WORD ON THE STREET: I am the president and chairman of a $250 million closely held community bank providing banking services to Sedgwick County, Kan. We have five branch locations: our charter bank location in Colwich, Kan. (population 1,400) and four branch locations in the Wichita, Kan., community.
Our 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 area has fared reasonably well throughout the current crisis relative to other markets, primarily due to the fact that Kansas – specifically Wichita – did not experience inflated real estate values of the past decade.
I understand that examiners are charged with a difficult task. On one hand, they are expected to protect against bank failures, ensure consumer compliance and regulation are adhered to, and satisfy community groups' and organizations' demand for fair banking practices and congressional demands for banking/financial oversight. On the other hand, regulators are – or should – be tasked with not interfering with a bank's corporate mission of creating value for its shareholders.
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, and an 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 the 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 ‘CAMEL’ component ratings, which measure a bank's capital, asset quality, management, earnings, liquidity and sensitivity to interest rates.
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 is given for the borrowers' past performance. 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 versus a re-budgeting 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 versus 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 oftentimes, an EIC does not want to overrule another examiner's findings regarding loan-quality issues or other components of an examination. Upon 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 ensure 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, micro-managing is unproductive. Part of the regulator's role is to offer insight into the 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 over-regulation is unnecessary. Regulatory burden and examiner expectations are disproportionate in their impact on community banks versus the largest banks. Many community banks have limited staff to respond to examiner expectations versus the largest banks' full-time staff devoted to regulatory compliance.
Frank A. Suellentrop is president and chairman of Legacy Bank, headquartered in Colwich, Kan. This article is edited and adapted from testimony delivered June 15 before the Senate Banking Committee's Subcommittee on Financial Institutions and Consumer Protection. The original text is available online.
