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I am intrigued by the attention community banks are attracting from state legislators. In New Mexico, a bill was introduced this session to move the state’s general fund depository account to community banks. The House passed the bill and a committee in the Senate passed it, but the session ran out before the full Senate took it up for consideration.

Then, in Illinois, a resolution was proposed encouraging municipalities and individuals to move their money to community banks. Read it for yourself here.

And last week, Minnesota Rep. Tim Mahoney (DFL-St. Paul) introduced a bill to give community financial institutions preference over non-resident financial institutions for state deposit accounts. Read the bill here.

While community bank advocates can appreciate these kinds of efforts, I think they miss the mark. In most healthy community banks, liquidity is not the problem; it’s loan demand. FDIC numbers for year-end 2009 show that while lending in many areas was generally down, deposits were generally up. As I have said before, what banks really need is relief from accounting rules which require them to immediately write down the lost value of impaired loans; give them five or 10 years to write those losses off and you will preserve a lot of bank capital, giving them much more strength to participate in the economy.

In Minnesota, this issue of who should be a depository for state funds has been debated before. It usually comes down to interest rates. Taxpayers want the greatest return for their money so public treasurers have generally selected depositories that pay the highest rates, even if those depositories are located in other states. In a low interest rate environment, however, you can make a case that those funds should be deposited with in-state institutions. Whether those institutions should be “community” institutions is still another debate.

Mahoney is a respected, 6th-term member of the Minnesota House, but I don’t see his bill gaining any traction. Wells Fargo and U.S. Bank have an enormous presence in Minnesota; they provide thousands of jobs and donate millions of dollars to charity. I can’t imagine a majority of legislators voting to exclude them from the possibility of holding state funds.

Actually, when you read the bill and its accompanying definitions, it isn’t clear whether banks such as Wells Fargo and U.S. Bank would be excluded. The bill only defines the term “community bank” as a bank or credit union in Minnesota. I am not sure how the proposed legislation applies to Wells Fargo, which is headquartered in San Francisco, chartered in South Dakota but has a major presence in Minnesota; or U.S. Bank, which has its headquarters here but its charter in Ohio.

The Minnesota legislature, like most state legislatures, is pre-occupied this session with budget issues. It will be interested to see if it finds time to deal with Mahoney’s bill. The Minnesota legislature, by law, must adjourn this year by May 17.

The main question that Sen. Linda Scheid had going into the hearing she conducted last week at the Capitol in St. Paul was whether the banking industry needs greater regulation. Marshall MacKay, president and CEO of the Independent Community Bankers of Minnesota, was one of the 10 people to offer testimony. He explained the extensive business review process already in place in the banking industry. Then he answered Sen. Scheid’s question, point-blank. Here is an excerpt, which I picked up from Mr. MacKay’s written testimony:

I’d like to broaden the discussion so you can better understand that while regulators conduct in bank “periodic examinations” every 12, or 18, months, between those on-site examinations is a continuous and comprehensive process that involves people inside the bank, outside third parties hired by the bank, as well as regulators.

This continuous “Examination Process” typically includes the following elements:

·        Individual Lender Authority – dollar and loan type specific, approved by the banks board of Directors and based on the lenders experience and knowledge.

·        Weekly loan reviews by the bank’s senior lender and/or internal bank credit committee;

·        Monthly reviews by the bank’s Board of Directors

·        Quarterly Financial Reviews – “Call Reports.” The call report, which is a 58 page document that banks submit electronically at the end of each quarter. It looks like this. This report is reviewed by state and federal regulators. It triggers bankers to call to ask questions and it triggers regulators to call a bank with questions.

·        Call Reports are due 30 days after the end of each quarter and are mandatory. They are available to read at the FDIC website.

·        External Credit Reviews – audits by outside sources before an exam to ensure things are in compliance and banks are prepared and in compliance with their Loan Policies. (They have dotted all the “I”s and crossed all the “t”s.

·        And the bank Directors also review their internal loan policy at least annually.

·        Add an Annual Director’s Audit – annual audit by outside source, paid for by the bank.

·        And then the Annual/Eighteen month Regulatory Examination

The process is comprehensive and continuous. Similar steps take place in banks to ensure they are in compliance with a host of regulations, such as the Community Reinvestment Act, Technology compliance, etc. Also exist, but I think you get the point.

And the point is that the regulatory examination, which occurs every 12 or 18 months by state or federal regulators, is just one point in a continuous examination process.

In between each examination by the regulator, is an examination process including weekly, monthly, quarterly, and annual review process by both internal and external entities. This process helps ensure banks are safe, and sound…  

Is more bank regulation needed or would have more examiners have made a difference?

The answer is no for the vast majority of banks – Minnesota’s community banks. The answer is much closer to yes if you are addressing regulation of the many non-bank financial firms and the challenges posed by systemically risky and too-big-to-fail institutions. But those institutions today primarily exist outside Minnesota.

Here’s another perspective on the hearing. This is from Sen. Kevin Dahle’s web site. He serves on Scheid’s committee.

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.”

About 50 people crowded into room 107 at the Minnesota Capitol yesterday afternoon for a hearing conducted by the Senate Committee on Commerce and Consumer Protection. Sen. Linda Scheid, chairman of the committee, called the hearing in response to a series of newspaper articles published last summer in the Minneapolis-based Star Tribune. The series, entitled “Lenders gone wild,” suggested that too few regulators were examining the banking industry in the state.

The following people presented at the hearing:

• Glenn Wilson, Commissioner of Commerce, State of Minnesota
• Kevin Murphy, Deputy Commissioner of Commerce, State of Minnesota
• James LaPierre, FDIC Kansas City Regional Director
• Keith Morton, Regional Director, National Credit Union Administration
• Joe Witt, President of the Minnesota Bankers Association
• Steve Huston, President BankWest, Rockford, Minn.
• Marshall Mackay, President and CEO, Independent Community Bankers of Minnesota
• Noah Wilcox, President and CEO, Grand Rapids State Bank, Grand Rapids, Minn.
• Mark Cummins, President, Minnesota Credit Union Network
• Bill Raker, President and CEO, U.S. Federal Credit Union, Burnsville.

The hearing lasted four hours, with Deputy Commissioner Murphy using an hour and 25 minutes to provide a thorough explanation of how a bank works and how banks are regulated. Each presenter offered educational testimony. Joe Witt of the MBA had the most impassioned presentation. His frustration with the major media was evident. Following are excerpts from his testimony.

We are not seeing anything different in Minnesota from what is happening in other states. In the second quarter, Minnesota banks out-performed the national averages. In the second quarter, 78.2 percent of Minnesota banks broke even or were profitable. The national figure was 71.7 percent. So we were a little better than the national average. As far as income generation, Minnesota banks made $153 million, as of the second quarter. Nationally, banks had lost $3.7 billion. So we were ahead of the national averages both in percentage of banks that were making money, and also in the profitability figures.

I don’t like to see any banks lose money. I am not trying to put a positive spin on that; it’s a fact that some banks are losing money. But it is also a fact that we are beating the national averages and you wouldn’t know that from reading some of the stories that are out there in the papers.

You’ve heard some big numbers thrown around – 70 banks are on the watch list, 90 banks that are losing money, those kinds of things. Those raw numbers make an impact, but when you look at the percentages, which is the way everyone in the industry looks at it, from a percentage standpoint our banks are doing better than banks in other states. I wish all the reporting would look at it that way, but again, they haveto do what they can. I also wish they would write the story that in the second quarter, 333 Minnesota banks were making money. You don’t see that story in your headlines among the stories you handed out there; it just doesn’t make what the newspapers consider to be good reporting these days, evidently.

…The fact is, Minnesota banks are lending. In Minnesota in 2008, bank lending was up 4 percent, including 1 percent total gross lending in the fourth quarter of 2008 when most people were reporting that the world was coming to an end. In 2009 in the first quarter, we were up another 1 percent and in the second quarter we were up another 2 percent; banks are definitely lending. Our biggest challenge is not that banks are not lending, our biggest challenge is we are struggling to find loan demand.

There have been a lot of media reports lately containing references to “risky” lending. “This bank, that bank gets into trouble for risky lending.” This term is never really defined but the story writers repeat it so often that they start to think that it’s true. I think you have to be really careful about these undefined terms.

For example, a bank in southeast Minnesota failed just last week. Second paragraph of the story says “that the Twin Cities banks are not the only ones engaged in risky lending.” The rest of the story goes on to tell you why that particular bank failed. It failed because of a large internal fraud and because one of its biggest loan customers misappropriated $1 million worth of collateral. That is why it failed. The story didn’t make any reference to risky lending, didn’t explain what that term meant, it just threw it around gratuitously because now it has become some sort of accepted fact that all the banks are into this, what they are calling risky lending. The damage has been done. The implication is that now all delinquent loans are somehow tied to this concept of risky lending. You can’t draw this conclusion, you just can’t. A perfectly underwritten loan can go bad. 

Our banks are generally very conservative underwriters, they have strong documentation standards. Some lenders in the marketplace truly do make risky loans and we have talked about that in this committee. We know that mortgage brokers made liar loans. Finance companies made 125 percent loan to value mortgage loans. They let you pull out a whole bunch of value that wasn’t even there, and that is when the values were inflated. That’s a risky loan. Other lenders made commercial loans without all the traditional documentation and covenants in them. Those are risky loans.

My point today is just because a loan went bad doesn’t mean that it was a risky loan. Regulated banks do not get away with making those types of risky loans. There’s different types of lenders so when you look at regulations, there are different types of regulation for different types of lenders. Make sure you acknowledged those differences when you make your regulations.

Sen. Scheid she does not expect legislation to result from the hearing. In an interview after the hearing, she answered her own question when she said to me: “Are we doing enough in our bank examination regimen, is that adequate? I think the answer is yes, it seems to me it works really well, and it is important that legislators understand.”

In the early 1990s, the Commerce Committee used to conduct informational hearings early in the session. More recently, however, they have gotten away from conducting those kinds on hearings. Sen. Scheid said it is very difficult to conduct informational hearings during the session because lawmakers want to focus on specific legislation during the session. Perhaps it would be good to get back to conducting these kinds of hearings every so often.

Recent moves to defund ACORN are restoring my confidence in government. Two days ago, Minnesota Gov. Tim Pawlenty said he wanted to cut off all state funds to the organization. Yesterday, the U.S. House of Representatives voted to stop sending money to the Association of Community Organizations for Reform Now.

ACORN has a long history of working against the banking industry, claiming in particular that some of the industry’s largest banks don’t do enough to help people get mortgages. That’s fine; it’s a free country and everyone’s entitled to an opinion.

What has bothered me, however, is the way the organization uses theater to make it look as if their “movement” has more support than it actually does. I was very surprised to learn years ago that ACORN actually pays people to march in its protest rallies. When one sees people marching in an ACORN rally in front of the Federal Reserve building, one assumes those are people who feel strongly about an issue and are demonstrating on the basis of personal conviction. But no. These typically are folks bussed in from miles away, earning an hourly salary.

Again, it’s a free country, so people are free to stage all the theatre they want. But I wish the newspapers that covered these rallies would have been more revealing about the movitation of the demonstrators. And, certainly, no government money needs to be funding this stuff.

Dave Knopick, the 2008-2009 chairman of the Independent Community Bankers of Minnesota, told NorthWestern Financial Review that the association expects the Minnesota legislature to revisit the issue of mandatory mediation in home foreclosures. He made the comment during an interview conducted at the association’s annual convention Aug. 7 in the Wisconsin Dells. During the 2009 session, the legislature passed a bill that would have required mediation of home mortgages in default, but it was vetoed by Gov. Tim Pawlenty.

“All along, we were fighting that mandatory mediation, which would not have helped at all,” commented Knopick, president of the Saint Stephen State Bank, near St. Cloud, Minn. “It just would have added to the costs. It was just not a good idea, but we know it is coming back this session.”

Gov. Pawlenty addressed the convention with a taped message, and referred to his veto. Here is a transcript of the governor’s message to the bankers:

The top issue this past legislative session was the mandatory homeowner lender mediation act. A bill that would have extended farmer/lender–like mediation to homeowners in foreclosure. Although this was a well-intentioned bill, and while I support some form of mediation option for certain foreclosures, the final version of this bill raised several concerns. I didn’t think it made sense to have mediators determine which borrowers were eligible for mediation. If the mediators decide which cases go to mediation, the mediation process would already have begun. Furthermore, I don’t believe the Attorney General’s office is the proper entity to select dispute resolution personnel, or procedures. Finally, the bill would have come on top of the many changes we made in 2008, one which included providing foreclosure counselors to all people in foreclosure. For these and other reasons I vetoed the bill.

I also vetoed a bill proposing numerous changes to already stringent laws concerning reverse mortgages. The intention of that bill was to protect borrowers from predatory lending practices, and I share that goal. However, this legislation was poorly written and could have triggered unintended consequences and increased costs to consumers.

On a positive note, I am glad we are on the same page in protecting the mortgage interest rate deduction. At a time when most economists say getting the housing market back on track is the key to economic recovery, eliminating the mortgage interest deduction, as some in the legislature proposed, would have been disastrous to the housing industry and the economic recovery that we all hope for.

In addition, I signed a new law allowing borrowers in foreclosure to postpone the sheriff sale as well as a bill requiring foreclosure lenders to do a better job protecting abandoned property foreclosure, in certain circumstances.

Look for complete ICBM convention coverage in the September 1 edition of NorthWestern Financial Review magazine.

I had a chance to visit with Kris Ausborn when I was in Okoboji, Iowa last week for the 38th annual convention of the Community Bankers of Iowa. Ausborn, of the Iowa Trust & Savings Bank, Emmetsburg, was the association’s 2008-2009 president. When I asked him about highlights during his year of leadership, he referred to CBI’s legislative effort to make it easier for banks to lend to businesses adversely affected by tornadoes and floods.

“We have an Iowa Credit and Guarantee Fund that has been funded for a number of years in this state,” Ausborn explained. “It was meant to fund a guarantee on loans to beginning businesses. It wasn’t getting the support it needed from the Iowa Department of Economic Development,” Ausborn explained.

CBI attempted to breathe some life into the program by redefining it so lenders could use the guarantee on loans they make to businesses attempting to rebuild after the natural disasters the state suffered in spring of 2008.

“We saw this as one way to really make that program viable. Let’s use those funds that are available for relief for victims of these natural disasters. The legislative leadership was in favor of it. They were looking for [disaster relief] funding from anywhere they could find it. On the last day of the session, our concept was attached to a bill and passed,” Ausborn explained. “The rules are still being drawn up on how we can distribute this funding but it will be open to any county that was declared a natural disaster in 2008, which is 80 to 90 percent of our counties.”

Although Ausborn was optimistic about the community banking industry in Iowa, he was realistic, particularly in light of developments on the national stage. “The problem we face is the number of banks continues to decline. There are going to continue to be consolidations, especially with what comes from the federal regulators — much more compliance and regulatory effort is going to be out there to contend with,” he said.

Ausborn said the growing regulatory burden is one of the main reasons bankers decide to get out of the business. “There are other community bankers,” he said, “who say ‘I understand your problem; if you want to sell out, we’d sure like the opportunity to buy.’ I do see a lot of that.”

Look for additional coverage of the Community Bankers of Iowa annual convention in the August 1-14 edition of NorthWestern Financial Review. Additional coverage also will be presented in the Sept. 1-14 edition.