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Echo Partners Community Bank Blog

    Fed President: Tailor Community Bank Regulation to Risks

    speechComments on community bank performance and regulation by Minneapolis Fed President Narayana Kocherlakota should be reviewed by all interested in community banking.  Read the speech here.

    Kocherlakota makes 4 main points on the state of community banking.

    1. Community bank recovery in asset quality has been strong.

    2. Lagging earnings and loan growth raise questions about the cost of new and enhanced regulation.

    3. Low earnings combined with higher compliance costs raise concerns about community bank consolidation.

    4. As a matter of public policy Kocherlakota supports tailoring supervision and regulation to reflects the risks and roles of community banks.

    Kocherlakota goes further and offers two specific ways regulation could be further tailored in the future.

    1. Congress and supervisors should exempt all community banks from certain regulations.  In fact, he goes so far as to state that "Exempting is the best way to guard against regulatory trickle-down."

    2. Narrow the focus of current supervisory methods that are too detailed across too many areas and apply to too many banks.  

    Instead, he suggests that regulators concentrate on the small handful of activities that are correlated with bad results.

    • Rapid loan growth.

    • High lending concentrations

    • Specific high-risk types of lending.

    • Specific wholesale funding strategies

    These types of common sense approaches to overly severe regulation should be supported by all community bankers. In our society, the way we make our support known is through our elected officials.

    Please call on your representatives to support even handed community bank regulation that focuses on actual risks associated with community banking, and not on nontraditional activities that larger TBTF banks pursue.



    Photo provided by Joseph Friedrich

    Bank Regulatory Trends in MRBA

    BankExamMatters Requiring Board Attention (MRBA) trends are a hot topic in the latest FDIC Supervisory Insights.  Read the full publication here.

    Over the period 2010 - 2013 the FDIC's MRBA comments on the Report of Examination (ROE) were collected, categorized and statistically aggregated.  This summary data forms the basis of the article.

    The most common areas ("Top 5") mentioned in MRBAs, along with key areas of specific mention, are listed below. Keep in mind these are typically for "1" or "2" rated institutions.

    1. Loans (Cited in 69% of all MRBAs)
    2. Board or Management (45%)
    3. Violations (24%)
    4. Earnings (24%)
    5. Interest Rate Risk (24%)

    Loans focused on credit administration, problem assets, ALLL deficiencies and concentrations.  Over the period of the study (2010 - 2013) the loan category has been declining in frequency, although it is still by far the most common category.

    Board / Management comments focused on policies, audit, strategic planning and succession planning.

    Violations typically involved appraisals and/or insider lending practices.

    Earnings is primarily concerned with strategies to safely improve earnings.

    Interest Rate Risk mentions have been on the rise since 2010.  This should be no surprise as numerous regulatory releases and attention since then have targeted interest rate risk.  Eventually rates will rise and your regulators' concerns will be realized.  The time to prepare is now.

    Generally, citations for interest rate risk have involved improved monitoring and control of the IRR process.

    Liquidity didn't make the "Top 5", but deeserved special mention for declining in importance over the period.  Again, as the crisis passes this is expected behavior.

    IT issues on the other hand were not in the "Top 5" but have increased in frequency over time.  Watch this emerging category.


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    OCC Calls Out Community Banks on Economic Value of Equity Risk

    riskyWe wrap up our overview of the OCC Semiannual Risk Perspective report with a focus on economic value of equity (EVE) or long term interest rate risk.

    You can read our earlier comments here and here.

    With key concerns over longer duration assets and fear of increased rate sensitivity for non-maturity deposit accounts, it only makes sense to examine long term EVE interest rate risk.

    The OCC offers a chart of historical EVE performance (provided by Olson Research Associates) showing a subgroup of bank EVE exposure to a 200bps rate hike, ending in Q2 2013.  In Q2 the levels shown averaged a 24% reduction in EVE for a 200bp rate hike.

    Based upon my own proprietary interest rate risk model, calculated for all FDIC-insured banks nationwide, the average EVE risk for a 200bp rate hike at September 2013 was 22%.  

    Remember, that's the average EVE reduction.  

    The riskiest 20% of all FDIC-insured banks at September 2013 had an EVE risk exposure (reduction in economic equity) in a 200bps rate hike scenario of greater than 33%.

    How does your EVE risk compare?  

    Email or call me if you wish to discuss how to mitigate your risk exposures.



    Photo provided by Paxson Woelber.

    OCC Reiterates Community Bank Interest Rate Risk Concerns

    DoNotReadThe OCC's Fall 2013 Semiannual Risk Perspective sounds suspiciously similar to the FDIC's recent warnings.  Just in case you didn't read the FDIC warnings, or even if you did, take a look at the OCC's message.

     Download the OCC Semiannual Risk Perspectives report here.

    Part III of the report, "Funding, Liquidity and Interest Rate Risk" focuses on 3 familiar topics.

    1. Retention and pricing of deposits
    2. Investment portfolios
    3. Increased Economic Value of Equity (EVE) risk

    We will quickly work through the OCC's concerns in a short series of articles.  This article will feature the OCC's perspective on the retention and pricing of deposits.

    OCC is focused on the retention rate and pricing of deposits and feels they may well be much more rate sensitive than historical relationships would suggest.  Sound familiar?

    Recent OCC supervisory efforts have focused on deposit pricing and runoff assumptions in stressed rate environments.  

    OCC is specifically calling for community banks to establish methods to capture deposit behaviors so as to improve the accuracy of interest rate risk modeling.  

    In English, this means that they want you to implement some form of deposit study.  Call or email me for help with this task.

    One last point.  When OCC and FDIC are coordinated in their approach to a risk issue, I'd suggest that you better pay attention.  Because your regulators will be asking about these items very soon.



    Photo provided by Nicolas Raymond.

    FDIC Questions Non-Maturity Deposit Stability

    bankdepositPreviously we reviewed the FDIC's interest rate risk warning on long duration securities.  You can find more on this topic here and here.  Now we will examine FDIC's related concerns on non-maturity deposit accounts (NMDAs) with respect to interest rate risk.

    The FDIC correctly observes that banking has experienced a surge in deposits since 2008.  This surge has been pronounced enough to result in the highest growth rate in domestic deposits in over 15 years.  Please note that although community banks have also seen historic deposit growth, the bulk of the volume has been at the largest banks.

    Deposit mix has also changed markedly, especially at community banks, where noninterest bearing deposits (many NMDAs) have grown to the largest allocation in over 15 years.  At the same time, time deposits at community banks have fallen to a 15 year low (with the silver lining that the duration of remaining time deposits has grown and is now longer than in 2008).

    But don't forget this is good news for community banks.

    These noninterest bearing NMDAs offer opportunities for cross selling and fee revenues as well as improving NIM for community banks.  These no cost deposits have displaced some time deposits, as well as brokered deposits and FHLB advances.  

    Now, I'm a big believer in time deposits, brokered deposits, and FHLB advances, but for this part of the rate cycle, I'm all in favor of maximizing NIM when you can do so safely.  In fact, using NMDAs more now means that community banks can keep their powder dry on those other liquidity sources.  Sounds like good planning to me.

    So given all of these benefits, what's FDIC concerned about?  Really, it boils down to the "What ifs" of NMDAs.

    What if the reason these NMDA accounts have grown is related to today's low rate environment and rates start to move up?

    What if NMDAs have grown due to a temporary reduction in risk appetite and that returns?

    What if NMDAs are simply a low cost substitute for a lack of alternative investment opportunities?

    It all comes down to one simple regulatory risk management question:  What if non-maturity accounts behave differently in the future than they did in the past?  What if it's different this time?  What if they are less stable and are actually much more rate sensitive than we expect?

    The answer then becomes that banks may need to replace this funding (at higher rates) at the exact same time that their longer duration assets suffer their greatest depreciation.  Sounds like a double whammy to me.

    FDIC then adds salt to the wound by postulating that Dodd Frank Act (DFA) may make this even worse with the end of prohibitions on the payment of interest on demand deposits.  You know, banks get in a bidding war to keep NMDAs.

    So, what's a prudent community banker to do?  I think it boils down to 3 things.

    1. Expect increased scrutiny of your NMDA assumptions.
    2. Proactively improve your NMDA modeling process
    3. Run more frequent "What if" scenarios with your NMDA assumptions

    I have already seen increased regulatory emphasis on NMDA assumptions during the examination process.  Remember, it's always best to have bank-specific assumptions.  And that means a deposit study of some sort.  Email me for details on how we can make this a reality at your bank.

    Similarly, if you already have bank-specific NMDA assumptions, now is the time to revisit them for accuracy, documentation and robustness.  Having wrong or misleading NMDA assumptions can actually be worse than not having any at all.  

    Finally, now is a great time to run more frequent NMDA assumption sensitivity analyses.  Speed up your decay rate (shorter average life) and increase your beta (more rate sensitivity).  Having these sensitivity scenarios ready to show your regulator can go a long way in getting them comfortable with your NMDA and overall deposit funding mix.

    If you have questions, please email me at howard.lothrop@echopartners.com



    Photo provided by Jo Naylor.

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