bank examinations and enforcement - manatt, phelps & phillips, llp
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BANK EXAMINATIONS AND ENFORCEMENTBANK EXAMINATIONS AND ENFORCEMENT
How Current Conditions Impact the Examination Process
March 11, 2008
Gordon M. Bava, Manatt, Phelps & Phillips, LLPWalter J. Mix, The Secura Group of LECG, LLC
Harold P. Reichwald, Manatt, Phelps & Phillips, LLP
How Current Conditions Impact the Examination Process
March 11, 2008
Gordon M. Bava, Manatt, Phelps & Phillips, LLPWalter J. Mix, The Secura Group of LECG, LLC
Harold P. Reichwald, Manatt, Phelps & Phillips, LLP
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Discussion TopicsDiscussion Topics
Introduction
The 2008 Examination
Regulatory Enforcement Tool
Cease and Desist Order – Nuts and Bolts
Likely Targets for Regulatory Enforcement
Questions and Answer Period
Introduction
The 2008 Examination
Regulatory Enforcement Tool
Cease and Desist Order – Nuts and Bolts
Likely Targets for Regulatory Enforcement
Questions and Answer Period
INTRODUCTION
Current Attitudes of Bank Regulators
INTRODUCTION
Current Attitudes of Bank Regulators
Harold P. ReichwaldPartner
Manatt, Phelps & Phillips, LLP310-312-4148
Harold P. ReichwaldPartner
Manatt, Phelps & Phillips, LLP310-312-4148
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In 2008 federal banking agencies examination cycle will be different
Greater number of banks will be examined
Examiners will be digging deeper
In 2008 federal banking agencies examination cycle will be different
Greater number of banks will be examined
Examiners will be digging deeper
Current AttitudesCurrent Attitudes
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Qualitative judgments will be more pronounced
Realistic identification of problems
“First loss is the best loss” attitude
Risk management function and liquidity management to be closely examined
Timely Board oversight is crucial
Qualitative judgments will be more pronounced
Realistic identification of problems
“First loss is the best loss” attitude
Risk management function and liquidity management to be closely examined
Timely Board oversight is crucial
Current AttitudesCurrent Attitudes
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Clear focus on:
High concentrations of commercial real estate lending – see 2006 Guidelines
Evaluation of liquidity policy and management function
Clear focus on:
High concentrations of commercial real estate lending – see 2006 Guidelines
Evaluation of liquidity policy and management function
Current AttitudesCurrent Attitudes
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Specific areas
Appraisals
Critical review of assets
Allowance for loan and lease losses
Additional capital investment
Liquidity analysis
Specific areas
Appraisals
Critical review of assets
Allowance for loan and lease losses
Additional capital investment
Liquidity analysis
Current AttitudesCurrent Attitudes
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“Hot Button” issues: summary
Quality of loan portfolio and risk management process vs. the adequacy of ALLL and capital
Liquidity risks and policy
Is Management and Board sufficient to meet the challenges?
Safety and soundness: compliance with law and regulation
“Hot Button” issues: summary
Quality of loan portfolio and risk management process vs. the adequacy of ALLL and capital
Liquidity risks and policy
Is Management and Board sufficient to meet the challenges?
Safety and soundness: compliance with law and regulation
Current AttitudesCurrent Attitudes
The 2008 Exam -Background and Preparation
The 2008 Exam -Background and Preparation
Walter J. MixManaging Director
The Secura Group of LECG, LLC213-243-3770
Walter J. MixManaging Director
The Secura Group of LECG, LLC213-243-3770
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Former banker, DFI Commissioner and now bank strategy/risk management consultant
Worked through problem bank period under FDICIA in early to mid 1990s, many bank closures and arranged marriages
Former banker, DFI Commissioner and now bank strategy/risk management consultant
Worked through problem bank period under FDICIA in early to mid 1990s, many bank closures and arranged marriages
Walt MixWalt Mix
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Economy and Subprime FalloutEconomy and Subprime Fallout
Subprime problem: $600 billion estimated cost, much larger than the S&L problem
Spreading to general economy, credit crunch, commercial real estate
Global impact/Capital flows
Fed action to address credit crunch (rate cuts and $100 billion liquidity action last week)
Quote: “The longer it lasts, the worse it will be when it ends” Bill Conway of the Carlyle Group
Subprime problem: $600 billion estimated cost, much larger than the S&L problem
Spreading to general economy, credit crunch, commercial real estate
Global impact/Capital flows
Fed action to address credit crunch (rate cuts and $100 billion liquidity action last week)
Quote: “The longer it lasts, the worse it will be when it ends” Bill Conway of the Carlyle Group
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Condition of Banking IndustryCondition of Banking Industry
Regulatory concern regarding Real Estate concentrations
Asset quality problems
Bank Profit declines
Low Bank PEs
Deposits – Core/Non-core
Managements/Boards
De Novos
Regulatory concern regarding Real Estate concentrations
Asset quality problems
Bank Profit declines
Low Bank PEs
Deposits – Core/Non-core
Managements/Boards
De Novos
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Observations RegardingRisk ManagementObservations RegardingRisk Management
Safety and soundness
Strong corporate governance and enterprise risk management
System of internal controls
“Basics” such as identifying, analyzing, monitoring and proper reporting and separation of production from approvals
Strength of audit committee/audit function
Strategic risk
Safety and soundness
Strong corporate governance and enterprise risk management
System of internal controls
“Basics” such as identifying, analyzing, monitoring and proper reporting and separation of production from approvals
Strength of audit committee/audit function
Strategic risk
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Regulatory Response:Enforcement ActionsRegulatory Response:Enforcement Actions
Regulators are gearing up for action this year
Off-site monitoring/analysis
Target examinations/write-downs
Regulatory Options: Board Resolutions, MOUs, CDs
Management reviews, asset write-downs, capital plans/infusions, ALLL, strategic plans/pro formas, compliance, asset liability management, liquidity
Congressional hearings – regarding financial industry/bank supervision
Regulators are gearing up for action this year
Off-site monitoring/analysis
Target examinations/write-downs
Regulatory Options: Board Resolutions, MOUs, CDs
Management reviews, asset write-downs, capital plans/infusions, ALLL, strategic plans/pro formas, compliance, asset liability management, liquidity
Congressional hearings – regarding financial industry/bank supervision
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Problem Bank Resolutions in Addition to Enforcement ActionsProblem Bank Resolutions in Addition to Enforcement Actions
Arranged marriages
Changes to managements/boards
Extreme regulatory action
Arranged marriages
Changes to managements/boards
Extreme regulatory action
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Litigation ExposureLitigation Exposure
Class action, securities, etc...
Fiduciary duties
Class action, securities, etc...
Fiduciary duties
Basic Regulatory Enforcement ToolsBasic Regulatory Enforcement Tools
Gordon M. BavaPartner
Manatt, Phelps & Phillips, LLP310-312-4205
Gordon M. BavaPartner
Manatt, Phelps & Phillips, LLP310-312-4205
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Hierarchy Formal vs. Informal ActionsHierarchy Formal vs. Informal Actions
Formal Actions
Are enforceable against the institution and institution-affiliated parties (“IAPs”) in a court of law; and
Subject institutions and IAPs to civil monetary penalties for violations
Informal Actions are not
Formal Actions
Are enforceable against the institution and institution-affiliated parties (“IAPs”) in a court of law; and
Subject institutions and IAPs to civil monetary penalties for violations
Informal Actions are not
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Types of Informal ActionsTypes of Informal Actions
General supervisory oversight and examinations
Periodic regular examinations
Findings of deficiencies and violations set forth in Reports of Examination
Day-to-day communications with regulators
General supervisory oversight and examinations
Periodic regular examinations
Findings of deficiencies and violations set forth in Reports of Examination
Day-to-day communications with regulators
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Types of Informal ActionsTypes of Informal Actions
Board resolutions
“Voluntary” adoption of “recommended”resolutions by the Board of Directors covering certain agreed upon remedial actions by target dates
Not disclosed by regulators but possible disclosure obligations for institutions under securities law depending upon nature of problem being addressed and remedial action to be taken
Board resolutions
“Voluntary” adoption of “recommended”resolutions by the Board of Directors covering certain agreed upon remedial actions by target dates
Not disclosed by regulators but possible disclosure obligations for institutions under securities law depending upon nature of problem being addressed and remedial action to be taken
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Types of Informal ActionsTypes of Informal Actions
Memorandum of Understanding (“MOU”)
Written document between institution and regulator
Involve specific commitments to take remedial action
Securities disclosure possible
Memorandum of Understanding (“MOU”)
Written document between institution and regulator
Involve specific commitments to take remedial action
Securities disclosure possible
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Types of Formal ActionsTypes of Formal Actions
Statutory context
Following the S&L crisis in the 1980s and numerous bank failures in the 1990s Congress adopted enhanced enforcement measures that reduced regulatory discretion that requires enforcement action be taken without extensive prior notice and hearings by institutions or IAPs.
A “Tripwire” approach was adopted in Section 38 of the Federal Deposit Insurance Act that requires prompt and forceful enforcement action tied to specific unsafe banking practices and increasingly severe actions as conditions deteriorate
The principal statutory basis for formal actions is Section 8(b) of the Federal Deposit Insurance Act
Statutory context
Following the S&L crisis in the 1980s and numerous bank failures in the 1990s Congress adopted enhanced enforcement measures that reduced regulatory discretion that requires enforcement action be taken without extensive prior notice and hearings by institutions or IAPs.
A “Tripwire” approach was adopted in Section 38 of the Federal Deposit Insurance Act that requires prompt and forceful enforcement action tied to specific unsafe banking practices and increasingly severe actions as conditions deteriorate
The principal statutory basis for formal actions is Section 8(b) of the Federal Deposit Insurance Act
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Types of Formal ActionsTypes of Formal Actions
Cease and Desist Order
The most utilized enforcement tool used where an institution is in very poor financial condition and where violations of law and insider abuse are present
Can require an institution or IAP to cease certain actions or to take certain actions
Can be enforced directly by Court order
Cease and Desist Order
The most utilized enforcement tool used where an institution is in very poor financial condition and where violations of law and insider abuse are present
Can require an institution or IAP to cease certain actions or to take certain actions
Can be enforced directly by Court order
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Types of Formal ActionsTypes of Formal Actions
Written agreements
Contractual rather than the result of Formal Charges and related process
End result is that it is enforceable as a C&D
Written agreements
Contractual rather than the result of Formal Charges and related process
End result is that it is enforceable as a C&D
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Types of Formal ActionsTypes of Formal Actions
Civil monetary penalty orders
Do not seek remedial action, but assess a fine against an institution or an individual
Can be assessed for
violations of law or regulationbreaches of final orders (C&Ds and written agreements)breach of any condition to any regulatory grant of authorityengages in unsafe or unsound practices; orbreaches of fiduciary
Civil monetary penalty orders
Do not seek remedial action, but assess a fine against an institution or an individual
Can be assessed for
violations of law or regulationbreaches of final orders (C&Ds and written agreements)breach of any condition to any regulatory grant of authorityengages in unsafe or unsound practices; orbreaches of fiduciary
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Types of Formal ActionsTypes of Formal Actions
CMPs are not intended to be guarantees of performance
3 tiers of penalty ranging from $5,000 and $25,000 per day up to $1,000,000
CMPs can be avoided if a good faith and diligent effort is made by the institution and IAPs to comply with the enforcement order or written agreement
CMPs are not intended to be guarantees of performance
3 tiers of penalty ranging from $5,000 and $25,000 per day up to $1,000,000
CMPs can be avoided if a good faith and diligent effort is made by the institution and IAPs to comply with the enforcement order or written agreement
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Types of Formal ActionsTypes of Formal Actions
Removals and prohibition orders
May be used to remove parties from institutions or to prohibit their participation in the affairs of an institution in the future
Criminal Referrals
If violations of criminal law are uncovered or suspected, agency must refer the matter to the Department of Justice for investigation and possible enforcement
Removals and prohibition orders
May be used to remove parties from institutions or to prohibit their participation in the affairs of an institution in the future
Criminal Referrals
If violations of criminal law are uncovered or suspected, agency must refer the matter to the Department of Justice for investigation and possible enforcement
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Cease and Desist Order:Nuts and BoltsCease and Desist Order:Nuts and Bolts
Key Issues
Seriousness of the regulatory concerns derived from the exam process
Quality of management and timely Board participation and oversight
Record of correcting past deficiencies identified in prior exams
A wake-up call
Key Issues
Seriousness of the regulatory concerns derived from the exam process
Quality of management and timely Board participation and oversight
Record of correcting past deficiencies identified in prior exams
A wake-up call
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Goal of a C&D OrderGoal of a C&D Order
Ensure sound underwriting and robust credit administration practices
Diversified funding sources with realistic contingency planning
Strong internal controls and risk management systems
Timely recognition of losses coupled with adequate ALLL and strong capital cushions
Ensure sound underwriting and robust credit administration practices
Diversified funding sources with realistic contingency planning
Strong internal controls and risk management systems
Timely recognition of losses coupled with adequate ALLL and strong capital cushions
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Overall DirectivesOverall Directives
Specific action plans in identified problem areas
Relatively short time frames for initial compliance
Periodic reporting on progress
Dissemination of specific elements to shareholder base
Specific action plans in identified problem areas
Relatively short time frames for initial compliance
Periodic reporting on progress
Dissemination of specific elements to shareholder base
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Specific Types of DirectivesSpecific Types of Directives
Hire independent consultant to examine and recommend changes
Retain qualified executive management
Increase Board participation
Hire independent consultant to examine and recommend changes
Retain qualified executive management
Increase Board participation
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Specific Types of DirectivesSpecific Types of Directives
Increase capital beyond minimum requirements
Adopt adequate ALLL policy and appropriate levels after required charge-offs
Plan for disposition of classified assets as approved by Board
Restrictions on new loans to identified borrowers without Board (or Board Loan Committee) approval
Review and revise loan policies
Increase capital beyond minimum requirements
Adopt adequate ALLL policy and appropriate levels after required charge-offs
Plan for disposition of classified assets as approved by Board
Restrictions on new loans to identified borrowers without Board (or Board Loan Committee) approval
Review and revise loan policies
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Specific Types of DirectivesSpecific Types of Directives
Development of strategic plan
Development of profit plan
Periodic review by Board of performance vs. plan
Restrictions on dividend payments
Quarterly reports to regulatory agencies
Shareholder disclosure of C&D
Development of strategic plan
Development of profit plan
Periodic review by Board of performance vs. plan
Restrictions on dividend payments
Quarterly reports to regulatory agencies
Shareholder disclosure of C&D
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Implementation StepsImplementation Steps
Request by Agency for a Consent Order
Board approval by resolution
Execution of Consent by Bank and by each director
Request by Agency for a Consent Order
Board approval by resolution
Execution of Consent by Bank and by each director
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Likely Targets for Regulatory EnforcementLikely Targets for Regulatory Enforcement
High concentration of CRE
High growth rate in loan portfolios from 2006 levels
Failure to act on prior year’s examination requirements
High concentration of CRE
High growth rate in loan portfolios from 2006 levels
Failure to act on prior year’s examination requirements
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Question and Answer PeriodQuestion and Answer Period
Contact Information:
Manatt, Phelps & Phillips, LLP:
Gordon Bava310-312-4205
Hal Reichwald310-312-4148
The Secura Group of LECG, LLC:
Walt Mix213-243-3770
Contact Information:
Manatt, Phelps & Phillips, LLP:
Gordon Bava310-312-4205
Hal Reichwald310-312-4148
The Secura Group of LECG, LLC:
Walt Mix213-243-3770