U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

75–069 PDF 2012

H.R. 3461: THE FINANCIAL INSTITUTIONS 

EXAMINATION FAIRNESS AND REFORM ACT 

HEARING 

BEFORE THE

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS 

AND CONSUMER CREDIT 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

FEBRUARY 1, 2012 

Printed for the use of the Committee on Financial Services 

Serial No. 112–97 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

SPENCER BACHUS, Alabama, Chairman 

JEB HENSARLING, Texas, Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

NAN A. S. HAYWORTH, New York 

JAMES B. RENACCI, Ohio 

ROBERT HURT, Virginia 

ROBERT J. DOLD, Illinois 

DAVID SCHWEIKERT, Arizona 

MICHAEL G. GRIMM, New York 

FRANCISCO ‘‘QUICO’’ CANSECO, Texas 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

BARNEY FRANK, Massachusetts, Ranking 

Member 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

JAMES H. CLINGER, Staff Director and Chief Counsel 

(III) 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER CREDIT

SHELLEY MOORE CAPITO, West Virginia, Chairman 

JAMES B. RENACCI, Ohio, Vice Chairman 

EDWARD R. ROYCE, California 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, North Carolina 

JEB HENSARLING, Texas 

PATRICK T. MCHENRY, North Carolina 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

FRANCISCO ‘‘QUICO’’ CANSECO, Texas 

MICHAEL G. GRIMM, New York 

STEPHEN LEE FINCHER, Tennessee 

CAROLYN B. MALONEY, New York, 

Ranking Member 

LUIS V. GUTIERREZ, Illinois 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

RUBE ́ N HINOJOSA, Texas 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

NYDIA M. VELA ́ ZQUEZ, New York 

GREGORY W. MEEKS, New York 

STEPHEN F. LYNCH, Massachusetts 

JOHN C. CARNEY, JR., Delaware 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

February 1, 2012 .............................................................................................. 1 

Appendix: 

February 1, 2012 .............................................................................................. 63 

WITNESSES 

WEDNESDAY, FEBRUARY 1, 2012 

Bertsch, Kevin M., Associate Director, Division of Banking Supervision and 

Regulation, Board of Governors of the Federal Reserve System ..................... 8 

Kelly, Albert C., Jr., Chairman and CEO, SpiritBank, and Chairman, the 

American Bankers Association (ABA) ................................................................ 42 

Kelly, Jennifer, Senior Deputy Comptroller for Midsize and Community Bank 

Supervision, Office of the Comptroller of the Currency (OCC) ........................ 13 

Kucey, Jeanne, President and CEO, JetStream Federal Credit Union, on 

behalf of the National Association of Federal Credit Unions (NAFCU) .......... 47 

Ludwig, Hon. Eugene A., Founder and Chief Executive Officer, Promontory 

Financial Group, LLC .......................................................................................... 49 

Marquis, David M., Executive Director, National Credit Union Administration 

(NCUA) ................................................................................................................. 11 

Thompson, Sandra L., Director, Division of Risk Management Supervision, 

Federal Deposit Insurance Corporation (FDIC) ................................................ 10 

Watts, Kenneth, President and CEO, West Virginia Credit Union League, 

on behalf of the Credit Union National Association (CUNA) ........................... 44 

Wilcox, Noah, President and CEO, Grand Rapids State Bank, on behalf 

of the Independent Community Bankers of America (ICBA) ........................... 45 

APPENDIX 

Prepared statements: 

Bertsch, Kevin M. ............................................................................................. 64 

Kelly, Albert C., Jr. .......................................................................................... 75 

Kelly, Jennifer .................................................................................................. 86 

Kucey, Jeanne ................................................................................................... 104 

Ludwig, Eugene A. ........................................................................................... 117 

Marquis, David M. ............................................................................................ 121 

Thompson, Sandra L. ....................................................................................... 140 

Watts, Kenneth ................................................................................................. 147 

Wilcox, Noah ..................................................................................................... 163 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Capito, Hon. Shelley Moore: 

Written statement of the Appraisal Institute and the American Society 

of Farm Managers and Rural Appraisers ................................................... 170 

Written statement of BancVue, Ltd. ............................................................... 172 

McCarthy, Hon. Carolyn: 

Written responses to questions submitted to Kevin M. Bertsch .................. 177 

Written responses to questions submitted to Jennifer Kelly ........................ 178 

Written responses to questions submitted to David M. Marquis ................. 181 

Renacci, Hon. James B.: 

Written statement of David Baris, Executive Director, American Association of Bank Directors .................................................................................. 184 

Page

VI 

Westmoreland, Hon. Lynn A.: 

Written responses to questions submitted to Kevin M. Bertsch .................. 188 

Written responses to questions submitted to Jennifer Kelly ........................ 190 

Written responses to questions submitted to David M. Marquis ................. 191 

Kucey, Jeanne: 

‘‘Managing Examinations in Challenging Times,’’ published September 

2010 ................................................................................................................ 192 

(1) 

H.R. 3461: THE FINANCIAL 

INSTITUTIONS EXAMINATION 

FAIRNESS AND REFORM ACT 

Wednesday, February 1, 2012 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS

AND CONSUMER CREDIT, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 2:01 p.m., in room 

2128, Rayburn House Office Building, Hon. Shelley Moore Capito 

[chairwoman of the subcommittee] presiding. 

Members present: Representatives Capito, Renacci, Royce, Manzullo, Hensarling, McCotter, Pearce, Westmoreland, Luetkemeyer, 

Huizenga, Canseco, Grimm, Fincher; Maloney, Watt, Hinojosa, 

McCarthy of New York, Scott, Lynch, and Carney. 

Also present: Representative Green. 

Chairwoman CAPITO. This hearing will come to order. I would 

like to inform Members and also the witnesses that we expect a series of votes at 5 o’clock. It is my intention to complete this hearing 

before the votes, if possible. And so, I would ask Members, as I do 

every single time, to abide by the 5-minute rule, and the witnesses 

as well. 

Over the last year, the Financial Institutions and Consumer 

Credit Subcommittee has heard testimony from community banks 

and credit unions from across the country about the challenges 

they face in the post-financial crisis world. 

We actually did two field hearings as well: one in Wisconsin; and 

one in Georgia. Throughout these conversations, one common 

theme has emerged: There is a perceived disconnect between what 

is said in Washington by Federal regulatory agencies and what is 

carried out in the field by the Federal institution examiners. It is 

not limited to one geographic region. We were in, as I think I mentioned, Georgia and Wisconsin. There is a growing chorus of concern about the consistency in the application of examination standards across the country. 

The product of these conversations is the legislation that is in 

front of us today. Ranking Member Maloney and I have crafted 

H.R. 3461, the Financial Institutions Examination Fairness and 

Reform Act, to elevate the conversation about potential solutions to 

three common concerns that have been raised: the time limits of 

examination reports from the agencies; the independence of the appeals process for institutions; and the issue of Federal agency guidVerDate Nov 24 2008 18:27 Dec 06, 2012 Jkt 075069 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\75069.TXT TERRI
2 

ance that is not being followed by examiners. This legislation has 

garnered strong bipartisan support, due in large part to the growing chorus of concerned Members who are hearing from their constituents. 

In order to address these concerns, our legislation proposes to ensure timely responses from agencies, codifies the guidance from the 

Federal Financial Institutions Examination Council (FFIEC), and 

creates a new independent examinations ombudsman at the Federal Financial Institutions Examination Council. We have been 

working with the Federal regulatory agencies on this legislation, 

and I understand that they have concerns about it, and they are 

before us today to discuss those concerns. And I am very appreciative of that. I know they are aware of the seriousness of this 

issue to many of the members of our subcommittee on both sides 

of the aisle. 

And so, we have put forward this legislation as a good faith effort 

to address many of the concerns that have been raised by Members 

on behalf of their constituents. Now is the time for all parties to 

come together to work towards a consensus solution to provide 

greater clarity in the examination process and a more independent 

avenue of appeal for financial institutions in case there are legitimate disputes, which there always are, we know, about the outcome of an examination. 

It is important for all parties to understand that the frustration 

we hear from our constituents on these issues is very real. It is 

small businesses, it is individuals, it is long-time customers, it is 

new customers, and it is financial institutions that feel—paralyzed 

is maybe too strong a word, but at least tied with one hand behind 

their back in certain instances. This legislation will hopefully provide more clarity to the system so institutions have a better idea 

of how certain issues will be viewed by regulators in the future. 

I would like to thank our witnesses for joining us here today. 

Their input on the merits of H.R. 3461 is invaluable and will assist 

us as we move through to continue to try to develop solutions to 

these problems. 

At this time, I would like to yield to my good friend and lead cosponsor on the bill, the ranking member of the subcommittee, Mrs. 

Maloney, for the purposes of making an opening statement. 

Mrs. MALONEY. Thank you. I would like to thank the chairwoman for her leadership and for calling this important hearing. 

I first want to make it very clear that I support fair, understandable, consistent, and transparent regulation. It is important to protect the public and the overall economy. I wholeheartedly support 

the regulators being able to do their job by identifying troubled institutions and helping to strengthen their safety and soundness 

through requirements like regulatory capital and governance 

changes. 

But along with the chairwoman and many members of this committee, I have heard repeatedly from community bankers in the 

district I am honored to represent, and other community bankers, 

about the burden they have felt during the crisis and their concerns about examination fairness, particularly as it pertains to 

commercial loans. They, in many cases, have faced the threat of literally being closed down. And in some cases, they felt that they did 

3 

not have a fair, independent appeals process. And I believe these 

are concerns we should address. 

Now, we have had numerous hearings in this area. But this good 

faith work document that we have put forward has generated a lot 

of concern. It is almost like you have to put a bill in to have people 

listen to what you are trying to say. And this bill has several important components, one concerning the exam reports and standards; that they match the guidance, that they be consistent. And 

a loan’s classification needs to reflect the true risk of the loan and 

be consistent with the agency’s guidance. 

And we are also looking at creating an appeals process, and no 

one disputes that we need a fair and independent process. We certainly need a route for people to raise concerns and raise their concerns about exam determination, about regulation. And certainly, 

a transparent process could highlight the areas that need to be improved. In most cases, the current process is an internal appeal directly back to the agency that made the decision in the first place. 

And in some cases, some institutions fear retaliation. 

They do not feel that the process would be fair. They feel that 

they don’t even want to go forward, even if they feel that it was 

wrongly decided. 

And I do want to compliment the work of a former Comptroller 

of the Currency, Eugene Ludwig, who will be testifying on the second panel today. He literally created an appeals process within the 

OCC back in 1993, and he told me that they resolved well over 110 

appeals that were filed between 1993 and 1996. 

And yet in 2010, when we were in a much worse financial situation, there were only 11. So I am interested in hearing from the 

regulators why they think there has been this kind of decline and 

why the number of appeals over time has been relatively small in 

other agencies. 

And they call us, but they shouldn’t have to call us. They should 

be able to go back to the regulators and go through a process they 

feel treats them fairly. I feel that it may be that just the mere existence of an external appeal process which, of course, would be 

under this FFIEC Unit which the chairwoman described. The bill 

that we have introduced is very much a starting point, and I am 

open to any suggestions of ways to make it better. 

I am sure that all the members of the subcommittee want to address the concerns of community bankers. The community bankers 

were real stars in this financial crisis and their response to communities. I welcome the concerns of the panelists today, and I look forward to your testimony. 

Chairwoman CAPITO. Thank you. 

I would like to recognize Mr. Royce from California for 11⁄2 minutes for an opening statement. 

Mr. ROYCE. Thank you. One of the great traits of the banking 

system that we have here in the United States as opposed to the 

one in most developed countries around the world is that our system is literally comprised of thousands and thousands of financial 

institutions and credit unions. And if you contrast that to the system in Europe, or in most developed countries, you have a few massive institutions. 

4 

Our system, though, is at risk of devolving into sort of the European model, largely because of the actions of Washington that are 

stacking the deck against smaller institutions. It was really Washington, D.C., that bailed out and propped up the too-big-to-fail institutions, and in so doing—really by lowering their cost of borrowing, by giving them nearly 100 basis points advantage because 

of the perception of the market of them being too-big-to-fail—it has 

led to a situation where they can out-compete and sort of gobble 

up their smaller competitors. 

And it was Washington, D.C., that gave the Dodd-Frank Act the 

wherewithal here, with these new rules on top of the old ones, to 

disproportionately burden smaller financial institutions. An additional problem faced by smaller firms is the disconnect between the 

regulatory community in Washington and the examiners on the 

ground and what that has meant. 

So, I want to just take a minute here and commend Chairwoman 

Capito for this proposed legislation which I have cosponsored, because I think it goes a long way toward recalibrating the examination process to better allow bankers to be bankers. And it is one 

of the first in a number of steps we really need to take to level this 

playing field. 

I yield back. Thank you. 

Chairwoman CAPITO. Thank you. 

I recognize Mr. Scott for 3 minutes for an opening statement. 

Mr. SCOTT. Thank you, Madam Chairwoman. Let me thank you 

and the ranking member for holding this hearing today concerning 

the Financial Institutions Examination Fairness and Reform Act. 

This is a very important hearing. Our financial institutions are 

quite honestly in a crisis in terms of the relationship between them 

and the examiners. 

This bill, of which I might add I am proud to be a cosponsor, will 

establish a new standard of examinations of financial institutions 

as well as create a new process for institutions to appeal the regulatory decisions. And I think that if there is one area we need to 

perhaps spend a little time on today making sure we get it right, 

is this appeals process that we have. 

We want to make sure that it does not cause any delay. And 

there are some concerns within the infrastructure, that the appeals 

process as outlined in the bill might cause some delay. So I would 

be interested to make sure that we get this right. 

The bill calls for the establishment of an independent office responsible for investigating concerns about regulatory examiners 

that have been brought up by these institutions. And, of course, another problem in this is—I represent Georgia and we are the epicenter of bank failures. We realize that a part of that reason was, 

many of our banks in Georgia did overleverage their portfolios into 

the real estate lending area. 

But there have been some major concerns. We recently had a 

hearing down in Georgia, in Newnan, Georgia, where one of the 

major concerns was the level of inconsistency between what the actual examiners were doing out in the field on the ground not following accurately what was coming out of Washington. And so, 

that is another area we have to get clear, to make sure those who 

5 

are on the ground are following the guidance that is coming out of 

Washington in a consistent manner. 

In 2011, we had—just this last year we had 92 bank failures. 

Twenty-three of them—23 of them, that is over 25 percent—were 

in one State, my State of Georgia. These financial institutions, especially the smaller ones, the community banks, continue to struggle just to stay afloat. And just 2 weeks ago, the FDIC seized 

Stockbridge-based First State Bank, right in the heart of my congressional district. Another one sort of bites the dust, shall we say. 

But H.R. 3461 will ease regulatory burdens on community banks 

like First State Bank as well as other financial institutions, as the 

legislation is not limited by asset size. The watchdog created by 

this bill will have jurisdiction over regulators, and they will hold 

quarterly meetings to review examination practices. And additionally, the legislation will permit financial institutions to appeal any 

determinations found by an examiner within 60 days. 

Now, these provisions would ease costly regulatory burdens that 

were put on already-struggling banks—and not only our banks, but 

our credit unions as well—and will help make sure that our banks 

and our credit unions—and help ensure their sustainability in the 

future. 

So it is a good bill, it is a good foundation. I look forward to this 

hearing. 

And thank you again, Madam Chairwoman, for hosting it. 

Chairwoman CAPITO. Thank you. 

Mr. Hensarling for 11⁄2 minutes for an opening statement. 

Mr. HENSARLING. Thank you, Madam Chairwoman. 

We all know that too many of our financial institutions are fighting an uphill battle: the struggling economy; a monetary policy 

which is squeezing their profit margins; clearly, Dodd-Frank compliance; the Durbin language, which imposed price controls on their 

interchange fees; and the new credit allocation czar. 

By its own estimate, the Consumer Financial Protection Bureau’s 

(CFPB’s) first rule will now require 7.7 million employee hours to 

implement, and comply with the new rule, as the gentleman from 

California pointed out, the serial bailouts of their larger competitors. If we are not careful, Madam Chairwoman, we are going to 

wake up and see more failures and more consolidations of these 

community financial institutions. That clearly leads to less competition and fewer choices. 

We know that our regulators must protect the health of individual institutions, the system as a whole and, certainly, taxpayerbacked deposits. But our community financial institutions are critical—critical to our small businesses, the job engine of America, 

and we have to do more to wring out some of the uncertainty in 

this system. 

So, Madam Chairwoman, I applaud you and the ranking member 

for attempting to take us in that direction. I have heard from way 

too many financial institutions in my district about months and 

months of waiting to get a final report on their exams, being tied 

up and stymied waiting for these reports, and then, finally, there 

being no change. 

6 

So I am looking forward to hearing the testimony of our witnesses because I believe the provisions of H.R. 3461 can indeed be 

helpful. 

I thank you, and I yield back. 

Chairwoman CAPITO. Thank you. 

I recognize Mr. Westmoreland for 1 minute for the purpose of an 

opening statement. 

Mr. WESTMORELAND. Thank you, Madam Chairwoman. And I 

want to thank you and the ranking member for introducing H.R. 

3461. Here we are, another year and another bank failure in my 

district. I, along with Congressman Scott, represent Georgia. And 

as you know, Georgia has more bank failures than any other State. 

And it is a shame because these banks have been part of the 

FDIC system. They pay fees. They pay the insurance. And the 

FDIC should look at them as someone that they need to be a partner with, not somebody that can put them out of business. And I 

understand that you have been trying to make sure that your policies are implemented consistently across-the-board. 

But trust me, that is not the case. I suggest that you get out of 

Washington and that you go into some of these States and that you 

talk to some of these people. Because as Congressman Hensarling 

said, the reviews that they have on exit interviews orally, and then 

what they get in writing, are sometimes totally different. 

And so, we have to do something to help these community banks. 

Because I cannot tell you the heartache and the financial disaster 

it causes some of these small communities. So I hope you will quit 

fighting this bill, embrace it, and show us a way that we can help 

you use some common-sense things to regulate these banks in our 

communities. 

With that, I yield back. 

Chairwoman CAPITO. Thank you. 

Mr. Luetkemeyer for 1 minute? 

Mr. LUETKEMEYER. Thank you, Madam Chairwoman. And 

thanks to you and the ranking member for addressing major issues 

that, despite our repeated calls for action, continue to pose problems for financial institutions. 

Even with the passage of this bill and other bills aimed at helping relieve unnecessary regulatory pressure, banks and other institutions will still be subject to rigorous examination procedures and 

heavy regulation. Regulatory burdens cost banks and credit unions 

thousands of manhours and millions of dollars each year and divert 

them from conducting their actual business, which is lending to 

customers, helping to move our economy forward. 

This is an industry that is and should be closely examined, but 

it is absurd to create an environment that is so rigorous that banks 

are no longer able to properly serve their customers. It is time to 

restore certainty to the exam environment and to restore practicality to the way we regulate these institutions. I look forward to 

a robust conversation today, and I yield back the balance of my 

time. 

Thank you, Madam Chairwoman. 

Chairwoman CAPITO. Thank you. 

I would like to recognize Mr. Lynch for 2 minutes for an opening 

statement. 

7 

Mr. LYNCH. Thank you, Madam Chairwoman. I also want to 

thank the witnesses for coming before us today. 

First of all, just to begin, I would like to say that I have enormous respect for the sponsors of this legislation. I have worked 

with both the chairwoman and the ranking member on a lot of legislation since coming here to Congress. This bill will not be one of 

them, however. 

I have grave, grave concerns about a number of the sections in 

this bill, too many to get into in the short time that I have right 

now, but I will get into it during the hearing. I do want to associate 

myself—I had a chance to read all the testimony—with Ms. Kelly’s 

testimony. I think she raised a lot of the concerns that I have. And 

then I have a few of my own. 

But look, I understand the need here for a fair regulatory process 

that doesn’t impinge unfairly upon our banks and financial institutions. The fact of the matter is, however, that we are coming 

through a very difficult time. We have a lot of banks that are still 

hurting on their balance sheets and have some very weak assets. 

And the answer is not to reduce the standards to protect those 

banks that are weak. It is to help them regain strength. But it is 

not to cover this up, and not to paper it over. This is the same argument we had on mark-to-market a couple of years ago, when institutions did not want to have their assets marked down. But we 

will get into it a little later. 

Madam Chairwoman, thank you for the great courtesy that you 

have afforded me, and I yield back the balance of my time. 

Chairwoman CAPITO. Thank you. 

Mr. Canseco for 1 minute for an opening statement. 

Mr. CANSECO. Thank you, Madam Chairwoman. And thank you, 

Ranking Member Maloney. 

There are several numbers that are very important to keep in 

mind today, and some of them are these: 30 years ago, there were 

over 14,000 community banks in the United States, and today 

there are less than 7,000. The Sarbanes-Oxley Act was projected to 

cost companies less than $100,000 per year to comply with it. In 

reality, that figure is over $2 million. And according to the CBO, 

it will take companies a total of 10.2 manhours per year to comply 

with Dodd-Frank. Doing simple math, and assuming a minimum 

wage rate of $7.25 per hour, that is a cost of almost $74 million 

per year in compliance wages. 

Undoubtedly, the greatest burden falls on community banks, and 

this problem is often compounded by an oftentimes disjointed or 

unpredictable bank examination process. H.R. 3461 goes a long 

way towards fixing the process our regulators use to conduct examinations. And I commend the chairwoman and the ranking 

member for introducing this bill. It is a small but very important 

step to ensuring that community-oriented banking remains a central part of our economic landscape. 

Thank you, and I yield back. 

Chairwoman CAPITO. Thank you. 

I think that concludes our opening statements, so I would like to 

now introduce our panel of witnesses for the purpose of giving a 

5-minute opening statement. 

8 

Our first witness is Mr. Kenneth M. Bertsch, Associate Director 

of the Division of Banking Supervision and Regulation, Board of 

Governors of the Federal Reserve System. I would also like to mention that Mr. Bertsch was kind enough to testify for the Federal 

Reserve at our hearing in Newnan Georgia. So I appreciate your 

traveling to Washington to make this testimony. 

Mr. Bertsch? 

STATEMENT OF KEVIN M. BERTSCH, ASSOCIATE DIRECTOR, 

DIVISION OF BANKING SUPERVISION AND REGULATION, 

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. BERTSCH. Chairwoman Capito, Ranking Member Maloney, 

and members of the subcommittee, I appreciate the opportunity to 

discuss the Federal Reserve’s views on the Financial Institutions 

Examination Fairness and Reform Act. The Federal Reserve shares 

the subcommittee’s interest in ensuring fair examinations, and providing banks with a robust and transparent process for appealing 

supervisory determinations. 

Accordingly, the Federal Reserve has taken a number of steps to 

ensure that examination findings are well-grounded in supervisory 

policy, fully supported, and give due consideration to all relevant 

information provided by bankers. 

We also encourage bankers to discuss with reserve bank supervision management any concerns they may have with the examination process. If bankers still have concerns after talking with supervisory staff, they are encouraged to contact the Federal Reserve’s ombudsman and consider filing a formal appeal. 

While we support efforts to ensure a fair examination process, 

some provisions of the proposed legislation appear to limit the ability of examiners to use judgment and may impede, rather than further, the ability of examiners to ensure the safe and sound operation of banking organizations. For example, the proposed bill 

could be interpreted to prevent an examiner from requiring a new 

appraisal on a performing commercial loan unless new funds are 

being advanced. 

In some cases, the absence of an updated appraisal would make 

it difficult for banks to appropriately assess their risk of loss and 

take actions to protect their financial interests. Similarly, the proposed bill could be read to prohibit examiners from recommending 

the placement of certain loans on non-accrual status, raising the 

potential that income could be overstated at some banks. 

Some might also interpret the bill as requiring that a loan be returned to accrual status if it is making payments according to its 

terms, regardless of whether those terms would assure the ultimate collection of the entire principal and interest due. This type 

of strategy is inconsistent with Generally Accepted Accounting 

Principles (GAAP), and past supervisory experience suggests it is 

often unsuccessful and can increase the cost of resolution in the 

event a bank fails. 

The proposed bill also appears to prohibit examiners from requiring a bank that meets the regulatory threshold for being well-capitalized from adding to its capital base. These provisions conflict 

with the expectations set forth in the recently enacted Dodd-Frank 

Wall Street Reform and Consumer Protection Act. 

9 

They also fail to recognize that the regulatory definitions for the 

various capital thresholds do not take into account the idiosyncratic 

risks at individual organizations or the potential effects on a bank’s 

capital position, of risk management deficiencies, or concentrations 

in problem assets. 

A key purpose of the proposed legislation appears to be to ensure 

a strong appeals process and independent ombudsman function for 

the resolution of bankers’ concerns. The Federal Reserve has in 

place a robust appeals process and an independent ombudsman 

function designed to provide institutions with a fair and fulsome 

review of complaints. 

We also maintain a strong anti-retaliation policy to protect any 

person who uses the appeals process or who contacts the ombudsman with concerns. Moreover, the Federal Reserve continues to 

evaluate methods for improving its ombudsman function and appeals process. 

We recognize the concerns expressed by bankers about the supervisory process and are taking steps to respond to them. In 2009, 

the Board established a subcommittee to focus on supervisory approaches to community and regional banks. This subcommittee is 

led by Board Governors Elizabeth Duke and Sarah Bloom Raskin. 

A primary goal of the subcommittee is to ensure that the development of supervisory guidance is informed by an understanding of 

the unique characteristics of community and regional banks, and 

consideration of the potential of excessive burden and adverse effects on lending. In addition, in 2010 the Board established the 

Community Depository Institutions Depository Advisory Council to 

provide input on the economy, lending conditions, and other issues 

of interest to community banks. 

Feedback from community bankers has persistently pointed to 

increasing regulatory burden as a concern. Last year, the Board’s 

Subcommittee on Community and Regional Banks asked that a series of initiatives be developed to clarify regulatory expectations, alleviate regulatory burdens where possible, and reduce the potential 

that regulatory actions could curtail lending. 

In response, Federal Reserve staff initiated a number of projects 

to enhance provision practices for community banks and alleviate 

some of the burdens that have been of most immediate concern. 

Overall, these efforts are intended to ensure a rigorous but balanced approach to safety and soundness supervision that fosters a 

stable, sound, and vigorous community bank population. 

In summary, the Federal Reserve supports efforts to ensure that 

the examination process is fair, balanced, and consistent, and 

strives to consistently improve its examination processes. 

Indeed, we have already initiated a number of changes to improve and clarify our supervisory policies and practices and, where 

possible, constrain burden. It is, however, important that the agencies not be impeded in taking steps to ensure the safe and sound 

operation of banking firms. 

We appreciate the subcommittee’s invitation to share our views, 

hope that our comments have been helpful, and would be happy to 

continue a dialogue on these very important issues. 

Thank you. 

10 

[The prepared statement of Mr. Bertsch can be found on page 64 

of the appendix.] 

Chairwoman CAPITO. Thank you. Our second witness is Ms. Sandra L. Thompson, Director of the Division of Risk Management Supervision, the Federal Deposit Insurance Corporation. 

Welcome. 

STATEMENT OF SANDRA L. THOMPSON, DIRECTOR, DIVISION 

OF RISK MANAGEMENT SUPERVISION, FEDERAL DEPOSIT 

INSURANCE CORPORATION (FDIC) 

Ms. THOMPSON. Thank you. Chairwoman Capito, Ranking Member Maloney, and members of the subcommittee, I appreciate the 

opportunity to testify on behalf of the FDIC about the Financial Institutions Examination Fairness and Reform Act. 

The FDIC shares the subcommittee’s goal of having a strong 

banking industry that serves as a source of credit to our Nation’s 

communities. At the same time, we share the responsibility with 

our fellow regulators of making certain that insured institutions remain safe and sound, and that their financial reporting accurately 

portrays their condition. 

This is a challenging time for financial institutions, and examination findings reflect a difficult economic environment. These difficulties, particularly as they affect real estate, have led to credit 

quality weaknesses that have increased the volume of classified 

and non-accrual loans. Where these credit quality issues are found, 

corrective action is necessary to help ensure that institutions remain solvent and risks to the Deposit Insurance Fund are mitigated. 

We also recognize that banks are working very hard to navigate 

the downturn. They have had to increase efforts to work with borrowers who are having difficulty making payments, address earnings compression, and deal with the credit availability needs in 

their respective communities. 

The stated purpose of H.R. 3461 is to improve the examination 

of depository institutions, another goal we share. The FDIC continually seeks to improve the bank examination process, and we are 

committed to ensuring that banks understand our examination 

findings. Importantly, this includes the opportunity to discuss and 

question and appeal those findings if they disagree, both formally 

and informally. 

The bank examination process in the United States has evolved 

over many decades and has been shaped by our collective experience in both good and bad times. Recent experience has reconfirmed an essential lesson of past crises. Namely, ongoing robust 

examination and early supervisory intervention are key to containing problems as they develop. 

We believe the current supervisory regime helps to promote public confidence by providing for the effective supervision of our Nation’s banks while protecting depositors. The bill proposes changes 

to important supervisory standards and limits our ability to consider all of the facts necessary to assess the credit quality of loans. 

The effect of these changes is that banks will no longer be required to recognize troubled assets in an accurate and timely manner. And our examiners will be prevented from considering mateVerDate Nov 24 2008 18:27 Dec 06, 2012 Jkt 075069 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 K:\DOCS\75069.TXT TERRI
11 

rial risk factors that have long been regarded as essential to assessing the credit risk in a bank’s loan portfolio. We are concerned 

that this could mask problems at insured depository institutions 

and block our ability to require weak institutions to take corrective 

action, potentially resulting in higher losses to the insurance fund. 

We are also concerned that this will lead to inaccurate financial 

reporting in banks’ regulatory reports since income and capital 

would be overstated. As a consequence, we would no longer be able 

to properly determine the institution’s condition, the adequacy of 

its capital and reserves, the performance of management, and the 

overall risk the institution may pose to the insurance fund. 

Under the proposed new appeals process, the Office of Examination Ombudsman within the FFIEC would have the authority to 

overturn determinations reached by the independent banking agencies. This would give the new ombudsman great authority, but no 

responsibility for the oversight of the bank or whether the bank 

survives or fails. 

Further, rather than shortening the examination process as the 

bill proposes, this process could have the opposite effect. My written statement summarizes the benefits of the current classification 

of loans, accurate financial reporting, and the current appeals process at the FDIC. We believe this approach provides for the timely 

recognition of problems, allows regulators and bankers to work together to solve problems, and helps avoid losses to the Deposit Insurance Fund. 

I would be happy to answer your questions. Thank you. 

[The prepared statement of Ms. Thompson can be found on page 

140 of the appendix.] 

Chairwoman CAPITO. Thank you. Our next witness is Mr. David 

M. Marquis, Executive Director, National Credit Union Administration. 

Welcome. 

STATEMENT OF DAVID M. MARQUIS, EXECUTIVE DIRECTOR, 

NATIONAL CREDIT UNION ADMINISTRATION (NCUA) 

Mr. MARQUIS. Thank you, Chairwoman Capito, Ranking Member 

Maloney, and members of the subcommittee. 

The National Credit Union Administration appreciates the invitation to testify on H.R. 3461, the Financial Institutions Examination Fairness and Reform Act. In difficult economic times, depository institutions encounter additional threats to their safety and 

soundness. As a result, regulators like NCUA must take prompt action to address the identified problems and mitigate emerging risk. 

We take these actions in order to maintain the safety and soundness of credit unions, safeguard the National Credit Union Share 

Insurance Fund, and protect consumer deposits and ensure that 

taxpayers do not experience a loss. When regulatory actions increase, complaints against the regulator typically arise. NCUA, 

however, actively works to minimize complaints by comprehensively training our examiners and by encouraging stakeholders to 

communicate with us. 

We have found that an effective exam program requires an ongoing two-way conversation. Direct communication between examiners and credit unions often resolves problems and misunderVerDate Nov 24 2008 18:27 Dec 06, 2012 Jkt 075069 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 K:\DOCS\75069.TXT TERRI
12 

standings. When such interactions fail to produce a consensus for 

resolutions, credit unions have other avenues to voice concerns. 

Specifically, NCUA has an open-door, multilayered appeals process 

that provides reconsideration of regulatory decisions. 

After appealing to supervisory examiners and regional directors, 

a credit union may request a reevaluation by our supervisory review committee, an independent interagency appeals panel. Consistent with H.R. 3461, NCUA has already adopted a zero tolerance 

policy to prevent retaliation against appealing credit unions. Every 

exam report contains a cover page that explains a credit union’s 

appeal rights and references NCUA’s policy on appeals and non-retaliation. This is also available on our Web site. 

Further, in accordance with the bill, we have prioritized the 

timely delivery of findings so that exams are properly completed 

and credit unions may quickly address smaller issues before they 

grow into big ones. In short, NCUA already meets several of the 

standards found in the bill, and we are firmly committed to fairly 

applying current law in order to protect the safety and soundness 

and to limit insurance fund losses. 

To address the problems the subcommittee has identified, H.R. 

3461 would institute new exam procedures, modify accounting 

practices, and create new appeal venues. Although well-intentioned, the bill could produce at least three unintended consequences. 

First, the bill would greatly increase NCUA’s costs. The documentation changes, for example, would increase the time spent on 

exams. The new appeals procedures would add more regulatory 

layers that would increase costs, without any assurance of greater 

effectiveness. 

To validate individual exam findings for administrative law 

judges, NCUA would need to write more detailed rules to clarify 

safety and soundness principles. Moreover, the bill’s changes to operations and funding for the Federal Financial Institutions Examination Council would significantly increase NCUA outlays. Ultimately, credit unions have to pay for these increased regulatory expenses. 

Second, in its present form, the bill could greatly increase risk 

to the Share Insurance Fund. For example, an administrative law 

judge’s decision to overturn safety and soundness action due to a 

lack of knowledge of financial institution operational risk on a forward basis might result in greater insurance fund losses in the future. 

Further, the bill’s modified exam procedures and expanded appeals rights would delay resolution of safety and soundness issues 

and allow problems to escalate. The increased time to settle issues 

runs counter to GAO’s recent recommendations that NCUA require 

early and forceful regulatory action well before capital deterioration 

triggers prompt corrective action tripwires. 

In addition, the commercial loan accounting changes could mask 

problems, and extend the time before we could take necessary action to mitigate losses in a distressed portfolio. Such accounting 

changes would also conflict, at times, with financial institutions’ reporting requirements under generally accepted accounting principles. 

13 

Third, the bill would result in a one-size-fits-all examination system. NCUA currently customizes its reviews based on size, scale 

and scope of each credit union. The largest bank holding company 

has more than $1 trillion in assets, yet nearly 70 percent of credit 

unions have $50 million or less in assets. The requirement to establish consistent exam standards across a wide range of financial 

institutions would decrease regulatory flexibility and add considerable cost. 

In sum, NCUA recognizes that financial services regulators must 

conduct exams fairly and consistently, and we strive to achieve this 

standard. NCUA is committed to addressing legitimate concerns 

about the present exam process, minimizing regulatory conflicts, 

promoting procedural fairness, and advancing exam consistency. 

Later this year, for example, NCUA will adopt a national supervisory policy manual to reinforce greater consistency amongst our 

exams and regions. We are also committed to working with Congress to explore other ways to address exam concerns. 

I look forward to answering any of your questions. 

[The prepared statement of Mr. Marquis can be found on page 

121 of the appendix.] 

Chairwoman CAPITO. Thank you. And our final witness on this 

panel—I would like to welcome her back; she has been before the 

committee before, and I appreciate her being here—is Ms. Jennifer 

Kelly, Senior Deputy Comptroller for Midsize and Community 

Bank Supervision, Office of the Comptroller of the Currency. 

Welcome. 

STATEMENT OF JENNIFER KELLY, SENIOR DEPUTY COMPTROLLER FOR MIDSIZE AND COMMUNITY BANK SUPERVISION, OFFICE OF THE COMPTROLLER OF THE CURRENCY 

(OCC) 

Ms. JENNIFER KELLY. Thank you. Chairwoman Capito, Ranking 

Member Maloney, and members of the subcommittee, I appreciate 

the opportunity to appear before you to discuss the OCC’s perspective on H.R. 3461. 

As the Senior Deputy Comptroller for Midsize and Community 

Bank Supervision, I serve as the senior OCC official responsible for 

the supervision of approximately 1,700 national banks and Federal 

savings associations with assets under $1 billion. These community-focused institutions play a crucial role in providing essential financial services to consumers and small businesses in communities 

across the Nation, as well as supplying the credit that is critical 

to economic growth and job creation. 

The bill contains measures directed at three basic concerns: first, 

assuring that banks have access to a fair and independent appeals 

process if they disagree with a regulator’s supervisory determination; second, clarifying or revising standards for classification of 

loans and placing loans in non-accrual status; and third, achieving 

timely communication of examination results. 

My managers and I hold numerous outreach sessions and meetings with bankers to listen, and respond, to their concerns and 

questions. And we have heard many of the same concerns that you 

have about the challenges that bankers are facing. We seek to ensure that the OCC’s examinations are fair and timely, and that the 

14 

OCC is fulfilling its mission of ensuring the safety and soundness 

of national banks and Federal thrifts by identifying problems at 

the earliest possible stage and holding institutions accountable for 

taking timely and effective corrective actions. 

While we understand and support the broader objectives of the 

bill, we believe it could impede our ability to deal with troubled institutions on a timely basis, and would undermine Congress’ clear 

direction that bank regulators identify and promptly address unsafe and unsound practices and that insured depository institutions 

report their financial condition in accordance with Generally Accepted Accounting Principles, commonly known as GAAP. 

The OCC fully supports providing bankers with a fair and independent process for appealing supervisory determinations, and we 

believe our current appeals process, run by our ombudsman, does 

just that. The bill’s approach to accomplishing that objective would 

involve creating a new Federal bureaucracy at the FFIEC, and risk 

disrupting appropriate and necessary supervisory activities by 

bank regulators. 

We believe there are better alternatives without those downsides 

that would accomplish the objectives of H.R. 3461. We would be 

happy to work with the subcommittee to frame out an alternative 

approach. 

We also have significant concerns that the standards for non-accrual loans in the bill could result in revenue recognition that is 

inconsistent with GAAP. FDICIA established that banks must follow GAAP, or standards that are no less stringent than GAAP, in 

reporting their financial condition. 

Congress put this requirement in place in response to the savings and loan crisis, where non-GAAP regulatory accounting 

masked the deteriorating financial condition of institutions until it 

became so serious that a massive bailout was needed. The bill 

would weaken this important standard. 

As I have previously testified before this subcommittee, the integrity of financial reporting and regulatory capital is vital to identifying and correcting weaknesses before they threaten a bank’s 

ability to continue to meet the needs of its customers and the communities it serves. 

As we have seen during the most recent crisis, it is also essential 

that supervisors have the ability to direct banks to hold capital 

commensurate with their risk profile. The bill would, in certain instances, tie the hands of regulators when they believe a bank’s risk 

profile requires more capital. 

Finally, we agree that completing and communicating our examination findings on a timely basis is essential. Clarifying those expectations can be a positive step. But flexibility is needed when an 

exam may not be finished or results communicated for good reasons, such as when a significant policy issue needs further deliberation before a conclusion is reached. 

My written testimony discusses the OCC’s perspectives and concerns with the proposed legislation in greater detail. I would be 

pleased to respond to any questions you have about my testimony 

or other matters relating to H.R. 3461. As I conclude, I would like 

to reiterate the OCC’s willingness to work with the subcommittee 

15 

to explore alternative approaches that would achieve the goals we 

share without raising the types of concerns I have identified. 

Thank you. 

[The prepared statement of Ms. Kelly can be found on page 86 

of the appendix.] 

Chairwoman CAPITO. Thank you, thank you all. And I would like 

to begin my 5 minutes of questions. 

Listening to the testimony from the four of you, I am kind of 

wondering if we are in a little bit of an alternative universe here. 

From what we are hearing from our constituents and the resultant effect of inability to lend to small businesses and, consequently, 

inability to create jobs, tightening in inconsistent standards—with 

the exception of, basically, Mr. Bertsch did say that the Fed had 

developed a council or a committee to try to respond to community 

bankers and concerns that they were having—it doesn’t seem 

like—and you mentioned, as well, that some adjustments had been 

made, although you didn’t get specific with what those might be. 

But you were at the hearing in Georgia and I think that those 

who testified on, I believe it was, the second panel after you testified, had conflicting statements as to what they were hearing on 

the ground and what was the resulting written report, or what the 

resulting actions were. 

So I guess what I am wondering here is we feel—and I think you 

have heard everybody in their opening statements feel and our constituents feel—that there is a problem here. And I don’t really get 

the impression, with the exception of Ms. Kelly did say that she is 

willing to work, but without specificity. Is there a big disconnect 

here? 

You kept going back to the safety and soundness argument. That 

is a logical and great argument. Because, certainly, the safety and 

soundness of financial institutions is the core of what we believe 

and what we all want across-the-board in a consistent way on all 

parties. Because it is not only good for the country, it is good for 

the institutions, it is good for the constituents, it is good for the 

small businesses and mom-and-pops that are working with these 

institutions. 

So I guess I would ask Ms. Thompson if you have—are you hearing the same things? You have been before this committee, the 

FDIC has been before the committee several times and heard the 

same repeating theme from us as Members of Congress. 

Is this a consistent disconnect between what we are seeing on 

the ground and what you all are seeing going forward? 

Ms. THOMPSON. Chairwoman Capito, thank you for the opportunity to respond. 

I would say that the FDIC, as the primary Federal regulator for 

over 4,600 institutions, has heard these comments regularly from 

bankers and we have really taken steps to try to address some of 

the things that we have heard. We have heard about inconsistencies between Washington and the field, we have heard about 

mixed messages. 

And one of the things that we have done is to reinforce our policies with our examiners. I personally have nationwide phone calls 

with my examination workforce. I personally visit all of the reVerDate Nov 24 2008 18:27 Dec 06, 2012 Jkt 075069 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 K:\DOCS\75069.TXT TERRI
16 

gional offices and go to the specific territories, and require our regional directors and our field management to do the same. 

We also meet with bankers regularly and we encourage them to 

address these issues with us specifically. In fact, last year, in 

March, the FDIC issued a Financial Institution Letter reminding 

institutions about the appeals process and reminding institutions 

about our ombudsman. Also, we established a direct e-mail box to 

me personally, directly to me, for bankers who had specific concerns before, during, or after an examination. 

And we are very concerned about the perception. We want to 

make sure that our examiners are following the instructions that 

we have given in Washington. And we would like—if you have specific instances, we would be happy to address those instances. 

Chairwoman CAPITO. I think, in our bill, we did go to the three 

instances—the timeliness of the reports; the looking at the commercial real estate assets on a regular-paying customer; even 

though the assets have fallen in value, how do you treat that on 

your books? And then, of course, the objectivity of the ombudsman 

has been an issue. 

We heard this in Georgia, that there was a feeling of retaliation. 

Somebody addressed that in their opening statement, about how 

they have tried to separate some kind of retaliatory measures. 

How are we going to bridge this gap? Ms. Kelly said you are willing to work. Do you have any suggestions on how we are going to 

close this gap between what you are saying and what we are hearing? 

Ms. JENNIFER KELLY. I believe that ongoing communication is 

the key to this. And going into the economic downturn, that was 

something we have emphasized with our examiners, I have emphasized with my managers. And we certainly have stepped up our 

outreach efforts in terms of meeting with bankers. I did a quick 

count. We had over 50 meetings just in 2011 with bankers about— 

Chairwoman CAPITO. But you are hearing the same thing we are 

hearing? 

Ms. JENNIFER KELLY. Yes, we hear complaints. Certainly, there 

are many more banks that are having problems now, given the economic environment we are in. The examiners are having more critical findings of those institutions. 

And if bankers don’t agree with the examiner’s finding, they 

raise concerns about that. That is why we get out there, we talk 

to them, we certainly encourage them. If they feel that the examiner has not laid out the rationale for the conclusion they have 

reached adequately, then not only do we have our formal appeals 

process through the ombudsman, but we also have an informal appeal process through the supervisory chain. 

And often, many of these issues are resolved just by having further conversations about it, getting higher levels of management in 

the district involved. I would go back to Mrs. Maloney’s comment 

about— 

Chairwoman CAPITO. I am going to stop you there, because I 

went over my time. 

And I am going to let Mrs. Maloney go ahead and begin her 

questioning. 

17 

Mrs. MALONEY. First of all, I would like to thank all the panelists for your public service and for your fine testimony and for raising legitimate concerns. 

It certainly is not my intention, in any way, shape or form, to 

undercut the GAAP accounting principles. We are in an international banking system now and have to have international ways 

to regulate. And that is one of the reasons we are having Basel I, 

II, and III. And we certainly don’t want to in any way, at least I 

don’t want to, undercut that. 

You have raised many concerns that I look forward to working 

with you on. But I would like to go to the appeal process, and first 

ask Mr. Bertsch from the Fed, you testified that you have a very 

robust appeal process. You already have an ombudsman in place. 

How many appeals, formal appeals, have been lodged with the Fed 

since the crisis in 2008 to now? Were any any formal complaints 

lodged? 

And also you testified, as did others, that you were concerned 

that an external appeals process would undercut your supervisory 

function. Can you think of modifications to the section that would 

allow some level of independent review but address your particular 

concern for supervisory function? First, Mr. Bertsch, and then I 

just want to go down the line. 

Mr. BERTSCH. We have had an increase in the number of appeals 

that we have gotten since 2007. I think we typically had gotten 

about 5 formal appeals a year, and in 2011, there were 10 appeals. 

We believe that the appeals process that we have in place at the 

Fed is effective in considering appeals. We have a three-level appeals process, as we described in the testimony. And we believe 

that it results in a satisfactory airing of facts and objective determinations on those appeals. 

Mrs. MALONEY. Any comments on Section 1015 and supervisory 

function? 

Mr. BERTSCH. I don’t believe that I specifically commented on 

that in my testimony. 

Mrs. MALONEY. Okay. 

Ms. Thompson, how many appeals to the FDIC? You were really 

involved deeply in responding, I believe in many ways, very appropriately to the crisis. Anyway— 

Ms. THOMPSON. As stated before, the FDIC has an informal and 

a formal appeals process. 

Mrs. MALONEY. Just the formal one. 

Ms. THOMPSON. Through the formal appeals process, since 2008, 

the FDIC has had 33 formal appeals. Our appeals process goes to 

our regional office. And if the bank does not agree with that appeal, it would go to the Division Director, me. But the final ability 

to overturn a supervisory appeal is a committee that is established 

by our Board of Directors, it is chaired by a Board Member, and 

it contains persons who are not involved in the supervisory process. 

So to the extent an institution has an appeal, they are appealing 

to the very highest levels of our organization. 

Mrs. MALONEY. Would you feel more comfortable with the legislation if the final word was the organization and not totally independent under the FFIEC? 

18 

Ms. THOMPSON. I believe our organizations are responsible for 

the safety and soundness of the banking system. The FDIC is also 

responsible for insuring deposits. And people work very hard to put 

their money in a financial institution, and we take that responsibility very seriously. 

I think the head of our agency, who is appointed by the President, serves as Chairman of our Board— 

Mrs. MALONEY. And we raised that to $250,000 in Dodd-Frank, 

which is very helpful for community banks. 

Ms. THOMPSON. That is exactly correct. But our Board consists 

of members of the other Federal banking agencies, and they have 

decided to establish a committee to look at supervisory appeals. 

And we think that is the appropriate level. 

Mrs. MALONEY. Mr. Marquis, I know from my district that the 

credit unions were not really involved in the crisis. They were not 

closed. They provided service, and continued functioning through it 

in a fine and excellent way. So, congratulations. But on the appeals 

process, do you have appeals? 

Mr. MARQUIS. We do a supervisory review committee for formal 

appeals. We had three last year, and most of them get resolved at 

the regional director’s level. We have had, of course, some strains 

with industry this year because of the tough economic climate. 

If you had asked me how many failures I thought we were going 

to have a year ago, I thought we would be at a much greater number. But through a lot of hard work between our examiners and 

CEOs that sometimes push back at each other, they eventually get 

to resolving the issue. One of the issues on terms of timeliness to 

go into the outside appeals process, as presented, was the 60 days 

it takes to file an appeal, 60 days to get to review it, and 60 days 

to issue a final determination. 

And some of our more troubled credit unions, Code 4s, by that 

time we have already done two additional supervision contacts to 

make sure that the ball has moved down the field and issues that 

are of great concern are actually being addressed. So that delay 

could potentially delay actions in moving credit unions to safety. 

Mrs. MALONEY. My time has expired, but if I could have 10 seconds to respond to one point he made, that the economy appears 

to be improving somewhat. Certainly, the number of complaints on 

commercial real estate loans and appeals has diminished, at least 

in my office, and probably many others. 

Thank you all for your testimony 

Chairwoman CAPITO. Thank you. 

Mr. Renacci, 5 minutes for questions. 

Mr. RENACCI. Thank you, Madam Chairwoman. I want to thank 

the witnesses for being here. 

I am going to follow up with what the chairwoman was saying. 

There really does seem to be some inconsistency. And I am going 

to give you three examples from my district. Three businesses—one 

of them employed 50 people, one of them employed 35 people, and 

one of them employed 25 people—and all of them had loans that 

were put on non-accrual basis. So all of them had issues that some 

regulator told the bank these were problem loans. 

This was done in late 2009, early 2010. This was before I was 

in Congress. I was a CPA, so I definitely knew those businesses 

19 

and what was going on. Today, two of those business are not nonaccrual anymore because they found another bank to refinance 

with. One of them is gone. 

The one business that is gone cost 25 jobs, yet that property sold 

for about 85 percent of the loan. So when we talk about the inconsistencies, I would look back to the jobs, the small business owner. 

Those are the ones who are having the issues. 

And we talk about the banks and the appeal process. I think 

there is a concern with some banks, when I talked to the banks, 

that they are concerned with the current appeal process. Because 

they think if they do those things, there will be retribution. And 

I think that is an issue too, from what I hear. 

So I am just telling you what I am hearing from back in my district. But I think it is an interesting story, when you talk about 

three specific businesses, when you tie it down in my district—and 

where one of them is gone, 25 jobs are gone, are never coming 

back, and the other two businesses, the way they were able to survive was by refinancing. 

Now, I want to move forward onto this. We have been throwing 

GAAP out, Generally Accepted Accounting Principles. And as an 

auditor, as a CPA, somebody who has done certified statements, I 

understand GAAP. I understand Generally Accepted Accounting 

Principles. I understand that many times, when I did a financial 

statement or when my company did a financial statement, you 

would have a going concern. 

But most of the times, those going concerns were because the 

bank would say the loan was not a collectible loan. Those are the 

questions I have. Who makes that judgment? How do we make that 

judgment? How specific are we on that judgment? And those are 

opinions. Somebody can say that loan will be paid, some will say 

it won’t. 

I just gave you three examples where two of them are doing very 

well right now and employing people. Now, just think if I was 

doing, or you all were doing, certified audits of those two businesses who were put on non-accrual, you would probably give 

them, I would give them, a going concern which means I doubt 

they can stay in business, and the problems that would occur. So 

tell me a little bit about why you feel this bill is inconsistent. 

I will start with you, Ms. Kelly, because I know you were talking 

about GAAP. Tell me why you feel it would inconsistent with 

GAAP. Because remember, GAAP is an opinion. And it can be your 

opinion versus somebody else’s opinion. 

Ms. JENNIFER KELLY. I would agree with that. GAAP is Generally Accepted Accounting Principles. It is principles-based. And 

then what the banking agencies have done is, in the call report instructions, we have taken those principles and better defined what 

we see as the standard for determining income recognition, what 

is appropriate, and whether a loan should be on an accrual basis 

or a non-accrual basis. 

In the instances that you cited, we would have to look at each 

situation specifically, and look at the facts and circumstances that 

are unique to that loan, to decide whether it was an appropriate 

determination or not. But it is important to understand that what 

examiners are doing is outlined in the call report instructions. The 

20 

call reports, which are the quarterly financial reports, are prepared 

by the banks. 

And so when our examiners go in, they are looking at the determinations that the bankers are making about those loans and 

whether they should be on non-accrual or not, in accordance with 

the call report instructions. So the examiners are looking at the 

documentation and discussing the loan with the banker to understand their rationale for keeping it on accrual, and determining 

whether they feel there is a sound basis for that. 

So that is what the examiners are doing. And if they tell the 

bank that they believe the loan should be on non-accrual, it relates 

to the income recognition by the bank. 

Mr. RENACCI. In these three instances, all three of these loans 

were making their payments, they were never behind, they were 

100 percent on time. So again, the inconsistency would be when I 

talk to the bank. And in the day, I did talk to the bank and say, 

‘‘Why are you putting these on non-accrual?’’ They are saying, ‘‘Because the regulators are forcing us to put us on non-accrual.’’ 

Ms. JENNIFER KELLY. You mentioned the word ‘‘collectability,’’ 

when you were framing up the question initially. And that is the 

key piece here. It is not only are the payments current, but it is 

an assessment of whether there is reason to believe that full principal and interest are going to be collectible on that loan. 

Mr. RENACCI. I know my time is running out, but just think of 

those two instances. That is why I bring out specifics. On those instances, they went—on those two out of three instances, they went 

non-accrual. And yet they are good loans, 100 percent collectible 

with another bank right now. 

Thank you very much. 

Chairwoman CAPITO. Thank you. 

Mr. Watt for 5 minutes. 

Mr. WATT. Thank you, Madam Chairwoman. And let me make a 

couple of comments. First of all, I am hearing the same complaints 

that everybody else has described. Second, I don’t agree that this 

bill is the solution to those complaints, nor will it minimize or reduce the complaints. And it will create some additional complaints, 

even for the things that it would resolve. 

I don’t think we can micromanage examinations in this committee, and when we try to do that, I think we do ourselves a disservice. So having said that, there is a lot of arbitrariness going on, 

and one of those sets of arbitrariness I want to direct to Mr. Marquis because something I think is arbitrary is going on in North 

Carolina. 

I don’t know if you are familiar with it or not, but the NCUA has 

announced that it will examine all 52 North Carolina chartered 

credit unions, completely separate from the North Carolina Credit 

Union Division, obviously, as a result of the North Carolina Credit 

Union Division’s decision to allow the North Carolina State Employees Credit Union to release estate CAMEL ratings. There is no 

rule against that. 

This is a North Carolina-regulated entity. And your reaction to 

it is that we are going to go out and make the life of 51 other businesses, credit unions, miserable because we don’t like what the 

North Carolina Credit Union Division has done with its own memVerDate Nov 24 2008 18:27 Dec 06, 2012 Jkt 075069 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 K:\DOCS\75069.TXT TERRI
21 

ber. That seems to me to be arbitrary, and it is the kind of thing 

that results in the kinds of reactions that you are hearing here. Because arbitrariness doesn’t seem to make anybody happy. 

So maybe you can explain to me why you think the NCUA has 

the authority, with a State-chartered credit union, to go on this 

kind of witch hunt. Because I am really concerned about where we 

are on this. 

Mr. MARQUIS. When we work with our State regulators, we accept their examination to the fullest extent possible. Sometimes, we 

do joint exams, and sometimes, we do separate insurance reviews. 

We also have an insurance agreement that every credit union 

agrees to, which is not to release information that is in our records 

that has to do with an exam report— 

Mr. WATT. There is something in your rules that says this Statechartered entity— 

Mr. MARQUIS. Yes, sir. 

Mr. WATT. They can’t release this CAMEL rating? 

Mr. MARQUIS. They can’t release it— 

Mr. WATT. Either there is or there isn’t, Mr. Marquis. Is there 

something in your rules that prohibits this? 

Mr. MARQUIS. Yes, there is. 

Mr. WATT. Okay. All right. You are going to send that to me, I 

am sure. 

Mr. MARQUIS. Yes, sir. 

Mr. WATT. Okay. Go ahead. 

Mr. MARQUIS. And what that does is, when a State uploads an 

exam report in our system, it is a record available to our use. 

Mr. WATT. Okay, but let me accept that. So for the sin of one 

credit union, you are going to go and subject 51 other credit unions 

to an extensive examination. That is what you are telling me, and 

that is rational to you? 

Mr. MARQUIS. What we are saying is we can’t accept that exam 

report being uploaded on a system. If they want to release the 

CAMEL code, States’ rights, we don’t care. But we can’t have that 

record in our system. And then, we don’t have to take exception 

with that particular union or all of those credit unions. 

We do have a concern with CAMEL code release because the 

other credit unions aren’t releasing their CAMEL code. So what 

does that speak of about the financial condition of those credit 

unions, since only one of them has been allowed to release that 

CAMEL code? 

Mr. WATT. So you are going to subject every State-chartered 

credit union in North Carolina to an examination just because one 

credit union released this CAMEL rating; with the authority, mind 

you, of the State telling them that they could do that. 

Mr. MARQUIS. That is correct. 

Mr. WATT. Somebody needs to come and talk to me. Because 

even though I don’t like this bill, we might need to add something 

to it when it gets marked up that says you can’t take that kind of 

arbitrary action. I think you are way beyond the authority that you 

have at the Federal level to do this. 

Chairwoman CAPITO. Thank you. The gentleman’s time has expired. 

Mr. Westmoreland for 5 minutes? 

22 

Mr. WESTMORELAND. Thank you, Madam Chairwoman, for yielding. 

How many times have each one of you all testified at congressional hearings or inquiries? All of you. 

Mr. BERTSCH. This is my second time. 

Mr. WESTMORELAND. Second time. 

Ms. THOMPSON. At least 10 times. 

Mr. WESTMORELAND. How many? 

Ms. THOMPSON. At least 10 times. Senate and House? 

Mr. WESTMORELAND. Yes. 

Ms. THOMPSON. A lot. 

Mr. WESTMORELAND. Would you say more than 20? 

Ms. THOMPSON. No, I would not say that. 

Mr. WESTMORELAND. Okay. 

Mr. MARQUIS. Three times. 

Mr. WESTMORELAND. Thank you. This bill that the chairwoman 

and the ranking member have come up with has, I think, been a 

direct result of us hearing from our constituents. And I know, Mr. 

Bertsch, you have been down to my district. I think you were at 

the field hearing that we had. 

So, this is a direct result of that, and us trying to keep our community banks from inconsistent regulations and hearing one thing 

from the regulators up here and then hearing something else from 

our constituents. And no disrespect, but we tend to believe our constituents, especially when the evidence is on their side. 

So do you think we can screw up this more than you all have? 

It is a simple question. We are trying to fix it, you all have not 

tried to fix it, and it just keeps perpetuating on itself. So do you 

really think that we can mess it up and cause more bank failures 

than what has happened so far? 

Any one of you? Go ahead. 

Ms. JENNIFER KELLY. Sir, as I said before, we work hard. We are 

out there talking to bankers all the time trying to understand 

where they feel there are inconsistencies, talk to them about our 

expectations, whatever actions we need to take to clarify things. So 

we are continuing to work this issue very aggressively. These are 

difficult times. 

Mr. WESTMORELAND. Do you think that banks need to have the 

ability to sue the FDIC, in the fact that any complaints that they 

have? And I will have to tell you, all my bankers, board of directors, and all of them have told me that they are afraid to come forward because of the possible retaliation. Because any complaint 

about the FDIC is actually handled within the FDIC, or the Board 

of Governors or wherever it is. 

Do you think that is fair, that their day in court, so to speak, is 

with the same people they are complaining against? 

Ms. JENNIFER KELLY. At the OCC, I do believe it is fair. Our ombudsman operates entirely outside the supervision process, he reports directly to the Comptroller, and he has the power to overturn 

supervisory decisions. And he does do that on occasion— 

Mr. WESTMORELAND. How many times would you say he has 

done that? 

23 

Ms. JENNIFER KELLY. In the last year, I think there were five decisions. And two went for the bank and three went for the OCC. 

The year before— 

Mr. WESTMORELAND. Okay. I would like to see some of those. 

Ms. JENNIFER KELLY. Yes, sir. They are all posted on our Web 

site. 

Mr. WESTMORELAND. Okay, great. 

Ms. JENNIFER KELLY. The decisions include a summary that does 

not identify the bank, but it identifies the issue. It is about a page 

long, describing the exact situation and what the decision was. 

Mr. WESTMORELAND. Ms. Thompson, how many times would you 

say regulators have been disciplined from the FDIC, FDIC regulators being disciplined because of a complaint that was filed by a 

lending institution? 

Ms. THOMPSON. First, I don’t have the specific answer to your 

question. But the FDIC takes its responsibilities very seriously, 

Congressman, and we really want a fair, open, and transparent 

process. Retaliation is prohibited at the FDIC. And to the extent 

that a banker would bring that to our attention, I would be dealing 

with those particular problems and situations. 

I really think that our examiners and our staff are professional, 

and I do believe that they understand that there are difficult circumstances. The economy was horrible. But I do think that the 

FDIC— 

Mr. WESTMORELAND. Ma’am, I am not trying to cut you off. But 

my question was, how many regulators have been disciplined as a 

result of complaints filed by banks with the FDIC? 

Ms. THOMPSON. I don’t know the answer to that, Congressman, 

I am sorry. 

Mr. WESTMORELAND. Could you find that out for me? 

Ms. THOMPSON. Yes, sir. I will. 

Mr. WESTMORELAND. Because didn’t you just say that retaliation 

was against the FDIC rules? 

Ms. THOMPSON. That is correct. 

Mr. WESTMORELAND. That is like your dog having his teeth into 

your neighbor’s leg, and you telling your neighbor, ‘‘I don’t allow 

him to bite.’’ But thank you very much, and my time has expired. 

And I want to thank the chairwoman. 

Chairwoman CAPITO. Thank you. 

Mr. Hinojosa? 

Mr. HINOJOSA. Thank you. Thank you, Chairwoman Capito. I believe this bill represents an accomplishment in bipartisanship. And 

I thank you, and Ranking Member Maloney, for both of your efforts 

on behalf of this legislation. 

The financial crisis pulled back the curtain on the bank examination process, and it is obvious to me that reform was needed. However, the regulation should not overburden our financial institutions during a time of economic uncertainty, when loans to creditworthy small businesses can spur job creation. 

I am especially concerned about overburdensome regs for community banks and credit unions in particular. They were not the cause 

of the financial crisis, and I don’t believe they should be stymied 

by overzealous regulation agencies. I believe that we will find common ground today, and I believe we can find a regulatory balance 

24 

to ensure an institution’s fiscal health while allowing for enough 

flexibility to encourage economic growth. 

I have two short questions. And I would ask Ms. Sandra Thompson, Director of the Division of Risk Management, FDIC, if she can 

please give me an answer to these two questions, as well as Ms. 

Jennifer Kelly, Deputy Comptroller for Mid Size and Community 

Banks. 

I have heard concerns from community banks in my district 

about the current internal appeals process, specifically, that they 

have limited options to contest the questionable decision. And we 

have all brought that up. Additionally, they fear the retribution because they must appeal to the very agency that regulates them. 

The question is, what are your objections to the outside appeals 

process outlined in this bill? And the second part of the question, 

assuming the creation of an outside appeals process, an ombudsman office, what would be your recommendations? 

Ms. Thompson? 

Ms. THOMPSON. With regard to your first question, the supervisory appeals take place at the highest level within our agency. 

We have both a formal and informal process. Our agency is run by 

a board, and the board established a committee that is chaired by 

a board member. 

The participants on that committee, who have the authority to 

overturn a supervisory decision, are independent of the supervisory 

process. So from the highest levels of our organization, they have 

the authority and the ability to overturn a supervisory decision. 

And we believe that because the head of our agency has been entrusted with the safety and soundness of the banking system, and 

also the deposit insurance responsibilities, that is something we, as 

an agency, take very seriously. Under the bill, the outside ombudsman will be overturning a decision made at the very highest levels 

of our agency. 

If the bill does go forward, with regard to the ombudsman, that 

would be located within the FFIEC. It would be very difficult to understand how this entity would have the ability to overturn, but no 

responsibility for the insured deposits or the people who put their 

deposits in financial institutions, or the safety and soundness of the 

institution. Those are tenets of what we do at the FDIC. That is 

part of our mission. 

It is just hard to understand how that would work, how you 

would have an entity with authority, but with no accountability or 

responsibility for the health of that institution. 

Mr. HINOJOSA. I would like to ask Ms. Jennifer Kelly if she 

would respond? 

Ms. JENNIFER KELLY. Certainly. As I was explaining earlier, our 

ombudsman operates entirely independently of our supervision 

line. We feel that provides sufficient independence. We also would 

share Ms. Thompson’s view of we are responsible—supervision of 

these institutions and the accountability for doing—that needs to 

stay with the head of our agency in terms of making those decisions. 

We also have concerns about the timing. Right now, our ombudsman is committed to resolving and making a decision on any appeals within 45 days. And that is very important because often, in 

25 

these situations, we are dealing with an institution that has problems and there needs to be supervisory action taken. 

So we believe that looking at the way the FFIEC process is laid 

out, best we can figure it is going to take at least 6 months from 

filing the appeal to a resolution with a decision by the FFIEC ombudsman. And 6 months in a critically challenged bank, that is a 

really precious period of time in terms of getting problems resolved. 

I would also say on the retaliation point, our examiners believe 

in the appeal process. They share the information with bankers. 

Everybody respects the appeal process. In addition, our ombudsman, once he renders a decision, 6 months after that decision is 

rendered, he contacts the bank personally to talk to them and ask 

whether they have experienced any retaliation. 

And then he makes a second contact 6 months after the first examination activity after the appeal has been decided. So not only 

do we encourage the bank to come back to us if they have any concerns about retaliation, but he reaches out to them to specifically 

inquire whether they have any concerns in that area. 

Chairwoman CAPITO. The gentleman’s time has expired. 

Mr. HINOJOSA. Thank you for your response. 

Chairwoman CAPITO. Thank you. 

Mr. Luetkemeyer for 5 minutes. 

Mr. LUETKEMEYER. Thank you, Madam Chairwoman. As we go 

through this process, it is pretty obvious what is happening here. 

We had a situation 2 years ago where financial institutions had 

some problems and we as a Congress ran in there, threw some regulations out there, and thought we were going to solve the problem. 

And now, the pendulum has swung the other way. Now, we have 

a situation where we are overregulating. We are stymieing the economic growth of our communities, and as a result, are running 

some of our banks out of business one way by being too loosely regulated, now they are being too closely regulated. 

We have to find that balance in the middle. And to date, I have 

yet to hear any of you make that comment, that you recognize that 

the pendulum is over here on the far left, and it has to fall back 

to the middle. Do any of you recognize that, or you all think we 

need to still be way out here? 

Raise your hand. Anybody believe we are—too much? Okay. That 

is why we have the hearing today, and that is why you see the bill 

in front of us. Because you guys are ready to keep coming down 

heavy-handedly on all the institutions that you make our small 

communities the places where people want to go and start their 

businesses. That is what is happening. 

Here I have an example from a local bankers association in Missouri. Director Thomas Curry was given data that showed that one 

in four banks was being criticized for their HMDA procedures, 

which is what the rate is for the FDIC. But that is twice the rate 

of the OCC and the Fed. 

Why, Ms. Thompson? 

Ms. THOMPSON. Sir, respectfully, we have 4,400 institutions. We 

have probably 2 or 3 times as many banks. But I do understand 

that we have been in touch with your office to talk about the 

HMDA process, which is very important because it involves fair 

26 

lending issues. And we certainly are open to any discussions you 

would want to have. 

Mr. LUETKEMEYER. Okay. My question is, why is it twice as 

many of the FDIC exams show problems with HMDA than the 

other ones? There is none. It is inconsistency of examinations. It 

is an example right there. 

You asked about the FDIC forcing banks to scrub their HMDA 

accounts. It is ridiculous. They come in and they brag about how 

many times that they are forcing banks to scrub their HMDA accounts, their book of business. That has to stop. Any response? 

Ms. THOMPSON. Sir, we value the dual banking system. We firmly believe in the viability of community banks. The FDIC has established a community bank advisory committee where we hear 

from community bankers directly. And we are getting ready to 

launch a huge initiative on community banking. 

Mr. LUETKEMEYER. Ms. Thompson, with all due respect, I have 

been here 3 years. I have a banking background, a regulatory background, so the bankers come to me all the time with their problems 

and concerns. And I bring them to you, all of you up there. 

I have brought issue after issue after issue, and you have never 

listened to a single thing I have said. Not once have you responded 

to some of the individual items that we have talked to you about, 

never. So in 3 years, when we have a bill like this come before us, 

this is our response to you because you don’t respond to us. 

How many consumers, Ms. Thompson, do you think read the 

HMDA forms that are in front of them? Do you have any studies 

on that to see how many of them actually read those things? 

Ms. THOMPSON. No, sir. 

Mr. LUETKEMEYER. Don’t you think that would be worthwhile? 

Ms. THOMPSON. I will forward that to our head of the Division 

of Depositor and Consumer Protection. 

Mr. LUETKEMEYER. Okay. Because it is not a safety and soundness issue, is it? 

Ms. THOMPSON. Consumer protection and safety— 

Mr. LUETKEMEYER. It is not a safety and soundness issue, is it? 

Ms. THOMPSON. They are two sides of the same coin, sir. 

Mr. LUETKEMEYER. Ms. Thompson, we have, I think, a lot of concerns with a lot of the banks with the way they are examining and 

enforcing. I have another situation—I have another minute to go— 

with regard to home builders. The FDIC and a number of banking 

regulators are forcing a lot of banks, once they hit 100 percent capital threshold with a particular line of credit—whether it is real estate or real estate development—once they hit that threshold, 

whether it is good loans or not, they are saying you can’t loan anymore. 

I have a quote for you right here from Ms. Sheila Bair. I am sure 

you remember who she is. 

Ms. THOMPSON. Yes, sir. 

Mr. LUETKEMEYER. Back on May 26th, in response to my question about how the collateral should affect the classification, said, 

‘‘If the loan’s performing, it’s a good loan.’’ Those are her words. So 

when you sit here and tell me—and we see over and over that we 

have situations where the capital is used as a threshold, rather 

than the quality of the loans, I think we have a huge problem. 

27 

Do you agree? 

Ms. THOMPSON. Yes, sir. I agree. And I do think we are looking 

at that one component. But we also need to look at the borrower’s 

ability to repay the loan as a part of that, as well. 

Mr. LUETKEMEYER. Ms. Bair says if it is performing, it is a good 

loan. Therefore, they have the ability to repay, don’t they? 

Ms. THOMPSON. That is correct, sir. 

Mr. LUETKEMEYER. Okay. And if they have the ability to repay, 

why do we have to have a threshold? If 100 percent of those loans 

are good loans, and they are paying, should we have a cap? 

Ms. THOMPSON. We need to assess their ability to continue to 

pay, sir. 

Mr. LUETKEMEYER. If they paid through this environment, don’t 

you think they will continue to pay down the road? 

Ms. THOMPSON. Yes, to the extent that their loan has not been 

restructured with a below-market interest rate. 

Mr. LUETKEMEYER. Ma’am, I just said they are performing loans. 

Ms. THOMPSON. Generally speaking, if it is a performing loan, we 

don’t classify that loan. 

Mr. LUETKEMEYER. I am not talking about classification. I am 

talking about putting caps on banks to be able to loan to certain 

groups of people, industry groups. 

We are putting those artificial caps. There is nothing in the 

FDIC rules about it. That is an artificial cap that you are imposing, 

is it not? There is no cap on the FDIC rules about developments, 

is there. 

Chairwoman CAPITO. The gentleman’s time has expired. Yes, if 

the witness has a follow-up answer? 

Mr. LUETKEMEYER. Thank you. Thank you, Madam Chairwoman. 

Chairwoman CAPITO. Mrs. McCarthy for 5 minutes? 

Mrs. MCCARTHY OF NEW YORK. Thank you. And thank you for 

calling this hearing so we can all, hopefully, figure out how we are 

going to, certainly, represent our small community banks, our credit unions. 

Listening to all of you, and listening to the members of this committee, there seem to be some issues. But I am one of those—this 

morning, we had a hearing and we had two Governors here. One 

was a Republican, and one was a Democrat. And both of them were 

actually on the same page, where we all sit down together, work 

together and try to come up with solutions. 

Because no one is, here, I don’t believe on what you are trying 

to do—and I also don’t believe anyone here on this committee is 

trying to make problems. We are actually trying to solve problems. 

And so, that means working together and I think that is important. 

This particular piece of legislation requires that regulatory agencies develop and apply uniform definitions and recording requirements for non-performing loans. We understand that, mainly because we have just gone through some terrible times and we want 

to make sure that they are doing the right thing. 

Ensuring that standards work for the smallest and the largest financial institutions, and allowing the flexibility to address the 

unique situations certainly of the smaller institutions, is important. 

You have your large institutions, you have your small institutions. 

28 

You have the same thing with our credit unions. Each one of them 

has different, unique issues. 

And they do. We have seen that over the last couple of years. So 

do you feel that uniform standards for non-performing loans are 

achievable? Or is there an alternative way to bring consistency to 

the loan classification process? 

One of the things that I heard from my colleagues, especially 

with the examiners—and it didn’t seem to matter where across-theboard—are they getting enough training, really, on what to look for 

so they can be working with the banks instead of causing problems? And I will throw that up to everybody. 

Mr. BERTSCH. We spend a lot of time training our examiners on 

how to classify loans. And it is something that takes a lot of time. 

It is something that we devote weeks of formal training to and a 

lot of on-the-job training, as well as providing specific guidance to 

the examiners on how to approach specific situations. 

It is very hard to boil down the judgments that examiners need 

to make and the different circumstances that they encounter into 

a very short statement of guidance that says, this is how you are 

going to do it consistently. And I think when we look at the bill, 

where we think there could be some clarification is making sure 

that we recognize that there are nuances in terms of how loans are 

classified and how they need to be thought of from an accounting 

perspective. 

One thing that I would commend to the attention of the subcommittee is the interagency guidance that was issued on prudent 

commercial real estate workouts. In that guidance, which was 33 

pages, we went through very specific examples of how we would approach fact situations for loans. You can see from looking at those 

33 pages that the same types of loan can have very many nuances 

in them. 

So what we are concerned about when we talk about the difficulties in taking judgment away from examiners is that there are a 

myriad of situations that you can encounter. And bankers do the 

same thing. Bankers, I imagine, would tell you they go through the 

same process when they evaluate their loans. And that if you ask 

them to summarize their process in one sentence, they might tell 

you that is quite difficult to do. 

So my point is, we train our examiners very hard. We teach them 

through in-the-field training. We provide very detailed guidance 

where we can, such as the prudent workout guidance. We provide 

extensive information in the CALL Report instructions on how to 

report and account for loans. 

If an examiner needs to know the nuances of non-accrual designation, there are three pages of glossary items specific to non-accrual that address specific items that we have seen over the years. 

The point overall is that we do believe very strongly that there can 

be consistency and we do believe very strongly that there should 

be consistency. 

We also recognize—because this is our business, we do it every 

day—that the circumstances we encounter and the loans that we 

encounter are very hard to boil down to simple statements or sentences. That is where we would like to work with the subcommittee 

to try to explain where those concerns come from, and perhaps exVerDate Nov 24 2008 18:27 Dec 06, 2012 Jkt 075069 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 K:\DOCS\75069.TXT TERRI
29 

plain a little bit more about how we train our examiners and how 

we ensure consistency. 

Mrs. MCCARTHY OF NEW YORK. Just quickly, because my time is 

over already, unfortunately. If the rest of you could—it doesn’t 

have to be a long—listen, this is a very technical bill. If you could 

send me your answers, I would appreciate it, so that we can certainly work with you and try and come to some conclusion on how 

we can work together so that you are doing your job. And certainly, 

our banks and credit unions can work together. 

Thank you. 

Chairwoman CAPITO. Thank you. 

Mr. Canseco, 5 minutes? 

Mr. CANSECO. Thank you, Madam Chairwoman. 

Good afternoon, ladies and gentlemen of the panel. This is for all 

of you. On average, how long does it take each of your agencies to 

complete examinations and report the results back to the financial 

institutions? 

Mr. Bertsch? 

Mr. BERTSCH. For a community bank, it takes us an average of 

75 days from the start of the exam to the finish. We have a 60- 

day guideline that we provide our reserve banks from the time of 

the exit meeting to provide the exam report to the institution. We 

try very hard to meet that deadline. We hit it in about 85 to 90 

percent of the cases. 

Mr. CANSECO. All right. 

Ms. Thompson? 

Ms. THOMPSON. For the FDIC, it is 45 days for risk management, 

start date to finish. And for compliance only, it is 90 days. Compliance and CRA, it is 120 days. 

Mr. CANSECO. Mr. Marquis? 

Mr. MARQUIS. All of our exams have to be done, start to finish, 

within 60 days. And that is mostly accomplished all of the time. 

Most of them get done in less than 30 days, including issuing the 

exam report to the credit union. 

Mr. CANSECO. And Ms. Kelly? 

Ms. JENNIFER KELLY. We try to have the exam report back within 60 days. But as I said in my testimony, there certainly are circumstances where it takes longer than that. And we are not going 

to rush to issue a report if there is further work that needs to be 

done. 

Mr. CANSECO. So how often would you say your agencies received 

complaints from financial institutions about delays in the examination procedures? And again, we will start with Ms. Kelly. 

Ms. JENNIFER KELLY. I couldn’t give you an exact number. We 

do receive complaints. And in those cases, the appropriate managers follow up directly with the institution. 

The other thing I would stress is that we encourage our examiners to have ongoing communication with the bank throughout the 

exam process so they clearly understand what our findings are, 

where we are in the process, and what the timeline looks like. 

Mr. CANSECO. Mr. Marquis? 

Mr. MARQUIS. I can’t recall any. But some may have been issued 

to the regional director, who addressed those issues very quickly. 

Mr. CANSECO. Thank you. 

30 

Ms. THOMPSON. We receive some complaints. And I don’t have 

the numbers in front of me, but there usually are complex circumstances or an exchange of information in those circumstances. 

Mr. BERTSCH. We are aware of complaints on that issue. I can’t 

give you the exact number, but it is an issue that we look at as 

part of our oversight of the Federal Reserve Banks when they do 

the exams. We actually are planning this year to do a specific review looking at the processing of exams to respond to information 

that we are getting that there are some concerns about this. 

Mr. CANSECO. And finally to the array, do you all agree that delaying examination reports can have an adverse effect on the industry? And do they cause greater uncertainty, especially for smaller institutions? 

Mr. BERTSCH. The timing can be an issue in getting information 

back to institutions. However, it is very important, in some complex and problematic institutions, to take the time to get the message right and to get the message documented appropriately. 

As the subcommittee has impressed upon us today, it is very important that we communicate very carefully and we support very 

carefully our conclusions. Therefore, there are some instances in 

which we think it is appropriate to go beyond those deadlines. 

Ms. THOMPSON. I would agree with that. I think it is important 

to get the final report of examination for the record, for the financial condition of the bank, right. And I do think that there are extenuating circumstances where information needs to be exchanged, 

but I think it is critical to get that final ROE right. 

Mr. MARQUIS. Same with us. Timely delivery of an exam report 

is very critical if you identify problems that need to be corrected. 

We even do a post-internal control review, as opposed to one before 

an exam is issued, so that exam report gets in the hands of officials 

very promptly. 

Ms. JENNIFER KELLY. I would agree with the comments of the 

previous folks. And I would just add that we do have ongoing communication with the bank throughout the process. So it is not that 

they don’t know what we are thinking and what we are working 

on. They are aware of any issues that we have identified. It is just 

making sure that the final product that is issued is fully supported. 

Mr. CANSECO. Thank you very much. 

And now, Ms. Kelly, in your testimony you stated that the OCC’s 

ombudsman does an adequate enough job. So if this is the case, 

why do the witnesses on our second panel support the creation of 

an interagency ombudsman, in your opinion? 

Ms. JENNIFER KELLY. I believe the—I read the ABA’s testimony, 

Mr. Kelly’s testimony. And he actually singled out the OCC ombudsman as saying it was different than the other agencies. So I 

can’t really speak—I think it is better for them to speak to why 

they— 

Mr. CANSECO. But I am just asking you if you have an opinion 

with regards to that. 

Ms. JENNIFER KELLY. Why they are recommending— 

Mr. CANSECO. Right, yes. 

Ms. JENNIFER KELLY. Obviously, they believe there would be 

greater independence if it was an interagency process. 

31 

Mr. CANSECO. Ms. Thompson, much of the banking industry considers the OCC’s interagency process to be the most effective. They 

attribute this to the fact that the OCC’s ombudsman is independent of the supervisory authority. So how does this differ from 

the FDIC’s interagency review process? 

Ms. THOMPSON. Our supervisory appeals review committee is established by our Board of Directors. The FDIC, again, is run by a 

Board and the Board established this committee that is empowered 

to overturn supervisory decisions. 

They are independent and composed of individuals from the 

highest level. A member of our Board sits on this committee, and 

no one from the supervision process participates on the committee 

at all. So the highest level of our agencies can overturn supervisory— 

Mr. CANSECO. My time is up, but if I may just follow up here. 

So what you are saying is that your ombudsman is also independent? 

Ms. THOMPSON. Our ombudsman is a mediator between the bank 

and our agency. The Supervisory Appeals Committee is a committee that is established by— 

Mr. CANSECO. I understand that. 

Ms. THOMPSON. —the FDIC Board of Directors. 

Mr. CANSECO. I understand that. So you are saying that it 

doesn’t differ from the OCC’s ombudsman facility? 

Ms. THOMPSON. The OCC has a single person. The ombudsman 

can overturn supervisory appeals with the concurrence of the 

Comptroller, I believe. And our supervisory appeals committee can 

overturn supervisory decisions, as well. 

Mr. CANSECO. Thank you very much. My time is way up, and I 

apologize for that. 

Thank you. 

Chairwoman CAPITO. Thank you. 

Mr. Scott, for 5 minutes. 

Mr. SCOTT. Thank you, Madam Chairwoman. 

I would like to address my questioning on two points as a result 

of listening to this discussion. One, of course, is the inconsistency 

that I brought up between what the policies are, we are trying to 

do here in Washington, and the banks feel that that these examiners on the ground are walking in another direction. 

And I would like to get, first of all, your opinions on that. Is that 

true, Ms. Thompson? 

Ms. THOMPSON. We have heard this, and in direct response to 

this, I know last year we did issue a Financial Institution Letter 

that we sent to all FDIC-supervised institutions explaining what 

our appeals process was, and explaining the ombudsman’s role. We 

meet with bankers regularly. Our Regional Directors meet with 

them and we meet with our field staff regularly because this is of 

concern to us. We— 

Mr. SCOTT. So you have been getting those same complaints? 

Ms. THOMPSON. That is correct. 

Mr. SCOTT. Okay. Is that true across-the-board for the rest of 

your regulators? 

Ms. JENNIFER KELLY. I would say we hear those general comments. But, obviously, our response to that is, please come to us 

32 

with specific examples so that we can look into it and figure out 

where the disconnect occurred. And that is one value of our appeals 

process; it is an opportunity for the bank to come to us when they 

feel something is happening locally that isn’t consistent. 

Mr. SCOTT. And so now we are addressing that in Section 1013 

in the bill, and you all are pretty happy with that? Are we moving 

in the right direction with what we are doing there? You have no 

problems with Section 1013? I gather that you don’t, then. That is 

very good. 

Now, let me ask you about the other issue. And that is this issue 

that we are trying to resolve in Section 1015, which is this appeals 

process. And this issue of retaliation, is that a fact? How many 

complaints do you get on that? And is this a very, very real issue? 

And what do our bankers, when they come to us and tell us that 

they fear retaliation—what are you doing to them that gets them 

into that angst? How are you retaliating against them? And for 

what? 

Ms. JENNIFER KELLY. Speaking for the OCC, I don’t believe we 

are retaliating against them. And as I indicated before, we have 

processes in place to make sure that bankers have a venue that 

they can come back to us and indicate if they feel they have been 

retaliated against. But unless they come and talk to us— 

Mr. SCOTT. But, you see, unless we can get to the truth of this 

retaliation, we really are not putting enough water on the fire. So 

would you all agree that there is a culture of retaliation, that this 

is not a figment of these bankers’ imaginations? That maybe there 

is? Because if you all don’t say there is, then we can’t even get to 

the solution to the problem. 

If they say there is retaliation and there are fearful of it, you 

have only had 11—let us see, you have had 11 formal appeals in 

2010 at the OCC, and other agencies among you had low numbers, 

as well. Is that indicative of the fact you have so low numbers that 

the reason why they are so low is that these bankers are afraid of 

retaliation? I would like to really get on the record, do we have retaliation going on or don’t we? 

Mr. BERTSCH. We do not tolerate retaliation from our examiners, 

and we have a process whereby our ombudsman would be in contact with the bankers who file appeals. Or if they want to discuss 

something confidentially, they can. 

Mr. SCOTT. So you are saying that you direct them not to retaliate. My question is, is there retaliation? Not that you all retaliate, 

but I am simply asking is there evidence that there has been retaliation? 

Mr. BERTSCH. I am not aware of a specific— 

Mr. SCOTT. Are there none? 

Mr. BERTSCH. —retaliation that would cause bankers to fear 

bringing issues to the attention of the regulators. I do want to 

point out that a lot of these follow-ups are handled confidentially. 

They are handled in a separate unit from the supervision function 

at the Federal Reserve. And the ombudsman has the power to follow up on any concerns of retaliation and bring that directly to a 

committee of the Federal Reserve Board of Governors for resolution. 

33 

I imagine my colleagues have similar setups in their agencies. 

We hear what you are hearing, that bankers say they are concerned about retaliation. We have safeguards in place to make sure 

that retaliation doesn’t happen. And I think one observation I 

would make, and that I think my colleagues have been making all 

day, is that the examination process, in and of itself, is a constant 

process of comparing what we think our findings are with what the 

banker’s view is and coming to a consensus view on what those 

issues are. 

A lot of these processes are differences of opinion or differences 

of view. By the nature of the examination process, they are aired 

during the examination process and then can get aired at several 

points along the way in exit meetings or through the issuance of 

reports which may get discussed with the district management, or 

with us. 

So there is a lot of opportunity to resolve differences before a 

bank goes to the formal appeals process. We believe that what 

works most effectively is to handle differences in an informal process. It is more timely. It can be more efficient to get to the issue. 

And quite honestly, I have worked with examiners for 20 years. 

They are very concerned about getting things right, about making 

sure they support their findings, and about doing the right thing. 

They are very attentive to their— 

Chairwoman CAPITO. The gentleman’s time has expired. 

Mr. BERTSCH. —responsibilities. 

Chairwoman CAPITO. Thank you. 

Mr. Pearce? 

Mr. PEARCE. Thank you, Madam Chairwoman. 

Ms. Thompson, if I understood your answer to Mr. Luetkemeyer, 

that retaliation is prohibited in the FDIC internal regulation, is 

that correct? 

Ms. THOMPSON. Yes, sir. It is. 

Mr. PEARCE. Does that mean that you believe that it is not occurring, then? It is against the rules. 

Ms. THOMPSON. I believe that our examiners are highly dedicated 

and very professional. I believe that differences can and have been 

worked out, not always to everyone’s satisfaction. 

Mr. PEARCE. And you just don’t believe people would break the 

rule? 

Ms. THOMPSON. I would ask that those instances be brought to 

my attention, and I would handle those— 

Mr. PEARCE. Did you know that there are 185 people in your department who don’t pay their taxes—$3,155,313, 185 people? That 

doesn’t give me a great deal of reassurance that the FDIC is sitting 

out there following all its internal rules, when they are not following the basics of paying taxes, which is part of the 99 percent’s 

responsibility, I guess. 

And maybe you understand the suspicion with which we regard 

the reassurances that our constituents are not being nailed up on 

a wall when we see documents like that. The Federal Reserve 

Board, by the way, is only 91 people, and $1.2 million, don’t pay 

their taxes in your department. 

Ms. Kelly, you had mentioned on page 13 that you are concerned 

about Section 1013(a)-1. And when I look at the bill, that section 

34 

is about commercial loans shall not be placed in non-accrual status 

solely because the collateral for such loan has deteriorated in 

value. And you are concerned about that provision. Does that mean 

that occasionally collateral writedowns occur? 

Ms. JENNIFER KELLY. I am sorry, could you—you are asking me 

do writedowns on the loan— 

Mr. PEARCE. Do collateral writedowns occur? 

Ms. JENNIFER KELLY. The loan balance being written down, or 

the— 

Mr. PEARCE. No, not the loan balance. Are loans classified because of the collateral value? 

Ms. JENNIFER KELLY. Yes. 

Mr. PEARCE. Yes. 

Ms. JENNIFER KELLY. If it is a collateral— 

Mr. PEARCE. Ms. Thompson, does that occur at the FDIC? 

Ms. THOMPSON. Yes. 

Mr. PEARCE. Yes. Yes? Could you state that more clearly? Yes? 

Ms. THOMPSON. A loan will not be put into non-accrual just because of the deterioration of the collateral value. I think that if 

there is a deterioration in the collateral value, that deterioration is 

written off as a loss. 

Mr. PEARCE. It could cause a classification? 

Ms. THOMPSON. And the rest is a substandard loan, the remaining loan. 

Mr. PEARCE. And substandard would be described how? 

Ms. THOMPSON. A classified loan. 

Mr. PEARCE. Substandard. What if a loan has never missed a 

payment? Would that be substandard? 

Ms. THOMPSON. That would be performing, and it wouldn’t be— 

Mr. PEARCE. It is a performing loan, and you are saying that 

those loans would not be written down? 

Ms. THOMPSON. Generally speaking, performing loans— 

Mr. PEARCE. Just based on collateral? 

Ms. THOMPSON. Generally speaking, yes. 

Mr. PEARCE. Generally speaking, yes, they would be? Or yes, 

they would not be? 

Ms. THOMPSON. Generally speaking, a performing— 

Mr. PEARCE. Ms. Kelly has said that occasionally it will occur because the asset basis underneath, the collateral basis underneath, 

is being written down. 

Ms. THOMPSON. Sir, if it is a collateral-dependent loan, if the borrower has no ability to repay and the bank— 

Mr. PEARCE. Okay. Because in New Mexico, I had a meeting with 

Indian-American hotel owners who came from Colorado, Texas, Arizona, and New Mexico who had never missed one payment, a whole 

group of them, who are being asked to provide more cash because 

the collateral was now being valued at less. 

Because, nationwide, hotels were not performing, so as a category they were just simply written down. And you are telling me 

that does or does not occur? 

Ms. THOMPSON. Generally speaking, it should not occur. 

Mr. PEARCE. It should not occur. 

Ms. THOMPSON. Correct. 

35 

Mr. PEARCE. And yet, it does occur. You have just heard Ms. 

Kelly say that it does occur. So you all have an internal rule that 

is different than the OCC? Is that right? 

Ms. THOMPSON. No we don’t, sir. If a loan— 

Mr. PEARCE. Because I am seeing it happen, and you are hearing 

other people up here talk about it happening and you want us to 

just go away from this hearing that it doesn’t happen? 

Ms. THOMPSON. Sir, every loan has facts and circumstances that 

are different. And to the extent that you have a loan and the collateral has depreciated, and there is no ability of the borrower to 

repay the loan other than the collateral, you classify the deficiency 

as a loss and the remaining loan is classified as substandard. 

Mr. PEARCE. But these loans had never missed a payment. 

Ms. THOMPSON. Generally speaking, a performing loan is not 

classified. But we do have to look at the ability of the borrower to 

repay the loan. 

Mr. PEARCE. If the collateral goes down and you are suspicious 

that it might not—Mr. French and I had a very engaging conversation, energized conversation, about this very matter is the reason 

I am trying to get it clear. Because your testimony still widely diverges from what our constituents tell us. 

Someday, I might invite you to New Mexico to come sit in on 

some of these meetings with boards, these stabilizing community 

banks and thrifts, that I see in Ms. Kelly’s testimony. Because we 

are not seeing that stabilizing occurring that you are talking about. 

I yield back. 

Chairwoman CAPITO. Thank you. 

Mr. Lynch? 

Mr. LYNCH. Thank you, Madam Chairwoman. Let me begin by 

thanking each of you. I think you have done an excellent job in explaining why you insist upon the policies that you do. And let me 

also thank you for protecting the American taxpayer. That is a lot 

of what this is about, to make sure that the deposits guaranteed 

by the FDIC and supported by the good faith in creditor of the 

American tax payer are not put in jeopardy. 

I also want to thank you for your restraint when the gentleman 

from Georgia asked you whether you thought Congress could mess 

this up worse than the regulators. Much appreciated. There has 

been talk here about a pendulum and regulatory enforcement. And 

look, I am just like everybody else. I get some complaints from my 

constituents about the way they are being treated. 

But I have to admit—I came into Congress in 2001, and I received very few complaints until about late 2007, 2008, when real 

estate values, commercial and residential, plummeted. And so, the 

underlying value in some of these projects went in the toilet, so to 

speak. And so the regulators, in trying to assess the creditworthiness of those borrowers, did a reassessment. 

It wasn’t the pendulum of enforcement that changed; it was the 

value of the real estate. Some parts of my district in New England 

and across the country dropped 35 percent, 45 percent, 55 percent. 

And so, there was a whole new analysis that had to be done on 

these commercial loans. So I don’t think that the regulatory environment changed. I think that the world around us changed. 

36 

And let me say also that in terms of the appeal process, this bill 

creates a huge new bureaucracy. I know that the bill, in part, creates what they call a new ombudsman. Now I have practiced a fair 

bit of administrative law in my prior practice, and an ombudsman 

is someone who is a mediator. They are not allowed to create new 

law. They are not allowed to enforce the law. 

Their decisions are not final and non-reviewable. In this case, 

under this bill, it should be the supreme examiner, not the ombudsman. Because this ombudsman can set aside—first of all, has a de 

novo hearing. It receives all the evidence that the court below did. 

It makes a new decision. It can set aside the agency decisions completely. 

And then their decision is final. The ombudsman’s decision is 

final and unreviewable. That is unbelievable. So at least the Supreme Court of the United States, on occasion, remands back for 

more details. In this case, the ombudsman gets to make the final 

decision and basically upends all the agency work before him. 

We could just get rid of all the agencies and just have this one 

ombudsman make all the decisions. And by the way, this bill has 

no resources, no new resources. You are cutting—the Republican 

budget is cutting the resources for all these agencies. So I don’t 

know where this new ombudsman and this new bureaucracy is 

going to get the money to do its work. That concerns me greatly. 

And I guess I don’t have a—I think you have suffered enough 

with questions today, so I won’t ask you a new one. I just want to 

thank you for your work. I think you are right on. I think, look, 

you could do your job better, like we all can. 

And I am sure there are those cases where our regulators are 

having a bad day and they overreach, but nowhere near the 

amount of overreach that is being exhibited here in this bill. So I 

want to thank you for your patience today. I want to thank you for 

your good work on behalf of the American taxpayer. 

And I yield back the balance of my time. 

Chairwoman CAPITO. Thank you. 

Mr. Huizenga? 

Mr. HUIZENGA. Thank you, Madam Chairwoman. And I, too, 

know you have been sitting here for a long, long time and I want 

to move on to this next panel, as well. I am somewhat pleased to 

hear the outrage from my colleague across the aisle at centralized 

power in bureaucracies. 

I am wondering if we can maybe direct a little of that towards 

the sort of appointed head of the CFPB and the centralized power 

that we have put in place there. But that is for another discussions. And I have been stepping in and out; I had a couple of phone 

calls and other things. I just want to make sure that I understand. 

Do any one of the four of you support this bill? 

Ms. JENNIFER KELLY. No. 

Mr. HUIZENGA. No? Okay. 

Mr. Marquis? Ms. Thompson? I am assuming your silence means 

‘‘no.’’ 

Mr. MARQUIS. Not in its current form, because it has some very 

unique unintended consequences that could play out. 

Mr. HUIZENGA. Do you concur, both of you? So as we are looking 

at summaries of this and what sort of the points are, headings such 

37 

as timely examination reports, you all believe that all of your reports are timely? Yes, I am seeing heads nod? 

Mr. BERTSCH.We think they are timely. But as the gentleman 

just pointed out, we can always keep working on doing our job better. 

Mr. HUIZENGA. Okay. 

Mr. BERTSCH. —so we can—opportunities. 

Mr. HUIZENGA. Okay. And that there are clear exam standards? 

You all believe that there are clear exam standards, that they are 

all consistent? Yes? 

Ms. JENNIFER KELLY. Yes, I believe there are. But there is a lot 

of judgment involved in bank examination. It is something the 

agencies work together to continue to make sure they are as clear 

as possible. 

Mr. HUIZENGA. I think that is what my friend from New Mexico 

was trying to point out because I hear very similar stories like 

that. So therefore, there really is not a need to establish an office 

of an examination ombudsman or to expedite those appeals? You 

all believe that that is unnecessary? 

Ms. JENNIFER KELLY. Yes, OCC does. 

Mr. HUIZENGA. Okay. I appreciate your candor. Those don’t 

sound like huge problems to me, short of maybe the ombudsman 

creation. But I am looking at this and I think, as Mr. Luetkemeyer 

was saying, there is a sense of frustration oftentimes that what we 

are hearing from our constituents and try to express is not responded to. And I can tell you, owning a small sand and gravel pit 

where I have to deal with mine safety and health, MSHA, I talk 

to other smaller operators who have significant issues. 

My inspector is always great. Just ask me. Unless you really 

want my opinion. There is that exact same sense, and I am seeing 

some of our friends who are regulated sort of making that exact 

same face that I would have. They will tell you until the cows come 

home that everything is fine. They will then tell us that things are 

not fine, because they are very much afraid of what is going to happen, rules or no rules, of retaliation. 

Human nature dictates that there are going to be times—if they 

are raising a ruckus about the work that someone has done, one 

of your examiners has done—there, in all likelihood, is going to be 

a problem for them on the back end. And whether it is those 

writedown rules—now, I am coming from Michigan, and we have 

had a decade of challenges—and I am coming out of the construction industry in Michigan, real estate background, construction 

background. 

It is a very difficult environment. And I have my banks, and especially those smaller community banks, saying, ‘‘Hey, Huizengas, 

we know that you are good for it. We have been doing business 

with you for 60, 70 years as a family. But guess what? Our examiner doesn’t want us to have a brand new loader on our books because construction isn’t going well in Michigan.’’ 

I am betting that you are not laying that out as a prescriptive. 

That is the judgment part you were talking about, I am assuming. 

And I guess what the frustration is, and why I believe that why 

you are seeing it in this particular legislation, is that people are 

38 

not feeling hurt. They are looking for openness and genuineness, 

and they don’t feel like they are getting that. 

So my time is going to be up. I don’t know if anybody has a quick 

response before my time is up, but I want to make sure that we 

are able to get to this panel. So thank you. And thank you for, 

hopefully, hearing what we are saying up here. 

Chairwoman CAPITO. Thank you. 

Mr. Carney for 5 minutes? 

Mr. CARNEY. Thank you, Madam Chairwoman. 

I yield to my friend from Massachusetts for 1 second. 

Mr. LYNCH. I thank the gentleman. Madam Chairwoman, I have 

here a report by the Americans for Financial Reform, and I would 

ask that through unanimous consent, it be entered into the record. 

Chairwoman CAPITO. Without objection, it is so ordered. 

Mr. LYNCH. Thank you. 

Mr. CARNEY. Thank you, Mr. Lynch. And thank you to the chairwoman and the ranking member for having this hearing today, and 

for putting forth and sponsoring this legislation, which I frankly 

think is a fairly common-sense approach by the Members on both 

sides of the aisle here in this committee to address frankly the concerns that we have heard from our constituents. 

And I am glad that Mr. Huizenga took us through section by section of the bill. Because as I look at it, it is pretty straightforward, 

pretty simple. And it doesn’t, in my view, violate the accounting 

standards or other things that, frankly, some of the other legislation that has been brought to us by banking institutions, by other 

interest groups, to address really what is a very difficult problem. 

And that is the disconnect between the regulators, the agencies at 

your level and the field examiners. 

We had a very interesting and long conversation with Sheila 

Bair, the former Chairman of the FDIC, when she was here a few 

months ago. And again, she heard from us, Democrats and Republicans, the same thing. Basically, we were talking about situations, 

specific situations, that we have been hearing from the institutions 

in our districts, and it reflected what you heard today. 

So we came up with this piece of legislation, which does really 

pretty simple things that—reports in Section 2, examination standards. I would like to come back to that, the ombudsman and the 

appeal process. As I heard all of you, you said you didn’t like the 

ombudsman because you had it, and you didn’t like the appeal 

process because you have that, and there is no responsibility that 

goes with that. 

And I understand that and appreciate that concern. So to me, the 

big issue, I think, is the examination standards; which, as I said, 

are not at all like some of the things that have been brought to us 

in pieces of legislation. In fact they are your standards, are they 

not? 

And I heard you say judgment and flexibility. But why is it unacceptable for us to put these standards in here, in the way that it 

has, to try to bridge the gap that we are hearing from people at 

your level and from the field examiners and the people that they 

examine. 

So why don’t we start on this end. Ms. Kelly? 

39 

Ms. JENNIFER KELLY. I will start with that. You are correct that, 

to a certain extent, there is an alignment with our standards. I 

have referred before to the call report instructions, but there are 

many more aspects that have to be considered in terms of the decision about whether to put a loan on non-accrual or leave it in accruing basis. 

And that— 

Mr. CARNEY. So is it your view that this would not allow you to 

do that, this legislation? 

Ms. JENNIFER KELLY. This ties it to whether payments are being 

made. 

Mr. CARNEY. Right. 

Ms. JENNIFER KELLY. And as I discussed earlier, there is also the 

issue of collectability and whether it is reasonable to believe that 

full principal and interest is going to be collected. 

Mr. CARNEY. I would like to skip over you for a second because 

you are limited in terms of the commercial lending you can do. 

Ms. THOMPSON. Can I use an example concerning prohibiting 

regulators from requiring more capital for institutions that are 

well-capitalized? To the extent an institution has a risky, troubled 

loan portfolio, the proposed bill would prohibit us from requiring 

additional capital if the institution was well-capitalized. 

To the extent that the institution was to enter into, let us say, 

a risky business line, and the bill would not allow us to require additional capital. It would really limit us using our judgment and 

prior experiences to make sure that the institution was conducting 

its activities in a safe and sound manner and that they had sufficient capital to cover any losses. 

Mr. CARNEY. Right. So thinking through that, it is a question of 

additional judgment, I guess, or judgment that would take in other 

factors. Is there a way that we could address that and maybe cure 

some aspects of this legislation? There are certain things that you 

are not going to, I guess, like, which is the independence of the ombudsman in Section 4 and the appeal process in Section 5. And I 

can understand that. 

But I really wanted to hone in on the examination standards. I 

know my friend, Mr. Renacci, wouldn’t want to change accounting 

standards, as a practicing accountant himself. And we have attempted to try not to do that kind of thing. Is there a way that we 

can cure this? 

Ms. THOMPSON. We are happy to work with the committee on 

anything that would improve the examination process. But again, 

we really want to make sure that the flexibility that the examiners 

have is preserved in terms of dealing with the individual facts and 

circumstances surrounding institutions and loans. There are 7,000 

institutions in this country. Every one of them is different. Every 

loan is different. 

Mr. CARNEY. My time has run out. Thank you for your willingness to do that. And I hope you understand the tension that we are 

feeling from those in our banking institutions that we represent, 

and the disconnect between the field examiners and the advice that 

you have given. 

Thank you, Madam Chairwoman. 

Chairwoman CAPITO. Mr. Manzullo is recognized for 5 minutes. 

40 

Mr. MANZULLO. Thank you. How many on this panel are going 

to stick around to hear the next panel? Would you do that? I know 

you are busy. It is important because the victims are behind you, 

and they should have an opportunity to speak and have you listen 

to them. 

But I want to share with you where, in the testimony by Mr. 

Marquis, there is I think one of the most outrageous and arrogant 

statements I have seen in my entire life before this committee. Go 

to page 9, please, and I am going to read it for you. ‘‘H.R. 3461 

would greatly raise NCUA’s administrative costs.’’ 

It talks about how ‘‘the legislators’ expansion of the existing definition of material supervisory determination would make virtually 

all examiner findings, recommendations, and action plans subject 

to formal appeal.’’ Listen to this, what you said: ‘‘In response, 

NCUA examiners would need to document each and every finding 

with specific references to NCUA rules and regulations.’’ 

You tell me what is wrong with that. The Sixth Amendment, sir, 

requires—says that ‘‘an accused shall be informed of the nature 

and cause of the accusation.’’ Anybody who is charged by your organization has an absolute obligation to tell the bank or credit union 

exactly, according to the rules and regulations, what they have 

done wrong. 

Why did you put that in your testimony? 

Mr. MARQUIS. Yes, sir. We do reference all of our rules and regulations for violations and safety and soundness issues where there 

are statutory violations. There are a lot of issues that we issue 

through guidance or examination procedures that deal with internal or operational risk of a credit union. All of the operational risk 

issues of a credit union are not documented in a regulation. 

Mr. MANZULLO. Then, they should be. Because you are saying 

they are doing something wrong. Then why shouldn’t you cite chapter and verse as to exactly why they are doing it wrong? Is that 

asking for too much? 

Mr. MARQUIS. But if we had a rule and regulation for every operational issue we encounter under safety and soundness, we would 

have an awful lot of regulations. 

Mr. MANZULLO. Now you know what the banks feel and the savings & loans. Let me just read to you some of the testimony, which 

I hope you stick around and listen to. Ken Watts, on CUNA, he 

says, ‘‘Twenty-seven percent of the respondents reported dissatisfaction with the recent exam because the examiners would 

offer their best practices rather than legal and regulatory requirements.’’ 

Eugene Ludwig of Promontory says, ‘‘Regulations grow like barnacles on a ship.’’ No one knows what is going on. The examiners 

can’t tell them what they are doing wrong. They ask for something 

in writing, nobody quotes chapter and verse on it. 

Take a look at the ABA, Albert Kelly: ‘‘To ensure a fair hearing, 

the ALJ’s decision is based upon an independent review of the 

agency’s action and by the relevant statutes, regulations and appropriate guidance.’’ 

If you look at the testimony coming up of NAFCU, she says that 

‘‘notwithstanding changes of regulations, the standards by which a 

credit union is evaluated, examinations should not change from 

41 

exam to exam.’’ The big problem here is the fact that they don’t 

know what to do. 

If somebody does something wrong, you have an obligation, sir, 

in writing, to let them know exactly what they are doing wrong. 

And you are not doing that, and that is what the bill says. If they 

are doing something wrong, then you tell us which regulation and 

which law they are violating. Is that asking for too much? 

Mr. MARQUIS. We do discuss with them what the elements of risk 

are. 

Mr. MANZULLO. No. Would you answer my question, please? 

Mr. MARQUIS. Do we tell them what regulation they are violating? We don’t have— 

Mr. MANZULLO. Yes. 

Mr. MARQUIS. We do not have a regulation for every operational 

risk issue in a financial— 

Mr. MANZULLO. Then that becomes the independent judgment of 

the regulators that floats from regulator to regulator? You don’t 

have any standards? 

Mr. MARQUIS. We do have exam standards, sir. 

Mr. MANZULLO. Those might be exam standards. But you are 

complaining because NCUA examiners would need to document 

each and every finding with specific references to NCUA rules and 

regulations. Is that asking for too much? Yes or no? 

Mr. MARQUIS. Yes, it is, when we talk about regulations that pertain to operational risk issues that are not actually contained in a 

regulation, per se. And they are generally done under the judgment 

of the risk— 

Mr. MANZULLO. Under the judgment of the risk. 

Mr. MARQUIS. —on a balance sheet that is— 

Mr. MANZULLO. On a balance sheet. 

Mr. MARQUIS. —very different based on management’s capabilities, and the size and scope of the institution. 

Mr. MANZULLO. But that would be—then it would violate a rule 

and regulation. Isn’t that correct? 

Mr. MARQUIS. Not necessarily. 

Mr. MANZULLO. Oh. 

Mr. MARQUIS. We don’t have a regulation that says that you 

want to write loans in a concentrated level, all to substandard borrowers. That is a— 

Mr. MANZULLO. No, I can— 

Mr. MARQUIS. —a concentration risk that exists that becomes a 

problem. 

Mr. MANZULLO. I can understand. But the purpose of legislation 

is so these people know why they are being written up. I had a ridiculous situation occur with a community bank, a partnership. 

Two brothers, 30 years at the same bank, were denied a line of 

credit. You know why? The regulator said, you didn’t have any surplus left in your Sub-S corporation. It had all been spun out to the 

brothers. 

That is the type of stuff we hear over and over again. But I 

would challenge you. This is why they are upset. And I would also 

ask you to stay here and listen to the people who are going to testify. Are you willing to do that, the four of you? Is anybody here 

wiling to listen to them? 

42 

Ms. Thompson? 

Ms. THOMPSON. Yes, I will. 

Mr. MANZULLO. Mr. Bertsch? 

Mr. Marquis? 

Mr. MARQUIS. Sure. 

Mr. MANZULLO. Ms. Kelly? All right. So let the record show that 

the panel, the first panel, will be present for the entire testimony 

of the second panel. Thank you. 

Chairwoman CAPITO. Should I take attendance? 

Mr. MANZULLO. Yes. 

[laughter] 

Chairwoman CAPITO. Thank you. I want to thank the witnesses. 

It has been lengthy. And I appreciate your willingness to hang in 

with us and answer what I think are very important questions. 

So I am going to dismiss the first panel and ask the second panel 

to come up. And I will be back in a few minutes. 

[Recess.] 

Chairwoman CAPITO. Back to order please. I would now like to 

welcome the second panel. I would like to introduce them individually for the purpose of making a 5-minute opening statement. Our 

first witness is Mr. Albert C. Kelly, Jr., chairman and CEO, 

SpiritBank, on behalf of the American Bankers Association. 

Welcome. 

STATEMENT OF ALBERT C. KELLY, JR., CHAIRMAN AND CEO, 

SPIRITBANK, AND CHAIRMAN, THE AMERICAN BANKERS ASSOCIATION (ABA) 

Mr. ALBERT KELLY. Thank you very much, Chairwoman Capito, 

and Ranking Member Maloney. My name is Albert Kelly, and I am 

president and CEO of SpiritBank in Bristow, Oklahoma, and this 

year’s chairman of the American Bankers Association. 

The ABA strongly supports H.R. 3461, and appreciates the leadership of Chairwoman Capito and Ranking Member Maloney in 

seeking changes that make an enormous difference in banks’ ability to meet the needs of their communities in a safe and sound 

manner. 

The banking industry and bank regulators share the same goal, 

to have a strong banking system that meets the needs of customers 

in a safe and sound manner. How that is accomplished, however, 

makes an enormous difference. Because the banking system is vital 

to the economic health of our Nation, the manner in which it is 

regulated has a direct impact on the country’s economic growth and 

vitality. 

There is no question that the regulatory pendulum has swung 

too far in reaction to the financial crisis. Overly conservative examinations translate into less credit in local communities, and that 

means businesses grow more slowly and create fewer jobs. 

H.R. 3461 takes a major step toward a more balanced approach. 

It is rooted in the fundamental principles of accountability, transparency, and quality assurance regarding how and on what basis 

decisions are made by the regulatory agencies in the examination 

process. Let me touch on a few of the many key provisions in this 

important bill. 

43 

One way to foster fair exams is to ensure there is a meaningful 

avenue to appeal exam findings when a bank disagrees with its examiner. H.R. 3461 addresses this by establishing an independent 

ombudsman’s office as part of the FFIEC, which is made up of the 

bank agency heads. 

The FFIEC’s congressional mandate is to provide for the uniform 

application of interagency examination standards. We believe that 

a timely and independent appeal process, which includes the opportunity to have a hearing before an administrative law judge, will 

hold the banking agencies accountable to this mandate. 

The bill does not change any agency’s existing appeals process. 

Instead, it adds an alternative route for banks to deal with an 

independent entity set up to address exam issues quickly, fairly, 

and consistent with interagency standards. It is the opportunity to 

take an appeal, not the frequency of appeals, that makes the process an effective check and balance. 

ABA is confident that the vast majority of supervisory matters 

would continue to be resolved without resorting to a formal process, 

as is the case today. H.R. 3461 also helps improve consistency in 

the application of interagency guidelines. Over the last several 

years, it was not uncommon to hear about inconsistent and unnecessary requirements by examiners. 

For example, banks have reported that examiners have required 

them to treat many performing commercial loans, where the borrower is making payments as promised, as non-accruals solely because of decline in collateral value. Such a treatment is not consistent with regulatory guidance or the definition of a non-accrual. 

We all want fair treatment of what is truly a troubled loan. However, the problem is bigger than the question of non-accruals. 

There are many related issues. How loans are classified as problem 

loans for regulatory purposes, how those loans are required to be 

valued, including those loans subject to modification characterized 

as troubled debt restructurings, how capital is calculated as a result of these classifications, these are all major issues. 

The consequences are broadly felt. Even profitable community 

banks with capital ratios at or above those of their peers, and 

above regulatory guidelines, are being told their capital is inadequate and to increase it. This inevitably impacts banks’ ability to 

meet the credit needs of their communities. 

In conclusion, community bankers like me work every day to 

serve the needs of our customers and your constituents. H.R. 3461 

would make an enormous difference in banks’ ability to meet the 

needs of all of our communities. We strongly support the legislation 

and urge its enactment. 

I am happy to answer any questions. Thank you. 

[The prepared statement of Mr. Kelly can be found on page 75 

of the appendix.] 

Chairwoman CAPITO. Thank you. Our next witness is from my 

native West Virginia, and he does a great job of representing the 

West Virginia Credit League. So I would like to welcome Mr. Kenneth Watts, president and CEO, West Virginia Credit Union 

League, on behalf of the Credit Union National Association. 

Welcome, Ken. 

44 

STATEMENT OF KENNETH WATTS, PRESIDENT AND CEO, WEST 

VIRGINIA CREDIT UNION LEAGUE, ON BEHALF OF THE 

CREDIT UNION NATIONAL ASSOCIATION (CUNA) 

Mr. WATTS. Thank you. Chairwoman Capito, Ranking Member 

Maloney, and members of the subcommittee, thank you very much 

for the opportunity to testify in support of H.R. 3461. 

On the whole, the exam process appears to work fairly well for 

many credit unions. However, steps must be taken to address real 

problems that some credit unions have with examinations. CUNA 

has been raising these concerns with NCUA for years. 

Attached to our testimony are principles that CUNA developed 

over a year ago which address real problems that credit unions 

have had with their examiners. This demonstrates there is a disconnect between NCUA board policies and examiner practices. 

While no piece of legislation is perfect, H.R. 3461 is a firm step in 

connecting board policies to examiner practices. 

The bill would grant credit unions access to the information used 

in the examination decisions. It would codify certain examination 

policy guidance. It would establish an ombudsman at the Federal 

Financial Institutions Examination Council to which financial institutions could raise concerns regarding their examination. And finally, the legislation would establish an appeals process before an 

independent administrative law judge. 

We are particularly pleased with the proposed Office of Examination Ombudsman, as well as the independent examination appeals 

process. These two steps could go a long way toward improving dispute resolution and alleviating some, but not all, of the concern regarding retaliation and prospects for success in the appeals process. 

While we are very supportive of this legislation, we have several 

recommendations designed to strengthen it. First, the legislation 

proposes deadlines for exit interviews in examination reports. Currently, NCUA generally meets or exceeds these deadlines. We hope 

the subcommittee will modify the bill to ensure that these deadlines do not become standard practice for regulators with a history 

of completing exit interviews and exam reports in less time than 

proposed. 

Next, the legislation will make available, upon the request of the 

credit union, information relied upon by examiners when making 

material supervisory determinations. In our view, this is information that credit unions should not have to ask for. It should be 

available to them as a matter of course. We encourage the subcommittee to remove the requirement that a credit union must ask 

for this information. 

With respect to the provisions for examination standards in Section 3, we encourage Congress to carefully consider potential unintended consequences resulting from the prescriptive nature of this 

language. In this regard, the provision requiring the regulators to 

develop and apply identical definitions and reporting requirements 

for non-accrual loans concerns us. 

We believe this language should be modified to allow NCUA to 

take into consideration the unique structural characteristics of 

credit unions. While we are very supportive of the creation of the 

examination ombudsman at the FFIEC, we have recommendations 

45 

in this area as well. As currently envisioned, the examination ombudsman would receive complaints or concerns from financial institutions. 

To enhance the effectiveness of this office, we suggest it design 

and implement a voluntary survey to be completed by a financial 

institution at the conclusion of the examination process. Further, 

this office should routinely ensure that no retaliatory actions have 

been taken against an institution. As part of this function, the ombudsman should also reach out to institutions it has not heard from 

to ensure they are being treated fairly. 

Section 4 of the bill directs the ombudsman to review examination procedures to ensure that policies are being followed and adhere to the standards for consistency established by the FFIEC. We 

suggest the language be modified to take into consideration the 

unique structural characteristics of credit unions, as well as the 

level of risk represented by an institution’s operations, size, and 

other relevant factors. 

Finally, whenever the regulatory or compliance burden changes, 

the cost of implementation is borne by the regulated entities. Recent history suggests that these costs for credit unions go only in 

one direction—up. Given the circumstances that have prompted 

Congress to consider legislation of this nature, few credit unions 

would view it as a net positive if the benefits of the legislation were 

accompanied by increased costs to credit unions. 

We encourage the subcommittee to add language directing the 

regulators to identify the additional costs associated with implementing this legislation and reduce expenses elsewhere. Over the 

last several years, NCUA has significantly increased its budget. 

With the financial crisis behind us, the improvements sought by 

this legislation could be paid for through reductions in expenses at 

the agency. 

Chairwoman Capito and Ranking Member Maloney, credit 

unions face a real crisis of creeping complexity with respect to regulatory burden. It is made all the more challenging by examination 

practices. H.R. 3461 would help make the exam process fairer and 

more consistent. We appreciate your leadership in sponsoring this 

legislation. 

We look forward to working with you as the bill moves through 

the legislative process, and I would be happy to answer any questions the subcommittee may have. 

[The prepared statement of Mr. Watts can be found on page 147 

of the appendix.] 

Chairwoman CAPITO. Thank you. Our next witness is Mr. Noah 

Wilcox, president and CEO, Grand Rapids State Bank, on behalf of 

the Independent Community Bankers of America. 

Welcome, Mr. Wilcox. 

STATEMENT OF NOAH WILCOX, PRESIDENT AND CEO, GRAND 

RAPIDS STATE BANK, ON BEHALF OF THE INDEPENDENT 

COMMUNITY BANKERS OF AMERICA (ICBA) 

Mr. WILCOX. Thank you, Chairwoman Capito, Ranking Member 

Maloney, and members of the subcommittee. As you said, my name 

is Noah Wilcox. I am president and CEO of Grand Rapids State 

Bank in Minnesota, and also a member of ICBA’s executive comVerDate Nov 24 2008 18:27 Dec 06, 2012 Jkt 075069 PO 00000 Frm 00051 Fmt 6633 Sfmt 6633 K:\DOCS\75069.TXT TERRI
46 

mittee. I am pleased to represent community banks and ICBA’s 

nearly 5,000 members at this important hearing today. 

The Financial Institutions Examination Fairness and Reform 

Act, H.R. 3461, will go a long way toward improving the oppressive 

examination environment by creating a workable appeals process 

and consistent common-sense standards for classifying loans, 

among other provisions. ICBA is pleased to support H.R. 3461. 

Invariably, those who have filed an appeal have described a process that is arbitrary and frustrating. Appeals panels routinely lack 

the independence and market expertise necessary to reach an informed, fair, and unbiased decision. A fair and effective appeals 

process would provide relief from an exam environment that is discouraging lending at the very time that bank credit is needed to 

sustain the economic recovery. 

Specific concerns include write-downs of performing loans based 

on collateral value regardless of the cash flow of the borrower, second-guessing of appraisals, changing an unpredictable interpretation of existing laws, and moving the capital goalposts beyond what 

is required by regulation. 

While all banks accept the need for balanced regulatory oversight, the pendulum has swung too far in the direction of overregulation. Good loan opportunities are passed over for fear of examiner 

write-down or criticism and the resulting loss of income and capital. The appeals process, which might offer relief, is instead an additional source of frustration. 

A typical community banker can expect to spend a year or more 

in appeals, and incur as much as $150,000 in legal fees. What is 

worse, a bias in favor of the examining agency is built into this 

process. Panels assembled to hear appeals are drawn from within 

the agency and consult closely with the examination team. Lacking 

adequate independence, their incentive and their priority appears 

to back decisions already made by the agency. 

Bias, or even the appearance of such, as well as fear of retribution is enough to deter bankers from using the appeals process. 

This is why the small number of appeals does not match the frustration of community bankers over exams. Taking the appeals process out of the examining agencies, as H.R. 3461 would do, is a positive step. 

And while not completely independent of the agencies, the 

FFIEC being composed of the five banking agencies, I expect this 

level of separation between the appeals process and the agencies 

will provide a measure of distance and some insulation that will 

perhaps raise the comfort level of bankers so that they are willing 

to use the process. 

ICBA would encourage members of this subcommittee to consider 

taking a harder line by adding provisions to the legislation that 

would bring a higher level of accountability to the regulators and 

their field examiners. The current system, which grants examiners 

almost unfettered, unassailable authority, begs for checks and balances. 

That said, we are pleased to support the appeals provisions of 

H.R. 3461 as a foundation on which to build a more rigorous process. ICBA also supports provisions of H.R. 3461 that would create 

47 

more consistent and common-sense criteria for loan classifications 

and capital determinations. 

Among other provisions, no commercial loan would be placed on 

non-accrual status solely because its collateral has deteriorated, 

and a modified loan must be removed from non-accrual status after 

it has performed for 6 months. Also, an examiner would not be allowed to require a well-capitalized institution to raise additional 

capital based on loan classifications under this legislation. 

Establishing conservative bright line criteria will allow lenders to 

modify loans as appropriate, without fear of being penalized. Often 

the best course for the borrower, the lender, and the community is 

a modification that will keep the loan out of foreclosure. 

But many examiners are penalizing modifications by aggressively 

and arbitrarily placing loans on non-accrual status following a 

modification, even though the borrower has demonstrated a pattern 

of making contractual principal and interest payments under the 

loan’s modified terms. If these standards become law, they will give 

bankers the flexibility to work with struggling but viable borrowers 

and help them maintain the capital they need to support their communities. 

ICBA appreciates the opportunity to testify today. The current 

examination environment is a serious impediment to the flow of 

credit that will create jobs and advance our economic recovery. Legislative solutions are clearly needed to improve this environment. 

ICBA and I support the advancement of H.R. 3461. 

Thank you. 

[The prepared statement of Mr. Wilcox can be found on page 163 

of the appendix.] 

Chairwoman CAPITO. Thank you, Mr. Wilcox. 

Our next witness is Ms. Jeanne Kucey, president and CEO, JetStream Federal Credit Union, on behalf of the National Association 

of Federal Credit Unions. Welcome. 

STATEMENT OF JEANNE KUCEY, PRESIDENT AND CEO, JETSTREAM FEDERAL CREDIT UNION, ON BEHALF OF THE NATIONAL ASSOCIATION OF FEDERAL CREDIT UNIONS 

(NAFCU) 

Ms. KUCEY. Good afternoon, Chairwoman Capito, Ranking Member Maloney, and members of the subcommittee. My name is 

Jeanne Kucey, and I am testifying today on behalf of NAFCU, 

where I serve on the board of directors. We appreciate the opportunity to share our views on H.R. 3461, the Financial Institutions 

Examination Fairness and Reform Act. 

I am the president and CEO of JetStream Federal Credit Union, headquartered in Miami Lakes, Florida. JetStream has $126 million in assets and serves more than 16,000 members. 

Credit unions were not the cause of the financial crisis, yet often 

feel the effect of punitive measures designed to reel in the practices 

of bad actors and other financial institutions. 

Part of the response to the economic crisis was to create new layers of regulations and institute more aggressive enforcement of existing law. Regulators have increasingly tightened examination 

standards. For example, since the start of the crisis, examination 

cycles for credit unions have gone from 18 months to 12 months. 

48 

Having examiners visit an institution creates a burden in itself, 

as credit unions must dedicate staff time and resources to prepare 

and respond to the examination. NAFCU supports effective exams 

that are focused on safety and soundness, and flow out of clear regulatory directives. 

However, the examination process by its very nature can be inconsistent. Regulatory agents in Washington try to interpret the 

will of Congress, examiners in the field try to interpret the will of 

their agency, and financial institutions often become caught in the 

middle. 

Many credit unions, including mine, have positive professional 

relationships with their examiners. We believe that this type of 

working relationship is important in having a successful process focused on safety and soundness. To that end, NAFCU has prepared 

a White Paper to help our member credit unions work with the 

NCUA and their examiners, and I would ask that a copy be inserted into the record with my testimony. 

Unfortunately, not all institutions have a positive relationship 

with their examiner, and thus there are four areas where Congress 

can help improve the examination process. First, congressional intent. Congress must make its intent clear to regulators. 

Second, transparency. Transparency is critically important to our 

Nation’s regulatory agencies to promote safety and soundness. Regulations, and any subsequent guidance, must include clear, tangible criteria which credit union executives can follow. Credit 

unions should have access to all materials and guidance that examiners use or reference during examinations. 

Third, consistency. Maintaining a consistent supervisory and examination environment is vital to ensuring compliance with both 

safety and soundness, as well as consumer protection regulations. 

Notwithstanding changes in regulation, the standards by which a 

credit union is evaluated should not change between exam cycles. 

Additionally, regulators should ensure that their regulations are 

consistently applied from one examiner to another. Credit unions 

struggle to comply with fluctuating standards when based on an 

examiner’s reliance on informal guidance. This ultimately increases 

compliance costs, without any clear benefit. 

Fourth and finally, the examination appeal process. The appeal 

process has a number of inherent flaws, including the exclusion, in 

most instances, of a review by an independent third party at any 

level of the process. Currently, the regulator serves as the prosecutor, judge, and jury. An independent review process could help 

ensure objectivity and avoid conflicts of interest. 

Several provisions in H.R. 3461 will address our concerns, as it 

will improve transparency and consistency in a meaningful manner. In conclusion, I would note that NAFCU supports effective and 

necessary regulation that provides a clear, tangible benefit to credit 

unions and their members. 

NAFCU believes that the legislation under consideration is a 

positive first step in improving the examination process. Introducing an independent third party to the appeal process will ensure that consistent standards are applied and will help bring more 

certainty to the examination process. 

49 

Thank you again, Chairwoman Capito, Ranking Member 

Maloney, and members of the subcommittee for the invitation to 

testify before you today, and I would welcome any questions that 

you may have. 

[The prepared statement of Ms. Kucey can be found on page 104 

of the appendix.] 

Chairwoman CAPITO. Thank you. Our final witness is Mr. Eugene Ludwig, founder and chief executive officer, Promontory Financial Group, LLC. Welcome. 

STATEMENT OF THE HONORABLE EUGENE A. LUDWIG, 

FOUNDER AND CHIEF EXECUTIVE OFFICER, PROMONTORY 

FINANCIAL GROUP, LLC 

Mr. LUDWIG. Thank you, Madam Chairwoman, Ranking Member 

Maloney, and members of the subcommittee. 

I want to thank you for inviting me to comment on this significant piece of legislation which addresses important issues of balance and fairness in the supervisory process. I would like to commend you, Madam Chairwoman, Ranking Member Maloney, and 

the other members of the subcommittee for your concern for this 

topic, and in particular for your giving serious consideration to the 

expanded use of ombudsman programs as part of the Federal financial regulatory and supervisory system. I will focus my remarks 

today on the ombudsman issue. 

America is blessed with an uncommonly capable group of financial supervisors, examiners, and regulators at our Federal agencies. 

As Comptroller of the Currency, a Member of the Board of the 

FDIC, and Chairman of the FFIEC, I spent 5 years surrounded by 

members of this group and had daily occasion to be impressed with 

their dedication, energy, and commitment to the tasks before them. 

Their efforts, and the efforts of their peers at other agencies, remain essential to the health of the U.S. financial system and the 

well-being of the American people. 

Nonetheless, every human system has its flaws. People make 

mistakes or differ in their judgments, and regulators are no exception. 

At regulatory agencies, identifying and rectifying mistakes is, of 

course, important to the particular institutions and individuals affected. However, it is also incredibly important to the financial system as a whole and the integrity of these important regulatory 

mechanisms. 

With this in mind, in 1993, while leading the OCC, I created the 

first formal ombudsman program at any financial regulatory agency. The program was successful. Four years later, when I appeared 

before this very committee, that ombudsman and his staff had resolved 110 formal appeals and facilitated resolutions in 359 additional cases. 

In the time since, such agencies as the Federal Reserve, the 

FDIC, the FHFA, and NCUA have followed the OCC’s example. 

Ombudsman programs recognize the strength of the supervisory relationship. They do not encourage laxity, nor should they. 

I am a very big believer in sound regulation and supervision of 

our financial system. We need tough, but clear and fair, financial 

50 

rules, not just to protect consumers, but also to ensure the quality 

of our banks and the health of our economic system. 

What H.R. 3461 proposes—what could be described as a ‘‘superombudsman’’—is a new authority to review a broad array of supervisory activities at all the banking agencies. The notion of an interagency ombudsman is thoughtful and has considerable merit, worthy of the very serious consideration that you are wisely giving it. 

I would suggest a few modifications to the concept you have proposed. Since the Federal regulatory agencies already have ombudsman programs with talented and experienced people involved, I 

would suggest that the new super-ombudsman play more of a coordinating role among the ombudsmen at the regulatory agencies, 

and act as a safety valve or an appeals mechanism. 

Another, perhaps even better, way to achieve the same goal, and 

one that might involve less new governmental expense, would be 

the creation of a new, permanent ombudsman task force at the 

FFIEC with a rotating chairperson responsible for its work. The 

task force would be made up of all the financial agency ombudsmen. And its work, along with the work of the individual ombudsmen, would be reportable to the Council and to Congress. The 

Council could help achieve the same goals of uniformity, quality 

control, and right of appeal as I suggest for the super-ombudsmen. 

I am also sympathetic to concerns raised by the agencies that, as 

proposed, a super-ombudsman would not be responsive to the 

heads of the financial regulatory agencies. Accountability to the 

agency head was, and remains, the cornerstone of the OCC ombudsman program. 

Agency heads have ultimate responsibility for the safety and 

soundness of the institutions their agencies supervise, and those 

heads should have the final say on agency matters. The legislation 

could clarify and ensure this responsibility without vitiating the effectiveness of the new ombudsman function. 

I would also suggest, Madam Chairwoman, that the new ombudsman function should also have the responsibility of reviewing regulations to try to achieve the most effective application of legislative 

mandates in the least burdensome fashion. This effort is important, 

and must be continual. 

Times change, and the rules that were once effective fall out of 

date or prove inefficient and need adjustment. Involving the ombudsman process, perhaps ombudsman-by-ombudsman, agency-byagency, in looking again at rules that may be out-of-date, I think 

would advance the cause of effective supervision. 

Accordingly, I very much favor the advancement of the ombudsman concept that this committee has thoughtfully raised. I want to 

thank you very much for the opportunity to address the subcommittee on this important subject, and I look forward to answering your questions. 

[The prepared statement of Mr. Ludwig can be found on page 

117 of the appendix.] 

Chairwoman CAPITO. Thank you. I would like to thank the panelists, and I would like to begin the questions myself. 

The question we heard—and we heard this sort of repeatedly 

with the first panel on the subject of the ombudsman—they, talkVerDate Nov 24 2008 18:27 Dec 06, 2012 Jkt 075069 PO 00000 Frm 00056 Fmt 6633 Sfmt 6633 K:\DOCS\75069.TXT TERRI
51 

ing about their individual review processes. And several members 

mentioned the incidences of retaliation. 

So I would like to ask Mr. Wilcox and Mr. Kelly and Mr. Watts 

and Ms. Kucey, really, have you heard of instances of retaliation 

by bank examiners? And what form does that take? Is it overt, subtle or whatever? 

Mr. Wilcox, if you will speak to that? 

Mr. WILCOX. Thank you. Not specific concerns, other than what 

has been widely reported in the media as recently as yesterday. 

There are some banks that have alleged that. I have not talked 

with them directly, but I would answer your question this way. 

What I do hear repeatedly from hundreds of bankers from coast to 

coast, in all 50 States, is their frustration, but their inability or paralysis about doing something because they are afraid of what is 

going to happen to them. 

And as a result, I have been asked by Members of Congress, both 

in the House and the Senate, to gather examples, to bring specific 

examples— 

Chairwoman CAPITO. Right. 

Mr. WILCOX. —to you. 

Chairwoman CAPITO. Right. 

Mr. WILCOX. And bankers will say, ‘‘No way. I am not going to 

put my name with that, absolutely not.’’ 

Chairwoman CAPITO. Right. We ran into that in the field hearing 

in Georgia. 

Mr. Kelly? 

Mr. ALBERT KELLY. Thank you, Chairwoman Capito. I think, 

from my standpoint, many of the situations that the bankers encounter are subject to just a judgment determination, as was talked 

about in the prior panel. And I think that the concern is, much as 

Mr. Wilcox has said, something can go one way or something can 

go another. And if I object too strenuously, it is going to be very 

difficult to keep myself out of the next problem. 

And so I would say that be it reality or be it perception, it is a 

very, very strong feeling that bankers have that they don’t really 

have, in many cases, the ability to object and to have a meaningful 

determination of something that probably was not as negative as 

it is posed to be. 

Chairwoman CAPITO. Yes. 

Mr. Watts? 

Mr. WATTS. I would concur with those sentiments. We hear a 

great deal, not just in West Virginia, but in access to meeting on 

committees with CUNA around the country, that these are common 

problems. And credit unions bring these up readily and frequently. 

Chairwoman CAPITO. The issue of retaliation, specifically? 

Mr. WATTS. But there is a concern, there is a frustration—not so 

much the retaliation, but the concern with the exam process. We 

encourage them to go through the channels that are currently in 

place and communicate either with NCUA, or through a survey 

that CUNA has, to be able to gather this information. 

They are fearful of putting the name on anything for the fear of 

what may come back to them. And even though we try to encourage them that it would be anonymous, there is this perception that 

52 

the information will be obtained and they will find out who they 

are, and consequently there will be some retaliation. 

So in effect, the number of complaints is very small. But that is, 

in my view, because of the fear of retaliation. 

Chairwoman CAPITO. Right. 

Ms. Kucey, did you have a comment? 

Ms. KUCEY. I definitely agree with what the other panelists have 

said. I think if you are a CEO and you have a contentious relationship with your examiner, and you are under examination and regulatory pressure, just the fear of retaliation is enough to keep you 

from voicing your concerns. 

Chairwoman CAPITO. Okay, thank you. I would like to—yes, I 

only have a minute left. So I will ask you the next question, then 

you can—I wanted to know. A lot of our concern is that this is 

hampering the banks’ ability to really expand this economy. 

And is part of the 8.5 percent unemployment that we are sort of 

stuck in a result of the banks’ hesitancy and reticence to lend because of the regulatory environment? 

Mr. Kelly? 

Mr. ALBERT KELLY. Just briefly on your prior question, the ABA 

has established an independent survey that is done after an examination. And we share that information, or in the process now of 

sharing that information with the regulator so that you know it is 

anonymous. But we do have that information and we are trying to 

build a better bridge. 

Chairwoman CAPITO. Okay. 

Mr. ALBERT KELLY. I think that there are a number of things— 

obviously the economy is such that it is still floundering. And so, 

it is sometimes hard to really find a good loan. But I believe also 

that there is much less exuberance on the part of banks to embrace 

the risk that they may have embraced in the past. 

When we talk about increased capital standards, in many cases 

smaller banks, most community banks, in reality, can only increase 

capital in this environment by shrinking. That is the only way 

their percentage goes up. 

And so, I think you see a lot of banks, that their strategic plan 

is to shrink the bank. One of the ways you do that is you don’t 

make as many loans. So that would be my response, is that I think 

that there is certainly less vigor in making loans today. 

Chairwoman CAPITO. All right. 

Mrs. Maloney for 5 minutes? 

Mrs. MALONEY. Thank you. I want to thank all of the panelists 

for being here. And I would like to ask Mr. Ludwig, in your testimony you raised one of the concerns that we heard from all of the 

regulators, that the final word should be what with the agency that 

has the responsibility of enforcement, of safety and soundness, of 

making the decisions to make the system work. 

So I think that you are in harmony with what they were saying 

to us in their prior testimony, every single one of them. I want to 

congratulate you for beginning, in 1993, the ombudsman system, 

when you were the Comptroller of the Currency of OCC. But how 

has it changed since then? Why do think the number has gone 

down so dramatically? 

53 

It has gone down dramatically from your time at OCC, but all 

of the other agencies were even lower than the OCC. And what is 

your assessment of the appeals process now? 

Mr. LUDWIG. Congresswoman Maloney, I think that is an excellent question. The fact is the whole process has evolved, and in a 

lot of ways has gotten ever more professional. So there has been 

a step forward here in the whole ombudsman process in the Federal Government. 

However the concerns that people have, I think, are real. There 

is a natural human tendency to worry about making an appeal 

against your supervisor. One of the things that we did during my 

time, which I would certainly suggest to the agencies, is to affirmatively encourage the banks to make appeals, and make clear 

through business with the examiners that there just absolutely 

can’t be any retaliation, that it would be a real violation of agency 

practice. 

I spent a lot of time myself vigorously pursuing that, and I would 

encourage the new heads of these agencies to do that. One thing 

that they did do at the Comptroller’s office, which may be true of 

the other agencies, is, after my time there was a discouraging, if 

not prohibition, of bringing matters to the ombudsmen if they were 

part of an enforcement action or pending enforcement action. 

I personally think that is a mistake. I think many of the issues 

that have become most contentious actually are headed towards enforcement issues. I think having the ombudsmen as a safety valve 

to hear virtually everything is a good thing. 

Mrs. MALONEY. Also, the prior witnesses, the regulators, were 

concerned that the external appeals process would hamper the 

agencies and make them less efficient. What is your response to 

that, and do you believe a bank should be required to exhaust the 

internal appeals process before seeking an external review? 

Mr. LUDWIG. I think having a coordinating function, whether it 

is a super-ombudsman or a task force at the FFIEC, that can be 

a safety valve when people really feel strongly about a matter and 

don’t feel they are getting redress at their own agency is a good 

thing. And I think that is perfectly consistent with giving the agency head, at the end of the day, the final say. 

Just allowing that transparency, that opportunity to be heard 

and have flexibility, I think would add a lot of value. 

Mrs. MALONEY. There was also a lot of concern about cost, particularly in this time where we are facing tremendous financial 

constraints. Could you comment on the cost, what you feel it would 

be? And do you prefer the task force approach in this situation? 

Mr. LUDWIG. The OCC ombudsman program during my time had 

three people and I think, by the end of my time in office, had heard 

close to 1,000 formal and informal appeals. So in and of itself, it 

wasn’t an expensive process. And I think one could do the same at 

the FFIEC level by way of coordination. 

But whether it is a super-ombudsman or a task force, there is 

a lot to be said for doing it as a first step as a task force, with 

many of the same attributes that are in this statute. But getting 

the ombudsman together as a consistent matter, and having a head 

of that task force rotate among the agencies, I think would take the 

whole process a step forward. 

54 

Mrs. MALONEY. Also, many of the regulators expressed concern 

on codifying the guidance. And they repeatedly expressed a concern 

to maintain a certain degree of flexibility. Do you share that concern? 

Mr. LUDWIG. I think what you and the chairman of the committee and subcommittee is doing here is really very important. 

Oversight hearings, and this is partially by way of oversight, add 

tremendous value, just like a board of directors to a corporation. 

And asking these important questions—even at a granular form 

as you have been doing on loan review and supervision and the actual supervision practices—is enormously important in terms of the 

integrity of the process. I myself am a little wary of hardwiring 

things. I think taking a next step, asking the questions, studying 

them and perhaps at some point hardwiring these rules. 

But the problem of hardwiring is, the world changes. And it lacks 

a certain amount of flexibility. I think by way of direction, oversight, review, encouragement of these agencies to take a look at 

these matters, I think that will be responded to and you will have 

fulfilled a major function. 

Mrs. MALONEY. Thank you. My time has expired. 

Chairwoman CAPITO. Mr. Renacci, for 5 minutes. 

Mr. RENACCI. Thank you, Madam Chairwoman. And I want to 

thank the members of the panel. I want to get back a little bit to 

retaliation, but not stick on it too long. 

My colleague, Mr. Scott, made a comment about how few appeals 

there were. And as a previous business owner in the nursing home 

business, I can tell you that when we had regulators and surveyors 

walk in, we did not appeal because we were fearful of what would 

occur the next time they walked in. 

So it is interesting. Because it is human nature, and there is 

nothing wrong with that. It is human nature, and I hope that 

many of the agencies who are here today will realize that—that it 

is human nature, and it is going to occur. 

With that said, Mr. Ludwig, you were talking about—and I am 

trying to figure this ombudsman program because I like the idea 

of an independent. But you were talking about a super committee. 

Do you like an independent versus an internal better, a combination? Because I am thinking an independent would lessen the retaliation. 

Mr. LUDWIG. I am kind of inclined towards a combo in coordination as a next step, sir. I think the ombudsman programs have 

taken a big step forward with the Federal Government. Now, it has 

taken many years. I was in office almost 20 years ago now when 

we started this thing. So it has been a bit of a time, but there have 

been steps forward. 

Allowing an appeals process, an independent appeals process 

which could be taken if things are egregious, I think does add 

value. But taking a step to basically vitiate the current programs 

and take them out of the agencies, I think has the disadvantage 

of discouraging what has evolved into a back-and-forth that adds 

value. 

Now, I do think encouraging insisting upon no retaliation, both 

of the committee in terms of oversight, asking the agency heads to 

redouble their efforts to ensure that doesn’t happen, adds a lot of 

55 

value. I don’t think I would go so far as a complete independent 

ombudsman at this time, but I think your oversight in this area 

is important. 

And I understand that human nature is, you are very reluctant 

to do it. And that is why I think it is up to the agency head and 

the agency to be very vigorous in making clear to the supervisee 

and to the examiners that retaliation is not acceptable. 

Mr. RENACCI. Ms. Kucey, you also talked about an appeal process, an independent third party. Do you agree with what Mr. Ludwig is saying, or do you believe it should be an independent third 

party? 

Ms. KUCEY. We believe it should be an independent third party, 

for the reasons brought up by this panel and also brought up by 

several of you. 

Mr. RENACCI. Okay. 

Mr. Wilcox, there seems to be a clear disagreement between regulators and bankers as to whether a loan should be placed on nonaccrual status. Do you believe the regulators are at least being consistent when they place a loan on non-accrual status, without retaliation? 

Mr. WILCOX. I will answer it this way. A lot has changed in the 

field examination process during the past several years. We used 

to see at least part of the examination team exam after exam after 

exam. So there was some level of market expertise, some understanding of our financial institution and the surrounding economic 

environment, which led to a better dialogue about those kinds of 

things and the types of loans that might be discussed regarding 

non-accrual. 

Today, I would say the last three, maybe four exams that we 

have had it is a rotating cast of characters who have no concept 

of task accounting in Minnesota, no concept of Grand Rapids State 

Bank. And as a result, we spend a lot of time trying to educate 

them about what is happening. And those are factors in the nonaccrual. 

I hear from colleagues across the country of loans that have positive cash flow and they are 20-year customers and have never 

missed a payment, but in the current economic environment the 

real estate or the equipment, something, has devalued. And that is 

being criticized and classified, which has other implications for the 

organization in terms of capital and other regulatory implications, 

other than just the classification. 

Mr. RENACCI. Do you feel timely payments are being considered 

at all in classifications? 

Mr. WILCOX. Not consistently. 

Mr. RENACCI. So there is some inconsistency. Mr. Ludwig, 

many—no, I am going to go back to you, Mr. Wilcox. So in your 

testimony, you state that community banks were facing up to 

$150,000 in legal fees as a result of the current appeals process. 

Do you think the appeals process proposed in this bill would save 

community banks money, or would it increase costs? 

Mr. WILCOX. I think to the extent that you can make this independent. And, frankly, I would suggest more of a firewall than this 

bill proposes and create it independently, outside of the FFIEC, so 

that you do have some insulation, which really takes out the issue 

56 

of retaliation. When they are separated from the agency and, potentially, as Mr. Ludwig commented, with that streamlining, you 

could potentially reduce the cost. 

Mr. RENACCI. Mr. Kelly and Mr. Watts, do you believe it should 

be independent or part of the organization? 

Mr. ALBERT KELLY. I believe that it should be independent. 

Mr. WATTS. I definitely believe it should be independent. 

Mr. RENACCI. All right. Thank you, gentlemen. 

Chairwoman CAPITO. Mr. Watt, do you have any questions? 

Mr. WATT. Thank you, Madam Chairwoman. I actually came 

back hoping to hear Mr. Ludwig’s testimony, because generally 

when he testifies, I want to be in the room and hear what he has 

to say. We have been longtime friends and I admire and respect 

him. 

I note that you spent a lot of time talking about the ombudsman 

part of this bill. And I don’t want to take you out too far, but it 

sounds to me like you don’t think the rest of this bill—or maybe 

you think the rest of the bill hardwires, as you said, things a little 

bit too much. Am I misreading what you are saying? 

Mr. LUDWIG. I have a lot of respect for the issues raised in this 

bill. I think it is an excellent effort on the part of the subcommittee, the ranking member, and the chairman to focus on real 

issues that bankers have to deal with day to day. 

But I think by way of oversight, other than the ombudsman issue 

and by way of direction, asking the agencies to review these matters with some care and oversight, and allowing some flexibility 

here, is probably a little better than hardwiring it. One might come 

to the conclusion at the end of today that there is not enough serious review of these issues by the agencies. 

One feels frustrated, and goes to the hardwiring. I don’t think we 

are there yet, and I think allowing for flexibility has some advantage. But I certainly commend the subcommittee for the oversight. 

And I think even putting in legislation and direction to review 

these matters with care adds a lot of value. 

Mr. WATT. All right. I thought that is what I heard you saying, 

and I don’t disagree with that. 

Mr. Watts, you were in the room when I asked the NCUA representative about a situation in North Carolina. Were you in the 

room? 

Mr. WATTS. Yes, sir, I was. 

Mr. WATT. Do you have any particular feelings about what the 

NCUA is doing to those 51 credit unions in North Carolina? 

Mr. WATTS. It is a fairly recent development, and I can’t say that 

I have a significant amount of knowledge about it. There is a coordination of effort between the State regulator and the Federal 

regulator for credit unions. And it is unfortunate that that coordination has eroded and dropped down to a level beyond what you 

would hope it would be. 

It is unfortunate that the other credit unions in North Carolina 

that were State-chartered and federally-insured were impacted as 

they were. And beyond, sir— 

Mr. WATT. They haven’t been impacted yet, but they are about 

to be if the regulator goes and uses this as an excuse to start auditing them. That seems, to me, to be completely unnecessary. Maybe 

57 

I am missing something, which is why I am asking if I am overstating my concern here. 

Mr. WATTS. I don’t have any additional insight that would lessen 

your concern. 

Mr. WATT. All right. It is great to see all of you. I am sorry I 

missed your testimony. I had another commitment, but I appreciate 

your being here, and it is always good to see my good friend, Mr. 

Ludwig. 

Mr. LUDWIG. And thank you, Mr. Watt, for those very kind remarks. I am honored by them. 

Mr. WATT. I didn’t mean to ruin your reputation by saying good 

things about you in public but sometimes I should adhere to the 

adage. I can say good things about you or bad things about you, 

whichever one will help you the most. 

[laughter] 

I yield back, Madam Chairwoman. 

Chairwoman CAPITO. Thank you. 

Mr. Luetkemeyer, for 5 minutes. 

Mr. LUETKEMEYER. Thank you, Madam Chairwoman. Just kind 

of quickly, I apologize for missing some of the earlier testimony. 

But Mr. Kelly and Mr. Wilcox, can you tell me whether the present 

ombudsman program is working? 

Mr. ALBERT KELLY. I am sorry? 

Mr. LUETKEMEYER. The present ombudsman program that the 

different agencies have, is it working very well? 

Mr. ALBERT KELLY. I believe that we noted in our written testimony that we thought that the OCC—the general view of the ABA 

is that the OCC’s program is the most effective. I think the lack 

of use of some of the programs are kind of reflective of the fact that 

they don’t enjoy the independence that is stressed in the bill. 

Mr. LUETKEMEYER. And cost. Is that an issue? Is cost an issue 

here? 

Mr. ALBERT KELLY. I am sure that cost is somewhat of an issue. 

But I would say that the independence is much more than the cost, 

quite frankly. 

Mr. LUETKEMEYER. Mr. Wilcox? 

Mr. WILCOX. When I listen to the number of concerns I hear from 

my peers around the country, and then I listen to the numbers that 

were talked about on the first panel, I am pretty stunned, quite 

frankly. And I would— 

Mr. LUETKEMEYER. Five or six complaints and probably in your 

neighborhood you probably have five or six folks who would love to 

appeal something. 

Mr. WILCOX. I am sure you probably hear from more than that 

on a daily basis. But those numbers tell me that it is not being effective. 

Mr. LUETKEMEYER. Yes. 

Mr. WILCOX. It is not comfortable. They don’t feel safe, or that 

it is going to be a wise use of their time to pursue that. That is 

the conclusion that I can draw, based on those numbers. 

Mr. LUETKEMEYER. As we are going through the process here, we 

are trying to form a bill that is going to try and give some regulatory relief to your institutions. What else would you put in there 

if you had the opportunity? What other problem do you see that we 

58 

are not addressing in here, or that you think would be something 

that we need to address or to recognize and perhaps come up with 

a solution for? 

Mr. Kelly? 

Mr. ALBERT KELLY. I think, first of all, I would say I think this 

is an excellent start. I think that we also believe that what may 

be called the penalty box needs to be reviewed, which is banks that 

end up under some type of various and sundry investigation are 

immediately prohibited from doing acquisitions and other things. 

And we think that would be a valuable piece to suspend because 

that is akin to you are going to be punished before you have your 

day in court, so to speak. And so I think that really ties up a number of banks that fall into that. At least that is what I have been 

told by a number of banks that have fallen into that path. 

Mr. LUETKEMEYER. Yes. Just to follow up on that, one of the 

banks in my area has a CRA exam that has been extended for almost 3 years. As a result of that, they can’t go out and expand with 

new branches or can’t go out and purchase an additional facility. 

So it really hampers their ability to deliver services and expand 

your operation. Is that kind of what you are talking about? 

Mr. ALBERT KELLY. Yes, that is what I am talking about. And 

that can go to a number of things— 

Mr. LUETKEMEYER. Right. 

Mr. ALBERT KELLY. — be it a fair lending exam or CRE, whatever it may be. 

Mr. LUETKEMEYER. Right. Okay. 

Mr. Wilcox? 

Mr. WILCOX. It is a good start, this bill. I think the independence 

issue, and taking that a little further, is something that I think deserves a hard look. In addition to that, expanding on the kind of 

transparency that is lacking today in terms of material supervisory 

determinations that examiners arrive at when they conduct an examination. 

For example, I hear lots of reports from friends and peers all 

over the country that they have been asked to allocate more dollars 

to their loan loss reserve. But when asking the regulator that is 

there at the exit interview or during the field examination to explain the formula, they are not given that information. 

If you are being asked to write a check that is $300,000 or 

$400,000 or $500,000, as an owner, as a CEO, I think you are perfectly entitled to understand how that math works. And that is just 

one simple example. There are lots of arbitrary decisions, or at 

least they appear arbitrary. 

And I think the communication and the transparency would go 

a long way to bettering that relationship, and putting bankers and 

regulators back on a path of working together and not having an 

adversarial relationship that seems to be developing. 

Mr. LUETKEMEYER. I know over the course of discussions with 

my local bankers—and, in fact, this past week I was discussing it 

with the president of a very large regional bank in my area. And 

there is some testimony that has occurred in this committee already with regards to the costs that the banks are incurring as a 

result of compliance with all the regulations that are coming out. 

59 

And it has reached the point where it is almost every time you 

hire one person, you have to hire one more person to do compliance. Is that what you see in the banks in your area, Mr. Kelly and 

Mr. Wilcox? 

Mr. ALBERT KELLY. The compliance area is certainly an area of 

expansion. And I think for all banks, we are no different. The ability to comply with the complexity of the regulations that are coming out in a very, very rapid-fire order, we are charged with doing. 

And so, we have staffed that up, and it is an expensive thing to 

do. 

Mr. LUETKEMEYER. Mr. Wilcox? 

Mr. WILCOX. If I may? 

Mr. LUETKEMEYER. Okay. 

Mr. WILCOX. I would concur. It is expanding. I would say our 

compliance cost has probably doubled in the last 24 months. That 

is non-revenue. It is great we are adding a job or two, but it is nonrevenue-producing and challenging for the bank, and that will continue to be the trend. 

Mr. LUETKEMEYER. And that is a cumbersome problem for the 

community banks, especially because they don’t have the ability to 

spread those dollars out like a big— 

Mr. WILCOX. That is right. 

Mr. LUETKEMEYER. Thank you, Madam Chairwoman, for your indulgence. 

Chairwoman CAPITO. Mr. Scott? 

Mr. SCOTT. I am glad that some of the regulators are still here 

because we sort of had a he said-she-said situation. And, I asked 

early about this retaliation and I just want to get a clear answer 

because I think we need to have the truth on the table of exactly 

what has happened. 

If there is a culture of this, we need to know it. It may be something, and then we need to make sure that we have the proper 

tools in place in this bill that will eliminate that. Because as I see 

it, I think the financial institutions feel that they believe that the 

existing internal agency appeals process is limited, and then they 

feel that they don’t have a recourse properly presented to them if 

they feel they got a wrong decision. 

And then this appeals process is in a way in which you feel if 

you do try to appeal it, they will retaliate. Is that a fair assumption 

of where we are? So tell me. We have two representatives of the 

banks and, I think, credit unions here. Is there retaliation? Give 

this committee an example of what that is, and let us get that on 

the table. Is it happening? Regulators are saying it isn’t. 

Mr. ALBERT KELLY. Thank you, Mr. Scott. What I would say 

would be, as earlier stated, there is certainly, in the banking industry, a concern that they will worsen their situation by making too 

much or by objecting to a particular point. 

Mr. SCOTT. Do you have any evidence or facts where that has actually happened? 

Mr. ALBERT KELLY. As I mentioned earlier, we have at the ABA 

coordinated to get examination results. As far as an improved environment, what is that? And I believe we have instances where we 

can provide to the committee our results, just as we provide them 

to the regulatory agencies. 

60 

Mr. SCOTT. Anyone else? 

Mr. WILCOX. If I may, I think retaliation is a little bit of a perception issue. It may be perceived on the bankers’ side as retaliatory or retribution. And the regulators may see that as a logical 

next step, not retribution. But I think the core of the problem, and 

the issue that is stymieing this and making it difficult to move forward, is simply the fear of it. What if? 

And because there is so much concentrated power with each regulatory authority—my bank has been in business for 98 years. And 

every time I have an exam, even though we are well-managed and 

we are in good shape, I know that if we did something wrong, they 

have the power to put the chains on my doors and put our business 

out of business. 

They hold that kind of power. That alone puts pause in somebody’s mind to say, ‘‘Hmm, how hard would you really want to 

push if there was an issue?’’ 

Mr. SCOTT. That is very good. That is what I meant. You have 

given a pretty good example. Do you believe that this ombudsman, 

or the mechanism we have in the bill, will suffice to bring this 

pressure of retaliation or whatever that is—that is what I am getting at. 

It bothers me for my bankers to come and say, ‘‘We are going to 

be retaliated against,’’ or, ‘‘We have been retaliated against.’’ And 

it is like I don’t know what a challenge it is here today to get anybody to give an example of that. And we have a bill here. One of 

the issues we are trying to address is how do we prevent that and 

make sure that there is no retaliation if we can’t get either side 

to tell us what it is? 

Mr. WILCOX. Sure. And I think one way to improve upon that— 

this is a good first step. You have a partially independent ombudsman process. Making it more independent may help, but the thing 

that you could add to that, that would really bring this full circle 

is a degree of accountability and a review process to hold the regulatory agencies accountable for their actions. 

That process doesn’t exist today, and the bankers have no way 

to initiate that kind of recourse unless they want to really fully 

gamble. 

Mr. SCOTT. Do you feel that the ombudsman’s part of this bill 

will suffice for that? Or we need to do something additional? 

Mr. WILCOX. I think you could strengthen it. It is a good first 

step, but building in accountability, some measures and processes 

of accountability for the regulatory agencies, in addition to independence for the appeals process, would help that matter greatly. 

Mr. SCOTT. Mr. Watts? 

Mr. WATTS. Yes, sir. From a credit union standpoint, NCUA has 

an ombudsman, but it does not deal with appeals. So this would 

be a significant improvement. Now, there is an appeals process and 

there is an opportunity for a credit union to be able to file for and 

have their particular case reviewed and there is a process that is 

followed. But the ombudsman is not the one that does that. 

This would actually allow for a much more specific opportunity 

by a third party, to be able to review any issues that come before 

it. So this is a much-improved process if this were adopted for credit unions. 

61 

Mr. SCOTT. Good. Thank you. 

Mr. RENACCI [presiding]. Thank you. 

Mr. Canseco, from Texas, for 5 minutes. 

Mr. CANSECO. Thank you, Mr. Chairman. 

Thank you very much for coming here today and offering your 

testimony. One thing I hear over and over again as I talk to Texas 

bankers, and also from around the country, is the difficulty they 

have in putting together a 5-year plan for their bank. There is simply too much uncertainty over upcoming rules and they don’t know 

how best to prepare their bank to compete in the future. 

Mr. Kelly, how would the provisions in this bill better prepare 

SpiritBank or the members you represent in preparing a 3- or 5- 

year plan for their bank? 

Mr. ALBERT KELLY. Portions of the bill, I believe, give additional 

certainty as to how certain things are treated. I think that certainly would be very helpful to any bank that is planning, relative 

to either loan growth or to managing some of the assets that they 

currently have. 

I think, likewise, trying to build a better regulatory environment, 

which I think is the intent of everyone from the regulatory panel 

to the bankers, is something that this bill provides; that there is 

something that actually is an independent voice out there where 

you can say, ‘‘I don’t really think this is the right way that this has 

been handled. Can we have an independent view of it?’’ 

99.9 percent of the banks out there want to please their regulators and want to stay on good terms with their regulators, and 

do not want to either risk irritating them or try to swim against 

the tide. But this gives something that allows them to have an— 

if it so breaks down to the point that they feel they need redress, 

this would allow them to know that they are able to work their 

plan and it be the plan that, hopefully, they will be able to take 

through to fruition. 

Mr. CANSECO. Has SpiritBank increased its compliance staff 

since 2008? 

Mr. ALBERT KELLY. Yes, sir, we have. We have increased our internal audit significantly, we have increased our compliance area 

with additional staff, and we have a chief risk officer who has that 

exclusive title, as well. So all of those things have been added. 

Mr. CANSECO. And is that true with what you hear from some 

of your members? 

Mr. ALBERT KELLY. I think all of our members would say that 

they are trying to prepare for the compliance; not only the compliance applications by the additional regulations that are being promulgated that certainly are required to be done. It takes an awful 

lot of time to be sure you are in compliance. 

Mr. CANSECO. And what have they told you about compliance 

costs? Is it the same as what you are experiencing at SpiritBank? 

Mr. ALBERT KELLY. Yes. I think the industry itself is seeing an 

increase, necessarily. When you have a 2,380-page bill, that is 

Dodd-Frank, that requires the regulators to promulgate regulations 

and procedures, and then you have heightened regulations—we 

have talked about the HMDA logs and things such as that. 

Those areas are very focused upon, and banks have really no 

choice but to prepare to increase their compliance costs. 

62 

Mr. CANSECO. In your relationship with bank examiners, what 

have been the most significant challenges for your bank, and how 

would they be addressed in H.R. 3461? 

Mr. ALBERT KELLY. I think when it comes to our bank, when we 

are talking about—all banks have disagreements relative to classification. There is never a right-size-fits-all. From a standpoint of 

the non-accruals, I would guess, from our standpoint, we have generally tried to follow what the regulatory agencies would follow. 

I think that the—so I don’t have and haven’t had, necessarily, 

disagreements with those particular points. I think that this bill 

would help greatly if, in fact, we talk about the fact that when you 

have a piece of collateral and you know that firm value, to classify 

the entire balance is, as we have stated in our written testimony— 

it is as much a negative overstatement as we heard earlier saying 

you are overstating earnings. 

You have a piece of property that is worth, as we said in our testimony, $9.5 million, and you have a $10 million loan, yes, you 

have an impairment of half a million dollars. But do you really 

classify the whole thing if it is performing? 

And that is something that I think, today, those loans all get 

classified. And those obviously have a large impact on your capital 

and a large impact on your standing. 

Mr. CANSECO. Can you offer any suggestions for improving H.R. 

3461? 

Mr. ALBERT KELLY. As I told the gentleman from Missouri, I 

think that if we were able to include provisions there that would 

allow the suspension of the penalty box for those banks that have 

ongoing disputes so that they can expand, and should they have opportunity and they can go into different lines of business during 

that period of the dispute, I hear that from a number of a banks, 

that they feel like they have been put on the sidelines, which becomes punitive. 

Even if they end up being successful in whatever dispute that 

might be, they still miss the opportunity. In some cases it stretches 

over several years. So I think that would be extremely helpful, to 

have that in there. 

Mr. CANSECO. Thank you very much, Mr. Kelly. 

My time has expired. 

Mr. RENACCI. Thank you. 

I want to thank the panel for their testimony today. Before closing, I would like to ask unanimous consent to submit for the record 

the testimony of David Baris, executive director, American Association of Bank Directors. Without objection, it is so ordered. 

The Chair notes that some Members may have additional questions for today’s witnesses, which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 

days for Members to submit written questions to these witnesses 

and to place their responses in the record. 

This hearing is adjourned 

[Whereupon, at 5:17 p.m., the hearing was adjourned.] 

(63) 

A P P E N D I X 

February 1, 2012 

64 


75069.001

For release on delivery 

2 p.m. EST 

February 1,2012 

Statement of 

Kevin M. Bertsch 

Associate Director 

Division of Banking Supervision and Regulation 

Board of Governors of the Federal Reserve System 

before the 

Subcommittee on Financial Institutions and Consumer Credit 

of the 

Committee on Financial Services 

U.S. House of Representatives 

February 1,2012 
65 


75069.002

Chairwoman Capito, Ranking Member Maloney, and members of the Subcommittee, I 

appreciate the opportunity to appear before you today to discuss the Federal Reserve's 

perspective on H.R. 3461, the "Financial Institutions Examination Fairness and Reform Act." 

The Federal Reserve supervises more than 5,000 bank holding companies and 825 statechartered banks that are members of the Federal Reserve System (state member banks). As of 

July last year, it also assumed responsibility for the supervision of more than 430 savings and 

loan holding companies. The Federal Reserve shares the subcommittee's interest in ensuring a 

fair examination process and providing banks with a robust and transparent process for appealing 

material supervisory determinations with which they disagree. 

Accordingly, the Federal Reserve has instituted a number of steps to ensure that 

examination findings are well grounded in supervisory policy, fully supported, and give due 

consideration to all relevant information provided by bankers. First, all examination findings are 

subject to a thorough review by the management of each Reserve Bank before being finalized. 

These reviews encompass an evaluation of all significant findings of the examination. They also 

focus particular attention on ensuring that examiner conclusions with which bank management 

has raised concerns or expressed disagreement are accurate and give appropriate consideration to 

relevant information presented by banking organizations. 

In addition, Board staff analysts assigned to monitor bank supervision activities sample 

recently completed examination reports to assess compliance with policies and support for 

examiner conclusions. These analysts also conduct periodic reviews of specific examination 

activities to assess their compliance with supervisory policy and standards. As we become aware 

of particular concerns being raised by bankers, we focus our reviews of examination activities on 

ensuring that examiners are appropriately addressing the areas of concern. For example, because 
66 


75069.003

- 2-

bankers have been raising significant concerns about the trcatment of commercial real estate 

workout loans by examiners, we have focused particularly on evaluating examiners' treatment of 

these loans in recent years. To reinforce sound cxamination approaches and respond to issues 

raised by bankers, we have also offered significant, targeted training to examiners on many 

supervisory issues. These include a number of issues that are addressed by the bill under 

discussion today, including proper determinations of accrual treatment, the circumstances under 

which new appraisals may be required, and the proper classification of commercial loans. 

The Federal Reserve also encourages bankers to discuss with Reserve Bank supervision 

management any concerns they may have. We find that many differences ofpcrspective can be 

resolved through open, constructive dialogue. If bankers still have concerns after talking with 

Federal Reserve supervisory staff, they are encouraged to contact the Federal Reserve Board's 

Ombudsman, who operates independently of the supervisory process and can address concerns 

on a confidential basis and provide information to the banker on how to file a formal appeal of 

material supervisory determinations. 

Indeed, the Federal Reserve has already taken steps to respond to many of the particular 

concerns addressed by the proposed legislation and is committed to taking additional steps as 

needed to assure a balanced and fair examination process. In the remainder of my remarks 

today, I will begin with comments and observations on the proposed legislation's requirements 

for examinations. I will then discuss the Federal Reserve's examination appeals process and 

Ombudsman function. Finally, I will briefly describe some of the steps the Federal Reserve has 

taken in recent years to enhance its communication with community and regional banks as well 

as some actions it is initiating to respond (0 feedback from these institutions. 
67 


75069.004

- 3 -

Comments on Provisions Addressing Examination Practices 

A number of the steps that would be required under the proposed legislation have already 

been adopted by the Federal Reserve. For example, Federal Reserve examiners discuss and 

share with bank management and directors the information relied upon to support material 

supervisory determinations during the course of examinations and in exit meetings. In addition, 

the banking agencies already use common definitions and reporting guidelines for nonaccrual 

loans as detailed in the instructions for the financial reports of condition and income (Call 

Reports) that banks must file each quarter. 

Several other provisions of the bill that prescribe specific supervisory or accounting 

treatments appear to limit the ability of examiners to use judgment in certain circumstances. As 

drafted, these provisions may impede, rather than further, the ability of examiners to ensure the 

safe and sound operation of banking finns. For example, the proposed bill could be interpreted 

to prevent an examiner from requiring a new appraisal on a performing commercial loan unless 

new funds are being advanced. The appraisal regulations of the federal banking agencies allow 

examiners to require a bank to obtain a new appraisal on an existing loan when there is sufficient 

reason to believe a bank's collateral position has deteriorated materially and could expose the 

bank to current or future losses. This could occur, for example, when a property collateralizing a 

loan loses a major tenant or when a borrower's cash flow is under pressure and a loan is 

becoming more dependent on the value of collateral for repayment. In these situations, an 

updated appraisal is often essential to determining the steps a bank should take to assure 

repayment of all principal and interest due. Often, banks order new appraisals in these situations 

without prompting by examiners to assess the likelihood of loss and determine whether other 
68 


75069.005

-4-

steps should be taken to obtain more collateral from the borrower or restructure a loan to protect 

the bank's financial interests. 

Similarly, the proposed bill specifies that a commercial loan cannot be placed on 

nonaccrual status solely because the collateral has deteriorated in value. Federal Reserve 

examiners do not currently require commercial loans to be placed on nonaccrual status solely 

because collateral has deteriorated in value. We want to make sure it is clear, however, that a 

loan with collateral that has deteriorated in value may be placed on nonaccrual status if there is 

other material information that suggests that the bank may not receive all principal and interest 

due under the terms of the loan. Placing a loan on nonaccrual status would be appropriate, for 

example, in cases in which a borrowcr's reported cash flows had fallen below the amount 

required to service the loan and the value of the collateral supporting the loan had fallen to a 

value below the amount due to the bank. By not placing such a loan on nonaccrual status, a bank 

would be overstating its income and understating the volume of its problem assets. 

The proposed bill would also require that restructured commercial loans be returned to 

accrual status when borrowers have demonstrated the ability to perform for six months. Current 

supervisory guidance similarly allows a loan to be returned to accrual status when the borrower 

has shown a sustained ability to perform for a reasonable period of time, typically six months. 

However, there are circumstances when this treatment is not appropriate. For example, a bank 

may restructure a loan with a periodic debt service payment that can be serviced by cash flow 

provided by the underlying collateral, but without sufficient cash flow to repay the loan over a 

reasonable amortization period. In this situation, the ultimate collection of the entire principal 

and interest remains in doubt and the loan would not be considered performing. This type of 
69 


75069.006

- 5 -

strategy is inconsistent with generally accepted accounting principles, and past supervisory 

experience suggests it is often unsuccessful and can increase the costs of resolution in the event a 

bank fails. In 2009, the Federal Reserve and the other agencies affinned these supervisory 

expectations in the Prudent Commercial Real Estate Workout Guidance. l 

The proposed bill also appears to prohibit examiners from requiring a bank that meets the 

regulatory threshold for being "well capitalized" under the prompt corrective action provisions of 

federal law to raise additional capital. These provisions conflict with the provisions recently 

enacted in the Dodd-Frank Wall Street Refonn and Consumer Protection Act, which require the 

federal agencies to consider the risk that banking finns-including those that are well capitalized 

under current regulatory definitions-pose to the financial system and impose enhanced 

supervisory requirements on those finns. These provisions also fail to recognize that the 

regulatory definitions for the various capital thresholds were designed to apply generically to 

banking finns and do not take into account the idiosyncratic risks at individual finns or the 

potential effects on a bank's capital position ofrisk-management deficiencies or concentrations 

in problem assets. Therefore, meeting these predefined thresholds does not imply that a bank has 

no need of further capital. Indeed. during the recent downturn, many communities experienced 

such sharp drops in real estate prices that local banks that entered the crisis at or above the "wellcapitalized" thresholds found existing capitallcvels inadequate to cover emerging loan losses. 

Prohibiting examiners from encouraging additions to capital at such banks during the recent 

crisis could, we think, have resulted in significantly higher losses to the deposit insurance fund. 

1 See Board of Govemors of the Federal Reserve System (2009), "Federal Reserve Adopts Policy Statement 

Supporting Prudent Commercial Real Estate Loan Workouts," press release, October 30. 

www.federalrcscrve.gov/newsevents/press/bcreg/20091030a.htm. 
70 


75069.007

- 6 -

Perspective on Provisions Regarding Appeals and the Ombudsman Function 

A key purpose of the proposed legislation appears to be to ensure a strong appeals 

process and independent Ombudsman function for the resolution of bankers' concerns about the 

fairness of the supervisory process. The Federal Reserve has in place a robust appeals process 

and an independent Ombudsman function designed to provide institutions with a fair and 

fulsome review of complaints. Currently, the Federal Reserve's rules provide any party affected 

by our supervisory process with three successive levels of appeal. First, the management team of 

a banking firm may appeal any material supervisory determination to a review panel composed 

of Reserve Bank staff that were not in any way responsible for the original supervisory 

determination. This panel typically is made up of experienced supervisory staff from Reserve 

Banks that were not involved in the supervisory determination and that were selected after 

consultation with Federal Reserve Board staff. The banking firm may submit to this panel any 

information that the firm believes is relevant to the determination and may appear before the 

panel to provide information orally. 

If the bank's management team feels its concerns are not satisfied by this panel's 

decision, the banking organization may make a second appeal to the president of the relevant 

Reserve Bank. This review focuses on ensuring that the deliberations ofthe initial review panel 

were objective, complete, and followed specified procedures. Again, the banking organization 

may submit any additional information it believes is relevant to the decision. If needed, a third 

review can be requested. This third review is undertaken by the member of the Board of 

Governors with oversight responsibility for the Federal Reserve's Banking Supervision function. 
71 


75069.008

- 7 -

As noted previously, the Federal Reserve also has an Ombudsman to provide banks with 

a means of raising issues regarding the examination process that are maintained in confidence. 

The Ombudsman also will provide information regarding the appeals process 2 The Ombudsman 

provides a neutral, independent, objective facilitator and mediator for the resolution of issues and 

complaints related to the System's regulatory and supervisory activities. The Ombudsman 

actively works with banking firms that have concerns about examinations and other supervisory 

matters, and works independently from the supervisory chain of command. The Ombudsman 

has broad authority to mediate complaints, including the authority to refer matters to the 

appropriate Federal Reserve Board committee. 

The Federal Reserve maintains a strong anti-retaliation policy to protect any person who 

uses the appeals process or who contacts the Ombudsman with concerns. The Ombudsman 

reaches out to every institution that has filed an appeal within six months after the appeal has 

been decided to inquire whether retaliation has taken place. The Ombudsman also has broad 

authority to investigate claims of retaliation. Where appropriate, and when corrective action has 

not been taken, the Ombudsman reports retaliation complaints to the appropriate Federal Reserve 

Board committee. 

The Federal Reserve continues to evaluate methods for improving its appeals process. At 

the same time, it has been our experience that most disagreements regarding supervisory matters 

are resolved promptly and informally through direct discussion between the Reserve Banks and 

the affected institutions, and we would not want to discourage this means of resolution. 

2 For more information, see the "Ombudsman for the Federal Reserve System" webpage at 

www.federalreserve.gov/aboutthefed/ombudsman.htm. 
72 


75069.009

- 8 -

Efforts to Address Regulatory Burdens 

We recognize the concerns expressed by bankers about the supervisory process and are 

taking steps to respond to them. The nation has just experienced an extraordinarily difficult 

financial crisis and continues to recover. As you would expect in these conditions, examiners 

have identified many supervisory concerns and are working with banking finns to address these 

concerns. 

In recent years, the Board has taken a number of steps to enhance its communication with 

community banks to ensure that their views on the supervisory process are considered. In 2009, 

the Board established a subcommittee to focus on supervisory approaches to community and 

regional banks. This subcommittee is led by Board Governors Elizabeth Duke and Sarah Bloom 

Raskin. A primary goal of the subcommittee is to ensure that the development of supervisory 

guidance is infonned by an understanding of the unique characteristics of community and 

regional banks and consideration of the potential for excessive burden and adverse effects on 

lending. In addition, in 2010, the Board established the Community Depository Institutions 

Advisory Council (CDIAC) to provide input on the economy, lending conditions, and other 

issues of interest to community banks. Members include representatives of banks, thrift 

institutions, and credit unions serving on local advisory councils at the 12 Federal Reserve 

Banks. One member of each of the Reserve Bank councils is selected to serve on the CDIAC, 

which meets twice a year with the Board in Washington, D.C3 

Feedback from community bankers has persistently pointed to increasing regulatory 

burden as a concern and threat to the viability of the community bank model. Last year, the 

3 See the Board's "Commuuity Depository Institutions Advisory Council" webpage at 

www.federalreserve.gov/aboutthefedlcdiac.htm. 
73 


75069.010

- 9-

Board's subcommittee on community and regional banks asked that a series of initiatives be 

developed to clarify regulatory expectations, alleviate regulatory burdens where possible, and 

reduce the potential that regulatory actions could curtail lending. In response, Federal Reserve 

staff initiated a number of projects to enhance supervision practices for community banks and 

alleviate some of the burdens that have been of the most immediate concern. 

Several of these projects aim to revise or clarify guidance. These include initiatives to 

reiterate when supervisory rating upgrades may be considered for community banks recovering 

from the effects of the recent crisis, to enhance the transparency and consistency of assessments 

of the adequacy of banks' allowances for loan and lease losses, and to clarify capital planning 

expectations for community banks. Others projects aim to improve our examination processes 

by reviewing exam preparation procedures to ensure that report findings are clearly 

communicated and fully consistent with information provided to bankers during exit meetings, 

developing and adopting common technology tools across the System to improve efficiency and 

potentially reduce burden on supervised companies, and evaluating applications-processing 

procedures to enhance transparency and identify opportunities for streamlining. And more 

projects are under consideration. Overall, these efforts are intended to ensure a rigorous, but 

balanced, approach to safety and soundness supervision that fosters a stable, sound, and vigorous 

community bank population. 

In summary, the Federal Reserve supports efforts to ensure that the examination process 

is fair, balanced, and consistent and strives to continuously improve its examination processes. 

Indeed, we have already initiated a number of changes to improve and clarify our supervisory 

policies and practices and, where possible, constrain burden while still ensuring a safe and sound 
74 


75069.011

- 10-

banking industry. It is important that the agencies not be impeded in taking steps to cnsure the 

safe and sound operation of banking firms. 

We appreciate thc subcommittee's invitation to share our views, hope that our comments 

have been helpful, and would be happy to continue a dialogue on these very important issues. 
75 


75069.012

February 1, 2012 

Testimony of 

Albert C. Kelly, Jr. 

On behalf of the 

American Bankers Association 

before the 

Subcommittee on Financial Institutions and Consumer Credit 

of the 

Committee on Financial Services 

United States House of Representatives 

~I American 

Bankers 

Association 
76 


75069.013

February 1, 2012 

Testimonyol 

Albert C. Kelly, Jr. 

On hehall of the 

American Bankers Association 

before the 

Subcommittee on Financial Institutions and Consumer Credit 

of the 

Committee on Financial Services 

United States House of Representatives 

February 1,2012 

Chairwoman Capito, Ranking Member Maloney. and members ofthe Subcommittee, my name 

is Albert C. Kelly. Jr., Chainnan and Chief Executive Officer, SpiritBank, a $1.25 billion bank 

headquartered in Bristow, Oklahoma. I am also the chainnan of the American Bankers Association. 

I appreciate the opportunity to present the views of the ABA on the Financial Institutions 

Examination Fairness and Refonn Act (H.R. 3461). The ABA represents banks of all sizes and 

charters and is the voice of the nation's $13 trillion banking industry and its two million employees. 

ABA strongly supports H.R. 3461, the bipartisan legislation introduced by Chainnan Capito 

and Ranking Member Maloney. This bill takes a major step toward a more balanced and 

transparent approach regarding how. and on what basis, decisions are made by the regulatory 

agencies in the examination process. It also addresses some examiner decisions that have 

effectively and unnecessarily reduced the amount of capital available for increased lendingparticularly to small businesses. We strongly urge its enactment, which would increase banks' 

ability to help local businesses grow and create jobs. 

The banking industry and bank regulators share the same goal: to have a strong healthy 

banking system that meets the needs of customers in a safe and sound manner. How that is 

accomplished, however, makes an enonnous difference. Because the U.S. banking system is vital 

to the economic health of our nation, the manner in which it is regulated has a direct impact on the 

country's economic growth and vitality. The financial crisis has, unfortunately, upset the balance 

between allowing banks the freedom to make reasoned judgments that effectively and efficiently 

meet the needs of their customers and the regulators' mission to assure safe and sound banking. 

~ I American Bankers Association 
77 


75069.014

February 1,2012 

Overly conservative examinations necessarily translate into less credit in local communities, which, 

in turn, means businesses grow more slowly and create fcwer jobs. There is no question that the 

regulatory pcndulum has swung too far in reaction to the financial crisis. 

Although no single piece of legislation could deal with the wide range of concerns bankers 

have about the current supcrvisory envirorunent, n.R. 3461 takes a major step to restore this 

balance. It is rooted in fundamcntal principles of accountability, transparency and quality assurance 

regarding regulators' decision-making during the examination process. The bill would confirm clear 

exam standards based on long-established interagency policy and create an independent FFIEC 

ombudsman to ensure the consistency and quality of all examinations. It provides mechanisms that 

guard against ovcrly conservative examinations and provides a meaningful path lor appeal by banks 

when there are legitimate concerns that the examination decisions have gone too far. 

Enacting H.R. 3461 is critical as it: 

» Establishes an independent ombudsman's office to receive complaints, review procedures to 

ensure consistcncy and quality of examinations, conduct appeals, and provide 

recommendations to Congress to improve examinations; 

» Establishes a timely, independent, and fair process for banks to appeal examination 

decisions without fear of retaliation by their primary supervisors; 

» Helps improve consistency in the examination process in accordance with regulatory 

guidance on performing loans, modified or restructured loans, appraisals, classifications and 

capital requirements; 

» Ensures that banks receive timely examination reports that fully document how the agencies 

arrived at their decisions; and 

>- Extends protection of privileged communications shared with supervisory agencies to cover 

the Bureau of Consumer Financial Protection. 

I will discuss each of these important provisions in tum. 

~ I American Bankers Association 
78 


75069.015

Fcbrumy 1, 2012 

I. FFIEC Ombudsman Established 

One way to foster fair and transparent exams is to ensure that banks have a meaningful avenue 

of appealing exam findings when a bank disagrees with its examiner. The health of the banking 

system depends on a supervisory system that fosters appropriate risk-taking by banks, and thc 

supervisory system works best when tbcre is candid, dispassionate communication bctwecn bankers 

and bank regulators aboul the many issues that arise during a typical bank examination. When 

issues cannot be resolved during an exam, the need for productive communication only grows. We 

believe that the mission of the Federal Financial Institutions Examination Council (FFIEC) should 

be strengthened by improving agency transparency and accountability for uniform application of 

interagency examination standards and by providing an option to invoke an effective interageneybased supervisory appeals proccss using an appellate body within the FFIEC. 

H.R. 3461 provides such a process which we strongly support. It creates an independcnt 

ombudsman's office within the FFIEC that is dedicatcd to recciving feedback from banks rcgarding 

examinations, conducting appeals, reviewing agency examination procednres to ensure consistency 

and quality, and to recommend to Congress ways to improve examinations. 

An important role of an FFIEC ombudsman under H.R. 3461 is to assure that written 

interagency policies and procedures arc being followed consistently in the field. We have often 

heard from bankers that changes are being made without any formal process, new standards are 

being applied without banks having a clear understanding of what they are and that some regulators 

diverge from interagency standards without advance notice to banks in their jurisdiction and without 

prior interagency deliberation or consensus. Banks should at least be told what ratios and other 

analytical standards the examiners are applying to measure the adequacy of institution compliance 

with interagency staudards or expectations. Moreover, often these changes are applied differently 

from bank to bank. H.R. 3461 provides a mechanism to address these concerns. 

A transparent program of quality assurance is the key to assuring the FFIEC memher 

agencies are held accountable for consistency. While the prudential regulators have separate 

programs, the aspiration for achieving uniformity among the FFIEC agencies demands that these 

programs be coordinated and the results disclosed on a comparative basis using aggregated data. 

This would be the fundamental responsibility of the FFIEC ombudsman. 

~ I American Bankers Association 4 
79 


75069.016

February r 2012 

II. Right to Appeal Before the FFIEC Ombudsman 

By allowing an appeal of material supervisory dctelminations to the Office of Examination 

Ombudsman, H.R. 3461 establishes a process for institutions to hold federal financial regulatory 

agencies accountable to the FFIEC mission of vigorous and unifonn supervision. This appellate 

option serves as a fitting capstone to Congress's charge to the FFIEC to promote examination 

consistency. 

We strongly support the approach in H.R. 3461, which sets up a process to appeal to the FFIEC 

ombudsman with the opportunity to have a hearing before an Administrative Law Judge (ALl). This 

approach combines the adjudicatory experience ofthe ALl in developing a factual record about the 

supervisory issue with the FFIEC ombudsman's statutory mandate (and agencies' efforts) to 

develop common regulatory standards and supervisory expectations. The result is an authoritative 

and sound resolution process for a dispute between an institution and a member agency. Having a 

final and binding decision made by the FFIEC ombudsman provides the appropriate power to 

ensure that each FFIEC agency will be held accountable for applying regulatory standards and 

interagency policies and procedures consistently across the industry. 

The ombudsman role is well regarded in government administrative process. It is an important 

means of assuring regulated firms that an agency operates fairly and consistently within its mission. 

While each of the banking agencies has an ombudsman, the OCC ombudsman stands alone among 

the banking agencies as an illustration of how it can be an effective model for conducting 

supervisory appeals. By being independent of the regular supervisory line of authority, the OCC 

ombudsman affords banks the ability to obtain a review of material determinations by an expert 

authority that has not previously become committed to tbe agency position. The OCC's track 

record demonstrates the efficacy of ombudsman responsibility for supervisory appeals. For 

instance, the OCC ombudsmau reports that out of the dozen appeals in 2010, 64 percent resulted in 

decisions upholding the supervisory office, 18 percent upheld the bank and the other 18 percent 

wcrc split decisions. 1 

H.R. 3461 provides for a similar process dedicated to a balanced and non-retaliatory approach 

where the issues have not been pre-judged and leverages this model to finally put some real 

backbone in the FFIEC's mandate of assuring uniform supervision and a consistent examination 

process. Some of the key features include: 

1 &span from tbe Offia if the Ombudsman, 2006-2010 HigblightJ,june 2011. 

~ ! American Bankers Association 
80 


75069.017

February 1,2012 

~ To assure a fair hearing, the ALl's decision is based upon an independent review of the 

agency's action in light ofthe relevant statutes, regulations and appropriate guidance. 

~ The decision must be timely, no later than 60 days after the record has been closed to assure 

that the bank knows where it stands as quickly as possible. 

~ None or the regulatory agencies, including the agency that is the source of the appeal may 

take retaliatory action against a bank or any of its officers, employees, service providers or 

institution affiliated parties for exercising its appeal rights. This includes delaying or 

denying any action by a regulatory agency that would benefit the bank on the basis that an 

appeal is pending. For example, a branch application should not be delayed if there is an 

ongoing appeal of another determination. 

~ The FFIEC ombudsman must report annually to Congress on issues raised by financial 

institutions and actions taken on appeals, so Congress can take a real oversight role in 

assuring that examination results are consistent and fair. 

Having an independent appeals process does no! open the door for a bank to appeal any 

examination dc'Cision. First, the appeals are limited to a "Material Supervisory Determination" 

which is defined (as amended by the bill) to include: examination ratings, the adequacy ofloan loss 

reserves, significant loan classifications, and "any issue specifically listed in an exam report as a 

matter requiring attention by the institution's management or board of directors." These are 

reasonable areas where ditJerences of opinion arc significant and have real economic consequences 

both for the bank and its ability to serve its commuoity. 

Second, it is highly unlikely that a bank would uodertakc the significant time and effort to 

appeal unless it truly felt that there was a significant problem to be addressed. Making a formal 

appeal of an agency decision eitber by invoking the agency's own process or the new proposed 

FFIEC process is not a step that is taken lightly. Working cooperatively with their supervisors is 

the preferred approach by all banks in the normal course of oversight. However, the ability to take 

exception to material determinations through a process that enables an independent review by those 

who have not pre-judged the issue is an important check and balance. In fact, the very existence of 

this appeals process, even if infrequently used, keeps the regular supervisory process fair and 

accountable. ABA is confident that the vast majority of supervisory matters would continue to be 

resolved without resorting to a formal appeal as is the case today. 

~ ! American Bankers Aqsociation 
81 


75069.018

Febru8fY 1, 2012 

Third, H.R. 3461 does nothing to change any agency's existing appeal process. Rather, it adds 

an alternative route for a financial institution to deal with an independent entity specifically set up 

to address examination issues quickly and fairly. 

Finally, H.R. 3461 does not undennine the legitimate supervisory authority of the supervisory 

agencies anymore than the existence of the FFIEC itself does. The procedural independence of the 

FFIEC ombudsman does not make him or her unaccountable to the Council, which is made up of 

the member agency heads. To the contrary, the FFIEC ombudsman is committed to the faithful 

execution of the Council's policies as determined by its agency members. At the end of the day, the 

FFIEC ombudsman is answerable to the Council for the performancc of all duties of the Office of 

the Examination Ombudsman. 

III, Examination Standards 

H.R. 3461 ensures consistency in application of the interagency guidance with respect to 

performing commercial loans, modified or restructured loans, appraisals where no new funds are 

extended, classification of loans, and additional capital requirements for well-capitalized banks. 

Over the last several years, it was not uncommon to hear about inconsistent and unnecessary 

requirements by examiners. Sueh an approach has important consequences for banks and their 

communities. Banks are working every day to make credit available. Those efforts are made more 

difficult by regulatory pressures that exacerbate, rather than help to mitigate, the problems. The 

ABA has raised the issue of ovcr~ealous examiners in hearings over the last several years and 

through letters to the banking agencies. While the agency heads in Washington have said the right 

things about encouraging reasonable judgment by field cxaminers, a common refrain from bankers 

over the last several years has been the overly conservative approach by regulators in their analysis 

of asset quality and the downgrades ofloans whenever tbere was any doubt about the loan's 

condition--<!ven in cases whcrc loans are fully perfonning. 

For example, many perfonning commercial loans-where the borrower is making payments as 

promised-have been accompanied by declines in the value of collateral that backs the loan. Banks 

have reported that examiners are requiring them to treat these loans as non-accruals. Such a 

treatment is not consistent with regulatory guidance or the definition of a non-accrual, which 

generally are those loans where the payment of interest and principal has lapsed or those where full 

payment of principal and interest is not expected. In some instances, this practice has forced hanks 

~ I American Bankers Association 
82 


75069.019

Februaty 1, 2012 

to raise capital in situations that may be unwarranted. FI.R. 3461 prohibits the practice of declaring 

a loan in non-accrual solely as a result of the decline in collateral value. 

We all want fair treatment of what is truly a troubled loan. However, the problem is bigger 

tban the question of non accruals. For example, how loans are classified as problem assets for 

regulatory purposes; how those loans are required to be valued (including tbose loans subject to 

modifications characterized as "troubled debt restructurings"); and how capital is calculated as a 

result o[these classificatioos are major issues. How each of these is done can have significant 

consequcnces for a bank's ability or willingness to make loans in their communities. Ovcrly 

conservative examiner judgments in any of these areas means far less credit will bc extended, whicb 

translates into slower economic grow1h for tbis COlU1try. 

This seems to be a particular issue with the classification of commercial real estate (CRE) 

loans. For example, bankers have told us that regulators generally classify the entire loan if the 

secondary source of repayment is impaired-even in cases where the borrower continues to make 

principal and interest payments. While an impairment of the secondary source-such as a decline 

in the collateral value ofthc underlying real estate--does raise concerns about potential losses, 

classifYing the entire loan as troubled makes no sense for many loans. Moreover, the loss on a loan 

backed by collateral (as is tbe case witb CRE loans) is typically mucb smaller than tbe full amount 

of tbe loan, and that assessment and any necessary impairment is recorded by the bank under 

generally accepled accounting principles (GAAP). Even with the drop in tbe collateral value 

(which has certainly taken place over the last several years), tbe property continues to bave positive 

value and tbe bank would not lose the entire amount of tbe loan sbould it ultimately default. Thus, 

by classifying the entire loan as troubled, rather than just a conservative value of anticipated loss, 

tbe extent of the problems are overstated-vastly overstated in some eases. 

For example, suppose a bank has a $10 million loan on a commercial property (non-owner 

occupied and leased) that is valued at $16 million at the time tbe loan was made. Even witb 

significant equity by tbe borrower, the decline in eRE property has been 40 percent on average 

nationwide. Tbus, a current appraisal migbt bave this property valued at $9.6 million. Wbile tbis is 

less than the loan, tbe borrower may-as is often the case-still be making principal and interest 

payments as promised on tbe loan. Even if the leasing is slow on tbe property, and even with a 

conservative discount on the appraisal (in ease tbe property bad to be sold quickly or in recognition 

of still-declining market values), the collateral backing the loan still bas considerable value. If the 

~ I American Bankers Association 
83 


75069.020

Febru8IY 1. 2012 

borrower does end up defaulting, the loss would not be $10 million, i,e" the original loan amount, 

Classifying as troubled the entire $10 million loan dramatically overstates the anticipated loss on 

this loan if it were to default (as is evidenced by the loss recorded under GAAP)---and the vast 

majority of such loans will continue to perform as expected and never default. But how this loan 

and other similar loans are treated by regulators, along with the need in some cases to raise 

additional capital as a consequence, will dramatically affect the ability and willingness of the bank 

to lend. 

Not only is the level of classified assets overstated, but some bankers have reported that the 

regulators are using fixed ratios of c1assitied loans to capital plus reserves as a determinant of exam 

ratings and as a driver to require the bank to increase capital levels. Evcn profitable community 

banks with capital-to-asset ratios at or abovc those of their peers--and at or above the regulatory 

guidelines-and without significant asset quality problcms, are being told thcir capital is inadequate 

and to increase it. 

As capital is particularly scarce in today's environment-particularly for smaller banks-the 

only course of action is for banks to stop lending and to shrink in order to meet the required capitalto-asset ratio prescribed by the regulators. Banks shrink by making fewer loans. This clearly has a 

dramatic and negative impact on the bank and means less credit will be provided to creditworthy 

borrowers. 

IV. Timeliness of Examination Reports 

Currently, there is no time certain for banks to receive examination reports. While the 

rcgulatory agencies endeavor to provide these final reports to banks in a reasonable time period, the 

fact is it is common lor final reports to be issued as long as 10 months after the examiners leave the 

bank. Moreover, many banks report that there are often surprises in the tinal report that were never 

discussed with their institutions. This includes additional downgradcs in the components of the 

overall exam rating and new requirements for corrective action that were unanticipated. Such 

unexpected decisions are very disruptive to efforts of banks to prudently respond to supervisory 

concerns. 

Changes are often made at the regional or even national level, second-guessing the reasoned 

judgment of the field examiners. Field examiners, having been overruled at the regional or national 

level, have every incentive to be even harsher in their next examination. This creates a cycle of 

~ i American Bankers Association 9 
84 


75069.021

February 1, 2012 

increasing regulatory pressure. Often, the hasis upon which further downgrades or detenninations 

are made are not fully documented or disclosed to the bank, making it appear that the decisions are 

arbitrary and part of an effort of being "tough" to avoid any perception of being too weak. This has 

significant consequences for communities: it means that good loans to creditworthy harrowers may 

not bc made. 

Delayed exam reports adversely affect banking operation efficiencies in two fundamental 

ways: First, they undemline the ability of hanks to expeditiously undertake examiner recommended 

improvements with which management concurs. Such consensus solutions are characteristic of the 

exam experience. However, because exam finality remains up in the air, banks cannot confidently 

rely on the consensus solutions arrived at with their examiners for fear that the ultimate report will 

remake supcrvisory conclusions and leave the bank in a "do over" situation-a costly and wasteful 

result. So improvements are at risk, held up or incompletely pursued until the final exam report is 

actually received. 

Second, in the cases where there arc disputed examiner findings, the long delay in obtaining a 

final position from agency higher-ups creates gridlock at the bank while the effected operations 

await reliable direction before proceeding with any similarly situated cases that may be subject to 

challenge. Both of these impacts heighten banker uncertainty, chilling the bank's ability to make 

decisions and readily serve the needs of its local community. 

Every bank wants a fair evaluation of its financial position and regulatory compliance 

perfonnance. It must be based on reasoned judgment, backed by facts that are presented in a 

transparent manner. Where there are areas that need corrective action or improvement, timely exam 

findings that reflect the understanding gained from the onsite exam are vital. Having timely 

examination reports is one of the many provisions in H.R. 3461 that help assure basic quality 

assurance standards and transparency regarding how material supervisory dctenninations are made. 

V, Extends protection of privileged commnnications to cover tbe Bureau of Consumer 

Financial Proteetion 

Banks currently have legal protection that allows them to be comfortable in voluntarily turning 

over privileged documents upon the request of the banking agencies. Thc section that affords this 

protection, 12 U.S.C. § 1828(x), creates a federal standard that protects the sharing of privileged 

communications with a prudential regulator from the assertion of an imputed waiver. However, the 

~ I American Bankers Association 10 
85 


75069.022

Fehru8lY 1. 2012 

section is not worded in such a way that it covers the CFPB; therefore, as ILR. 3461 proposes, it 

should he extended to cover banks sharing similar communications with the Bureau. ABA wholeheartedly supports this provision in the bill. 

In addition, ABA recommcnds that the companion protection afforded by 1821 (t) also be 

amended to explicitly include the Bureau so that further sharing of such privileged communications 

by the original agency recipient with another supervisor or federal government agency is also 

protected from any assertion of waiver. Testifying before the House Ovcrsight and Government 

Reform Subcommittee last weck. Mr. Richard Cordray acknowlcdged that although the Dodd-Frank 

Act had not includcd the Bureau among the banking agencies covered by the existing protections, 

he would support such a change to protect privilcged information shared by banks with the Bureau. 

Conclusion 

Community bankers like me work every day to scrvc the needs of our customcrs and your 

constituents. For many banks, the ability to mect our communities' needs has becn hampered by 

decisions made during the examination process that have effectively and unnecessarily reduced the 

amount of capital available for lending-particularly to small businesses. These decisions hinder 

banks' ability to help local businesses grow and create jobs. 

R.R. 3461 is the type of legislation that is needed to address this critical issue, particularly for 

community banks. The bill would clarify certain exam standards and creates an independent FFIEC 

ombudsman to ensure the consistency and quality of all examinations. H.R. 3461 also would ensure 

that financial institutions receive timely examination reports that include documentation of the 

infonnation regulators used to make their determinations. In addition, the bill would create an 

expedited process for banks to appeal examination decisions without fcar of reprisals. 

ABA strongly supports H.R. 3461 and appreciates the leadership of Chairman Capito and 

Ranking Member Maloney in seeking changes that make an enormous difference in banks' ability 

to meet the needs of their community in a safe and sound manner. 

(fi.'\) I American Bankers AssociatiOrl 11 
86 


75069.023

For Release Upon Delivery 

2:00 p.m., February 1,2012 

TESTIMONY OF 

JENNIFER KELLY 

SENIOR DEPUTY COMPTROLLER 

FOR MIDSIZE AND COMMUNITY BANK SUPERVISION 

OFFICE OF THE COMPTROLLER OF THE CURRENCY 

Before the 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER CREDIT 

COMMITTEE ON FINANCIAL SERVICES 

U. S. HOUSE OF REPRESENTATIVES 

February 1,2012 

Statement Required by 12 U.S.C. § 250: 

The views expressed herein are those of the Office of the Comptroller ofthe Currency 

and do not necessarily represent the views of the President. 
87 


75069.024

Introduction 

Chairman Capito, Ranking Member Maloney, and members ofthe Subcommittee, 

I appreciate the opportunity to appear before the Subcommittee on Financial Institutions 

and Consumer Credit to discuss the Office of the Comptroller of the Currency's (OCC) 

perspectives on H.R. 3461, "The Financial Institutions Examination Fairness and Reform 

Act." 

As the Senior Deputy Comptroller for Midsize and Community Bank Supervision 

for the OCC, I serve as the senior OCC official responsible for community bank 

supervision. The OCC supervises approximately 1,700 national banks and federal 

savings associations with assets under $1 billion. These community-focused institutions 

(collectively referred to as "banks" in my testimony) playa crucial role in providing 

consumers and small businesses in communities across the nation with essential financial 

services as well as the credit that is critical to economic growth and job creation. 

H.R. 3461 contains measures directed at three basic concerns: I) assuring that 

banks have access to a fair and independent appeals process if there are disagreements 

about a bank regulator'S supervisory determinations; 2) clarifying or revising standards 

for classification of loans and placing loans in nonacerual status; and 3) achieving timely 

examinations and communication of examination results. 

My managers and I hold numerous outreach sessions and meetings with bankers 

to listen and respond to their concerns and questions, and we have heard many of the 

same concerns that you have about the challenges bankers are facing. We seek to ensure 

that the OCC's examinations are fair, balanced, and timely, and that the OCC is fulfilling 

2 
88 


75069.025

its mission of ensuring the safety and soundness of national banks and federal thrifts by 

identifying problems at the earliest possible stage and holding institutions accountable for 

taking timely and effective corrective actions. While we understand and support the 

broader objectives of H.R. 3461, we believe provisions of the bill in its current form 

could impede our ability to deal with troubled institutions on a timely basis and would 

undermine Congress's clear direction that regulators 1 identify and promptly address 

unsafe and unsound practices at depository institutions. 

First, let me emphasize that the OCC fully supports providing bankers with a fair 

and independent process for appealing supervisory determinations. We think our current 

appeals process, run by our Ombudsman, does just that. H.R. 3461' s approach to 

accomplishing that objective would involve creating a new federal bureaucracy at the 

Federal Financial Institutions Examination Council (FFIEC) and risks disrupting 

appropriate and necessary supervisory activities by bank regulators. We believe there are 

better alternatives - without those downsides that would accomplish the objectives of 

H.R. 3461, and we would be happy to work with the Subcommittee to frame out an 

alternative approach. 

Second, we have significant concerns that the standards for nonaccrualloans in 

H.R. 3461 could result in revenue recognition that is inconsistent with generally accepted 

accounting principles (GAAP). The Federal Deposit Insurance Corporation Improvement 

Act of 1991 (FDICIA) established that banks must follow GAAP, or standards that are no 

1 Federal Deposit Insurance Corporation Improvement Act of 1991. Pub. L No. 102-242. §t1 12 j. 

131-32, amending the Federal Deposit Insurance Act, 12 USc. §§ 1831n. 18310, 183 L 

3 
89 


75069.026

less stringent than GAAP, in reporting their financial condition. Congress put this 

requirement in place in response to the savings and loan crisis, where non-GAAP 

regulatory accounting masked the deteriorating financial condition of institutions until it 

became so serious that a massive bailout was needed. 2 H.R. 346 I would slacken this 

important standard. 

The integrity of financial reporting and regulatory capital is vital to identifying 

and correcting weaknesses before they threaten a bank's ability to continue to meet the 

needs of its customers and the communities it serves. Those standards must not be 

compromised. As we have learned in the most recent crisis, it is also essential that 

supervisors have the ability to direct banks to hold capital commensurate with their risk 

profile. H.R. 3461 would, in certain instances, tie the hands of regulators when they have 

determined that an institution's risk profile warrants a larger capital buffer. 

Finally, we agree that completing and communicating our examination findings 

on a timely basis arc essential if we expect bankers to initiate appropriate corrective 

action to address problems or deficiencies identified by examiners. While clarifying 

expectations regarding examination timing and communication can be a positive step; as 

H.R. 3461 recognizes, however, there needs to be flexibility to accommodate situations 

where an exam may not be finished, or results not yet communicated, for good reasons, 

such as when an issue raises significant policy issues that need further deliberation before 

a conclusion is reached. 

2 A June 1991 Congressional Budget Office Staff Memorandum concluded that a policy of 

regulatory forbearance increased the eventual bill for resolving failed thrift institutions by about $66 

billion. See: CBO Staff Memorandum, "The Cost of Forbearance During the Thrift Crisis," June 1991. 

4 
90 


75069.027

Before elaborating further on each of these areas, I want to briefly report on the 

overall condition of national community banks and federal savings associations. While 

we have been through an extremely difficult economic cycle, I am pleased to report that 

conditions are beginning to stabilize for most community banks and thrifts. Through the 

third quarter of last year, noncurrent loan levels for most loan types have begun to 

stabilize or trend downward, and returns on assets and equity for many ofthese financial 

institutions have improved. However, their operating environment remains challenging. 

Lending activity, which is the primary revenue source for these institutions, continues to 

be hampered by the overall economic downturn and net interest margins continue to be 

strained. Given these challenges, some of these institutions will continue to face 

significant problems. In these cases, the goal of our supervisory actions is to restore the 

bank or thrift to health and, if that is not possible, to seek an orderly and least cost 

resolution. 

Despite the financial crisis and the deep recession, three quarters of the 

community banks and thrifts we supervise have satisfactory supervisory ratings, 

reflecting their sound management and strong financial condition. These institutions 

have successfully weathered the recent economic turmoil by focusing on strong 

underwriting practices, having timely and accurate recognition of problem loans, and 

maintaining strong capital buffers. These are basic tenets of sound banking practice. 

With this as background, let me discuss in greater detail my perspectives and 

concerns with the three major provisions ofH.R. 3461. 

5 
91 


75069.028

Fair and Independent Appeals Process 

My management team and I encourage community bankers who have concerns 

about a particular examination finding to raise those concerns with his or her examination 

team and with the district management team that oversees the bank. Nonetheless, we also 

recognize the need for bankers to have an independent channel to raise and discuss their 

concerns outside of the direct supervisory process. Because of this, the OCC established 

an Ombudsman's office before it was required by statute. This office provides a venue 

for bankers to discuss their concerns informally or to formally request an appeal of 

examination findings. 

H.R. 3461 would augment the agencies' existing Ombudsman offices with a 

separate and independent Office of Examination Ombudsman that would operate as a 

component of the FFIEC. 3 This office would be authorized to investigate complaints and 

receive appeals directly from bankers. It would also be charged with holding periodic 

meetings to obtain feedback from bankers on examination policies and practices and to 

conduct a regular program on examination quality assurance for all examination types 

conducted by the federal regulatory agencies. 4 

These provisions ofH.R. 3461 would create a new federal bureaucracy - a 

program office in the FFIEC that will need to be funded and staffed. It also could have 

3 The FFIEC is an interagency body with six voting members: a Governor of the Board of 

Governors of the Federal Reserve System, the Chairman of the Federal Deposit Insurance Corporation, the 

Chairman of the Board of the National Credit Union Administration, the Comptroller of the Currency, the 

Director of the Consumer Financial Protection Bureau, and the Chairman of the State Liaison Committee. 

The Council's activities are supported by interagency task forces and by an advisory State Liaison 

Committee, comprised of five representatives of state agencies that supervise financial institutions. 

4 Certain provisions, such as quality assurance reviews of examination practices, would not apply 

to the Consumer Financial Protection Bureau or state financial regulators. 

6 
92 


75069.029

the unintended consequencc of substantially prolonging and adding complexity and costs 

to the examination process. We believe there are better ways to achieve an effective and 

independent appeals process that would not involvc these downsides. The alternatives 

we envision would provide an independent and empowered appeals process within each 

agency. This maintains appropriate agcncy accountability for the actions it ultimately 

takes, and would avoid creating a process that could forestall needed corrective actions 

for up to six months or longer. 

In its 2011 policy position papers and in previous correspondence6 with the OCC, 

the American Bankers Association (ABA) noted that an effective ombudsman-run agency 

appeals process has several important characteristics: I) independence, functioning 

outside of the supervision area with a direct reporting line to the head of the agency; 2) 

the authority to suspend or overrule an exam finding, subject only to the final 

determination by the agency head, and authority to conduct an independent review of 

post-exam surveys; 3) expertise and sufficient staff that is seasoned and well-respected 

within the agency; and 4) established processes and time frames following the resolution 

of an appeal and again after the next examination to see if the bank perceives any 

examiner retribution, with reports of such reviews provided to the head of the agency and 

the head of supervision. The ABA also noted the value of having more informal means 

for a banker to appeal examination findings and to identify issues or practices where there 

5 A copy is available at: http://www.aba.com/lssues/lssuesExaminationReview.htm. 

6 Letter from Wayne A. Abernathy, Executive Vice President, Financial Institutions Policy and 

Regulatory Affairs, American Bankers Association, to John C. Dugan, Comptroller of the Currency 

(January 31, 2008). 

7 
93 


75069.030

appears to be a disconnect between the agency's stated supervisory policies and how 

those policies are being implemented in the field. 

We support the principles for an open and fair appeals process as outlined by the 

ABA. Indeed, these characteristics are consistent with the OCe's current approach, 

which works well. 

National banks and federal savings associations currently can file appeals with the 

deputy comptroller that oversees their local supervisory office or directly with OCe's 

Ombudsman's office. If a banker disagrees with the decision of an appeal filed through 

the supervisory channel, the banker may subsequently appeal the matter to the 

Ombudsman. 

The OCe's Ombudsman is fully independent of the supervisory process, and 

reports directly to the Comptroller, not to a supervisory committee or other group that 

must ratify his decision. In this regard, the OCe's Ombudsman has direct decisionmaking authority and is empowered to obtain directly whatever information he believes is 

needed to make a decision. The scope of the Ombudsman's authority includes 

examination ratings and findings, including items identified in an examination report as a 

matter requiring attention, the adequacy of loan loss reserves, and appropriateness of loan 

classifieations. With the consent of the Comptroller, the Ombudsman may stay any 

appealable agency decision or action during the resolution of an appealable matter. The 

Ombudsman also reports weaknesses in OCC policy to the Comptroller, and makes 

recommendations regarding changes in OCC supervisory policy. The OCe's 

Ombudsman is a seasoned national bank examiner with over 20 years of experience and 

is supported by a dedicated staff of other seasoned bank supervision professionals. 

8 
94 


75069.031

To provide transparency to the appellate process, the Ombudsman's office 

provides a summary on the OCC's public Web site of every formal appeal it receives and 

its disposition. 

We encourage national banks and federal thrifts to contact the Ombudsman to 

discuss any agency policy, decision, or action that might develop into an appealable 

matter. The Ombudsman's objective in thcse cases is to seek a resolution to the dispute 

before it develops into a formal appeal. This avenue provides an opportunity for a 

financial institution to resolve issues in the most efficient and expeditious manner 

possible. 

OCC examiners respect the role thc Ombudsman's office plays in the OCC's 

supervisory process and are familiar with the process for filing and reviewing an appeal 

of examination findings. They are trained to share that information with bankers when 

circumstances warrant. The Comptroller and I have made it clear that we will not tolerate 

actions or statements by an examiner that may suggest that a banker would be subject to 

any type of retaliation or retribution should he or she raise concerns about their 

institution's examination. As an additional safeguard, the OCC's Ombudsman's office 

contacts each appellant bank approximately six months after a decision is rendered to ask 

whether the bank believes OCC examiners have taken retaliatory action against the bank. 

In general, this process is completed within 30 days. If the Ombudsman finds evidence 

that retaliation has occurred, he will refer the complaint for appropriate follow-up. 

In addition to administering the OCC's formal appeals process, the Ombudsman's 

office also assists the agency by administering an optional, confidential questionnaire that 

bankers can fill out at the end of each of our examinations. This questionnaire helps us to 

9 
95 


75069.032

collect candid feedback on the strengths and weaknesses of our examination processes. 

Bankers send their responses to the Ombudsman's office to ensure their confidentiality. 

Depending on the response, the Ombudsman's office may contact the banker to discuss 

his or her concern or to gather more information. The Ombudsman's office analyzes and 

shares aggregate responses internally on a semi-annual basis. This feedback is valuable 

in identifying areas where we may need to make improvements or determine whether 

there may be "mixed messages" between headquarters and the field. 

We welcome the opportunity to share these experiences with the Subcommittee in 

exploring alternatives to H.R. 3461's approach to an independent appeals process. 

Standards for Nonaccrual, Loan Classifications, and Capital Determinations 

Assessments of a bank's credit quality as reflected in its nonaccrual and loan 

classification policies and decisions, and the bank's ability to weather unexpected losses 

through its capital planning and capital buffers are core elements in ensuring the safety 

and soundness of financial institutions. H.R. 3461 attempts to provide more clarity and 

consistency in the regulators' application of non accrual, appraisal, classification, and 

capital standards by, among other provisions, setting forth limitations on when a loan 

could be placed on nonaccrual status and when a restructured loan would have to be 

removed from that status. In these cases, it also would prohibit the agencies from 

directing a bank that meets the Prompt Corrective Action (PCA) definition of "well 

capitalized" to raise additional capital- regardless of the institution's risk profile. 

10 
96 


75069.033

As I have previously testified, 7 the OCC is committed to providing clear and 

consistent standards for loan classification and nonaccrual status, and I appreciate the 

constructive dialogue that I and others at the OCC have had with members of the 

Subcommittee and their staff on these important issues. Nonetheless, we are concerned 

that the standards set forth in H.R. 3461 could have several harmful consequences. 

First, I would like to provide some clarity regarding the agencies' loan 

classification and nonaccrual policies. As stated in the agencies' October 2009 policy 

statement on prudent commercial real estate (CRE) loan workouts, loans that are 

adequately protected by the current sound worth of the borrower or underlying collateral 

generally are not adversely classified,8 i.e., not graded "substandard," "doubtful," or 

"loss.,,9 The policy statement also acknowledges that examiners should not adversely 

classifY performing commercial loans solely because of a decline in value of the 

underlying collateral as long as there is not a well-defined weakness that jeopardizes 

repayment. If a loan is classified, bankers and examiners need to consider whether the 

bank should continue to accrue income on the loan. The determination as to whether a 

loan should be placed in nonaccrual status is primarily based on an assessment of the 

collectibility of both principal and interest. Colleetibility is the primary basis for these 

7 See: Testimony of Jennifer Kelly before the Subcommittee on Financial Institutions and 

Consumer Credit, Committee on Financial Services, July 8, 20 II. 

8 See: Policy Statement on Prudent Commercial Loan Workouts. available at: 

http://www.oce, gov/news-issuances/bulletins/2009/bulletin-2009-128a,pdf, page 7, 

9 The criteria for these classifications can be found in Appendix 4 of the 2009 CRE policy 

statement, page 33, 

11 
97 


75069.034

nonaccrual policies, because GAAP prohibits the recognition of income if collectibility is 

not reasonably assured. 10 

Dctermining whether a loan payment, either principal or interest, is collectible 

requires judgment on the part of the banker. We are concerned that attempts to impose 

bright line statutory standards fail to recognize this. 

We agree that both collateral value and delinquency status, among other factors, 

should be considered when assessing whether a loan and interest income are collectible. 

However, neither of these considerations in and of themselves are sufficient to 

appropriately assess collectibility. These decisions require an understanding of the loan's 

term and structure and the borrower's historical and future ability to repay both principal 

and interest - factors that require considerable judgment based on each loan and 

borrower's specific facts and circumstances. Removing this judgment from the 

examination process, the OCC believes, could constrain an examiner's ability to ensure 

that bankers are preparing financial statements that accurately reflect the condition of 

their loan portfolio and conform to GAAP. Tying the hands of cxaminers on these core 

supervisory judgments, in our view, undermines an essential element of the supervisory 

process. 

As the agencies noted in the 2009 CRE guidance, as the primary sources ofloan 

repayment decline, the importance of the collateral's value as a secondary repayment 

source increases. We are concerned that H.R. 3461 oversimplifies this important 

10 In accordance with GAAP, the recognition of income involves consideration of two factors: (I) 

being realized or realizable, and (2) being earned. The first consideration is generally more difficult for 

financial institutions because it requires an assessment of collectibility. If collection is not reasonably 

assured, recognition of income, including interest income, is not appropriate. 

12 
98 


75069.035

distinction. H.R. 3461 's treatment of commercial loans where there has been a decline in 

collateral values highlights this problem. For example, the bill adds to the FFIEC Act of 

1978 (the FFIEC Act) a new section 1013(a)(l) which directs that a commercial loan 

shall not be placed in nonaccrual status solely because the collateral for such a loan has 

deteriorated in value. This is problematic because for many CRE loans the collectibility 

of the loan is inextricably linked to the value of the collateral, as the sale of the collateral 

is the primary or sole source of the loan's repayment. In these cases, understanding the 

current value of the collateral is critical to asscssing the collcctibility of both principal 

and interest. Continuing to recognize interest income on such loans despite evidence that 

the income will never be collected in cash is inconsistent with GAAP. 

H.R. 3461's treatment of when a loan could be removed from nonaccrual status 

presents similar concerns and potential inconsistencies with GAAP as it focuses solely on 

a borrower's current performance. As previously noted, while a borrower's current 

performance is certainly a key variable in making an assessment of collectibility, a 

banker must also consider the borrower's continued capacity to meet the loan's terms in 

the future. For example, it is common for many construction loans to be structured with 

an "interest reserve" for the construction phase of the project, with the lender recognizing 

interest income from the rescrvc. Proceeds from the sale of lots, homes, buildings or 

permanent financing based on stabilized occupancy are used for the repayment of 

principal, which includes any draws from the interest reserve that have been capitalized 

into the loan balance. However, if the development of the project stalls and bank 

management fails to evaluate the eollectibility ofthe loan, interest income will continue 

to be recognized from the initial interest reserve and capitalized into the loan balance 

13 
99 


75069.036

even though the project is not generating sufficient cash t10ws to repay the principal. In 

such cases, the loan will be contractually current but collection of principal and interest 

may not be reasonably assured. 

In both instances, the bill would require a divergence from GAAP that could 

result in the overstatement of income and therefore, regulatory capital. As noted before, 

similar consequences of regulatory accounting practices were prevalent in the savings 

and loan crisis that led Congress to pass FDICIA. 

Section tOl3(b) of the FFIEC Act added by H.R. 3461 would prohibit the 

regulatory agencies from requiring a financial institution that is "well capitalized" to raise 

additional capital in lieu of an action prohibited under Section 1013(a). A lesson learned 

from the recent crisis is that the PCA definition of "well capitalized" does not provide a 

sufficient capital buffer to maintain a bank's viability in the face of higher levels of risk. 

This is especially true for community banks that may have a concentration of exposures 

to certain types of borrowers or industries and geographic areas. We also know that 

raising capital becomes more difficult as a bank's condition deteriorates and that 

declining capital ratios often are a lagging indicator of increasing risk in the bank's 

assets. That is why we direct banks with significant concentrations, or deteriorating asset 

quality that may pose a risk to their capital, to increase capital before their capital levels 

breach regulatory minimums at a stagc when they are able to take action to ensure that 

they can continue to lend to sound borrowers. Such determinations, however, are not 

made arbitrarily or unilaterally by an individual examiner. Directives to increase capital 

require multiple layers of management review and concurrence at the OCe. 

14 
100 


75069.037

Restricting the ability of bank regulators to direct institutions with higher risk 

profiles to hold higher levels of capital undermines a key provision of PCA and is 

contrary to the recommendation of the Government Accountability Office that the 

agencies consider additional measures - including higher capital thresholds - to require 

early and forceful regulatory action to address unsafe banking practices. II 

Section lO13(c) of the FFIEC Act added by H.R. 3461 would also require the 

agencies to develop and apply identical definitions and reporting requirements for 

nonaccrualloans. In this regard, I would simply note that the agencies already have 

uniform loan classification standards. Likewise, the agencies' Call Report Instructions 

set forth common definitions and standards for detennining when a loan should be 

reported as nonaccrual for financial reporting purposes. 

Timely Examination Communications 

n.R. 3461 would establish statutorily mandated time frames for conducting exit 

interviews and issuing reports of examinations. Exit interviews and thus completion of 

the examination - would generally be required within nine months after the start of the 

examination, and a final examination report issued no later than 60 days after the later of 

the exit interview or the provision of additional information by the bank. While the OCC 

shares the goal of ensuring timely and efficient exanlinations, we are concerned that 

hardwired statutory deadlines could have unintended consequences. We arc particularly 

concerned that such mandates could undermine our objectives of ensuring that all 

II See: GAO, Bank Regulation: Modified Prompt Corrective Action Framework Would Improve 

Effectiveness, GAO 11-612 (Washington D.C.: June 2011). 

15 
101 


75069.038

relevant infornlation about a bank's condition is considered before we reach and issue 

final conclusions. Similarly, when an examination raises complex policy or legal issues, 

it is critical that our policy and legal staff have sufficient opportunity to review and 

provide direction. Such deliberations may often involve consultations with our 

regulatory colleagues to help ensure consistency in our supervision. 

H.R. 3461 would allow an exception to these provisions by providing written 

notice to the bank and the proposed FFIEC's Office of Examination Ombudsman. The 

involvement of the proposed external Ombudsman in this facet of bank supervision 

simply accentuates the concerns we have expressed about the creation of a new 

bureaucracy and unduly complicating and dclaying necessary examination activities. 

Indeed, engaging an Ombudsman's office at this stage could taint an Ombudsman's 

independence should a bank want to file a formal appeal once a final report is issued. 

It may be helpful to briefly describe the OCC's processes to ensure open and 

frequent communication with the banks we supervise, before, during, and after our onsite examinations. Our goal in maintaining ongoing communication is to avoid surprises 

or misunderstandings about the OCC's assessment of: or expectations for, a bank and to 

keep bank management fully informed of our supervisory activities. Our examiners meet 

with bank management at the start of each examination to discuss the purpose and scope 

of the examination and to answer any questions that bank management may have. 

Throughout the examination, examiners hold periodic meetings with bank management 

to discuss and seek clarification about potential issues. Such communication helps to 

prevent misunderstandings and allows bank management to provide additional 

information on substantive issues. 

16 
102 


75069.039

Examiners review their preliminary examination conclusions and potential 

matters that require attention with bank management before leaving the bank. If there are 

open issues, examiners will generally provide bank management with an opportunity to 

provide additional information before the formal examination report is completed and 

issued. While examiners will typically establish a deadline for providing the additional 

infonnation to allow timely finalization of conclusions, we do not have arbitrary time 

frames for management responses, and we will generally work with bank management 

teams that have shown a commitment to being responsive. We will not however, allow 

bank management to unnecessarily delay finalization of our conclusions in order to 

forestall necessary corrective actions. 

Once an examination is completed, and any additional information from bank 

management has been received and considered, we strive to complete and issue our 

formal Report of Examination as quickly as possible. Examination conclusions for 

problem banks receive additional levels of review. While this additional level of review 

may lengthen the time required to issue the report, we believe it is an important safeguard 

to ensure consistency and balance in our examination decisions. In these cases, our local 

offices keep bank management informed of the status of the review process. If material 

changes are made as a result of this review, we will meet with bank management to 

discuss those changes before the final report is issued and to give bank management an 

additional opportunity to present their perspective on the findings and to address any 

factual errors we may have made. When the Report of Examination has been finalized 

and issued to the bank, the Examiner-in-Charge and an OCC manager with direct 

responsibility for the supervision of the institution will meet with the board to review the 

17 
103 


75069.040

findings, answer questions, and discuss any required corrective actions, including the 

OCe's plans for supervisory follow-up on thosc issues prior to the next examination. 

Conclusion 

In conclusion, let me reiterate the OCe's strong commitment to fair, timely, and 

balanced supervision, and our willingness to work with the Subcommittee to explore 

alternative approaches that would achieve goals we share, without raising the types of 

concerns we have identified. 

18 
104 


75069.041

Testimony of 

Jeanne Kucey 

President and CEO of JetStream FCU 

On behalf of 

The National Association of Federal Credit Unions 

Before the 

House Financial Services Committee 

Subcommittee on Financial Institutions and Consumer Credit 

United States House of Representatives 

February 1,2012 
105 


75069.042

Introduction 

Good afternoon, Chairman Capito, Ranking Member Maloney, and Members of the 

Subcommittee, My name is Jeanne Kucey, and I am testifying today on behalf of the National 

Association of Federal Credit Unions (NAFCU). Thank you for holding this important hearing. 

We appreciate the opportunity to share our views on H.R. 3461, the Financial Institutions 

Examination Fairness and Reform Act. 

I am the President and CEO of JetStream Federal Credit Union, headquartered in Miami Lakes, 

Florida. Jetstream has $126 million in assets and serves more than 16,000 members in our seven 

locations, including one in Puerto Rico. I also serve on the Board of Directors ofNAFCU. 

Prior to joining JetStream, I was President and CEO of Retail Employees Credit Union in 

Atlanta, Georgia. I have more than 20 years of executive level experience including serving as 

both Vice President of Operations at Atlanta City Employees Credit Union and Vice President at 

San Diego County Credit Union. 

NAFCU is the only national organization that exclusively represents the interests of the nation's 

federally chartered credit unions. NAFCU is comprised of over 800 member-owned and 

operated credit unions. NAFCU member credit unions collectively account for approximately 62 

percent of the assets of all federally chartered credit unions. 
106 


75069.043

Background on Credit Unions 

Historically, credit unions have served a unique function in the delivery of necessary financial 

services to Americans. Established by an Act of Congress in 1934, the federal credit union 

system was created-and has been widely recognized-as a way to promote thrift and to make 

financial services available to all Americans who would otherwise have limited access to 

financial services. Congress established credit unions as an alternative to banks and to fill a 

precise public need-a niche that credit unions fill today for nearly 94 million Americans. 

Every credit union is a cooperative institution organized "for the purpose of promoting thrift 

among its members and creating a source of credit for provident or productive purposes." (12 

U.S.c. §1752(l)). While more than 75 years have passed sinee the Federal Credit Union Act 

(FCUA) was signed into law, two fundamental principles regarding the operation of credit 

unions remain every bit as important today as in 1934: 

• Credit unions remain singularly committed to providing their members with efficient, 

low cost, personal service; and 

• Credit unions continue to emphasize traditional cooperative values such as democracy 

and volunteerism. 

The nation's approximately 7,200 federally insured credit unions serve a different purpose and 

have a fundamentally different structure than banks. Credit unions exist solely for the purpose of 

providing financial services to their members-while banks strive to make a profit for their 

shareholders. As owners of cooperative financial institutions united by a common bond, all 

credit union members have an equal say in the operation of their credit union-"one member, 
107 


75069.044

one vote"-regardJess of the dollar amount they have on account. These singular rights extend 

all the way from making basic operating decisions to electing the board of directors. Federal 

credit union directors also generally serve without remuneration-a fact epitomizing the true 

"volunteer spirit" permeating the credit union community. 

Today, credit unions continue to playa very important role in the lives of millions of Americans 

from all walks of life. As consolidation among financial depository institutions has progressed 

with the resulting de-personalization in the delivery of financial services by some large banks, 

the emphasis in consumers' minds has begun to shift not only to services provided but also-and 

in many cases more importantly-to quality and cost. While many large banks have increased 

their fees and curtailed customer service as of late, credit unions continue to provide their 

members with high quality personal service at the lowest possible cost. This is evidenced, most 

recently, as thousands of Americans turned to local credit unions after several large national 

banks proposed new fee increases. 

Current Examination Process 

Credit unions were not the cause of the financial crisis, yet often feel the effect of punitive 

measures designed to reel in the practices of bad actors and other financial institutions. 

Part of the response to the economic crisis was to create new layers of regulations and institute 

more aggressive enforcement of existing law. In order to aggressively enforce new and old 

regulations and to avoid a repeat of the crisis, regulators have increasingly tightened 

examinations standards. For example, since the start of the crisis, examination cycles for credit 

3 
108 


75069.045

unions have gone from 18 months to 12 months. Having examiners visit an institution adds its 

own burden to the institution, as they must dedicate staff time and resources to prepare and 

respond to the examination. 

NAFCU supports effective exams that are focused on safety and soundness and flow out of clear 

regulatory directives. However, the examination process, by its very nature, can be inconsistent. 

Regulatory agencies in Washington try to interpret the will of Congress, examiners in the field 

try to interpret the will of their agency, and financial institutions often become caught in the 

middle as they try to interpret all three as they run their institution. Unfortunately, the messages 

are not always consistent. NAFCU members have long had issues with the examination process, 

as have other regulated entities. NAFCU supports efforts to help reduce the regulatory burden 

on credit unions. This is one of the reasons that NAFCU urges the committee to consider 

improvements to the examination process. 

Many credit unions, including mine, have positive professional relationships with their 

examiners. We believe that this working relationship is important in having a successful 

examination process focused on safety and soundness. 

Unfortunately, not all institutions have this positive relationship with their examiner. It is with 

this in mind that we believe that consistency, the handling of guidance versus regulation, the 

management of examiner expectation and managing the exam relationship are all areas where 

improvement in the examination process could occur. 

4 
109 


75069.046

Areas where Congress can help improve the examination process through H.R. 3461 and beyond 

include: 

Congressional Intent 

IdentifYing and adhering to Congressional intent is key to the proper promulgation and 

implementation of regulations. Congress must make its intent clear to regulators. One result of 

the rhetoric and regulations stemming from the Dodd-Frank Wall Street Reform and Consumer 

Protection Act has been a message to regulators to conduct draconian supervision and apply rigid 

parameters in examinations. As a result, credit unions find themselves using precious resources 

trying to navigate a new and unfamiliar exam process while simultaneously trying to guide their 

member-owners through the worst financial crisis since the Great Depression. 

While we agree that the unregulated bad actors that caused the crisis are in desperate need of 

regulations to curtail their risky and abusive practices, credit unions certainly do not fall in that 

category. Unfortunately, credit unions now face many of the same costly and burdensome 

regulations as the bad actors, in addition to a restrictive examination environment. 

Transparency 

Ensuring transparency in government is a laudable goal embraced by many members of the 

Committee and the Administration. Transparency is critically important at our nation's 

regulatory agencies. The standards of a regulatory regime must be articulated with a level of 

clarity and definition that provides for as little ambiguity as possible. We believe there are two 

ways to go about this. 
110 


75069.047

First, regulations and any subsequent guidance must include clear tangible criteria which crcdit 

union executives can follow. Furthermore, credit unions should have access to all materials and 

guidance that examiners use or reference during examinations. Since credit unions do not have 

all the guidelines used by examiners, it is understandably difficult to comply to the extent that 

the credit union or the NCUA may prefer. 

Second, credit unions should always receive constructive feedback in regard to issues an 

examiner may identify. Some credit unions have reported receiving unclear or inadequate 

responses. In other instances they have received information that is inconsistent with published 

examination guidelines. Improving this process should help both the examiner and the 

institution. 

lJltimately, more transparency in the regulatory process will lead to more consistency and 

promote safety and soundness throughout the system. 

Consistency 

Maintaining a consistent supervisory and examination environment is vital to ensuring 

compliance with both safety and soundness as well as consumer protection regulations. 

Notwithstanding changes in regulation, the standards by which a credit union is evaluated during 

examinations should not change from examination to examination. Unfortunately, this is not 

always the case and credit unions are too often left guessing which particular business area will 

6 
111 


75069.048

receive the most emphasis by an examiner. For example, while one examiner may find mortgage 

lending to carry the most importance, another may plaee emphasis on business lending. 

Additionally, regulators should ensure that their regulations are consistently applied from one 

examiner to another. Inconsistent application of laws and regulations among examiners 

increases uncertainty. This increased uncertainty adds another unnecessary layer of difficulty for 

credit unions to maintain the highest levels of compliance. 

More importantly, it is also unclear how an examiner will evaluate compliance. In addition to 

actual regulations, the NCUA also routinely provides "guidance" in anyone of a number of 

different forms. Some examiners treat the guidance as just that; a tool to be used for credit 

unions to comply with regulations or implement best practices. Some examiners, however, 

treat the "guidance" as if it were part of the regulation itself, and consider failure to comply with 

the guidance as something roughly equal to failing to comply with the regulation. Examiners' 

misuse of and misplaced reliance on guidance documents is an increasing concern for credit 

unions. More should be done to ensure that all examiners treat both regulations and guidance 

consistently and for the purpose each was issued. Asking credit unions to comply with 

fluctuating standards, based on each individual examiner's reliance on informal guidance, 

ultimately increases compliance costs without any clear benefit. 

Examination Report Appeal Process 

NAFCU understands that some of our concerns cannot be addressed by regulators. Generally, 

NCUA and its examiners do a satisfactory job, but every inconsistency that forces credit unions 

7 
112 


75069.049

to divert more resources to compliance reduces their ability to better serve their members. This 

ultimately translates to lower interest rates on savings, higher interest rates on loans, and in some 

cases, the inability to extend credit to a member that would receive credit otherwise. 

It is with this delicate balance in mind that NAFCU urges reforms to the current appeal process. 

The appeal process should provide an opportunity to identify inconsistencies and serve as a 

quality assurance check. The existing appeal process does not promote either. It is worth noting 

that NCUA should not be blamed for the shortcomings of the appeal process. The true issue is 

the structure 0 f the process. 

NCUA currently serves as the prosecutor, judge, and jury. Under the existing process, if an 

examiner makes a determination to take action against the credit union, the credit union must 

first address the issues with the examiner. The second step is to contact the supervisory 

examiner, who evaluates the facts and reviews the analysis. If the issue is still not resolved, the 

credit union may send a letter to the regional director. 

After the previous steps have been taken, if the appeal concerns a material supervisory 

determination, the credit union may appeal to the NCUA Supervisory Review Committee. 

Material supervisory determinations are limited to: (1) composite CAMEL ratings of 3, 4, and 5 

and all component ratings of those composite ratings; (2) adequacy of loan loss reserve 

provisions; (3) loan classifications on loans that are significant as determined by the appealing 

credit union; and (4) revocations of Regulatory Flexibility Program (RegFlex) authority. The 

8 
113 


75069.050

NCUA Supervisory Review Committee consists of three regular members of the NCUA's senior 

staff appointed by the NCUA Chairman. 

The appeal process has a number of inherit flaws, not the least of which is the exclusion (in most 

instances) of a review by an independent third party at any level of the process. Under these 

circumstances it is almost impossible to avoid conflicts of interest and approach each situation 

objectively. A number of issues result from this lack of independent review. 

Any regulatory agency would be hesitant to support an appeal of an internal decision. 

Undoubtedly, and understandably, agency officials have more faith in their examiners than the 

regulated entity. Overturning the decision of a field examiner could be extremely difficult for a 

supervisory examiner or regional director, especially in the absence of clear cut evidence that an 

examiner has acted in conflict with agency guidance. Approving an appeal may reflect poorly on 

the examiner and possibly the supervisory examiner or regional director. For example, NCUA's 

Supervisory Review Committee, which is comprised of senior staff of the agency, could 

unintentionally be influenced by the impact that overruling an examiner could have on the 

agency. It is elearly evident that at some point in the appeal process, the appeal needs to be 

heard by someone without any interest in the outcome. 

Consumer Financial Protection Bureau 

H.R. 3461 will help foster a stronger relationship between the CFPB and the financial services 

industry by encouraging a transparent and consistent examination process. Certainly, the 

legislation will have a similar impact on all financial regulators, but the impact with regard to the 

9 
114 


75069.051

CFPB is magnified because it is a new agency with little to no precedent on which to rely. As 

institutions are examined and interact with the CFPB, providing clear guidance as to the basis for 

material supervisory determinations will help institutions comply with this new regulatory 

landscape. 

H.R. 3461, the Financial Institutions Examination Fairness and Reform Act 

Several provisions in the Financial Institutions Examination Fairness and Reform Act will 

address concerns with the cxamination process. We support this bill as it will improve 

transparency and consistency in a meaningful manner. A provision in Section 2 of the legislation 

would require examiners to disclose all examination and other factual information relied upon in 

support of a material supervisory determination. This would help ensure that regulatory 

guidance is being applied consistently. NAFCU strongly supports this provision; however, it can 

be improved by removing the requirement that financial institutions request this information. 

This information should always be provided to financial institutions upon completion of the 

examination process. 

The establishment of the Office of Examination Ombudsman in the Federal Financial Institutions 

Examination Council will promote consistency and eliminate the current conflict of interest 

inherent in the process. Currently, for some issues, such as certain cease and desist proceedings, 

there is a formal independent appeal process available to credit unions. However, an expanded 

right to appeal all actions to an administrative law judge will ensure that appeals receive an 

independent review. 

10 
115 


75069.052

Disclosure of the information used in support of a material supervisory determination combined 

with an independent review of appeals will assist in exposing any disconnect between the 

guidance given by agency leadership in Washington and field examiners. 

Finally, as the committee considers this legislation, we ask that you ensure the costs associated 

with these improvements are not simply passed on to credit unions and other financial 

institutions. There are many ways to enhance the efficiency of the examination process to help 

offset any potential cost increases that may arise as a result of these much needed reforms. In 

some instances the establishment of a new office or increased disclosure can provide a reason for 

increascd assessments on financial institutions or requests for additional taxpayer funds that may 

not be necessary. With the fiscal situation facing our country, we must ensure every segment of 

government is maximizing all available resourccs. 

Conclusion 

In conclusion, I would note that NAFCU supports effective, demonstratively necessary 

regulation. We believe that credit unions should have a respectful non-adversarial professional 

relationship with examiners. We do not support new regulatory burdens that detract from credit 

unions serving their members without providing a clear tangible benefit. 

NAFCU believes the legislation under consideration is a positive first step in improving the 

examination process and we support it. Introducing an independent third party to the appeal 

process will ensure that consistent standards are applied and will help bring more certainty to the 

examination process. 

11 
116 


75069.053

Thank you again, Chainnan Capito, Ranking Member Maloney, and Members of the 

Subcommittee for the invitation to testifY before you today. We appreciate the opportunity to 

share our views on H.R. 3461, the Financial Institutions Examination Fairness and Reform Act. 

12 
117 


75069.054

STATEMENT OF 

EUGENE A. LUDWIG 

FOUNDER AND CHIEF EXECUTIVE OFFICER, 

PROMONTORY FINANCIAL GROUP, LLC 

BEFORE THE 

UNITED STATES HOUSE OF REPRESENTATIVES 

COMMITTEE ON FINANCIAL SERVICES 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND 

CONSUMER CREDIT 

FEBRUARY 1, 2012 
118 


75069.055

STATEMENT OF 

EUGENE A. LUDWIG 

FOUNDER AND CHIEF EXECUTIVE OFFICER, 

PROMONTORY FINANCIAL GROUP, LLC 

BEFORE THE 

UNITED STATES HOUSE OF REPRESENTATIVES COMMITTEE ON FINANCIAL SERVICES 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER CREDIT 

FEBRUARY 1, 2012 

Madam Chairman, Ranking Member Maloney, members of the Subcommittee, thank you for 

inviting me to comment on this significant piece of legislation, which addresses important 

issues of balance and fairness in the supervisory process. I would like to commend you, 

Madam Chairman, Ranking Member Maloney and the other members of this Subcommittee, 

for your concern for this topic, and in particular for your giving serious consideration to the 

expanded use of ombudsman programs as part of the federal financial regulatory and 

supervisory system. I will focus my remarks today on the ombudsman issue. 

America is blessed with an uncommonly capable group of financial supervisors, examiners 

and regulators at our Federal agencies. As Comptroller of the Currency, a member of the 

Board of the FDIC, and Chairman of the FFIEC, I spent five years surrounded by members of 

this group and had daily occasion to be impressed with their dedication, energy, and 

commitment to the tasks before them. Their efforts, and the efforts of their peers at other 

agencies, remain essential to the health of the U.S. financial system and the well-being of 

the American people. 

Nonetheless, every human system has its flaws; people make mistakes or differ in their 

judgments, and regulators are no exception. At regulatory agencies, identifYing and 

rectifYing mistakes is of course important to the particular institutions and individuals 

affected. However, it also has an important effect on the financial system as a whole, 

increasing public confidence in the fairness and balance of our regulatory mechanisms. 

With this in mind, in 1993, while leading the OCC, I created the first formal ombudsman 

program at any financial regulatory agency. The program was intended to improve 

communications between supervisors and supervisees, and to give banks an opportunity to 

present concerns about their examination findings and other supervisory matters. We 

appointed an especially capable, fair-minded person to head the office; gave him the 

discretion to supersede any agency resolution or action on an appealable matter; and most 

importantly, worked hard to eliminate any prejudice towards those who brought concerns 

to him. Four years later, when I appeared before this Subcommittee, that Ombudsman and 

2 
119 


75069.056

his staff had resolved 110 formal appeals from national banks and facilitated resolutions in 

359 additional cases. In the time since, such agencies as the Federal Reserve, FDIC, FHFA, 

and NCUA have followed the OCC's example. 

Ombudsman programs recognize the strength of the supervisory relationship-a strength 

that, in some ways, is even greater than the bonds of marriage. There are no divorces in 

banking. Without a polite, professional relationship marked by mutual respect, 

communication can deteriorate in a way that benefits no one. When an issue does arise, 

such a negative dynamic increases the time and expense of reaching a resolution, as well as 

the risk of an adverse event in the meantime. By keeping the lines of communication open, 

and by offering each party a better understanding of the other's concerns, financial agency 

ombudsmen make supervisory efforts all the more effective. 

Ombudsman programs do not encourage laxity, nor should they. I am a very big believer in 

the sound regulation and supervision of our financial system. We need tough but clear and 

fair financial rules not just to protect consumers, but also to ensure the quality of our banks 

and the health of our economic system. 

However, a strong ombudsman system helps to maintain consistent, high standards of 

conduct, a challenge that is more important now than ever. Regulatory agencies have long 

had tremendous discretion and power over the supervision of financial institutions, but 

their remit has grown steeply over the last several decades. Recent reforms, induding 

elements of the Dodd-Frank Act, have provided regulators with new tools that can make 

our financial system more trusted, resilient, and innovative. But the dramatic increase in 

quantity and complexity of financial regulations could increase both the likelihood and the 

cost of regulatory error. The supervisory process sometimes leads to actions that involve 

re-grading loans, changing business practices, and even submitting to formal court orders. 

We are in the midst of great change, and it is not surprising that Congress would want to 

revisit ways to ensure supervisors are making the right call. 

What H.R. 3461 proposes-what could be described as a "super-Ombudsman"-is a new 

authority to review a broad array of supervisory activities at all the banking agencies. The 

notion of an interagency Ombudsman is thoughtful and has considerable merit, worthy of 

the very serious consideration that you are wisely giving it. 

I would suggest a few modifications to the concept you have proposed, to capture the 

advantages while avoiding excess bureaucracy and cost. Since the federal regulatory 

agencies already have Ombudsman programs with talented and experienced people 

involved, I would suggest that the new "super-Ombudsman" playa coordinating role 

among the Ombudsmen at the regulatory agencies and act as a "safety valve" or appeals 

mechanism. In such an arrangement, the super-Ombudsman would (i) work to ensure 

consistency and high quality of agency Ombudsman efforts, and (ij) hear cases that an 

agency Ombudsman refuses to hear or where an appeal is lodged. 

Another way to achieve this same goal, and one that might involve less new governmental 

expense, would be the creation of a new, permanent Ombudsman Task Force at the FFIEC. 

3 
120 


75069.057

The task force would be made up of all the financial agency Ombudsmen, and its work, 

along with the work of the individual Ombudsmen, would be reportable to the Council and 

to Congress. The Council could help achieve the same goals of uniformity, quality control, 

and right of appeal as I suggest for the super-Ombudsman. 

I would also suggest, Madam Chairman, that whether it be a "super-Ombudsman" or an 

"Ombudsman Task Force," the new mechanism-and indeed the existing agency 

Ombudsman-should also have the responsibility of reviewing regulations, to try to 

achieve the most effective application of legislative mandates in the least burdensome 

fashion. This effort is important and must be continual. Times change, and rules that were 

once effective fall out of date or prove inefficient, and need adjustment. Involving the 

super-Ombudsman or the Ombudsman Task Force in this effort could inject a strong dose 

of regulatory harmonizing into the process. 

Regulations grow like barnacles on a ship: New circumstances and new lessons learned 

give rise to new rules. Once those rules are established, they are rarely removed. A 

conscious and concerted effort to scrape away the excess can make the system safer and 

more efficient. Where agencies and supervisees have to comply with out-of-date or 

ineffective regulations or guidance, they have less time to focus on what matters most: the 

safety and soundness of the system. Too many barnacles on the hull of a ship can sink it. 

And too many rules, particularly where they do not efficiently fulfill a needed function, can 

hurt the financial system. 

Accordingly, I very much favor the advancement of the Ombudsman concept that this 

legislation embodies. I urge this Subcommittee and Congress generally to think broadly 

along the lines of what this bill and its authors are proposing. Both Congressional leaders 

and the President have listed regulatory reform among their priorities, and a broader use 

of regulatory Ombudsmen is an effective way to achieve it, fostering a stronger financial 

system and a healthier American economy. 

Thank you again for the opportunity to address the subcommittee on this subject; I look 

forward to answering your questions and hearing your comments. 

4 
121 


75069.058

STATEMENT OF 

DAVID M. MARQUIS 

Embargoed Until Delivery 

2:00 p.m. EST 

February 1,2012 

EXECUTIVE DIRECTOR 

NATIONAL CREDIT UNION ADMINISTRATION 

BEFORE THE 

HOUSE FINANCIAL SERVICES SUBCOMMITTEE ON 

FINANCIAL INSTITUTIONS AND CONSUMER CREDIT 

HEARING ON H.R. 3461, THE FINANICAL INSTITUTIONS 

EXAMINATION FAIRNESS AND REFORM ACT 

WEDNESDAY, FEBRUARY 1, 2012 
122 


75069.059

I. Introduction 

Chairman Capito, Ranking Member Maloney, and Members of the Subcommittee, the 

National Credit Union Administration (NCUA) appreciates the invitation to offer our 

views on H.R. 3461, the Financial Institutions Examination Fairness and Reform Act. 

Introduced by Chairman Capito and Ranking Member Maloney, H.R. 3461 seeks to 

improve the examination process for depository institutions by, among other things, 

making available to financial institutions the information used to make examination 

decisions and codifying certain examination policy guidance. The bill also would create 

an ombudsman at the Federal Financial Institution Examination Council (FFIEC) to 

which financial institutions could raise concerns with respect to their examinations. 

Additionally, H.R. 3461 would establish an appeals process before independent 

administrative law judges overseen by the FFIEC ombudsman. 

In the invitation to testify, the Subcommittee has asked NCUA to comment on the need 

for reforming the examination appeals process. The invitation also requests NCUA's 

views on whether H.R. 3461 appropriately and effectively reforms the examination 

appeals process. Finally, the Subcommittee has inquired about the need to amend the 

legislation to better achieve the bill's objectives. 

In difficult economic times, depository institutions will encounter additional stresses. As 

a result of these pressures, safety and soundness problems will increase, and financial 

services regulators, including NCUA, will take prompt action to address the identified 

issues and mitigate emerging risks. NCUA takes these actions in order to maintain the 

safety and soundness of credit unions, safeguard the National Credit Union Share 

Insurance Fund (NCUSIF) from losses, protect consumer deposits, and endeavor to 

assure that taxpayers not experience a loss. 

When regulatory actions increase, complaints against the regulator typically rise. NCUA 

believes that credit unions should have an effective appeals system that works to 

resolve legitimate concerns and protect against reprisals. NCUA also works to minimize 
123 


75069.060

complaints by comprehensively training our examiners and encouraging stakeholders to 

communicate with us before, during, and after an examination. 

This written testimony will provide general background about NCUA and NCUA's 

existing examination process. It will also highlight the strengths of NCUA's current 

appeals process, which we believe respects credit unions, and brings fairness to our 

actions and determinations. 

Most importantly, this statement will outline how the implementation of H.R. 3461, as 

introduced, could produce a number of unintended consequences, including increased 

administrative costs, higher insurance premiums, and less examination flexibility. To 

pay for these higher costs, credit unions will likely lower interest rates for deposits and 

increase interest rates for loans. As a result, consumers will ultimately bear the costs of 

this legislation, and NCUA expects that the time to resolve emerging issues in credit 

unions will be greatly extended. The increased time to settle issues, however, runs 

counter to the recent recommendation of the Government Accountability Office (GAO) 

that NCUA "require early and forceful regulatory action" well before capital deterioration 

triggers the statutory tripwires of prompt corrective action. 

II. About NCUA 

NCUA's primary mission is to ensure the safety and soundness of federally insured 

credit unions. NCUA performs this important public function by: 

• examining all federal credit unions; 

participating in the supervision of federally insured, state-chartered credit 

unions in coordination with state regulators whenever possible; and 

insuring federally insured credit union members' accounts. 

2 
124 


75069.061

In its statutory role as the administrator of the NCUSIF, 1 NCUA provides oversight and 

supervision to 7,179 federally insured credit unions. These federally insured credit 

unions represent 98 percent of all credit unions and serve 91.4 million credit union 

members" 

III. NCUA's Current Appeals Process 

NCUA recognizes that our examination process, like that of every other financial 

institution regulator, can be improved and enhanced. As such, we are constantly 

working to refine our examination methods and practices. Moreover, NCUA actively 

works to minimize complaints about the examination process through comprehensive 

training for our examiners on proper examination procedures, effective communication, 

and the need to remain objective and respectful at all limes. We also encourage credit 

unions to communicate with us throughout the examination process. Effective 

communication between the regulator and the regulated can often resolve problems on 

the frontlines and avoid the need for pursuing appeals. 

In working to protect deposits, keep the credit union system safe and sound, and 

maintain a strong insurance fund, NCUA must ensure that every federally insured credit 

union operates in accordance with the law, in the best interest of its members, and that 

its officers and directors are held to the highest fiduciary standards. The NCUA 

examiner is at the forefront of these regulatory efforts, making sure every federally 

insured credit union meets these requirements. 

NCUA holds our examiners accountable for their findings, which is why they must 

conduct thorough reviews. This accountability, however, should not prevent an ongoing 

dialogue between credit unions and examiners. Consistent with the timelines contained 

1 Congress established the NCUS1F in 1970 as part of the Federal Credit Union Act (P.l. 91-468) and amended the 

NCUSIF's operations in 1984 (P.L. 98-369). The NCUS1F operates as a revolving fund in the U.S. Treasury under 

the administration of the NCUA Board for the purpose of insuring member share deposits in aU federal credit unions 

and in qualifying state credit unions that request insurance. As of November 30, 2011, the NCUSJF had total assets 

of$11.7 billion dollars. 

2 NCUA does not oversee approximately 150 state-chartered, privately insured credit unions. The term "credIt union~ 

is used throughout this statement to refer to federally insured credit unions. 

3 
125 


75069.062

in H.R. 3461, NCUA also prioritizes the timely delivery of examination reports by 

examiners so credit union management and boards can take prompt action to address 

problems. For this reason, credit unions should maintain continuing discussions with 

their examiners to solve problems before the issuance of examination findings. 

When ongoing, two-way communication fails to produce a consensus for resolution, 

credit unions have other avenues to voice their concerns. Specifically, NCUA has 

adopted an appeals system to consider and resolve legitimate problems. This system 

allows credit unions to appeal examination findings through formal and informal 

channels, including to our Supervisory Review Committee3 To prevent unnecessary 

conflicts and appeals, NCUA examiners do their best to provide regular feedback to 

credit unions, and NCUA encourages credit union management to engage with our 

examiners before receiving the final report. 

When examination problems arise, NCUA recommends that credit union management 

first engage directly with their examiners to resolve these issues. Direct communication 

often resolves issues like implementation timelines and the imposition of new controls. 

By talking to each other, the parties frequently can come to a meeting of the minds, or, 

at the very least, a better understanding of the issues involved. This step can be 

effective when there is disagreement over the facts, conclusions, or tone of the 

examination report. 

Should the discussions with the examiner fail to produce a solution acceptable to the 

credit union, NCUA advises credit unions to contact the supervisory examiner, who will 

evaluate the facts and review the examiner's analysis. At this time, each NCUA 

supervisory examiner oversees about 9 examiners and roughly 93 credit unions. 

If consultations with the supervisory examiner do not resolve a problem, a credit union 

may appeal the issue to the regional office in which it is located (there are five 

3 The Riegle Community Development and Regulatory Improvement Act of 1994 (P.L. 103-325) required each federal 

banking agency and NeUA to establish an independent, intra-agency appellate process. NeUA created its 

Supervisory Review Committee in response to the Riegle Act's mandate. 

4 
126 


75069.063

throughout the nation). Credit union management would initiate this appeal by sending 

a letter to the regional office. The regional director would then weigh the facts involved 

and reach a decision. 

Should the regional director fail to find ccmmon ground with a credit union, a credit 

union may contact NCUA's Supervisory Review Committee as the next step in the 

appeals process. This independent panel comprised of three senior NCUA 

professionals, none of whom is involved with the examination process, considers and 

makes recommendations on a variety of issues. Primarily, though, it handles appeals 

on examination CAMEL ratings, the adequacy of loan loss reserve provisions, and 

classifications on loans that are significant to an institution. A credit union may then 

appeal a decision of the Supervisory Review Committee to the NCUA Board. 

A credit union's ability to seek redress is in no way limited to the procedures outlined 

above. Informal dispute resolution mechanisms include writing to NCUA's Office of 

General Counsel about legal issues or NCUA's Office of Examination and Insurance 

about safety and soundness matters. When warranted, credit unions may also contact 

NCUA's Office of the Inspector General. 

Moreover, consistent with a requirement of H.R. 3461, NCUA has already taken steps 

to ensure that credit unions may appeal without fear. To protect credit unions from 

examiner reprisals, NCUA has instituted a zero-tolerance retaliation policy. Examiners 

may not take action against a credit union for using any formal or informal appeal 

channel. Moreover, every exam report provides information on the appeals process 

and reference to our non-retaliation policy. NCUA's policy is also available on our 

public website. 

IV. Addressing Examination Problems Promptly 

As noted earlier, NCUA works to prevent problems in the examination process and 

minimize complaints by credit unions. NCUA's supervisory examiners play an important 

5 
127 


75069.064

role in this regard. NCUA deploys these supervisors in the field with our examiner staff 

to ensure that NCUA has decision-makers in place at credit unions when problems 

emerge. The ability of our supervisory examiners to get immediately involved in the 

examination process often resolves issues as they arise and before they approach the 

level of a major complaint. 

Sometimes an examiner's actions may lead to a problem, and the supervisory examiner 

must step in to resolve the matter. For example, during a routine examination at one 

troubled credit union, the supervisory examiner attended the exit meeting. During the 

meeting, the supervisory examiner observed considerable stress and at times hostile 

comments from the credit union's leadership. Management had concerns about the 

decision to keep the credit union in troubled status because of a failure to fully resolve 

all of the problems identified in prior examinations. As the meeting progressed, the 

discussions became strained. The supervisory examiner also observed a loss of 

objectivity from the examiner, so the NCUA supervisory examiner stepped in, changed 

the meeting's tone, and directed the rest of the jOint conference. Subsequently, the 

supervisory examiner counseled the examiner on more appropriate ways to handle the 

situation. 

In another case, the manager of a small credit union complained to the supervisory 

examiner about the lack of respect demonstrated by the examiner. As a result, the 

supervisory examiner joined the onsite portion of the examination. The issue arose 

from the examiner's practice of walking into the manager's office without knocking, and 

using the photocopier or pulling loan files independently without seeking the manager's 

assistance. Given the limited space, the credit union had located both the copier and 

loan file cabinets in the manager's office. The supervisory examiner, upon observing 

the interaction between the examiner and the manager, counseled the examiner, and 

instructed him to knock and respectfully request the use of the photocopier and access 

to the records needed for the examination. The supervisory examiner resolved the 

issue onsite and before the issues escalated to a formal complaint. 

6 
128 


75069.065

As much as we would like to believe that all credit union officials have the best interest 

of their credit union and its members at heart, some, unfortunately, do not. It is in these 

instances that examiners often receive criticism for being too tough. Yet, this is when 

an NCUA examiner performs at his or her best. The following two examples detail an 

instance when a difficult examination led to the uncovering of fraud and one case when 

anger by a credit union to its lowered CAMEL rating was appealed unsuccessfully, only 

to have the credit union realize the situation was far worse than it had imagined. 

In one credit union, the CEO openly displayed hostility toward the team of examiners, 

causing the examiners to work under duress during most of the fieldwork. The CEO 

repeatedly challenged the examiners, questioning why they needed certain information, 

and frequently quoting policy from the NCUA examiner's guide. Although the manager 

often degraded examiners as lacking sufficient knowledge, the examiners maintained 

their professionalism throughout the examination. During a review of key employee 

accounts, the examiners noted a single, unusual deposit in the CEO's personal account. 

After further investigation, the examiners discovered that the CEO had funneled tens of 

thousands of dollars from a sweep account for several years. 

In some instances, an NCUA examination will identify a problem at a credit union for 

which management will at first express doubt, but later express appreciation. At a large 

credit union, for example, examiners observed inappropriate responsiveness to the 

recent mortgage market crisis. A key problem involved the use of a valuation 

methodology inconsistent with current economic conditions. During the examination, 

the credit union's management openly challenged NCUA's conclusions and expressed 

anger about the downgrade to a troubled CAMEL code. 

After an unsuccessful appeal, NCUA examiners performed a new supervisory contact at 

this credit union. During the contact, the credit union indicated that it had not only 

adopted NCUA's recommendations, but it also admitted that the conditions about which 

NCUA examiners had warned were worse than imagined. The credit union's 

management subsequently took very drastic actions to reverse the financial erosion of 

7 
129 


75069.066

the credit union. In this case, the credit union did not initially agree with the examiner 

and challenged the exam. Calling the credit union's attention to the problem and 

requiring management to take action when it did, however, likely saved this credit union 

from failing. 

V. Current Economic Environment and the Regulatory Response 

NCUA is aware of and understands the pressures that financial institutions must 

confront on a daily basis, particularly during difficult economic times. As a result of the 

recent financial crisis, credit unions have experienced historically high default rates, 

although these rates have begun to decline since peaking in 2009. Additionally, difficult 

economic periods can lead to increased fraud at credit unions. Falling home prices, 

unemployment, and lower investment returns have also affected the bottom lines of 

credit unions in recent years. 

Despite these and other challenges, credit unions have weathered the economic crisis 

relatively well. The industry's net worth ratio has increased from 9.89 percent in 

December 2009 to 10.15 percent in September 2010. Over the same time period, the 

system's return on average assets has jumped from 0.18 percent to 0.66 percent. 

NCUA continues to closely monitor the industry's performance in order to make 

adjustments to the agency's examination program aimed at identifying emerging risks 

and addressing problems on a forward-looking basis. 

As noted earlier, credit unions will encounter additional threats to their safety and 

soundness during periods of economic uncertainty. In response, NCUA must take 

prompt actions to address the identified problems and mitigate emerging risks. We take 

these actions in order to maintain the safety and soundness of credit unions, safeguard 

the NCUSIF, protect consumer deposits, and ensure that taxpayers never experience a 

loss. 

8 
130 


75069.067

When regulatory actions increase, there typically is an associated increase in 

complaints against the regulator. Through the mechanisms noted earlier in this 

testimony, NCUA works to minimize complaints and address appeals expeditiously 

when they occur. Moreover, NCUA has had in place since 1995 a non-retaliation policy 

to ensure that credit unions can raise concerns without fear of experiencing retribution 

from the regulator. 

VI. Analysis of H.R. 3461 

To address issues identified in the Subcommittee's recent hearings, H.R. 3461 would 

institute new examination procedures, modify accounting practices, and create new 

appeal venues. Although well intentioned, the bill in its current form could produce a 

number of unintended consequences. Our testimony will focus on three of these 

unintended consequences-increased administrative costs, higher risks for the 

NCUSIF, and the imposition of an inflexible, one-size-fits-all approach in the 

examination of financial institutions. 

Increased Costs for NCUA 

First, H.R. 3461 would greatly raise NCUA's administrative costs. For example, the 

legislation's requirements to index and produce information supporting a finding would 

increase the time spent on examinations. The legislation's expansion of the existing 

definition of a "material supervisory determination" also would make virtually all 

examiner findings, recommendations, and action plans subject to formal appeal. In 

response, NCUA examiners would need to document each and every finding with 

specific references to NCUA rules and regulations. Additionally, at a time when NCUA 

is actively moving to shorten the timeframes and curtail regulatory burdens for the 

smallest credit unions, H.R. 3461 would force examiners to spend more time on these 

examinations. 4 

4 !n order to better align agency resources with industry risks, NCUA is implementing the Small Credit Union 

Examination Program (SCUEP) that shifts examination hours away from smaller federal credit unions with a record of 

sound performance and towards those credit unions that present more risk to the NCUS!F. The SCUEP is limited to 

9 
131 


75069.068

Today, NCUA operates with an extremely efficient organizational approach. We deploy 

our subject matter experts as a shared resource and do not assign these experts to 

every examination. This organizational structure reduces costs to the agency and these 

reduced costs are passed on to the industry. 

Examinations requiring the assistance of a subject matter expert may occur through 

direct in-person participation or via informal consultation through phone conversations 

and email exchanges with the examination team. While many of these interactions are 

consultative in nature, they could be considered a portion of the source for reaching 

conclusions in an examination. If so, then the bill's documentation requirements would 

result in the need to index and share these sources-email chains, notes of 

conversations, and phone logs-with the credit union. NCUA, therefore, believes that 

the bill, as introduced, could be disruptive to our existing internal consultation process 

and possibly stimulate greater appeals to examination findings, both increasing risk to 

the NCUSIF and costs to the industry. The changes may also cause examiners to seek 

subject matter experts in less significant risk cases as a defensive measure to ensure 

that issues are not challenged. In either event, the net result would be higher 

administrative costs for the agency. 

Moreover, the legislation's provisions to create additional appeals processes would add 

more regulatory layers that would increase costs without any assurance of greater 

effectiveness. Again, this change would cause examiners to fully document each and 

every finding, and examination costs would increase. 

Currently, much of an examiner's findings are based on sound judgment and sound 

business or industry practice. The changes proposed in the bill, however, would likely 

cause NCUA to issue numerous new prescriptive regulations in order to provide 

examiners with sufficient support for prudential-related concerns that are currently 

federal credit unions with $10 million or less in assets that received a CAMEL composite rating of 1,2, or 3 at the last 

examination. The target average examination time for SCUEP examinations is 40 hours 

10 
132 


75069.069

scaled using professional judgment, based on the size, complexity, and level of risk 

within the individual credit union. The need to issue new rules and regulations would 

run counter to NCUA's Regulatory Modernization Initiative adopted in response to 

Executive Order 13579.0 

For example, there is no hard-and-true formula about proper asset diversification. 

Today, if an examiner looks at a credit union's books and sees too many mortgages 

with only a three percent down payment or inappropriately large mortgages, he or she 

will warn of overconcentration in the exam report. If, however, a credit union appealed 

this finding to an administrative law judge as allowed under the bill, NCUA could not 

point to the violation of a specific regulation, other than citing the fact that 

overconcentration is an unsafe and unsound practice. 

H.R. 3461 would therefore require NCUA to set all such limits in regulation, leaving the 

examiner with less flexibility. These new regulations would require increased time and 

resources to implement. Such new regulations would also limit diversity in credit union 

business models and increase administrative burdens and compliance costs. 

Moreover, NCUA would need to significantly increase legal staff in response to allowing 

credit unions to appeal examination findings to administrative law judges. These cases 

may also include expert witnesses and would tie up the examiner, the supervisory 

examiner, and regional management. As a result, NCUA would likely need to hire 

additional staff to make up for the lost time of preparing and testifying in addition to the 

new attorneys. NCUA has further apprehensions that H.R. 3461, in its present form, 

could lead to frivolous appeals, and such appeals would increase costs NCUA's 

operational costs and cause the loss of significant amounts of time. The Subcommittee 

may therefore want to consider adding safeguards to prevent this problem. 

5 1n issuing Executive Order 13579, President Obama ordered independent regulatory agencies to periodically review 

existing significant regulations for those that may be "outmoded, ineffective, insufficient, or excessively burdensome, 

and to modify, streamline, expand, or repeal them~ accordingly. Through the Regulatory Modernization Initiative, 

NCUA is working to improve the regulatory environment by ensuring that NCUA rules are in sync with the modem 

marketplace, clearly written, and targeted to areas of risk. NCUA is also working to eliminate regulations that limit 

flexibility and growth without jeopardizing safety and soundness. 

11 
133 


75069.070

In addition, the bill's ombudsman and operational funding formula changes would 

significantly increase NCUA's expenditures for the FFIEC. 6 NCUA has historically paid 

for one-fifth of the FFIEC's operations. H.R. 3461 correctly removes the Office of Thrift 

Supervision from shouldering a portion of the FFIEC budget, but the bill fails to reassign 

this share to the FFIEC's newest member-the Consumer Financial Protection Bureau 

(CFPB). As reflected by the 2012 FFIEC budget, CFPB is now fully participating in the 

cost-sharing of the FFIEC expenses. Left unchanged in the bill, NCUA's expenditures 

for the FFIEC's costs and expenses will increase from 20 percent to 25 percent. 

The bill also requires the FFIEC to establish an ombudsman and appeals process 

involving administrative law judges. This change would likely result in a large addition 

to the FFIEC staffing levels depending on the number of requests for reviews and the 

time needed to investigate complex issues. In short, these changes would increase the 

costs of all FFIEC members that pay for the FFIEC's activities. 

In previously requiring NCUA and federal banking agencies to establish independent, 

intra-agency appeals panels, Congress placed limits on the issues that financial 

institutions could appeal. Specifically, the Riegle Community Development and 

Regulatory Improvement Act of 1994 stipulates that credit unions may only appeal 

determinations related to examination ratings, allowances for loan and lease losses, 

and classifications on loans significant to a financial institution. H.R. 3461, as 

introduced, would expand the definition of a material supervisory determination to 

include any issue specifically listed in an exam report as a matter requiring attention by 

the institution's management or board of directors. This change would encourage 

appeals on virtually any and all issues because there would be no limitations on such 

actions. 

6 NeUA Board Chairman Debbie Matz became the FF!EC Chairman in April 2011. The FFIEC chairmanship has a 

two-year term. 

12 
134 


75069.071

In sum, NCUA expects the administrative and regulatory costs imposed by H.R. 3461 to 

be considerable. Ultimately, credit unions and their members would pay for these 

increased expenses. 

Increased Risks for the NCUSIF 

Second, H.R. 3461 in its present form appears likely to greatly increase risks to the 

NCUSIF. Increased risks to the NCUSIF would result in higher insurance losses and 

higher premiums for credit unions in the future. 

The changes to examination standards dealing with commercial loan non-accrual status 

and restoration to accrual status, for example, have the potential to mask problems and 

extend the time before NCUA may take needed supervisory action. Specifically, the 

new Section 1013 of the Federal Financial Institutions Examination Council Act of 1978 

proposed in H.R. 3461 essentially codifies in statute income recognition and loan loss 

provisioning rules more appropriately within the purview of the accounting standardssetters. If adopted, such practices may result in a credit union continuing operations 

beyond a point where NCUA would normally take action to mitigate insurance losses 

because of a hindrance in full transparency around loan non-performance. This change 

could keep NCUA in the dark about existing credit risk at credit unions. As a result, the 

NCUSIF would likely incur larger insurance losses. 

The bill's provisions on non-accrual status are generally consistent with current 

accounting and financial reporting practices. Yet, because these provisions create 

bright lines that may permit financial institutions to ignore other available information 

about the borrower that should be properly factored into evaluations of a commercial 

loan's collectability, there is a risk that some institutions may game the system by 

structuring loans in a way to make it more difficult to properly provision for losses. For 

instance, the ability-to-perform language in the restoration to accrual paragraph goes 

beyond current practice when the commercial loan does not have monthly repayment 

terms. Under current practice, financial institutions must evaluate the probability that 

13 
135 


75069.072

the loan will be repaid according to contract terms. Financial institutions must also 

value the loan accordingly using generally accepted accounting principles (GMP). 

Likewise, to maintain accrual status, the loan should be well secured and in the process 

of collection. Any restructured loan must generally remain in non-accrual status for six 

months and the borrower must demonstrate repayment performance under the modified 

terms before the loan can be returned to accrual status. 

To ensure harmonization with GMP, the Subcommittee may want to clarify these 

issues. In this regard, the Subcommittee may wish to consider the views of the 

Financial Accounting Standards Board (FASB) before moving forward with 

consideration of the bill. FASB would be in a position to provide full insights on financial 

reporting impact of the proposed bill. 

The new Section 1013(a)(3) is unclear, in part, because the provision fails to specifically 

refer to a refinance in the language limiting a new appraisal for a commercial loan. The 

section, however, suggests the institution is taking action. In cases where an institution 

is involved in a loan restructuring with no cash out, the bill would prohibit NCUA from 

expecting the credit union to evaluate risk exposure through requiring appraisals of the 

properties in question. Historically, a bank or credit union would normally require a new 

appraisal as part of its underwriting on the modified loan. More current value 

information is critical to appropriately assess the reserving needs for impaired loans. 

The limitations on obtaining a new appraisal would likely increase the risk of loss to the 

NCUSIF because NCUA would have less knowledge about the value of collateral on an 

impaired loan. When a credit union depends solely on the sale of collateral for 

repayment, the proper valuation of the collateral-often obtained through a new 

appraisal-is critical to assessing risk and capital exposure. 

The new Section 1013(c) would further require NCUA and the banking regulators to 

develop identical definitions and reporting requirements for non-accrual loans. FFIEC 

agencies would therefore have to develop and apply a uniform definition to all financial 

14 
136 


75069.073

institutions, regardless of size or activities. For many years, NCUA has tied the 

definition of non-accrual to GAAP, as required by the Credit. Union Membership Access 

Act of 1998 (P.L. 105-219). In January, the NCUA Board issued for public comment an 

accounting Interpretative Ruling and Policy Statement that will further modify the 

definition of non-accrual. The bill's requirements to apply identical definitions and 

reporting requirements for non-accrual loans would have a real impact on NCUA, and a 

significant change in this area could have a material cost impact on every credit union 

requiring needed changes to data processing systems. 

NCUA also has concerns that the administrative law judge and FFIEC ombudsman 

appeals processes would produce greater uncertainty in the examination process. For 

example, the recommendations of administrative law judges and the decisions of the 

FFIEC ombudsman do not have to accord deference to agencies' actions and could 

result in the overturning of precedent. Additionally, the bill does not contain procedures 

for handling instances when two different administrative law judges issue two different 

recommendations in substantially similar cases. Besides problems related to 

inconsistency, an administrative law judge's recommendation to overturn a safety and 

soundness action due to a lack of knowledge of financial institution operational risk on a 

forward-looking basis might result in greater insurance losses in the long term. 

In addition, NCUA is greatly concerned that any appeals to an administrative law judge 

could lead to public hearings with no confidentiality granted to the subject matter unless 

the bill is further clarified. Public hearings featuring the release of confidential 

supervisory information could easily become reported by the press or posted on the 

internet and, in the worst case, cause members to rethink their choice in financial 

services providers in an institution that NCUA is working to strengthen. 

NCUA has continued to emphasize and reinforce a forward-looking view of risk to 

effectively steer institutions away from catastrophic outcomes. This examination 

approach requires an examiner to prospectively consider the long term and future 

impact of current decisions and trends when making recommendations or developing 

15 
137 


75069.074

action plans based on those judgments. Under the proposed law, we believe examiners 

would become less inclined to make a more forward-looking assessment of risk. 

Instead, they would approach nuanced institutional business models with an 

assessment that is less tailored to the unique business model, strategy, and consumer 

base of a specific institution. 

NCUA also believes that the proposed appeals system could increase the risk of 

NCUSIF losses through delayed action as the process advances. Additionally, the 

legislation's independent appeals process would sidestep the critical communication 

process and dialogue that occurs between examiners, NCUA's leadership, and 

regulated institutions. As a result, NCUSIF risks could increase. 

Moreover, the increased time to settle issues runs counter to a recent GAO 

recommendation that NCUA "require early and forceful regulatory action" well before 

capital deterioration triggers prompt corrective action. 7 The provisions in H.R. 3461 

would require greater documentation for all examinations to insure proper preparation 

for any appeals to an administrative law judge or the FFIEC ombudsman for potential 

appeals. 

In sum, unless modified, H.R. 3461 could significantly increase risks for the NCUSIF, 

and credit unions would pay higher premiums for the associated losses. 

One-Size-Fits-AII Examination Approach 

Third, HR. 3461 would produce a one-size-fits-all system for financial institution 

supervision as a result of the requirement to establish consistent examination standards 

across regulators. This change would decrease regulatory flexibility and add 

considerable costs, especially for small credit unions. 

7 See National Credit Union Administration: Earlier Actions Are Needed to Better Address Troubled Credit Unions 

(GAO-12-247). 

16 
138 


75069.075

NCUA currently customizes its reviews based on the size, scale, and scope of each 

credit union. This customization of examinations provides flexibility and helps to 

decrease examination costs for the smallest of credit unions. 

The largest bank holding companies have more than $1 trillion in assets, yet nearly 70 

percent of credit unions have $50 million or less in assets. The requirements to 

establish consistent examination standards across regulators will decrease regulatory 

flexibility and require similar treatment for all institutions regardless of size. 

The smallest credit unions offer basic banking services like taking deposits and making 

small personal loans to members. Many of these credit unions have a very small or 

part-time staff, along with very limited resources that are already imposed upon during 

examinations. These small credit unions would be harmed by the implementation of 

uniform examination standards for all banks and credit unions. 

NCUA has been actively working to reduce the regulatory burden on credit unions and 

develop a forward-looking regulatory approach that seeks to anticipate the risks to 

which individual credit unions are subject. NCUA is concerned that the requirement of 

consistent industry-wide examination standards contemplated in H.R. 3461 would 

reverse these efforts to ease the regulatory burdens of smaller credit unions. 

VII. Conclusion 

In sum, NCUA recognizes that financial services regulators must conduct exams fairly 

and consistently, and we strive to achieve this standard. NCUA is also committed to 

addressing legitimate concerns about the present exam process, minimizing regulatory 

conflicts, promoting procedural fairness, and advancing exam consistency. 

Later this year, for example, NCUA will adopt a National Supervisory Policy Manual to 

replace regional policies that dictate procedures. In addition to enhancing the 

consistency of NCUA examinations, this manual will retain the necessary flexibility that 

17 
139 


75069.076

examiners need when conducting examinations of both the largest and smallest credit 

unions, which range in size from less than $1 million to more than $45 billion. 

While economic conditions and business models change, regulators must work to 

ensure that the institutions they oversee are well aware of the risk of their business and 

are properly protected against losses when circumstances change. NCUA must also 

balance competing concerns in order to protect safety and soundness and limit risks to 

the NCUSIF. 

As introduced, H.R 3461 would significantly increase administrative costs and 

insurance risks, and decrease regulatory flexibility. NCUA respectfully requests that the 

Subcommittee carefully weigh these concerns against the laudable goals of increased 

transparency and additional rights for financial institutions. The Federal Credit Union 

Act requires NCUA to ensure that credit unions are operated in a safe and sound 

manner. NCUA believes that this legislation will make that mission much more 

expensive and difficult 

The additional appeals processes would also create new conflicts in exams and 

encourage frivolous legal challenges. The Subcommittee might consider inserting 

provisions that impose penalties for appeals deemed to be frivolous by the ombudsman 

or the administrative law judge and also make such appeals possible only after the 

existing appeals process has been exhausted. While this does not address all of 

NCUA's concerns with these provisions, these improvements will go a long way to 

reducing unintended consequences. 

NCUA is committed to working with Congress to explore these issues and other ways to 

address concerns about the examination process. We look forward to your questions. 

18 
140 


75069.077

EMBARGOED UNTIL DELIVERY 

STATEMENT OF 

SANDRA L. THOMPSON 

DIRECTOR 

DIVISION OF RISK MANAGEMENT SUPERVISION 

FEDERAL DEPOSIT INSURANCE CORPORATION 

on 

H.R. 3461 

THE FINANCIAL INSTITUTIONS EXAMINATION FAIRNESS 

AND REFORM ACT 

before the 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS 

AND CONSUMER CREDIT 

COMMITTEE ON FINANCIAL SERVICES 

February 1,2012 

2128 Rayburn House Office Building 
141 


75069.078

Chairman Capito, Ranking Member Maloney, and members of the Subcommittee, 

I appreciate the opportunity to testify on behalf of the Federal Deposit Insurance 

Corporation (FDIC) about the "Financial Institutions Examination Fairness and Reform 

Act" (H.R. 3461) and its potential impact on the supervisory process. In my testimony, I 

will discuss the FDIC's perspectives on how the proposed legislation would affect the 

bank supervisory process, which helps ensure the safety and soundness of our nation's 

banks, and the Deposit Insurance Fund (DIF). 

The FDIC continually seeks to improve the bank examination process, and we are 

committed to ensuring that banks understand our examination findings and have the 

opportunity to discuss, question and appeal those findings if they find it appropriate, both 

formally and informally. This is a challenging time for financial institutions, and 

examination findings reflect the difficult economic environment. These economic 

difficulties, particularly as they affect real estate, have led to credit quality weaknesses 

that have increased the volume of classified and nonaccrualloans. These credit quality 

issues require remediation to help ensure that institutions remain solvent and risks to the 

DIF are mitigated. At the same time, we recognize that banks are working very hard to 

navigate the downturn. Among other challenges, they have had to increase efforts to 

work with borrowers who are having difficulty making payments; address earnings 

compression; and deal with the credit availability needs in their respective communities. 

The FDIC shares the Subcommittee's goal of having a strong banking industry 

that serves as a source of credit to our nations' communities. At the same time, we share 

the responsibility with our fellow regulators of making certain that insured institutions 

remain safe and sound and that their financial reports accurately portray their financial 

condition. 

The stated purpose of H.R. 3461 is to improve the examination of depository 

institutions - also a goal that we share. However, the proposed legislation could mask 

problems at insured depository institutions and inhibit our ability to require weak 

institutions to take corrective action - potentially resulting in higher losses to the DIF. 

Most important, the bill would constrain the ability of bank supervisors to evaluate and 

work with banks to address emerging problems while there is still a chance to correct the 

problems and avoid needless failures. 

The bank examination process in the U.S. has evolved over many decades and has 

been shaped by our collective experience in both good times and bad. Recent experience 

has reaffirmed an essential lesson of past crises: namely, on-going, robust examination 

and early supervisory intervention are key to containing problems as they develop. We 

believe the current supervisory regime helps to promote public confidence by providing 

for the effective supervision of our nation's banks while protecting depositors and the 

taxpayers. 

-2-
142 


75069.079

Ensuring Accurate Portrayal of an Insured Depository Institution's Financial Condition 

The reliability and integrity of regulatory and financial reporting are fundamental 

to understanding the health and performance offinanciaI institutions. This is especially 

important when weak economic conditions are causing increased problem asset levels. 

Banking supervisors employ a standardized framework to evaluate a bank's risk 

profile, identifY higher-risk assets and business lines, and assess the institution's overall 

tinancial health and consumer protection performance. These examination procedures 

form a toolkit of risk assessment and mitigation activities that help supervisors address 

problems as they emerge and protect the federal safety net from unnecessary outlays. 

Assessing a bank's individual risks is a fact-specific process that depends greatly on the 

institution's risk selection, managerial oversight, and market circumstances. At the most 

fundamental level, bank supervision requires flexibility and use of expert judgment 

customized to each bank's profile and risk-taking. 

Classification o(Loans - H.R. 3461 could impair the banking supervisors' ability 

to assess and monitor risks by changing the method by which adverse classifications are 

derived. Adverse classifications represent a specialized analysis of an institution's 

problem assets. Regulators use these classifications to determine capital adequacy and 

overall financial health. The process for deriving adverse classification was first 

developed in the late 1930' s and has been refined in successive decades to better monitor 

risk. The classification system consists of designations that identify different degrees of 

credit weaknesses. A loan is considered "classified" when it is rated either 

"Substandard," "Doubtful," or "Loss." A statutory change to the classification process, 

as described below, would reduce the effectiveness of the metrics that bank regulators 

rely on to evaluate the condition of institutions, the adequacy of their capital and reserves, 

the performance of management and the appropriate risk-based deposit insurance 

premium. 

When the financial condition and repayment capacity of a commercial borrower 

deteriorates, the loan may be subject to adverse classification. In deciding whether to 

classify a loan, supervisors look first and foremost to the borrower's cash flow and ability 

to repay. If the borrower is expected to repay the loan in full according to its terms, the 

loan would not be classified. If repayment capacity is insufficient, however, the loan 

may be subject to adverse classification. In certain cases when significant deterioration 

in the borrower's financial condition is evident, such impaired credits may be viewed as 

"collateral dependent." For collateral-dependent loans with weakened repayment 

prospects, examiners typically classify the entire committed balance of the loan due to the 

uncertainty of repayment, with the portion supported by collateral classified 

"Substandard" and the amount not supported by collateral classified "Loss." 

H.R. 3461 would mandate that the amount of the adverse classification for 

commercial loans evidencing deterioration in collateral value be restricted to the 

deficiency relating to the decline in collateral value and repayment capacity of the 

-3-
143 


75069.080

borrower. Under the proposed statute, the deficiency amount that is classified "Loss" and 

subject to charge-off appears to be the only portion of the loan that examiners could 

adversely classify. Thus, while the credit weakness that led to the loan's impairment 

would still be present, examiners could no longer measure, through the classification 

process, the portion of the committed balance that continues to pose an elevated risk of 

credit loss to the bank. This would mask continuing potential problems in the loan 

portfolio, hindering the examiners' ability to evaluate capital and reserves adequately in 

relation to problem asset levels or to measure the overall risk the institution may pose to 

the DIF. 

Accurate Financial Reporting - In order to accurately portray their financial 

condition, banks and other financial institutions have been required for many years to 

consistently apply uniform criteria and standards for nonaccrual treatment and chargeoffs of uncollectible loans in their regulatory filings, especially their quarterly Call 

Reports. The banking agencies regularly update their regulatory reporting instructions to 

conform to changes in U.S. generally accepted accounting principles (GAAP), and to 

enhance the comparability and consistency of reporting across the industry. Supervisors 

use regulatory reports as a key tool in evaluating the health of individual financial 

institutions and the state of the industry. Similarly, in the private sector, investors, 

creditors and others use the reports in making their business decisions relating to a 

particular insured financial institution. 

The current regulatory requirement for reporting nonaccrualloans is that all 

evidence, both positive and negative, be weighed in reporting loan impairment. This 

requirement is consistent with GAAP. H.R. 3461 would legislate some ofthe decision 

criteria for nonaccrualloan reporting. We believe the bill would in effect create safe 

harbors that could allow banks to avoid reporting as nonaccrual certain loans for which 

full repayment is not expected, resulting in an overstatement of income and capital in 

such instances. 

The nonaccrual criteria underlying regulatory reports and loan classification 

practices also serve as key inputs for identifying and reporting impaired loans in GAAP 

financial statements prepared for investors. Thus, the use of these criteria and practices 

by financial institutions also enhance the comparability of their financial statements. The 

unintended consequence of setting certain reporting criteria in statute is that regulatory 

reporting of non accrual loans could become de-linked from GAAP requirements. l This 

could diminish the credibility of both regulatory reports and financial statements 

potentially resulting in difficulty for institutions to attract investors and raise capital. 

In addition, not reporting impaired loans as nonaccrual would reduce the FDIC's 

ability to price deposit insurance assessments based upon risk and result in healthy 

institutions having to subsidize troubled institutions. It could also result in higher losses 

to the DIF by delaying timely regulatory intervention and lowering a bank's allowance 

for loan and lease losses, and thereby its ability to absorb identified losses. 

I Section 37 of the Federal Deposit Insurance Act requires that regulatory reporting principles must be no 

less stringent than GAAP. 

-4-
144 


75069.081

Constraints on Requiring Capital Commensurate with Risk 

Section lO13(b) would also constrain thc regulators' ability to require troubled 

institutions to hold additional capital. This section states that the agencies may not 

require a bank that is well-capitalized to raise additional capital "in lieu of' actions the 

bill prohibits with respect to the agencies' identification of non accrual loans, 

requirements for an appraisal, or adverse classification of a loan. Some banks, however, 

have a large volume of troubled assets and a consequent need for additional capital 

regardless of whether they are nominally "well-capitalized." We are concerned that these 

provisions could be used to prevent the agencies from requiring such banks to hold the 

additional capital that is needed to address the risks in their loan portfolios. 

The FDIC and other regulators have longstanding policies that require institutions 

to hold capital commensurate with risk. Well-capitalized thresholds in the Prompt 

Corrective Action framework are intended for sound, well-managed institutions that do 

not pose more than the normal level of risk of failure. However, some lending activities 

and business strategies are inherently more risky even at well-capitalized institutions. 

Examples can include subprimc lending, high concentrations of poorly underwritten 

construction and development loans, and elevated levels of problem assets. These risk 

exposures often require additional capital to protect against loss. Importantly, this is a 

matter of supervisory judgment that the banking agencies exercise to ensure that 

institutions benefiting from the federal safety net have an appropriate capital cushion 

against the risks they face. Lack of adequate capital increases the chance that an 

institution will fail and the likely cost to the DIF. 

Proposed New Appeals Process 

The Subcommittee has asked us to comment on provisions ofH.R. 3461 that 

propose a new appeals process for supervisory determinations. The bill would create a 

separate appeals process through a new Office of Examination Ombudsman within the 

Federal Financial Institutions Examination Council (FFIEC). 

As proposed, the new Office of Examination Ombudsman would not function as a 

party that mediates disputes between banks and their supervisors. This office would 

instead have the authority to overturn determinations reached by the independent banking 

agencies and substitute its judgment for the judgment of the supervisory agency. 

Moreover, the administrative process informing the new Ombudsman would be 

prohibited from deferring to the expert opinions of the examiner or the agency. This lack 

of deference could have the effect of making all examinations more formal, legalistic, 

and significantly longer. The administrative process as proposed will likely be 

enormously expensive for both the banks and the supervisory agencies - the costs of 

which will ultimately be borne by the banking industry. At the end of the day, the new 

Examination Ombudsman would have authority, but no accountability or responsibility 

for the condition of the insured institution or the DIF if the bank ultimately fails. 

-5-
145 


75069.082

Further, we are concerned that the processing of the appeals proposed in the bill 

could delay implementation of important examination findings and corrective measures. 

We are especially concerned that such delays could further impair the safety and 

soundness of troubled institutions, which often refuse initially to acknowledge the 

severity of their problems and thus risk increased losses for the DIF. A few months' 

delay in implementing corrective measures, particularly in times of precipitous economic 

decline, can mean the difference between failure and survival for a troubled bank. More 

fundamentally, we believe the authority granted to this office would compromise the 

independence of the banking agencies. 

Current FDIC Appeals Process 

The FDIC is committed to a fair and transparent appeals process including the 

opportunity for banks to air concerns with the examination process without fear of 

retribution. Existing FDIC procedures require that at the conclusion of on-site 

examination work, FDIC examiners discuss their preliminary findings with bank 

management and the board of directors. Such communication provides bankers with an 

opportunity to probe the FDIC's conclusions and express the bank's viewpoint on 

findings, recommendations, and the supervisory process in general. The FDIC follows an 

open, two-way communication process with financial institutions, and we consider 

banks' comments about our conclusions in the shared interest of accurately assessing the 

bank's risk profile, understanding its strategic goals, and serving the local community. 

On March 1,2011, the FDIC issued Financial Institution Letter-13-20Il, 

Reminder on FDIC Examination Findings, which reiterates the FDIC's long-held policy 

of encouraging banks to express their concerns about an FDIC examination or supervisory determination through informal or formal channels. If an institution is unable to 

resolve its concerns or believes that our regional office is not correctly following FDIC 

policies, the institution is encouraged to contact our Washington office. An institution 

may also contact the FDIC Ombudsman to facilitate the resolution of problems and 

complaints. No matter how the bank contacts the FDIC, our policy strictly prohibits any 

retaliation or retribution by any examiner or employee against any institution. 

In our experience, most follow-up discussions arc successful in resolving the 

issue; however, if these informal channels do not resolve concerns, a formal appeals 

process is available? After requesting a review by the Director of the Division of Risk 

Management Supervision or the Director of the Division of Depositor and Consumer 

Protection, as appropriate, an institution may appeal the Director's determination to the 

FDIC's Supervision Appeals Review Committee (SARC). The SARC is chaired by an 

FDIC Board member and composed of senior-level FDIC officials who are not directly 

involved in supervisory functions. An institution can request to present its case orally to 

the SARC and such requests are normally granted. Final SARC decisions arc provided to 

the institution in writing and are published on the FDIC's website after reasonable steps 

are taken to protect the identity of the appellant institution. 

2 See http://www.fdic.gov/regulations/laws/sarc/sarcguidelines.htm!. 

-6-
146 


75069.083

The FDIC's formal and informal appeals processes are comprehensive and fair. 

They permit a bank to state concerns about supervisory processes and conclusions in a 

variety of ways, while at the same time not unduly encumbering the FDIC's ability to 

carry out it critical supervisory and insurance functions. Furthermore, we do not believe 

that the industry has supported its contention that the existing appeals processes 

established by each of the agencies in conformance with the Riegle-Neal Act are unfair. 

The proposed appeal process and powers granted to the Office of Examination 

Ombudsman are, in our judgment, both unprecedented and unnecessary. 

Conclusion 

The FDIC appreciates the opportunity to present our perspectives to the 

Subcommittee today. We are committed to continually enhancing the overall supervisory 

process, examining banks in a fair and balanced manner, and assuring accurate financial 

reporting by all financial institutions. We believe this approach provides for the timely 

recognition of problems, allows regulators and bankers to work together to remediate 

problems, and helps avoid losses to the DIF. 

-7-
147 


75069.084

tl@ 

CUNA 

"dltlln1<J.!lII..troiW;~1\IJI 601 Pennsylvania Ave .• NW I South Building, Suite 600 t Washington, DC 20004·2601 1 PttOH£: 202,638-5777 1 FAX: 202·6)8-7734 

cuna.org 

TESTIMONY OF 

KEN WATTS 

PRESIDENT AND CHIEF EXECUTIVE OFFICER 

WEST VIRGINIA CREDIT UNION LEAGUE 

ON BEHALF OF 

THE CREDIT UNION NATIONAL ASSOCIATION 

BEFORE THE 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER CREDIT 

COMMITTEE ON FINANCIAL SERVICES 

UNITED STATES HOUSE OF REPRESENTATIVES 

HEARING ON 

H.R. 3461, THE FINANCIAL INSTITUTION EXAMINATION FAIRNESS AND REFORM ACT 

FEBRUARY 1,2012 
148 


75069.085

Testimony of 

Ken Watts 

President and Chief Executive Officer 

West Virginia Credit Union League 

On Behalf of 

The Credit Union National Association 

Beforc the 

Subcommittee on Financial Institutions and Consumer Credit 

Committee on Financial Services 

United States House of Representatives 

Hearing on 

H.R. 3461, the Financial Institution Examination Faimess and Reform Act 

February 1,2012 

Chainnan Capito, Ranking Member Maloney, Members of the Subcommittee: 

Thank you very much for the opportunity to testify at today's hearing in support of H.R. 3461, 

the Financial Institution Examination Faimess and Refonn Act. My name is Ken Watts, and I 

am President and Chief Executive Officer of the West Virginia Credit Union League.! I am 

testifYing today on behalf of the Credit Union National Association (CUNA).2 

CUNA strongly supports H.R. 3461 and, while it is not a perfect piece oflegislation, we view it 

as a finn step in the right direction toward ensuring the federal financial institution regulatory 

agencies (regulators) conduct fair exams which are consistent with the law and regulation and 

ensure safety and soundness. 

H.R. 3461 would make available to financial institutions the infonnation used to make decisions 

in their examination; codifY certain examination policy guidance; establish an ombudsman at the 

Federal Financial Institution Examination Council (FFIEC) to which financial institutions could 

raise concerns with respect to their examination; and, establish an appeals process before an 

independent administrative law judge. 

I The West Virginia Credit Union League represents 100 state and federally chartered credit unions headquartered in 

West Virginia, which serve 377,800 members. 

2 CUNA is the largest credit union advocacy organization in the United States, representing nearly 90% of 

America's 7,300 state and federally chartered credit unions and their 93 million members. 
149 


75069.086

The Need for This Legislation 

Credit unions strongly support fair and appropriate safety and soundness regulation and oversight 

to protect the financial resources of credit unions and their members; to minimize costs to the 

National Credit Union Share Insurance Fund (NCUSIF) bome by all federal insured credit 

unions; and to preserve credit unions as unique institutions, offering meaningful choices to 

consumers in the financial marketplace. On the whole, the exam process appears to work fairly 

well for many credit unions. However, steps must be taken to address real problems that some 

credit unions have with examinations. 

CUNA has been working very closely with its member credit unions in an effort to provide 

resources for them regarding the examination process and to make them aware of the dispute 

resolution process when they feel the facts of their situations justify challenging examiner 

directives. Based on a number of concerns raised by credit unions regarding examination issues, 

in January 2011, CUNA published a report focusing on the duties and responsibilities of credit 

union officials and examiners in the examination process. As part of this report, CUNA 

developed a list of credit union examination rights, which has become known as the "Credit 

Union Bill of Rights:' The list of examination rights, which we have attached to the testimony, 

includes many items inspired by experiences credit unions have had during their examinations. 

Simply stated, an examiner's chief duties are to review a credit union's financial performance 

and compliance with applicable regulations, and to assess how well the credit union is managing 

its risks. Credit unions have the right to manage risk without being directed by examiners to 

eliminate it. In that regard, regulators should address the supervision and examination of credit 

unions in a professional manner, taking into full account legal requirements credit unions must 

meet as well as the need for credit unions to have reasonable flexibility to serve their members 

well. Likewise, credit union boards and management must meet their responsibilities, including 

supervisory requirements and their fiduciary duties to the credit union's members. 

While the issues regarding the examination process and examiners are perennial, the number of 

concerns credit unions have raised regarding examinations increased appreciably with the onset 

of the current economic crisis. In late 2010, CUNA informally surveyed several of its members 

regarding examination experiences. One-in-five credit unions reported dissatisfaction with their 

2 
150 


75069.087

previous exam; 27% of respondents reported dissatisfaction with their most recent exam. One of 

the more common concerns among credit unions is that examiners tended to focus too much on 

their own view of best practices rather than on legal and regulatory requirements. Respondents 

who expressed concerns also frequently indicated that the examiners did not listen well and 

carefully consider alternative approaches; did not offer helpful advice; did not allow enough time 

for management to review their findings before bringing issues to the attention of the board; did 

not use their time well; and often failed to cite legal authority for directives, which at times seem 

arbitrary to the credit unions. 

Credit unions have also told us that the state and federal examination dispute resolution 

processes are not as clear or as helpful as they should be. There is a palpable fear of retaliation 

among credit unions, notwithstanding "non-retaliation policies" that agencies may have. Of the 

credit unions that responded to our survey, only 3% actually used the appeals process during 

their last two exams, but over one-in-five (21 %) indicated that they wanted to appeal but did not. 

Two-thirds of the credit unions that wanted to appeal indicated they did not appeal for fear of 

retaliation by examination staff. Nearly the same number indicated they did not appeal because 

they did not believe it would make a difference in outcome. Over one-third of credit 1l1lions who 

had examination eoncerns did not appeal because they were not aware of the process. 

While this legislation will not solve all of the problems that credit 1l1lions face when dealing with 

their examiners, we are hopeful that the attention that Congress gives to this issue will lead the 

NCUA and the other regulators to take steps to ensure that examiners treat credit unions fairly 

and that they acknowledge credit 1l1lions should have the flexibility to manage risk, consistent 

with legal and supervisory requirements. 

We are particularly pleased that the legislation would create an office of examination 

ombudsman at FFIEC and establish an independent examination appeals process before an 

administrative law judge. These two steps could go a long way toward improving this process 

and alleviating some, but not all, of the concern regarding retaliation and prospects for success in 

the appeals process. 

3 
151 


75069.088

Recommendations 

While we are very supportive of this legislation, we recommend the Subcommittee consider the 

following enhancements designed to strengthen it: 

• The proposed deadlines for exit interviews and examination reports should not 

become standard practice for regulators with a history of completing these in less 

time than proposed. 

• Information relied upon by examiners when making material supervisory 

determinations should be made available to examined entities without a requirement 

that the financial institution request the information. 

• The exam standards in section 3 of the legislation should be carefully considered to 

ensure that there are no unintended consequences resulting from the prescriptive 

nature of this language. 

• The provision requiring the regulators to develop and apply identical definitions and 

reporting requirements for non-accrual loans should be modified to take into 

consideration the unique structural characteristics of credit unions. 

• The examination ombudsman should be directed to design and implement a routine 

survey for financial institutions to complete on a voluntary basis at the conclusion of 

the examination process, to report to the ombudsman on their examination 

experience. 

• The examination ombudsman should routinely follow up with financial institutions 

that have raised issues with respect to or appealed examination findings to ensure that 

there have been no retaliatory actions taken against the institution. The ombudsman 

should also reach out to institutions it has not heard from to ensure they are bcing 

treated fairly in the examination process. 

• The language directing the examination ombudsman to review regulators' 

examination procedures to ensure that examination policies are being followed and 

adhere to the standards for consistency established by the FFIEC should be modified 

to take into consideration the unique structural characteristics of credit unions, as well 

as the level of risk represented by an institution's operations, size and other relevant 

factors. 

• Regulators should be directed to identify the additional costs associated with 

implementing this legislation, and reduce expenditures elsewhere within their budgets 

by the same amount. Further, we encourage the committee to direct the FFIEC to 

divide the cost of implementing this legislation among the regulators on a pro-rata 

basis so that for example, the NCUA is not assessed for the costs incurred by other 

regulators. 

4 
152 


75069.089

Examination Reports and Exit Interviews 

Section 2 would require regulators to provide a final examination report to the financial 

institution no latcr than 60 days after the exit interview for an examination or the provision of 

additional information relating to the examination, whichever is later. This section also would 

require the exit interview to be conducted within nine months of the commencement of the 

examination. 

Credit unions report that the NCUA generally meets or exceeds these deadlines already, and by a 

substantial amount. We recommend adding language to ensure that the deadlines proposed by 

this legislation do not become the new standard for regulators which have a history of more 

timely completion on examination processes. 

Availability of Information Relied Upon When Making Material Supervisory Determinations 

Section 2 also requires regulators to include in the final examination report an appendix listing 

all examination or other factual information that examiners relied upon when making material 

supervisory determinations, upon the request of the financial institution. 

Credit unions deserve to know what information was used by examiners during the course of the 

examination. The bill in its current form would permit credit unions to request this information, 

but we believe that the examiners should furnish this information as a matter of course. We 

recommend eliminating the requirement that financial institutions request the information. 

Further, as we have noted, credit unions report that some examiners have required them to take 

action or have made determinations that either were not required by or went further than what is 

required under law or regulation. We recommend that the Subcommittee consider requiring 

regulators to provide information on a regular basis to the FFIEC on the extent to which 

examiners identify the specific legal basis under which any material supervisory determination is 

made. 

Examination Standards 

Section 3 includes several provisions related to examination standards and the treatment of 

certain loans; these provisions appear consistent with FFIEC guidance issued in 2009. We 

5 
153 


75069.090

support the intent of including this language in this legislation, which is to ensure that the policy 

guidance issued by Congress and the regulators in Washington is applied as intended by the 

examiners in the field. While we have concerns with the prescriptive nature of the language in 

this section, we recognize that if there were not so many concerns regarding the examination 

process, it would not be necessary for Congress to consider such language. 

One provision of Section 3 with which we would request further consideration is the provision 

requiring the regulators to develop and apply identical definitions and reporting requirements for 

non-accrual loans. While it is important for there to be consistency among the regulators' 

examination processes, we believe the NCUA should have some flexibility in this area given the 

unique structural characteristics that differentiate credit unions from banks. In fact, just last 

week, the NCUA issued a proposal that would provide for much more accurate reporting and 

regulatory treatment of troubled debt restructurings (TDRs); if adopted, the NCUA would no 

longer require TDRs that are performing to be treated as delinquent, although they would 

continue to be reported at TDRs. 

Office of Examination Ombudsman 

Section 4 would establish an office of examination ombudsman at the FFIEC to receive and 

investigate complaints from financial institutions concerning examinations, practices and reports. 

This office would also be responsible for reviewing regulators' examination procedures to ensure 

that exan1ination policies are being followed and adhere to the standards for consistency 

established by the FFIEC. This section also includes an annual report to Congress on several of 

the issues addressed by this legislation. 

We strongly support the establishment of this office at the FFIEC, and would recommend the 

following three changes to this section. 

First, the ombudsman should be directed to design and implcment a routine survey for financial 

institutions to complete on a voluntary basis at the conclusion of the examination process, to 

report on their examination experience to the FFIEC. The NCUA presently conducts such a 

voluntary survey; other regulators may as well. We would hope that this survey would be made 

available to the financial institution as part of the final examination report. We believe that 

6 
154 


75069.091

credit unions would be more comfortable in completing such a survey if it were collected by an 

ombudsman once removed from the NCUA. Further, we would hope that the results of this 

survey would be aggregated and reported to Congress in the annual report required under this 

section. 

Second, the legislation includes language designed to prohibit retaliatory action against a 

financial institution that complains about or appeals an examination finding. We recommend the 

Subcommittee takes an additional step to assuage the real concerns that financial institutions may 

have regarding the utilization of the complaint or appeal process by directing the ombudsman to 

routinely follow up with financial institutions that have raised issues with respect to or appealed 

examination findings to ensure that there have been no retaliatory actions taken against the 

institution. This type of action may reduce the concern regarding retaliation that some financial 

institutions may have, notwithstanding the prohibition against retaliatory action. 

Third, we have concerns related to the language directing the ombudsman to review regulators' 

examination procedures to ensure that examination policies are being followed and adhere to the 

standards for consistency established by the FFIEC. As we have noted, credit unions have 

unique structural characteristics that differentiate them from banks. We question whether this 

language would sufficiently enable the NCUA to establish examination procedures that take into 

consideration these characteristics. Furthermore, we believe there is merit to permitting 

regulators to establish examination procedures that take into account the risk, size and 

complexity of the institution. The examination of a $7 million credit union should not 

necessarily follow the same procedures as the examination of a $45 hillion credit union or one of 

the largest banks. We believe that all financial institutions of similar size and structure have 

every right to expect consistency of treatment, but examination practices should be tailored to the 

type and size of institution. 

Cost of Implementation 

Whenever there are changes to the regulation or compliance burden, the cost of implementation 

is borne by the regulated entities. History suggests that these costs for credit unions go only in 

one direction: up. We anticipate that several of the provisions of this legislation would result in 

increased costs for the NCUA, which regrettably would be passed on to credit unions, and 

7 
155 


75069.092

ultimately credit union members if Congress does not include language to guard against this 

result. Credit unions already pay a substantial amount to fund regulators and to comply with 

ever-increasing regulatory requirements. 

Given the circumstances that have prompted Congress to consider legislation of this nature, few 

credit unions would view this legislation as a net positive if the benefits of the legislation were 

accompanied by increased costs to credit unions. We encourage the Subcommittee to add 

language directing the regulators to identify the additional costs associated with implementing 

this legislation, and reduce expenditures elsewhere within their budgets by the same amount. 

Over the last several years, the NCVA has proposed significant increases in its budget. We have 

confidence that the improvements sought by this legislation could be paid for through reductions 

in expenses at the agency. 

Further, the NCVA staff has brought to our attention their concern that (he cost to FFIEC of 

implementing this legislation would be divided equally among the members of the Council 

notwithstanding the fact that the number or nature of the inquiries and appeals of Council 

members' decisions may not bc cqual. We share this concern: each regulator should contribute 

its fair share toward to the cost of implementing this legislation. We encourage the 

Subcommittee to include language that divides the cost to the FFIEC of implementing this 

legislation among the regulators on a pro-rata basis, based on each regulator's actual costs of 

implementation. 

Conclusion 

Chairman Capito, as the economy struggles to recover from the recent financial crisis, credit 

unions face a crisis of creeping complexity with respect to regulatory burden which is made all 

the more challenging by examination practices that are, in some cases, based on policy guidance 

and examiners' view of best practices rather than regulation and law, and an examination disp.?te 

resolution process under the auspices of the regulator employing the examiner. H.R. 3461 would 

help make the exam process fairer and more consistent. We appreciate your leadership in 

sponsoring this legislation. We look forward to working with you as the bill moves through the 

legislative process. I would be happy to answer any question the Subcommittee may have. 

8 
156 


75069.093

1. CUNA's list of Credit Union Examination Rights (with Commentary) 

1. Credit unions have the right to manage risk without being directed by 

examiners to eliminate it. Authorized by NOJA Examiner's Guide 

(NEG) page 1-3. 

Commentary: As the Examiner's Guide points out, examiners should 

not "insist that a credit union eliminate risk but, instead, should 

ensure that credit unions identify and manage their risks. The 

desired reward for taking risk is stable profitability and increased net 

worth. Credit unions must balance risk and reward responsibly." 

2. Credit unions have the right to respectful conduct from the examiner. 

NEG pages 21-3 and 21-4. 

Commentary: Credit unions, as well as regulators, expect examiners 

to act professionally-which they do most of the time, according to 

credit unions. However, if a credit union feels that an examiner has 

stepped over the line in terms of conduct involving the credit union, 

the credit union should report the incident to the supervisory 

examiner or regional office, without fear of retaliation. 

3. Credit unions have the right to be examined by well-trained, 

competent examiners who understand the unique characteristics of 

credit unions. NCUA Strategic Plan 2011-2016, pages 1 and 2. 

Commentary: Strong safety and soundness depends, in large 

measure, on capable supervision. Examiners who are well-suited for 

their jobs in terms of experience, expertise, and conduct help support 

safety and soundness and strengthen the credit union system. 

4. Credit union officials have the right to meet and discuss examiner 

findings, conclusions, directives, and any administrative actions with 

the examiner, or privately among themselves without the examiner 

present. Credit union officials should be able to have management 

staff present at the officials' discretion. NEG pages I-II, 1-15, 21-2, 

and 21-3. 

Commentary: According to NCUA's Examiner's Guide, examiners are 

instructed to provide time throughout the examination process for 

discussion with management and officials regarding developments 

and findings in the examination. Examiners are encouraged to 

provide credit union officials with a draft copy of the examination 

report and give officials sufficient time to review it before the joint 

S"l.@ Credit Union National Association Page 1 
157 


75069.094

conference or exit interview. As the Examiner's Guide notes, "Nothing 

presented at the joint conference, exit interview, or in the 

examination report should surprise the [credit union's] officials." It 

is equally important that credit union officials not surprise examiners 

and that they take advantage of opportunities to meet with examiners 

and discuss issues throughout the examination process. 

5. Credit union officials have the right to question and seek corrections 

to examiner findings, conclusions, and directives. NEG page 1-15. 

Commentary: Accuracy is an essential component of strong safety 

and soundness regulation. Examiners are human and all humans 

make mistakes. It is not only appropriate but very important that 

credit unions work with their examiner to ensure all reports are as 

accurate and timely as possible and that all directives are based on 

accurate information. 

6. Credit union officials have the right to provide alternatives and/or 

additional data, conclusions, and solutions to address problems 

identified by the examiner. NEG pages 1-11, 2-3, 3-10, and 21-6. 

Commentary: According to the Examiner's Guide, examiners are not 

expected to dictate credit union policies but rather should work with 

credit union officials to reach a favorable outcome. The Examiner's 

Guide emphasizes cooperation and coordination between examiners 

and credit union officials, which should include flexibility for credit 

union management to provide alternative perspectives and data as 

well as alternative solutions to problems-as long as such 

alternatives are factually based and appropriate for the situation. 

7. Credit union officials have the right to know the speCific authority or 

legal basis for an examiner's directive. and this authority should be 

provided by the examiner in the exam report or directive. NEG page 

20-7. 

Commentary: The Examiner's Guide makes it clear that examiners 

must be willing and able to provide to credit union officials the legal 

authority for the action they are suggesting or directing the credit 

union to take. In addition, examiners do not have flexibility to insist 

on actions or poliCies that are counter to or inconsistent with 

statutes, agency policy. or GMP. 

8. Credit union officials have the right to receive clearly written 

examination reports on a timely basis. Any other directives and 

.S'''l.~, Credit Union National Association Page 2 
158 


75069.095

notices from the examiner should also be clearly communicated in 

writing. NEG page 20-1. 

Commentary: Credit unions should not be expected to comply with 

directives that are not in writing. In order for the credit union's 

record of performance, including efforts to address problem areas, to 

be as accurate as pOSSible, directives should be provided in writing to 

the credit union and included in the credit union's examination 

history. 

9. Credit union officials have the right to have examination reports, 

findings, directives and administrative actions that are based on all 

relevant facts, including current data. NEG page 1-27. 

Commentary: The examination report should present a current, 

factual picture of the credit union's financial performance and risk 

management. When material problems arise that the examiner 

expects the credit union to correct, the record must include a 

complete and well-documented accounting of the problems and the 

efforts by the credit union and the examiner to address them fully. 

10. Credit union officials have the right to be evaluated on their own 

strengths and weaknesses and not solely on the basis of regulator 

concerns about trends or general problems in the credit union system 

or within their peer group. NEG page 3-5. 

Commentary: While examiners must be mindful of problems and 

conditions in their regions and even across the country, it is essential 

for the accuracy of each credit union's examination report that the 

examiner's assessment of a credit union reflects an accurate 

depiction of the performance and operations of the credit union 

under review. 

11. Credit union officials have the right to be evaluated for progress 

toward objectives that are realistic and achievable, proportionate to 

the risk presented and the resources of the credit union, and in the 

time frame established with the credit union. NEG page 3-11. 

Commentary: Goals and directives that are not realistic are 

counterproductive and undermine safety and soundness. Examiners 

should not arbitrarily set requirements that the credit union cannot 

meet but rather there should be coordination and cooperation 

between the credit union's officials and the examiner regarding goals 

$C)~ ,~) Credit Union National Association Page 3 
159 


75069.096

that are achievable within an acceptable amount of time for both the 

examiner and the credit union. 

12. Credit unions have the right for their examination findings and 

directives to be risk prioritized. NEG pages 1-1 and 20-1. 

Commentary: Examiners are directed to focus their reviews and 

reports on applicable risks, and those activities that present the 

greatest risk receive the most attention. A standard procedure that 

the examination findings and directives must be listed in order of 

their importance based on the amount of risk presented is fully 

consistent with the risk-focused examination process. 

13. Credit union officials have the right to appeal examiner findings, 

conclusions, or directives without fear of retaliation from their 

regulator.' 

Commentary: It is clear that under the Feu Act, agency policy and 

practice, credit unions have the right to appeal "material supervisory 

determinations, including decisions to require prompt corrective 

action" to the NCUA Board. As discussed in this Section, matters that 

may be appealed include, for example, cease and desist orders, 

removal of officials, and conservatorships. Credit unions also have 

the right to appeal material examination report findings, conclusions, 

and directives from the examiner. Documents of Resolution and 

LUAs are not generally "appealable" because they are technically 

voluntary agreements, but the credit union should be able to appeal 

to the regional director as part of the DoR or LUA negotiation 

process. 

14. Instructions on how to appeal examiner findings, conclusions, or 

directives should be detailed on every examination report form that 

is provided to credit unions. NEG page 17-1. 

Commentary: NCUA's process for allowing an appeal is far from 

clear. NCUA and state regulators should ensure that all examination 

report forms which examiners provide to credit unions include 

sufficiently detailed information as to which issues may be appealed 

, See, e.g., 12 u.s.c. §1790d(k) (addressing PeA appeals); NCUA, Interpretive Ruling and Policy Statement (IRPS) 02-1 

("Supervisory Review Committee"), available af 

http://ncua.gQv IResources/RegulationsOpinionsLaws/lRPS12002 IlRPS02 -l.html; NCUA, IRPS 95-1 ("Guidelines for the 

Supervisory Review Committee "), available at http://ncua.gov IResources/RegulationsOpinionsLaws!IRPS/1995 IIRPS95-

l.html. 

$'~(,) Credit Union National Association Page 4 
160 


75069.097

or challenged and the process for making such an appeal. CUNA and 

the Leagues are pursuing greater transparency in the appeals process. 

15. Credit union officials have the right to record meetings with 

examiners and other agency personnel and other regulatory 

proceedings related to the examination (subject to confidentiality). 

NEG page 21-2. 

Commentary: The Examiner's Guide states that credit unions often 

use tape recorders to record their meetings at the joint conference, 

and that the NCUA examiners usually agree to the request, and may 

request a copy of the tape or transcript. A recorded meeting provides 

an objective transcript of the discussion between the examiner and 

the credit union officials. 

16. Credit union officials have the right to have a representative, such as 

an attorney or League representative, present during meetings with 

the examiner and other regulatory personnel. NEG page 21-6. 

Commentary: The Examiner's Guide states that credit union officials 

have the right to invite other persons to the joint conference, and 

that an examiner will rarely object to the attendance of any outside 

individual. Proper communication about the attendees in advance 

will facilitate the meeting. 

17. Credit unions have the right to have any published orders-at least 

consent orders-address only facts and not conjecture or speculation 

by the examiner. NEG pages 20-1, 20-6, and 30-3. 

Commentary: Any published orders must be based on the facts in an 

examination report that are reviewed by the credit union. The 

Examiner's Guide states that the examination report must have 

proper documentation to support an examiner's findings and 

conclusions. For the confidential section of the report, examiners 

should only cover pertinent matters that are based on fact, and not 

"statements based on gossip or hearsay." 

18. Credit unions have the right to confidential, non-discoverable 

communication with their legal counsel regarding examination issues. 

Commentary: There are longstanding legal principles in this country 

regarding attorney-client privilege that also apply to a credit union's 

$~~ @ Credit Union National Association Page 5 
161 


75069.098

management and officials in regard to examination and supervisory 

issues. 2 

19. Credit unions have the right to develop and use "high-level" policies, 

which should be separate and distinct from detailed procedures. NEG 

page 21-5. 

Commentary: Examiners should not dictate broader credit union 

policies, but rather should lead and persuade officials to proper 

action. Credit union management and officials have the right to use 

business judgment in developing their policies. 

20. State credit unions have the right to a lead examiner that is a state 

regulator, consistent with the credit union's charter type. NEG page 

22B-3. 

Commentary: NCVA appears to be compelled to accompany state 

regulators during the examination of state-chartered credit unions, 

particularly on federal "hot button" issues such as MBL and indirect 

lending. Thus, it is important that the lead examiner be comparable 

to the credit union's charter type. It is also important that the state 

regulator-not NCVA-be responsible for assigning the credit union's 

CAMEL rating during an examination. 

21. Credit union officials have the right to know the timing of when their 

regulators, such as NCVA, will publish an LVA. NEG page 29-10. 

Commentary: This right does not address whether NCVA should 

publish an LVA, it simply addresses the need for notification of when 

the LVA will be published. Currently, credit unions are learning 

about publication by either checking NCVA's website or, more likely, 

via NCVA's mass emails-which can be unintentionally inflammatory. 

NCVA should follow the lead of a number of state regulators that 

inform the credit union on when publication will occur. 

22. Credit union officials have the right to defer to their certified public 

accountant (CPA) if there is a disagreement between the officials and 

'See, e.g., Upjohn Co. v. United States, 449 U.S. 383, 386·99 (l98!); Clarke v. Am. Commerce Nat 'I Bank, 

974 F.2d 127,129·30 (9th Or. 1992); 12 C.F.R. § 747.24(c) ("Prtvileged documents are not discoverable. 

Privileges include the attorney-client privilege, work-product privilege, any government's or government 

agency's deliberative· process privilege, and any other pri'ileges the Constitution, any applicable act of 

Congress, or the principles of common law provide,"). 

$'~ C') Credit Union National Association Page 6 
162 


75069.099

their regulator regarding issues related to U.S. generally accepted 

accounting principles.' NEG pages 5A-4 and 7-28. 

Commentary: Credit unions over $10 million in assets are required 

to follow GAAP and a credit union's CPA is responsible for ensuring 

that the credit union's activities and financial statements are in 

compliance with GAAP. Therefore, rather than the regulator 

becoming involved in the specific accounting issues of numerous 

credit unions, the examiner should not seek to override the credit 

union's CPA when disagreement on accounting issues arise, absent 

clearly erroneous guidance from the CPA. Such practice will benefit 

not only the credit union but also the regulator by freeing up its 

resources. 

23. Credit union officials have the right to communication (Le., 

discussion of draft findings) with their examiner prior to final 

issuance of the examination report. NEG page 21-1. 

Commentary: The NCUA Examiner's Guide states that examiners 

should set aside "time periodically to discuss with management and 

officials developments in the examination." NEG page 21-1. In 

addition, an examiner should provide "credit union officials and 

management sufficient time to review it before the joint conference 

or exit interview." NEG page 20-I. 

24. Credit unions have the right for directives from examiners (including 

verbal and written comments) to be consistent with agency policy, 

such as NCUA's letters to credit unions. NEG pages 3-1, 6-15, 6-16,6-

20,7-35, 9A-18, and 10-1 - 10-14. 

Commentary: While this seems like an obvious right, this is 

frequently raised by credit unions across the country. NCUA 

examiners must follow the guidelines in the Letters to Credit Unions. 

For example, the Examiner's Guide states that credit unions must 

follow Letters to Credit Unions in areas such as CAMEL ratings, riskbased lending, and risk management. 

; See U.S.C 1782(a)(6). 

$'~ ,,) Credit Union National Association Page 7 
163 


75069.100

~~NDENT COMMUNITY 

BANKERS of AMERICA 

Testimony of 

Noah Wilcox 

President and CEO of Grand Rapids State Bank 

Grand Rapids, MN 

On behalf of the 

Independent Community Bankers of America 

Before the 

Congress of the United States 

The House Financial Services Committee 

Subcommittee on Financial Institutions and Consumer Credit 

Hearing on 

"H.R. 3461: The Financial Institutions Examination Fairness and 

Reform Act" 

February 1, 2012 

Washington, D.C. 
164 


75069.101

Opening 

Chairman Capito, Ranking Member Maloney, and Members of the Subcommittee, I am Noah 

Wilcox, fourth generation President and CEO of Grand Rapids State Bank and a member of the 

Executive Committee of the Independent Community Bankers of America. Grand Rapids State 

Bank is a state chartered community bank with $236 million in assets located in Grand Rapids, 

Minnesota. I am pleased to represent community bankers and ICBA's nearly 5,000 members at 

this important hearing on "H.R. 346 I: The Financial Institutions Examination Fairness and 

Reform Act (H.R. 3461 )." This bill will go a long way toward improving the oppressive 

examination environment, a priority concern of community bankers and a barrier to economic 

recovery, by creating a workable appeals process and consistent, commonsense standards for 

classifYing loans. ICBA is pleased to support H.R. 3461. 

In my role at ICBA, I talk to a lot of community bankers in Minnesota and around the country, 

including a number who have appealed exams. Invariably, those who have filed an appeal have 

described a process that is arbitrary and frustrating. Appeals panels, or other processes, routinely 

lack the independence and market expertise necessary to reach a fair, unbiased decision. H.R. 

3461 is a good start to improving the appeals process and by doing so it would likely improve 

exams. Examiners will be more circumspect knowing that bankers have access to a workable 

appeals process. 

Oppressive Examination Environment 

The current oppressive exam environment is hampering lending at the very time that bank credit 

is needed to sustain the economic recovery. While all banks accept the need for balanced 

regulatory oversight, the pendulum has swung too far in the direction of over-regulation. There 

is an unmistakable trend toward arbitrary, micromanaged, and unreasonably harsh examinations. 

Specifically, examiners are: 

Requiring write-downs or reclassification of performing loans based on the value of collateral, 

disregarding the income or cash flow of the borrowers; 

• Placing loans on non-accrual even though the borrower is current on payments; 

• Substituting their judgment for that of the appraiser; 

• Criticizing the use of certain types of non-core funding such as Federal Home Loan Bank 

advances and brokered deposits including certificate of deposit account registry service 

(CDARS) reciprocal deposits, which are used to distribute a large deposit across a network of 

banks so that it does not exceed the deposit insurance limit at anyone bank; and 

• Moving the capital level goalposts back beyond stated regulatory requirements. 

Community bankers nationwide have reported that bank regulators are often demanding 

significant capital increases above the minimum regulatory levels established for well-capitalized 

banks. For example, some examiners are requiring banks to maintain minimum leverage ratios 

2 
165 


75069.102

as high as 8 to 9 percent (versus the 5 percent required by regulation) and minimum Tier I riskbased ratios as high as 10 percent (versus the 6 percent required by regulation). To bankers, the 

process appears arbitrary and punitive. A moving aud unpredictable capital goalpost makes it 

nearly impossible to satisfy capital demands in a difficult economy aud capital marketplace. As 

a result, bankers are forced to pass up sound loan opportunities in order to preserve capital. This 

is not helpful for their communities aud for overall economic growth. All bank lending requires 

judgment and calculated risk. If regulators work to squeeze every ounce ofrisk out of the 

system, they will only succeed in stemming the flow of credit to local economies and threatening 

bank viability. There has to be a reasonable regulatory balauce. 

In addition, examiners' interpretation of existing law frequently appears to change from exam to 

exam. A practice that was in compliance one year is questioned the following year. Other 

community baukers have described a similar experience and we've developed a term for it, 

"auticipatory regulation," because it seems as though the examiners are trying to get ahead of 

trends in legislation aud regulation before they become law. At a minimum, community bankers 

need to know what is expected of them and that practices deemed compliant in the past will be 

acceptable in future exams. We understand that examiners have a difficult job, and the stakes 

were raised sharply after the financial crisis. But I believe mauy examiners have overreacted, 

with adverse consequences for banks aud the economy. 

Before the crisis, examiners frequently worked in partnership with the banks they examined. 

They were a resource in interpreting often ambiguous guidance. Where corrections were needed, 

opportunity was given to make them, and compliance was a mutual goal. This is the best meaus 

of achieving safety and soundness without interfering with the business oflending. Today, these 

relationships are too often adversarial. Understandably, an examiner docs not want to be blamed 

for the next crisis. Examiners are not evaluated on banks' contribution to the economy. At all 

costs, they want to avoid a bank failure that would put a black mark on their record. As a result, 

the examiner's incentive is to err on the side of writing down too mauy loans and demauding 

additional capital. The current crisis was not caused by a failure to adequately examine 

community banks. 

Additionally, bankers used to receive prompt feedback following their exams which they could 

act on immediately as part of the exam process. Today, detailed examination reports often arrive 

months after the examiner's visit, with little opportunity for the banker to sit down with the 

examiner, go over the results, and respond to the examiner's concerns on the spot. 

The misplaced zeal and arbitrary demands of examiners are having a chilling effect on credit. 

Good loau opportunities are passed over for fear of examiner write-downs o[ criticism aud the 

resulting loss of income and capital. The contraction in credit is having a direct, adverse impact 

on the economic recovery. Exams could be greatly improved by being made more consistent aud 

rational. This would eneourage prudent lending without loosening standards. 

3 
166 


75069.103

Appeals of Exam Results Are Costly and Biased 

The process for appealing exam decisions, which might offer relief, is instead an additional 

source offrustration. Appeals are lengthy and expensive. A typical community banker can 

expect to spend a year or more in appeal and incur as much as $150,000 in legal fees. What's 

worse, a bias in favor of the examining agency is built into the process. Panels assembled to hear 

appeals are drawn from the agency and consult closely with the examination team. The 

Ombudsman whose job is to receive complaints about the exam and the appeal is, again, an 

employee of the examining agency. Lacking adequate independence, their incentive and their 

priority appears to be to back decisions already made by the agency. A fair and impartial hearing 

is difficult if not impossible under these circumstances. The agencies will dispute this, but even 

the appearance of bias is enough to dcter bankers from using the appeals proccss. Another 

concern is that the appeals panel is often drawn from other regions of the country. While this is 

intended to create a degree of separation betwecn the appeals panel and the examiner, it does not 

provide for expertise in the local market which is essential to fairly evaluating a community 

bank. 

This lack of independence in the appeals process - or even the appearance of such - has another 

important consequence. Community bankers, however frustrated they are with exam results, do 

not appeal those results out of fear of retribution. Many community bankers are reluctant to talk 

publicly about their experiences, let alone undertake an appeal. I've talked to hundreds of 

community bankers within the last year alone. Frustration with the exam environment is running 

high, but bankers typically will not share their stories out of fear of retribution, much less will 

they seek appeals. This is why the small number of appeals does not match the frustration of 

community bankers over exams. rCBA surveys have consistently shown that exams are a top 

concern among community bankers. 

Under the circumstances, for any community banker who believes that their exam results are 

inaccurate, unfair, and harmful to their ability to serve their community, the incentive is to not 

question the results, however unjust, and to absorb their frustration and minimize any disruption 

to their business. Because too few bankers challenge exam results, examiners have no incentive 

to improve their performance. A workable appeals process will introduce the right incentives 

and set the system on a course of self-correction. Examiners will be more circumspect about 

substantiating thcir results knowing that bankers have a viable avenue to appeal. As exam 

quality improves, there will be less need for appeals. And as the economy improves, examiners 

will feel less pressure to protect themselves through inappropriately rigorous exams. This will 

set us on a course to restoring the balanced and productive partnerships many community 

bankers enjoyed with their examiners before the crisis struck. 

4 
167 


75069.104

H.R. 3461 Will Improve the Appeals Process 

Taking the appeals process out of the examining agencies, as B.R. 3461 would do, is a positive 

step. The bill would create an expedited appeals process under which appeals of a "material 

supervisory determination" contained in a final report of examination would be heard before an 

independent administrative law judge without deference to the opinions of the examiner or 

agency. The administrative law judge would make a recommendation to a newly created 

Ombudsman, located within the Federal Financial Institutions Examination Council (FFIEC), 

who would make a final decision that would be binding on the agency and the financial 

institution. 

The Ombudsman would also carry out other duties intended to improve the quality and 

consistency of examinations across all federal banking agencies, including investigating 

complaints related to examinations, meeting with banks from around the country to discuss their 

examination experiences, reviewing agency procedures, and reporting annually to Congress on 

these activities. 

While not completely independent of the agencies - FFlEC is composed of each banking agency 

- I expect that this level of separation between the appeals process and the agencies will provide 

a measure of distance and insulation that will make it more impartial and that will perhaps raise 

the comfort level of bankers so that they are willing to use the process. The provisions of B.R. 

3461 designed to make final examination reports more timely and requiring agencies to disclose 

all materials on which they based a material supervisory determination will also be helpful. 

ICBA would encourage Members of this Subcommittee to consider taking a harder line by 

adding provisions to this legislation to bring a higher level of accountability to the regulators and 

their field examiners. The current system, which grants examiners almost unfettered, 

unassailable authority, begs for checks and balances. That said, we are pleased to support the 

provisions of Section 4 ofB.R. 3461, as a foundation on which to build a more rigorous appeals 

process in the future. 

H.R. 3461 Will Provide for Consistent, Commonsense Loan Classifications 

H.R. 3461 will also bring common sense to loan classifications and more consistency to the 

examination process. The bill provides that, for the purpose of determining regulatory capital 

requirements, no commercial loan will be placed on non-accrual status solely because its 

collateral has deteriorated, and a modified loan must be removed from non-accrual status after it 

has performed for six months. The bill also prohibits an examiner from requiring a new 

appraisal on a performing commercial loan unless an advance of new funds is involved. Loan 

classifications in which collateral value has deteriorated would be limited to the amount of the 

decline in collateral value and the repayment capacity of the borrower. An examiner would not 

be allowed to require a well capitalized institution to raise additional capital based on a loan 

classification under this legislation. 

5 
168 


75069.105

Establishing these conservative, bright-line criteria will allow lenders to modify loans, as 

appropriate, without fear of being penalized. When loans become troubled in a tough economic 

environment, oftcn the best course for the borrower, lender, and the community is a modification 

that will keep the loan out of foreclosure. But, as I've discussed, many examiners are penalizing 

loan modifications by aggressively and arbitrarily placing loans on non-accrual status following 

a modification - even though the borrower has demonstrated a pattern of making contractual 

principal and interest payments under the loan's modified terms. This adverse regulatory 

classification results in the appearance of a weak capital position for the lender, which dampens 

further lending in the community and puts a drag on the economic recovery. 

The provisions of Section 3 of H.R. 3461 are consistent with agency guidance on troubled debt 

restructurings providing that a modified loan should be placed on accrual status when there is a 

sustained period of repayment performance - generally recognized as six months - and 

collection under the revised terms is probable. 

Community bankers support the revised examination standards of Section 3 because they 

resonate with their current experience in examinations. If thesc standards become law, they will 

give bankers the flexibility to work with struggling but viable borrowers and help them maintain 

the capital they need to support their communities. Community banks would welcome additional 

clarity in other regulatory areas as well, so that they can be confident in their lending and risk 

management. 

Communities First Act Will Provide Additional Relief 

Finally, I would like to advocate for another important piece oflegislation that would help to 

relieve community banks of certain burdensome regulations they face, both in examination and 

in compliance, and help community bank customers save and invest. We are grateful to this 

Subcommittee for convening a hearing late last year on the Communities First Act (CF A, H.R. 

1697) and giving ICBA Chairman Sal Marranca the opportunity to testify. The Communities 

First Act was introduced in the House by Rep. Blaine Luetkemeyer and currently has over 70 

cosponsors with strong representation from both sides of the aisle. A similar bill has been 

introduced in the Senate. Notably, CFA would: 

• Increase the threshold number of bank shareholders from 500 to 2,000 that trigger SEC 

registration. Annual SEC compliance costs are a significant expense for listed banks. 

• Provide relieffrom new Dodd-Frank data collection requirements in connection with loan 

applications from women-owned and minority-owned businesses. 

• Extend the 5-year net operating loss (NOL) carryback provision to free up community bank 

capital now when it is most needed to boost local economies. 

6 
169 


75069.106

Allow S corporation banks to raise additional capital by increasing the shareholder limit, 

allowing IRA shareholders, and allowing them to issue preferred stock. 

These and other provisions would improve the regulatory environment and community bank 

viability, to the benefit of their customers and communities. Again, we thank the Subcommittee 

for its hearing on CF A and request that the legislation be marked up in the near future. 

Closing 

ICBA appreciates the opportunity to testify. The current examination environment is a serious 

impediment to the flow of credit that will create jobs and advance the economic recovery. 

Legislative solutions are needed to improve this environment. ICBA supports the advancement 

of H.R. 3461. 

Thank you. 

7 
170 


75069.107

February 1, 2012 

Appraisal 

Institute® 

rrQfC$.5i(iI1(},t,~ PfYwidinlf 

Ileal f':$talC Solutiofl$ 

The Honorable Shelley Moore Capito 

Chairman 

Subcommittee on Financial Institutions and 

Consumer Credit 

2443 Rayburn House Office Building 

Washington, DC 20515 

Dear Chairman Capito and Ranking Member Maloney, 

~I 

Properly Economic' Professional; 

The Honorable Carolyn Maloney 

Ranking Member 

Subcommittee on Financial Institutions and 

Consumer Credit 

2332 Rayburn House Office Building 

Washington, DC 20515 

On behalf of the 25,000 members of our professional organizations, thank you for the opportunity to submit a 

statement for the record, and share the perspective of the real estate appraisal profession on H. R. 3461, the 

Financial Institutions Examination Fairness and Reform Act. Our organizations support the goals of H.R. 3461, 

namely promoting consistency of bank examinations and due process, and we are supportive of any efforts that 

would enhance consistency in the interpretation and understanding of the guidelines and regulations. 

Within the realm of appraisal, bank appraisal departments and appraisers themselves have often faced 

inconsistent interpretations of the Interagency Appraisal and Evalualion Guidelines and other applicable 

guidelines, such as the Policy Statement on Prudent Commercial Real Estate Loan Workouts. For instance, the 

area of "subsequent transactions" (modifications, refinancings, etc.) is confusing and has seen inconsistent 

statements from the regulators, some contending that an appraisal is required when there is a material change in 

market conditions, when the Guidelines themselves determine something different '. The addition of an 

ombudsman may be helpful to addressing some of these concerns. We also support due process and an 

administrative appeals program in connection with disputes regarding valuation or appraisal methodology. 

While we support the overall goals of H.R. 3461, one area of concern relates to Sec. 1013(a)(3) of the legislation, 

which we fear will unnecessarily tie the hands of bank examiners in protecting safety and soundness. Specifically, 

Sec. 1013(a)(3) is inconsistent with Real Estate Lending regulations, the Interagency Appraisal and Evaluation 

Guidelines, and the Policy Statement on Prudent Commercial Real Estate Loan Workouts as introduced in that it 

would prohibit any reappraisal of a performing loan even if examiners identified safety and soundness concerns. 

We do not believe that federal bank examiners should have their "hands tied" on issues of fundamental 

importance to safety and soundness. 

, According to a 2008 presentation by a Federal Reserve offiCial, "A subsequent transaction (even with the 

advancement of new monies) may be exempted from the appraisal requirement, but a bank must obtain or 

perform an evaluation. If there has been obvious and material changes in market conditions or phvsical aspects of 

the property that threaten the adequacy of the bank's collateral protection the transaction does not qualify for 

exemption and the bank must obtain an appraisal." See Slide 16 at 

http://www. fdic.gov/regulations/resources/minority/eventslinteragency/presentations08/Siddigue. pdf The 2010 

Interagency Appraisal and Evaluation Guidelines state: A subsequent transaction is exempt from the appraisal 

requirement if no new monies are advanced (other than funds necessary to cover reasonable closing costs) even 

when there has been an obvious and material chanqe in market conditions or the physical aspects of the prooerty 

that threatens the adequacy of the institution's real estate collateral protection. See Page 46 at 

htlp:llwww.ncua.gov/NewslPressINW20101202InteragencyAppraisal.pdf 
171 


75069.108

HR. 3461, the Financial Institutions Examination Fairness and Reform Act 

February 1, 2012 

In our view, Sec. 1013(a)(3) may not be necessary because current regulations and guidance do not require 

reappraisal of performing loans. Under the regulations, outside of the safety and soundness trigger, a new 

appraisal is not required for a loan workout or refinance unless there are new monies involved and there has 

been a material change in market conditions or the physical aspects of the property. Otherwise, an "evaluation" is 

acceptable. In this regard, including Sec. 1013(a)(c) may confuse a matter that is already seltled through existing 

regulations. 

Consistent Value Definitions 

One set of issues that deserves consideration within the context of the bill are definitions of value used by federal 

bank regulatory agencies. We believe examinations would be made more consistent through the establishment of 

clear value definitions. Specifically, bank risk assessment of troubled loans would be enhanced greatly by 

obtaining both Market Value and Liquidation Value under commonly accepted definitions. A definition of 

Disposition Value may also be beneficial, as appraisals are commonly ordered with two or more values, and there 

are distinct definitions for all three. 

While Market Value is essential to understand the position of the credit, Liquidation Value can enhance the 

decision making of banks during loan workouts by establishing worst case scenarios for the bank. This is 

essential to making determinations on whether it is belter to foreclose on the property or conduct a loan workout. 

Such appraisal assignments are common today, but not recognized in regulations. Yet, if a bank orders a 

valuation product with such a value as part of the scope of work, our members have reported that examiners have 

demanded it be used in lieu of Market Value. 

Such demands are not appropriate and lead to unnecessary write downs of loans. A clarifying amendment 

defining the appropriate use of Liquidation Value and prohibition against using it to classify the loan would help 

improve overall bank risk management activities. 

Definition of Performing Loan 

An additional recommendation that would help enhance consistency in regulations, and protect safety and 

soundness, would be to define "Performing loan", as it is not currently defined in regulation or guidance. The 

Policy Statement on Prudent Commercial Real Estate Loan Workouts makes clear that loans should be based on 

"reasonable terms." As such, we suggest the following definition: 

For the purposes of this subsection, all performing commercial loans shall be based on reasonable loan 

terms and the cash flow potential of the under/ying collateral or business and be paying as agreed to 

those under contract. 

Thank you for the opportunity to speak on the record, and we look forward to working with you on passage of H.R. 

3461. 

Sincerely, 

Appraisal Institute 

American Society of Farm Managers and Rural Appraisers 
172 


75069.109

Statement of BancVue, Ltd. 

Hearing on H.R. 3461, Financial Institutions Examination Fairness and Reform Act 

Committee on Financial Services 

United States House of Representatives 

February 1, 2012 

BancVue, Ltd. ("BancVue") is pleased to provide this statement in connection with the hearing 

on H.R. 3461, Financial Institutions Examination Fairness and Reform Act. BancVue supports 

community financial institutions and assists them in competing against large financial 

institutions by providing innovative products and services. For the reasons set forth below, 

BancVue strongly supports H.R. 3461 and encourages lawmakers to pass the legislation with two 

minor modifications. 

Regulatory compliance continues to grow in complexity. However, lawmakers have long 

reeognized the importance of consistency in the development and application of banking 

regulations. In fact, the Federal Financial Institutions Examination Council Act of 1978 

established the FFIEC to "prescribe uniform principles and standards for the Federal examination 

of financial institutions," "make recommendations to promote uniformity in the supervision" of 

financial institutions, and "promote consistency" in examinations. I 

At BancVue, we support the compliance efforts of community financial institutions and want to 

assist them in meeting Federal regulatory requirements. Likewise, we believe that the Federal 

regulatory agencies strive to apply Federal regulatory requirements in an appropriate marmer, 

and support their efforts to educate and cooperate with financial institutions regarding regulatory 

requirements. However, inconsistencies that have arisen in the application and enforcement of 

the Federal regulatory requirements have given rise to confusion, frustration, and countcrproductivity for many financial institutions and examiners alike. 

I. The Timeliness of Examination Reports provisions will improve the consistency 

and timeliness of the examination process. 

While community financial institutions' experiences vary, the general view appears to be that 

examinations are continuing to get longer and less timely, with sometimes significantly extended 

time periods between the information request, the initial onsite visit, the conclusion of the onsite 

work, the exit interview and the completion of the final report. We believe that the requirements 

in the bill for an exit interview to be held within 9 months after commencement of the 

examination, and for the final examination report to be provided to the institution within 60 days 

1 Federal Financial Institutions Examination Council Act of 1978 § 1002, 12 U.S.C. § 3301 (1979). 
173 


75069.110

after the later of the exit interview or the institution providing additional information, will 

improve the delays and timeliness issues that financial institutions are experiencing in 

examinations. 

II. The establishment of the Office of Examination Ombudsman and Right to 

Appeal Before an Independent Administrative Law Judge will aid both 

regulatory agencies and financial institutions in understanding and applying the 

regulations in a consistent manner. 

Over time, the regulatory requirements have become increasingly complicated and challenging to 

apply. Some complexities have arisen from the regulatory requirements themselves, while some 

have arisen from the inconsistent application and enforcement of the regulatory requirements 

between the agencies. For example, the Federal Reserve indicated in its Consumer Compliance 

Outlook publication that an overstated APR could result in a financial institution being required 

to rediscJose its early Truth in Lending disclosure on mortgage loans? However, after a 

considerable number of conversations with financial institutions, we have found no evidence that 

other agencies are applying the regulatory requirements in this manner. 

Similarly, consistent application and enforcement of the regulatory requirements can become 

extremely difficult when one agency writes the rules but other agencies are required to enforce it. 

For example, there appeared to he significant variations in how the different agencies enforced 

the RESPA regulations written by HUD. Financial institutions that sought assistance in trying to 

comply with the RESPA rules were faced with the conundrum of getting advice from HUD, 

which did not examine them, or getting advice from their examining agency, in which case the 

response was often that the agency could not advise on another agency's regulation. The 

consolidation of the rulewriting responsibilities of consumer protection laws within the 

Consumer Financial Protection Bureau should simplify and streamline inconsistencies within the 

regulations. However, enforcement of the CFPB's rules by the primary regulatory agencies 

could cause considerable confusion about the proper interpretation and application of the 

regulatory requirements if efforts are not made to ensure consistency between the agencies. 

Below are quotes from community tinancial institutions that have experienced difficulty with the 

application or enforcement of the regulatory requirements firsthand: 

"Our exam this past summer. .. was a dual exam between the Federal Reserve and 

the New York State Banking Department. The exam included Compliance, CRA 

and Fair Lending. The exam lasted 4-5 weeks (they came, left and then returned 

so the exact number of days is unclear) and the number of people ranged from 6-

8. We had an excellent rating prior to this exam ... The compliance examiners 

come in with unlimited budgets and correspondingly unlimited time to search our 

2 Ken Shim, Mortgage Disclosure lmprovement Act: Corrected Disclosurefor an Overstated APR, Federal Reserve 

Consumer Compliance Outlook (I" Quarter 20 II). 
174 


75069.111

files for errors that prove exactly what? That our people are guilty of clerical 

errors? As the fonns become more numerous they are assured of finding more 

errors if only due to the size and complexity of the additional requirements. And it 

still comes back to the basic question of for what purpose? The cost has to be 

enonnous in relation to what they could possibly find in our institution and 

thousands of similar institutions throughout the U.S." Alden State Bank, Alden, 

NY 

"We have received examination criticism that was inconsistent with what prior 

examiners found, inconsistent with what was found in prior examinations by the 

same examining body, and inconsistent with guidance from our regulator. We did 

not attempt to get assistance from the senior exam staff at our regional agency 

office, appeal the findings, or get assistance from our ombudsman. The 

inconsistency of the examination has made it extremely difficult for us to 

understand what is expected of us and comply with the expectations of our 

examiner, [and] anticipate what will be considered to be noncompliant in 

upcoming examinations that was considered to be compliant in the past." This 

institution has requested that we omit their name but has allowed us to provide it 

upon request. 

"We received a Document of Resolution (DOR) during our 2010 exam, requiring 

us to dramatically reduce activity in a portion of our business. While the issues 

cited were taken care of and outstanding concerns were far less when reviewed 

during our 2011 exam, the DOR remained in place, although with a slightly less 

severe outcome than the previous year. We specifically asked the examiners 

when the DOR would be lifted or what we need to do before it would be lifted. 

They replied that we couldn't get it lifted, that it will come down to the 

detennination ofthe examiners to lift the DOR. There needs to be a framework in 

which a [financial institution] can prove they have remedied a situation to the 

point where the examiner has to lift the DOR, not simply go on the judgment of 

an examiner at some future point in time." The institution has requested to 

remain anonymous. 

"My financial institution has not tried to appeal a decision from our regulator. 

The appeals process does not appear to us to be independent. The appeals 

process appears to bc similar to being bullied in elementary school and your only 

appeal [is] to the bully's mother. As a result, we did not feel that it would help us 

resolve the dispute with our examiner. .. Typically in the past if the examiners 

found areas of concerns they would identify the area of concern and make 

suggestions on how to improve in these areas. Now, minor infractions are met 

with severe criticisms and or penalties ... The exam process now seems to be 

totally adversarial...I am not opposed to a regulated financial system but the 
175 


75069.112

players in our system need to work together to keep our system safe, sound and 

profitable. At this time one of the players in this system is not accountable to the 

others and this is creating problems that we will be a long time in overcoming 

unless we return to the sense of cooperation that we have had in the past." The 

institution has requested to remain anonymous. 

Several financial institutions expressed a desire to comment but chose not to due 

to concerns about potential retaliation. 

We strongly support Sections 3 and 4 of the bill because they should add an extremely important 

and often missing element of consistency between regulators in the examination process. Under 

the bill, the Office of Examination Ombudsman will be responsible for obtaining feedback from 

financial institutions about their examination experiences, investigating complaints about the 

examination process, conducting quality assurance of all examination types, processing certain 

supervisory appeals, and ensuring that examination procedures are consistent between the 

regulatory agencies. These critical responsibilities will help increase consistency within the 

examination process itself. 

Further, the bill's appeals process for obtaining a hearing with an Administrative Law Judge 

provides an impartial, independent means for financial institutions to seek recourse for material 

examination issues, as well as a way for the Ombudsman to identifY variations in how the 

agencies may be enforcing the regulations. This insight into potential enforcement 

inconsistencies, combined with the Ombudsman's responsibilities relating to consistent 

examination procedures, could provide an exceedingly effective means of improving consistency 

in the interpretation and application of the regulatory requirements. 

III. BancVue Recommends Two Minor Clarifications to the Bill in Order to 

Strengthen its Effectiveness. 

BancVue believes that H.R. 3461 will be very effective in improving the timeliness and 

consistency of the examination process. However, there are two clarifications that we believe 

will further improve the effectiveness of the proposed legislation. 

a. Section l014(d)(3) should be revised to require the Ombudsman to review all 

supervisory guidance, not just the examination procedures, of the Federal 

regulatory agencies. 

While examination procedures arc widely used when performing examinations, banking and 

credit union examiners also look to a variety of other agency guidance, such as: 

• Interagency guidance; 

• Supervisory guidelines; and 

• Supervisory articles, bulletins and other publications. 
176 


75069.113

As a result, inconsistencies can arise even when examination procedures are consistent between 

regulatory agencies. We recommend that the reference to examination procedures in Section 

1014(d)(3) of the bill be modified to state that the Ombudsman shall "review examination 

procedures and other supervisory material of the Federal financial institutions regulatory 

agencies." 

b. An additional provision should be added to Section 1015 to clarify that the 

Right to Appeal Before an Independeut Administrative Law Judge is 

available without regard to whether a financial institution has utilized its 

regulator's intra-agency appeals process. 

We interpret H.R. 3461 to provide financial institutions with the right to appeal all material 

supervisory determinations that are included in a final examination report, regardless if the 

institution sought relief through its primary Federal regulator's intra-agency appellate process. 

We do not encourage financial institutions to seeking relief through multiple channels in order to 

get a result that they desire. However, we are concerned that any administrative procedures that 

will be developed to implement the bill's right to appeal before an independent Administrative 

Law Judge could require a financial institution to meet additional requirements before exercising 

its right, such as seeking recourse with its primary Federal regulator before seeking relief 

through the appeals process. In order to reduce the risk that this important right to appeal will 

not be inadvertently hampered when it is implemented, we recommend that a statement be added 

to Section 1015 indicating that a financial institution is not required to seek relief from its 

Federal regulatory agency prior to requesting a hearing with an Administrative Law Judge. 

Thank you for the opportunity to express our support for H.R. 3461 and voice the experiences of 

some of the community financial institutions that we serve. We believe that the bill will be 

extremely effective in improving the examination experience as well as the consistency with 

which the Federal regulatory requirements are interpreted, applied, and enforced. Such 

consistency will provide financial institutions and examiners with more clarity, thereby 

improving examiners' ability to understand and communicate regulatory requirements and 

financial institutions' ability to meet them. 
177 


75069.114

Questions for Kevin M. Bertsch, Associate Director, Division of Banking Supervision and 

Regulation, Board of Governors of the Federal Reserve System, from Representative 

McCarthy: 

The legislation requires regulatory agencies to develop and apply uniform definitions and 

reporting requirements for non-performing loans. Ensuring that standards work for both 

small and large financial institutions, while also giving the agencies flexibility to continue to 

address unique situations of smaller institutions is vital. 

Do you feel uniform standards for non-performing loans are achievable, or are there 

alternative ways to provide for consistency of the loan classification process? 

For many years, the banking agencies have utilized uniform classification definitions for key 

asset types, including commercial loans, retail loans, and investment securities. In addition, as 

set forth in interagency Call Report instructions, the agencies have long relied on U.S. GAAP to 

guide bank financial reporting on asset categories that are often included in definitions of 

"nonperforming," such as nonaccrualloans, loans past due 90 days or more, and troubled debt 

restructurings. From time to time, the agencies have also issued supplemental interagency 

guidance to enhance the consistency with which classification definitions are being applied for 

specific asset types, addressing, for example, classification of commercial real estate loan 

workouts in 2009. We believe that uniform regulatory standards for non-performing loans are 

achievable. At the Federal Reserve, we have taken steps to promote consistency by ensuring that 

examiners are well-trained on classification and financial reporting requirements, supporting 

examiners with staff that have accounting expertise and can respond to questions about 

appropriate accounting treatment as needed, and reviewing selected examination reports and 

work-papers to ensure consistency with existing guidance. 
178 


75069.115

Questions for the Record 

Financial Institutions Subcommittee Hearing 

"HR 3461 - The Financial Institutions Examination Fairness and Reform Act" 

February 1,2012 

Rep. Carolyn McCarthy (NY-4) 

Panel 1 - to all witnesses: 

The legislation requires regulatory agencies to develop and apply uniform definitions and 

reporting requirements for non-performing loans. Ensuring that standards work for both small 

and large financial institutions, while also giving the agencies flexibility to continue to address 

unique situations of smaller institutions is vital. 

Do you feel uniform standards for non-performing loans are achievable, or are there alternative 

ways to provide for consistency of the loan classification process? 

Uniform standards for "non-performing loans,,1 

Yes, uniform standards for nonperforming loans are achievable and in fact are currently used in 

interagency policies and regulatory reporting instructions. For example, nonperforming loans 

are generally loans that have been placed in nonaccrual status. The Federal Financial 

Institutions Examination Council (FFIEC) Consolidated Reports o/Condition and Income (call 

report) instruction glossary establishes criteria for when a loan should be placed on nonaccrual 

status and when a nonaccrualloan should be restored to accrual status. All institutions required 

to file a call report must apply these nonaccrual standards. The OCC strives for consistent 

application of these uniform nonaccrual standards within our agency through training, internal 

guidance and quality assurance reviews. 

It is important to note, however, that all classified loans are not necessarily nonperforming loans, 

under interagency regulatory definitions. The determination to put a loan on nonaccrual status is 

independent of the loan classification. Classification decisions require judgment and an 

understanding of the loan's term and structure and the borrower's historical, current, and future 

ability to repay both principal and interest - factors that require careful consideration and 

analysis based on each loan. 

1 Nonperforming loans are considered loans that are 90 days or more past due plus loans on nonaccrual. 
179 


75069.116

Consistency on Loan Classification Process 

Uniform Definitions 

The federal banking agencies have uniform definitions for assets adversely classified as well as 

those assets listed as special mention.2 These long-standing definitions were included as an 

attachment to the October 2009 Interagency Policy Statement on Prudent Commercial Real 

Estate (CRE) Loan Workouts (policy statement). The policy statement states that loans 

adequately protected by the current sound worth of the borrower or underlying pledged collateral 

generally are not adversely classified. The policy statement further directs that examiners should 

not adversely classify performing commercial loans solely because of a decline in value of the 

underlying collateral as long as there is not a well-defined weakness that jeopardizes repayment. 

Examiner Training 

Each agency has ongoing training programs in place to ensure the loan classification process is 

consistent. The agencies also offer through the FFIEC a variety of courses for examiners to 

ensure consistent application of the agencies' loan classification policies. These courses include: 

Advanced Cash Flow Concepts and Analysis; Advanced Commercial Credit Analysis; Cash 

Flow Construction and Analysis from Federal Tax Returns; Distressed Commercial Real Estate; 

and, Real Estate Appraisal Review. 

Commercial Credit Policies 

To further promote loan classification consistency across the agency, the OCC has commercial 

credit lead experts (lead experts) in each OCC district and a commercial credit policy division 

headquartered in Washington, DC. The lead experts are experienced commissioned examiners 

with extensive commercial credit knowledge and skill in applying the uniform classification 

guidelines, and are members of the OCC's National Commercial Credit Committee that meets 

each quarter. The lead experts share information across districts and confer on a routine basis to 

ensure that the uniform classification guidelines and the OCC's supervisory policies are 

consistently and appropriately applied in our examinations. They work with our credit policy 

division to provide policy clarification and support to examiners and bankers, and to respond to 

questions and emerging issues. They also work with the OCC's district management teams on 

the application and execution of quality control reviews performed throughout the districts to 

ensure consistent application of the interagency loan classification definitions. 

Examination Quality Control 

Loan classifications and accrual determinations are reviewed and discussed by examination 

teams with sign off by the examiner-in-charge before finalizing bank examinations. This 

promotes consistent application of the interagency loan classification guidelines. Each district 

conducts ongoing quality assurance reviews to uphold the consistent application of classification 

standards. The OCC also conducts periodic national calls to discuss supervision requirements 

2 Comptroller's Handbook "Rating Credit Risk" April 200] and Banking Bulletin 93-35 "Interagency Definition of 

Special Mention Assets" 
180 


75069.117

and expectations. These calls are led by senior management and include speakers with subject 

matter expertise. For example, the September 201 1 call focused on troubled debt restructurings, 

specific valuation allowances, other real estate owned, and other topics. The February 201 1 call 

included a review and discussion of the interagency appraisal requirements. 

Banker Outreach and Appellate Process 

In addition to these internal and interagency efforts to promote consistency, the OCC also 

provides classification guidance directly to bank management and directors through OCC 

outreach functions. For example, the OCC conducts bank director workshops to educate bank 

directors on various risk management practices, including credit3 The credit workshop is 

designed for strengthening credit risk understanding and is presented to outside directors of 

national community banks and federal savings associations. 

The OCC appeals process provides a means for bankers to have an independent review of 

classification decisions with which they disagree.4 

3 Credit Risk: A Director's Focus (multiple locations) 

4 National Bank Appeals (June 2010) 
181 


75069.118

NCVA's Responses to Questions for the Record 

House Financial Services Financial Institutions and Consumer Credit Subcommittee 

Hearing on H.R. 3461, the Financial Institutions Examination Fairness and Reform Act 

February 1,2012 

Question Submitted by Congresswoman Carolyn McCarthy 

• Are uniform classification standards achievable or is there an alternative way to bring 

consistency to the loan classification process for non-performing loans? 

In response to your question, I would like to emphasize, first and foremost, that eommercial 

lending represents less than 10 pereent of all lending activity in credit unions and amounts to 

$37.2 billion in lending activity on an industry asset base of$961 billion. Additionally, NCUA's 

response refers to the commercial lending activities of credit unions and not consumer lending 

activities, as the testimony and related questions foeused on commercial loans. NCUA also 

believes the intention was to discuss non-accrual loan classification approaches, as well. 

All of the federal regulators, including NCUA, participated in the development of the 2009 

Interagency Guidance on Prudent Commercial Real Estate Loan Workouts.! This authoritative 

guidance for credit unions details prudent best practices for commercial loan restructures and 

refinances. While this guidance is not incorporated in regulation, it provides a flexible prudential 

framework for financial institutions without creating undue regulatory burden or constraining 

institutions with varying degrees of risk, complexity, and diversity within their business models 

and commercial loan portfolios. 

NCUA has also issued a Supervisory Letter in January 20 I 0 entitled Current Risks in in Business 

Lending and Sound Risk Management Practices.2 This supervisory release identified NCUA's 

evaluation of risk in the industry, and set expectations for appropriate risk-management 

practices, as well as areas of focus by examiners. 

NCUA trains examiners on the job and through fonnal classroom training on eommercial 

lending practices and techniques. NCVA also makes use of specialized examiners with 

enhanced commercial loan training in our most sophisticated and largest commercial lending 

credit unions. 

Finally, it is important to emphasize that a classification methodology is primarily a vehicle to 

ensure that loan valuations are correct for financial statement presentation. Those valuations 

ensure that users of the financial statements, including investors and depositors, have a 

transparent view of the true financial eondition of a financial institution. Any approach that 

1 See http://www.ncua.govIResources/Documents/LCU201 0-07Encl.pdfas well as NCUA's Letter to Credit Unions 

10-CU-07 

2 See http://www.ncua.gov/ResourceslDocuments/LCU201 0-02Encl.pdfas well as See NCUA's Letter to Credit 

Unions IO-CU-02 
182 


75069.119

clouds transparency would prove counterproductive and could have the effect of creating greater 

uncertainty in the marketplace. 

Identical Classification for Non-Performing Loans 

The classification of a commercial loan is, by nature, judgmental and requires both the financial 

institution management and examiner to evaluate collectability of a loan under unique 

circumstances related to that specific loan. Differences between loans, institutional undcrwriting 

practices, or even geographic concentration risks can vary significantly from one loan to another 

and one institution to another. It would be very difficult to apply a rigid set of identical 

standards across regulators when the conditions affecting the classification of a commercial loan 

can vary widely. As a result, the judgment of management and the examiner are critical to the 

effective classification of non-performing loans. 

Currently, NCUA places the responsibility on credit unions to establish an appropriate 

classification policy that meets the complexity, size, and risk profile of the institution's 

commercial loan portfolio. Credit unions arc further expected to consistently apply the 

methodology. 

NCUA instructs examiners to evaluate the rigor and appropriateness of the credit union's 

methodology given the complexity, size, and risk profile of the institution's commercial loan 

portfolio. NCUA's evaluation will often include testing on individual credits, which can lead to 

conflict with management over a classification methodology. As mentioned earlier, NCUA's 

Letter to Credit Unions that circulated the Interagency Guidance on Prudent Commercial Real 

Estate Loan Workouts provides authoritative guidance to credit unions and examiners alike. 

Identical Classification for Non-Accrual Loans 

H.R. 3461 also would require the establishment of identical definitions and reporting 

requirements for non-accrual loans. The creation of "bright line" statutory requirements for 

financial reporting may grant relief during trying economic periods. Such laws, however, may 

have the opposite effect in periods of economic growth. Additionally, any legislative changes 

that could blur the public perception that financial statements are not transparent could result in a 

negative market effect. 

The interagency Policy Statement on Prudent Commercial Real Estate Loan Workouts outlines 

policy considerations that should govern and inform credit unions' non-accrual and classification 

decision processes based on the size and complexity of the institution.3 

3 Currently, credit unions have the freedom to develop their own loan grading schematic. NCUA does not impose 

specific standards on credit unions, but provides guidelines to credit unions in a 2006 Interagency ALLL Policy 

Statement through an Appendix entitled Loan Review Systems. Examiners review a credit union's loan grading 

system as it provides important information on the collectability of the portfolio for use in a number of areas within 

the examination process. NCUA realizes loan grading assessments by their very nature involve a high degree of 

SUbjectivity. And NCUA has observed that a credit union's ability to estimate identifY nonperforming loans and 

eSlimate credit losses on specific loans and groups ofloans should improve over time as substantive information 

accumulates regarding the factors affecting repayment prospects. Therefore, our examiners should generally accept 

management's assessments when evaluating the appropriateness of the credit union's loan grades, and not seek 
183 


75069.120

NeUA's approach provides greater flexibility to credit unions to adapt to changing economic 

conditions. NeUA's approach also ensures that credit unions maintain autonomy in making loan 

performance judgments based on all the available facts and circumstances affecting loan 

collectability and performance. 

The establishment of a statutory "bright line" to inform judgments that by their very nature 

require judgment may permit credit unions to ignore other available information about the 

borrower in consideration of true loan collectability. Less transparency or incomplete analysis 

can reduce the reliability of financial statements which could prove destabilizing. 

NeUA's existing agency guidance allows for credit union and examiner judgments, but cautions 

examiners on a numbcr of issues addressed in the proposed legislation. The existing guidance, 

when appropriately implemented, strikes the appropriate balance for all stakeholders. 

Many of the concepts revolving around non-performance and non-accrual are also founded in 

Generally Accepted Accounting Principles (GAAP). Any legislative changes that conflict with 

GAAP have the potential to reduce transparency on the financial performance of a financial 

institution and could result in additional administrative burden of maintaining both a statutory 

and a GAAP financial statement presentation. 

NeUA respectfully submits that the way to achieve consistency in the loan 

classification/grading, loss provisioning, and non-accrual processes is to strengthen consistent 

implementation of existing interagency guidance. 

adjustments when management has effectively incorporated reasonable and properly supported assumptions, 

valuations, and judgments into the evaluation process; and analyzed all significant qualitative or environmental 

factors that affect the collectabilily ofthe portfolio as ofthe evaluation date in a reasonable manner. 
184 


75069.121

TESTIMONY OF DAVID BARIS 

EXECUTIVE DIRECTOR, AMERICAN ASSOCIATION OF BANK DIRECTORS 

BEFORE THE 

US HOUSE SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND 

CONSUMER CREDIT 

NEWNAN, GEORGIA 

AUGUST 16,2011 

Good morning Chairwoman Capito, Ranking Member Maloney and members of the 

Subcommittee. Thank you for the opportunity to submit this statement for the hearing record. 

The American Association of Bank Directors provides advocacy, informational and 

educational support for bank and savings institution directors. 

Your hearing today and previous hearings on the bank examination process on July 8 and 

May 26, 2011 are extraordinarily important. They help to shed light on a process that often is 

shrouded in secrecy. Bank examiners can make life and death discretionary examination 

decisions. Public pronouncements by federal banking agency heads, while made in good faith to 

make the process more transparent, may not always be consistent with what may happen during 

and after an examination of an individual bank. 

The federal banking agencies have had virtually unbridled discretion in how they 

examine banks. 

Until recently, Congressional oversight of the bank examination process has been limited 

and lacked depth. 

Banks may appeal examination rcsults to thc Ombudsman of the agency that examines 

them, but many banks are reluctant to appeal for fear of retribution and others decide not to 

because they do not believe that the Ombudsman is truly independent of the agency. 

Banks have no statutory right to appeal adverse results of an examination to a federal or 

state court. 

The examiners in the field as well as some of their supervisors realize that if they err on 

the side of stringency, they will not be criticized. But they know that the Inspectors General of 

the respective federal banking agencies will criticize them for not having identified problems 

earlier in banks that ultimately failed. The reports of the Inspectors General frequently criticize 

the primary federal banking regulator of the failed bank for not having identified and acted on 

deficiencies earlier, but never criticize the regulator for being too stringent. 

Bank examiners have discretion on a wide array of matters, including whether to classify 

a loan, whether to place a loan in nonaccrual cven though it is performing, and to substitute their 

own ALLL methodology for that of the bank. This is so even though a bank might have had 
185 


75069.122

reasonable systems and controls in thc bank to make reasoned determinations of their own, or 

may have relied on qualified third party auditors or loan review advisors for their determinations. 

Many of these decisions arc judgment calls based on the facts and circumstances of the 

individual bank. It matters a great deal as to the extent to which examiners allow banks to 

exercise reasonable discretion in exercising their good faith judgment. 

During good times, examiners tend to give bankers some leeway in applying reasonable 

judgment as to these matters; but when the economy weakens, there is a greater tendency to 

substitute the examiners' judgment for that of the bankers. This is unfortunate since examiner 

judgments can make a recession deeper and longer than it needs to be. That is because a bank's 

financial condition will often dictate whether it can make loans to those who reside and do 

business in their community and because the uncertainty and unpredictability of examiner 

judgments make banks less willing to lend except in limitcd circumstances involving 

extraordinarily strong borrowers. 

Another disincentive to lend is the risk of personal liability that bank directors face from 

enforcement actions and suits by the FDIC following a bank failure. AABD recently advised 

bank directors to stop approving loans until the FDIC satisfactorily provides a "safe harbor" 

under certain circumstances for bank directors who approve loans. The FDIC has declined the 

offer. Outside directors are generally individuals with no bank lender experience who rely in 

good faith on the recommendations of their banks' lenders and credit officers. In his Grant 

Interest Rate Observer dated July I, 2011, under the heading "Chill is in the air", James Grant 

questioned whether bank directors will continue to approve loans in face of the potential personal 

liability they face if their bank fails or gets into trouble. 

The banking regulators sometimes have exercised their enormous unfettered discretion in 

determining when to seize a viable community bank, resulting in catastrophic economic 

consequences for communities served by such community banks improperly seized and for their 

shareholders, and irreparable reputational and economic damage to the local business leaders 

who serve on local community bank boards of directors. There is a pressing need to protect 

against such regulatory abuse by requiring a higher level of accountability and transparency to 

ensure that the banking agencies act in accord with legal standards governing the extraordinary 

regulatory remedy of a bank seizure. 

The Subcommittee's hearing on January 21, 2010 on the closing of Park National Bank, 

Chicago, a leading community bank lender to Chicago'S inner city, raised significant questions 

about the propriety and wisdom of closing that bank. 

In one especially troubling example of a plainly impropcr community bank seizure, a 

viable Denver bank with $400 million in available cash was seized by the OTS and FDIC 

without adequate statutory grounds. United Western Bank was on the verge of a $200 million 

private-sector recapitalization that would have further strengthened the bank's financial position 

and avoided a large and wholly unnecessary loss to the FDIC Deposit Insurance Fund. But in the 

face of a private-sector solution that would have led to expanded community banking activities 

in the Denver market, the OTS and FDIC precipitously and improperly closed the bank because, 

we believe, the regulators did not like the bank's business modeL 

2 
186 


75069.123

Immediately following the seizure, all of the deposits and most of the assets of the bank 

were assumed by First-Citizens Bank and Trust Company, a North Carolina-based institution 

with over 400 branches that is owned by one of the 50 largest holding companies in the United 

States. Almost immediately following the January 2011 seizure and sale of the Bank by the OTS 

and FDIC, the acquiring bank closed four of United Western's eight branches, suspended United 

Western's large and successful SBA lending program, informed existing borrowers and new 

applicants that it would not make loans in the Denver market for at least 18 months, and fired 

approximately 50 local employees. 

The regulators no doubt thought their drastic actions to impose the ultimate punishment 

on the bank for not embracing the business advice of the regulators would go unchallenged and 

their decision-making process remain secret, as they havc in the almost 400 bank seizures since 

2007. They were wrong in this instance. United Western Bank's owners sued the OTS and 

FDIC demanding the return of the bank to its rightful owners. At every tum in that proceeding, 

which is pending in U.S. District Court in the District of Columbia, the OTS and FDIC have 

attempted to evade judicial scrutiny and the exposure of their secretive internal processes. First, 

the OTS and FDIC sought to dismiss the case on technical grounds. Later, and only after being 

ordered to do so by the Court, the OTS produced a hand-picked, sanitized administrative record 

that excluded all of the many discussions between the agencies concerning the FDIC's distaste 

for the bank's business model and directive that the OTS force the bank to change that model 

and any internal communications discussing whether failing the bank was the right answer given 

its relatively strong financial position relative to other regulator-defined "troubled banks." 

Indeed, the regulators sought to persuade the Court that only a grand total of two intcrnal email 

communications within or between the agencies were relevant to determination to seize the bank. 

Notwithstanding these efforts to protect the secrecy of the regulatory proceedings leading 

to the seizure of this bank, in this case these proceedings may yet be exposed to public review. 

The OCC (who was substituted for the now-defunct OTS) was ordered by the court last week to 

certify the completeness of the censored administrative record or supplement the record as 

necessary after failing to convince the court that the administrative record, which will be made 

public, should consist of only those documents assembled by the OTS to support its position 

rather than everything, favorable or unfavorable, considered by the OTS. The court rejected 

soundly the longstanding position of the regulators that they are entitled by law to avoid judicial 

and public scrutiny of their actions and decision-making process related to seizing a community 

bank.] 

While the United Western case and other subsequent cases involving other community 

bank seizures may ultimately cause the regulators to curtail the improper use of their 

extraordinary powers to seize community banks virtually at their whim, this subcommittee has 

the opportunity immediately to create transparency in the process and modifY banking agency 

practice to conform to legal requirements. 

IDavid Baris is a partner in the law firm of BuckleySandler LLP, which represents the 

former owners of United Western Bank. 

3 
187 


75069.124

This subcommittee has the authority to obtain agency materials and ask probing questions about 

the United Western Bank seizure and other comparably questionable recent seizures by the bank 

regulators. A strong community bank system is of critical importance throughout this nation to 

ensure availability of credit to small businesses and families. It should be the highest priority of 

the federal bank regulatory system to avoid wherever possible that which the FDIC and the OTS 

caused to occur in the case of United Western Bank, the seizure ofa local bank and its resale to a 

large bank thousands of miles away that immediately stopped delivering certain basic banking 

products and services to the local community. 

H.R. 2056, which passed the House of Representatives last month, is a step in the right 

direction. More can be done. The House Committee on Financial Services can direct the GAO 

to conduct a thorough study on the bank examination process to assure that the process is fair 

and consistent and properly gives banks reasonable discretion to classify loans, determine the 

accrual status of loans, adopt and apply a reasonable ALLL methodology, and make other 

reasonable determinations in operating their businesses. 

4 
188 


75069.125

Questions for Kevin M. Bertsch, Associate Director, Division of Banking Supervision and 

Regulation, Board of Governors of the Federal Reserve System, from Representative 

Westmoreland: 

How many examiners have been disciplined since 2008? How many were disciplined for 

not fully utilizing staudard agency guidance for examination procedures? 

How many examiners have had employment terminated since 2008 as a result of poor 

performance? 

The Federal Reserve conducts its supervisory activities through its twelve Federal Reserve Banks 

across the country. Supervision is guided by policies and procedures established by the Board, 

but is conducted day-to-day by the Reserve Banks and their examiners. The performance of 

examiners is overseen and managed by officials of the Federal Reserve Banks. 

In order to ensure consistent application of agency guidance, Federal Reserve examiners 

complete a comprehensive training program that includes course work, on-the-job training, and 

testing prior to becoming a commissioned examiner. This comprehensive training program takes 

approximately thi-ee years to complete and combines on-the-job training with the development of 

competencies through course work in primary areas of examination focus, including credit, 

operations, market, and management risk. Candidates must successfully complete two 

standardized and validated proficiency exams that test knowledge of concepts related to 

managing an institution and an overall understanding of other specialty areas. Typical classes 

include Banking and Supervision Elements, Credit Risk Analysis School, Financial Analysis and 

Risk Management, Principles of Asset Liability Management, Bank Management, and 

Examination Management. 

In addition, Federal Reserve examiners receive continuing professional development to maintain 

and augment their skills. To provide examiners with training on content that is relevant to the 

current business environment, the Federal Reserve has developed an online Learning Center. 

The Learning Center provides exarniners in the field with access to online training on the latest 

supervisory and regulatory guidance and emerging issues. Once delivered, the hour-long 

webcasts, called Rapid Response, are available to all Federal Reserve staff on demand. To date, 

more than 250 topics have been presented. In addition to Board guidance and policy, topics 

include Credit Analysis, Consumer Compliance, Operational Risk, Banking and Financial 

Environment, and Failed Bank Case Studies. 

Based on the individual performance planning process, the Federal Reserve also supports other 

individual professional development needs. This may include the pursnit and maintenance of 

industry certifications, attendance at advanced skill training courses, peer forums, or 

participation in skill affinity groups. 

In addition, Federal Reserve examiners are subject to a comprehensive performance management 

system. This includes annual performance planning that defines key objectives, deliverables, 

and development plans; regular performance feedback; and an annual appraisal. If a Federal 

Reserve examiner fails to meet the requirements of the position, the examiner is subject to a 
189 


75069.126

-2-

disciplinary process that could result in termination if the employee fails to correct perfOlmance 

problems. Depending on the severity of the issue, and whether it is a recurring one, a manager or 

supervisor may begin the disciplinary process at an advanced stage, up to and including 

termination. Further, management may deny or postpone merit increases for examiners on 

disciplinary status. 

In regard to issues raised by bankers and other members of the public about examiner 

performance with the Federal Reserve Board's Ombudsman's office, the Ombudsman 

investigates the issues, and, iffacts warrant, refers performance matters to the Reserve Banks for 

appropriate action within the existing performance management system. 
190 


75069.127

Questions Submitted by Representative Westmoreland 

Hearing: "H.R. 3461: the Financial Institutions Examination Fairness and Reform Act" 

February 1,2012 

For all witnesses on Panel 1: 

How many examiners have been disciplined since 2008? How many were disciplined for not 

fully utilizing standard agency guidance for examination procedures? 

How many examiners have had employment terminated since 2008 as a result of poor 

performance? 

The OCC process for ensuring consistent application of examination policy and procedures and 

sound performance by examiners is multi-faceted, and relies on formal training, regular 

communication with bankers, the performance review process, and a robust quality assurance 

review program to ensure the consistent application of examination policy. Support is provided 

by lead experts (credit, consumer compliance, capital markets, etc.) housed in each district office 

as a resource for field examiners and their managers to ensure correct and consistent application 

of policy and the arrival of accurate conclusions. Instances of examiner failure to accurately 

apply policy or arrive at accurate conclusions are typically dealt with as performance issues by 

field managers whose primary responsibility is to ensure effective bank supervision. Field 

managers review and sign-off on all Reports of Examination prior to issuance to ensure the 

accuracy and appropriate support for conclusions, citations for violations or policy exceptions, 

along with corrective action proposed. Field examiners are evaluated twice each year for, among 

other things, their technical and analytical skills, along with their ability to effectively 

communicate examination conclusions. Consistency is further assured through a quarterly 

quality assurance process. Bankers also have the opportunity to discuss and appeal examination 

conclusions via the local Assistant Deputy Comptroller, the District Deputy Comptroller, and/or 

the OCC's Ombudsman. 
191 


75069.128

NCVA's Responses to Questions for the Record 

House Financial Services Financial Institutions and Consumer Credit Subcommittee 

Hearing on H.R. 3461, the Financial Institutions Examination Fairness and Reform Aet 

February 1, 2012 

Questions Submitted by Congressman Lynn Westmoreland 

• How many examiners have been disciplined since 2008? How many were disciplined 

for not fully utilizing standard agency guidance for examination procedures? 

Since 2008, the National Credit Union Administration (NeUA) has disciplined 15 examiners. 

Of the 15 examiners disciplined, two of them were for not fully utilizing standard agency 

guidance. 

• How many examiners have had employment terminated since 2008 for performance? 

Since 2008, NeUA has terminated 29 examiners for performance. Of those 29 examiners, 26 

were terminations of probationary employees within their first year offederal employment, and 

three had worked at NeUA for more than a year. 
192 


75069.129

IIIIIII 

II1111II 

NAFCU 

Managing Examinations in Challenging Times 

Published September 2010 

(Last Updated March 2011) 

This document is designed to highlight how credit unions may challenge actions or 

findings made by NCUA examination staff In addition, it will discuss issues that credit 

unions may wish to consider when "managing" the supervision and examination process. 

It is important to remember that each credit union's situation is unique. The decision 

regarding how to respond to an NCUA examination is, of course, the responsibility of 

each individual credit union and very much depends on the particular circumstances. 

For that reason, this document does not give legal advice. Rather, it highlights existing 

processes, guidance documents and ideas shared with us by both NCUA officials and 

NAFCU member credit unions. In providing this document, NAFCU does not necessarily 

infer inappropriate behavior on the part of NeUA examiners or inadequate internal 

controls on the part of credit union boards and management. Rather, NAFCU is 

highlighting resources and ideas that can lead to examinations that accurately rate the 

operation of a credit union against existing NCUA requirements. Finally, this document 

is intended to be preventive - to assist credit unions in avoiding a serious dispute when 

less confrontational means of resolution are available. 

The current economic downturn has placed a great deal of stress upon the financial 

services industry, including NCUA and the credit union industry. In response to the 

pressures of increased NCUSIF assessments, increased delinquencies, foreclosures, 

charged off accounts and member unemployment, federal regulators have taken a more 

aggressive stance concerning enforcement and administrative actions. Agency officials 

have indicated that NCUA will take administrative actions more quickly than before in 

order to protect our insurance fund. 

Our industry may take some solace in the fact that we are not alone. A recent article in 

the American Banker by David D. Gibbons, former Deputy Comptroller of the Currency 

for Special Supervision discussed supervisory actions. Gibbons, in "Responding to 

Regulatory Actions: 5 Steps to Get it Right," wrote that, "the surge in supervisory 

- 1 -
193 


75069.130

enforcement actions is a painful reality for bankers today ... (that) CEOs and board of 

directors cannot afford ... (to) ignore .... (as) enforcement actions ... are growing 

steadily .... " Gibbons went on to state that examiner "tolerance for further risk is low, 

and their expectations for corrective action are high," and he listed "five essential" steps: 

• Taking it seriously and mobilizing one's team - not denying the problems, 

ignoring their severity or "fighting city hall"; 

• Planning for contingencies and communications; 

• Not waiting for the enforcement action to be executed to establish 

appropriate board and management governance and oversight; 

• Getting a plan in place to comply with the action and its provisions; and 

• Ensuring balance sheet risks are measured and reported accurately and in a 

timely fashion with accurate credit risk ratings and loan accounting. 

From the credit union perspective, NCUA's new stance has created more disagreements 

between credit unions and examiners. NCUA acknowledges that their examiners are not 

infallible, and in spite of examiner training, disagreements and inconsistencies may occur 

in any given examination report. NCUA has a process in place for accommodating these 

situations. How to navigate this process, and even whether to challenge exammer 

findings, are things that credit unions should consider as an ongoing concern. 

First, keep in mind that NCUA has a broad range of administrative tools at its disposal. 

Two good sources of infonnation about these administrative powers are Chapters 20 and 

30 of the NCUA Examiner's Guide. The following briefly describes some of the powers 

NCUA has at its disposal. 

• Document of Resolution. Examiners usc this administrative power, commonly 

referred to by its acronym of DOR, to fonnally document plans and agreements 

reached with credit union staff and officials to reduce areas of unacceptable risk. 

NCUA has indicated that this tool should not be used for minor issues. 

• Letter of Understanding and Agreement. A Letter of Understanding and 

Agreement, commonly referred to by its acronym of LUA, is essentially a 

contract between NCUA and a credit union. In an LUA, the credit union 

agrees to take, or not take, actions outlined in the document. NCUA has 

indicated that it issues LUAs when credit unions have not adequately 

responded to less severe measures such as DORs. 

• Cease and Desist Order. Akin to an injunction, the Federal Credit Union Act 

generally empowers NCUA to issue cease and desist orders when a credit union is 

or has engaged in an unsafe or unsound practice, or when the credit union has or 

is about to violate a law, regulation or a condition imposed in writing by NCUA's 

board. Credit unions that receive a cease and desist order have a right to a fonnal 

hearing before an administrative law judge. Once effective, violating the tenns of 

a cease and desist order can trigger additional administrative actions, including 

civil money penalties. 

• Other Powers. NCUA has numerous other administrative powers, including the 

following: 

- Issuing civil money penalties. 

- 2 -
194 


75069.131

Removing credit union officials. 

Issuing prohibition orders, which prohibit an individual from being 

involved in the affairs of any insured credit union. 

Conservatorship. 

NCUA's more aggressive stance very likely has led to inconsistent examinations. 

NCUA, like any organization, acts through its employees and agents. No matter how 

much training is received, employees will react differently to the same situation. Some 

employecs are more seasoned and will be bcttcr prcpared than others. Mistakes will be 

made by examiners and credit unions; neither is immune from this phenomcnon. It is no 

surprisc that there are increasing occasions when a credit union and the NCUA examiner 

do not see eye-to-eye on a givcn issue. 

What is a credit union to do whcn it disagrees with an examination finding? It is an easy 

question to ask, but a very difficult one to answer. NAFCU members have indicated that 

it is best to consider this issue in a step-by-step process that must be undertaken in a very 

careful, considered and deliberate manner. 

Do nothing. If the issue is minor, a credit union may wish to concede. Challenging an 

examination takes time, effort and occasionally a good deal of money. Many credit union 

executives have indicated to NAFCU that they "pick thcir battles" carefully, avoiding a 

costly confrontation except in the most extreme and unusual circumstanccs. If a finding 

is minor and can be corrected quickly, many credit unions will make the suggested 

change cven though they may disagree with the examiner's logic. 

Discuss the issue. If the credit union disagrees and wishes the examiner to reconsider his 

or her position, the first step would be to discuss the disagreement informally with the 

examiner. NCUA officials have indicated to NAFCU that when they investigate credit 

union-examiner disagreements, a breakdown in communications is usually the cause. To 

maximize their chances of success at this lcvcl, NAFCU members have indicated to us 

that a credit union should communicate the rationale for its position clearly and without 

emotion. In addition, should attempts to resolve the matter with the examiner be to no 

avail, NAFCU-membcr credit unions have indicated that, depending on the weight of the 

matter, it can be advantageous to bring supervisory examiners into the conversation 

before resorting to a formal dispute. 

Formal appeals. Should informal conversations fail to resolve a disagreement between a 

crcdit union and an examiner; credit unions have rights through which they can formally 

appeal exam findings. NCUA discussed these rights in the March 2010 issue of the 

NCUA report. Keep in mind that a credit union's board must authorize an appeal before 

it is filed. In short, the steps are as follows: 

I. Request a review from the appropriate regional director in writing within 30 days 

of receiving a final report from an examiner. The regional director is to respond 

within 60 days. 

2. Should a credit union not agree with the regional director's response or if the 

regional director does not respond within 60 days of receiving the request for 

- 3 -
195 


75069.132

appeal, a credit union may submit an appeal to NCUA's Supervisory Review 

Committee. The Committee's structure and operation are outlined in 

Interpretive Ruling and Policy Statement (lRPS) 11-1. Credit unions should 

review the IRPS closely, as the Supervisory Review Committee only handles a 

limited number of "material issues." In addition, the following text from IRPS 

11-1 is worth noting: 

The determination or denial remains in effect pending appeal. The appeal 

does not prevent the NeVA from taking any action, either formal or 

informal, that it deems appropriate during the pendency of the appeal. 

The Committee's decision is appealable to the NCUA Board within 30 days of 

receipt. 

3. There are other procedures in place for credit unions to use when contesting 

examiner findings. These can be found in the following Parts of NCUA's rules 

and regulations: 

• Part 709 (creditor claim appeals); 

• Part 745 (share insurance appeals); 

• Part 792 (Freedom ofInformation Act appeals); 

• Part 747 (appeals of various administrative and enforcement actions); 

• In addition, the NCUA Board serves as the final administrative decision 

maker for major disputes that are not otherwise covered by IRPS 95-1 

(amended by IRPS 02-1) or the regulations noted above. These issues 

include disputes over chartering, insurance applications, field of 

membership expansion, merger, certain corporate credit union matters, 

charter changes and letters of understanding and agreement. NCUA has 

indicated that these issues should first be pursued through the appropriate 

Regional Office. After that, appeals concerning these matters should be 

addressed to the NCUA Board, but submitted through the appropriate 

Regional Office. 

Given the various avenues that credit unions can pursue, it is important to know 

which avenue is the proper one given the nature of the credit union's appeal. 

In addition, there may be some other issues to keep in mind as you work through the 

exam process. 

1. Respect NeUA's position. No matter how junior the examiner, he or she 

represents an independent agency of the United States government. That agency 

has a wide array of administrative powers at its disposal. Keep in mind that an 

examination report, email, or letter comes from NCUA, not the examiner. The 

examiner is an agent of the agency. For that reason, NAFCU members have 

indicated to NAFCU that they treat official communications that they receive 

from NCUA with gravitas. The same would go for communications they send to 

NCUA or other regulators. 

- 4-
196 


75069.133

2. Due diligence. Do not sign anything on behalf of your credit union unlcss you 

understand the nature of the document. NCUA officials have indicated that credit 

unions who sign a Document of Resolution or Letter of Understanding and 

Agreement will be held to the agreement. Be prepared to discuss the terms of 

these agreements with the examiner. Even issues such as timing are open to 

debate. 

3. Develop in-house capabilities. In order to confidently appeal an examiner's 

finding, a credit union must understand NCUA's official position on a given 

issue. Credit unions should consider the development of staff with strong skills 

and expertise in the areas of accounting, finance, legal, loan underwriting, 

compliance, and statistics. Developing expcrtise in these areas will not only help 

you during a dispute. but having skilled staff will help you run your credit union 

in compliance with the laws, regulations and regulatory guidance documents that 

govern it. While the development of such skills may use considerable salary and 

training dollars, that development may payoff later in dealing with a dispute or 

preventing one from happening. 

4. Develop outside relationships. Credit unions may wish to develop relationships 

with outside auditors and attorneys. Along those lines, many NAFCU members 

advise us that it is their routine practice to have legal counsel present when the 

agency requests to meet with the credit union's CEO and board. In addition, 

credit unions should consider consulting with these outside experts on a regular 

basis, rather than waiting for a formal dispute or other "emergency" to develop. 

Bringing an outside auditor or attorney up to speed on an issue is much easier to 

do when he or she is already knowledgeable about your credit union's operations. 

In addition, consulting with outside experts can also help you avoid problems, 

thereby minimizing the chance that a need for a formal appeal would be 

necessary. Such experts often can perform audits to identifY problem areas before 

an examiner can locate them. Much like developing in-house capabilities, 

developing outside relationships will take up credit union resources. 

5. Be proactive. Many credit unions have indicated to NAFCU that it pays to be 

proactive during an exam process. Examiners visit many credit unions, but no 

one examiner is an expert on your credit union. Credit unions that actively tcach 

examiners about their skilled staff, dedicated board, credit union operations and 

the rationale behind practices, policies, and procedures may benefit. 

6. Document policies, procedures and training. Board training, practices and the 

reasons why things are done must be translated into records, procedures and other 

documents that an examiner can review. In addition, research, statistics and 

information as to why a credit union created a certain practice or procedure may 

be helpfuL 

7. Be readily acquainted with NeUA's examiner manual. NCUA has an 

Examiners Guide. Thirty-two chapters in length, the Examiners Guide is the 

reference guide for credit union examiners. Chapters cover issues such as 

lending, asset liability management, exam report writing and administrative 

actions. The guide is a good way to understand NCUA expectations on a given 

issue. lfthe examiner is not following the guide's recommendations, it would be 

reasonable to ask why. 

8. Stay professional. Creating an honest and cordial relationship with an examiner 

can go a long way. Many NAFCU CEOs have repeated a common theme make 

- 5 -
197 


75069.134

the examiner's job as easy as possible. If items have been requested ahead ofthe 

exam, gather them and have them ready when the examiner arrives. If the 

examiner asks for a document or policy, promptly providc it. Treating an 

examiner with respect and giving the examiner a comfortable and productive 

work environment can only help your case. 

9. Be specific. When an examiner (or outside auditor) indicates that you must not 

do A or B, or that you must do C or D, ask them what law, regulation or guidance 

document is the basis for the recommendation. Many credit unions ask for the 

specific legal or regulatory citation. 

10. Stay connected. While each credit union is unique, many of the situations we 

face have been seen by others. NAFCU-member credit unions have indicated to 

us that the more a credit union taps into networking, trade associations, training 

and conferences, the better prepared they are to deal with the uncertainties 

involved with NCUA supervision and examinations. 

Given the unique nature of each credit union's operations, NAFCU understands that it is 

nearly impossible to generalize how a credit union should respond to NCUA. Each 

situation will be unique, and the credit union must make a business decision on how to 

choose to respond, or not to respond, to an examination finding. In the current 

environment, NAFCU wants credit unions to be able to access all the tools available to 

get the examinations that they feel are accurate and support the condition of their credit 

union. 

o 

-6-