28

Minutes

of

The Meeting of the Advisory Committee on Community Banking

of the

Federal Deposit Insurance Corporation

Held in the Board Room

Federal Deposit Insurance Corporation Building

Washington, D. C.

Open to Public Observation

April 21, 2010 - 8:30 A.M.

The meeting of the FDIC Advisory Committee on Community

Banking ("Committee") was called to order by Martin J.

Gruenberg, Vice Chairman, Federal Deposit Insurance Corporation

("Corporation" or "FDIC") Board of Directors.

The members of the Committee present at the meeting were:

R. Daniel Blanton, President and CEO, Southeastern Bank

Financial Corporation and Georgia Bank & Trust Company of

Augusta, Augusta, Georgia; Dorothy J. Bridges, President and

CEO, City First Bank of D.C., Washington, D.C.; Charles G.

Brown, I I I, Chairman and CEO, Insignia Bank, Sarasota, Florida;

Deborah A. Cole, President and CEO, Citizens Savings Bank and

Trust Company, Nashville, Tennessee; James H. Gray, Chairman,

Beach Business Bank, Manhattan Beach, California; Jack E.

Hopkins, President and CEO, CorTrust Bank, National Association,

Sioux Falls, South Dakota; Timothy W. Koch, Professor and Chair,

Finance Department, Moore School of Business, Uni versi ty of

South Carolina, Columbia, South Carolina; John P. Lewis,

President and CEO, Southern Arizona Community Bank,

Tucson, Arizona; Rebecca Romero Rainey, Chair and CEO, Centinel

Bank, Taos, New Mexico; Bruce A. Schriefer, President, Bankers'

Bank of Kansas, National Association, Wichita, Kansas; Laurie

Stewart, President and CEO, Sound Community Bank,

Seat tIe, Washington; Ignacio Urrabazo, Jr., President, Commerce

Bank, Laredo, Texas; and Matthew Williams, Chairman and

President, Gothenburg State Bank & Trust Company,
29

Gothenburg, Nebraska. Committee members Jan A. Miller,

President and CEO, Wainwright Bank & Trust Company,

Boston, Massachusetts; and Craig M. Goodlock, Chairman and CEO,

Farmers State Bank of Munith, Munith, Michigan, were absent from

the meeting.

Members of the FDIC Board of Directors present at the

meeting were: Martin J. Gruenberg 1 Vice Chairman; Thomas J.

Curry 1 Director (Appointive); and John E. Bowman 1 Director

(Acting Director, Office of Thrift Supervision) .

Corporation staff who attended the meeting included: Ruth

Amberg 1 Valerie J. Best 1 Michael W. Briggs, Luke H. Browni

Glenn E. Cobbi Kymberly K. Copai Patricia DeVotil Diane L.

Ellis, Robert E. Feldman, Ralph E. Frable, George E. Frenchi

Steven D. Frittsi Tiffany K. Froman, Mitchell L. Glassman,

William F. Harral i Tray Hal versoni Herbert J. Held, Ellen W.

Lazar, Alan W. Levy i Roberta K. McInerneyl Tariq A. Mirzai

Arthur J. Murton, Paul M. Nash, Christopher J. Newbury,

Thomas E. Nixon, Richard J. Osterman, Jr., Sylvia H. Plunkett,

Jeanne R. Rentezelas, Claude A. Rollin, Lisa K. Roy, Barbara A.

Ryan, Christopher J. Spoth, Kimberly Stock, Sandra L. Thompson,

Jesse o. villarreal i and Mindy West.

Charlotte M. Bahin, Senior Counsel for Special Proj ects,

Office of Thrift Supervisioni was also present at the meeting.

Vice Chairman Gruenberg opened and presided at the

meeting. After noting that Chairman Bair was unable to attend

the meeting, he welcomed the Committee members. He then provided

a brief overview of the meeting agenda and introduced Paul M.

Nash, Deputy to the FDIC Chairman for External Affairs, as the

overall meeting moderator.

Sandra L. Thompson, Director of the FDIC1 s Division of

Supervision and Consumer Protection ("DSC"), and George E. Frenchi

Deputy Director, Policy, DSC1 moderated the first panel

discussion titled, "Funding and Liquidity Issues Facing

Community Banks." Ms. Thompson thanked the Committee for its

previous feedback and noted that the FDIC had made various

supervision changes based on it. She noted that interagency

guidance had been issued recently which spelled out sound

practices for identifying, measuring 1 monitoring, and

controlling funding and liquidity risk.

Ms. Thompson noted that the FDIC is not critical of

wholesale funding if it is used as part of an overall sound

April 211 2010
" ' 30

funding and liquidity program. She asked the Committee members

to share their experiences concerning whether examiners viewed

wholesale funding adversely. Ms. Thompson also spoke about core

deposit funding and the Certificate of Deposit Account Registry

Service ("CDARS"). She noted that although CDARS provides a

useful service for bank customers, they are still broke red

deposi ts, and are not core deposits. She acknowledged that

reciprocal CDARS deposits may be more stable than other brokered

deposits, if the originating bank has developed a relationship

with the depositor. While recognizing that the use of CDARS was

a continuing topic of discussion, she indicated that reciprocal

CDARS should not be criticized in examinations if they are

effectively used as part of a comprehensive funding strategy.

She asked the Committee if examiners investigate whether there

are reciprocal and long-term relationships behind CDARS

holdings.

Mr. French spoke about interest rate caps, the statutory

requirement that prevents less than well-capitalized banks from

paying significantly more than the prevailing interest rate

(whether national or local market area rates, depending on where

the deposits are solicited). Interest rate caps, he continued,

have become more important as more banks are not wellcapitalized. Concerning rates for nationally solicited

deposits, Mr. French stated that the FDIC has published on its

website a schedule of nationally prevailing interest rates based

on nationwide data. Any bank may comply with the interest rate

regulation by paying up to 75 basis points more than the posted

nationally prevailing rates, he continued.

Mr. French observed that, in a previous meeting 1 the

Committee had raised the negative impact on community banks of

the FDIC's method of calculating local area rates in geographic

areas with many branches of large banks. The FDIC's previous

method resulted in relatively low interest rate caps, he

explained, because each of the large bank branches was counted

separately in calculating the prevailing local interest rate,

and such branches have access to cheaper funding by being part

of a large bank. Mr. French said that the FDIC had studied how

to equalize the situation, and, several weeks ago, Chairman Bair

announced a new methodology for calculating the local area

market rate. Under the new approach, he explained, the FDIC

regional office could collapse all of the rates paid by branches

of the same legal entity into a single rate when looking at a

geographical area. After computing the prevailing rate on that

basis, he continued, if the FDIC determines that the market is

high-cost compared to the national rates schedule, a bank may

April 211 2010
31

use the locally prevailing rate for its interest rate cap. The

net effect, Mr. French concluded, is that the community banks in

such areas will be able to pay a little bit more, based on the

difference between the average rates paid by the large banks and

by the smaller banks (at present, the difference is about 40

basis points) .

A second issue discussed by Mr. French was whether the

Uniform Bank Performance Report definition of core deposits

should be changed. He noted that core deposits are currently

defined to be the sum of demand depositsi NOW accountsi other

transaction accounts, money market deposit accounts, savings

depositsi and time deposits less than $100,0001 and he observed

that the significance of the $100,000 threshold had diminished

over the years. Mr. French noted that there was nothing magical

about a particular dollar threshold such as $100,000, and that

examiners were expected to look behind the dollar amount to

determine whether the particular deposit was from a stable

deposit relationship or "hot money." He also noted that the

FDIC had raised the issue of changing the core deposit

definition with other banking agencies but there was no

consensus for making a change. He asked the Committee for its

views about changing the core deposit definition, including the

impact on a bank's core dependency ratio (which measures the

degree to which the bank is funding longer-term assets with noncore fundingi such as brokered deposits) .

Mr. Blanton noted that examiners in a recent examination

had properly allowed the bank to demonstrate that certain

deposits were long-term, core deposits. He notedi however, that

outside rating agencies who looked only at the core dependency

ratio-as affected by the current definition of core deposits-do

not do further investigation, and banks are incorrectly viewed

as "running hot" as a result. Committee members Urrabazo and

Hopkins agreed with this observation. They observed that the

misleadingly high dependency ratio is reported by newspapers and

an incorrect impression of a risky liquidity position is

created.

Ms. Thompson asked the Committee whether examiners were

properly looking at CDARS and not lowering the liquidity

component of the CAMELS rating if the CDARS were legitimate and

reciprocal. In response, Ms. Cole noted that examiners allowed

her bank to show that their CDARS were from long-term customers

who were moving their money into CDARS for safety. Mr. Blanton

agreed about the examiners' treatment and noted that CDARS are

often held by elderly clients. Committee members Lewis and Cole

April 211 2010
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observed that a bank's use of CDARS should be described in its

liquidity plan and made available to examiners so that the

examiners are not surprised. Mr. French noted that large

deposits can be less stable if a bank gets into a troubled

condition, so that a bankl s liquidity plan should include stress

testing for the effect of a downgrade below well-capitalized on

a bank's deposits and funding capacity.

On behalf of field supervisors, Ms. Thompson asked the

Committee to comment on the use of QwickRate, a non-brokered

marketplace for funding and investing that connects

institutional buyers and sellers directly to help maximize net

interest marginsi and gathering deposits off the Internet in the

context of the discussion of core deposits and volatile funding.

Professor Koch responded thati as an economist i core deposits

should be considered on the dimension of interest elasticity.

Banks using QwickRate or running a certificate of deposit ("CD")

special are essentially buying rate- sensi ti ve money 1 he

observed, and those deposits should not be viewed as core

deposits, even if they are below the $100,000 threshold. He

noted that to measure volatility in an economically correct way,

examiners would need to measure the interest elasticity of every

account. Mr. French said that an interagency proj ect examining

deposit data and liquidity data is addressing those questions.

Concerning QwickRate, Mr. Brown noted that they often provide a

lower cost of funds than the local market, so that banks look at

them as a source of funds.

Mr. Blanton stated that he views the discussion about

Internet CDs and related items as a concentrations issue, not a

product issue, and that it is important for banks to diversify

their portfolio concentrations rather than follow an easier path

of concentrating in a single area. Mr. French noted that

interagency guidance agreed about funding concentrations. Ms.

Thompson confirmed that concentrations-on both the liability and

asset sides-were an important issue for banker and regulator

focus. Ms. Cole observed that a bank's deposit mix required

proper management, but noted that it was critical to community

bank deposit gathering to have reciprocal CDARS deposits

available for customers who need insurance coverage.

Noting that volatile funding sources had played a role in

recent bank failures, Ms. Thompson inquired whether members

thought that supervisory thresholds would be helpful on the

liquidity side. Committee members generally did not think that

thresholds would be helpful i that they would be overly

prescripti ve, and might have unintended negative consequences.

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Mr. French asked the Committee for comments about a recent

proposal on liquidity by the Basel Committee on Banking

Supervision, which would first apply on the international level,

but may eventually impact community banks. The proposal 1 he

said, would require large, international banks to maintain a

liquidi ty coverage ratio and those banks to have high quality

liquid assets sufficient to withstand a 30 -day severe stress

period. Professor Koch noted that he liked moving the

regulatory focus toward cash flow, rather than the current 1 more

static approach of community bank liquidity standards.

Mr. Williams commented that bankers have traditionally

managed risk and was concerned about a supervisory trend toward

focusing on worst-case scenarios. Ms. Thompson said that the

FDIC did not want to be too prescriptive; however, difficult

circumstances can arise quickly and it is important for bankers

to fully understand their portfolios. Ms. Bridges commented

that community banks pride themselves on relationship banking,

and that prescribing ratios cause banks to be more formulaic,

like large banksi and inhibit developing relationships.

Concerning liquidity guidance, Ms. Stewart stated that she

preferred specific guidance that allows bankers to articulate

why they do not fit in over non-specific guidance which allows

bankers not to plan, or not to think through why they can

maintain a higher concentration. She suggested that perhaps

bankers had paid too little attention to liquidity in the past.

The Committee also discussed the issue of credit risk in a

rising interest rate environment. Mr. Brown had earlier noted

that a problem on the horizon in the next year may be a conflict

between interest rate management and liquidity management. Mr.

Lewis noted that he would need to be looking at asset quality in

a rising interest rate environment. Mr. Koch indicated that

community banks may not be developing sufficient sophistication

on the subj ect .

Ms. Thompson solicited comments on the recently extended

Temporary Liquidity Guarantee Program's Transaction Account

Guarantee ("TAG") program, which provides customers of

participating insured depository institutions full insurance

coverage on transaction accounts, and thus acts as an important

funding source for community banks. Vice Chairman Gruenberg

inquired whether the TAG program had brought in new customers.

Several Committee members respondedi indicating generally, that

the TAG program brought deposit growth, and helped keep

customers, even if it did not substantially increase the number

April 21, 2010
34

of new customers. Ms. Stewart indicated that Washington state

community bankers had expressed appreciation for the competitive

deposi t pricing that the TAG program made possible.

Before the session endedi Director Bowman recommended

reviewing the FDIC Inspector General's Material Loss Reviews

("MLRs"), which analyze the causes of failed banks and are

publicly available. Director Bowman and Vice Chairman Gruenberg

noted that they found the MLRs helpful, and that they revealed

some common factors leading to bank failures. Committee members

Brown and Blanton agreed and noted that they reviewed MLR

findings with their boards of directors. Director Curry invited

the Committee to suggest ways in which the FDIC could better

share information on emerging issues and risks concerning

liquidity and funding without being excessively prescriptive.

Vice Chairman Gruenberg then called for a short recess.

Accordingly, at 9: 59 a. m. 1 the meeting stood in recess.

* * * * * * *

The meeting reconvened at 10: 20 a. m. that same day.

Ellen W. Lazar, Senior Adviser to the FDIC Chairman for Consumer

Policy, and Luke H. Brown, Associate Director, Compliance Policy

Branch, Policy, DSC, moderated the discussion titled, "Consumer

Protection - Level Playing Field for Community Banks." Ms.

Lazar noted that community banks face a substantial burden

complying with regulations designed to solve problems for which

they were not the driving force in creating, such as subprime

and non-traditional loans. She recognized that banks have

concerns about the proposed new consumer financial protection

agency, but noted that regulatory reform would help level the

regulatory playing field between banks and non-banks that offer

competing financial products. Ms. Lazar noted that Chairman

Bair has often spoken about the important, posi ti ve,

relationship between consumer protection and safety and

soundness. She requested the Committee to share its

observations.

Committee members discussed compliance with the Real Estate

Settlement Procedures Act ("RESPA") 1 which several viewed as

overly burdensome with relatively little consumer benefit.

Generally, Committee members Hopkins and Blanton observed that

consumers do not read the voluminous documentation provided to

them. Committee members Hopkins and Blanton also suggested that

the new RESPA rules might increase costs to consumers because

banks 1 which now have to provide a firm estimate, will make

April 211 2010
35

their estimates higher. Committee members Williams and Hopkins

indicated that the increased cost of RESPA compliance could

cause community banks to withdraw from real estate lending,

especially in rural areas where there is inadequate volume to

justify the compliance cost. Mr. Urrabazo suggested that the

lack of financial responsibility of some consumers was a partial

cause for the countryl s recent real estate financing problems.

The FDIC's Mr. Brown indicated that an interagency group was

gathering feedback from this committee and other sources to

share with the Department of Housing and Urban Development,

which is responsible for RESPA.

The Committee discussed whether the proposed financial

reform legislation would adequately level the regulatory playing

field between banks and non-banks. Ms. Bridges stated that shei

like all community bankers, favors consumer protection, and

finds the robust enforcement environment that banks experience

to be acceptable on the whole. She was concerned, however, that

non-banks would not experience similarly robust oversight.

Committee members Brown, Schriefer, and Hopkins expressed

similar views. Mr. Williams expressed concern that the new law

and regulation would impose compliance burdens that are not

currently anticipated.

Vice Chairman Gruenberg stated that he thought the

strongest case for the new law was that it would fill in

regulatory gaps which contributed to predatory lending practices

and the financial crisis. He noted that the majority of

subprime lending was driven by non-bank financial companies

which were not subj ect to adequate rules or enforcement. Under

the new law, he continued, the non-banks would be subject to the

rules and enforcement of the new consumer financial protection

agency. Although the non-bank enforcement authority may not be

as strong as that of the banking regulators 1 it would, in his

view, be a significant step in the right direction.

The Committee discussed whether the new law 1 or other

forces, would create opportunities for community banks to

provide consumer banking services. Mr. Brown commented that he

heard that the financial reform law would prompt large banks to

exit consumer banking, which could provide opportunities for

community banks.

The Committee also discussed why consumers choose to be

unbanked and the impact of fees on their decisions. Vice

Chairman Gruenberg mentioned the January 2009 FDIC National

Survey of Unbanked and Underbanked Households. He noted that

April 211 2010
36

many respondents reported that they did not maintain bank

accounts because they did not have sufficient income to justify

an account, while another significant percentage cited the fees

associated with accounts, including overdraft fees. Committee

members Brown and williams noted that fees generated by

overdraft protection provide the revenue that allows banks to

offer free checking accounts. They suggested that if banks

charged less overdraft fees, they would have to find a new way

to balance their expenses, and may no longer offer free

checking.

Mr. Urrabazo stated that his bank had reviewed over 340,000

of its consumer accounts and found that about 5 percent of the

holders had excessive overdraft fees 1 while about 60 percent

used the overdraft function infrequently, perhaps once a

quarter. He felt it would be unfair to penalize the majority of

people who used overdraft protection as intended because a small

minori ty abuses it. vice Chairman Gruenberg indicated that the

FDIC survey results were similar: about 75 percent of customers

did not use overdrafts; another 10 to 15 percent used it fewer

than five times per year; and the great concentration of

overdraft use was by repeat users. He noted that a small

percentage of customers were driving a large percentage of the

revenue. For those frequent users, he suggested, overdraft

protect ion was not a protection but an extraordinarily expensive

source of credit, and one used by persons at the lower end of

the income spectrum.

Several Committee members offered examples of their banks 

1

experiences with overdraft protection. Mr. Urrabazo stated that

not all chronic overdraft users were poor; rather, some were

weal thy and apparently not dissuaded by the fees. Mr. Blanton

said that his bank had identified chronic overdraft users,

refunded their fees, and counseled them concerning al ternati ves

that would avoid the fees, but found that they would soon resume

chronic overdraft use. Ms. Bridges found that some chronic

users were on fixed incomes, used overdrafts to pay necessary

bills, and that their usage of overdrafts became pro-cyclical.

She said that her bank determined it could not continue

overdraft protection when used for that purpose. Mr. Brown

noted that agency guidance recommended that banks monitor

accounts for excessive use. He said that once the bank

identified excessive use, it was important to guide the

customers to more affordable, alternative products.

Mr. Nash and Roberta K. McInerney, Deputy General Counseli

Consumer and Legislation Branchi FDIC Legal Divisioni moderated

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the discussion ti tIed, "Legislative Update: Status of Regulatory

Reform Legislation." Mr. Nash began with an overview of the

Senate financial reform bill proposed currently under

consideration, and the House bill which passed in December 2009.

He noted that the FDIC has focused on the resolution authority

of firms that had been considered "too big to fail." By making

the very large firms face the same type of resolution

consequences that small banks facei Mr. Nashl s view was that it

would help end the funding advantage that large banks currently

have over community banks.

Ms. McInerney provided the Committee with a comparison of

corresponding parts of the Senate and House bills. Under the

House bill, she notedi the consumer financial protection agency

would be funded by assessments on financial service providers

(insured institutions below $10 billion would be exempt), and

under the Senate billi all of the agency funds would come from

the Federal Reserve System, with no fees on banks. Under both

bills, she continued, the consumer financial protection agency

would have rulemaking and enforcement authority over non-banks,

while enforcement authority for community banks would remain

wi th their primary regulators.

A significant part of the discussion concerned the

resolution process of financial institutions determined to be

systemically important, the outcomes of such a resolution, and

how a resolution would be paid for. Mr. Hopkins asked if the

bill had the necessary ingredients to successfully complete the

resolution process of banks and non-banks. Mr. Nash responded

that Chairman Bair had had a lot of input into the subj ect and

that the FDIC thinks that the process can work. He indicated

that resolution will be a credible process that makes clear that

firms going into it will not be "bailed out/" thus giving them a

great incentive to avoid being subject to it. There would be,

he continued, a very high bar to trigger the resolution process,

involving a range of decision makers, after which the FDIC would

run the process. Mr. Nash explained that the FDIC would place

the firm in a bridge bank, then work to preserve its value and

mi tigate systemic risk while winding the firm down.

The Committee also discussed the liquidation fund provided

for in both bills. Mr. Urrabazo asked about the FDIC's opinion

between the House bill's $150 billion fund and the Senatel s $50

billion one. Mr. Nash noted that the liquidation funds were not

funded by taxpayers, but rather would be risk-based assessments

imposed on eligible financial companies. He indicated that $50

billion would likely be sufficient for the FDIC to start the

April 211 2010
38

resolution process. If $50 billion would be insufficient, he

said, the FDIC would have the ability to borrow funds from the

Treasury. Ms. McInerney pointed to the pre-paid aspect of the

liquidation fund as further evidence that the resolution

provisions could not be fairly characterized as a bailout.

In response to a question from Professor Koch about the

effect on firms that go into the new resolution process, Mr.

Nash clarified that such a firm would not be reconstituted. Its

management and board would be removed, the firm would be sold

off for parts, and its shareholders would be wiped out. In

response to a question from Director Bowman, Mr. Nash noted

that, after the bankruptcy bar had expressed a concerni the bill

clarified that creditors would be treated equally whether a firm

went through bankruptcy or the new resolution process. He noted

that this outcome would help bring market discipline to

systemically large firms.

The Committee discussed the relationship between firms that

would be assessed for the proposed liquidation fund and those

subject to resolution. Mr. Nash clarified that firms assessed

for the liquidation fund would be identified, but that

assessment would not necessarily mean that the firm would be

resol ved through the systemic process instead of bankruptcy.

Those two decisions would be separate, he indicated. In

response to a question from Director Curry, Mr. Nash noted that

the law would prohibit any comingling of funds between the

Deposit Insurance Fund ("DIF") and the new liquidation fund.

Ms. McInerney stated that the bank resolution process would not

be changed by the new law.

In response to Director Bowman's request for a review of

some of the proposed bills' impacts on community banks, Mr. Nash

noted that DIF assessments would be based on assets rather than

deposits, and that this should generally reduce costs to

community banks. He also noted that in the Senate billi the

Board of Governors of the Federal Reserve System would no longer

supervise state member institutions, and all holding companies

would be supervised by the primary bank regulator (for example,

a state chartered holding company would go to the FDIC). Ms.

McInerney noted that the legislation would promote financial

stability and the avoidance of liquidity crises, which would

benefit community banks. She also thought that the elimination

of the idea that some firms are too big to fail would help

reduce the funding advantage that large banks have over

community banks. Finally 1 Ms. McInerney indicated that the

bills' placement of consumer protection enforcement authority

April 211 2010
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wi th community banks' primary regulators would be helpful.

Director Curry added that insurance assessments should be

generally lower if it is no longer believed that some firms are

too big to fail.

Mr. Gray noted that increased reporting requirements and

other regulatory burden may result from the new legislation.

Mr. Nash indicated that it is difficult to quantify the

additional regulations that will result and added that, while

there is reasonably a fear of the unknown 1 the legislation dealt

wi th known problems of great magnitude 1 such as those that the

economy has recently experienced.

The Committee discussed various other subj ects impacted by

the legislation. In response to a question from Ms. Stewart

about proposals to limit the size of systemically large

institutions, Mr. Nash indicated that he felt it unlikely that

such a proposal could muster sufficient votes to be passed. In

response to a question from Mr. Hopkins, Mr. Nash noted that the

United States Senate Committee on Agriculture, Nutrition &

Forestry had passed a provision that would bring more

transparency to the derivatives market.

Mr. Williams indicated that he thought that the issue of

preemption should be cleaned up. Ms. McInerney stated that 1

currently, the Office of the Comptroller of the Currency takes a

preemption approach; it preempts the state law that interferes

with the national bank's ability to conduct lending and other

business. She indicated that both the Senate and House bills

provide a more case-by-case approach.

Vice Chairman Gruenberg had been obligated to depart during

the panel for a previous engagement. Mr. Nash called for a

lunch recess at 12: 16 p. m. The afternoon session was convened

by Director Curry at 1:26 p.m.

* * * * * * *

Christopher J. Spoth, Senior Deputy Director, Supervisory

Examinations 1 DSC, and Steven D. Fritts, Associate Director,

Risk Management Policy Branch, Policyi DSC, moderated the panel

titled "Temperature Check on the Lending Environment and Real

Estate Values." Mr. Spoth discussed several financial metrics

that may affect lending markets for CRE, renewals,

restructuring 1 and lending in general. First, concerning

capital, he noted that nearly $12 billion of capital was added

to the industry in the fourth quarter of 2009. In 20101 some

April 211 2010
40

failing banks had been able to raise capital, avoid failure and

restructure themselves; these developments, he said, may

indicate that banks had the ability to restructure loans or

provide new lending. Mr. Spoth noted that profitability is

improving and would show strength in the first quarter 1

particularly among community banks. He noted that reserves are

at the highest level they have ever been, and this may indicate

that some of the credit risk may now be accounted for in bank

earnings. On the other handi he noted that the level of

reserves to non-performing loans had diminished, and that FDIC

analysts were studying that data. Non-performing loans had not

peaked in the last quarter of 2009, nor had they likely peaked

in the first quarter of 2010, Mr. Spoth observed, but they may

be increasing at a slower rate. Finally 1 he noted that the

dollar volume of lending declined 7.5 percent in 2009, with 90

percent of that decline among the very largest banks, while the

smallest banks had a slight increase in lending.

Mr. Fritts began his remarks by noting that he had recently

spoken with members of the National Association of Home Builders

who had indicated that it is very difficult for a builder to

obtain loans, regardless of their credit characteristics

(particularly in certain markets). He observed that the credit

retrenchment has been most pronounced in the big banks and may

be driven by economic and financial model ing 1 not by

relationship banking. Mr. Fritts stated that small business

guidance emphasized that credit decision-making should be

predicated on the borrower's merits and the banker's prudential

underwri t ing standards, not primarily on balance sheet,

economic-driven models.

Mr. Fritts discussed collateral valuation under the FDICI s

regulation and supervisory guidance, noting that loans that had

been reasonably underwritten several years ago are coming due

but cannot be easily re-underwritten because of declines in real

estate values. He then reviewed valuation methodologies that

are available from a credit administration standpoint. He noted

that the regulation requires an appraisal only at origination

and that if a loan comes up for renewal or refinance, without

new money involved, banks can perform an evaluation of the loan

as an alternative to an appraisal. Mr. Fritts stated that an

evaluation is not specifically defined and that examiners have

been instructed to consider what is appropriate for making the

business decision. He noted that banks have flexibility and may

rely on relatively inexpensive sources of information that have

developed in the last decadei including sales activityi and

market and industry information. He indicated that examiners

April 21, 2010
41

would first look generally at a bank's program for collateral

evaluation, and then, when individual loans are reviewed,

confirm that the bankl s collateral valuation information is

adequate and accurate.

In response to a question from Mr. Lewis, Mr. Fritts

clarified that an account 

i s loan officer should not make the

collateral evaluation in order to preserve the independence of

the process. He added that the FDIC would expect the bank to

establish a realistic estimate of a loan's collateral positioni

relative to the overall risk factor of the loan. Mr. Schriefer

complimented the usefulness of the interagency Policy Statement

on Prudent Commercial Real Estate ("CRE") Loan Workouts (October

30, 2009) and asked whether is might be updated. Mr. Fritts

said that he would inquire if the other agencies would update

the guidance but noted that it had been a lengthy, labor

intensive effort. He suggested that bankers could call their

regulator and obtain good directional advice from a bank

supervisory standpoint, but that advice about accounting aspects

can be more complex.

Mr. Brown remarked that in restructuring a loan pursuant to

the CRE workout guidance, it had been difficult to document the

borrower's ability to make payments because of changes in

borrowers' cash flow characteristics. In response to a question

from Mr. Spoth, Mr. Brown indicated that the FDIC examiners had

been cooperative in evaluating the bank's decisions pursuant to

the workout guidance. Mr. Spoth indicated that the FDIC wants

to examine the borrower 

i s ability to pay, and only if that is

not well -documented, would the examiner focus on the collateral

(unless it was a collateral dependent loan). Mr. Brown reported

that, based on his experience speaking to a number of

organizations, there was good news on the issue of nonperforming asset reserve coverage. In his estimation, the slide

in property values is moderating. Ms. Cole noted that

appraisers in certain parts of her region were more conservative

than those in other parts, especially wi th loans where the

collateral was atypical, such as a church.

Finally, the Committee had an extended discussion of the

proper time for a bank to charge off a loan for which it had

established a specific reserve. Mr. Brown suggested that

clarification would help because he was aware of several cases

in which examiners had required charge-offs of loans that banks

had not previously taken. Mr. Fritts agreed that the issue

should be addressed because examinations should generally

validate a bank's financial statementsi and big charge-offs

April 211 2010
42

following an exam were undesirable. Committee members Brown,

Blanton, Cole, and Schriefer provided various factual examples

and accounting interpretations. Mr. Fritts and Mr. Spoth

indicated that it was understandable that banks had used the

approach that they had with regard to certain types of loans in

transition, where the bank is awaiting information before making

a decision. UI timately, however 1 Mr. Spoth indicated that, when

the bank knows it has a loss, it should go through the chargeoff line.

The panel discussion titled, "Deposit Insurance Assessment

Issues i" was then moderated by Arthur Murton, Director, FDIC

Division of Insurance and Research ("DIR") 1 and Diane L. Ellis,

Deputy Director, Financial Risk Management and Research, DIR.

Mr. Murton first discussed the status of the DIF, which had a

negative balance of $21 billion at the end of 2009.

Deterioration was slowing down 1 and, perhaps, flattening out, he

indicated. He noted that the three year pre-pay of deposit

insurance premiums (of $46 billion) had provided necessary

liquidity for the fund, and that the DIF ended the year with $66

billion of liquidity. The bank failure rate had been slightly

less than had been proj ected, he observed, while the cost of

failures had been less than proj ected because the FDIC had been

able to pass more assets through by using more loss-share

agreements.

Mr. Murton discussed the notice of proposed rulemaking and

request for comment on large institution insurance pricing

issued by the FDIC Board on April 13, 2010. He noted that the

FDIC had separate pricing systems for small and large banks, and

that the small bank pricing formula was based on financial

ratios and weighted CAMELS. The large bank pricing formula had

changed since inception, he explained, so that, in addition to

the original two-element formula of weighted CAMELS and debt

ratings, the FDIC had added a financial ratios component.

Having undergone the recent crisis, he said that the FDIC is

proposing to eliminate the debt ratings component as well as the

existing four risk categories. Under the proposal, he

explained, large banks will get a performance score, which

measures how likely it is that the bank will fail, and a loss

severity score, which measures how large the losses would be if

a bank failed.

Mr. Murton indicated that, under the proposed pricing

system, larger 1 riskier banks would pay more into the DIF, and

that additional amount would flow to larger, safer banks and to

the majority of small banks. About 75 percent of small banks

April 211 2010
43

would pay a lower insurance rate, 15 percent would pay about the

same, and 10 percent would pay more 1 he said. The proposal

would not affect the assessment base in any way. Mr. Murton

stated that the FDIC back-tested the proposed scorecard approach

to the period before the recent crisis and it performed

significantly better than the CAMELS system alonei or the

current pricing system.

Several Committee members provided feedback about banking

conditions and likely first quarter results in response to a

question from Mr. Murton. Mr. Schriefer observed that business

conditions in his area were slowly getting a little better, but

that it remained a "hunker down" mentality. Mr. Blanton noted

that banks' numbers get worse after they fully recognize the

problems facing them, after which the numbers get better. What

banks report will depend on where they are in that recognition

and response process. Mr. Williams reported that the majority

of bankers he had spoken to were feeling positive about their

banks generally, but that a minority, in certain locations, was

still facing fresh bad news. Mr. Blanton stated that there are

still many banks on the edge of failing or surviving in the

Atlanta area. There was some agreement that the bottom had been

reached, but that conditions might remain there for some time.

Ms. Ellis reported about the FDIC's January 12, 2010,

Advance Notice of Proposed Rulemaking regarding Incorporating

Employee Compensation Criteria Into the Risk Assessment System.

She reported that a common response was that banks should not

award bonuses or promotions based on volume metrics such as

number of loans booked, for example. Some comments opposed to

the proposal, she said, had questioned whether there really is a

causal relationship between compensation practices and the risks

that an institution takes, while others cautioned against using

a one-size-fits-all approach. At this early stage, she stated,

the feedback suggests that the FDIC should take a principlesbased approach and that some compensation should be deferred.

Responding to a question of Mr. Urrabazo, Ms. Ellis noted

that MLRs had suggested a relationship between bank failures and

compensation practices that rewarded people for loan volume.

She said, in response to Mr. Schriefer, that bank examiners had

always been able to criticize compensation practices and ask for

changes. She clarified, however, that examiner criticism might

be viewed as setting a minimum standard, while adjusting the

assessment system to a bank's compensation program could reward

safer practices. Mr. Blanton observed that there are many

different types of banks and ownerships and that it would be

April 211 2010
44

difficul t to set a compensation standard affecting so many

different models. Mr. Brown cautioned against overreaction and

expressed concern over how a rule would affect the banking

industry's ability to attract and keep talented employees.

Mr. Nash moderated the discussion titled, "Roundtable

Discussion." At the start, Mr. Lewis distributed a document

from a Florida business that is about to launch a program to

communi ty banks across the country that involves Smal i Business

Administration ("SBA") paper. He explained that he was not

endorsing the program or answering questions about it, but had

been asked to gather member comments. It was agreed that the

Committee would review the document and provide any comments to

Mr. Lewis after the meeting.

The Committee discussed the possible use of money from the

Troubled Asset Relief Program ("TARP") to provide small business

funding and/or a capital program aimed at community banks. In

response to a question from Mr. Brown, Mr. Nash noted that TARP

and other programs had lacked a community bank focus. Mr. Nash

observed that there had been a serious effort some months

earlier to create a program to stimulate small business lending

but that the momentum had dissipated, perhaps because of the

focus on financial regulatory reform. Ms. Cole emphasized the

need for funding to be provided to community banks for capital,

to preserve their existence, and not necessarily tied to making

small business loans. Mr. Brown commented that the plan that

had been under consideration was good, because it would both

stimulate small business lending and provide capital to

community banks. Ms. Stewart observed that, even if the program

did not stimulate new lending, it would have a positive impact

if it merely helped banks avoid calling in credits. Mr.

Urrabazo expressed doubt that any new capital inj ection into the

banking system would stimulate demand for business or jobs

because people are very reluctant to take any kind of risk. He

did note that the SBA had restructured some of its programs and

that community banks should be able to make more SBA loans as a

result.

Mr. Nash asked the Committee whether there was loan demand

in their local markets, explaining that he often heard from

Congress that regulators are too tough and are not "letting"

banks make loans. Mr. Blanton said that his customers are

currently frightened of debt 1 and that there was very little

demand for loans. He and Committee members Cole 1 Bridges 1 and

Urrabazo noted that the primary demand for loans at community

banks was from borrowers whose performing loans were being

April 21, 2010
45

pushed out of regional banks. Ms. Stewart observed that loans

were i imi ted by a combination of capital constraints, the

economy, and regulatory crackdown. Ms. Rainey observed that in

her market 1 there was a pickup in loan demand but that all of

the demand was in areas where the bank already had

concentrations so that the loan demand could not be met. Mr.

Blanton indicated that his bank was looking to develop

relationships, not just accepting a hot loan that had been

pushed out of a larger bank.

Mitchell L. Glassmani Director, FDIC Division of

Resolutions and Receiverships ("DRR"), and Herbert J. Held,

Associate Director, Resolution Strategy Section, Franchise and

Asset Marketing Branch, DRR, also answered Committee questions.

Mr. Hopkins, whose bank had made bids on failed banks shared

concerns about changes the FDIC had made in contracts with

purchasers. Mr. Held noted that transactions are evolving with

the market. He said that the FDIC's documents were under review

to simplify them and make them more consistent 1 and that

questions and feedback from acquirers was welcome. Mr. Glassman

added that the FDIC contacts acquirers a week after a bank

failure to obtain feedback, and again after a month. He noted

that issues facing acquiring banks are important and that the

FDIC would try to resolve them.

Mr. Schriefer reported that a recent Federal Reserve

seminar had been titled "Now that the financial crisis has

passed" and said that he hoped that this was not the generally

held view because the situation is still quite tender. Vice

Chairman Gruenberg responded that the financial crisis for the

big systemic institutions may have passed last year, but that

regional and community banks were now being particularly

impacted. For those smaller banks, the peak of bank failures

may occur this year and be followed by a downward trend next

year, so that much of the FDIC/s work is still ahead of it.

April 21, 2010
46

In closing, Vice Chairman Gruenberg stated that he found

the Committee's meet ings to be very valuable experiences.

Directors Curry and Bowman agreed and noted that the meetings

provide valuable exchanges of ideas.

There being no further business, the meeting was adj ourned. ~d"bRobert E. Feldman

Executive Secretary

Federal Deposit Insurance Corporation

And Committee Management Officer

FDIC Advisory Committee on Community

Banking

April 21, 2010
Minutes

of

The Meeting of the FDIC Advisory Committee on Community Banking

of the

Federal Deposit Insurance Corporation

Held in the Board Room

Federal Deposit Insurance Corporation Building

Washington, D. C.

Open to Public Observation

April 21, 2010 - 8: 30 A. M.

I hereby certify that, to the best of my knowledge, the attached

minutes are accurate and complete.

Mart in J. Gru

~

Vice Chairman

Board of Directors

Federal Deposit Insurance Corporation

and

Presiding Officer

April 21, 2010, Meeting of the

FDIC Advisory Committee on Community Banking

Dated: July 20, 2010