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Summer 2009
Central
N e w s a n d V i e w s f o r E i g h t h D i s t r i ct B a n k e r s
F e at u r e d i n t h i s i s s u e : Stress-Testing Large Banks | Re-establishing Connections
Not Normal Times
What Is the Future of CRA?
S
ince the financial crisis began,
many bankers have wondered how
the Community Reinvestment Act
(CRA) will be updated to fit the changing financial landscape.
The 1977 law was created to make
financial services more readily available in low- and moderate-income
communities. However, some observers say it is time to update the law. Fed
Gov. Elizabeth Duke, a former community banker, outlined the principles
needed for a new CRA framework in a
speech earlier this year.
“Keep the most effective feature of
the law—its flexibility,” she said. “Any
new regulatory structure should also
be clear about the problem we are trying to solve, determine who is in the
best position to solve the problem, and
be transparent and designed to ensure
that community benefit is maximized
without placing excessive regulatory
burden on financial institutions.”
Locally, bankers are seeing fewer
opportunities to pursue CRA activities, and are wondering what’s going
to change. “Obviously, during normal
economic times CRA is a challenge
for lending, service and investment,”
says William Stemmler, vice president
for CRA Community Development of
Cadence Bank N.A. in Memphis, who
attended a Fed CRA Interagency Training Workshop in April.
“These are not normal times, and I
must say I have never lived through
opportunity
foreclo
liquidity
cra
growth
bankruptcy
such a challenge during my 40 years in
banking,” he says. “Foreclosures, bankruptcy, unemployment and the banking
liquidity crisis have made community
development extremely difficult in most
markets across the United States. Now,
you have to work a lot harder to uncover
opportunities for CRA.”
To help you understand where CRA
is headed, download the Fed’s new
“Revisiting the CRA: Perspectives on
the Future of the Community Reinvestment Act” at www.bos.frb.org/
commdev/cra/index.htm. The book
offers a variety of ideas and opinions
on revising the law.
>> M o r e O n li n e
Read Gov. Duke’s speech:
www.federalreserve.gov/newsevents/
speech/duke20090224a.htm
T h e F e d e r a l R e s e r v e B a n k o f St . L o u i s : C e n t r a l t o A m e r i c a ’ s Ec o n o m y ™
Central View
News and Views for Eighth District Bankers
Vol. 19 | No. 2
www.stlouisfed.org/publications/cb
Editor
Scott Kelly
314-444-8593
scott.b.kelly@stls.frb.org
Central Banker is published quarterly by the
Public Affairs department of the Federal
Reserve Bank of St. Louis. Views expressed
are not necessarily official opinions of the
Federal Reserve System or the Federal Reserve
Bank of St. Louis.
To subscribe for free to Central Banker or any
St. Louis Fed publication, go online to
www.stlouisfed.org/publications/subscribe.
html. To subscribe by mail, send your name,
address, city, state and ZIP code to: Central
Banker, P.O. Box 442, St. Louis, MO 63166-0442.
The Eighth Federal Reserve District includes
all of Arkansas, eastern Missouri, southern
Illinois and Indiana, western Kentucky and
Tennessee, and northern Mississippi. The
Eighth District offices are in Little Rock,
Louisville, Memphis and St. Louis.
2 | Central Banker www.stlouisfed.org
Why Stress-Test
Large Banks?
By Julie Stackhouse
E
arlier this year, Treasury Secretary
Timothy Geithner outlined a comprehensive plan to restore stability to
our financial system. The plan encompasses several components, including a
public/private investment program for
legacy loans and securities, a mortgage
refinancing program and a Capital
Assistance Program (CAP).
Julie Stackhouse is
The CAP has received significant
senior vice president
attention because it serves as a compleof the St. Louis Fed’s
ment to the recently completed “stressdivision of Banking
test” of the nation’s 19 largest financial
Supervision, Credit
organizations. The stress-test is a
and the Center for
forward-looking assessment by bank
Online Learning.
supervisors, intended to ensure that
these very large banks remain wellcapitalized in the event of a worsethan-expected recession.
So, why was it beneficial to stress-test large banks?
Large-bank lending is of vital importance to the health
of the economy. Large corporations redeploy loans from
large banks into productive economic resources. Without a
healthy financial system, economic growth weakens.
Market concerns over the capital positions of these large
organizations have made it impossible for them to raise the
capital they need on favorable terms and have led them to
pull back from lending. This pullback materially reduces
the ability of the financial system overall to perform the
critical role of credit origination. A capital buffer increases
the likelihood of lending and reduces the risk that problems
at a very small number of institutions—through the many
linkages across institutions—lead to the failure of otherwise
viable institutions.
What happens now that the stress test is complete? By
early June, the 10 banking organizations needing to augment
their capital buffer were to develop detailed capital plans
to be approved by their primary regulators, in consultation
with the FDIC. The 10 organizations will have six months
to implement the plans. If needed, the Treasury is making capital available under the CAP as a bridge to private
capital in the future. The assistance, in the form of mandatory convertible preferred stock, is expensive. CAP securities carry a 9 percent dividend yield. After seven years, the
security will automatically convert into common equity if
not redeemed or converted before that date.
Q u a r t e r ly r e p o r t
Slump Persists for District
and U.S. Banks
By Michelle Neely
E
arnings and asset quality continued their downward slide in the
first quarter at Eighth District and
U.S. commercial banks, reflecting the
nation’s real estate overhang and economic contraction.
Profitability at District banks fell
yet again in the first quarter. Return
on average assets (ROA) declined six
basis points to 0.34 percent, and was
down 59 basis points from its year-ago
level. (See table.) U.S. peer banks
(banks with average assets of less than
$15 billion) actually collectively posted
losses, with ROA measuring –0.02 percent. Negative earnings were concentrated at peer banks in the $1 billion to
$15 billion size range. U.S. banks with
assets of less than $1 billion recorded
an average ROA of 0.38 percent; District banks posted an average ROA of
0.73 percent.
In the District, the ROA drop can
be attributed to a fairly sharp decline
in the net interest margin and an
increase in the loan loss provision
(LLP) ratio. For peer banks, the ROA
decline was due entirely to sharp
increases in LLP, as the net interest
margin stayed flat and net noninterest
expenses declined.
LLP as a percent of average assets
rose to 0.88 percent at District banks
and 1.25 percent at U.S. peer banks.
The LLP ratio has increased at a rapid
rate at both sets of banks to replenish loan loss reserves that are being
drained by ever-increasing chargeoffs of nonperforming loans. Still, the
coverage ratio continues to decline.
On March 31, District banks had 74
cents reserved for every dollar of
nonperforming loans compared with
86 cents at year-end 2008 and $1.78 at
year-end 2006. U.S. peer banks had 55
cents reserved for every dollar of nonperforming loans at the end of the first
quarter, down from 64 cents at yearend 2008 and $1.83 at year-end 2006.
Increases in LLP and declines
in coverage ratios can be traced to
continued deterioration in asset quality
at District and U.S. peer banks. The
ratio of nonperforming loans to total
loans rose to 2.19 percent at District
banks and an unusual 3.31 percent at
peer banks in the first quarter. In the
District, increases in nonperforming
commercial and industrial loans and
all types of real estate loans were the
main contributors to the rise in the
composite nonperforming loan ratio.
Construction and land development
(CLD) loans remain—by far—the most
troubled part of loan portfolios. At the
end of the first quarter, 6.26 percent of
District banks’ outstanding CLD loans
were nonperforming; at U.S. peer
banks, an astonishing 11.05 percent of
CLD loans were nonperforming.
Despite the poor earnings and
asset quality numbers, District banks
remain on average well-capitalized.
At the end of the fourth quarter, just
three banks (out of 695) failed to meet
at least one of the regulatory capital
minimums. District banks averaged a
leveraged ratio of 8.92 percent.
Michelle Neely is an economist at the Federal
Reserve Bank of St. Louis.
No Turnaround in Sight
Q1 2008
Q4 2008
Q1 2009
0.93%
0.80
0.40%
0.08
0.34%
–0.02
3.79
3.99
3.78
3.82
3.64
3.82
0.43
0.58
0.77
1.06
0.88
1.25
1.72
1.63
1.76
2.69
2.19
3.31
Return on average assets
District Banks
Peer Banks
Net interest margin
District Banks
Peer Banks
Loan Loss Provision Ratio
District Banks
Peer Banks
Nonperforming loans Ratio
District Banks
Peer Banks
SOURCE: Reports of Condition and Income for Insured Commercial Banks
Banks with assets of more than $15 billion have been excluded from the analysis. All earnings
ratios are annualized and use year-to-date average assets or average earning assets in the
denominator. Nonperforming loans are those 90 days or more past due or in nonaccrual status.
Central Banker Summer 2009 | 3
In-Depth
Re-establishing Connections
With Checks Gone, Fed Staff Looks To Rekindle Frequent Contact
By Robert Hopkins
N
ot long ago, Federal Reserve
banks and branches had what
seemed like continuous contact
with financial institutions across
the country. This was, in large part,
attributable to involvement in near
round-the-clock processing of check
payments for financial institutions.
What Is the FI Touch?
The Financial Institution Touch (FI Touch) program has three
broad objectives:
1.
Through face-to-face meetings with Eighth District bankers, share
key Fed messages and relay banker concerns to appropriate Bank
management.
2.
Acquire additional, contemporaneous input for the Bank’s
economic information-sharing initiatives, e.g., Beige Book and
Burgundy Books, through the informal surveying of bankers on
local economic activity.
3.
Share Fed resources and technical expertise with communities
throughout the various District zones and identify opportunities
where the Federal Reserve Bank of St. Louis can provide added
value to communities and leaders, i.e., bankers, chambers of commerce, educators, community development groups, etc.
With paper check-processing consolidated down to a few offices, we
realized that we missed the everyday,
valuable interaction that we once
enjoyed with bankers, and we could
use a fresh start. Last year, my colleagues and I—Martha Perine Beard
and Maria Hampton, respectively the
senior branch executives of the Memphis and Louisville branches—started
a new program called Financial
Institution Touch (FI Touch), through
which we systematically and routinely
meet with officials from Eighth District financial institutions to rekindle
that interaction.
4 | Central Banker www.stlouisfed.org
We have many reasons for doing
this. (See sidebar: What Is the FI
Touch?) In addition to reconnecting
with bankers, we’re also assessing
local economies—such information
can make its way into the Fed’s Beige
Book and Burgundy Books reports—as
well as seeking feedback on other
important issues confronting financial
institutions and the Federal Reserve.
In conjunction with these visits, we
assess community needs and identify
possible opportunities to provide Bank
resources to the financial institutions
and their communities.
Not surprisingly, my colleagues
and I are finding the anecdotal economic information provided by bankers thoughtful and helpful. Because
bankers and community leaders have
unique perspectives on their local
economic conditions and community
needs, our discussions enable us to
more effectively provide suggested
assistance.
For example, one banker indicated
that he had recently attended a Fed
forum where an economist had presented current research and believed
a similar program in his community
would be beneficial. Another banker
inquired about a recent regulatory
issue confronting community banks
and another about steps required to
become a state member bank.
Another example: Steve Trusty,
president of Simmons Bank of Hot
Springs, Ark., told me recently, “I
appreciate the opportunity to visit with
Federal Reserve officials to share both
the economic successes and challenges
of the community we serve. I also find
it beneficial to provide perspectives
on policy debates occurring in Washington, D.C., and across the country
that likely will have an impact on large
financial institutions and community
banks like ours.”
The bankers that my colleagues and
I have met with so far have put us in
touch with local school administrators, where we shared economic and
personal finance curricula and teacher
R egiona l Spot l igh t
Fed Looks at Student Loans
and Community Colleges
training programs that the St. Louis
Fed produces. Bankers learned about
the Fed and subsequently partnered
with us in April (national Personal
Finance Month) to teach local primary
school children how to save.
We’ve also shared information and
technical assistance with communities
that historically have not functioned
well so that we can help improve community development finance, asset
building, and neighborhood stabilization and revitalization. Bankers have
partnered with us to consider better
ways to improve credit access for lowand moderate-income communities.
Because there are approximately
700 banks located in parts of seven
states, St. Louis Fed officials have an
ongoing challenge to personally maintain existing relationships, as well as
build new ones, with bankers across
the Eighth District. Through our
public programs, supervision activities,
financial services account executives
and, now, our FI Touch program, we
intend to meet the challenge. We can
serve you better by understanding the
unique economic conditions and needs
of your communities.
For more information on St. Louis
Fed banking and other programs, see
www.stlouisfed.org/banking.
>> M o r e O n li n e
Little Rock Branch:
www.stlouisfed.org/littlerock/
Louisville Branch:
www.stlouisfed.org/louisville/
Memphis Branch:
www.stlouisfed.org/memphis/
Bankers might find two separate reports from the St. Louis Federal Reserve useful when considering loans for higher education.
Rajeev Bhaskar and Yadav Gopalan, research associates at the
St. Louis Fed, explore the difficulty of getting school loans these
days, even as college costs are rising. Their study, explored in the
summer issue of the Bridges newsletter (www.stlouisfed.org/
publications/br/), takes a closer look at various aspects of the
financial needs of college-bound students, from what makes up
the overall cost to what types of student loans are available. The
authors also look at the rising cost of college and the impact of
the credit crisis on student loans.
Second, economist Natalia Kolesnikova has written a report titled
Community Colleges: A Route of
Upward Economic Mobility. It looks
at the advantages and disadvantages of attending community
colleges and the characteristics
of their students. Among the
advantages are affordability,
an open-admission policy
and, ultimately, higher wages
compared with the pay earned
by those who have only a high
school diploma. The study found
that there is an increase in annual earnings of 5 percent
to 8 percent for each year of community college education. Those
who obtain an associate degree earn 16 percent to 17 percent more
on average than high school graduates. Kolesnikova has been
presenting the results of her study to audiences around the Eighth
District of the Fed.
Natalia
Kolesni
kova
l Reserv
e Bank
of St. Lo
uis
March
2009
Federa
>> O n ly o n l i n e
View a clip of Kolesnikova’s presentation:
www.stlouisfed.org/video/
community-colleges.mp4
Community Colleges report:
http://stlouisfed.org/community_development/
assets/pdf/CommunityColleges.pdf
Robert Hopkins is the senior branch executive
of the St. Louis Fed’s Little Rock Branch.
Central Banker Summer 2009 | 5
Ec o n o m i c F o c u s
Banking Sector in Springfield, Mo.,
Shows Stress of Competition
By Gary S. Corner and Rajeev R. Bhaskar
To learn why, we compared
Springfield with four similar mid-sized metro areas.
S
pringfield, Mo., is a mid-sized
metropolis nestled in the Ozark
Mountains in the southwest corner of
the state. The local economy is heavily
dependent on health care, education,
manufacturing, retail and tourism. The
gross metro product for Springfield
in 2007 was $14.5 billion, giving it a
national rank of 127 among metro areas.
Solid economic growth has attracted
Table 1
Fact Sheet on Springfield, Mo.
Springfield, Mo.
5 MSA Average
420,020
249,422
2.4%
2.2%
Population
Population Growth Rate
Unemployment Rate
Current Total Workforce
Gross Metro Output (in billions)
Current Per Capita Income
Cost of Living Index
6%
5.6%
220,026
130,280
$14.5
$9.2
$29,577
$30,107
87.4
89.2
SOURCES: Springfield Business Development Corporation, Bureau of Labor Statistics, Bureau
of Economic Analysis, Bureau of the Census and Council for Economic Activity and Research
many banks to operate in the area.
Recent reports indicated, however,
that there was some weakness in the
banking sector.
To analyze the Springfield market,
we performed a comparative study
by looking at four mid-sized markets
representing a cross section of the
Eighth District outside of the four
major metropolitan statistical areas
(MSA). Besides Springfield, the other
four markets were Columbia, Mo.,
Fayetteville, Ark., Jonesboro, Ark., and
Jackson, Tenn. The study entailed
6 | Central Banker www.stlouisfed.org
comparing Springfield’s economic and
banking statistics with those of the
four metropolitan areas.
Springfield Shows Banking Weaknesses
Table 1 compares economic data for
Springfield with that of the other four
MSAs; in terms of population and economic output, Springfield is somewhat
larger than the average of the other
MSAs. It compares fairly equally on
the other metrics of unemployment,
population growth rate, per capita
income and cost of living. Springfield
does not appear to be experiencing
any unique economic shocks, such as
big factory closings. Conditions there
resemble what’s typically happening
in other parts of the nation.
However, in our analysis of banking conditions, we observed that of
the five markets, Springfield showed
some extra weakness on a number of
metrics. (See Table 2.) At year-end
2008, return on assets at all Springfield
banks was –0.15 percent, compared
with 0.56 percent for Jonesboro (the
second lowest) and 1.02 percent for
Columbia (the highest). For the other
metrics examined—loan loss reserves,
CAMELS ratings and leverage ratio—
Springfield banks ranked in the
middle. Only one other metropolitan
area (Fayetteville, 2.42 percent) had a
higher proportion of nonperforming
loans than Springfield (1.84 percent).
Springfield banks have higher
levels of commercial real estate (CRE)
concentration and noncore funding
ratios compared with banks in the
other areas. These observations, along
with some of the other metrics, point
to an extremely competitive market in
Springfield.
Is Springfield’s Market Overcrowded?
Springfield has had a decent share
of banks open since the 1990s that
have contributed to the crowded local
financial services environment. Currently, 22 banks are headquartered in
Springfield, compared with 12 in the
second highest MSA. In addition, 18
banks that are headquartered elsewhere operate branches in the Springfield market. When we applied the
Herfindahl-Hirschman Index (HHI) to
Springfield, a measure that attempts to
capture the level of competition within
a market by using the market share of
all institutions operating in the region,
we saw that Springfield has a very
high level of competition. The value
of HHI varies from zero to 10,000; the
lower the number, the more competitive a market is. The HHI for the
Springfield market is 730, the lowest of
all metro areas in the study. See Table
2 for HHI scores of the other MSAs.
Springfield’s overcrowded market
observation has been echoed by local
representatives of other regulatory
agencies and banking leaders. It has
also been noted that the market has
not experienced a significant economic
downturn in recent history. Consequently, some institutions may not
have an institutional history of working through stressful economic periods. This lack of experience affects
the competitive forces at work and
influences credit underwriting, pricing
and deposit practices.
In general, we do observe some
extra weakness in the Springfield market compared with the other MSAs,
although nothing we would categorize
as severe. This weakness, we believe,
is due to the relatively higher level of
competition. Springfield has always
been an attractive banking market with newer banks adding to the
pressure on growth and earnings at
existing banks. Until recently, banking conditions were largely unaffected
by the increase in competition. The
funding and asset deployment strategies in such a competitive market,
though, are proving to be less resilient
in an economic downturn.
Gary Corner is a senior examiner and Rajeev
Bhaskar is a senior research associate of the
Banking Supervision and Regulation division
at the St. Louis Fed.
Table 2
A Comparison of Springfield Banks with Other Metropolitan Area Banks, Q4 2008
Springfield, Mo.
Columbia, Mo.
Fayetteville, Ark.
Jonesboro, Ark.
Jackson, Tenn.
22
8
12
6
3
Total Assets (in millions)
$5,888
$1,982
$12,961
$3,356
$571
Return on Assets
-0.15%
1.02
0.68
0.56
0.96
1.84%
1.05
2.42
0.76
1.29
67.82
189.06
Banks Headquartered in Town
Nonperforming Loans / Total Loans
Loan Loss Reserves / Nonperforming Loans
Tier 1 Leverage Ratio
CRE to Total Loans
Herfindahl-Hirschman Index (HHI)
94.97%
141.3
8.25
98.2
8.83%
8.16
8.0
9.14
30.26%
26.35
28.12
27.7
21.9
730
1407
1943
1634
1474
SOURCES: Call Reports and CASSIDI (Federal Reserve Bank of St. Louis). Numbers in red indicate notable differences when compared with the other metropolitan
areas’ banks.
Central Banker Summer 2009 | 7
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V IE W S
RE G ULATIONS
• We take a look at fair
value accounting
• New Truth in Lending
final rules take effect
• District bankers share
views on exploring
innovation in community
development
• Board delays enactment
of trust preferred securities rule for one year
• Shape of effective reform
is not yet clear
• Keep the appropriate
allowance for loan and
lease loss reserve
TELL YOUR STA F F
• Food coupons officially
going away
• Memphis Branch transitioning to currency
strap imaging
TOOLS
• Is it time for you to
Ask the Fed?
• St. Louis Fed joins PBS
on YouTube
> > O n l y O n l i n e
Read these features at
www.stlouisfed.org/
publications/cb/
Understand the Financial
Climate with the Fed
You can’t escape the word “recession” in
today’s news. But do the raw numbers
contain a different message? Is this really a
depression instead of a recession? And how
is the Fed responding? Understand what’s
going on with two dynamic Fed web sites:
Tracking the Global Recession
http://research.stlouisfed.org/recession/
This site tracks the current economic environment through easy-to-understand charts of
monthly indicators, such as employment,
industrial production, retail sales and real
income; current GDP data breakdowns; data
from other countries; and more.
The Financial Crisis
http://timeline.stlouisfed.org/
The St. Louis Fed began this site last year to
help the public better understand the major
financial events and policy actions that the
Fed has taken over the past months. Since
spring, the site has been enhanced with new
functionality and a wider array of material.
CENTRAL BANKER | SUMMER 2009
https://www.stlouisfed.org/publications/central-banker/summer-2009/fairvalue-accounting-dont-shoot-the-messenger
Views: Fair-Value Accounting: Don't Shoot the
Messenger!
William R. Emmons
A long-standing criticism of historical-cost accounting (HCA) is that, while it may provide good information
about things that already have happened, it may not tell us much about what has happened in the recent past
or what is likely to happen in the future.
For example, a bank may have acquired a bond some time ago at a price of $100, but it might be possible to
sell the security today for only $80. If the bank classifies the security as "held to maturity" and believes that it
will pay off in full at maturity, it is allowed to carry the security at $100 and need not recognize any loss when
reporting its earnings and capital.
Fair-value accounting (FVA) is a framework for assigning current values to assets and liabilities. In the example
above, a loss of $20 would be recognized both in the bank's earnings and its capital as soon as it occurred.
The bank would have no choice, even though it might believe there has been no permanent impairment of the
security's value.
Many academics, policymakers and others have applauded FVA as a vast improvement over HCA, because it
is likely to accelerate the recognition and (hopefully) resolution of troubled banks and other financial firms. At
the same time, some bankers, politicians and others have derided FVA as a principal cause of the financial
turmoil we are experiencing because it translates financial-market volatility into wild and largely unjustified
fluctuations in banks' earnings and capital.
In fact, both extreme positions are wide of the mark. FVA is neither perfect nor pernicious in its own right.
There are many difficult conceptual and practical issues surrounding FVA that remain to be resolved. In the
meantime, all concerned parties should learn more about FVA and work toward a more effective
implementation. Fair-value accounting is just the messenger and it wouldn't be wise to "shoot it down" just
because the message it is bringing today is unpleasant.
Fair-value Accounting in the United States
U.S. GAAP (generally accepted accounting principles) has been moving toward FVA principles for a number of
years, but GAAP remains a hybrid system. That is, it is an evolving mixture of historical-cost, LOCOM (lowerof-cost-or-market) and fair-value accounting principles.
As of late 2007, banks and other firms may choose to apply fair-value principles to any financial asset or
liability, but they need not do so in some cases. Certain items, such as derivatives, always must be reported at
fair value. Others, such as loans, rarely are. Liabilities may be marked up or down to reflect changes in fair
value, giving rise to the paradoxical implication that a firm's financial difficulties actually may increase its
earnings and capital. For example, a bank that has issued $100 million of debt may increase its earnings and
capital by $10 million if its debt is trading at 90 percent of par in the secondary market.
The "fair-value option" is explained in FAS (Financial Accounting Standards) 159. If choosing FVA for a loan,
security or liability, a bank applies the "fair-value hierarchy" spelled out in FAS 157. In particular, an asset or
liability is reported at market value, if a price is available (a level-one valuation); at a value derived from a
closely related market price or prices (a level-two valuation); or at a value determined by a valuation model,
such as an estimate of the values of the asset's discounted cash flows (a level-three valuation).
What Fair-value Accounting Does and Does Not Do
As currently implemented in U.S. GAAP, relevant FVA standards are intended to answer how much a
competent liquidator would receive for this asset, and how much it would have to pay to extinguish that liability,
in a non-distress transaction under normal market conditions.
This statement of its intent shows that application of FVA struggles with at least three difficult problems:
First: The "exit-price notion" of fair value is a liquidation value, which may differ significantly from an asset's or
liability's "value in use." It disregards any "going-concern value" that may be attached to a particular asset or
liability, such as the value of a bank-borrower relationship, market-specific knowledge, or a core-deposit
franchise. Thus, FVA may materially misrepresent the economic value of a viable bank, as distinct from the
sum of its component assets and liabilities if transferred (hypothetically) to another bank. Note, however, that
historical-cost accounting also may report an enterprise value far from the total market values of a viable
bank's debt and equity.
Second: FVA is highly subjective whenever there is no deep and liquid market for one of the bank's assets or
liabilities. In these situations—much more common today during the financial turmoil than in years past—FAS
157 details valuation techniques based on "close substitutes" (a level-two valuation) or a discounted-cash-flow
or other model-based valuation (a level-three valuation). These valuations require expert judgment and are
likely to differ significantly across banks and from day to day when financial markets are volatile.
Third: In important respects, application of FVA under GAAP is voluntary, and thus makes comparisons across
banks more difficult. Some banks will report a larger proportion of their assets and liabilities at fair values than
others, making standard accounting ratios difficult to interpret.
The Fog of War
The financial crisis has demonstrated a key advantage of FVA in providing relatively prompt updates on the
financial conditions of some banks and other financial firms. But it also has highlighted some of FVA's
weaknesses. Moreover, the Financial Accounting Standards Board in early April issued clarifications of several
FVA statements. FASB said the clarifications would make the fair-value framework "more flexible" by
encouraging banks to use their own judgments more often about whether the markets used for valuation
purposes were "not orderly." This will increase the frequency of level-three valuations, in particular.
While FASB was criticized by many for "compromising" or "weakening" FVA, it's more accurate to say that
FASB merely has altered the elaborate compromise represented by GAAP's incorporation of fair-value
principles. A similar controversy is raging around accounting standards outside the U.S.
Fair value is neither a perfect accounting framework nor more inherently flawed than any other approach.
Ironically, the prominence of fair-value accounting principles in U.S. GAAP increased just as the financial crisis
was unfolding. It would be a mistake to blame FVA for the crisis, but we also should learn from recent
experience that its application has been problematic.
ABOUT THE AUTHOR
William R. Emmons
Bill Emmons is an assistant vice president and economist in the
Supervision Division at the Federal Reserve Bank of St. Louis.
CENTRAL BANKER | SUMMER 2009
https://www.stlouisfed.org/publications/central-banker/summer-2009/alll-best-practices-keep-the-appropriate-allowance-for-loanand-lease-losses-reserve
Views: ALLL Best Practices: Keep the Appropriate
Allowance for Loan and Lease Losses Reserve
Timothy A. Bosch , Salvatore Ciluffo
During these uncertain economic times, lenders must continually actively assess the quality of their loans. It
seems like a simple statement; however, a bank can hurt itself without such diligence.
For example, many banks with high concentrations of commercial real estate loans have incurred
extraordinary losses. Therefore, it is imperative to document the rationale behind all quantitative and qualitative
factors, and be vigilant, proactive and realistic. Examiners will view favorably banks that are quick to selfidentify problem assets and that apply a solid reserve against those loans that will likely result in some loss.
To help your institution explore the quality of your loans, pay attention to your allowances for loan and lease
losses (ALLL). For several years, the banking industry enjoyed low loan loss rates. Normally, during periods of
economic stability, most ALLL methodologies use a three- to five-year-average net loss history to determine
the loss factors for the homogeneous loan pools for the Financial Accounting Standard (FAS) 5 portion of the
ALLL. However, during periods of significant economic contraction—such as now—banks should adjust for
their recent loss experience, which they should expect to more accurately estimate their inherent losses.
Accounting rules require consideration of external and internal factors affecting the adequacy of the ALLL.
Banks should modify their qualitative and environmental factors to ensure that allowance estimates place
appropriate emphasis on current market information and events in a bank's lending area:
External factors include the direction of national and local economies, changes in bankruptcy rates,
changes in unemployment rates, and levels of national and local foreclosures.
Internal factors include asset quality trends, trends in nonperforming loans and charge-offs, portfolio
concentrations, refinance risk, and the strength of the bank's credit administration practices.
Simply stated, examiners expect higher FAS 5 adjustments when the bank is experiencing larger losses and
the economy is weak.
In addition, FAS 114 requires an individual credit impairment analysis. A loan is impaired if it's probable that all
principal and interest payments will not be received according to the contractual terms of the loan agreement.
Banks should define, in their loan policies, which loans will be tested for impairment, such as all loans over a
certain size, all classified loans or all non-accrual loans.
Once the loan is determined to be impaired, the amount of the impairment needs to be measured using one of
the three methods, the most common of which is fair value of collateral less selling and carrying costs. The
challenge in today's economic environment is obtaining a realistic appraisal. Bank management is encouraged
to maintain a FAS 114 analysis indicating the amount of impairment for each loan tested.
Don't hesitate to contact your examiners if you have questions on ALLL methodology.
>> More Online
Bank Directors Desktop
Federal Agencies' Q&A on ALLL
CENTRAL BANKER | SUMMER 2009
https://www.stlouisfed.org/publications/central-banker/summer-2009/bankers-explore-innovation-in-a-difficult-economy
Views: Bankers Explore Innovation in a Difficult
Economy
In this economy, can you be innovative and create sustainable economic opportunities and still meet
obligations and customer expectations?
The Federal Reserve Bank of St. Louis helped bankers and other community leaders from 21 states answer
that nagging question during the springtime Exploring Innovation: A Conference on Community Development.
The St. Louis Fed holds the conference every other year.
Among those who attended was Ben Steinberg of Southern Bancorp Inc., who complimented the closing
address by Bill Strickland, president and CEO of
Manchester Bidwell Corp. "In my mind, Strickland was able to connect what he was doing in Pittsburgh with
the successful programs like KIPP Delta Public School in Helena, Ark. Both programs raise the bar of
expectations. Both programs provide high quality space to their participants. Both have a much wider impact
and extend far beyond the expected movement in one set of benchmarks."
Bobby Culler of First Bank & Trust Co. Inc. in Caruthersville, Mo., said during the conference that it's good to
network and collaborate with people who have some of the same kinds of situations and problems that his
organization faces. Patricia Avery of Old National Bank in Evansville, Ind., said that the conference exposed
participants to a wide variety of successful programs and models that she's now considering.
"But perhaps most importantly, the message that 'now is the time to innovate' came through loud and clear,"
said Avery, who serves as Old National's director of community innovation. "We know what's worked in the
past. But if we're going to succeed in strengthening our communities, we've got to move beyond what we're
comfortable with now and develop 21st century strategies and tools that can change the future of our
communities."
Avery and Culler were among the bankers and other participants who were interviewed during the conference
for the Exploring Innovation YouTube channel.
Before the conference, the majority of attendees were not optimistic about community development
opportunities in their areas, but by the end, their attitudes had changed.
For more information on exploring innovation in community development, see the St. Louis Fed's Community
Development web page or visit the conference page.
CENTRAL BANKER | SUMMER 2009
https://www.stlouisfed.org/publications/central-banker/summer-2009/shape-of-effective-reform-not-yet-clear
Views: Shape of Effective Reform Not Yet Clear
While history shows important financial crises have resulted in new reform-oriented legislation—and that the
current crisis is likely to follow this pattern—the design of an effective reform is far from clear at this point, said
St. Louis Fed President James Bullard.
Bullard spoke May 1 at the 119th annual Arkansas Bankers Association convention in Hot Springs. In his
presentation, "The U.S. Financial System and Macroeconomic Performance," Bullard said that parts of the
regulatory system have proven to work well, such as the monitoring practices and fairly clear rating system
currently in place for smaller banks.
"Deposit insurance and prudential regulation have proven to be successful in avoiding small bank panics," he
said. "Supervision allows the regulator to anticipate potential bank failures and prepare accordingly."
He also pointed out that with smaller banks "a clear resolution regime is in place," and that the U.S. has a
system for closing banks in a way that does not damage others in the industry.
The problem areas in the crisis have centered on large banks and especially large non-bank financial firms,
which makes monitoring far more difficult and the resolution regime unclear. Thus, two of the elements that
make smaller bank regulation successful are missing for larger financial firms, he said.
These firms are often thought to be too big to fail, but Bullard said that they are only too big to fail quickly. He
argued that one goal of a successful reform should be to find a method to allow failure, but in a way that does
not cause significant market disruption. He stressed that a good resolution regime for these firms must be
credible, so that all market participants understand what will happen in the event of failure.
Bullard also discussed the Federal Reserve's role in a new regulatory landscape. He said that the Fed is the
nation's lender of last resort, and so, needs to be involved in the regulation of firms that have access to the
discount window. He also said that the Fed needs to know the condition of the financial system to run an
effective monetary policy, and that this also argues for a substantial Fed role in the regulatory structure. Both of
these needs have been underscored in the current crisis.
Bullard said that the Fed has been the nation's de facto systemic risk regulator. He named three important
systemic risk calls made by Fed officials in recent years. He argued that systemic risk regulation has come to
mean many things to many people and that the debate needs to be sharpened substantially before progress
can be made.
CENTRAL BANKER | SUMMER 2009
https://www.stlouisfed.org/publications/central-banker/summer-2009/is-it-time-for-you-to-ask-the-fed
Tools: Is It Time for You To Ask the Fed?
Since November 2008, the St. Louis Fed has offered an exclusive communications channel between Fed
officials and the leaders of state member banks and bank holding companies in the Eighth District.
Ask the Fed is an hour-long conference call/program offered once a month, featuring candid discussions on
topics of the day. If you're a senior officer of a state member bank or bank holding company and haven't yet
joined an Ask the Fed session, here's what you've missed so far:
The mortgage crisis: Root causes and consequences for the economy (November 2008)
What's new in the federal funds market? (December 2008)
Changes to the Fed's payments system risk policy: What does it mean for your bank? (January 2009)
Remarks on the U.S. economy with St. Louis Fed President Jim Bullard (February 2009)
A panel discussion on the Federal Reserve discount window, with additional comments on liquidity
implications that face financially troubled institutions and understanding the impact of the OTTI
impairment affecting FHLB securities portfolios (March 2009)
Discussion and Q&A with Elizabeth Duke, member of the Federal Reserve Board of Governors (April
2009)
From the examiner's perspective: Challenges facing community banks (May 2009)
If you sign up to participate in any subsequent Ask the Fed, you can access previous program materials. If you
would like to participate, contact the St. Louis Fed's Patrick Pahl, Banking Supervision & Regulation, at 314444-8858 or askthefed@stls.frb.org. Remember, participation is limited to senior officers of state member
banks and bank holding companies in the Eighth District.
The St. Louis Fed's web site has been revamped with a fresh, new design and streamlined navigation. Located
at www.stlouisfed.org, the site also offers several new features and tools. These features include easy-to-use
economic charts and data, including charts from the Fed's Little Rock, Louisville and Memphis zones; regionspecific news and events; more multimedia features; RSS feeds and an expanded menu of e-mail alert
choices. Watch for even more features and functionalities to be launched in the coming months.
CENTRAL BANKER | SUMMER 2009
https://www.stlouisfed.org/publications/central-banker/summer-2009/st-louis-fed-joins-pbs-on-youtube
Tools: St. Louis Fed Joins PBS on YouTube
The St. Louis Fed has been working with KETC (Channel 9), the St. Louis PBS station, since the summer of
2008 in an effort to educate St. Louis-area residents about the mortgage and financial crises. KETC created a
web site called Facing the Mortgage Crisis and an accompanying YouTube channel, which highlights videos of
economists and other experts speaking on related topics.
Among the experts is St. Louis Fed economist Bill Emmons, who appeared on the national PBS program
"NewsHour with Jim Lehrer" as part of a week-long spotlight on the St. Louis region. Emmons addressed the
regional employment situation as part of a panel discussion moderated by PBS correspondent Gwen Ifill. Other
participants included Tony Thompson, CEO of the Kwame Building Group; Ellen Sherberg, publisher of the St.
Louis Business Journal, and Michael Holmes, executive director of the St. Louis Agency on Training and
Employment. Watch the broadcast segment or read the transcript. Emmons is also featured in 12 segments on
the KETC YouTube channel discussing a variety topics related to the financial crisis and the St. Louis region.
In another spotlight episode the same week, St. Louis economist Howard Wall joined a forum of St. Louis
business leaders at a St. Louis Fed economic forum filmed for the April 29 "The Newshour with Jim Leher"
program. The topic was the importance of downtown St. Louis. Gwen Ifill, PBS' senior national correspondent
for "The NewsHour with Jim Lehrer," hosted the forum, which also included Jim Alexander, vice president of
business recruitment for the Regional Commerce and Growth Association; Rodney Crim, executive director of
the St. Louis Development Corporation; and Kitty Ratcliffe, president of the St. Louis Convention and Visitors
Commission. The video appears below:
CENTRAL BANKER | SUMMER 2009
https://www.stlouisfed.org/publications/central-banker/summer-2009/regulatory-roundup
Regulatory Roundup
New Final Truth in Lending Rules Issued
The Federal Reserve Board issued on May 12 the final rules for Regulation Z (Truth in Lending) that revise
disclosure requirements for mortgage loans. The final rules implement the Mortgage Disclosure Improvement
Act (MDIA), which was enacted in July 2008 as an amendment to the Truth in Lending Act.
The new final rules are similar to the Reg Z rules finalized in July 2008, except the MDIA is broader and
includes more. The new rules are designed to ensure that consumers receive cost disclosures earlier in the
mortgage process. Under the MDIA, creditors must comply with the new provisions starting on July 30, 2009.
The regulations apply to dwelling-secured consumer loans for which a creditor receives an application on or
after July 30, 2009.
Among the requirements, creditors must:
give good faith estimates of mortgage loan costs ("early disclosures") within three business days after
receiving a consumer's application for a mortgage loan and before any fees are collected from the
consumer, other than a reasonable fee for obtaining the consumer's credit history;
give early disclosures for loans secured by dwellings other than the consumer's principal dwelling, such
as a second home;
wait seven business days after providing the early disclosures before closing the loan; and
provide new disclosures with a revised annual percentage rate (APR) and wait an additional three
business days before closing the loan, if a change occurs that makes the APR in the early disclosures
inaccurate beyond a specified tolerance.
The rules would permit a consumer to expedite the closing to address a personal financial emergency, such as
a foreclosure.
Changes Made to Tier 1 Capital Rules
Bank holding companies can now include in their Tier 1 capital, without restriction, senior perpetual preferred
stock issued to the U.S. Treasury Department under the Troubled Asset Relief Program (TARP). The Federal
Reserve Board issued the final rule on May 22, after adopting the interim final rule in October 2008.
In addition, the Board announced the adoption of an interim final rule that will let bank holding companies that
are S-Corps or that are organized in mutual form to:
include in Tier 1 capital all subordinated debt issued to Treasury under TARP, provided that the
subordinated debt has to count toward the limit on the amount of other restricted core capital elements
includable in Tier 1 capital; and
exclude subordinated debt issued to Treasury under TARP from treatment as "debt" for purposes of the
debt-to-equity standard under the Board's Small Bank Holding Company Policy Statement.
Reminder: New Limits on Trust Preferred Securities Delayed until
2011
The Federal Reserve Board decided in March to delay full implementation of final rules that place new limits on
the inclusion of trust preferred securities and other restricted core capital elements in tier 1 capital of bank
holding companies. The Board did this because of stress on the financial markets and efforts of bank holding
companies to increase their capital levels. Because of the delay, all bank holding companies may include
cumulative perpetual preferred stock and trust preferred securities in tier 1 capital up to 25 percent of total core
capital elements. Read the final rules.
CENTRAL BANKER | SUMMER 2009
https://www.stlouisfed.org/publications/central-banker/summer-2009/understand-the-financial-climate-with-the-fed
Understand the Financial Climate with the Fed
You can't escape the word "recession" in today's news. But do the raw numbers contain a different message?
Is this really a depression instead of a recession? And how is the Fed responding? Understand what's going
on with two dynamic Fed web sites:
Tracking the Global Recession
http://research.stlouisfed.org/recession/
This site tracks the current economic environment through easy-to-understand charts of monthly indicators,
such as employment, industrial production, retail sales and real income; current GDP data breakdowns; data
from other countries; and more.
The Financial Crisis
http://timeline.stlouisfed.org/
The St. Louis Fed began this site last year to help the public better understand the major financial events and
policy actions that the Fed has taken over the past months. Since spring, the site has been enhanced with new
functionality and a wider array of material.
CENTRAL BANKER | SUMMER 2009
https://www.stlouisfed.org/publications/central-banker/summer-2009/tell-your-staff
Tell Your Staff
Food Coupons Officially Going Away
After Sept. 17, the Federal Reserve will no longer accept paper food coupons from banks. Last year, as part of
the 2008 farm bill (Food, Conservation and Energy Act of 2008), Congress mandated that all benefits for the
Supplemental Nutrition Assistance Program (formerly the food stamp program) be issued electronically.
States were ordered to stop issuing paper coupons for food last June. This year, retailers are to stop accepting
stamps and RCs on June 17, and all banks are to stop accepting paper coupons from retailers on July 18. All
outstanding paper coupons and RCs will be de-obligated as of June 18. For more information on food coupon
redemption procedures, see http://www.frbservices.org/operations/currency/food_coupons.html
Memphis Branch Transitioning to Currency Strap Imaging
If your institution used cash services at the St. Louis Fed, be aware that the Memphis Branch of the St. Louis
Fed will begin switching over to currency strap imaging for currency processing on Aug. 24.
Make sure your appropriate staff members know that they may see a delay in receiving cash difference
advices. Currently, your depository institution receives original currency straps for differences found in your
deposits. During the transition, your DI may receive original currency straps, printed images of original
currency straps or a combination of the two.
The depositor information required on the strap remains unchanged; however, this information must be
readable if printed images from the straps are sent. Currency strap imaging is being implemented throughout
the Fed System as part of the Fed's re-engineering of manual paper-based processes.
@FedFRASER