Banking Law

A recent article in the American Banker (paid subscription required) discussed briefly some of the arguments that federal banking regulators have been making to members of Congress in opposition to the loss-amortization provisions of the small business financing bill that made it through the House. The bill faces stiff opposition from Republicans in the Senate, due to the fact that they're cynically attempting to exploit the anti-bailout sentiment among many voters by labeling the small business lending program "just another Tarp." As I've urged community bankers recently, come November, remember who your true friends are but, more importantly, remember who your true enemies are. Republicans who will throw you under the bus in order to exploit base emotions and misperceptions among voters for victory in November are as much your enemy as is a so-called "populist" like Sheila Bair. You can't vote Bair out of office (she failed in her one and only attempt to run for public office when her "mentor" Bob Dole supported her opponent, and she's wisely chosen a "non-elected" line of work since then), but you can vote against any purported champion of small businesses in Congress who voted against the bill that contains CRE loss amortization. That would include all but three House Republicans, by the way.

The regulators are apparently pushing three basic themes in their attempt to influence legislators. According to the American Banker article, the regulators are arguing that amortization of CRE loan losses over a period of up to 10 years is bad because (1) it undermines confidence in banks, (2) it hides "true" losses, and (3) it creates a "moral hazard" because banks that receive it are likely to take big risks going forward in an attempt to recover before the amortization period runs out. I don't think the regulators who are making these arguments actually believe them to be true, although I can't insert myself into their minds to accurately discern their intent (any more than I could--or would desire--to enter the mind of a Mafia don). Instead, I assume that for these Pontius Pilates, "truth" is a relative term. It's not what an objective observer would conclude after attempting to be fair and reasonable. Instead, it's all about spinning the story so that it achieves the objective of preserving the power of the regulators to act without any interference with their ability to pick winners and losers among the too-small-to-save community banking business. If you think that sounds cynical, you're dead on.

The "undermining confidence" and "hiding true losses" arguments both are related to the alleged "fact" that by allowing banks to amortize losses on CRE, the "true" financial condition of the banks is "masked."  Inasmuch as the recently passed legislation requires banks to report regulatory capital calculations with and without the loss amortization, those arguments are bogus. Full disclosure will be made. Private equity investor representatives I have spoken to (and the "forbearance" would not apply to publicly-traded banks) state that this is a non-issue for them. As to the regulators, are they saying that they can't figure out the actual financial condition of a bank that is amortizing losses for regulatory capital purposes? If not. Who, then, can't see through the so-called "mask"? Depositors? Congress just voted to protect all of them up to $250,000, so who, exactly, is so unsophisticated that they might be unwittingly deceived and harmed by the fact that there are side-by-side regulatory capital calculations being reported, one with and one without amortization of CRE losses?

As for the "moral hazard" argument, that, too, is patently false. The loans that the amortization would apply to must have been "originated" prior to January 1, 2008, so it won't apply to new loans. Moreover, the bank's federal regulator(s) must approve the bank for eligibility, which means that if the regulator believes that the bank's current management is the type to take unjustifiable risks going forward, the bank won't be participating. The regulators must also create underwriting guidelines for banks participating in CRE loss amortization, so that should provide yet one more safeguard to bar future excessive risk taking. Finally, since banks file quarterly CALL reports (and since many are under enforcement actions that require more frequent reporting and restrictions on the bank's activities), the regulators are going to be able to know quickly if unreasonable growth is taking place, and where that growth is coming from.

Based upon discussions with the loss amortization provisions' supporters, it also appears that the regulators are trying to conflate CRE loss-amortization with the types of forbearances that were used by the late, not-lamented Federal Savings and Loan Insurance Corporation in the 1980s in order to prop up failing savings and loan associations throughout the country. It seems that the regulators are citing studies by various academics and government agencies that purport to "prove" that the S&L forbearances were an "Epic Fail" and were also largely responsible for making the eventual thrift failures much more costly, and then allege that the CRE loss amortization is the same type of forbearance.

These arguments are misleading at best, intellectually dishonest at worst. The CRE loss amortization provisions are not akin to the across-the-industry forbearances that were issued by the FSLIC, but are substantially similar to the very narrow loss amortization provisions of the Competitive Equality Banking Act of 1987 that applied to agricultural banks. A study apparently not cited in any of the voluminous footnotes in letters that regulators have sent to Congress is a 1998 review by the FDIC of the banking crises of the 1980s and early 1990s. That study reveals that "class-of-bank" forbearance programs are clearly distinguishable from the widespread forbearance programs like that employed by the FSLIC, and, moreover, are much more successful in both rescuing banks that would otherwise have failed and in lowering losses of those banks that eventually fail despite the forbearance. Of 33 banks in the 1987 program, 27 survived as independent, 2 were merged without FDIC assistance, and only 4 failed. Moreover, as to all "class-of-bank" forbearance programs implemented in the 1980s, the banks in the programs that did fail had lower, not higher, losses than those that did not participate in the programs. While condemning the FSLIC-type widespread forbearance programs as "disasters," the report has this to say about more narrowly-focused temporary forbearance programs:

The more favorable results of bank forbearance programs as compared with the FSLIC strategy reflect the smaller number of banks involved, the closer monitoring of banks, the fact that problems addressed by bank forbearance programs were temporary and cyclical in nature, and (most important) the fact that bank regulators sought to control risk taking by participating institutions rather than encourage it.

All of the above factors should apply to the proposed CRE loss amortization program. Arguments that this is another FSLIC-type forbearance program are disingenuous. This is a targeted, temporary, narrowly focused forbearance program,designed to address problems that are temporary and cyclical in nature. The federal bank regulators will have plenty of power to determine who participates and who does not, and, as to those who participate, that no excessive risk taking will be permitted.