089

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

Ma y 1 l, 20 1 1 8: 34 A. M.

The meeting of the FDIC Advisory Committee on Community

Banking ( "Committee") was called to order by Sheila C. Bair,

Chairman, Federal Deposit Insurance Corporation (" 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, Pres ident and

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

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

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, Vice Chairman, Bank of Tucson,

Tucson, Arizona; Jan A. Miller, President and CEO, Wainwright

Bank & Trust Company, Boston, Massachusetts; 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,
'J 090

Sound Community Bank, Seattle, Washington; Ignacio Urrabazo,

Jr., President, Commerce Bank, Laredo, Texas; and Mat thew

Williams, Chairman and President, Gothenburg State Bank & Trust

Company, Gothenburg, Nebraska.

Members Deborah A. Cole, President and CEO, Citizens

Savings Bank and Trust Company, Nashville, Tennessee, and Craig

M. Goodlock, Chairman and CEO, Farmers State Bank, Munith,

Michigan, were absent from the meeting.

Members of the FDIC Board of Directors present were: Sheila

C. Bair, Chairman; Martin J. Gruenberg, Vice Chairman; Thomas J.

Curry, Director (Appointive); and John E. Bowman, Director of

the Office of Thrift Supervision (Acting).

Corporation staff who attended the meeting included:

Ruth R. Amberg, Steven o. App, Luke H. Brown, Richard A. Brown,

Glenn E. Cobb, Kymberly K. Copa, Christine M. Davis, Patricia B.

Devoti, Doreen R. Eberley, Diane L. Ellis, Robert E. Feldman,

Ralph E. Frable, George French, Steven D. Fritts, Alice C.

Goodman, Shannon N. Greco, Tray Halverson, Nancy W. Hunt, Kenyon

T. Kilber, Ellen W. Lazar, Alan W. Levy, Robert W. Mooney, Tariq

A. Mirza, Paul M. Nash, Christopher J. Newbury, Thomas E. Nixon,

Sylvia H. Plunkett, Grace Pyun, Carolyn D. Rebmann, Claude A.

Rollin, Barbara A. Ryan, Christopher J. Spoth, Robert F. Storch,

Jesse O. Villarreal, Cottrell L. Webster, Melinda West, James R.

Wigand, and Katherine G. Wyatt.

William A. Rowe, III, Deputy to the Chief of Staff and

Liaison to the FDIC, Office of the Comptroller of the Currency;

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

Office of Thrift Supervision, were also present at the meeting.

Chairman Bair welcomed the attendees and, noting that she

would be stepping down from office on July 8, 2011, thanked the

Committee for its service providing the FDIC with input on the

effects of the FDIC's various initiatives. She said that Vice

Chairman Gruenberg, the Board of Directors, and FDIC staff fully

embraced the Committee's work and would continue to rely on it.

Chairman Bair observed that the banking sector

generally, and community banks particularly, had turned a

posi ti ve economic corner, and reviewed a variety of banking

performance indicators. She then introduced Paul M. Nash,

Deputy to the Chairman for External Affairs, who moderated the

day's meeting. Mr. Nash then introduced Christopher J. Newbury,

Associate Director, Division of Insurance and Research ("DIR"),

May 11, 2011
091

Luke H. Brown, Associate Director, Division of Depositor and

Consumer Protection (" DCP"), and Steven D. Fritts, Associate

Director, Division of Risk Management Supervision ("RMS"), who

moderated the first panel, "Trends in Community Banking."

Mr. Newbury provided an overview of trends that the FDIC

was tracking. He noted community banks' reputation as survivors

and innovators and observed that small businesses, which create

two-thirds of new jobs, prefer to do business with community

banks, where decisions can be made locally and products can be

customized for them. Mr. Newbury recognized that banks of all

sizes had struggled in the recent financial crisis, but noted

that community banks were showing signs of recovery and he then

reviewed a variety of performance statistics that illustrated

his point. He said that the FDIC continues to be concerned

about concentrations, particularly those in commercial real

estate ("CRE") loans, but noted that concent rations were

starting to improve as well. Mr. Newbury observed that the Wall

Street crisis had impacted Main Street businesses such as

community banks, but noted that various aspects of the DoddFrank Wall Street Reform and Consumer Protection Act ("DoddFrank Act") were intended to create conditions that would assist

communi ty banks. He recognized that community bankers had a

variety of concerns and invited Committee members to provide

their input.

Member Blanton responded that Georgia continued to face a

difficul t economy and banking environment but that conditions

were significantly improved over the previous year. He observed

that the FDIC has bank resolution work to complete in Georgia,

and that loan demand remained weak although bank customers were

calmer. Member Brown of Florida echoed those observations,

adding that the improvements were perhaps a quarter or two

earlier than he had expected.

Member Brown noted that community banks would soon face

revenue changes, some additional expenses and higher capital

requirements, and observed that community banks needed to

transition to a business model of providing an income stream and

a return on investment to shareholders. Member Blanton said

that community banks had long been income stocks, and had

suddenly become growth stocks only more recently. Member

Urrabazo stated that the key component to the capital situation

was earnings; he indicated that community banks needed to focus

on profitability to attract capital from small investors, since

they would not get capital from institutional investors.

May 11, 2011
092

Member Gray expressed the view that community banking had a

very bright future; in California, institutional investors were

approaching them; merger acti vi ty was beginning to occur; the

industry would be healthier because sloppy or tired participants

were exiting the business; and he expected an increase in new

charters. Member Urrabazo expressed the view that newly

chartered banks might engage in high-risk lending using highcost deposits. On the topic of de novo banks, Chairman Bair

observed that the FDIC had input on new charters and was

conscious of avoiding excessive risk. Member Williams was also

optimistic about community banks' long term prospects but noted

that agricultural lending was an emerging risk in Nebraska and

supported the FDIC's close monitoring of it.

Member Bridges, speaking from the perspective of a

community development financial institution, observed that banks

appeared to be merely trading assets among themselves and that

the problem was the lack of real loan growth. She added that

liquidi ty was not a problem and that there was demand for

building affordable housing, a focus of her bank. Regarding

innovation, Member Bridges stated that she modified larger bank

innovations to create programs that worked for her smaller

institution and aligned wi th its mission. Member Miller,

speaking from the perspective of a mutual bank, viewed the next

challenge to be how to create earnings, which are necessary for

a mutual bank to increase capital. He stated that community

banks currently enj oy attractive interest margins but that

margin compression was a problem on the horizon. Member Miller,

observing that non-interest income was under challenge and that

operational costs were increasing, expressed concern about

potential community bank consolidation. Member Stewart agreed

that the current favorable margins were probably not sustainable

so that community banks needed to evaluate future sources of

revenue and earnings. She added that more merger dialogues were

occurring in Washington, partly because boards of directors were

tired and their work was no longer fun.

Member Urrabazo said that margins were critical. He

observed that a conservatively run bank would generally have

small margins and, if they were being compressed, then banks

would have to consider al ternati ves such as fees or cutting

costs; he said that banks were near the end of their ability to

cut costs. Member Gray agreed that banks would be challenged as

interest rates rose but noted that his bank, a business bank,

has used adj ustable rates and floors in its lending portfolio.

Member Gray observed that large banks did act as innovators but

were also slow to act compared to community banks. Member

May 11, 2011
093

Blanton also observed that community banks work with small

businesses, which large banks do not pursue because they find

more profit elsewhere. Member Stewart and Member Blanton further

observed that community banks are small businesses themselves.

Member Gray opined that community banks have the competi ti ve

advantage of longer tenured employees who can better learn the

business of small customers.

Member Brown noted that the Committee had previously

discussed the impact of regulatory change and observed that his

bank had recently spent substantial hours complying with a

mortgage lending change that had probably been intended to be

simple. He expressed concern about chaos in the secondary

market mortgage industry and the difficulties it caused for

borrowers. Member Brown further noted concern that community

bank interests would not be sufficiently considered as changes

were made to the operations of Fannie Mae and Freddie Mac, and

that a move toward greater privatization would tend to exclude

lower volume community banks.

Chairman Bair inquired why loan demand from small business

remained relatively sluggish. Member Blanton stated that his

customers did not want to take on any additional debt; in the

building industry particularly, there was no backlog of work.

Member Bridges added that businesses had learned to operate more

efficiently and were not anxious to add expenses; they would do

so only when they saw true demand growth. Member Schriefer

observed that a bank's lending decisions were based on borrower

projections and that bankers were somewhat more skeptical in

their reviews. Member Urrabazo agreed that uncertainty was the

main driving force of low loan demand but added that delays in

receiving Small Business Administration ("SBA") approvals for

SBA loans also contributed to the problem. Later in the panel,

Member Williams observed that it is difficult for government

programs, such as those providing extra capital to banks, to

create loan demand. He said that loan demand was constrained by

small business owner uncertainty about a variety of factors,

including heal thcare costs. Member Hopkins added that energy

cost uncertainty was also a consideration.

Member Brown said that contractors were using less

leverage than they had previously so that proj ects had more

cushion in case of a downturn. Member Gray observed that

contractors may be contributing more equi ty to proj ects because

alternate investments for their money were not as at tractive.

Member Brown noted that he had seen substantial numbers of

large, all cash transactions, and suggested that, when there

May 11, 2011
094

were better uses for excess cash, more leverage would be used.

Members Koch and Miller expressed concern about a double-dip in

housing and the effect of that concern on current lending;

Member Miller added that his bank required a 20 percent down

payment to cover potential ten percent declines in property

values. Mr. Newbury indicated that analysts expected continued

housing declines. Member Brown suggested that an effect of the

current concerns was a move toward multi-family housing

construction. Member Gray observed that foreclosures would have

to occur eventually which would affect their neighborhood

values. Chairman Bair indicated that the FDIC encouraged more

short sales in its resolution processes, as an alternative to

foreclosures, which appeared to become increasingly delayed.

She noted that short sales can reduce costs and clear the market

faster than foreclosure, and also had the advantage of

maintaining continuity of owner presence in a house.

Chairman Bair inquired on different occasions how product

innovation or FDIC actions could encourage mortgage lending.

Member Urrabazo described a situation in which certain

affordable properties were hard to sell because potential buyers

could not qualify for a mortgage and discussed the possibility

of using a rent-to-own approach to resolve the problem.

Chairman Bair noted that there had been discussions about a

secondary market for rent-to-own mortgages, and suggested that

the topic was worth further pursuit since so many people do not

qualify for mortgages. At the Chairman's request, Mr. Fritts

discussed some legal limitations on bank ownership of property.

Member Schriefer, a banker's banker, stated that many of

his small bank customers were frustrated with new real estate

and escrow regulations and that the new rules encouraged banks

to stop making real estate loans. Member Brown indicated that

his bank had to increase real estate lending staff and that

those increased costs could result in higher rates being passed

on to borrowers. After describing some risks associated with

long-term fixed rate mortgages, he suggested that the market

might see a seven or ten year fixed rate mortgage that remained

in a bank's portfolio. Member Miller stated that his bank had

experienced good customer interest in a ten year fixed rate loan

that the bank kept on its books; he noted that the bank closely

monitored its interest rate risk on the product. Member

Urrabazo described a similar loan product from his bank.

Chairman Bair inquired what Committee members saw as the

future of mortgage financing if it was assumed the governmentsponsored entities (Fannie Mae and Freddie Mac) ceased existing

May 11, 2011
095

in their current form. Member Blanton indicated that the

housing market would be significantly slowed if there was no

government-backed mortgage market and suggested that there

needed to be some government-backed program for 30 year

mortgages. Member Stewart stated that some customer need for

mortgage financing could be met by innovative products such as a

ten year mortgages held in banks' portfolios.

Member Hopkins expressed concern about new rules affecting

the compensation structure of servicing portfolios. The new

incentive structure, he said, punished banks that had been

selecti ve in purchasing loans for servicing and warned that

banks such as his would be forced out of the business. He

suggested that these circumstances could lead to further

consolidation, which would not be good for the industry. Member

Stewart and Chairman Bair discussed new risk retention rules,

clarifying that the retention requirement applied to mortgage

securi tizers, not originators. Member Brown reported that his

conversations with bankers indicated an expectation of

constrained credit availability for home loans; he added that

community bankers were concerned about not having access to

mortgage funds if there was a trend to privatization. Member

Hopkins noted that Fannie Mae and Freddie Mac had operated

successfully for decades before they changed course; he

suggested that the Federal Home Loan Bank model could be a good

model to pursue, one with public backing but private capital.

Several members shared observations about borrower and

banker trends and difficulties in obtaining mortgage financing

in the present environment. Member Gray observed that mortgage

financing required excessive disclosures. Members Brown,

Urrabazo, Blanton and Hopkins agreed that the mortgage process

was frustrating for bank customers; Member Brown said that his

bank worried that the frustration could lead to reputational

damage. Member Williams cautioned that customer frustration was

not limited to mortgage financing and noted that opening a new

account could also require excessive time due to required

disclosures and explanations.

Member Williams asked Chairman Bair about her thoughts

concerning the future of community banking and consolidation.

Chairman Bair noted that she had heard mixed reports and

acknowledged that concerns had been expressed, but she thought

that community banks had a good business model and a bright

future once the problems with the broader economy and borrower

demand were righted. She observed that community banks provided

high touch service, could be more nimble and innovative, and

May 11, 2011
096

were not the focus of consumer frustrations. Chairman Bair

added that regulatory costs were a significant issue and

suggested that a more formalized, two-tiered regulatory

structure was worth considering, so that when regulators had to

address a big bank problem, it did not always have to negatively

affect community banks. She noted that more regulation about

mortgage servicing was likely and that she was concerned that

those rules might create another obstacle for small banks

providing mortgages. Member Schriefer later indicated that he

supported such a two-tier regulatory approach.

The Committee discussed whether economies of scale or

other issues meant that a bank needed to be at least one billion

dollars of assets in size. Vice Chairman Gruenberg shared the

resul ts of his inquiry on the distribution of insured

institutions by asset size, observing among other things, that a

substantial maj ori ty of the 7, 650 insured institutions had below

$250 million of assets. Geographically, he noted that smaller

institutions were concentrated in the center tier of the country

in smaller towns. Vice Chairman Gruenberg said that although

consolidation among smaller banks was occurring, most community

banks had weathered the economic downturn, had business models

that worked quite well, and played an important role in meeting

the needs of their communi ties.

Member Hopkins inquired about the possible relationship

between the smaller number of insured institutions and

consolidations of charters wi thin holding companies. Mr.

Newbury said that, although he did not have precise numbers, he

generally agreed that a big factor in the reduction in the

number of insured institutions (from about 15,000 to 7,500 over

the last two decades) resulted from holding companies responding

to the end of unit banking and other restrictions. Member

Hopkins indicated that an analysis of the issue could help allay

fears that community banks were not viable; the Vice Chairman

agreed that such an analysis would be helpful.

Commi ttee members indicated that talk of a minimum one

billion dollar asset size for viability often came from bank

consultants. Member Brown later added that he suspected that

billion-dollar institutions were not necessarily more profitable

than smaller institutions; that leaders of smaller banks might

think that a larger size would allow them to do things that they

currently could not; and that the market helped establish the

billion-dollar marker, because at that level, a franchise might

be appealing to potential investors and buyers. Member Blanton

said that a study indicated that $250 million bank had roughly

May 11, 2011
097

half as much return on assets and equity as a billion dollar

bank, and thus, an investment in a billion-dollar bank was more

attracti ve. Member Koch added that chartering agencies were

also signaling that smaller institutions were less viable.

Member Urrabazo said that he obtains many resources from his

bank's holding company, and that it would be significantly

harder to perform his work if his bank were independent.

Vice Chairman Gruenberg noted that staff at the FDIC's

Kansas City office had observed that many community banks were

essentially family run businesses and that intergenerational

transfer was an issue in community bank viability. Members

Urrabazo, Rainey, Lewis, Hopkins, Schriefer, Blanton discussed

various related issues: attracting the necessary expertise to

smaller communi ties; family member participation in family owned

banks; the extent to which community banking is related to

monetary returns; and how to value nonmonetary elements of

personal satisfaction, such as community involvement and being

an entrepreneur. Member Blanton noted that excessive regulatory

burden can playa big role in balancing the various interests.

Member Stewart noted that the mutual form of organization had

been vibrant for many years, thus supporting the idea that

shareholder return was not the only factor.

In response to a question from Chairman Bair about

possible posi ti ve effects of recent legislation and regulation,

Member Brown observed that his bank had hired well-qualified

mortgage brokerage staff members who were no longer employed by

less-regulated mortgage companies, and that more consumers were

attracted to banks based on the factor of trust. Member Blanton

noted that many non-bank competitors were now gone from the

marketplace. Member Hopkins noted that his bank had regained

substantial market share in mortgage brokering.

In response to a question from Mr. Nash, Members Urrabazo,

Gray and Blanton discussed the use of consultants and how they

can provide an expertise that a community bank may not have at a

particular time. Mr. Luke Brown noted that, while consultants

can be useful, some third-party vendors did not provide quality

advice on all subj ects for which they might be hired, and that

it is important for banks to provide proper oversight.

Mr. Nash observed that the first two panels scheduled for

the day had been merged; the panel titled "Community Bank

Lending" was not separately convened. The Committee stood in

recess at 10:19 a.m. and reconvened at 10:35 that same day.

May 11, 2011
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Chairman Bair introduced James R. Wigand, Director of the

Office of Complex Financial Institutions ("OCFI"), and David

Wall, Assistant General Counsel, Legal Division, who spoke about

"The End of Too Big To Fail." Mr. Wigand noted that the FDIC

created OCFI to respond to important new FDIC responsibilities

under the Dodd-Frank Act and described three primary ways the

new legislation and implementing regulations would work to

prevent a future taxpayer bailout of a systemically important

financial institution ("SI FI"). First, he noted, there is a

supervisory component for SIFI's, including more stringent

capital, leverage, and contingent capital requirements, which

would help avoid the likelihood of a default. If a SIFI

nonetheless started on a default traj ectory, Mr. Wigand said,

there were also early remediation supervisory requirements,

which are similar to the prompt corrective action requirements

that already exist for FDIC insured institutions.

Mr. Wigand described a second category of Dodd-Frank Act

requirements as resolution planning and credit exposure

requirements. Regarding resolution planning, SIFI' s will be

required to establish resolution plans (also called "living

wills") for themselves under the United States ("U. S. ")

Bankruptcy Code, which would allow for their resolution without

creating systemic risk to the overall economy. This resolution

planning requirement, he noted, is being implemented by joint

rulemakings by the FDIC and the Board of Governors of the

Federal Reserve System (" Federal Reserve"). Mr. Wigand

indicated that SIFI's will benefit from resolution planning

because it will cause them to review how they are structured,

funded, manage risk, and how they are interconnected with the

financial system. Regulators will benefit, he said, because

they will better understand the risks SIFI' s pose and will

dialogue with the institutions to mitigate those ris ks. Mr.

Wigand indicated that another element of this second category of

Dodd-Frank Act requirements will be periodic credit exposure

reports that will help provide transparency about where

counterparty risks actually reside in a highly interconnected

financial system.

The third category of new requirements Mr. Wigand described

was the FDIC's orderly liquidation authority over SIFI's, which

is modeled after and similar to the FDIC's resolution authority

over FDIC insured institutions. He observed that, with regard

to FDIC insured institutions, the FDIC is often able to collect

information and pre-plan a resolution strategy before an

institution actually fails , resulting in a lower cost

May 11, 2011
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resolution. The FDIC also has conservatorship authority that

allows it to maintain the going concern value of a failing

entity. Mr. Wigand observed that in the 2008 financial crisis,

no regulator had pre-planning or conservatorship authority,

which resulted in a very disruptive resolution of Lehman

Brothers, where simultaneous liquidations created damaging

economic ripple effects.

Mr. Wigand stated that the recently created OCFI will have

about 155 staff members: about half of whom will be dedicated

to monitoring the risk that SIFI' s pose to the financial system;

a second group will review resolution plans and consider how the

FDIC would resolve such institutions if necessary; and a third

group would deal with cross border international issues that

would almost necessarily arise. The OCFI would also participate

in the working of the Financial Stability Oversight Council,

whose membership includes the FDIC Chairman and the heads of

other financial regulatory agencies, and which will monitor

financial system risk and provide interagency coordination.

Finally, Mr. Wigand stated that the FDIC was establishing a

Systemic Resolution Advisory Committee.

Mr. Wall then discussed various FDIC rulemaking acti vi ties

to implement its Dodd-Frank Act responsibilities, noting that

good regulations would help provide credibility to the assertion

that there would no longer be firms that are too big to fail.

The process proposed in the joint FDIC-Federal Reserve rules, he

said, would require SIFI's to submit their resolution plan to

the agencies for an initial review to determine if the plan

contained the minimum elements, was credible, and would lead to

an orderly transition. If a plan did not meet those

requirements, the agencies could issue a notice of deficiency

and request resubmission. If subsequent resubmission also did

not meet the criteria, the agencies could impose more stringent

liquidi ty, capital or other regulatory requirements. Finally,

he stated, if that did not work, the agencies could require an

insti tution to restructure itself to promote an orderly

resolution.

Mr. Wall said that the agencies expected the plan

development process to be cooperative; affected firms could

recognize risk management issues in their structure and

complexi ty, and make changes to promote efficiency. He then

discussed related rulemakings that are in process.

Member Hopkins expressed some skepticism whether the

resolution process was credible, observing that the firms

May 11, 2011
100

perceived to be "too big to fail" had only gotten larger through

the recent crisis. Member Blanton indicated that community

bankers had to rely on the FDIC's reputation because the issues

were beyond members' ability to judge. Member Urrabazo observed

that the issues were still critical to community bankers because

they have correspondent relationships with large institutions

and could be directly affected in a crisis. In response to a

question from Member Urrabazo, Mr. Wigand agreed that the

circumstances of a systemically important failure would be

complex, but indicated that a goal of the resolution planning

process would be to achieve certain increased simplicities that

do not exist currently. He noted that in some resolutions, it

would be important to keep critical operations intact and

working; that systemic risk could occur if an important firm

broke apart without a good plan and the predictability of a

chain of events faltered, such as occurred with Lehman Brothers.

Mr. Wigand observed that, in many of the largest firms,

separate business lines may have a greater cumulative

dissolution value than the firm as a whole, in part because

there could be multiple bidders for a business line but a very

limited market for the entire firm because of its size.

However, some of the largest firms have legal entity structures

that are inconsistent with their business lines, which could

make it difficult to sell parts of the firm while keeping other

cri tical parts intact. Mr. Wigand said that the resolution

planning process is much more than the creation of a document;

it is a risk management practice and a dialogue between business

and regulator with two main components, one informational and

one strategic analysis.

Committee members provided a variety of comments and

questions. Member Urrabazo said that requiring more capital for

SIFI's was key but he was concerned that such increased capital

requirements would trickle down to community banks. Member Koch

indicated that he was skeptical that there would be sufficient

poli tical will to carry out the Dodd- Frank Act's resolution

process when it became necessary. He added that he felt that

the systemically important firms had been given a "Mulligan" in

the recent crisis, and that they should be restructured into

smaller entities if it occurred again. Chairman Bair later

noted agreement with these observations; Mr. Wigand stated that

there is a market and a regulatory aversion to the largest firms

becoming bigger in a subsequent crisis and that some form of

immediate dissolution or containment would likely occur if there

was such a subsequent crisis. In response to a question from

Member Bridges concerning the transparency of resolution plans,

May 11, 2011
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Mr. Wigand stated that there is a tension between providing

transparency to provide credibility in the marketplace and the

presence of confidential business information in the plans. How

to balance that tension, he said, is under consideration.

Chairman Bair later added that she did not foresee entire

resolution plans being made public, but that making credible

summaries of them public would help convince the market that

there would not be future taxpayer bailouts.

Chairman Bair also indicated that serious thought should be

given to requiring foreign subsidiaries to be legally separate

so that the entities could be marketed separately, although she

recogni zed that structural change would be expensive. In

response to a question from Member Hopkins about the possible

repeal of the Gramm-Leach-Bliley Act and reinstatement of the

Glass-Steagall Act, Chairman Bair stated that she did not think

that there was political support for those changes although one

could make strong arguments for both sides. In response to a

question from Member Schriefer, Mr. Wigand described a study

that the FDIC had published analyzing how the Lehman Brothers

resolution might have occurred if the Dodd-Frank Act orderly

liquidation authority had been in place. He added that a

benefi t of there being credible liquidation authority and a

resolution plan was that a failing firm would be more likely to

accept being acquired in a crisis, or to raise more capital,

rather than expect a bailout. In response to questions from

Members Bridges and Urrabazo concerning how community banks

could perform due diligence on systemically important firms with

whom they have correspondent relationships, Mr. Wigand indicated

that the FDIC could not release supervisory information such as

CAMELS ratings, but indicated an expectation that the

marketplace would develop financial condition metrics that all

SIFI stakeholders could review. Members Schriefer and Hopkins,

Chairman Bair and Mr. Wigand also discussed the relationship

between early remediation authority of SIFI' s and prompt

corrective action orders; it was noted that there was a tension

between using these authorities and their potentially

destabilizing impact on the subject firms.

Member Hopkins' observed that community bankers were

frustrated that no one had been punished for causing the recent

crisis. Chairman Bair responded that the FDIC's new orderly

resolution authority involves a harsh process that gives the

FDIC no discretion; executives would be removed and there is

potential for a two-year clawback of compensation, so that

leaders have incentive to right their own ship. In response to

a question from Member Lewis about the recent failures of three

May 11, 2011
102

large Puerto Rico banks, Chairman Bair and Mr. Wigand clarified

that those had been classic bank failures resolved in a

tradi tional way and were not liquidity failures that raised

systemic issues.

On the subj ect of big institutions getting bigger when

there is a failure, Member Rainey reported that New Mexico

community bankers had not been able to bid on branches of a

failed mid-sized regional bank that was instead sold to a much

larger bank. Mr. Wigand indicated that, when possible, the FDIC

tried to expose branches of failed banks to a broader market,

including competing community banks, but that the reality often

was that a failed bank's branches are so integrated that it is

difficult to break them up. He added that resolution planning

process could ease such problems. Member Brown reported public

reaction to the creation of "living wills" was that they made

general sense but that people were skeptical that they could

work in the reality of very complex organizations.

Mr. Nash then introduced the moderators for the panel

titled, "Alternative Lines of Credit," Mark E. Pearce, Director,

DCP, Melinda West, Chief, Policy and Program Development, RMS,

and Michael W. Briggs, Supervisory Counsel, Legal Division. Mr.

Pearce referred to the FDIC's guidance on overdraft payment

programs and said that a goal of the day's discussion was to get

members' insights into al ternati ves to automated overdraft

programs; the FDIC was interested in learning about challenges

that bankers faced in offering alternatives, and if unnecessary

regulatory challenges could be reduced.

Since the last Committee meeting, Mr. Pearce said, the FDIC

had received substantial feedback on the overdraft program

guidance, had used the information to arrange a nationwide callin with over 4,000 bankers to clarify the FDIC's expectations,

and followed that by providing a written set of questions and

answers. One area the FDIC clarified, he said, was that the

guidance applied only to automated programs, where the decision

to pay an overdraft did not involve much bank employee

invol vement; the guidance did not apply to ad hoc overdraft

programs (operated by about 60-70 percent of community banks)

where bank employees made more individualized decisions on

overdrafts. A second clarification, Mr. Pearce said, were

FDIC's expectations concerning a bank's response to a customer

who frequently overdrafted their account. The original guidance

had discussed a targeted outreach to the frequent overdraft

customer, and Mr. Pearce said that such an approach was

illustrative and that banks could respond to frequent overdraft

May 11, 2011
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use in a variety of ways. Another method, he said, could be to

include on the monthly statement of frequent overdraft users, a

highlighted statement which noted the frequent overdraft use and

a description of al ternati ves available to the customer.

Mr. Pearce said that the FDIC wanted to explore all aspects

of al ternati ves to automated overdraft programs: could

customers frequently using overdrafts qualify for lines of

credi t; what are marketing challenges of al ternati ves; did

regulators create an unlevel playing field in scrutinizing lines

of credit, and could those obstacles be reduced? Ms. West noted

that the FDIC was at a preliminary point in considering

al ternati ve lines of credit and noted that cost was an element

that the FDIC had heard was a barrier. She inquired if it would

be helpful if examiners placed less focus on the bank's

underwri ting of the al ternati ve lines, since potential customers

would usually be customers with a record of paying their

overdrafts, and the loan amounts would generally be small?

An exchange between Member Brown and Mr. Pearce indicated

that there had been some uncertainty among banks about what

steps banks needed to accomplish by July 1, 2011 to comply with

the FDIC guidance. Member Brown said that his bank had

cancelled its automated overdraft program because it did not

think that it had sufficient time to achieve compliance; he also

noted his staff had experienced regulatory fatigue on the issue.

He said that in order to implement a customer notice in a

monthly statement, the bank had to work through its vendor,

which involved a lag time and cost uncertainties. Regarding

possible al ternati ve lines of credit, Member Brown indicated

that most bankers would run various models to choose the best

one from a revenue and resources standpoint, but bankers

probably would not be attracted by the concept of lower

examination scrutiny of underwriting, because the underwriting

would have to make sense to the bank in any case. Member Miller

observed that frequent users pay their overdrafts because they

have no choice but to pay, so he did not think that a criterion

of a history of overdraft payment would be useful in making a

credit decision. The difficult question was how could line of

credi t customers be made to make payments? In response to a

question from Member Blanton about the different treatments of

ad hoc and automated overdraft payment programs, Mr. Pearce

explained that traditionally, ad hoc programs had been one-time

accommodations based on a banker's knowledge of the customer,

while automated programs can run with limited bank employee

oversight which raised regulator concerns. Member Urrabazo

expressed a concern that ad hoc programs created the potential

May 11, 2011
104

for Regulation B fair lending violations if bankers accommodated

people who they knew without treating everyone else similarly;

he noted that automated systems allowed his bank to pay about 80

percent of overdrafts in contrast to an historical record of

returning 80 percent.

Member Urrabazo said that automated overdraft payment

programs are driven by the market, and exist because people want

them, adding that very few of those customers would qualify for

a line of credit. Chairman Bair inquired -- if a bank has

credi t risk on overdrafts and uses criteria to qualify overdraft

users for fee-based payments -- what prevented the bank from

applying the same credit qualifications for issuing a line of

credi t? She added that the credit could be tied to having

direct deposits, or could require that the loan be repaid over

several pay periods. Member Urrabazo said that there were two

points: first, opening a line of credit almost always implied a

subprime lending situation because most of the customers do not

really qualify for a loan; second, the bank's decision is not

driven by credit scores or borrower qualifications, rather, it

is driven by volume, like a credit card type of business.

Chairman Bair indicated that she thought that the FDIC

understood that, but wanted to know if the economics of lines of

credit could be streamlined so that they became an economically

viable al ternati ve. Member Blanton indicated that one issue was

how certain customers managed their finances, and that certain

people would draw their entire line of credit and soon return to

relying on overdrafts; he also expressed the view that many

customers do not have employment that could result in direct

deposit relationships.

Member Stewart stated that, in her understanding, the

models banks used for automated overdraft scoring were different

than the credit model; overdraft scoring is tied to factors such

as the nature of the deposit relationship, how long a person has

been a client, their average deposit and the number of

overdrafts; in contrast, the credit model is based on a credit

score and possibly a bankruptcy indicator score. In addition to

the different data sets, she said, a history of consistent

deposi ts into a checking account may indicate that an overdraft

would soon be paid. Member Stewart then described her bank's

overdraft line of credit: the lines of credit can go up to

$ 1,500; they are not considered subprime although they can be

based on somewhat lower credit scores than other loans because

of their limited size; and payments are set to automatically

come from checking accounts. She said that the loans are

offered to customers when they open a checking account or upon

May 11, 2011
105

their first overdraft, and while the accounts do have a higher

interest rate and a transfer fee, they do not generate as much

revenue as an overdraft program. In her experience, about 15

percent of clients with the line of credit later have overdraft

issues. Chairman Bair congratulated Member Stewart on

profi tably offering an al ternati ve line of credit.

Member Miller stated that charge-off rates for overdraft

programs were likely between 5 and 10 percent and suggested that

the economics of lines of credit charging 12 to 15 percent

interest would not support a similar charge-off rate. Chairman

Bair responded that the FDIC recognized that any lending had to

be supported by economics, and referred to guidance that allowed

banks to charge higher interest, which, she noted, would still

be lower than the effective interest rates on overdraft

programs. Member Miller noted that state usury laws often

prohibi ted higher rates.

Member Williams indicated that his rural bank was done

debating whether the overdraft guidance was good and had decided

to embrace it. He had observed his customer service

representatives becoming defensive in responding to customers

about overdrafts, and thought that offering al ternati ve products

would help build customer relationships. Members Blanton and

Urrabazo indicated that their banks also offered overdraft lines

of credit but that some customers' management of their finances

made the products unattractive and unused. Member Urraba zo

complimented the FDIC's national conference call as being

cri tical to his bank's decision to continuing its overdraft

program. Mr. Pearce expressed appreciation for the members'

feedback and echoed Chairman Bair's desire to continue the

conversation about how the FDIC could help remove regulatory

obstacles to support al ternati ve lending products.

The Committee stood in recess at 12:09 p.m., and reconvened

at 1:41 p.m. that same day.

Mr. Nash introduced Christopher J. Spoth, Senior Deputy

Director, RMS, and Sylvia H. Plunkett, Senior Deputy Director,

DCP, who moderated the panel titled, "Overview of Latest

Findings in Bank Examination." Mr. Spoth reviewed recent

banking statistics, including those about bank failures and

problem banks. He said that the peak in bank failures occurred

in the third quarter of 2009; that there had been about 40 to

date in 2011, with a possibility of somewhat over 100 for the

year; regarding problem banks, their number remained high but

was not growing. Mr. Spoth said that credit risk was among the

May 11, 2011
106

issues seen in examinations, and that the past due or nonperforming ratio was slightly better than last year in almost

every loan class. He said that CRE continued to be the highest

non-performing loan category, even after some troubled debt

restructurings ("TOR") and write-offs, and that the FDIC

continued to monitor redefaul ts. Mr. Spoth said that a quarter

of all banks were unprofitable in the fourth quarter of 2010,

but that he expected a significant drop in unprofitable

institutions in the first quarter of 201l. He observed that

community banks had not generally reduced their allowance for

loan and lease losses, unlike the largest banks.

Ms. Plunkett then discussed issues the examiners are

finding in consumer law compliance examinations. She noted that

the FDIC risk scopes its examinations by considering the size

and complexity of a bank and the types of products it offers,

and then identifying areas that pose risk to consumers as well

as to the bank, for example, reputational or legal damage. Ms.

Plunkett said the FDIC had seen a slight increase in the number

of problem-rated institutions and observed that compliance

problems sometimes occurred when a bank facing financial

problems reallocates resources away from consumer protection.

She said that significant components of a smaller bank's

compliance management program include audit and monitoring; the

best way to do those functions, she said, is to have a dedicated

compliance officer, but that less expensive options existed,

including: sharing an audit program wi thin a holding company

structure, sharing an audit program among different community

banks in a geographic area, or by hiring an outside consultant.

Ms. Plunkett said that a significant risk area was bank

oversight of vendors that offer products in the bank's name.

She said that banks may consider using a vendor to offer a

product to increase fee income, and that the vendor may perform

the product's marketing and administration, but that it remained

the bank' s responsibility to assure consumer law compliance as

if the bank offered the products directly to consumers. Mr.

Spoth noted that problems with third party vendors can also

raise risk management issues, particularly if the product

involves a credit or payment system issue. Mr. Spoth and Ms.

Plunkett invited members to raise issues of interest to them.

In response to questions from Members Blanton and Hopkins,

Mr. Spoth discussed banks' use of brokered deposits; when their

use was a concern to the FDIC; and the relationship of brokered

deposi ts to de novo banks and bank failures. He noted that the

FDIC was conducting a study of brokered deposits pursuant to the

May 11, 2011
107

Dodd-Frank Act. Member Brown provided examples of examiner

communications to bank representatives during examinations; some

had been helpful and supportive, others appeared to be

aggressi ve; he added that examiner communications can have big

effects on a bank's board of directors. Member Urrabazo also

provided feedback about a recent examination. Mr. Spoth and

Chairman Bair said that the FDIC encouraged bankers to provide

feedback to help ensure an effective supervisory process, and

that a recent Financial Institution Letter (FIL 13-20 ll)

addressed the issue. Member Schriefer spoke about high levels

of classified loans. He suggested that it would be good if

banks and examiners could discuss loans with well-defined

weaknesses and obtain examiner concurrence that deficiencies had

been corrected earlier than the next regular examination. Mr.

Spoth said that the FDIC was trying to reflect improvements in

composite ratings as soon as the facts made it appropriate, much

as the FDIC had done in downgrading ratings; he added that

conversations between banks and examiners about improvements

could occur at the individual loan level as well.

In response to a question from Member Urrabazo about the

relationship of classified loans to capital, Mr. Spoth said that

there were not rules of thumb about ratios, that as.set component

ratings were driven by the particular characteristics of a given

loan portfolio. Member Miller commented that it appeared that

the FDIC was inconsistently applying guidelines concerning real

estate reappraisals, and that there were also unresolved

questions about TOR's. In response to a question from Member

Bridges about a possible double dip in real estate, Mr. Spoth

said that there could be a continued slide in commercial or

residential real estate in certain geographic areas. He added

that there was a concern about the effect of an interest rate

increase on concentrated CRE portfolios, as some of those loans

come due in the next 18 months, and that the FDIC was monitoring

the issue. Member Brown and Mr. Spoth discussed possible risks

in the recent trend toward building multi-family rental

properties. Member Brown indicated that he was pleasantly

surprised that many loans were underwritten based on income

rather than property appreciation, and that owners were drafting

leases to protect against future inflationary pressures.

The Committee discussed problems associated with

appraisals and the requirement for independence of a bank's

appraisal reviewer. Member Brown said that his bank understood

recent regulatory guidance to impose a harder line, so that any

bank personnel involved in the credit approval process could not

perform an appraisal review. He observed that all the people

May 11, 2011
108

who were capable of doing a review were involved in the credit

administration process. Member Blanton noted that the problem

was especially acute in rural areas, where appraisal services

are harder to obtain. Member Hopkins said that appraisals and

reviews were his bank's current top issues. Member Bridges

stated that her understanding of the regulators' concern was

that lenders did not have the skills to appropriately evaluate

the risk in-house, and that increased training of bank personnel

might respond to the problem. Mr. French, Deputy Director,

Policy, RMS, said he believed that the guidance had not been

intended to add new requirements, and thanked the members for

the feedback, which the FDIC would evaluate. Member Bridges

reported that her bank was having success in lending to

mul tifamily housing proj ects. Member Blanton observed that CRE

loans were coming due and borrowers were trying to renew them.

He discussed an example of his bank's successful negotiation of

a CRE loan that had been previously made by a nontraditional

lender. Mr. Spoth said that he hoped that the Dodd-Frank Act

would level the playing field so that community banks could make

more loans that previously went to nontraditional lenders.

Mr. Nash observed that the Committee had moved into the

"Roundtable Discussion" part of the day's agenda and asked if

there were other issues members wanted to raise. In response to

a question from Member Gray about the status of Dodd-Frank Act

regulations, Chairman Bair reviewed rules that were in process

and noted that most of them would have almost no direct impact

on community banks. She and Mr. Nash noted that the FDIC had

added community bank impact statements to transmittal memos of

new regulations so that bankers needed only to read the first

paragraph to determine if further review was required. Mr. Gray

renewed an earlier recommendation that the various Dodd-Frank

Act rules be reviewed for their interaction with each other and

existing rules.

Member Hopkins and Mr. French and Mr. Spoth discussed the

use of credit rating agencies' ratings of municipal securities

by banks and regulatory agencies. Mr. French clarified that

regulators were required to remove reliance on credit agency

ratings from their rules, but said that banks were not

prohibited from relying on credit agency ratings as part of

their internal risk management. Mr. Spoth said that some banks

had an emerging vulnerability in their municipal bond portfolios

and that FDIC examiners would review highly concentrated banks.

May 11, 2011
109

Chairman Bair and Director Curry thanked the members for a

valuable meeting; the Chairman added that she hoped that they

would enj oy their continuing work with the FDIC.

There being no further business, the meeting was adj ourned

at 2:31 p.m. ~j/ Robert E. Feldman

Executi ve Secretary

Federal Deposit Insurance Corporation

And Committee Management Officer

FDIC Advisory Committee on Community

Banking

May 11, 2011
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

May 11, 2011 - 8:34 A.M.

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

minutes are accurate and complete.

~~.~ Martin J. Gr~n~

Acting Chairman

Board of Directors

Federal Deposit Insurance Corporation

Da ted: August 5, 2011