic system. So treat us in that way.
Understand the role that we provide in the community. Because
if they put us out of business, when we are gone we are gone,
and it will be too late for my community.
Mr. Moran. Mr. Suellentrop, Kansas has lost thirty banks in
the last 5 years, as I understand the numbers. One of my
concerns is that community banking may become a thing of the
past based upon increasing regulations and the cost associated
with that. And by that I mean that community banks will need to
have more branches, be acquired by a larger bank to spread
those costs among, more assets, more loans, more customers.
Is there a consequence to the ability to keep community
banking alive and well? Is there a consequence to this
regulatory environment? And is there anything you see that is
coming down the road? We still have the Consumer Protection
Financial Bureau regulations to be put in place. Are there
fears about what the next--my guess is you may tell me you may
survive today, but are you worried about what is coming in the
future and the uncertainty of that? How does it affect the
operations of your bank?
Mr. Suellentrop. Senator, I would say that there is a
concern in terms of the number of community banks continuing to
decline. In conversations with bankers through meetings I
attended, I would say that in the past year or 2 years there is
a significant concern that bankers who are likely to sell their
bank and to probably merge with another institution. And one of
the things that I think is holding them back is that their
market for that is not good right now. But there are many
bankers frustrated by the rules and regulations and
examinations and looking to possibly get out of the banking
business in the next several years. I do not see anything
immediate that is on the horizon that is going to change that.
The Consumer Protection Bureau, as you suggested, has not yet
begun to issue its regulations. That has certainly bankers
concerned about the potential impact of additional regulatory
burden.
Things that were discussed earlier, such as access to the
secondary mortgage market, are very important to our bank and
community banks because that is one of the significant ways we
can increase our business exposure in our community.
Mr. Moran. Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Moran.
Senator Merkley.
Senator Merkley. Thank you, Mr. Chairman, and thank you
both for bringing your insights from the front line, if you
will.
Mr. Marranca, you addressed in part the risk retention rule
and noted that we should have a broad exemption for qualified
mortgages. By broad exemption, I wanted to interpret that, but
I wanted to make sure I had the correct interpretation.
Currently there is discussion of a very sizable downpayment
requirement, which has been of great concern to me. When you
are speaking about a broad exemption, are you talking about a
much smaller downpayment requirement, if you will?
Mr. Marranca. I think--and I will use the word
``arbitrary''--20 percent is just unrealistic in the market, at
least for a community bank, especially in my rural market. We
have a very low per capita income and so forth. We have two
family income earners struggling to either get into their first
home or upgrade their home. We try very hard to make that dream
come true and get a person in the right house. Mandatory 20
percent or a concentration of the secondary mortgage market out
of my control, and I would hate to see it be with one of those
20 largest banks, I think would be--do a disservice to the
housing market in our country and in my market.
Senator Merkley. Thank you. I think of what 20 percent is
in the working community that I live in where houses are about
$200,000, and the idea of families having $40,000 in savings to
put down on a house seems one in a million. Thus, the folks
would fall into a second category or a different mortgage
market with yet to be understood interest penalties for that.
My concern--and it sounds like you are echoing this--is that we
essentially put home ownership out of reach of families.
Mr. Marranca. I do not think you can legislate or mandate,
if you will, the underwriting process. Our job--and I have 30
years' experience, and I have a mortgage officer with many--our
job is to underwrite our consumers when they walk in and they
want that mortgage. We know how to do that, and it is not just
downpayment. It is the ability to pay and certainly their
credit and the debt-to-income. There are many, many factors
involved.
We can make a business judgment if somebody can afford it
and that is the right home for them at the right price. We
certainly have never done any subprime and 110-percent loans,
et cetera, et cetera. So leave the business of lending to us.
Senator Merkley. Mr. Suellentrop, do you share that concern
over the potential 20-percent requirement?
Mr. Suellentrop. Absolutely, Senator. We have been in the
business of making residential lending since I joined the bank
40 years ago almost as a key component of what we do for our
customers in our community. Twenty percent down for the vast
majority of homeowners is unreasonable. With the use of private
mortgage insurance, there are many, many ways to satisfy safety
and soundness in a mortgage transaction, and we originated over
$30 million in mortgage lending last year. A very important
part of our business and serving our customers and our
community, and 20 percent would be a substantial impact to that
process and that product for our customers.
Senator Merkley. Thank you both. I want to turn to a
different topic, which is the ability to make additional loans.
Mr. Marranca, in your testimony you note that banks have had to
pass up sound loan opportunities, or at least your bank has, in
order to preserve capital. This goes to the leverage ratio that
the FDIC holds. And as I was talking to community banks in
Oregon, they expressed the challenge of raising capital. We
have gone from irrational exuberance to irrational fear, if you
will, of investing in community banks.
So the result was developing the Small Business Lending
Fund, which ICBA endorsed and assists with. We have had 600 to
700 applications so far to Treasury for Small Business Lending
Fund equity so that banks could do additional lending but are
constrained by the capital requirements, and not a single
decision has been made yet by Treasury.
What is going wrong? Why isn't Treasury making decisions
and using this program to increase access to capital, both
important to the community banks and important to small Main
Street businesses across America?
Mr. Marranca. Senator, I certainly cannot speak for the
Treasury, but I would comment--I would love to participate in
that, but I have looked at it very carefully, and there is just
no way I can do it. First of all, one capital ratio size does
not fit all, just like one regulation does not fit all. We have
plenty of capital at our bank, and, in fact, we need to grow
our capital, but for a good reason: because our bank has grown
30 percent in the last 3 to 4 years. We acquired two branches
in an adjoining county. That dropped our capital level down.
But I am making a decision for my shareholders in the long run.
What is in the best interests of the bank in the long run? So
we dropped down, if you will, to a 7-percent capital level.
Given our CAMELS ratings, our risk rating and so forth, 7
percent capital is more than adequate.
When an examiner comes in and says, ``I do not know about
that 7. It looks like you have dropped. I think you need to get
up to 9, and we will see how you do, and we are going to be
watching,'' that gets my attention. It does not make me not
make a loan, but yet it gets my attention. And I have had to
slow down the growth of our bank from a depository standpoint
because that affects the capital ratio, too.
On the Small Business Lending Fund, our bank has $100
million--we are a small bank--a $100 million loan portfolio. It
takes $1 million a month in new loans just to maintain that
level at $100 million, $1 million in new loans a month. I am in
a very rural, nongrowth market. It is very difficult to do
that. But we are doing it.
If it is very difficult to do that, it is going to be
extremely difficult if not impossible for me to raise my
lending 5 percent, 6 percent, 4 percent. Thus, I cannot
participate in the Small Business Lending Fund. I cannot create
loan demand. I have the products, I have the people, I have the
money to lend. But I cannot create loan demand in a
recessionary, very challenges economic market.
Senator Merkley. Yes. And you are in a different situation
than some community banks in that access to capital was not
your primary challenge, if you will, so that makes a lot of
sense.
Any thoughts on this, Mr. Suellentrop?
Mr. Suellentrop. Well, Senator, I know there is a lot of
interest in the Small Business Lending Fund, but I honestly do
not have any insight into why the program is floundering.
Senator Merkley. Well, the main challenge is Treasury is
not making any decisions.
Mr. Suellentrop. That is right.
Senator Merkley. So I am just trying to get a sense from
the field. I know I am hearing from community banks that are
very frustrated that have applied, feel like this would--these
are banks that are constrained by their capital ratios, and so
their ability to make additional loans is directly impacted by
that.
I wanted to go back to--actually I am over my time, so
thank you all.
Chairman Brown. Thank you, Senator Merkley.
I wanted to follow up on one comment that Senator Merkley
made or your response to the question about the 20 percent. I
appreciate the flexibility and how you know your customers and
know your communities, and a 20-percent downpayment might make
sense for some, somebody else doing 15 percent, but having a
strong financial credibility with you and all. So I certainly
understand that flexibility.
Senator Corker mentioned that earlier. He had had an
amendment, my recollection is, on the Senate floor during Dodd-
Frank. He had an amendment for a requirement of a downpayment
of 5 or 10 percent. I cannot remember. Understanding if we had
had that, some standard across the country, some of our
problems might not have--surely would not have happened. Would
any requirement make sense? I understand 20 percent can be
harsh when you know your customers well and need flexibility.
If there were--and, again, this is not in the statute, to my
understanding, but if there were a 5- or 10-percent
requirement, would community banks object to that? Is that
something that would make sense to you?
Mr. Marranca. It makes a lot of sense to me, Senator. I am
a strong proponent of you have to have some skin in the game,
whether it is buying a car, a house----
Chairman Brown. And you do not mind a Federal rule perhaps
saying 5 or 10? You would rather not have 20, but 5 or 10?
Mr. Marranca. If there were some flexibility there with
some limited skin in the game, I do not see--I do not believe
in 100-percent lending.
Chairman Brown. OK. Any thoughts, Mr. Marranca?
Mr. Marranca. Well, I know that the recent past has proven
that downpayments are important. However, I know that there are
a number of first-time home buyer programs out there through
various sources that are important to the housing industry and
individuals and families getting into their own homes. So I
think we would need to recognize that there are some programs
that might be impacted if we demand a minimum amount of 5 or 10
percent.
Chairman Brown. OK. Thank you very much, Mr. Suellentrop
and Mr. Marranca. Thank you very, very much.
The record will remain open for 5 days, as we typically do.
I appreciate your attendance, and thank you, Senator Merkley
and Senator Moran.
The Subcommittee is adjourned.
[Whereupon, at 11:44 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF MICHAEL R. FOLEY
Senior Associate Director, Division of Banking Supervision and
Regulation, Board of Governors of the Federal Reserve System
June 15, 2011
Introduction
Chairman Brown, Ranking Member Corker, and other Members of the
Subcommittee, thank you for the opportunity to testify today regarding
the Federal Reserve Board's supervision and examination of financial
institutions and changes to our supervisory policies and procedures for
these institutions in response to the recent financial crisis. I am a
senior associate director in our Banking Supervision and Regulation
division.
Background
The Federal Reserve has supervisory and regulatory authority for
bank holding companies, including the consolidated supervision of
large, complex financial firms, State-chartered banks that are members
of the Federal Reserve System (State member banks), and certain other
financial institutions and activities. We work with other Federal and
State supervisory authorities to ensure the safety and soundness of the
banking industry, foster the stability of the financial system, and
provide for fair and equitable treatment of consumers in their
financial transactions.
The Federal Reserve is involved in both regulation, that is,
establishing the rules within which banking organizations must operate,
and supervision, ensuring that banking organizations abide by those
rules and remain, overall, in safe and sound condition. A key aspect of
the supervisory process is evaluating risk-management practices.
Because rules and regulations cannot always reasonably prescribe the
exact practices each individual bank should use for risk management,
supervisors design policies and guidance that expand upon requirements
set in rules and regulations and establish expectations for the range
of acceptable practices. Supervisors rely extensively on these policies
and guidance as they conduct examinations and assign supervisory
ratings.
Enhancing Supervision of Large Institutions
The recent financial crisis revealed critical vulnerabilities in
the financial regulatory framework and the financial system. In the
years before the crisis, nonbank financial entities proliferated by
exploiting gaps in the regulatory framework. This occurred during a
period of increasing asset prices and abundant capital and liquidity,
which eventually led to a relaxing of underwriting standards,
deterioration in risk-management practices, and rapid growth of complex
and opaque financial products for both consumers and investors. The
combination of these factors created the vulnerabilities that
ultimately led to the financial crisis and, in response, the Congress
and the Administration last year addressed many of these issues by
enacting the Dodd-Frank Wall Street Reform and Consumer Protection Act.
However, even before passage of the Dodd-Frank Act, the Federal
Reserve had been taking action to reorient its supervisory structure
and strengthen its supervision of the largest, most complex financial
firms in response to the crisis. In so doing, the Federal Reserve
enhanced its large bank supervision program through the creation of the
Large Institution Supervision Coordinating Committee, a centralized,
multidisciplinary body made up of bank supervisors, economists,
attorneys, and others. Relative to previous practices, this body makes
greater use of horizontal, or cross-firm, evaluations of the practices
and portfolios of the largest institutions. It relies more on
additional and improved quantitative methods for evaluating the
performance of firms, and it employs the broad range of skills of
Federal Reserve staff more effectively. In addition, we have
reorganized to more effectively coordinate and integrate policy
development for, and supervision of, systemically important financial
market utilities.
More recently, we have also created an Office of Financial
Stability Policy and Research at the Federal Reserve Board. This office
coordinates our efforts to identify and analyze potential risks to the
broader financial system and the economy. It also helps evaluate
policies to promote financial stability and serves as the Board's
liaison to the Financial Stability Oversight Council.
The crisis demonstrated that a too narrow focus on the safety and
soundness of individual firms can result in a failure to detect and
thwart emerging threats to financial stability that cut across many
firms. The Dodd-Frank Act requires supervisors to take more of a
macroprudential approach; that is, to supervise financial institutions
and critical infrastructures with an eye toward not only the safety and
soundness of each individual firm, but also taking into account risks
to overall financial stability. The Supervisory Capital Assessment
Program (SCAP), led by the Federal Reserve in early 2009 as a key
element of the plan to stabilize the U.S. financial system,
demonstrated the feasibility and benefits of employing such a
perspective.
Building on SCAP and other supervisory work coming out of the
crisis, the Federal Reserve initiated the Comprehensive Capital
Analysis and Review (CCAR) in late 2010 to evaluate the internal
capital planning processes of large, complex bank holding companies.
The CCAR represented a substantial strengthening of previous approaches
to ensuring that large firms have thorough and robust processes for
managing and allocating their capital resources. We also focused on the
risk measurement and management practices supporting firms' capital
adequacy assessments, including their ability to deliver credible
inputs to their loss estimation techniques.
While our revised internal organizational structure facilitates our
implementation of a macroprudential approach to supervision, it does
not diminish the need for careful microprudential oversight of
individual institutions. This serves many purposes beyond the
enhancement of systemic stability, including the protection of the
deposit insurance fund, the detection of money laundering and other
forms of financial crime, and the prevention of unlawful discrimination
or abusive lending practices. Equally important, is that
microprudential oversight also provides the knowledge base on which a
more systemic approach must be built; we cannot understand what is
going on in the system as a whole without a clear view of developments
within key firms and markets. Without a strong microprudential
framework, macroprudential policies would be ineffective.
Supervision of Community and Regional Banks
While many of our recent actions have focused on enhancing the
supervision programs for the largest institutions, we have also been
making adjustments to the supervision programs for community and
regional banks in response to lessons learned. As liquidity strains
developed at many banks during the crisis, we adjusted our focus to
place greater emphasis on evaluating liquidity contingency funding
plans at supervised community and regional banks. Liquidity pressures
have eased considerably due to actions taken by the banking agencies
during the crisis, recent legislative changes to increase the level of
deposits insured by the Federal Deposit Insurance Corporation, and more
stable market conditions. But given our experience during the crisis we
are retaining a heightened focus on liquidity management and planning,
particularly for institutions that rely on more volatile or
nontraditional funding sources.
As commercial real estate (CRE) began to deteriorate and affect the
performance of supervised institutions, we conducted reviews of our
implementation of the 2006 interagency guidance addressing CRE
concentrations. These reviews helped us to identify issues for which
examiners and bankers needed clarification and to contribute to the
2009 interagency guidance aimed at facilitating prudent workouts of CRE
loans. As real estate conditions have remained weak and adversely
affected the performance of many banks, we have continued to refine our
examination procedures to address emerging supervisory issues related
to CRE lending.
To learn more from recent events, we have begun to analyze the
characteristics of community banks that remained in sound condition
throughout the crisis. Our preliminary work suggests that these
institutions had many fundamental characteristics in common. For
example, most of these banks had relatively well-diversified loan
portfolios and because of that were able to report strong earnings and
net interest margins throughout the crisis. They tended to have limited
reliance on noncore funding and had strong capital levels as they
entered the crisis. As we continue our study, we hope that what we
learn will prove helpful in our efforts to evaluate and refine
supervisory processes in the wake of the crisis.
In addition to these efforts, we have also increased our outreach
efforts with community and regional banks. In October 2010, the Board
formed a Community Depository Institutions Advisory Council that
includes representatives from across the country and provides the
Federal Reserve with direct insight and information from community
bankers about the economy, lending conditions, supervisory matters, and
other issues of interest. We expect these ongoing discussions will
provide a particularly useful and relevant forum for improving our
community bank supervision program, and a better understanding of how
legislation, regulation, and evolving examination activities affect
small banking organizations.
Additionally, the Board recently established a special supervision
subcommittee that provides leadership and oversight on a variety of
matters related specifically to community bank supervision. A primary
role of this subcommittee, which includes Governors Elizabeth A. Duke
and Sarah Bloom Raskin, two Board members with significant community
banking experience, is to review policy proposals and evaluate their
potential effect on smaller institutions, both in terms of safety and
soundness and potential regulatory burden.
While the crisis has made it clear that some tightening of
supervisory expectations was needed, we are also mindful of the risks
that excessive tightening could have on banks' willingness to lend to
creditworthy small businesses and consumers. Consequently, we have
worked hard to ensure that our examiners are well-trained and employ a
balanced approach when reviewing banks' underwriting and risk-
management practices. We expect examiners to strive for consistency in
the examination process throughout the business cycle. Our Rapid
Response program, which has been in effect since the crisis, is a
widely attended weekly conference call for examiners that has been
invaluable in delivering these messages, and others, to our field
examiners.
Compliance and Examination Costs
Banks consistently tell us that they face a number of regulatory
uncertainties, which makes it hard for them to calculate the potential
cost of compliance and its potential effect on operations and
profitability. Firms of all sizes have been communicating these
concerns, despite the fact that the requirements of the Dodd-Frank Act
are primarily directed at firms with consolidated assets of $50 billion
or more. Smaller institutions voice concerns that supervisory
expectations being set for the largest institutions could ultimately be
imposed on them in a burdensome way, which will adversely affect
community bank competitiveness and profitability, as these institutions
have less ability to absorb increased compliance costs and have less
staff available to manage new processes.
The Federal Reserve is cognizant of the challenges institutions,
especially smaller institutions, face in the current environment.
Banking supervision should be conducted in a way that is effective for
all institutions, but it should also be scaled to the size and
complexity of the supervised firm. The largest, most complex banks will
incur costs to comply with the requirements of the Dodd-Frank Act. For
example, stress testing provisions in the Dodd-Frank Act require these
institutions to adequately identify the risks associated with their
diverse business lines and to quantify this risk taking, which will
require investments in data management technology and other risk
identification systems. Smaller institutions, while still expected to
adequately measure, monitor, and control risk in their organizations,
will not necessarily need to incur additional costs, assuming existing
risk management structures are sufficiently robust.
Continuing Credit Challenges
Credit markets have been recovering slowly since the financial
crises, and recent measures of aggregate credit outstanding have shown
signs of improvement after declining throughout 2009 and much of 2010.
Nonrevolving consumer credit outstanding, which includes auto and
student loans, has increased for the past 9 months. Issuance of
corporate bonds and syndicated loans has been robust for the past few
quarters, and new issuance of commercial mortgage-backed securities
increased in the first quarter of 2011, albeit from very low levels.
Outstanding balances of commercial and industrial loans have also
resumed modest growth.
However, residential and commercial real estate remain lagging
sectors. This continues to present challenges for banks and
supervisors. With housing values flat or deteriorating in many markets,
there are renewed concerns about the health of the mortgage market and
home equity loans in particular. In addition, weak fundamentals in the
CRE sector, including high vacancy rates and declining rents, continue
to place pressure on all but the highest quality properties with strong
tenants in healthier markets. With residential and commercial property
values still under strain, heightened reserve levels at banks remain
appropriate for these sectors, and we expect that banks will continue
to incur losses due to ongoing weakness in real estate markets. It will
take time to make progress on the overhang of distressed commercial and
residential real estate, and banks will need to take strong steps to
ensure that losses are recognized in a timely manner, and that reserves
and capital levels remain adequate.
Conclusion
The crisis demonstrated the need to always be mindful of and
diligent about addressing the possible implications of severely adverse
outcomes for individual institutions and the financial system more
broadly. Enhancements the Federal Reserve has made to its supervisory
process, coupled with improvements required by the Dodd-Frank Act,
support enhanced regulation and supervision of large, complex firms
that have the potential to trigger systemic risks. But, improvements in
the supervisory framework will lead to better outcomes only if day-to-
day supervision is well executed, with risks identified early and
promptly remediated. When we have significant concerns about risk
management at complex firms, we are raising those concerns forcefully
with senior management at the firms, holding them accountable to
respond, and tracking their progress.
The Federal Reserve is also enhancing supervision of regional and
community banks, placing greater emphasis on the development of sound
risk-management practices. In so doing, we are mindful of the need to
ensure that bank supervision is scaled to the size and complexity of
the supervised firm; and that bank management and examiners take a
balanced approach to ensuring the safety and soundness of the banking
system and serving the credit needs of the community.
______
PREPARED STATEMENT OF CHRISTOPHER J. SPOTH
Senior Deputy Director, Division of Risk Management Supervision,
Federal Deposit Insurance Corporation
June 15, 2011
Chairman Brown, Ranking Member Corker, and Members of the
Subcommittee, thank you for the opportunity to testify on behalf of the
Federal Deposit Insurance Corporation (FDIC) about our supervisory
process, how it has changed based on lessons we learned from the
crisis, and what we see as opportunities for continued improvement.
Congress created the FDIC in 1933 in response to the most serious
financial crisis in U.S. history. Our mission is to promote financial
stability and public confidence in individual banks and in our Nation's
banking system through bank supervision, deposit insurance, consumer
protection, and the orderly resolution of failed banking institutions.
As the primary Federal supervisor for the majority of U.S. community
banks, the FDIC seeks to maintain a balanced approach to bank
supervision, regardless of financial and economic conditions. In our
unique role as deposit insurer, we have a vital interest in assessing
risks to the Deposit Insurance Fund (DIF) posed by all FDIC-insured
institutions.
My testimony today first provides some background information on
the condition of the industry and the problems that led to the recent
financial crisis. I will discuss our approaches to supervising large
institutions and smaller community banks. Finally, I will discuss some
provisions of the Dodd-Frank Wall Street Reform and Consumer Protection
Act (Dodd-Frank Act) that we are incorporating into our supervisory
process.
Condition of the Industry
Leading up to the financial crisis, FDIC-insured institutions
recorded 6 consecutive years of record earnings, culminating in $145.2
billion in 2006. However, this extended period of industry
profitability masked the underlying weaknesses in credit quality that
would emerge starting in 2007 as real estate markets weakened and the
U.S. economy moved into recession. By 2008, annual industry earnings
had fallen to just $4.5 billion and, in 2009, the industry recorded a
net loss of $9.8 billion--the largest loss in its history. Quarterly
provisions for loan losses taken by FDIC-insured institutions since the
end of 2007 now total just under $645 billion, equal to over 8 percent
of the book value of loans outstanding at the beginning of 2008.
During the first quarter of 2011, FDIC-insured institutions
recorded annual net income of $29 billion, the highest level since
before the recession, but still well below the all-time highs of the
mid-2000s. The main driver of earnings improvement has been steadily
reduced provisions for loan losses. This reflects general improvement
in asset quality indicators, including declining levels of noncurrent
loans and net charge-offs for all major loan types. However, the ratio
of noncurrent loans \1\ to total loans, at 4.7 percent, is still
relatively high and remains above the levels seen in the late 1980s and
early 1990s. While the reduced provisions for loan losses are
encouraging, it is important to note that net operating revenue fell by
$5.5 billion in the first quarter of 2011 compared to 1 year ago. Lower
revenues, in part, reflect reduced loan balances, which have declined
in 10 of the past 11 quarters. Growth in well-underwritten loans is
essential not only for banks to build revenues but also to provide a
stronger foundation for economic recovery. Recent surveys, such as the
Federal Reserve Senior Loan Officers' Opinion Survey and the National
Federation of Independent Businesses' Survey on Small Business Economic
Trends, also indicate that borrower demand remains sluggish.
---------------------------------------------------------------------------
\1\ Noncurrent loans are those that are 90 or more days past due
or are on nonaccrual.
---------------------------------------------------------------------------
Despite the economic challenges, community banks, which comprise
the vast majority of banks that we supervise, continue to play a vital
role in credit creation across the country, especially for small
businesses. This has been borne out by loan originations over the past
several years. On a merger-adjusted basis, community bank loan balances
have increased by about 1 percent since the second quarter of 2008. \2\
However, over the same period, overall industry loan balances fell by
about 9 percent.
---------------------------------------------------------------------------
\2\ In merger-adjusted growth analysis, loan balances reported by
banks with assets less than $1 billion in the current quarter are
compared with these same institutions' loan balances in a prior period.
Prior-period loan balances include those of any institutions merged or
acquired in intervening periods.
---------------------------------------------------------------------------
While commercial property fundamentals point to stabilization,
recent weakness in both residential and commercial property price
trends highlight continued concerns. The S&P/Case-Shiller National
Housing Index is down 5.1 percent year-over-year through first quarter
2011 and the Moody's/REAL Commercial Property Price Index has decreased
by 8.5 percent in the year ending in March 2011. In both cases,
distressed properties are weighing down prices.
Overall, we are cautiously optimistic regarding the current
condition and trends in the banking industry. The number of
institutions on the FDIC's ``Problem List'' is leveling off and the
number of institution failures appears to have peaked in 2010. During
the first quarter of 2011, the number of institutions on the FDIC's
``Problem List'' increased slightly from 884 to 888. Similarly, the
current pace of failures is lower than the 157 failures in 2010.
Nevertheless, the number of troubled institutions remains high at 12
percent of all insured institutions, indicating that a portion of the
industry continues to struggle with lingering credit-quality issues.
These issues adversely impact the ability of many institutions to grow
their lending activity.
Factors That Led to the Recent Financial Crisis
Factors that led to the crisis of 2008 and motivated the
legislative reforms were in four broad areas: excessive reliance on
debt and financial leverage, misaligned incentives in financial
markets, failures and gaps in financial regulation, and the erosion of
market discipline due to regulatory arbitrage and ``Too Big to Fail.''
With regard to financial regulation, the regulatory reforms put in
place for federally insured depository institutions following the
banking crisis of the 1980s and early 1990s helped to constrain risk-
taking on bank balance sheets. However, opportunities for regulatory
arbitrage allowed risks to grow in the so-called shadow banking
system--a network of large-bank affiliates, special-purpose vehicles,
and nonbank financial companies that existed largely outside of the
prudential supervision, capital requirements, and FDIC receivership
powers that apply to federally insured depository institutions in the
U.S. The migration of financial activities outside of regulated
financial institutions to the shadow banking system ultimately lessened
the effectiveness of regulation and made the financial markets more
vulnerable to a breakdown.
Many of the structured finance activities that generated the
largest losses were complex and opaque transactions undertaken at the
intersection of the lightly regulated shadow banking system and the
more heavily regulated traditional banking system. For instance,
private-label mortgage backed securities (MBS) and associated
derivatives were originated through mortgage companies and brokers and
facilitated by banks that were securitizers. As became evident, many of
the underlying mortgage loans were poorly underwritten and contained a
host of layered risks.
The housing bubble ensued, fueled with poorly underwritten loans
originated for sale into the securitization market. The MBS were
subject to minimum securities disclosure rules that are not designed to
evaluate loan underwriting quality. For banks, once these loans were
securitized, they were off the balance sheet and no longer on the radar
of many banks and bank regulators. The mortgage loans began to default
in high numbers undermining the MBS market. Eventually, the housing
bubble collapsed, construction and development slowed, unemployment
rose, and the economy went into recession. In addition, home prices
continue to be depressed due to several factors including flawed
mortgage servicing practices, which are not yet fully corrected, the
overhang of foreclosure inventory, and the potential for litigation
exposure.
One of the most powerful inducements toward excess leverage and
institutional risk-taking in the period leading up to the crisis was
the lack of effective market discipline. Several large, complex U.S.
financial companies at the center of the 2008 crisis could not be wound
down in an orderly manner when they became nonviable. With the
exception of any insured depository institutions that they owned, their
operations were subject to the commercial bankruptcy code, as opposed
to FDIC receivership laws. In addition, some major important segments
of their operations were located abroad and therefore outside of U.S.
jurisdiction. In the heat of the crisis, policy makers in several
instances resorted to bailouts instead of letting these firms collapse
into bankruptcy because they feared that the losses generated in a
failure would create a cascade of defaults through the financial
system, freezing financial markets and seriously damaging our economic
system.
Community banks were generally not involved in the mortgage-related
issues at the first stages of the financial crisis, but were impacted
as the recession took hold. Community banks tend to focus on local
markets and loans for which local knowledge and personal service
provide a competitive advantage, such as residential construction loans
and other smaller commercial real estate projects. Construction and
development (C&D) lending in areas that had experienced the steepest
increase in home prices during the boom was hit first. Credit losses
rose and subsequently spread across all loan types and rose as
borrowers were caught in the recession and then slow recovery. At the
same time, community banks' other sources of revenue used to offset
credit losses from real estate portfolios was limited.
FDIC Supervisory Responsibilities
Despite the recent economic disruptions and subsequent
stabilization, the FDIC's supervisory programs, while responsive to
intensified problems in the industry, remain balanced. To accomplish
this goal, the FDIC continuously enhances its examination and other
supervisory approaches and maintains dialogue with institutions
throughout the examination cycle.
The FDIC serves as the primary Federal regulator for State-
chartered institutions that are not members of the Federal Reserve
System. The FDIC currently supervises 4,664 institutions, 4,358 of
which have total assets of less than $1 billion. Regardless of size, as
deposit insurer, the FDIC has an important interest in the condition of
all insured institutions and their individual and aggregate impact on
the DIF. As a result, the FDIC also has back-up authority to
participate in examinations, with the primary Federal regulator, at any
insured institution.
The FDIC has, for a number of years, had different approaches to
its supervision of larger, complex institutions from that of community
banks. The larger, more complex institutions, and some mid-tier
institutions, are subject to continuous on-site examination by teams of
examiners and to extensive reporting. The smaller community banks have
an annual or 18-month exam cycle and are also monitored off-site using
quarterly Call Report information. The differences in the supervision
of large and small banks are discussed in more detail below.
Supervision of Large Banks and Financial Firms
Supervisory programs, particularly for the larger institutions,
have evolved to address the issues that led to the financial crisis,
and to reflect the important protections and changes added by the Dodd-
Frank Act. The Act requires that the FDIC and the Federal Reserve Board
jointly issue regulations to implement new resolution planning and
reporting requirements. These rules will apply to bank holding
companies with total assets of $50 billion or more and nonbank
financial companies designated by the Financial Stability Oversight
Council (FSOC) as ``Systemically Important Financial Institutions''
(SIFIs).
In addition, covered companies would be required to submit a
resolution plan. Resolution plans should identify and map covered
companies' business lines to legal entities and provide integrated
analyses of their corporate structure; credit and other exposures;
funding, capital, and cash flows; domestic and foreign jurisdictions in
which they operate; their supporting information systems and other
essential services; and other key components of their business
operations. The resolution plan requirement in the Dodd-Frank Act
appropriately places the responsibility on financial companies to
develop their own plans ``for rapid and orderly resolution in the event
of material financial distress or failure'' with review by the FDIC and
the Federal Reserve Board.
The agencies are also working to develop a substantive process for
reviewing resolution plans to determine whether a plan is both credible
and would facilitate an orderly resolution of the company under the
Bankruptcy Code. If a resolution plan is found to be ``not credible,''
then the FDIC and the Federal Reserve Board may impose more stringent
standards and take other action. If, after 2 years, the company's plan
is still ``not credible,'' the FDIC and the Federal Reserve Board may,
in consultation with the FSOC, direct a company to divest certain
assets or operations.
To focus the FDIC's expanded responsibilities to monitor and,
potentially, resolve SIFIs, we established an Office of Complex
Financial Institutions (OCFI). The OCFI will be responsible for the
FDIC's role in the oversight of large bank holding companies and their
corresponding insured depository institutions as well as for nonbank
financial companies designated as systemically important by the FSOC.
The OCFI will handle the FDIC's responsibilities, in concert with the
Federal Reserve Board, for reviewing resolution plans and credit
exposure reports developed by the SIFIs. Also, the OCFI will be
responsible for implementing and administering the FDIC's SIFI
resolution authority and for conducting special examinations of SIFIs
under the FDIC's back-up examination and enforcement authority.
Supervision of Community Banks
Supervision of community banks consists of regular on-site
examinations along with quarterly off-site monitoring of financial
performance. Where conditions dictate closer supervision, we conduct
on-site visits and collect supplemental information. As the supervisor
of 4,358 community banks, \3\ the FDIC has a keen appreciation for the
important role community banks play in the national economy. Community
banks have branches in nearly all towns and urban areas, and about two-
thirds of all branches in rural areas belong to community banks.
---------------------------------------------------------------------------
\3\ Throughout this testimony, for purposes of data analysis,
community banks are defined as banks and thrifts with total assets of
less than $1 billion.
---------------------------------------------------------------------------
The FDIC's supervisory activities are carried out by examiners
working from field offices located in 85 communities across the
country. These examiners know the community banks in their areas and
are familiar with the local conditions facing those banks. Many have
seen more than one previous economic down cycle and recognize the
critical role that community banks play in credit availability.
As discussed earlier, community banks still face lingering problems
in their real estate loan portfolios and spillover effects caused by
the collapsed housing bubble and the slow economy. Asset quality is not
deteriorating as before, but volumes of troubled assets and charge-offs
remain high, especially in the most affected geographic areas. The FDIC
supervisory responses are scaled according to the severity of the
weaknesses that a bank may exhibit. Banks with significant loan
problems require close supervisory attention.
Supervisory Action To Encourage Real Estate Recovery and Lending
Throughout the real estate and economic downturn, the FDIC has
advocated for policies that will help community banks and their
customers navigate this challenging period and mitigate unnecessary
losses. We share community banks' desire to restore profitability,
strengthen asset quality, and serve the credit needs of local markets.
The FDIC has worked closely with banks as they have taken steps to
raise capital, enhance their loan workout functions, and revise
strategic plans to remain competitive in the financial services
industry. Through our regional and field offices located throughout the
country, the FDIC actively communicates with the community banks we
supervise and provides recommendations for addressing operational and
financial weaknesses as appropriate.
In addition, the FDIC has joined several interagency efforts that
encourage banks to originate and restructure loans to creditworthy
borrowers, and to clarify outstanding guidance. For example, the
Federal bank regulatory agencies issued the Interagency Statement on
Meeting the Needs of Creditworthy Borrowers on November 12, 2008, which
encouraged banks to prudently make loans available in their markets.
The agencies also issued the Interagency Statement on Meeting the
Credit Needs of Creditworthy Small Business Borrowers on February 12,
2010, to encourage prudent small business lending and emphasize that
examiners will apply a balanced approach in evaluating loans. This
guidance was issued subsequent to the October 30, 2009, Policy
Statement on Prudent Commercial Real Estate Workouts that encourages
banks to restructure loans for commercial real estate mortgage
customers experiencing difficulties making payments. The CRE Workouts
Guidance reinforces long-standing supervisory principles in a manner
that recognizes pragmatic actions by lenders and small business
borrowers are necessary to weather this difficult economic period.
The FDIC also joined the other banking agencies in issuing the
Interagency Appraisal and Evaluation Guidelines on December 2, 2010, to
clarify expectations for real estate appraisals. Clarification of these
guidelines was important for the industry given changes in property
values over the past several years. We do not require banks to
recognize losses on loans solely because of collateral depreciation or
require appraisals on performing loans unless an advance of new funds
is being contemplated. Moreover, the interagency guidance recognizes
that borrowers' ability to repay real estate loans according to
reasonable terms remains the primary consideration in a lending
decision.
We also actively engage with community banks at the State level and
nationally through various trade associations, which helps our agency
articulate its supervisory expectations on important issues through a
variety of forums. For example, the FDIC established an Advisory
Committee on Community Banking to provide us with advice and guidance
on a broad range of policy issues impacting small community banks, as
well as the local communities they serve, with a focus on rural areas.
The Advisory Committee has provided valuable input on examination
policies and procedures, credit and lending practices, deposit
insurance assessments, insurance coverage issues, regulatory compliance
matters, and obstacles to the continued growth and ability to extend
financial services in their local markets. We also sponsor training
events for community banks including regional and national
teleconferences on risk management and consumer protection matters, as
well as Directors Colleges to help bank directors better understand the
supervisory process.
The FDIC conducts more than 2,500 on-site examinations annually,
and we recognize that questions and even disagreements with individual
examination findings may sometimes arise, especially in difficult
economic times. The FDIC has a number of outlets for bankers to express
their concerns when this occurs. On March 1, we issued guidance
reiterating that FDIC-supervised institutions can voice their concerns
about an examination or other supervisory determination through
informal and formal channels. The FDIC takes pride in the
professionalism of its examination force but also strongly encourages
banks to provide feedback on FDIC examinations. The guidance highlights
that often the most effective method for understanding why the FDIC
reached a particular conclusion during its examination is for the
bankers to discuss the issue with the examiner-in-charge, field office
supervisor, or the appropriate official in the Regional Office.
Addressing Regulatory Burden
The FDIC is interested in finding ways to eliminate unnecessary
regulatory burden on community banks, whose balance sheets are much
less complicated than those of the larger banks. We continuously pursue
methods to streamline our supervisory process through the use of
technology and other means to reduce disruption associated with
examination activity. While maintaining an effective examination
process is paramount, we are sensitive to banks' business priorities
and strive to be efficient in our work.
Certain supervisory programs are designed to be less burdensome on
small banks compared to the larger, more complex institutions. For
example, statutorily mandated examinations are less frequent for
certain well-managed, well-capitalized institutions under $500 million
in size. There are also fewer reporting requirements for smaller
institutions, including Call Report line items and requirements for
other reporting. In addition, to make it easier for smaller
institutions to understand the impact of new regulatory changes or
guidance, we specifically note up front in our Financial Institution
Letters (the vehicle used to alert banks to any regulatory changes or
guidance) whether the change applies to institutions under $1 billion.
Finally, there are less burdensome requirements for smaller
institutions in their implementation of the Community Reinvestment Act.
As we testified before this Subcommittee in April, much of the
Dodd-Frank Act should have no direct impact on community banks, and
certain changes in the Act provide benefits. For example, the Act
permanently increased deposit insurance coverage to $250,000 and made
changes in the assessment base that will result in significantly lower
premiums for most banks under $10 billion in assets. Further,
provisions of the Act that impose additional capital and other
heightened prudential requirements on the largest financial
institutions are aimed at reducing systemic risks. Those and other
provisions of the Act should do much to return competitive balance to
the marketplace by restoring market discipline and ensuring appropriate
regulatory oversight of systemically important financial companies.
Finally, the Dodd-Frank Act should help level the playing field
with nonbanks as they will now be required to meet the same standards
as banking institutions, especially in the mortgage finance arena.
However, it is clear that consumers have come to expect, and depend
greatly on, insured institutions to design and offer fair and equitable
financial products and services. We believe the public's significant
trust in community banks has been fostered by their diligence in
maintaining effective consumer protection programs.
Much of the regulatory cost of the Dodd-Frank Act will fall, as it
should, directly on the large institutions that create systemic risk.
The leveling of the competitive playing field will help preserve the
essential diversity of our financial system, and prevent any
institution from taking undue risks at the expense of the public.
Conclusion
The FDIC understands the significant challenges faced by banks and
their borrowers as the real estate markets and the financial sector
recover from the dislocations that precipitated the crisis. The FDIC
has made supervisory enhancements that address the lessons learned from
the recent crisis and organizational changes to implement our new
responsibilities from the Dodd-Frank Act. The FDIC has joined with
other Federal financial regulators in encouraging lenders to continue
making prudent loans and working with borrowers experiencing financial
difficulties. As the primary Federal regulator for most community
banks, the FDIC recognizes their critical role in helping local
businesses fuel economic growth and we support their efforts to make
good loans in this challenging environment.
Thank you and I would be pleased to answer any questions.
______
PREPARED STATEMENT OF DAVID K. WILSON
Deputy Comptroller, Credit and Market Risk, Office of the Comptroller
of the Currency
June 15, 2011
I. Introduction*
Chairman Brown, Ranking Member Corker, and Members of the
Subcommittee, my name is Dave Wilson, and I am currently the Deputy
Comptroller for Credit and Market Risk at the Office of the Comptroller
of the Currency. In July, I will assume the position of Senior Deputy
Comptroller for Bank Supervision Policy and Chief National Bank
Examiner at the OCC. I appreciate the opportunity to discuss the OCC's
perspectives on lessons learned from the financial crisis and our
ensuing approach to bank supervision.
---------------------------------------------------------------------------
* Statement Required by 12 U.S.C. 250: The views expressed herein
are those of the Office of the Comptroller of the Currency and do not
necessarily represent the views of the President.
---------------------------------------------------------------------------
My testimony addresses four key areas. First, I briefly summarize
some of the major factors that contributed to the financial crisis.
Next, I discuss lessons learned from the crisis and specific steps the
OCC is taking to incorporate those lessons learned into our bank
supervision activities and practices. With this background, I then
describe the OCC's overall approach to bank supervision--our role as
supervisors, and the efforts we are taking to ensure that as we
implement needed supervisory enhancements and the reforms mandated by
the Dodd-Frank Act, our supervision remains balanced, fair, and
appropriately tailored to the size and risk of individual institutions.
Finally, pursuant to the Subcommittee's request, I provide a brief
update on small business and real estate lending, mortgage servicing,
and trading.
II. Factors That Contributed to the Financial Crisis
Numerous studies and papers have been written that explore in depth
the causes and factors that led to the recent crisis. Rather than
catalog and summarize those findings, I want to offer my perspective,
as a bank examiner and supervisor, on key precipitating factors that
both supervisors and bankers failed to adequately recognize and
mitigate.
In many respects, the seeds for the crisis were sown by the
prolonged period of a relatively benign economy that fostered a market
environment where investors, lenders, and supervisors became overly
complacent about risk. This environment, characterized by low interest
rates, strong economic growth, excess liquidity, and very low rates of
borrower defaults spurred investors to chase yields, and U.S. mortgage-
backed securities offered higher yields on historically safe
investments. Hungry investors tolerated increased risk to obtain those
higher yields, especially from securities backed by subprime markets,
where yields were highest. This demand attracted new mortgage lenders
and brokers many of whom had limited business experience or financial
strength and operated outside of the commercial banking system and with
little regulatory oversight. Increased risk layering--in the form of
smaller downpayments, lower required credit scores, higher debt-to-
income ratios, reduced documentation of income, and temporary
reductions in monthly payments--became prevalent as lenders and
borrowers became willing to finance and take on ever higher levels of
debt, often on the belief that such debt could be easily refinanced or
extinguished through the sale of underlying assets whose prices, it was
assumed, would continue to escalate. The rapid increase in market share
by unregulated brokers and originators put pressure on regulated banks
to lower their underwriting standards, which they did, though not to
the same extent as was true for unregulated mortgage lenders.
Investor demand for yield was also affecting the commercial
leveraged loan market as many institutional investors were willing to
accept increasingly liberal repayment terms, reduced financial
covenants, and higher borrower leverage in return for marginally higher
yields. The apparent risk to commercial banks' own loan portfolios was
considered limited, because such banks and bank affiliates increasingly
followed an ``originate-to-distribute'' model, syndicating most of
these exposures for sale to institutional investors rather than holding
them on their balance sheets for extended periods.
Compensation structures that rewarded loan production over loan
quality placed added incentives for lenders to originate and produce
loan products. Over time, product structures and funding mechanisms
became more complex and opaque as underlying loans were repackaged,
tranched, and further leveraged and financed in the form of various
securitization and off-balance sheet funding conduits. Some of these
structures, such as complex collateralized debt obligations, were
poorly understood. Credit rating agencies and investors had a false
sense of security that, no matter how poor the underwriting of the
underlying asset, the risk could be adequately mitigated through
geographic and product diversification, sufficient credit tranching,
and other financial engineering. In many cases, the net result was
poorly underwritten loans that financed longer-term assets and that
were funded through short-term wholesale funds providers who, as it was
later revealed, were extremely sensitive to real or perceived risks.
Smaller community banks were not immune from the build-up of risks
occurring in the system. In particular, as the larger players increased
their market shares in various retail credit products, such as
residential mortgage loans and credit cards, community banks
increasingly had to look elsewhere for profitable lending
opportunities. For many community bankers, the housing and attendant
real estate boom provided a natural area for growth--CRE (commercial
real estate) lending for construction and development. This was
especially true in areas with vibrant housing markets, where home
building was a key part of the regional economy. Because this type of
lending puts more of a premium on knowledge of individual borrowers and
local market conditions, this type of lending is often well-suited for
community banks. However, many smaller banks became overly concentrated
in this sector and a smaller, but not insignificant, number fueled
their rapid CRE growth--often in areas outside of their home market--
with short-term volatile funding sources.
Lax underwriting, excessive leverage, rapid growth, and
concentrations are all too familiar refrains from past credit cycles
and were symptoms that, with the benefit of hindsight, supervisors and
market participants should have better mitigated at a much earlier
stage. What amplified these factors from past cycles was the manner in
which these excesses were spread and disbursed throughout the global
financial system. When the subprime mortgage market began to collapse,
the opaqueness of the more complex product and funding structures made
it difficult for bankers, investors, funds providers, and supervisors
to readily assess the nature and scope of potential risk exposures.
This uncertainty contributed to an abrupt shift in risk tolerance by
many market participants across the globe and served to compound losses
as investors attempted to unwind positions. Secondary market liquidity
for mortgages and leveraged loan products largely evaporated, leaving
many larger banks with an unfunded pipeline of loan commitments that
would require on-balance sheet funding. Likewise, short-term funding
vehicles, such as asset-backed commercial paper conduits, became
strained as investors increasingly chose not to roll over maturing
paper, placing further strains on the balance sheets of banks that
served as sponsors to such conduits. Bankers and supervisors
underestimated the resulting rapidity and depth of the global liquidity
freeze.
As various external funding sources evaporated, concentrations and
correlations that bank risk managers believed had been diversified away
became more apparent. For example, direct exposures to subprime
mortgages that had been avoided in a bank's lending operations
nonetheless emerged through bank affiliate activities and affiliate-
sponsored off-balance sheet vehicles. Products, markets, and geographic
regions that previously were looked to as a source of risk
diversification became more highly correlated as contagion effects
spread across the globe and industry sectors.
The resulting strains of the financial crisis have been felt by
both large and small banks. While the initial impact was largely
confined to the largest institutions that were heavily reliant on
wholesale funding, as the economy continued to deteriorate, banks of
all sizes faced higher loan losses, lower margins, and reduced
profitability, and are only now showing signs of recovery.
III. Lessons Learned and Areas for Continued Improvement for Bank
Supervision
The financial crisis underscored that no amount of financial
engineering can obviate the need for bankers and bank supervisors to
adhere to and monitor the basic precepts of sound banking practice:
prudent underwriting practices throughout the credit cycle; strong
risk-management systems that identify and control the build-up of risk
concentrations across products and business lines; diversified funding
sources, adequate loan loss reserves, and strong capital cushions that
allow the bank to continue its normal operations during downturns or
funding strains; and strong corporate governance, including
compensation structures, that set the tone for balanced and prudent
risk taking. While these fundamentals are clearly important, they
primarily focus on the risks within an individual banking organization.
As the financial crisis highlighted, bankers, and more importantly
supervisors, must develop better tools to evaluate and address emerging
risks across the system and how those risks may be interconnected.
Similarly, regulators need to take steps to restore greater
transparency and accountability by all market participants--lenders,
borrowers, and investors--to facilitate market discipline on excessive
risk taking and dispel reliance on potential or perceived Government
backstops.
The sections that follow describe in some detail steps that the OCC
has or is taking to address each of these areas. But let me begin by
noting that while the OCC believes that these lessons are applicable
for banks of all sizes, we are cognizant of the need to tailor our
expectations to the scope and complexity of each bank's activities. As
a result, our expectations for large banking organizations are
generally more stringent and higher than for community banks whose
scale of operations and complexity are considerably smaller. While we
believe large banks must be held to higher standards, we do not
subscribe to the view that big, in and of itself, is bad. Our country's
economic well-being is inevitably linked to the global economy and if
the U.S. financial system is to remain a predominant force in the
global environment, we need to have banking organizations that can
compete effectively with their global counterparts across product and
business lines. Similarly, as we institute reforms to address some of
the problems and abuses stemming from the last crisis, we need be
careful that we do not attempt to wring all the risk or complexity out
of the banking system. Banks' fundamental role is risk intermediation,
and financial innovation and expansion of credit are important drivers
of our economy. Banks must be able to respond to customer and investor
demand for new and innovative products and services. As corporations
become more risk management savvy, so do their demands for risk
management products, such as various derivative instruments. Similarly,
as technology advances, the methods and ways that consumers choose to
interface with banks will become more complex and varied. We must allow
banks to respond to this changing landscape provided that they do so in
a manner that is safe and sound and conducted with integrity.
A. Prudent Underwriting Throughout the Cycle
The financial crisis underscored that underwriting standards
matter, regardless of whether loans are being originated to hold on the
bank's own balance sheet or sold to third party investors. Supervisors
and banking organizations must be more diligent in ensuring that
underwriting standards are not compromised by competitive pressures
from unregulated firms, by investors who may be willing to take on more
risk for incremental yield, or by desire for rapid growth or market
share in products or geographic regions.
In the immediate aftermath of the subprime crisis, the OCC
cautioned national banks that they should apply sound, consistent
underwriting standards regardless of whether a loan is originated with
the intent to hold or sell. Likewise, we have admonished national banks
not to compromise their underwriting standards due to competitive
pressures. Where we see signs of such slippage, we are intervening at
an early stage. For example, last June in response to signs of slippage
that examiners were seeing in some leveraged loan facilities, we issued
guidance to our examiners that reinforced our supervisory expectations
for this type of lending and directed them to criticize or classify
credits that exhibit minimal repayment capacity, excessive leverage or
weak/nonexistent covenants, even when the credits had been recently
advanced.
Because of the adverse impact that competitive pressures can have
on underwriting standards, the OCC has been a strong proponent for
national, uniform standards for certain lending products, most notably
residential mortgage loans.
As we take steps to promote more consistent and uniform
underwriting practices and standards and to lean in more forcefully
when we see slippage either in the system or at individual banks, we
are mindful of the need to strike an appropriate balance. Ensuring that
banks remain safe and sound, while at the same time meeting the credit
needs of their communities and customers is one of the OCC's core
missions, and knowing when to bear down is one of the most fundamental
calls that examiners and policy makers must make. Waiting too long or
supervising too lightly will result in some banks using federally
insured deposits to make unsafe loans that can ultimately cause them to
fail. On the other hand, supervising too strictly or inconsistently can
cause banks to become too conservative and deny loans to creditworthy
borrowers.
Since the onset of the financial crisis, the OCC has taken a number
of actions to improve our ability to objectively monitor trends in
credit quality and underwriting standards to help us determine when
stronger supervisory intervention is needed. These actions supplement
our more traditional tools of on-site examinations, the annual
interagency Shared National Credit review, and the OCC's annual
underwriting survey. In 2009, we began collecting and analyzing
detailed loan-level data on home equity, credit card, CRE, and large
corporate syndicated credits at some of the largest national banks.
This effort builds off of the highly valuable Mortgage Metrics data
project that the OCC initiated in 2008 and provides us with much more
granular level data than could be collected cost-effectively through
the Call Report. This comprehensive loan-level credit data allows us to
conduct comparative analysis of credit risk across large banks in a
timelier manner and to identify potential systemic risk issues. In
addition, these large comprehensive data sets provide us with the
ability to conduct more forward-looking analyses to determine what
could happen to credit quality under varying economic scenarios and
assumptions. A key focus of our large bank examination and policy staff
will be to identify and institutionalize critical underwriting metrics
and related benchmarks so that we can objectively track the migration
of practices over the course of future credit cycles. By limiting our
data collection to the largest players, we are able to develop a
system-wide view while minimizing undue reporting and compliance costs
on smaller institutions.
For smaller institutions, our emphasis has been more tailored and
focused on ensuring that these banks effectively recognize and manage
the inherent concentrations that they may have in their lending
portfolios. These efforts have included targeted examinations of key
portfolios, most notably CRE portfolios, and providing examiners and
bankers more analytical tools to assess how stresses in external market
factors may affect those portfolios.
B. Strong Risk Management Systems That Identify and Control Risk
Concentrations
The financial crisis exposed weaknesses in many banks' risk
management systems and models. In many cases, risk concentrations
accumulated undetected across products, business lines, and legal
entities within an organization. Complex product structures and various
off-balance sheet funding structures obfuscated certain exposures and
risks. Credit risk models relied too heavily on historical correlations
and did not adequately address their risk exposures to highly rated
CDOs and other structured securities. Similarly, banks' internal stress
tests failed to fully capture the risks that could be posed from
various ``tail'' events and from off-balance sheet structures that were
legally separate from the firm, but that the firm ultimately supported
in order to maintain relationships with counterparties, funds
providers, and investors. Many stress tests failed to fully estimate
the potential severity and duration of stress events or focused on a
single line of business.
Strengthening risk management practices and institutionalizing more
robust and enterprise-wide stress testing has and continues to be a
point of supervisory emphasis, particularly at the largest national
banks. Given the need to implement such practices across the entire
banking organization, we are working closely with our colleagues at the
Federal Reserve on many of these efforts.
Given the importance and the role that these large institutions
play in the overall financial stability of the U.S., we have instructed
our examiners that these organizations should not operate with anything
less than strong risk management and audit functions--anything less
will no longer be sufficient. To build out this capability, examiners
are directing these banks to improve their risk concentration
aggregation and stress testing processes, requiring more robust model
validations, and stepping up their challenges of quantitative models
and the key assumptions supporting those models. These examiner
directives have been supplemented with supervisory guidance, including
the enhanced risk management requirements adopted by the Basel
Committee for banks operating under the Basel II capital framework.
Critics of Basel II have focused on the potential for an internal-
models-based approach to produce lower capital charges for certain
portfolios, a concern that has been addressed in the past year by
substantial strengthening of the framework and the increased capital
levels under Basel III. Meanwhile, the great benefit of the framework
has been, and remains, its requirement for more stringent and robust
risk management standards at applicable banks. The compliance costs
associated with the Basel II advanced approaches rule is one reason why
the OCC and other U.S. banking agencies limited its mandatory
application to the largest U.S. banking organizations.
More recently, in April, the OCC and Federal Reserve issued
guidance on model risk management that expands upon the OCC's previous
guidance on model validation. The guidance articulates the elements of
a sound program for effective management of risks that arise when using
quantitative models in bank decision making. It also provides guidance
to OCC examining personnel and national banks on prudent model risk
management policies, procedures, practices, and standards. Last week,
the OCC, Federal Reserve, and FDIC issued for comment Proposed Guidance
on Stress Testing for Banking Organizations With More Than $10 Billion
in Total Consolidated Assets. This joint interagency guidance outlines
high-level principles for stress testing practices, applicable to all
banking organizations with more than $10 billion in total consolidated
assets. The proposed guidance highlights the importance of stress
testing as an ongoing risk management practice that supports a banking
organization's forward-looking assessment of its risks. It outlines
broad principles for a satisfactory stress testing framework, and
describes the manner in which stress testing should be employed as an
integral component of risk management. While not intended to provide
detailed instructions for conducting stress testing for any particular
risk or business area, the proposed guidance describes several types of
stress testing activities and how they may be most appropriately used
by banking organizations. Although the guidance does not explicitly
address the stress testing requirements imposed upon certain companies
by section 165 (i) of the Dodd-Frank Act, the agencies anticipate those
provisions, to be addressed in a future rulemaking, will be consistent
with the principles in the proposed guidance.
As with other risk management practices, the OCC believes certain
aspects of stress testing--such as scenario analysis of key
portfolios--can also be a valuable tool for smaller banks. Thus, as
previously noted, we have been working with community bankers to
improve their ability to stress test CRE and other highly concentrated
and volatile portfolios. For example, we have instructed banks that
their stress testing of CRE transactions should consider the effect of
multiple variables (e.g., changes in interest rates, vacancy rates, and
capitalization rates), and that such stress tests should be performed
periodically throughout the life of the loan.
To assist community bankers in identifying and assessing potential
CRE vulnerabilities, we developed, and have made available via our
National BankNet Web site, loan level CRE stress testing tools that
bankers can use. We also have developed a portfolio level model, which
our examiners are now testing. Our intent is to also publish this on
BankNet after proper validation. In addition to these tools, we provide
examiners with access to various market databases that allow them to
monitor and analyze CRE trends by major geographies and product types
and are developing additional tools that they can use in their
discussions with bank management about potential concentrations.
While more robust stress testing and improved risk management can
help identify and mitigate the risks arising from concentrations, the
financial crisis illustrated that there may be some types and levels of
concentrations that, in a severe or protracted downturn, may simply be
too large for a bank to absorb. Indeed, a common thread in the vast
majority of bank failures in both this and previous credit cycles has
been a concentration in certain types of CRE lending. Many of these
banks had other risk management weaknesses that accentuated their CRE
problems; however, some banks that had sound underwriting and internal
controls for the CRE operations nonetheless failed due to their level
of concentrations to this sector and the cascading effects that the
downturn had on their borrowers and projects. This is the primary
reason why we are directing smaller banks with these types of
concentrations to shore up their capital base and to maintain capital
levels above required regulatory minimums. Consistent with the GAO's
recent report on CRE concentrations, we are continuing to assess and
discuss with our supervisory colleagues whether additional
clarification on supervisory expectations or other measures, such as
more explicit limits, capital requirements, or triggers within the
Prompt Corrective Action framework may be warranted to address the
risks posed by excessive concentrations.
C. Diversified Funding, Strong Capital Cushions, and Adequate Loan Loss
Reserves
In periods of severe financial stress, having sufficient liquidity,
loan loss reserves, and capital become paramount in ensuring a bank's
continued operations. Each of these components of a strong balance
sheet had weakened in the years preceding the crisis.
As previously noted, many banks--both large and small--relied
excessively on short-term and volatile funding sources to expand and
fuel their growth. As banks competed for short-term profits and higher
margins, traditional sources of asset-based liquidity, such as short-
term, readily marketable securities were replaced with less liquid
assets that offered higher yields. Many banks' liquidity plans assumed
that there would be a continuously ready market for highly rated assets
that could provide liquidity and likewise failed to fully anticipate
the liquidity demands resulting from their ``originate to distribute''
loan pipelines or off-balance sheet conduits. This combination of
factors--undue reliance on short-term liabilities, little asset
liquidity, and a growing accumulation of off-balance sheet assets that
would require funding--proved disastrous for some firms when the short-
term funding markets abruptly shut down in 2007.
Similarly, the crisis clearly demonstrated that common equity is
superior to other capital instruments in its ability to absorb losses
on a going-concern basis. Hybrid capital instruments that paid
cumulative dividends and/or had a set maturity date had become an ever-
larger proportion of the capital base for bank holding companies of all
sizes, but were found lacking. While many banks hold innovative
instruments that would have permitted them to defer or cancel
dividends, during the financial crisis many banks did not exercise this
option, which could have preserved liquidity and capital, for fear that
such actions would reinforce market perceptions of the bank's weakened
financial condition. Many non-U.S. banks even exercised call options to
redeem hybrid instruments for fear that failure to do so would send
strong market signals about the deteriorating condition of the bank.
Correcting these shortcomings has been the focus of considerable
work by the OCC and other regulators and, as Acting Comptroller Walsh
noted in his testimony before the full Committee in February, is the
objective of various provisions of the Dodd-Frank Act. \1\ The hallmark
of this work internationally has been the enhanced and more stringent
global capital and liquidity standards for large, internationally
active banks adopted by the Basel Committee, known as Basel III. These
reforms, when integrated with the various capital and liquidity
provisions of Dodd-Frank will materially affect the level and
composition of capital and liquidity for large banks. Together, these
reforms tighten the definition of what counts as regulatory capital;
expand the types of risk captured within the regulatory capital
framework; increase overall capital requirements; establish an
international leverage ratio applicable to global financial
institutions that constrains leverage from both on- and off-balance
sheet exposures; and provide for a more balanced consideration of
financial stability in bank supervision practices and capital rules.
The Basel reforms also introduce global minimum liquidity standards
that set forth explicit ratios that banks must meet to ensure that they
have adequate short-term liquidity to offset cash outflows under acute
short-term stresses and maintain a sustainable maturity structure of
assets and liabilities.
---------------------------------------------------------------------------
\1\ See, Testimony of John Walsh, Acting Comptroller of the
Currency, before the Committee on Banking, Housing, and Urban Affairs
of the United States Senate, February 17, 2011.
---------------------------------------------------------------------------
Since the Basel III enhancements can take effect in the U.S. only
through formal rulemaking by the banking agencies, U.S. agencies have
the opportunity to integrate certain Basel III implementation efforts
with the heightened prudential standards required by the Dodd-Frank
Act. Such coordination in rulemaking will ensure consistency in the
establishment of capital and liquidity standards for similarly situated
organizations, appropriately differentiate relevant standards for less
complex organizations, and consider broader economic impact assessments
in the development of these standards. Beyond the Basel III reforms, we
have been directing banks of all sizes to improve their capital
planning and liquidity risk management processes to ensure their
ability to adequately fund and support anticipated growth and withstand
unforeseen events. As part of this effort, we expect all banks to
maintain a contingency funding plan that sets forth the bank's strategy
for addressing unexpected liquidity shortfalls.
One of the most striking sidebars in the story of the financial
crisis is the unprecedented speed with which once well-capitalized
institutions succumbed to their credit losses. One reason for this is
that banks held historically low levels of loan-loss reserves coming
into the current recession. We agree with the findings and
recommendations of the Financial Accounting Standards Board (FASB) and
the International Accounting Standards Board (IASB) Financial Crisis
Advisory Group on the need to amend accounting standards that
contributed to the delayed recognition of losses on loans.
Specifically, the accounting rules and the way they were applied made
it difficult for bankers to reserve for losses that could be reasonably
anticipated. The result was that when subsequent charge-offs on
impaired loans did occur, the loan loss reserves were not there to
support them, and higher provision levels reduced capital. This
accelerated the spiral into insolvency for many financial institutions.
As the FASB and IASB (collectively, the Boards) have recognized, this
emphasizes the need for a revised accounting model for more adequate
loan losses to supplement the strong capital cushions required by
prudential regulators. The OCC has been a strong proponent of this need
to make the loan loss allowances more forward looking so that banks can
appropriately build their reserves when inherent credit risk is
increasing, rather than waiting until loan problems are obvious. The
OCC has been actively engaged in efforts by the Boards to revise the
current impairment model for recognizing loan losses to provide for
more forward-looking reserves. As part of this effort, OCC staff has
served as the U.S. banking agencies' representative on the IASB's
Expert Advisory Panel on Impairment and participated in various
educational sessions as well as drafting interagency and Basel
Committee comments to the Boards on this issue.
A challenge we and the industry face as implementation of these and
other reforms mandated by the Dodd-Frank Act move forward is assessing
their potential interaction and cumulative impact on banks' business
models and strategic plans. While we support efforts to raise and
strengthen capital and liquidity cushions, these standards must be
reflective of the underlying risks and not become so excessive that
they serve to promote rather than discourage risk-taking. In addition,
we are concerned that some of the parameters underlying the Basel III
liquidity standards are excessively conservative and, if implemented in
their current form, could unnecessarily impede banks' balance sheet
capacity for lending activities.
D. Strong Corporate Governance
The financial crisis highlighted that risk management is, and must
be, more than simply a collection of policies, procedures, limits, and
models. Effective risk management requires a strong corporate culture
and corporate risk governance. This culture must be set, embraced, and
enforced by the bank's board of directors and its senior management,
and it must permeate all of the bank's activities. This is a point of
emphasis in all of our meetings with senior management teams and
directors. We are reminding bank directors that they should not be
passive bystanders and should be willing and able to provide credible
challenges to bank management on key issues and strategic plans.
Informed directors are well positioned to engage in value-added
discussions that provide knowledgeable approvals, guidance to clarify
areas of uncertainty, and prudently question the propriety of strategic
initiatives, human capital decisions (including compensation
arrangements), and the balance between risk taking and reward.
Fulfilling these roles and responsibilities can be especially
challenging for directors at smaller institutions who may have fewer
resources or outside expertise to assist them. To assist them in this
task, we offer a comprehensive series of director workshops, taught by
some of our senior supervisory staff. These workshops, offered
throughout the year in various locations across the country, cover four
topics: a director's fundamental responsibilities, risk assessment,
compliance risk, and credit risk. Participants receive an extensive
package of resources, including a precourse reading packet, course
materials, a CD containing selected OCC Web and telephone seminars, and
other supporting materials.
A key component of prudent corporate governance is the
establishment of well-defined and understood risk tolerances and
limits. At larger banks, the science of defining and measuring risk
tolerance levels has typically been confined to the business unit and
more micro levels of the organization. While these lower level risk
limits are generally effective in controlling individual areas of risk
taking, they do not enable senior management or board members to
monitor or evaluate concentrations and risks on a firm-wide basis.
Consequently, we are directing larger banks to complement existing risk
tolerance structures with more comprehensive measures and limits of
risk addressing the amount of capital or earnings that may be at risk
on a firm-wide basis, including the amount of risk that may be taken in
each line of business, and the amount of risk that may be taken in each
of the key risk categories monitored by the banks. For banks of all
sizes, we are emphasizing the need for sound enterprise-wide asset-
liability management systems that identify, monitor, and effectively
limit the bank's liquidity and interest rate risks exposures. As part
of our ongoing supervisory process, we are reviewing compliance with
these directives.
As previously noted, flawed incentive compensation practices in the
financial industry were among the factors contributing to the financial
crisis. To address this issue, in June 2010, the OCC and other Federal
banking agencies issued guidance on sound incentive compensation
policies and practices. Key tenets of that guidance are that such
practices should appropriately balance risk and reward; be compatible
with effective controls and risk management; and be supported by strong
corporate governance, including active and effective oversight by the
organization's board of directors. In April, the OCC and other
regulators issued proposed rules to implement the incentive-based
compensation provisions of section 956 of the Dodd-Frank Act. This rule
would build upon the agencies' June 2010 guidance by requiring the
reporting of certain incentive-based compensation arrangements and
prohibit incentive-based compensation arrangements that provide
excessive compensation or that could expose the institution to
inappropriate risks that could lead to material financial loss.
Consistent with the statute, institutions with less than $1 billion in
assets would not be subject to this rule.
E. Identifying, Assessing, and Addressing Emerging Risks Across the
Financial System
As I noted earlier, the financial crisis demonstrated the need for
supervisors to improve their ability to identify, assess, and address
emerging risks not only within a banking organization, but across the
banking and broader financial system. Strengthening supervisors'
ability to identify and respond to emerging systemic risks is clearly a
key objective of the Dodd-Frank Act and a core mission of the FSOC.
Beyond the measures provided for by the Dodd-Frank Act and the
activities being conducted through the FSOC and its various staff
committees, the OCC has taken a number of steps to enhance our ability
to identify and respond to risks across the industry and financial
system.
As previously noted, we are now obtaining granular, loan level
information on key credit portfolios from the largest national banks to
help identify underwriting and performance trends across the system. We
have also developed a liquidity risk monitoring program to standardize
liquidity monitoring information across 15 of the largest national
banks and to provide more forward looking assessments of liquidity
mismatches and capacity constraints that could signal future problems.
We also have established network groups among our examiners at large
national banks to facilitate information sharing and promote consistent
supervisory actions for nine key risk areas.
In 2008, we established a Financial Markets Group within the agency
and tasked it with the build-out of a market intelligence program.
Their mission is to seek out early warning signs of emerging and
systemic risk issues. This team is comprised of highly experienced bank
examiners and subject matter specialists, and they spend considerable
time meeting with bank investors, bank counterparties, bank analysts,
and other relevant stakeholders to gain insights on emerging trends. To
support the work of the OCC's National Risk Committee (NRC), this group
has also developed a dashboard of metrics that provide early indicators
of the build-up of risks within the system that may signal the need for
firmer supervisory intervention at a juncture when such action can be
modulated and most effective. These metrics are designed to provide
warning signs before risks become manifested in market performance such
as prolonged periods of low volatility that can promote complacency
among investors and bankers and lead to excessive risk taking. While
any one metric would be insufficient grounds for firmer intervention,
warning signals across a number of measures will trigger a more formal
review and assessment of the risks and the need for appropriate
supervisory response by the OCC's NRC and Committee on Bank
Supervision.
F. Restoring Transparency and Market Discipline
The problems that supervisors and market participants faced when
trying to assess the nature and scope of exposures in complex
structured products, off-balance sheet funding vehicles, derivatives,
and trading strategies have been well documented. In many cases these
challenges were further exacerbated by complex organizational
structures of individual firms.
Providing greater transparency in financial statements has been a
key objective of recent proposals by the FASB, and the OCC has provided
its views and expertise on these proposals. One of the most significant
revisions, as it pertains to various securitization and off-balance
sheet funding vehicles that were prevalent before the crisis, has been
the adoption and implementation of revisions to the Accounting
Standards Codification (ASC) Topic 860, Transfers and Servicing, and
ASC Topic 810, Consolidation (through Statements No. 166, Accounting
for Transfers of Financial Assets--an amendment of FASB Statement No.
140, No. 167, Amendments to FASB Interpretation No. 46(R)). As a result
of these statements, many securitized assets must now be reflected on
banks' balance sheets. The OCC and other Federal banking agencies have
amended the agencies' risk-based capital rules to be consistent with
these accounting changes. Many of the derivatives-related provisions of
the Dodd-Frank Act will likewise provide greater transparency through
increased disclosures and more extensive use of central counterparties
or clearinghouses.
The combined provisions of Titles I and II of the Dodd-Frank Act
that provide the authority to extend the Federal Reserve's supervisory
oversight of certain nonbank financial companies and for the orderly
liquidation of failing financial companies that pose significant risk
to the financial stability of the U.S., are critical tools in restoring
market discipline and accountability for large financial firms. Through
FSOC, the OCC is actively engaged in efforts to implement these
provisions.
As problems in the mortgage market have vividly demonstrated,
improved transparency and disclosures about the terms, costs, and risks
of retail banking products are critical to promote informed consumer
choice and responsibility. We have long supported that goal and applaud
the Consumer Financial Protection Bureau's initiative to start this
process through the testing of revised residential mortgage disclosure
forms.
IV. OCC's Supervisory Approach--Balanced Supervision, Tailored to Risks
The OCC's core mission is to assure the safety and soundness of the
institutions subject to our jurisdiction and to ensure that those
institutions support fair access to financial services and fair
treatment of their customers. We carry out this mission through our
ongoing supervisory activities. Through these activities we evaluate
banks' compliance with applicable laws, regulations, and supervisory
requirements, and we assess whether they have adequate risk management
systems, controls, and capital to support the size, scope, and
complexity of their activities. Where we find weaknesses or violations,
we direct management to take appropriate and timely corrective action.
Provided that the bank has the requisite corporate governance, risk
management, and capital infrastructure to support risk taking, it is
not the job or role of an examiner to determine whether or what lines
of business, products, or strategic focus is appropriate--these are
decisions that the bank's board must make. Likewise, examiners do not
tell bankers which loans to make or deny. However, they will assess
whether such loans have been prudently underwritten, properly risk-
rated, and, if any show signs of trouble, are appropriately classified
and reserved for.
As I previously noted, one of the most difficult jobs we have in
carrying our this mission is knowing when and how hard to tap on the
brakes to rein in excessive risk taking without causing bankers to
become so conservative or uncertain about regulatory actions that they
unduly restrict credit. We are acutely aware that our actions--both on
the policy side at the 50,000 foot level, and on the ground, through
our on-site examinations--can and do influence banks' behavior and
their appetite for taking risk. We also recognize that in past
downturns, many believed that overzealous regulators and examiners
exacerbated the contraction in credit.
One of the lessons we learned is the detrimental effect of waiting
too long to warn the industry about excesses building up in the system,
resulting in bankers and examiners slamming on the brakes too hard when
the economy experienced problems. This is one reason why we are working
to develop better tools that will enable us to identify signs of
accelerating risk taking at an earlier stage when our actions can be
more modulated. We know that it is critical that our expectations for
bankers be clear and consistent, that the ``rules of the game'' under
which banks operate not be changed abruptly, and that changes in
regulatory policies are made in an open and transparent manner that
provides bankers with reasonable time frames to make necessary
adjustments. This will be especially true as bankers try to absorb and
comply with the myriad of rules and regulations that will result from
the implementation of the Dodd-Frank Act.
We are particularly mindful that new or changing regulatory
requirements can often have a disproportionate cost and burden on
community banks due to their limited size and resources. For this
reason, as we develop regulations, supervisory policies, and
examination standards, we strive to provide sufficient flexibility in
the application of those standards to reflect the size and complexity
of the institution. As the complexity and scope of a bank's activities
and its potential impact on the financial system increases, so do our
expectations for their internal controls and risk management systems.
To provide consistency and continuity in our supervision, we
organize our supervision programs around a common framework and
national perspective that is then supplemented by the hands-on
knowledge of our examiners. Our supervision by risk framework
establishes a common examination philosophy and structure that is used
at all national banks. This structure includes a common risk assessment
system (RAS) that evaluates each bank's risk profile across eight risk
areas--compliance, credit, interest rate, liquidity, operational,
price, reputation, and strategic--and assigns each bank an overall
composite rating and component ratings on the bank's capital adequacy,
asset quality, management, earnings, liquidity, and sensitivity to
market risks using the interagency Uniform Financial Ratings System
(informally known as CAMELS). Specific examination activities and
supervisory strategies are tailored to each bank's risk profile. These
strategies are updated and approved annually. While tailored to each
individual bank's risk profile, they also incorporate key agency
supervisory priorities for the coming year.
To reflect the different expectations for controls and risk
management between large and small banks, our bank supervision programs
and core examination procedures to determine a bank's RAS and CAMELS
ratings are aligned across two primary lines of business: Midsize and
Community Bank Supervision, and Large Bank Supervision. Upon full
integration of OTS, we will align Federal thrifts into these lines of
business.
Our community bank supervision program is built around our local
field offices located in over 60 cities throughout the U.S. Every
national community bank is assigned to an examiner who monitors the
bank's condition on an ongoing basis and who serves as the focal point
for communications with the bank. The primary responsibility for the
supervision of individual community banks is delegated to the local
Assistant Deputy Comptroller, who is under the oversight of a district
Deputy Comptroller, who in turn, reports to our Senior Deputy
Comptroller, Jennifer Kelly. The frequency of our on-site examinations
for community banks follows the statutory provisions set forth in 12
USC 1820(d), with on-site exams occurring every 12 to 18 months. The
scope of these examinations is set forth in the OCC's Community Bank
Supervision handbook and requires sufficient examination work and
transaction testing to complete the core assessment activities in that
handbook, and to determine the bank's RAS and CAMELS ratings. On-site
activities are supplemented by off-site monitoring and quarterly
analyses to determine if significant changes have occurred in the
bank's condition or activities.
Our Large Bank program is organized with a national perspective. It
is centralized and headquartered in Washington, and structured to
promote consistent uniform coordination across institutions. As part of
our Large Bank Supervision program, we maintain on-site resident
examination staff that conducts ongoing supervisory activities and
targeted examinations of specific areas of focus. This process allows
the OCC to maintain an ongoing program of risk assessment, monitoring,
and communication with bank management and directors. Given the volume
and complexity of the literally hundreds of thousands of transactions
that flow through large banking organizations, it is not feasible to
review every transaction in each bank, or for that matter, every single
product line or bank activity in each supervisory cycle. Nonetheless,
as in our community bank examinations, examiners must complete
sufficient work and transaction testing throughout the year to complete
the core assessment activities set forth in the OCC's Large Bank
Supervision handbook, and to determine the bank's RAS and CAMELS
ratings. The on-site teams at each bank are led by an Examiner-in-
Charge, who reports directly to the Deputy Comptrollers in our Large
Bank Supervision Office, and in turn, to our Senior Deputy Comptroller,
Mike Brosnan.
In January 2010, we updated and revised our RAS system as it
applies to both community and large banks to reflect and incorporate
lessons learned from the financial crisis. We also have directed
examiners to be more forward looking when they are assessing and
assigning RAS ratings. Specifically, when assessing direction of risk
for all risk categories, examiners should consider current practices in
the bank and how those practices, combined with other quantitative and
qualitative factors, affect direction of risk over the next 12 months.
For example, the direction of credit risk may be increasing if a bank
has relaxed its underwriting standards during a strong economic cycle,
even though the volume of troubled credits and credit losses remain
low. Similarly, the direction of liquidity risk may be increasing if a
bank has not implemented a well-developed contingency funding plan
during a strong economic cycle, even though existing liquidity sources
are sufficient for current conditions. We will be reinforcing this
message with our examination staffs at our upcoming staff conferences
in July that will bring together all of our examination staffs across
our lines of business and those examiners who are joining the OCC from
the Office of Thrift Supervision.
In both our Midsize and Community Bank Supervision and Large Bank
Supervision programs, we have mechanisms in place to ensure that our
supervisory policies and procedures are applied in a consistent and
balanced manner. Every report of examination is reviewed and approved
by the responsible ADC or Deputy Comptroller before it is finalized.
Both units have formal quality assurance processes that assess the
effectiveness of our supervision and compliance with OCC policies. Our
examination force is kept abreast of emerging issues and supervisory
policies through weekly email updates and periodic nationwide
conference calls, team meetings, and staff conferences.
A key element of the OCC's supervisory philosophy is open and
frequent communication with the banks we supervise. In this regard, our
senior management teams encourage any banker that has concerns about a
particular examination finding to raise those concerns with his or her
examination team and with the district management team that oversees
the bank. Should a banker not want to pursue those chains of
communication, our Ombudsman's office provides a venue for bankers to
discuss their concerns informally or to formally request an appeal of
examination findings. The OCC's Ombudsman is fully independent of the
supervisory process, and he reports directly to the Comptroller. In
addition to hearing formal appeals, the Ombudsman's office provides
bankers with an impartial ear to hear complaints and a mechanism to
facilitate the resolution of disputes with our supervisory staff.
The OCC also recognizes the importance of communicating regularly
with the industry outside of the supervision process to clarify our
expectations, discuss emerging issues of interest to the industry, and
respond to bankers' concerns. We participate in numerous industry-
sponsored events, as well as conduct a variety of outreach activities,
including Meet the Comptroller events, chief executive officer
roundtables, and teleconferences on topical issues.
V. Current State of Small Business and Real Estate Lending, Mortgage
Servicing, and Trading Lines of Business
The Subcommittee's letter of invitation noted the uncertainty that
remains in small business and real estate lending, mortgage servicing,
and trading, and requested the OCC's views on the state of those
business lines. Let me conclude with a brief overview of each.
A. Small Business Lending
National banks are significant providers of small business credit,
but discerning trends in small business lending is difficult due to the
variety of lending facilities that small business owners use for
financing. One proxy for a portion of small business lending is the
data collected in the quarterly Call Reports on commercial and
industrial loans in amounts less than $1 million and agricultural loans
less than $500,000. In the last few years, the outstanding balance of
these loans has declined, reflecting both demand and supply factors.
Mirroring trends in the broader economy, demand for credit by many
businesses has weakened as both businesses and their consumers have
scaled back spending and investments. It is also true that some
bankers, in response to deteriorating credit and economic conditions,
have become more risk averse and selective in their lending.
The OCC recognizes the important role of small businesses in the
economy, their dependence on banks for credit, and the difficulty that
some small business owners have reported in obtaining new credit or
renewing existing credit. In response to these concerns, in February
2010, the OCC and other Federal banking agencies issued a statement on
creditworthy small businesses. The statement is intended to facilitate
small business lending and provide bankers with more regulatory
certainty by outlining our expectations for prudent underwriting
practices. In this statement and in our ongoing discussions with
examiners and bankers, we reiterate our policies that we encourage
bankers to lend to creditworthy borrowers and to work constructively
with borrowers who may be facing difficulties, and that examiners
should take a balanced approach and not criticize banks that follow
sound lending practices.
We actively encourage national banks to participate in various
Government programs that are designed to support small business
lending. These include the Small Business Administration loan guarantee
programs and the $30 billion Small Business Lending Fund program
established as part of the Small Business Jobs Act of 2010. To-date
approximately 106 national banks have applied for this program, and we
are in the process of providing Treasury with information to assist
them in evaluating those requests.
There is some evidence that credit conditions for small business
lending are improving. In our recent annual credit underwriting survey,
a few respondents have eased small business underwriting standards in
anticipation of market growth and an opportunity to compete. Just over
half of the banks in the survey are planning to grow their small
business lending portfolio greater than 10 percent over the next year.
Many of the largest national banks have revamped and built up their
small business lending operations.
Despite these positive signs, the ongoing lack of sales revenue and
widespread uncertainty about the economy continue to hamper small
business owners' sentiments and bankers' ability to develop loan growth
in this market segment. In its May 2011 report on small business
economic trends, the National Federation of Independent Business (NFIB)
stated credit supply was not the problem for the overwhelming majority
of small business owners and that weak sales and uncertainty continue
to be major factors for the lack of credit demand. \2\ This uncertainty
is reflected in the NFIB's small business optimism index: while this
index has bounced back from the 2009 lows, its level has declined in
March and April. \3\
---------------------------------------------------------------------------
\2\ See, NFIB Small Business Economic Trends, May 2011, p. 2.
\3\ Ibid., p. 4.
---------------------------------------------------------------------------
B. Real Estate Lending
Commercial real estate lending is a prominent business line for
many national banks and is a sector that the OCC monitors very closely.
While there are signs that the commercial real estate markets are
beginning to stabilize, we are a long way away from a full recovery.
Vacancy rates across all major property types are starting to recover,
but remain high by historical standards. We expect vacancy rates to
remain elevated and recovery to be slow.
Capitalization rates--the rate of return demanded by investors--
have also shown recent signs of stabilization. Cap rates fell
substantially from 2002 through 2007 to a point where they often did
not fully reflect the risks associated with the properties being
financed. Then they increased markedly in 2008 and 2009 as investors
became more risk averse. Recently, cap rates appear to have stabilized,
particularly for high quality assets, but the spreads being demanded by
investors, relative to Treasuries, for lower quality assets remain
wide.
A key driver for property values and CRE loan performance is the
net operating income (NOI)--or cash flows--generated by the underlying
commercial properties. Overall, NOI has continued to decline due to
soft rental rates. While we expect the rate of decline to lessen, only
apartments are expected to show meaningful NOI growth this year, with
other major market segments expected to turn positive in 2012.
Property prices have also shown some signs of stabilization.
Although the Moody's All Property Index recorded a decline of 4.2
percent in March 2011, transaction volumes have increased. We expect
volatile prices until underlying market fundamentals improve
consistently.
The trends and performance of CRE loans within the national banking
system mirror those in the broader CRE market. While there are signs of
stabilization in charge-off rates and a decline in nonperforming loans,
levels remain elevated and continue to require significant attention by
bank management and supervisors. The effect of the distressed CRE
market on individual national banks varies by the size, location, and
type of CRE exposure. Because charge-off rates for construction loans
led performance problems in the sector, banks with heavier
concentrations in this segment tended to experience losses at an
earlier stage. Performance in this segment is expected to improve more
rapidly as the pool of potentially distressed construction loans has
diminished. In contrast, performance of income-producing commercial
mortgages continues to be more stressed and one that we continue to
monitor closely.
C. Mortgage Servicing
As the Subcommittee's letter of invitation references, the mortgage
servicing business is also under severe stress. Its business model was
already challenged by the mortgage crisis, and that challenge is now
compounded by widespread deficiencies in foreclosure processing.
Through our recent consent orders, the OCC is focused on fixing the
very serious problems we found in foreclosure processing; ensuring that
any borrowers harmed by shoddy practices receive appropriate remedies;
and getting mortgage markets operating again. Yet as Acting Comptroller
Walsh recently noted in his remarks before the Housing Policy Council
of the Financial Services Roundtable, additional challenges and
uncertainties loom ahead for this line of business. \4\ The new Basel
III framework will require that servicing rights beyond relatively
modest levels be deducted from capital for regulatory capital
calculations, effectively increasing the capital requirements for
mortgage servicers. The Dodd-Frank Act will impose a myriad of new
requirements that mortgage lenders will need to address. As the Acting
Comptroller noted, while each of these requirements individually have
merit, it is hard to predict how all of these requirements will work
together.
---------------------------------------------------------------------------
\4\ See, Remarks by John Walsh, Acting Comptroller of the
Currency, Before the Housing Policy Council of The Financial Services
Roundtable, May 19, 2011, available at: http://www.occ.gov/news-
issuances/speeches/2011/pubspeech-2011-60.pdf.
---------------------------------------------------------------------------
In addition to the requirements of Dodd-Frank, an important area
for reform in the mortgage servicing business is the need for uniform
mortgage servicing standards that apply to all facets of servicing the
loan, from loan closing to payoff. A number of months ago, to further
this effort and interagency discussions, the OCC developed a framework
for comprehensive mortgage servicing standards that we shared with
other agencies, and other agencies put forward their recommendations as
well. We now have underway an active interagency effort to develop a
set of comprehensive, nationally applicable mortgage servicing
standards. As an example, these standards would address:
Handling borrower payments, including applying payments to
principal and interest and taxes and insurance before they are
applied to fees, and avoiding payment allocation processes
designed primarily to increase fee income;
Providing adequate borrower notices about their accounts
and payment records, including a schedule of fees, periodic and
annual statements, and notices of payment history, payoff
amount, late payment, delinquency, and loss mitigation;
Providing an easily accessible single point of contact for
borrower inquiries about loss mitigation and loan
modifications;
Ensuring appropriate levels of trained staff to meet
current and projected workloads;
Responding promptly to borrower inquiries and complaints,
and promptly resolving disputes;
Providing an avenue for escalation and appeal of unresolved
disputes;
Effective incentives to work with troubled borrowers,
including early outreach and counseling;
Making good faith efforts to engage in loss mitigation and
foreclosure prevention for delinquent loans, including
modifying loans to provide affordable and sustainable payments
for eligible troubled borrowers;
Implementing procedures to ensure that documents provided
by borrowers and third parties are maintained and tracked so
that borrowers generally will not be required to resubmit the
same documented information;
Eliminating ``dual track'' processes where legal steps to
foreclose on a property or conduct a foreclosure sale go
forward even when a borrower has completed an application for a
loan modification or is in a trial or permanent modification
and is not in default on the modification agreement;
Notifying borrowers of the reasons for denial of a loan
modification, including information on the NPV calculation; and
Implementing strong foreclosure governance processes that
ensure compliance with all applicable legal standards and
documentation requirements, and oversight and audit of third
party vendors.
While we are at an early stage in this interagency process, the OCC
is optimistic that the agencies can achieve significant reforms in
mortgage servicing practices across the board for all types of mortgage
servicing firms. These types of standards should help put the mortgage
servicing business on sound footing for the future.
D. Trading Activities
Trading revenues in the banking system have been quite strong, as
the industry reported record trading revenues in both 2009 and 2010.
After a loss of $836 million in 2008, insured commercial banks reported
trading revenues of $22.6 billion and $22.5 billion in 2009 and 2010
respectively despite reductions in trading assets and risk. A key
driver of the strong results has been predominately one-way bull
markets as bonds, equities, commodities, and foreign currencies
rallied. In the first quarter of 2011, insured commercial banks added
another $7.4 billion in trading revenues. Notwithstanding the current
strength of trading revenues, however, there are a number of issues
that create uncertainty, and will likely limit, trading revenues
prospectively. Section 619 of the Dodd-Frank Act restricts many forms
of proprietary trading, but for banks, stand alone proprietary trading
has generally accounted for a relatively small portion of trading
activity, so the impact of this change should be limited. There are,
however, other provisions of the Act that could affect trading
activities at national banks. Legislative mandates to increase central
clearing may reduce trading activity generally and narrow profit
margins. Recently proposed swap margin rules require, for the first
time, initial margin for inter-dealer and dealer/financial end-user
trading activity, raising costs and potentially reducing the
transaction volumes that create revenue. Revenues from securitization
activities remain weak due to continued weakness in loan volumes and
underlying asset prices for housing. In addition, securitization
markets may be affected by uncertainty associated with implementation
of the Dodd-Frank Act risk retention requirements and proposed changes
in the regulatory capital treatment of mortgage servicing rights.
Finally, bull markets for the past 2 years have stimulated client
demand for risk management products, reduced market-making risk, and
increased interest income spread on market-making inventory resulting
from the steep yield curve. The potential for markets to be less
bullish and to become more volatile may put further pressure on bank
trading revenues.
VI. Conclusion
The financial crisis exposed fundamental weaknesses in risk
management and supervisory practices across the financial industry and
supervisory community. Numerous initiatives, including those mandated
by the Dodd-Frank Act, are underway to address these failures. The OCC
has and is continuing to take steps to enhance its supervision programs
and to implement its responsibilities under the Dodd-Frank Act. As we
implement these changes, we will strive to do so in a manner that, to
the greatest extent possible, continues to allow all U.S. financial
firms to compete fairly both within our own financial system and the
broader global economy. We are also mindful of the special role that
community banks play in our financial system and the disproportionate
burden that changing regulatory requirements can pose to these
entities. In this respect, our overarching goal and mission remains the
same--to assure the safety and soundness of the institutions under our
jurisdiction, to ensure that they treat their customers fairly, and in
carrying out this mission, to conduct our supervision in a balanced and
fair manner that reflects and is tailored to the risks posed by each
institution.
______
PREPARED STATEMENT OF SALVATORE MARRANCA
Director, President, and Chief Executive Officer, Cattraugus County
Bank, Little Valley, New York
June 15, 2011
Chairman Brown, Ranking Member Corker, and Members of the
Subcommittee, I am Sal Marranca, Director, President, and CEO of
Cattaraugus County Bank, a $174 million asset bank in Little Valley,
New York. I am pleased to be here today to represent the nearly 5,000
members of the Independent Community Bankers of America. Thank you for
convening this hearing on ``Enhancing Safety and Soundness: Lessons
Learned and Opportunities for Continued Improvement.''
The safety and soundness of our banking system is a significant
concern to community banks. Early in my career, I was a Senior Bank
Examiner with the FDIC for over a decade, and the commitment I made
then to safety and soundness I still carry with me today as President
of Cattaraugus County Bank and as Chairman of ICBA.
The recent financial crisis was caused by high risk lending and
speculation by the megabanks and Wall Street firms. Significant harm
was done to taxpayers and the economy. Community banks too were harmed.
The economic decline retracted consumer spending and dramatically
reduced the demand for credit. Residential and commercial real estate
markets remain stressed in some areas. Still, the community banking
industry remains well capitalized and--because we take a conservative,
commonsense approach to lending--we have fewer problem assets than
other segments of the industry.
We must ensure the crisis never repeats itself, and appropriate
supervision of all financial services providers is an important part of
that. But how safety and soundness is achieved is very important.
Misguided, though well intentioned, efforts could be very economically
damaging. Frankly, many community bankers are deeply frustrated with
the current exam environment, which has consistently registered as a
top concern among ICBA members.
Difficult Exam Environment
As we consider the topic of safety and soundness, we must remember
that community banks did not cause the financial crisis, nor are they a
source of ongoing systemic risk. Community banks have a starkly
different risk profile from other financial services providers because
of their smaller scale, which precludes systemic risk, and more
importantly, because they practice conservative, common sense lending
to customers they often know personally. This different risk profile
must be taken into consideration as policy makers consider how
community banks should be examined. Community banks are eager to make
prudent loans in their communities, and as we consider ways to enhance
safety and soundness, we must not tip the scale into actions that will
suffocate economic activity. Safety and soundness is a very real
concern, but so is the seemingly intractable unemployment that has
plagued our economy for nearly 3 years. Smart examination and
compliance practices will allow for more lending without creating undue
risk to the financial system.
Specifically, exams could be greatly improved by being more
consistent and rational. This would encourage prudent lending without
loosening standards. Arbitrary exams chill lending indiscriminately--
sound loans as well as risky loans. There are more thoughtful,
systematic ways to reduce risk without discouraging sound lending.
I'm fortunate to enjoy a cooperative and constructive working
relationship with my regulator, the FDIC. I value this relationship
very highly. It is an important part of the success of my bank and has
allowed me to weather the financial crisis. Having worked as a bank
examiner, I've been on both sides of the table and can appreciate the
concerns and challenges examiners face. It's a difficult job with a
great deal at stake. The stakes were raised sharply after the financial
crisis, but I believe many examiners overreacted and the pendulum has
swung too far in the direction of overregulation. I've met with
thousands of community bankers from every part of the country in recent
years, and I can tell you there is an unmistakable trend toward
arbitrary, micromanaged, unreasonably harsh examinations that have the
effect of suffocating lending.
This has not always been the case. Before the crisis, examiners
frequently worked in partnership with the banks they examined. They
were a resource, a help in interpreting often ambiguous guidance. Where
corrections were needed, opportunity was given to make them, and
compliance was a mutual goal. This was the model of examination I
followed when I was an examiner. I believed then and still believe
today it is the best means of achieving safety and soundness without
interfering with the business of lending. Currently, the relationships
are too often adversarial. Understandably, an examiner does not want to
be blamed for the next crisis. Examiners are not evaluated on banks'
contributions to the economy. At all costs, they want to avoid a bank
failure that would put a black mark on their record. The examiner's
incentive is to err on the side of writing down too many loans,
demanding too much capital.
The crisis was not caused by a failure to adequately examine
community banks, but examiners have reacted to the crisis with
overreaching exams that have harmed the economy and made it harder to
emerge from the recession.
A particularly frustrating aspect of the exam environment is the
disconnect between the examiners in the field and the directives from
Washington. A November 2008, Interagency Statement on Meeting the Needs
of Creditworthy Borrowers established a national policy for banks to
extend credit to creditworthy borrowers in order to help initiate and
sustain an economic recovery. It stated, ``The agencies expect all
banking organizations to fulfill their fundamental role in the economy
as intermediaries of credit to businesses, consumers, and other
creditworthy borrowers.'' Unfortunately, this policy is often neglected
by examiners in the field, especially in the regions most severely
affected by the recession. Field examiners are second guessing bankers
and independent professional appraisers. They are demanding
unreasonably aggressive write-downs and reclassifications of viable
commercial real estate loans and other assets. The misplaced zeal of
these examiners is having a chilling effect on lending. Good loan
opportunities are passed over for fear of examiner write-down and the
resulting loss of income and capital. The contraction in credit is
having a direct, adverse impact on the recovery.
Furthermore, examiners are demanding capital levels higher than
those required by regulation. To bankers, the process feels arbitrary
and punitive. Many community banks complain that the required capital
level goalpost is unpredictable. Regulators simply keep moving it
further, making it nearly impossible to satisfy capital demands in a
difficult economy and capital marketplace. So bankers are forced to
pull in their horns and pass up sound loan opportunities in order to
preserve capital. This is not helpful for their communities and
economic growth. Bankers used to expect prompt feedback that they could
act on immediately as part of the exam process. Quick, useful feedback
has been replaced by examination reports that follow months after the
examiner's visit, with no opportunity for the banker to sit down with
the examiner, go over the results, and respond to the examiner's
concerns on the spot.
Legislative Help Is Needed
ICBA supports legislation to bring more consistency to the
examination process. With regard to loan classifications, for example,
one of community bankers' greatest concerns, a bill recently introduced
in the House would establish criteria for determining when a loan is
performing and thereby provide for more consistent classifications.
When loans become troubled often the best course for the borrower,
lender, and the community is a modification that will keep the loan out
of foreclosure. But in recent years, many examiners have penalized loan
modifications by aggressively placing loans on nonaccrual status
following a modification--even though the borrower has demonstrated a
pattern of making contractual principal and interest payments under the
loan's modified terms. This adverse regulatory classification results
in the appearance of a weak capital position for the lender, which
dampens further lending in the community and puts a drag on the
economic recovery. Representative Bill Posey's Common Sense Economic
Recovery Act of 2011 (H.R. 1723) would establish conservative,
commonsense criteria for loan classifications.
Community bankers enthusiastically support this bill because it
resonates with their experience in examination. It would give bankers
flexibility to work with struggling but viable borrowers and help them
maintain the capital they need to support their communities. We hope a
counterpart bill will soon be introduced in the Senate and considered
by this Committee.
Consumer Financial Protection Bureau
The new Consumer Financial Protection Bureau (CFPB) presents
another potential challenge to the safety and soundness of community
banks, which will be subject to its rules though institutions with less
than $10 billion in assets are exempt from primary examination. Because
the CFPB is not charged with protecting safety and soundness, and does
not have experience or expertise in this area, there is a real risk
CFPB rules could promote consumer protection at the expense of safety
and soundness. For example, any rule that interferes with a bank's
ability to price for risk in a given product, or that disrupts an
important revenue stream, could compromise safety and soundness.
Prudential regulators, on the other hand, have long experience with
regulating consumer protection in the context of safety and soundness.
This is why ICBA supports legislation that would give prudential
regulators a stronger voice in CFPB rulemaking.
There are different ways of accomplishing this. One example is a
bill recently passed by the House Financial Services Committee. The
Consumer Financial Protection Safety and Soundness Improvement Act,
sponsored by Representative Sean Duffy, would strengthen prudential
regulatory review of CFPB rules, which is extremely limited under the
Dodd-Frank Act. Prudential regulators have the ability to comment on
CFPB proposals before they are released for comment and an extremely
limited ability to veto regulations before they become final. This veto
can only be exercised if, by a \2/3\ vote, the Financial Stability
Oversight Council (FSOC) determines that a rule ``puts at risk the
safety and soundness of the banking system or the stability of the
financial system,'' a standard that is nearly impossible to meet. A
rule that doesn't meet this high standard could nevertheless do
extraordinary harm to banks and consumers. H.R. 1315 would change the
voting requirement for an FSOC veto to a simple majority, excluding the
CFPB Director, and change the standard to allow for a veto of a rule
that ``is inconsistent with the safe and sound operations of United
States financial institutions.'' While this change would improve CFPB
rulemaking, ICBA has proposed language that would further broaden the
standard to allow FSOC to veto a rule that could adversely impact a
subset of the industry in a disproportionate way. We believe that this
standard would give prudential regulators a more meaningful role in
CFPB rule writing.
Communities First Act
The ICBA-backed Communities First Act (CFA, H.R. 1697) captures
many reforms the community banking sector deems necessary to alleviate
the difficult regulatory burden they face, including a change to the
FSOC veto standard for CFPB rules very similar to H.R. 1315 discussed
above. This legislation was recently introduced in the House and
cosponsored by members from both sides of the aisle. ICBA is working to
introduce a similar bill in the Senate. Notably CFA would:
Increase the threshold number of bank shareholders from 500
to 2,000 that trigger SEC registration. Annual SEC compliance
costs are a significant expense for listed banks.
Reduce the paperwork burden that acts as a dead-weight cost
for community banks, consuming scarce resources that could
support lending.
Defer taxation of interest on long-term certificates of
deposits and tax the interest at capital gains rates so more
consumers are rewarded for saving and investing.
Extend the 5-year net operating loss (NOL) carryback
provision to free up community bank capital now when it is most
needed to boost local economies.
These and other provisions would improve the regulatory environment
and community bank viability, to the benefit of their customers and
communities.
Moral Hazard and Too-Big-To-Fail Institutions
The greatest threat to safety and soundness remains the too-big-to-
fail institutions that dominate the financial services sector. Today,
the four largest banking companies control more than 40 percent of the
Nation's deposits and more than 50 percent of the assets held by U.S.
banks. The largest banks have grown larger since the financial crisis.
The ten largest hold 77 percent of all U.S. bank assets compared with
55 percent of total assets in 2002, according to a recent Bloomberg
study. ICBA does not believe it is in the public interest to have 10
institutions controlling a significant majority of the assets of the
banking industry. A more diverse financial system would reduce risk and
promote competition, innovation, and the availability of credit to
consumers of various means and businesses of all sizes.
As a result of the financial crisis, our Nation went through an
agonizing series of forced buy-outs or mergers of some of the Nation's
largest banking and investment houses, costing American taxpayers
hundreds of billions of dollars. Some mega-institutions--too-big-to-
fail and also too big-to-be-sold to another firm--were directly propped
up by the Government. One large institution, Lehman Brothers, was
allowed to go bankrupt, with disastrous consequences that only
confirmed the policy of too-big-to-fail. The doctrine of too-big--or
too-interconnected--to-fail finally came home to roost, to the
detriment of the American taxpayer and our economy. Our Nation cannot
afford to go through that again. Systemic risk institutions that are
too big or interconnected to manage, regulate or fail should either be
broken up or required to divest assets until they no longer pose
systemic risk.
In a speech made as the country was emerging from the crisis,
Federal Reserve Chairman Ben S. Bernanke outlined the risks of the too-
big-to-fail system:
The belief of market participants that a particular firm is
considered too big to fail has many undesirable effects. For
instance, it reduces market discipline and encourages excessive
risk-taking by the firm. It also provides an artificial
incentive for firms to grow in order to be perceived as too big
to fail. And it creates an unlevel playing field with smaller
firms, which may not be regarded as having implicit Government
support. Moreover, Government rescues of too-big-to-fail firms
can be costly to taxpayers, as we have seen recently. Indeed,
in the present crisis, the too-big-to-fail issue has emerged as
an enormous problem.
Unfortunately, Government interventions necessitated by the too-
big-to-fail policy have exacerbated rather than abated the long-term
problems in our financial structure. Through Federal Reserve and
Treasury orchestrated mergers, acquisitions and closures, the big have
become bigger. A recent Bloomberg Government study concluded that the
number of too-big-to-fail banks will increase by 40 percent over the
next 15 years.
Government efforts to stabilize the financial system, though
necessary to stave off a full scale financial collapse and even deeper
recession, were deeply unfair to community banks. The Government bailed
out too-big-to-fail institutions, while the FDIC summarily closed too-
small-to-save institutions, victims of a crisis created on Wall Street.
Community bankers across the country were deeply angered by the results
of too big to fail.
This is why ICBA generally supports the too-big-to-fail measures in
the Dodd-Frank Act. These include measures to prevent firms from
getting too big; offset the advantages of being too big; more diligent
monitoring for systemic risk; subject large, interconnected firms to
enhanced capital and prudential standards; and create a resolution
authority for large firms so the Government is never again forced to
choose between propping up a failing firm and allowing it to fail and
wreak havoc on the financial system. However, whether the Dodd-Frank
Act will succeed in ending the market perception that large,
interconnected firms are too big to fail will largely depend on the
implementing rules and how diligently they are enforced in the coming
months and years.
Housing Finance Reform, If Not Done Properly, Could Lead to Industry
Concentration
Key aspects of the housing finance system--the rules governing
underwriting, risk retention, servicing, foreclosure, securitization,
and the structure of secondary market entities--are facing review and
revision. This is an expected and appropriate response to the housing-
driven financial and economic crisis we've just experienced. But we
must recognize that ill-considered changes--singly and cumulatively
across a number of areas--could unintentionally reduce competition,
amplify moral hazard, and jeopardize safety and soundness.
Specifically:
The agencies ``qualified residential mortgage'' (QRM)
exemption from the Dodd-Frank risk retention requirement on
mortgages sold and securitized should be sufficiently broad to
encompass the majority of the residential mortgage market,
consistent with stronger underwriting standards. Because risk
retention will require increased capital, which will pose a
challenge for community banks, a narrow definition of QRM will
drive thousands of community banks and other lenders from the
residential mortgage market, leaving it to the largest lenders
whose actions brought about the financial crisis. In our view,
the QRM definition currently proposed by the banking agencies,
which includes a 20 percent downpayment requirement, is too
narrow.
While policy makers are rightly alarmed by the sloppy and
abusive servicing standards of some large lenders, they must
recognize that community banks have fundamentally different
standards, practices, and risks. With smaller servicing
portfolios, better control of mortgage documents, and close
ties to their customers and communities, community banks have
generally been able to identify repayment problems at the first
signs of distress and work out mutually agreeable solutions
with struggling borrowers. Overly prescriptive servicing
requirements--a burden for community banks which do not have
the staffing and financial resources to implement extensive new
programs--could cause many community banks to exit the mortgage
servicing business and accelerate consolidation of the
servicing industry with only the largest too-big-to-fail
lenders surviving.
As proposals for replacing Fannie Mae and Freddie Mac are
considered, policy makers should be extremely careful not to
recreate the moral hazard they represented. Some of the
proposals put forward would, by allowing just a small number of
large banks to dominate the secondary mortgage market, create a
new variety of moral hazard, just as pernicious as the old
variety. Any solution that fuels consolidation is only setting
up the financial system for an even bigger collapse than the
one we've just been through.
Policy makers must proceed with caution in housing finance reform.
The mortgage market is critical to the broader economy, as we learned
during the recent crisis, and the potential for unintended consequences
is significant.
Conclusion
Thank you again for convening this hearing and giving ICBA the
opportunity to testify. We share your commitment to enhancing the
safety and soundness of our financial system and hope that the
community bank perspective has been valuable.
______
PREPARED STATEMENT OF FRANK A. SUELLENTROP
Chairman and President, Legacy Bank, Colwich, Kansas
June 15, 2011
Chairman Brown, Ranking Member Corker, and Members of the
Subcommittee, thank you for the opportunity to testify before you today
regarding the topic of ``Enhancing Safety and Soundness: Lessons
Learned and Opportunities for Continued Improvement.''
My name is Frank Suellentrop and I am President and Chairman of
Legacy Bank in Colwich, Kansas. We are a $250 million closely held
community bank providing banking services to the area of Sedgwick
County, Kansas. We have five branch locations: our charter bank
location in Colwich, Kansas, population 1,400, and four branch
locations in the Wichita, Kansas, community.
Our bank was established in February 1886, which means that we are
celebrating 125 years in 2011. I am fourth generation President of our
bank with over 38 years of employment at Legacy Bank. I have been
President of our bank since 1991. From that experience, I have seen the
beginnings of consumer regulation in the early 1970s, the agriculture
crisis, the savings and loan and real estate crisis of the 1980s and
early 1990s, and now, the Wall Street-induced real estate crisis of
2008.
Legacy Bank is significantly involved in residential development,
residential construction, and commercial property lending and
therefore, has been impacted greatly by the economic slowdown and
depressed real estate market values. Fortunately, the economy in the
Wichita, Kansas, area has fared reasonably well throughout the current
crisis relative to other markets, primarily due to the fact that
Kansas, specifically Wichita, had not experienced inflated real estate
values of the past decade.
I would like to preface my comments regarding a recent examination
by saying that I understand examiners are charged with a difficult
task. On one hand, they are expected to protect against bank failures,
insure consumer compliance and regulation are adhered to, satisfy
community groups and organizations demand for fair banking practices,
and Congressional demands for banking/financial oversight. On the other
hand, regulators are/should be tasked with not interfering with a
bank's corporate mission of creating value for its shareholders. Legacy
Bank is a ``for-profit'' corporation. Our most recent 2010 examination
revealed stark differences from prior exams: higher capital and
liquidity standards, more demanding asset quality evaluations,
expectations for higher allowance for loan and lease loss reserves
(ALLL), and increased focus on management assessment and compensation
practices.
Comments made by regulators during our last exam include, ``We
don't like your risk profile'' and ``We're not going `to bat' for you
in Washington.'' To put the first comment in context, our bank has been
a lender to residential real estate developers, homebuilders, and
commercial property owners since the late 1980s. We feel our lending
staff has the experience and knowledge to manage our loan portfolio
composition. These comments were significantly more aggressive compared
to prior examination observations. Due to recent failures or problem
banks in other areas of the country, our lending ``risk profile'' is
now unacceptable. In addition to standard loan underwriting criteria of
evaluating a borrower's capital, collateral, capacity to repay, and
market conditions, we have added a new component to our loan approval
discussion process--``Will the loan pass examiners' review and
approval?'' This component should not be a loan approval consideration.
A customer's loan request should be based on its viability and
productive value. With respect to the latter comment, it illustrates a
regulatory attitude that all banks in real estate lending are unsafe
and unsound in their practices.
Banks are evaluated based on their CAMELS component ratings, which
measures a bank's capital, asset quality, management, earnings,
liquidity, and sensitivity to interest rates. My comments on each of
these bank evaluation components under the current regulatory
environment are provided below.
Capital
Capital standards for most banks are being dictated above levels
for regulatory defined ``well-capitalized' banks and standards required
for our Nation's largest financial institutions. Regulators are using
their discretionary capital standards caveat to demand capital levels
above those banks defined as ``well-capitalized.'' Capital below the
mandated Tier-One and risk-based levels are likely to receive a lower
``capital component,'' which may subject banks to a ``troubled bank''
status. Discretionary capital standards create a difficult moving
target for banks as we seek to achieve an acceptable capital component
rating.
Asset Quality
Examiners are slow to recognize when credit risk has been
mitigated. Classifications are inconsistent. No credit given for past
performance of the borrower. Some classifications are backdated after
the borrower begins to show improvement.
Management
Management compensation is now being reviewed by examiners,
suggesting potential negative impact to earnings and capital. Without
significant discussion during our last examination, examiner comments
dictated a requirement that we justify management compensation and
benefits. Somehow ``Wall Street'' excesses on executive pay have crept
into regulators view of ``Main Street'' banking compensation practices
when there is no valid comparison to their abuses.
Earnings
Earnings evaluations are focused on budget expectations and provide
a source of capital growth. Budgets are a fluid document where changes
occur relative to changing market conditions. Variances occur
throughout the year and are detailed in monthly review of performance
vs. a rebudgeting process as suggested by an examiner.
Liquidity
Current examination expectations dictate a higher level of
liquidity to protect against the ``what ifs'' for funding assets.
Examiners are reluctant to recognize the value of purchased funding
costs vs. core deposit funding. Levels of purchased funding should be
variable to the institution and not an industry standard.
At each examination, an Examiner in Charge (EIC) is designated. My
experience with this practice is that often an EIC does not want to
overrule another examiner's findings regarding loan quality issues or
other components of an examination. On completion of an examination,
EIC comments are submitted to a Review Examiner. The Review Examiner
then does not want to overrule an EIC's submitted comments; therefore,
the process can be problematic for bankers where an inexperienced or
unqualified examiner's findings become a part of the ``report of
examination.'' These results then become a part of the final report for
bank examination ratings and mandated actions to address findings. Only
experienced examiners capable of managing others' activities should be
designated as an ``Examiner in Charge'' to insure quality in a final
report of examination. Recourse for bankers disputes regarding
examination findings are often treated as we agree to disagree by
examiners.
In summary, micromanaging is unproductive. Part of the regulator's
role is to offer insight into latest industry trends and issues.
Instead, exam outcomes now seem predetermined with enforcement actions
imposed for minor issues that do not enhance a bank's viability. To
move forward in a productive, mutually beneficial manner, there should
be more focus on the root cause of examination findings. Examiners
should expect results, but if capital is solid and management is
capable, then overregulation is unnecessary. Regulatory burden and
examiner expectations are disproportionate in their impact on community
banks vs. the largest banks. Many community banks have a limited staff
to respond to examiner expectations vs. the largest banks full-time
staff devoted to regulatory compliance.
Thank you again for the opportunity to comment. I hope that this
testimony provides productive insight into the current regulatory
environment for community banks.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM MICHAEL R. FOLEY
Q.1. What is the purpose of the Commercial Bank Examination
Manual? While certain sections were updated in April (which was
identified as ``Supplement 35''), it appears that there has
been no comprehensive review and update of the entire manual.
Does the Federal Reserve intend to conduct a comprehensive
rewrite of this manual? Why or why not?
A.1. Response not provided.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM MICHAEL R. FOLEY
Q.1. Examination Staffing--Recent reports indicate the Federal
banking agencies are increasing their on-site examination teams
at the largest banks. For each of the six largest banking
organizations that your agency respectively supervises today,
please detail: (a) how many examiners you have had dedicated to
supervising each such organization for each year beginning in
2005 through the present; (b) whether those examiners resided
on-site at the firm's headquarters permanently, whether those
examiners resided on-site occasionally for examination periods,
or whether those examiners remained at the agency (and if so,
which office/Reserve Bank); and (c) what the principal
responsibilities of those examiners were (for example, data
analysis of risk models, supervising management compliance with
policies and procedures, etc.).
For those 6 largest banking organizations, please also
quantify the number of personnel at each banking organization
working in the risk management group, or the internal audit
department.
A.1. Response not provided.
Q.2. Examination Staffing--Please provide specific detail
regarding the methodology you used/use for determining how many
examiners you dedicate to firms you supervise. Please provide
other information relevant to staffing levels and practices for
your examinations, such as the FTE examination hours applicable
per $10 billion of assets at the 10 largest banking
organizations and the FTE examination hours applicable for $10
billion of assets at all other banking organizations.
A.2. Response not provided.
Q.3. Examination Staffing--During the 2005 through 2010 period,
please detail the dates on which peer reviews or other internal
reviews were conducted within your organizations that evaluated
the sufficiency of examination staffing for the six largest
institutions under your supervision. Please state the staffing
conclusions for each such peer review.
A.3. Response not provided.
Q.4. Interagency Cooperation--Senior examiners have indicated
that the largest banking organizations run their businesses
without respect to the legal entity involved, and that specific
business operations can straddle entities with different
regulatory jurisdictions. In light of Dodd-Frank, how has the
communication among agencies changed? When multiple regulators
oversee a banking organization, what procedures do you have in
place to review and follow-up on concerns raised by one
regulator when such concerns may touch upon oversight conducted
by other regulators or the entire firm?
A.4. Response not provided.
Q.5. Investigations--The HUD Inspector General has recently
issued findings that at least one major financial institution
has obstructed a State attorneys general investigation and a
HUD investigation into foreclosure and servicing abuses. What
specific steps have you taken to ensure that all institutions
under your supervision are complying with both your supervision
and with relevant investigations by other regulatory agencies
and law enforcement officials?
A.5. Response not provided.
Q.6. Documentation Oversight--Following the robosigning scandal
and the difficulty some banks have had documenting the claim of
ownership on mortgages on which they are pursuing foreclosure,
what steps have you taken to increase oversight of
documentation requirements at large complex financial
institutions?
A.6. Response not provided.
Q.7. International--What systems do you have in place or do you
envision needing to ensure the proper supervision of large
complex foreign financial institutions which either operate in
the U.S. or which materially affect U.S. financial markets?
A.7. Response not provided.
Q.8. Trading Book--For the firms that now make up the six
largest bank holding companies, what percentage of losses by
those firms on a consolidated basis during the 2008 financial
crisis were due to losses in their respective trading books as
opposed to their banking books? Please include within that
analysis assets which would have been losses had those assets
not been transferred from the trading book to the banking book
and therefore not subject to fair value accounting. Also
include in those losses assets or positions that were placed on
the books of that national bank, after the outbreak of the
crisis, such as the liquidity puts that were used to bring back
CDQs onto a bank's balance sheet.
Please provide relevant data/analysis as appropriate.
A.8. Response not provided.
Q.9. Review of Trading Operations Under FRB Manuals--Section
2030.3 of the Federal Reserve's Commercial Bank Examination
Manual, in effect since March 1994, lists certain specific
procedures that examiners are expected to conduct in their
supervision of commercial banks' trading operations. For
example it asks examiners to ``test for compliance with
policies, practices, procedures, and internal controls . . . ''
(#3); requests a series of schedules, including ``an aged
schedule of securities,'' ``an aged schedule of trading account
securities . . . held for trading or arbitrage purposes,'' ``a
schedule of loaned securities,'' etc. (#4); requests the
examiner to ``review customer ledgers, securities position
ledgers, etc., and analyze the soundness of the bank's trading
practices by . . . reviewing a representative sample of agency
and contemporaneous principal trades . . . and reviewing
significant inventory positions taken since the prior
examination'' (#9).
Today, some of the largest bank holding companies conduct
their derivatives trading operations directly through Federal
Reserve-regulated member banks. How frequently do examiners
conduct the reviews directed by section 2030.3? Under what
circumstances will you discipline an examination team for
failing to follow policies and procedures set out in agency
manuals--please describe up to three examples?
A.9. Response not provided.
Q.10. Safety and Soundness Review of Trading Operations--The
Federal Reserve Trading and Capital Markets manual sets out a
wide range of approaches to monitoring firms' trading
activities, in particular focusing on whether firms have in
place policies and procedures to monitor risks. As part of this
monitoring of risks, on what occasions might you make an
independent evaluation of the trading positions themselves on a
safety and soundness basis, rather than simply the policies and
procedures regarding risk management?
For example, the former CEO of one large banking group said
he couldn't be bothered with his firm's $43 billion dollar
exposure on subprime CDOs because he had a $2 trillion balance
sheet to manage. However, that $43 billion dollar exposure
represented \1/3\ of the group's capital. Meanwhile, community
bank examiners regularly examine the substance of large loans
for conformance with safety and soundness. Under what
circumstances would a trading position such as the one outlined
above be reviewed for the underlying risk by your examiners?
Please detail at least three examples in the last 5 years.
How has oversight of trading activities changed between
prefinancial crisis and now?
A.10. Response not provided.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN
FROM DAVID K. WILSON
Q.1. In a speech in London yesterday, Acting Comptroller Walsh
cited a 2007 study which stated that ``there is widespread
agreement in the theoretical academic literature that the
immediate effects of constraining capital standards are likely
to be a reduction in total lending and accompanying increases
in market loan rates and substitution away from lending to
holding alternative assets.'' If this was true prior to the
financial crisis, when this study was conducted, it is no
longer the case today. There now appears to be widespread
agreement that equity is not expensive and that increased
capital buffers are a good thing.
In August of 2010, Professor Anat Admati and several of her
colleagues published a paper explaining that requiring banks to
increase their funding through equity will not contract
lending.
David Scharfstein and Jeremy Stein of Harvard University
argued last September in the Financial Times that increased
capital will make institutions safer, and actually reduce the
risk of a credit crunch.
A study by the Bank for International Settlements suggests
an optimal capital ratio of about 13 percent.
A Government-sponsored panel in Switzerland has said that
massive banks UBS and Credit Suisse should hold a 19 percent
capital buffer.
The Bank of England is reportedly considering capital
ratios as high as 20 percent.
In his recent testimony before the Congressional Oversight
Panel of TARP (COP), Professor Allan Meltzer noted that large
banks in the 1920s held capital equal to 15 to 20 percent of
their assets.
In response to written questions pursuant to a February
hearing in the Senate Banking Committee, FDIC Chairman Sheila
Bair stated, ``we do not agree that the new [capital]
requirements will reduce the availability of credit or
significantly raise borrowing costs.''
a. Do you believe that equity is expensive despite the work
of respected academics showing that it is not?
b. What are the costs of increasing banks funding through
equity?
c. What other evidence, aside from the study cited by Mr.
Walsh, supports your conclusion that banks increasing their
equity funding would be expensive and contract lending?
d. Does the OCC have any evidence suggesting that the
alleged costs of additional equity funding outweigh the costs
associated with undercapitalization at rates below those
required by Basel III combined with an additional SIFI capital
buffer?
e. What does the OCC believe to be the optimum capital
buffer?
A.1. Response not provided.
Q.2. According to a June 12th report in the Financial Times,
OCC data shows that nearly 20 percent of private label
mortgage-backed securities held by banks are at least 30 days
late or in some stage of foreclosure. Amherst Securities
estimates that 30 percent of mortgages contained in PLS held by
outside investors are at least 60 days delinquent.
The COP estimates that, at the end of the third quarter
2010, the four largest banks reported $420.0 billion in second
lien mortgages. The OCC sent a letter to Representative Brad
Miller in December in which you estimated that banks' total
losses on second liens would not exceed $18 billion.
COP estimates that banks are subject to $52 billion in
mortgage-backed security put-back claims. Institutional Risk
Analytics estimates that JPMorgan Chase alone is subject to $50
billion in investor claims under the Securities Act.
a. What losses does the OCCproject the banks to incur on
their private label MBS holdings? Please provide a specific
number, and please explain the assumptions and rationale behind
your calculation.
b. What losses does the OCC project banks to incur on their
second lien portfolios? Please provide a specific number, and
please explain the assumptions and rationale behind your
calculation.
c. What losses does the OCC project banks to incur through
investors' securities claims? Please provide a specific number,
and please explain the assumptions and rationale behind your
calculation.
A.2. Response not provided.
Q.3. In February, Acting Comptroller Walsh testified that
``[mortgage servicing] deficiencies have resulted in violations
of State and local foreclosure laws, regulations, or rules.''
a. In written questions for that hearing I asked Mr. Walsh
what specific laws, regulations, or rules were violated. The
only specific laws cited were State attestation and
notarization laws. In a subsequent answer, he noted violations
of the Servicemembers Civil Relief Act, bankruptcy law, and
mortgage modification programs.
i. Please list all of the violations of specific laws,
regulations, or rules--either local, State, or Federal--that
your reviews uncovered.
ii. How many violations of each law, regulation, or rule
did you uncover?
b. The Treasury Department was unable to determine in 18.8
percent of Bank of America's HAMP files whether a second look
had been conducted, and there were income miscalculations in 22
percent of cases. The numbers for JPMorgan Chase were 11.3
percent and 31 percent, respectively.
Mr. Walsh noted in his written responses that ``Documents
in the foreclosure files may not have disclosed certain facts
that might have led examiners to conclude that a foreclosure
should not have proceeded however, such as misapplication of
payments that could have precipitated a foreclosure action or
oral communications between the borrower and servicer staff
that were not documented in the foreclosure file.''
i. What other errors did you uncover in your reviews that
might have led examiners to conclude that a foreclosure should
not have proceeded? Please describe every error that you
uncovered.
ii. How many files reviewed by the OCC contained such
errors?
A.3. Response not provided.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM DAVID K. WILSON
Q.1. Please provide a response to May 12, 2011, questions that
were submitted to the Office of the Comptroller of the Currency
(OCC). No response has been received to date.
A.1. Response not provided.
Q.2. What is the purpose of the Comptroller's Handbook? What
revisions have been made to the Comptroller's Handbook to
address observations from the financial crisis? When will there
be a comprehensive rewrite?
A.2. Response not provided.
Q.3. Please describe the specific changes you have made to the
training programs for examiners in response to matters observed
during the financial crisis.
A.3. Response not provided.
Q.4. What reliance do you place on a bank's internal control
system? What basis do you have for that reliance? Describe what
work the OCC has done to be assured that there are no
significant weaknesses the agency is inherently relying on.
Please describe any meetings that the OCC has had with the
Public Company Accounting Oversight Board (PCAOB) to discuss
any weaknesses the OCC identified in the internal control?
Please indicate the date of such meetings and the substance of
the matters discussed.
Please describe any meetings that the OCC has had with the
Securities and Exchange Commission (SEC) about such weaknesses.
Please indicate the date of such meetings and the substance of
the matters discussed.
A.4. Response not provided.
Q.5. Describe the facts and circumstances, if any, that may
prevent principal reduction, whether structured as forbearance
or forgiveness, from being considered as a viable option in
mortgage modifications. Please indicate whether the agency has
taken any position with respect to mortgage servicer accounting
for all forms of mortgage modifications. Please include any
guidance provided to servicers or other regulators, including
the date and substance of the guidance provided.
A.5. Response not provided.
Q.6. Describe the facts, circumstances, and relevant accounting
guidance that applies to accounting for mortgage modifications
by mortgage servicers. Please provide internal or external
guidance.
A.6. Response not provided.
Q.7. Describe the facts, circumstances, and relevant accounting
guidance that concerns servicers consolidation of
securitization trusts. Please describe the total mix of
information considered, including all quantitative and
qualitative factors, with respect to defining ``significance.''
Please indicate the reasons that servicers have or have not
consolidated securitization trusts as a result of recently
implemented generally accepted accounting principles (including
SFAS Nos. 166 and 167). Please include specific discussion of
anticipated losses as a result of servicer conduct that is the
subject of the OCC Consent Orders and other reviews.
A.7. Response not provided.
Q.8. Provide the data that serves as the basis for the
statement made by Mr. Walsh on June 21, 2011, ``Capital levels
are now extraordinarily high by historical standards.'' Please
include the period of time considered and the relevant
quantitative measure at each interval.
A.8. Response not provided.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM DAVID K. WILSON
Q.1. Examination Staffing--Recent reports indicate the Federal
banking agencies are increasing their on-site examination teams
at the largest banks. For each of the six largest banking
organizations that your agency respectively supervises today,
please detail: (a) how many examiners you have had dedicated to
supervising each such organization for each year beginning in
2005 through the present; (b) whether those examiners resided
on-site at the firm's headquarters permanently, whether those
examiners resided on-site occasionally for examination periods,
or whether those examiners remained at the agency (and if so,
which office/Reserve Bank); and (c) what the principal
responsibilities of those examiners were (for example, data
analysis of risk models, supervising management compliance with
policies and procedures, etc.).
For those 6 largest banking organizations, please also
quantify the number of personnel at each banking organization
working in the risk management group, or the internal audit
department.
A.1. Response not provided.
Q.2. Examination Staffing--Please provide specific detail
regarding the methodology you used/use for determining how many
examiners you dedicate to firms you supervise. Please provide
other information relevant to staffing levels and practices for
your examinations, such as the FTE examination hours applicable
per $10 billion of assets at the 10 largest banking
organizations and the FTE examination hours applicable for $10
billion of assets at all other banking organizations.
A.2. Response not provided.
Q.3. Examination Staffing--During the 2005 through 2010 period,
please detail the dates on which peer reviews or other internal
reviews were conducted within your organizations that evaluated
the sufficiency of examination staffing for the six largest
institutions under your supervision. Please state the staffing
conclusions for each such peer review.
A.3. Response not provided.
Q.4. Interagency Cooperation--Senior examiners have indicated
that the largest banking organizations run their businesses
without respect to the legal entity involved, and that specific
business operations can straddle entities with different
regulatory jurisdictions. In light of Dodd-Frank, how has the
communication among agencies changed? When multiple regulators
oversee a banking organization, what procedures do you have in
place to review and follow-up on concerns raised by one
regulator when such concerns may touch upon oversight conducted
by other regulators or the entire firm?
A.4. Response not provided.
Q.5. Investigations--The HUD Inspector General has recently
issued findings that at least one major financial institution
has obstructed a State attorneys general investigation and a
HUD investigation into foreclosure and servicing abuses. What
specific steps have you taken to ensure that all institutions
under your supervision are complying with both your supervision
and with relevant investigations by other regulatory agencies
and law enforcement officials?
A.5. Response not provided.
Q.6. Documentation Oversight--Following the robosigning scandal
and the difficulty some banks have had documenting the claim of
ownership on mortgages on which they are pursuing foreclosure,
what steps have you taken to increase oversight of
documentation requirements at large complex financial
institutions?
A.6. Response not provided.
Q.7. International--What systems do you have in place or do you
envision needing to ensure the proper supervision of large
complex foreign financial institutions which either operate in
the U.S. or which materially affect U.S. financial markets?
A.7. Response not provided.
Q.8. Trading Book--For the firms that now make up the six
largest bank holding companies, what percentage of losses by
those firms on a consolidated basis during the 2008 financial
crisis were due to losses in their respective trading books as
opposed to their banking books? Please include within that
analysis assets which would have been losses had those assets
not been transferred from the trading book to the banking book
and therefore not subject to fair value accounting. Also
include in those losses assets or positions that were placed on
the books of that national bank, after the outbreak of the
crisis, such as the liquidity puts that were used to bring back
CDQs onto a bank's balance sheet.
Please provide relevant data/analysis as appropriate.
A.8. Response not provided.
Q.9. Review of Trading Operations Under FRB Manuals--Section
2030.3 of the Federal Reserve's Commercial Bank Examination
Manual, in effect since March 1994, lists certain specific
procedures that examiners are expected to conduct in their
supervision of commercial banks' trading operations. For
example it asks examiners to ``test for compliance with
policies, practices, procedures, and internal controls . . . ''
(#3); requests a series of schedules, including ``an aged
schedule of securities,'' ``an aged schedule of trading account
securities . . . held for trading or arbitrage purposes,'' ``a
schedule of loaned securities,'' etc. (#4); requests the
examiner to ``review customer ledgers, securities position
ledgers, etc., and analyze the soundness of the bank's trading
practices by . . . reviewing a representative sample of agency
and contemporaneous principal trades . . . and reviewing
significant inventory positions taken since the prior
examination'' (#9).
Today, some of the largest bank holding companies conduct
their derivatives trading operations directly through Federal
Reserve-regulated member banks. How frequently do examiners
conduct the reviews directed by section 2030.3? Under what
circumstances will you discipline an examination team for
failing to follow policies and procedures set out in agency
manuals--please describe up to three examples?
A.9. Response not provided.
Q.10. Safety and Soundness Review of Trading Operations--The
Federal Reserve Trading and Capital Markets manual sets out a
wide range of approaches to monitoring firms' trading
activities, in particular focusing on whether firms have in
place policies and procedures to monitor risks. As part of this
monitoring of risks, on what occasions might you make an
independent evaluation of the trading positions themselves on a
safety and soundness basis, rather than simply the policies and
procedures regarding risk management?
For example, the former CEO of one large banking group said
he couldn't be bothered with his firm's $43 billion dollar
exposure on subprime CDOs because he had a $2 trillion balance
sheet to manage. However, that $43 billion dollar exposure
represented \1/3\ of the group's capital. Meanwhile, community
bank examiners regularly examine the substance of large loans
for conformance with safety and soundness. Under what
circumstances would a trading position such as the one outlined
above be reviewed for the underlying risk by your examiners?
Please detail at least three examples in the last 5 years.
How has oversight of trading activities changed between
prefinancial crisis and now?
A.10. Response not provided.
Q.11. Your testimony on page 24 [Editor: See, Page 51, Part D,
of this hearing] regarding section 619 suggests a narrow view
of proprietary trading that seems to envision a world wherein
all proprietary trading occurs on distinct, separate stand-
alone proprietary trading desks.
Please provide details on what, if any, analysis the OCC
has made on the conflicts of interest and risks to institutions
from proprietary trading wherever it may occur, and
particularly that which occurs on market-making desks and in
other business units of a firm, such as securitization-
structured product underwriting and merchant banking.
For example, the U.S. Permanent Subcommittee on
Investigations found that large, conflicted proprietary trading
activities of one firm occurred on its mortgage desks, which
were non- stand-alone proprietary trading desks. How does the
OCC identify those conflicts and risks now and what new forms
of oversight are you contemplating putting in place to ensure
the statutory intent of section 619 is implemented?
A.11. Response not provided.
Additional Material Supplied for the Record
STATEMENT SUBMITTED BY THE AMERICAN BANKERS ASSOCIATION
Chairman Brown, Ranking Member Corker, and Members of the
Subcommittee, the American Bankers Association appreciates the
opportunity to submit this statement for the record on ways to enhance
safety and soundness in the aftermath of the financial crisis. The ABA
represents banks of all sizes and charters and is the voice of the
Nation's $13 trillion banking industry and its two million employees.
The topic of this hearing is very important. In an effort to deal
with the aftermath of the financial crisis, the response by Congress
and the regulators has been to drive out all the risk from the system
in the name of safety and soundness. This has meant that good loans
that could and should be made are left unfunded. The pendulum has swung
too far in favor of tighter regulation, micromanagement, and second-
guessing. This has made the daily efforts of banks to make credit and
financial services available much more difficult. Combined with
hundreds of new regulations expected from the Dodd-Frank Act, these
pressures are slowly but surely strangling traditional community banks,
handicapping their ability to meet the credit needs of communities
across the country.
Congress must be vigilant in overseeing regulatory actions that
unnecessarily restrict loans to creditworthy borrowers. Holding
oversight hearings like this one is critical to ensure that banks are
allowed to do what they do best--namely, meet the credit needs of their
communities.
For banks to be successful and meet the needs of their customers,
they need to be profitable. There is no better assurance of safety and
soundness than a healthy, profitable industry. Once again, Congress and
the regulators have acted to reduce sources of income, made it much
harder to raise capital, and threaten to drive some banks completely
out of business lines, such as acting as municipal advisors or making
residential mortgage loans.
One of those very important sources of income that will be
significantly diminished is a direct result of the Durbin Amendment in
the Dodd-Frank Act that imposes severe restrictions on interchange
prices. The ABA and the thousands of banks we represent were deeply
disappointed with the outcome of Senate vote last week. Failure to
approve the bipartisan amendment sponsored by Senators Tester (D-
Mont.), Corker (R-Tenn.), and others to address the serious concerns
over the interchange amendment marks a dark day for every bank that
issues debit cards and for consumers that have come to rely on them.
American consumers will now have to pay more for basic banking
services, while big-box retailers go off and count their unjustified
profits. Community banks--the backbone of local communities--will
suffer the most. They will see a reduction in a key source of revenue
that allows them to offer low-cost banking services to everyday
consumers and supports lending and fraud protection measures. Key
banking regulators--including Federal Reserve Board Chairman Ben
Bernanke and FDIC Chairwoman Sheila Bair--have unequivocally stated
that small banks will be harmed by the implementation of the Durbin
Amendment. While a majority of Senators supported the Tester/Corker
amendment, it is simply unconscionable that the Senate will not
complete the work and protect community banks from this destructive
effect.
It is within the Federal Reserve's power to mitigate the disastrous
consequences that are sure to come from this policy initiative, and we
urge the Fed to take all necessary action to do so.
The entire banking industry thanks Senators Tester and Corker--and
the other 52 senators that stood up for debit card customers--for their
extraordinary effort to address this serious problem in a constructive
and deliberate way.
The remainder of this statement focuses on several key issues:
Driving all the risk out of the system means slower
economic and job growth;
Access to New Capital for Community Banks is Problematic;
and
Restrictions may drive banks out of some lines of business
altogether.
I. Driving All the Risk out of the System Means Slower Economic and Job
Growth
ABA believes that it is a mistake for policy makers to apply the
most restrictive approach to every bank. By swinging the pendulum too
far in the direction of minimizing risk, the Dodd-Frank Act risks
choking off important banking activity that can and should be done by
banks--particularly by banks that had no hand in creating the financial
crisis. It is important to keep that pendulum close to the center in
order to encourage diversity and innovation.
The health of the banking industry and the economic strength of the
Nation's communities are closely interwoven. ABA strongly believes that
our communities cannot reach their full potential without the local
presence of a bank--a bank that understands the financial and credit
needs of its citizens, businesses, and Government. This model will
collapse under the massive weight of new rules and regulations. The
vast majority of banks never made an exotic mortgage loan or took on
excessive risks. They had nothing to do with the events that led to the
financial crisis and are as much victims of the devastation as the rest
of the economy. These banks are the survivors of the problems, yet they
are the ones that pay the price for the mess that others created.
Managing this mountain of regulation will be a significant
challenge for a bank of any size. For the median-sized bank with only
37 employees this burden will be overwhelming. The new rules create
more pressure to hire additional compliance staff, not customer-facing
staff. They mean more money spent on outside lawyers to manage the risk
of compliance errors and litigation. They mean more money to hire
consulting firms to assist with the implementation of all of the
changes, and more money to hire outside auditors to verify there are no
compliance errors. They mean more risk of regulatory scrutiny, which
can include penalties and fines. All of these expenditures take away
precious resources that could be better used serving the bank's
community.
The consequences are real. Costs are rising, access to capital is
limited, and revenue sources have been severely cut. It means that
fewer loans get made. It means a weaker economy. It means slower job
growth. With the regulatory overreaction, piles of new laws, and
uncertainty about Government's role in the day-to-day business of
banking, meeting local community needs is difficult at best. Without
quick and bold action to relieve regulatory burden we will witness an
appalling contraction of the banking industry.
II. Access to New Capital for Community Banks Is Problematic
Banks have to be profitable and provide a reasonable return to
investors. If they do not, capital quickly flows to other industries
that have higher returns. Capital is critical as it is the foundation
upon which all lending is built. Having sufficient capital is critical
to support lending and to absorb losses when loans are not repaid. In
fact, $1 worth of capital supports up to $10 in loans. Most banks
entered this economic downturn with a great deal of capital, but the
downward spiral of the economy has created losses and stressed capital
levels. Not surprisingly, when the economy is weak, new sources of
capital are scarce.
The timing of the Dodd-Frank limitations on sources of capital
could not have been worse, as banks struggle to replace capital used to
absorb losses brought on by the recession. While the market for trust
preferred securities (which had been an important source of capital for
many community banks) is moribund at the moment, the industry needs the
flexibility to raise capital through various means in order to meet
increasing demands for capital. Moreover, the lack of readily available
capital comes at a time when restrictions on interchange and higher
operating expenses from Dodd-Frank have already made building capital
through retained earnings more difficult.
These limitations are bad enough on their own, but the consequences
are exacerbated by bank regulators piling on new requests for even
greater levels of capital. Many community banks have told us that
regulators are pressing banks to increase capital-to-assets ratios by
as much as 4 to 6 percentage points--50 to 75 percent--above minimum
standards. For many banks, it seems like whatever level of capital they
have, it is not enough to satisfy the regulators. This is excess
capital not able to be redeployed into the market for economic growth.
Thus, to maintain or increase capital-to-assets levels demanded by
the regulators, these banks have been forced to limit, or even reduce,
their lending. The result: the banking industry becomes smaller while
loans become more expensive and harder to get.
While more capital certainly can improve safety and soundness, it
ignores the fundamental fact that banks are in the business of taking
risk--every loan made runs the risk of not being repaid. Ever-
increasing demands for more capital are dragging down credit
availability at the worst possible time for our Nation's recovery.
Moreover, it works at cross purposes with banks' need for the strong
and sustainable earnings that will be the key to addressing asset
quality challenges. Therefore, anything that relieves the increasing
regulatory demands for more capital will help banks make the loans that
are needed for our Nation's recovery.
III. Regulatory Risk and Uncertainty Are Rising, Reducing Incentive To
Lend
Businesses--including banks--cannot operate in an environment of
uncertainty. Unfortunately, Dodd-Frank increases uncertainty for banks,
and as a consequence, raises credit risks, raises litigation risks and
costs (for even minor compliance issues), leads to less hiring or even
a reduction in staff, makes hedging risks more difficult and costly,
and restricts new business outreach. All of this translates into less
willingness to make loans. In fact, banks' biggest risk has become
regulatory risk. Four examples help to illustrate this increase in
regulatory risk and uncertainty:
First, the nature and extent of rules from the Consumer Financial
Protection Bureau are unknown, but uncertainty about the potential
actions creates potential litigation risk as actions taken today may
conflict with the changes in rules devised by the Bureau. The
expectation of significant new disclosures, for example, translates
into less willingness to lend (and therefore less credit extended
overall), and higher costs to borrowers that still have access to
credit to cover the added risks and expenses assumed by banks.
A second important example of uncertainty and unease created by
Dodd-Frank arises from the provisions regarding preemption. Congress
explicitly preserved in the Dodd-Frank Act the test for preemption
articulated by the United States Supreme Court for deciding when a
State law is preempted by the Federal laws that govern national banks'
activities. Nevertheless, any mention of the preemption standard in a
statute is likely to generate lawsuits from those who argue that the
standard somehow has changed. The Dodd-Frank Act preemption provisions
will affect all banks, including State-chartered banks and thrifts that
benefit from wildcard statutes. State attorneys general will have
greater authority to enforce rules and regulations, specifically
including those promulgated by the Consumer Financial Protection
Bureau. The potential changes and risk of litigation necessarily reduce
the willingness of banks to lend to any business or individual with
less than a stellar credit history.
Third, Government involvement in price controls--such as the Durbin
Amendment on interchange fees--sets a dangerous precedent, suggesting
that financial institutions may be subject to future, unknowable price
controls on other financial products and services, undermining
important free-market principles. Banks have always accepted the
operational, reputational, and financial risk associated with
developing new products and services and making them available to
millions of consumers. Now financial institutions risk losing their
investments of billions of dollars into improvements of existing
products and services, and the creation of new ones, through Government
price controls. Why would any business invest in an innovative product
knowing the Government ex post facto will interfere by imposing price
controls? The Durbin Amendment serves as a strong disincentive for
innovation and investment by financial institutions in other emerging
payment systems and financial products and services. In the end, it is
the American public who suffers.
The fourth uncertainty relates to the implementation of the swap
rules. Banks do not know yet how the swaps exchanges will operate, what
impact the clearing requirements will have on banks' ability to
customize swaps, or even which banks and transactions will be subject
to each of the new rules. For example, while other end users will be
exempt from complex and costly clearing requirements, we are waiting to
find out if our community banks will receive the same treatment. If
not, then these banks might not be able to use swaps and the end result
would be reduced lending, increased risk for banks, and higher costs
for customers if banks cannot hedge the risk.
We urge Congress to actively oversee the Commodity Futures Trading
Commission (CFTC) and SEC as they implement the new swaps requirements
to be sure there are no adverse affects on lending or competition for
U.S. banks. We also encourage Congress to enact legislation explicitly
granting small banks the same exemption from swaps clearing
requirements that is available to other end users.
IV. Restrictions May Drive Banks Out of Some Lines of Business
Altogether
Safety and soundness is best protected when banks are able to meet
the credit needs of their customers. This is what is so disturbing
about the implementation of some rules under Dodd-Frank that would
effectively drive banks out of lines of businesses altogether. This not
only hurts the customers, but also means less income--and less
diversified sources of income--that forms the base of financial health
for any bank. New rules on registration as municipal advisors and on
mortgage lending are two particularly problematic provisions.
Proposed SEC municipal advisor rules could limit banking options for
State and local governments.
ABA believes that Dodd-Frank intended to establish a regulatory
scheme for unregulated persons providing advice to municipalities with
respect to municipal derivatives, guaranteed investment contracts,
investment strategies or the issuance of municipal securities. Most
community banks do not deal in bonds or securities. But banks do offer
public sector customers banking services and are regulated closely by
several Government agencies.
The Securities and Exchange Commission has proposed a very broad
definition of ``investment strategies'' that would cover traditional
bank products and services such as deposit accounts, cash management
products and loans to municipalities. This means that community banks
would have to register as municipal advisors and be subject to a whole
new layer of regulation on bank products for no meaningful public
purpose. The result of this duplicative and costly regulation is that
banks may decide not to provide banking services to their local
municipalities--forcing these local and State entities to look outside
of their community for the services they need. This proposal flies in
the face of the President's initiative to streamline Federal oversight
and avoid new regulations that impede innovation, diminish U.S.
competitiveness, and restrain job creation and economic expansion.
We urge Congress to oversee this implementation and ensure that the
rule addresses unregulated parties and that neither Section 975 of
Dodd-Frank nor its implementing regulation reaches through to
traditional bank products and services.
New proposed mortgage rules likely to drive many community banks out of
mortgage lending.
ABA has grave concerns that the risk retention proposal issued by
the regulators will drive many banks from mortgage lending and shut
many borrowers out of the credit market entirely. Responding to
widespread objections from consumer groups, banks, and Senators and
Congressman, the regulators extended the comment period from June 10th
to August 1st. While more time for commenting on such a far reaching
regulatory proposal is welcome, what is really necessary is for the
rule to be withdrawn in its current form and substantially
reconsidered.
It is true that the proposal's immediate impact is muted by the
fact that loans sold to Fannie Mae and Freddie Mac while they are in
conservatorship escape risk retention. However, once the rule's
requirements are imposed broadly on the market (should they be adopted)
they would likely shut out many borrowers entirely and act to
destabilize the housing market once again. Since it is also the stated
goal of both the Congress and the Administration to end the
conservatorship of Fannie and Freddie, it is important that risk
retention requirements be rational and nondisruptive when they are
applied broadly to the market. The rule as proposed does not meet those
tests.
Therefore, ABA urges Congress to ensure that the regulators revise
the risk retention regulation before it is imposed on the mortgage
market broadly. Specifically we recommend:
Exemption from risk retention provisions must reflect
changes in the market already imposed through other
legislative and regulatory change.
In the Dodd-Frank Act, Congress determined that some form of risk
retention was desirable to ensure that participants in a mortgage
securitization transaction had so-called ``skin in the game.'' The goal
was to create incentives for originators to assure proper underwriting
(e.g., ability to repay) and incentives to control default risk for
participants beyond the origination stage. There have already been
dramatic changes to the regulations governing mortgages. The result is
that mortgage loans with lower risk characteristics--which include most
mortgage loans being made by community banks today--should be exempted
from the risk retention requirements--regardless of whether sold to
Fannie Mae and Freddie Mac or to private securitizers.
Exempting such ``qualified residential mortgage'' loans (QRM) is
important to ensure the stability and recovery of the mortgage market
and also to avoid capital requirements not necessary to address
systemic issues. However, the QRM as proposed is very narrow and many
high-quality loans posing little risk will end up being excluded. This
will inevitably mean that fewer borrowers will qualify for loans to
purchase or refinance a home. Instead, the QRM definition should more
closely align with the proposed QM definition promulgated by the
Federal Reserve Board. The QM definition (as proposed) focuses on a
borrower's ability to repay and allows originators to measure that
ability with traditional underwriting tools. The proposed QRM rule, in
contrast, takes most underwriting decisions away from originators in
favor of rigid loan to value and other targets.
For example, for the loan to qualify for QRM status, borrowers must
make at least a 20 percent downpayment--and at least 25 percent if the
mortgage is a refinancing (and 30 percent if it is a cash-out
refinance).
Certainly loans with lower loan-to-value (LTV) ratios are likely to
have lower default rates, and we agree that this is one of a number of
characteristics to be considered. However, the LTV should not be the
only characteristic for eligibility as a ``Qualified Residential
Mortgage,'' and it should not be considered in isolation. Setting the
QRM cutoff at a specific LTV without regard to other loan
characteristics or features, including credit enhancements such as
private mortgage insurance, will lead to an unnecessary restriction of
credit. To illustrate the severity of the proposal, even with private
mortgage insurance, loans with less than 20 percent down will not
qualify for the QRM.
ABA strongly believes that creating a narrow definition of QRM is
an inappropriate method for achieving the desired underwriting reforms
intended by Dodd-Frank.
The Risk Retention Requirements as proposed will inhibit
the return of private capital to the marketplace
and will make ending the conservatorship of Fannie
Mae and Freddie Mac more difficult.
The proposal presented by the regulators will make it vastly more
difficult to end the conservatorship of Fannie and Freddie and to
shrink FHA back to a more rational portion of the mortgage market. As
noted above, under the proposed rule, loans with a Federal guarantee
are exempt from risk retention--which includes loans sold to Fannie Mae
and Freddie Mac while they are in conservatorship and backed by the
Federal Government. FHA loans (as well as other federally insured and
guaranteed loan programs) are also exempt. Since almost 100 percent of
new loans today being sold are bought by Fannie and Freddie or insured
by FHA--and as long as these GSEs can buy loans without risk
retention--it will be dramatically more difficult for private
securitizers to compete. In fact, the economic incentives of the
proposed risk retention strongly favor sales of mortgages to the GSEs
in conservatorship and not to private securitizers. Thus, this proposal
does not foster the growth of private label securitizations that would
reduce the role of Government in backing loans.
Equally important is the fact that the conservatorship situation is
unsustainable over the long term. That means that eventually, these
highly narrow and restrictive rules would apply to a much, much larger
segment of the mortgage market. That means that fewer borrowers will
qualify for these QRM mortgage loans and the risk retention rules make
it less likely that community banks will underwrite non-QRM--but
prudent and safe--loans. Some community banks may stop providing
mortgages altogether as the requirements and compliance costs make such
a service unreasonable without considerable volume. Driving community
banks from the mortgage marketplace would be counterproductive as they
have proven to be responsible underwriters that have served their
borrowers and communities well. Instead of exempting the GSEs from risk
retention, the QRM should also factor in the underwriting requirements
of the GSEs. If a loan meets those requirements (which we anticipate
will evolve to conform with any new QM definition) and is thus eligible
for purchase by the GSEs, it should also be exempt from risk retention
requirements. More closely conforming the QM, QRM, and GSE standards
will set the foundation for a coherent and sustainable secondary
mortgage market.
The imposition of risk retention requirements to improve
underwriting of mortgage loans is a significant change to the operation
of the mortgage markets and must not be undertaken lightly. ABA urges
Congress to exercise its oversight authority to assure that rules
adopted are consistent with the intent of the statute and will not have
adverse consequences for the housing market and mortgage credit
availability.
Conclusion
Safety and soundness is best protected by created an environment
where banks can make good business decisions and take prudent risks.
Unfortunately, the pendulum has shifted too far in favor of driving out
risk entirely and constant second-guessing of banks' decisions.
Ultimately, it is consumers that bear the consequences of
Government imposed restrictions. The loss of interchange income will
certainly mean higher costs of using debit cards for consumers. Greater
mortgage restrictions and the lack of certainty on safe harbors for
qualified mortgages means that community banks may no longer make
mortgage loans or certainly not as many. Higher compliance costs mean
more time and effort devoted to Government regulations and less time
for our communities. Increased expenses often translate into layoffs
within the bank.
This all makes it harder to meet the needs of our communities. Jobs
and local economic growth will slow as these impediments inevitably
reduce the credit that can be provided and the cost of credit that is
supplied. Fewer loans mean fewer jobs. Access to credit will be
limited, leaving many promising ideas from entrepreneurs without
funding. Capital moves to other industries, further limiting the
ability of banks to grow. Since banks and communities grow together,
the restrictions that limit one necessarily limit the other.
Lack of earning potential, regulatory fatigue, lack of access to
capital, limited resources to compete, inability to enhance shareholder
value, and return on investment, all push community banks to sell. The
Dodd-Frank Act drives all of these in the wrong direction and is
leading to consolidations. The consequences for local communities are
real.
The regulatory burden from Dodd-Frank and the excessive regulatory
second-guessing must be addressed in order to give all banks a fighting
chance to maintain long-term viability and meet the needs of local
communities everywhere.