Main Street Lenders Choked by Regulators

Robert Barone TheStreet.com May 14, 2010

By Robert Barone of Ancora West Advisors

The system that America got used to from 1990 through 2007 where credit was easy to get and consumption and investment grew as a result, has disappeared. In its place is emerging a system that is 180 degrees opposed. Those that are "Too Big to Fail" are getting bigger. Meanwhile, the small community bank, the source of working capital for America's small businesses, is being choked by the regulatory system. Ask any CEO of a community financial institution who he/she works for -- the answer won't be the Board of Directors or the Shareholders -- inevitably, the answer will be the regulator (FDIC, OCC, Fed, OTS). It appears that, having failed to detect the subprime, housing and derivative bubbles (which emanated from Wall Street), the regulatory agencies have decided to get tough on Main Street lenders. Never mind that community institutions didn't participate in the subprime debacle or didn't sell synthetic securities to their clients while simultaneously taking short positions. And, ignore the $20 billion of capital that these institutions lost at the flick of the Treasury Secretary's magic wand (FNMA and FHLMC preferred stock). If you want to figure out why the economy cannot find solid footing, look no further than the way the regulators are treating commercial real estate loans in community bank portfolios. As presently enforced, federal regulations prescribe that all loans in excess of $250,000 that are secured by real estate must be periodically appraised in accordance with mark-to-market rules to determine value. For appraisals that show deteriorating property values, examiners, sometimes using arbitrary criteria, often impose write-off requirements, require additional collateral or demand cash payment for the difference between appraisal and the required loan-to-value ratio. These actions have set in motion "death spirals" in many communities based on fire-sale prices for assets which results in further market devaluations of other similar assets. Most borrowers in this economic climate cannot provide additional cash or collateral, and financing from an alternative source is simply impossible to get. The loan is classified even if the borrowers have made timely payments. The result is that the community bank has had to utilize its capital to create a reserve for any potential loss the examiner has determined, including loans that are not maturing for a considerable period of time. Under these constraints, most community banks do not have sufficient capital to expand their loan portfolios and finance local economic growth. If a community bank adheres to Congressional pleas to assist borrowers who may have borrowed when interest rates were substantially higher by reducing interest rates to current market levels and bringing the loan in line with the established income of the borrower and/or the property in question, the regulators deem the loan to be "restructured and impaired" and compel the bank to create a reserve and write down the value of the loan. This occurs notwithstanding that the borrower can demonstrate that he and/or the property can sustain the payments at the restructured level. This policy penalizes the bank for assisting a borrower. It is contradictory policy to have the Congress and the Administration urging community banks to lend more to stimulate economic growth and job creation while at the same time the banking regulators increasingly demand that banks build up their capital while substantially increasing their reserves to cover losses generated by the mark to market rules. Increasing capital and increasing lending activity are inconsistent goals in today's market. All market participants want "transparency", i.e., want to know what is on a bank's balance sheet, the market values of those assets, what other off balance sheet items exist, and how earnings are calculated. Transparency, then, appears both reasonable and necessary for market participants. On the other hand the function of a bank is to turn illiquid assets into liquid ones for its borrowing clients. Marking illiquid assets, which are not easily saleable in the best of times and which are not for sale and aren't intended to be for sale, to fire sale prices makes little sense. The balance sheet assets of community banks are not there for a quick flip; they are managed over very long periods of time. The current requirement that they be marked to fire sale prices impacts community bank capital and the local economy that those banks serve. Loading Comments... 1 2 Last » Next ›

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Main Street Lenders Choked by Regulators

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