SINK, DON'T SWIM

We've spoken in general terms about the difficulties a bank's directors and management face when hit with regulatory enforcement. The orders are complex, compliance challenging, and often contradictory.

The devil is definitely in the details, and the details are vital, with very unpleasant consequences for non-compliance.

But there's one thing that's absolutely essential to the suvival of the bank:

Be profitable.

Management and directorates get so focused on getting a hall pass from the regulators just to use the restroom that making money may not get the attention it needs.

Bad assets engender operational losses, and these are the two primary factors that trigger a supervisory love letter from Uncle Sam. The beleaguered bank can't make the bad assets go awy; only time (and deep pockets) will heal that wound. Unfortunately, the one thing that management does have a modicum of control over, operational profit, will be very difficult to accomplish.

And, if you're not profitable, you're dead. Next to liquidity (the ability to pay out withdrawals) there's no element of banking that the reulators monitor more closely. If a bank is under an enforcement actgion, core profit, that is, profit from traditional banking activities, must be demonstrated.

If it isn't, it won't matter how meticulously management meets the order's reporting deadlines, or how well structured the new policies and procedures are. even capital injections lose their impact if the capital account is constantly be drained by red ink on the operational side.

There myriad reasons why achieving profitability can be almost impossible if a bank is under an enforcement action. Actually, it's a corporate work release program. You get to go to work in the morning, but often little else.

For one thing, the bank's main business line may have been taken from it. For example, if a major activity was construction lending, then,inevitably,the bank's asset problems will involve construction loans. It can be counted on that the Cease and Desist order from the regulators will mandate no further construction lending. Period.

It won't say, "Make good construction loans", or "Make them carefully". Rather, it'll be, "What is it that you don't understand about DON'T?".

So, it's likely your previous business model has been suddenly terminated. The bank has to find a new revenue producing business line,fast. And it has to pass regulatory muster, which isn't easy considering that the short list of acceptable activities is pretty short.

Some points to carefully consider:

• How will yoou make money out a new activity? Obviously, the bank hasn't made big money doing it previously.
• Who's going to do it? The bank's current specialists aren't going to turn into new experts overnight, and you don't have much time to make the transition..
• The bank's current management and staff may simply not have the time to realign the business model. They're working on problem asset mitigation and enforcement compliance, which is pretty much a full time job.
• You don't have a lot of rope. Positive results must be quickly apparent.

For a bank, being under a regulatory enforcement action is kind of like being dumped from a boat a couple of miles from land without a life jacket. You're making good progress swimming for shore when the Coast Guard comes along and says, "Stop swimming, tread water".

"But if I do that, I'll eventually drown".

"Hmmm"

Under the circumstances, calling on competent outside help may be essential to survival.

QUOTE OF THE WEEK:

No mercy

"I did not run for office to help out a bunch of fat cat bankers on Wall Street".

President Barack Obama

THE GAME NEEDS NEW BLOOD!

Well, we're a couple of years into the recession, and I hope we're all enjoying ourselves. Contrary to informed predictions, the sun has come up every morning, it still rises in the east, and the home team continues to break your heart.

So, where to we go from here?

Civilization as we know it did not end, but things on the financial front will be different for some time. The lessons learned will control banking and the movement of money for, probably, at least a decade (or until we forget how much the recession hurt, whichever comes first)

For sure, we've learned that Americans can't be allowed to play Monopoly without close supervision, and the playground supervisors aren't any smarter than the kids on the merry-go-round. (See Madoff, Bernie)

There's a universal realization that we don't play well with real money, and it's hampering the recovery. Everybody's afraid to make a move; the consequences are simply too dire. Many banks can't lend because of problem assets and regulatory fiat that virtually shut off the discretionary lending that's vital to a vibrant economy. Those that can lend are afraid to; if they have few problems, the want to keep it that way, so robust or even conservative lending is being put on the back burner for the duration. And nobody knows what the duration might be.

In the second quarter, outstanding bank loans took the sharpest drop since the statistic was instituted in 1984. The Fed is pumping stimuli into the economy, and bank regulators are chomping like beavers to dam it up before banks, who've proven themselves irresponsible, get crazy all over again and lend it out.

Want to see a creature roll up into a ball like an armadillo? Just threaten a regulator's job and pension. No regulator ever got fired for saying "no". Many have been fired for saying "yes".

I would be great if somebody besides Uncle Sam would get in the banking business. Better for the taxpayers, for sure. Private capital is starting to wake up from hibernation and is sniffing around for investments. There are some banks out there for sale that have relatively few problems, and could do some exciting things for their investors,customersandthe economy. But the federal regulatory agencies are making it almost impossible for private purchasers to cut a deal, for fear, apparently, that entrepreneurs can't be trusted.

I've spoken to some of these groups. They're levelheaded business people with conservative business plans. But the supervisory agencies, smarting from media and congressional criticism for being lax, simply aren't letting private capital in the door.

The business of banking involves making a profit on the movement of money. If it doesn't move, the recession will last a lot longer than anybody wants to imagine.

The world economy needs new players and fresh capital. The feds need to let them suit up and get into the game.

OBSERVATION OF THE WEEK:

Boards of troubled banks often don't know the trouble their in, or how to navigate their institution through the maze of regulatory sanctions. More on that in the next posting.

RAP SHEET:



I've been in banking since I got out of the Marine Corps in 1961. I had a wife, a six month old son and no job. So, I answered an ad for "mtg. trainee", not knowing what that was. Turns out it meant "mortgage trainee". As luck would have it, (or not) I was hired.



So, I haven't had a real job in 48 years. I've been a trainee; I've been (whispers) a banker.



Experience is one thing they can't take away from me. I've seen more bubbles than Mark Phelps. I survived the Savings and Loan debacle of the late 80's and got to see the debris as a consultant and during a short regulatory gig. At the time, I thought that banking poobahs couldn't ever do anything more stupid than during those years.



Of course, turns out I was wrong.



I was the president of a de novo thrift in Aspen, Colorado that was chartered in 1973 and sold in 1985 that was banking success story driven by the good fortune of being in the right place at the right time with the right business model.



I was the president Colorado Federal Savings Bank, another de novo, started in 1990 that looked like it might be repeat of the Aspen experience. In 2003 and 2004 the bank was in the top five nationally in profitability for institutions under $100 million. The operation was run as a mortgage banker with net branches across the country. Whoops; wrong place, wrong time, wrong business model.



We managed to find an acquirer in 2008 before Uncle Sam stepped in. Doesn't sound like much, but it was quite an accomplishment, even if we got virtually nothing for 18 years of work.



There isn't an aspect of mortgage lending that I haven't, at one time or another, considered myself an expert at, and then found out I wasn't.



In all of this time, I've learned a few things. Here are three of them:

• Bankers can be very smart, and yet do very dumb things.


• I was never as smart as I thought I was when things went well, or as dumb as I viewed myself when they went badly.


• And, to paraphrase Bobby Kennedy on politicians (and he got it from somebody else): "To be a banker, you've got to be smart enough to do it, and dumb enough to think it's important".

This blog takes an irreverant, contrary view of banking in a variety of its aspects, from Wall Street to Elm Street, and the elements that contributed to to the Great (Made in America) Recession of 2007.

INTEREST RESERVES:

Now, that's a nice gimmick that you'll hear a lot about today, especially if you overhear regulator talk.

It's one of those neat arrangements that make co-conspirators drool. A bank makes a loan to a developer of a commercial property, subdivision or to build a spec house and says, "Bubba, not only are we making you a loan so you can get fabulously rich, but you're not even gonna have to pay interest while you've got the loan". Then the bank lends extra money to pay the interest. The borrower doesn't pay a dime out of pocket.

A while back I talked to a developer who had an interest reserve on his loan, plus a very low rate; something like 3.5 or 4%. The loan had matured, no units had been sold, and the bank said it could extend the loan only if there was a big principal reduction and realistic rate of 8% or so.

The borrower's comment was instuctive: "I couldn't pay four percent. How am I supposed to pay eight?"

Back in the day, right after the S&L's went kerplunk, bank regulators frowned on interest reserves, which were responsible for masking bad loans until it was too late. In fact, they downright forbid the scam in most cases. In a little over ten years, lenders were lining up to offer this and other preferential terms, and regulators were studiously looking the other way.

Banking and childbirth have one thing in common: It's so much fun getting to the painful part that you forget how much it hurt the last time.