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When should a banker get a new appraisal on collateral? That question came up at the regulator panel hosted by the Minnesota Bankers Association earlier this month in Duluth. James LaPierre, the FDIC Director of the Kansas City Region offered guidance.

“The expectation is that you will have a current appraisal,” LaPierre said. “The most likely need for an appraisal less than annually is if the existing appraisal does not show what is happening in the project.”

LaPierre suggested an example of a condominium project in which the bank loaned the developer money based on a business plan to sell each of the condos. Mid-project, the developer decides to rent the condos. In that situation, “we would expect a new appraisal,” he said.  

“The more likely scenario is we will simply adjust the appraisal. If we see a project where the business plan says we are going to sell eight units a month for 10 months and the sales level is actually four units a month with the sales price $25,000 per unit less than anticipate, that will be an adjustment — assuming you are down to a collateral bases where the loan has become collateral dependent,” LaPierre said.

“If it is not collateral dependent and the borrowers continue to make payments, it is a much more difficult thing because the question becomes ‘does that borrower have both the capacity and the willingness to continue?’ We have seen cases where borrowers had significant other assets, but they get to the point where they realize that it is no longer a good economic decision for them to continue to pay, and if they are paying it is very difficult to look forward and say they are going to get to that point.”

Blake Paulson of the Office of the Comptroller of the Currency, had this to say: ”On appraisals, it is very important that you have done your analysis. And if it is a severe problem loan, I would expect every quarter that you have done you analysis of what that collateral is worth, given recent information. If the examiners see that you have done that analysis and it is reasonable, they are much more likely to accept that than if they open the loan file and there is no appraisal and it looks like the economics have changed. You are much better off doing the analysis yourself and let the examiners validate that, versus forcing the examiners to do their own analysis.”

Look for in-depth coverage of the regulatory panel in the July 15 edition of NorthWestern Financial Review magazine.

We last wrote about Square in December, and it turns up in the news again with the introduction of the iPad. This article from netbanker notes that Squarewas among the financial services offerings available through iPad apps on opening day for the hot new computer.

I am surprised that none of the very large banks hooked up with Apple on this. Where was Wells Fargo, U.S. Bank, BofA or Citi? These guys understand the potential that electronic delivery of services offers. I find it hard to believe they were asleep on this.

But also, where were the core processing vendors who serve the community banking industry? Where were the various divisions of Fiserv, Harland, Jack Henry, and the others? They could be bringing hundreds of community banks to iPad users around the country.

Community bankers should be asking their core processing representatives about this. Typically these companies are responsive; if you ask for something, they deliver. If there is anyone reading this who knows something about working with Apple on something like this, I hope you will add to the conversation by leaving a comment.

Square allows anyone to accept credit and bank card payments. If you owe your buddy $10, and he has Square, you could give him a credit card, he could swipe it, and you’d be “square.” The potential on a product like this is huge.

If your bank is marketing to the general retail customer sector, it is essential that it be a part of projects like Square and the iPad. Your core processing vendor should be your partner in this arena.

Here is a healthy dialogue taking place among residents of Northfield, Minn., a vibrant community about 45 minutes south of the Twin Cities. The main point of discussion concerns the degree of transparency under which banks should operate. There are some participants in the discussion who say the local banks should be more forthcoming and there are those who say the banks have been sufficiently communicative.

Let’s remember that banks already are one of the most transparent businesses out there. Very detailed information is published quarterly about every FDIC-insured bank in the country. Those numbers reveal a lot, and in fact, at NorthWestern Financial Review magazine we use those numbers all the time to cover the industry. Furthermore, publicly-held banks are subject to additional disclosures required by the SEC.

I would argue, however, that banks deemed too-big-to-fail should be subject to an even greater level of tranparency. If taxpayers are on the hook, we have a right to know what’s going on at the bank on a day-to-day basis. That means public access to loan files and the investment portfolio. The public should be able to see what kinds of risk the institution is taking, both in the form of lending and in the form of other investments.

You cannot make the same argument for community banks, however. If Citibank gets into trouble, there is an impact on the taxpayer. If your local bank fails, there is no impact on taxpayers. This is an important point. When a small bank fails, no one with deposits of $250,000 or less lose any money. In many cases, even if deposit accounts exceed that amount, the depositor retains the entire account balance. The FDIC handles failed banks and the cost is charged completely to the deposit insurance fund, which is industry-funded. It is not taxpayer funded.

Even now, when the FDIC fund balance is technically negative, it is important to realize there is a lot of money in the fund. A reserve within the fund is established for projected future losses. The reserve balance is subtracted from the fund balance, so the actual balance of the entire fund is higher than the reported balance. Furthermore, banks prepaid three years’ worth of insurance premiums on Dec. 31, 2009; standard accounting practices prevent the FDIC from booking that money as income right away, although the money is available right away. The point is, the failed bank resolution process is entirely industry-funded for banks that are not deemed too-big-to-fail.  

So while I cannot think of a public policy reason smaller banker should be required to make greater levels of disclosure, I do think the managers of those institutions have an interesting question on their hands. How much should they disclose about the condition of their bank? Each manager is likely to come up with their own answer; some might choose to reveal more than the requirements of the Call Report, and others might choose to reveal nothing more. Customers might react differently to each choice; clearly, anticipating customer reaction is one of the key factors bank managers would have to take into account when making such a decision.

Anyone who works with numbers knows they can be deceiving. I have to call the Minneapolis-based Star Tribune on some numbers they ran in their Jan. 11 edition. Here is the online version of the article the newspaper ran about high concentrations of commercial real estate loans at some Minnesota banks. The print edition of the newspaper included a list of 17 banks that it says have commercial real estate loan concentrations equaling more than 400 percent of capital. The list does not appear online.

No. 14 on the list is Central Bank of Stillwater. It caught my eye because my colleague Tony Telschow and I just spent quite a bit of time researching this bank, which experienced phenomenal growth in 2009. When you receive your January edition of NorthWestern Financial Review in a day or two, you will see that we have named the management team at the bank — Owner John Morrison, Chairman Kurt Weise and President Larry Albert — our Bankers of the Year.

The Star Tribune article implies that high concentrations of real estate loans put these banks on shaky financial ground. But in the case of Central Bank, the numbers are misleading. A substantial portion of the real estate loans currently on the books at Central Bank came from failed bank acquisitions. Virtually all of those loans come with an 80 percent loss-share agreement with the FDIC. That means they pose little risk to the bank. Should a million dollar loan go bad, the FDIC will pick up $800,000 of the loss. Central Bank would never have acquired these assets had they not come with the FDIC loss-share agreement.

The article makes it sound as if these banks exercised poor judgment but in the case of Central Bank acquiring these assets was a savvy move. With the loss-share agreement in place, the bank picks up an investment with little down-side potential and tremendous up-side potential.

Data by itself never tells the whole story. You have to look beyond the numbers. To get a more complete story about Central Bank, be sure to read our January edition of NorthWestern Financial Review.

Via The Financial Brand, which says that any social media strategy worth its salt requires at least one full-time operative. Snippet from the article:

“It’s very easy to underestimate the amount of time and energy it takes to create any kind of success in the social media space. Just to run a blog, it take[s] a bare minimum of five hours a week, and more realistically 10-20 hours. Add another five or so hours a week for Twitter. If you run promotions, or integrate video into your social media initiatives, the hours really start to balloon.”

The post refers to an online report on a well known organization that spent two years and hired two employees but still only had 135 fans on its Facebook page. That changed recently. Ask yourself, when you click through to find out how, whether your bank can find an equivalent approach–or be in position to benefit when some unknown user (perhaps inadvertently) launches the next Facebook fad.

H/T to ICBM’s Current News.

NPR’s Marketplace Morning Report had an interesting item this morning about how FDIC is considering charging higher fees for deposit insurance based on executive compensation models. The goal is to curb risk taking. The fees could be reduced if banks had clawback provisions for recovering bonuses paid on risky deals that wound up losing the bank money.

Reporter Nancy Marshall Genzer said, “the thinking is that bonuses based on quick profits encourage executives to take risks, and that’s what helped lead to the financial crisis.”

Listen to Genzer’s report here.

The FDIC is expected to vote on the proposal in its board meeting next Tuesday.

Beside a lousy economy and a sense (if not a certainty) that they’re suffering for the excesses of their most ruthless competitors, self-described “good” banks are facing plenty of consequent headwinds. Just a few, gleaned from magazine interviews over the last few months:

• Paying for strength: the financial crisis may have drawn customers to banks with lots of capital and liquidity, but those things are expensive to maintain. Will customers continue to pay for strength? Bankers and consultants note that it’s the weak banks that have to pay up on deposits–but good banks have to compete with the weak ones for funds–and it’s not easy to sell stability over basis points.
• Guiding perception: customers and employees may be aware that your nonperforming loans and charge offs are higher. Is it beneficial to compare your results to your competitors’? If your problem loans are higher now but still noticeably lower than what your competitors are reporting, do you highlight that information?
• Maintaining morale: can employees accept that “least bad” or “relatively good” are as good as it gets in some cases? Bankers say it’s an ongoing challenge to help employees understand why they should feel good about their banks, especially when employees perceive that they could make more money at bigger–albeit more troubled–banks. As one banker said: “you need to be happy making less money if you work for a good bank; it’s a lifestyle decision.”

If you want to know what it is like for regulators to close your bank, be sure to read the first person account of the closing of Jennings State Bank of Spring Grove and Stillwater, Minn. The state Commerce Department closed the bank on Oct. 2. Paul Jennings, who ran the bank with his brothers, Steven and David, writes about the experience for an essay that appears in the November 1 edition of NorthWestern Financial Review. Here is an excerpt:

A week before they closed us down, FDIC started asking about our fidelity bonds and our insurance policies, which they said the acquiring bank was asking for.  It seemed strange that any buyer would be interested in those policies but we provided what was requested.  Then the night we were closed the resolution team “interviewed” (interrogated) bank employees with special attention to the management team. They informed us it was “standard practice” for the FDIC to make a claim against the failed bank’s policies if they could find any way at all to allege a basis. They said if we had a problem with that to talk to the on-site ombudsman. This person was apparently put there as window dressing because the first question we asked her she refused to answer.

 

We felt we had done the right things during two years under C&D. We said, “This is our government and they are asking us to do these things. Can we do them? Yes.” We could have walked away at any time. It was hard hanging in there and keeping things together as long as we did. Toward the end we thought, at least we will be able to walk out with our reputations intact.

 

Now it appears we may need to gear up to defend ourselves against a purely frivolous claim by our government aimed at exacting money from our insurance carriers. Not only is this abusive, but it is a terrible way for our federal government to be conducting itself against its own citizens. Bankers need to start speaking out publicly about these types of unjust abuses or they will certainly continue unchecked. They probably also need to make a much less naïve assessment than we did of how much it is actually in their own best interest to cooperate with any agency of the U.S. government.

NorthWestern Financial Review will continue to follow the Jennings’ story as it unfolds.

The U.S. Government should not be involved in decisions to determine compensation for executives at companies in the private sector. Compensation is a can of worms, and only those closest to the situation should be involved in determining the appropriate levels.

Ken Feinberg, the so-called “pay czar” in the Treasury Department, reportedly is requiring that compensation be reduce by 50 percent for the top 25 executives at seven companies that got government bailout money. Seems to me the real winner in these cases will be the guy currently receiving the 26th-highest pay in the company. Keep in mind that none of the “czars” that are populating the Obama Administration were elected, nor even confirmed by the senate.

Reducing executive compensation is purely a populist move designed to win political points for those who were elected; it will do nothing to improve the performance of these companies, nor reduce the risk they take. If anything, these restrictions will weaken the companies as they find themselves unable to compete with companies that can pay their execs whatever they deem appropriate.

Pay levels should be up to the companies, their boards of directors, and their shareholders. If those folks fail to do their job and their companies falter, then they should be allowed to falter. In most cases, shareholders respond and the market reacts. It’s actually a pretty good system.

If the market doesn’t work, and the government feels these companies are so important to the economy that they have to step in and keep them going, then at that point they should fire the executive team, perhaps some board members, and allow the remaining company leaders (possibly in consultation with government officials) to name a new executive team. This is a much better way to maintain order in the economy; restricting compensation does nothing to improve the outlook for the company. By the way, this is essentially what happens in small banks all the time. A small bank gets in trouble, and regulators often demand that new managers be brought in.

Politically, it might be easier to win recognition for capping pay, but forcing management change would be a better route. Our government is a republic, not a pure democracy, precisely to protect againt emotional, populist whims. The country will not survive if 51 percent of the population can vote to punish the other 49 percent. My point is, even though most people are outraged by the level of executive compensation, that doesn’t give them the right to cut their pay. In a republic, we elect officials to exercise judgment based on careful research and thorough reasoning. I am not seeing that in this latest effort to cap executive pay.

Steve Huston, president and CEO of BankWest in Rockford, Minn., was one of the 10 people who testified Tuesday at the Senate committee hearing conducted at the Minnesota State Capitol. His bank is located in Wright County, west of the Twin Cities where loan problems have been particularly acute given the very robust real estate activity that took place there a few years ago. Huston explained that banks don’t make bad loans, but that loans sometimes go bad.

He gave an example from another bank in his county. The owner of a bar and restaurant wanted to expand his business in 2005. The town had a major employer – a company that employed 1,200 people around the clock. At the end of each shift, many of those employees would stop into the bar/restaurant; business was good. It seemed like a good time to expand. Based on 2005 cash flow and modest growth projections, the owner obtained a loan from a local bank to construct a new building.

Huston explained that since then, the major employer has reduced employment to 200 people. No one stops into the restaurant after their shift anymore. The owner’s cash flow is no longer sufficient to cover the loan payments on the new building. For the bank, it is an impaired loan – a situation made worse by the fact that regulators require the bank to get a new appraisal of the building. The appraisal is partially based on comparables from other buildings in the area, which also have been negatively affected by the layoff of 1,000 people from the area’s major employer.

Huston then gave a second example. This one featured a husband, who worked at the major employer, and a wife, who ran a daycare center in their home. The housing market was strong in 2005 when they decided to move into a new house. The bank qualified them for a loan based on his income and her daycare revenue. Today, Huston explained, the husband is without a job and uncertain about when or if he will be called back to work. The wife’s daycare business is off substantially because many of the children she used to care for had parents at the major employer. They have all been laid off, too, so they no longer have need for daycare services. Huston said the couple can no longer afford to make mortgage payments; for the bank, that means another impaired loan as a new appraisal puts the value of the home at less than the loan amount.

Huston said neither of these loans was bad when it was made. “What I will submit to you is that it was not a risky loan when it was made. This was a good, sound loan. The bank that made these loans went through all the right procedures but it still has a problem today.”

Huston said that the media is really missing the point when it blames bankers for making bad loans.

“Traditional community bankers make loans to their neighbors in the community,” he said. “The problems we are having is because our communities are suffering. My bank will continue to make good loans. We don’t need more regulations or regulators to get our communities back on track.”