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FALL 2013 CENTRAL NEWS AND VIEWS FOR EIGHTH DISTRICT BANKERS FEATURED IN THIS ISSUE | Could Rising Municipal Bond Securities Holdings Increase Community Banks’ Risk Profiles? | Community Banking in the 21st Century | The Troubled Asset Relief Program—Five Years Later St. Louis Fed Research Focuses on How Community Banks Get or Stay Healthy in Difficult Times R esearchers have paid considerable attention to studying what can be learned from the failures of community banks during the recent financial crisis. Researchers at the Federal Reserve Bank of St. Louis, however, have taken a different approach in their studies of recent community bank performance. In two separate research papers, authors Alton Gilbert, Andrew Meyer and James Fuchs explored features that distinguish community banks that thrived during the recent financial cri- sis and those that were distressed and subsequently recovered. The paper “The Future of Community Banks: Lessons from Banks That Thrived During the Recent Financial Crisis” was published in the March/April 2013 issue of the St. Louis Fed’s Review. The working paper “The Future of Community Banks: Lessons from the Recovery of Problem Banks” was presented at the research conference Community Banking in the 21st Century, co-hosted continued on Page 4 TABLE 1 Metrics of Thriving and Recovering Banks Lessons from Thriving Banks Number of banks TL / TA CRE / TL CLD / TL Nonfarm nonresidential / TL Multifamily / TL Farmland-secured / TL 1- to 4-family property-secured / TL HELOC / TL C&I / TL Consumer / TL Agricultural / TL All other loans / TL Core deposits / Total deposits Lessons from Recovered Banks Thriving 702 54.4 23.3 4.6 17.4 1.0 11.4 Surviving 4,525 65.0 34.4 8.3 23.8 1.9 7.8 CAMELS 5 191 63.19 56.23 9.40 42.73 3.91 2.21 CAMELS 4 332 63.12 50.11 8.10 37.48 4.13 3.64 CAMELS 3 196 63.03 49.79 6.96 38.09 4.34 4.89 CAMELS 1 or 2 155 61.15 43.42 5.56 33.70 3.79 6.48 24.4 23.8 22.12 22.52 20.26 22.10 1.2 13.7 10.5 14.1 1.2 83.0 2.5 14.4 7.6 8.2 0.9 80.7 4.16 11.12 2.42 0.82 0.74 72.88 3.66 13.82 3.62 1.85 0.37 78.45 3.40 13.06 3.46 3.52 1.22 81.08 2.81 14.81 3.90 5.33 0.77 82.94 SOURCES: “The Future of Community Banks: Lessons from Banks That Thrived During the Recent Financial Crisis,” R. Alton Gilbert, Andrew Meyer and James Fuchs, Review, March/April 2013; “The Future of Community Banks: Lessons from the Recovery of Problem Banks,” R. Alton Gilbert, Andrew Meyer and James Fuchs, working paper, September 2013. T H E F E D E R A L R E S E R V E B A N K O F S T. L O U I S : C E N T R A L T O A M E R I C A’ S E C O N O M Y® | STLOUISFED.ORG CENTRAL VIEW Vol. 23 | No. 3 www.stlouisfed.org/cb Community Banking in the 21st Century EDITOR By Julie Stackhouse News and Views for Eighth District Bankers RC Balaban 314-444-8495 robert.c.balaban@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. Subscribe for free at www.stlouisfed.org/cb to receive the online or printed Central Banker. 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. To receive other St. Louis Fed online or print publications, visit www.stlouisfed.org/subscribe. Follow the Fed on Facebook, Twitter and more at www.stlouisfed.org/followthefed. 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. Selected St. Louis Fed Sites Dodd-Frank Regulatory Reform Rules www.stlouisfed.org/rrr FRED® (Federal Reserve Economic Data) www.research.stlouisfed.org/fred2 Center for Household Financial Stability® www.stlouisfed.org/HFS FRED is a registered trademark of the Federal Reserve Bank of St. Louis O ver the past 20 years, we have seen a material and sustained change in the structure of banking. Twenty years ago, there were more than 10,000 community bank charters. As of the end of 2012, there were approximately 6,000. Over that same time period, the percentage of banking assets held by community banks fell from 50 percent to Julie Stackhouse 17 percent. The past five years have furis senior vice ther challenged community banks, with president of Banking nearly 500 bank failures over that time. Supervision, Yet, we intuitively know that commuCredit, Community nity banks are important to their comDevelopment and munities and the U.S. economy. Learning Innovation For that reason, the Federal Reserve for the Federal System and the Conference of State Reserve Bank of Bank Supervisors partnered to sponsor St. Louis. Community Banking in the 21st Century, the inaugural community banking research conference held Oct. 2-3 at the Federal Reserve Bank of St. Louis. The goal of the conference was to foster expanded research on topics affecting community banks and to encourage policymakers to be cognizant of the value these institutions provide. While challenges persist and some consolidation may be inevitable, the community bank business model clearly remains viable and important to the communities served. The conference covered three sessions of academic papers and one practitioners’ panel composed of bankers. The first academic session addressed the role of community banks; the second, community bank performance; and the final session, supervision and regulation. (Summaries of the papers can be found on Pages 6 and 7.) The practitioner session covered the results of 51 town hall sessions held in 28 states and involving 1,700 bankers. Attendees also heard comments from Federal Reserve Chairman Ben Bernanke, Fed Gov. Jerome Powell and banker Dorothy Savarese. The conference noted a number of strengths of community banks: • Community banks have a key advantage: social capital. They are an integral part of their communities. continued on Page 7 2 | Central Banker www.stlouisfed.org Q U A R T E R LY R E P O R T Third-Quarter 2013 Banking Performance1 Earnings Performance RETURN ON AVERAGE ASSETS 2012: 3Q 2013: 2Q 2013: 3Q 0.99% 0.89 1.13 0.67 1.12 1.10 0.91 0.92 0.83 1.00% 0.92 1.23 0.80 1.09 0.89 0.88 0.93 0.85 1.02% 0.95 1.25 0.86 1.09 0.88 0.89 0.97 0.90 3.87% 3.84 4.19 3.62 3.92 4.04 4.05 3.71 3.92 3.79% 3.66 4.07 3.44 3.74 3.80 3.85 3.48 3.85 3.83% 3.72 4.11 3.46 3.76 3.83 3.89 3.67 3.89 0.35% 0.41 0.37 0.58 0.22 0.40 0.25 0.37 0.36 0.20% 0.21 0.19 0.30 0.13 0.24 0.14 0.15 0.22 0.19% 0.20 0.20 0.27 0.10 0.23 0.13 0.15 0.18 2 All U.S. Banks All Eighth District States Arkansas Banks Illinois Banks Indiana Banks Kentucky Banks Mississippi Banks Missouri Banks Tennessee Banks NET INTEREST MARGIN All U.S. Banks All Eighth District States Arkansas Banks Illinois Banks Indiana Banks Kentucky Banks Mississippi Banks Missouri Banks Tennessee Banks SOURCE: R eports of Condition and Income for Insured Commercial Banks NOTES: 1 2 3 4 Because all District banks except one have assets of less than $15 billion, banks larger than $15 billion have been excluded from the analysis. All earnings ratios are annualized and use year-to-date average assets or average earnings assets in the denominator. Nonperforming assets are loans 90 days past due or in nonaccrual status, plus other real estate owned. The loan loss coverage ratio is defined as the loan loss reserve (ALLL) divided by nonperforming loans. LOAN LOSS PROVISION RATIO All U.S. Banks All Eighth District States Arkansas Banks Illinois Banks Indiana Banks Kentucky Banks Mississippi Banks Missouri Banks Tennessee Banks Asset Quality Measures 2012: 3Q 2013: 2Q 2013: 3Q NONPERFORMING ASSETS RATIO3 All U.S. Banks All Eighth District States Arkansas Banks Illinois Banks Indiana Banks Kentucky Banks Mississippi Banks Missouri Banks Tennessee Banks 4.11% 4.50 5.04 5.35 2.87 3.69 4.33 4.03 4.70 3.17% 3.62 4.37 4.18 2.33 3.32 3.55 3.04 3.81 2.94% 3.40 3.96 3.88 2.15 3.20 3.30 3.09 3.47 67.22% 66.11 69.39 55.99 79.09 71.63 62.96 83.97 68.86 81.06% 78.01 72.65 69.05 93.03 74.93 74.11 103.10 81.87 85.15% 81.11 81.03 71.20 98.93 75.05 76.51 107.03 84.36 LOAN LOSS COVERAGE RATIO 4 All U.S. Banks All Eighth District States Arkansas Banks Illinois Banks Indiana Banks Kentucky Banks Mississippi Banks Missouri Banks Tennessee Banks Central Banker Fall 2013 | 3 Community Banks continued from Page 1 by the St. Louis Fed, the Conference of State Bank Supervisors and the Federal Reserve System. (See article “Bankers, Regulators and Academics Gather at St. Louis Fed to Discuss State of Community Banking” on Page 6 for a summary of the conference.) In both papers, the authors took qualitative and quantitative approaches to their research, not only digging into the data of qualifying banks, but also interviewing officials from these institutions to provide additional insights into how their institutions fared as they did. How Thriving and Recovered Banks Performed The authors discovered similarities between banks in both categories. (See the Definitions box below for definitions of thriving and recovered banks.) In general, thriving and recovered banks had lower total-loans-to-totalassets ratios and were less concentrated TABLE 2 Asset and Loan Growth of Thriving and Surviving Banks Asset Growth Thriving Surviving 2004–2007 23.58 44.28 2008–2011 31.16 26.91 Loan Growth 2004–2007 31.06 66.04 2008–2011 19.68 18.67 SOURCE: “The Future of Community Banks: Lessons from Banks That Thrived During the Recent Financial Crisis,” R. Alton Gilbert, Andrew Meyer and James Fuchs, Review, March/April 2013. DEFINITIONS CAMELS ratings are nonpublic supervisory ratings of a bank’s overall condition. The ratings focus on six areas: capital protection (C), asset quality (A), management competence (M), earnings strength (E), liquidity risk exposure (L) and market risk sensitivity (S). Each category gets a rating from 1 (best) to 5 (worst), and the bank is given a composite CAMELS rating, also 1-5. A rating of 1 means strong performance, while a 2 means satisfactory performance. Ratings below 2 may prompt supervisory action. In the paper on thriving community banks, banks are split into two groups: thriving banks and surviving banks. A “thriving bank” was defined as a bank with total assets of less than $10 billion that achieved a composite CAMELS rating of 1 from 2006 through 2011. Banks that did not meet these criteria were considered “surviving banks,” though it’s important to note that many surviving banks, while not thriving, were still in sound financial condition. The paper on recovered community banks focused on banks that had a CAMELS rating of 4 or 5 at some point between 2006 and March 31, 2013, and subsequently recovered to a CAMELS rating of 1 or 2. 4 | Central Banker www.stlouisfed.org in construction and land-development loans, commercial real estate and home equity lines of credit and were more reliant on core deposits. (See Table 1 on Page 1.) These similarities weren’t limited to a particular asset range. Both thriving and recovered banks ranged from having less than $50 million in assets to near or slightly more than $10 billion in assets. Thriving banks were not concentrated in any particular asset range, though the greatest percentage of recovered banks was in the $300 million to $1 billion range. As one might expect, performance metrics were better over the periods studied for thriving banks and recovered banks compared with their counterparts. The mean return on assets (ROA) for thriving banks was 1.5 percent, compared with only 0.8 percent for surviving banks, while the mean return on equity (ROE) was 12.7 percent for thriving banks versus 7.3 percent for surviving banks. Regarding recovered banks, those with CAMELS ratings of 1 or 2 experienced ROA of 0.88 percent and ROE of 7.50 percent, compared with -0.81 percent ROA and -20.55 percent ROE for banks with a CAMELS rating of 5. Lessons from Community Bankers During the interviews with bank leaders, the authors sought common threads among these banks. For both thriving and recovered banks, management and ownership were significant factors, with local presences of each contributing directly to the banks’ prosperity. Many bankers from thriving banks indicated that they recruited managers and staff specifically from the communities they served because they would know the communities the best and be known by the banks’ customers. Bankers also said the importance of all staff members staying active in their communities was paramount because it helped build relationships based on trust and serving community needs. Perhaps not surprising, recovered banks often experienced a change in management and/or ownership, and when a change in management occurred, the new president was generally well-known in local banking circles and well-connected in the geographic area served. It should be noted that a change in ownership did not necessarily dictate a change in management. In some cases, new owners would leave existing management in place if they believed the banks’ problems were caused by the previous owners. Local ties were also important in helping foster relationships within the community, which thriving and recovered banks alike cited as being important to their successes. For example, the president of a recovered bank mentioned the importance of retaining nonmanagerial employees who had day-to-day interactions with customers and treating employees professionally and with respect as keys to managing the bank’s reputation. Related to the leadership of the banks was an emphasis by management of both thriving and recovered banks on basic banking practices. Many of those interviewed from thriving banks cited their conservative growth strategies as a reason for success, though it meant seeing slower growth than their competitors in the years leading up to the crisis. (See Table 2 on Page 4.) Maintaining high lending standards was one example cited by many thriving banks. One bank in particu- lar required its lenders to review all charged-off loans, reassess the fundamentals of the loan at the time it was made and communicate with management whether they would still make that loan today. Most new presidents of recovered banks emphasized the need to return to such core banking principles and conservative underwriting standards. In many cases, this meant providing additional education to the bank’s directors. One president, for example, used significant amounts of time during board meetings to educate the directors on their responsibilities and hired an outside consultant to analyze lending opportunities and present them to the board. Summary The results of both papers show banks that emerged from the financial crisis in good health—either through recovery or by maintaining good health throughout the period—largely centered on a commitment to sound standards and strong management. Dodd-Frank Act Stress Testing Begins for Institutions with Assets of $10 Billion to $50 Billion By Mike Milchanowski T he annual cycle for Dodd-Frank Act (DFA) stress testing for banking institutions with average assets of between $10 billion and $50 billion (midsized institutions) officially began Oct. 1. The DFA requires annual company-run stress tests for bank holding companies (BHCs) with average total assets of between $10 billion and $50 billion and for savings and loan holding companies (SLHCs) and state member banks (SMBs) with $10 billion or more in total assets. The rules were announced by the Federal Reserve Board, Federal Deposit Insurance Corp. (FDIC) and Office of the Comptroller of the Currency (OCC) on Oct. 9, 2012. The rules allow stress testing for institutions in this asset size range to be tailored to match the size and complexity of the institution. DFA stress testing is one component of a bank’s broader stress-testing program, which should also include, among other things, capital planning and an assessment of capital adequacy. Institutions meeting the minimum average asset size requirement as of year-end 2012 are subject to DFA stress tests this fall. SLHCs will be subject to the rule at a future date to be determined. Going forward, as a company crosses the $10 billion asset threshold, it will become subject to the requirements in the test cycle starting the next calendar year. Under the DFA stress-test rules, midsized institutions must assess the potential impact of a minimum of three macroeconomic scenarios—baseline, continued on Page 11 Central Banker Fall 2013 | 5 Bankers, Regulators and Academics Gather at St. Louis Fed to Discuss State of Community Banking O n Oct. 2-3, the Federal Reserve Bank of St. Louis, the Conference of State Bank Supervisors and the Federal Reserve System co-hosted the first annual community banking research conference, Community Banking in the 21st Century. The conference focused on the opportunities and challenges facing the community banking industry. The conference featured remarks from Fed Chairman Ben Bernanke and St. Louis Fed President James Bullard and keynote speeches from Fed Gov. Jerome Powell and Cape Cod Five Cents Savings Bank President and CEO Dorothy Savarese. Attendees also heard presentations of the latest academic research on community banking. In all, 12 papers were presented over the course of three sessions: the role of community banks, community bank performance and supervision and regulation of community banks. Summaries of the research papers can be found below. Capping off the conference was a presentation of the results of a series of town hall meetings, during which bankers from across the country gathered to discuss the state of community banking. More than 1,700 bankers from 28 states participated in the town hall events, which ultimately culminated in the publication, “Community Banking in the 21st Century: Opportunities, Challenges and Perspectives.” For more information about the conference, see the Central View column by Julie Stackhouse, senior vice president of Banking Supervision, Credit, Community Development and Learning Innovation for the St. Louis Fed, on Page 2 or visit www.stlouisfed. org/CBRC2013. The next conference will be held in 2014 at the St. Louis Fed. Details about next year’s conference will be available in a future issue of Central Banker. COMMUNIT Y BANKING RE SE ARCH Do Community Banks Play a Role in New Firm Survival? Smith Williams, Yan Y. Lee The authors find a negative relationship between bank distance and the likelihood of using bank financing to finance operations. Equipment Lease Financing: The Role of Community Banks Charles Kelly, Mohammed Khayum, Curtis Price Banks participating in equipment lease financing (ELF) had better performance metrics than community banks in general, suggesting that ELF may be an untapped opportunity. Bank Failure, Relationship Lending and Local Economic Performance John Kandrac Recent bank failures were followed by significantly lower income and compensation growth, higher poverty rates and lower employment. Small Business Lending and Social Capital: Are Rural Relationships Different? Robert DeYoung, Dennis Glennon, Peter Nigro, Kenneth Spong The authors conclude that loan defaults are lower in communities arguably expected to have large amounts of inexpensive soft information and at banks likely to have a high level of personal knowledge about their customers. Financial Derivatives at Community Banks Xuan (Shelly) Shen, Valentina Hartarska The authors find that derivative use at community banks increased profitability over the period 2003–2012, and banning its use would have hurt banks, making them more vulnerable to interest rate risk and credit risk. Lessons from Community Banks That Recovered from Financial Distress R. Alton Gilbert, Andrew P. Meyer, James W. Fuchs (See article “St. Louis Fed Research Focuses on How Community Banks Get or Stay Healthy in Difficult Times” on Page 1.) 6 | Central Banker www.stlouisfed.org Central View • Growing compliance costs continued from Page 2 • Lack of economies of scale • Community banks have intense knowledge of the local market and flatter organizational structures. They are willing to tailor products to local needs (if the cost is not too high). • Management exhaustion, making it difficult to be visionary and strategic • Community banks play a critical role in small-business, farm and residential lending. This lending is critical to community building and stabilization. Finally, the conference found some possibilities for innovation. While more exploration is needed, they include: • Community banks enhance the chance for survival of startups. Startups create jobs. • A large number of community banks execute exceptionally well on the fundamentals. • Great management can do great things, such as turning around a severely troubled bank. However, challenges persist, including: • Outmigration of population from small communities, which creates issues for economic viability, workforces and succession planning • Rapid changes in technology, which create new competitors and new costs (but opportunities as well) The Effect of Distance on Community Bank Performance Following Acquisitions and Reorganizations Gary D. Ferrier, Timothy J. Yeager The authors find that long-distance acquisitions are less profitable and riskier than near-distance acquisitions for the three years following the transaction. Performance of Community Banks in Good Times and Bad Times: Does Management Matter? Dean F. Amel, Robin A. Prager The authors find that variables under bank control generally have much bigger effects on profitabilities than variables not under bank control. Estimating Changes in Supervisory Standards and Their Economic Effects William F. Bassett, Seung Jung Lee, Thomas W. Spiller The authors find that standards in assigning CAMELS ratings were consistent across the period 1991-2011. • Banks seeking profit by undertaking big shifts in strategy without the necessary expertise • Finding “pockets of opportunity,” such as equipment lease financing and Small Business Administration lending • Focusing on talent management, such as using local retirees as a source of mentoring and focusing on the development of younger employees • Creating mechanisms to more closely align regulation with risk Video recordings of the sessions and PDFs of the academic papers are available at www.stlouisfed.org/CBRC2013. Overall, the conference was encouraging. While challenges persist and some consolidation may be inevitable, the community bank business model clearly remains viable and important to the communities served. The Impact of Dodd-Frank on Community Banks Tanya D. Marsh, Joseph W. Norman The authors conclude that while it is currently impossible to quantify the impact of the DoddFrank Act, enough burdens have been placed on community banks that a deeper look at the federal regulatory system is needed. Capital Regulation at Community Banks: Lessons from 400 Failures Robert R. Moore, Michael A. Seamans The authors show that the majority of failed community banks would have been considered wellcapitalized even two years prior to failing. Capital at these banks didn’t begin dropping until about one year prior to failing. A Failure to Communicate: The Pathology of Too Big To Fail Harvey Rosenblum, Elizabeth Organ The authors present the Dallas Fed Financial Reform Plan for resolving the “too big to fail” issue. Central Banker Fall 2013 | 7 The Troubled Asset Relief Program—Five Years Later By Gary S. Corner Status of TARP Initiatives T To date, cash recovered in excess of TARP’s initial investments has been generated from its bank investment programs and credit market programs. TARP’s auto programs and housing programs are expected to return less than their initial investments.1 Treasury’s investment in AIG through TARP resulted in a loss. However, when combined with other Treasury investments in AIG, Treasury experienced a net gain of $2.4 billion. The Treasury Department estimates TARP will bear an overall lifetime loss of about $41 billion, as further funding of TARP’s housing program is expected. According to the Treasury Department, funds that have been or are expected to be dispersed under TARP’s housing program are generally not considered recoverable. he Troubled Asset Relief Program (TARP) was created to stabilize the financial system during the financial crisis of 2008. Congress authorized $700 billion through the Emergency Economic Stabilization Act of 2008, and the program is overseen by the U.S. Department of the Treasury. TARP is generally seen as one of the federal government’s primary responses to the financial crisis. Usage of TARP Funds While widely known for use in the bank Capital Purchase Program (CPP), TARP funds were also used to make loans and direct equity investments to select auto industry participants, backstop credit markets, provide a lifeline to the American International Group (AIG) and provide ongoing support for government housing initiatives. The Treasury Department is actively exiting its remaining investments made under its CPP and auto industry and credit market programs and has already closed several other bank investment programs and its investment in AIG. It has not, however, taken specific actions to exit from its Community Development Capital Initiative. Moreover, the TARP housing program remains active with additional funding allocations. As of Sept. 30, $421 billion has been deployed through TARP, although existing obligations may raise the total to $457 billion. (See Table 1 below.) The Bank Investment Program TARP’s bank investment program consists of five components, of which the CPP was the most significantly funded component.2 The CPP was designed to bolster the capital position of viable banks of all sizes and locations, though the program heavily supported banking organizations with less than $10 billion in assets. (For locations of these TARP fund originations, see Figure 1 on Page 9.) Under the program, 707 institutions received capital investments. (See Figure 2 on opposite page). In exchange, the Treasury Department received preferred stock or debt securities at a dividend rate of TABLE 1 Financial Status of TARP Initiatives TARP initiatives Banking programs Credit market programs Automotive programs AIG Housing programs Total for TARP Treasury obligation (billions) $250.46 20.08 79.69 67.84 38.49 $456.56 Disbursed $245.46 19.09 79.69 67.84 9.48 $421.20 SOURCE: Office of Financial Stability TARP Report, Oct. 18, 2013 NOTE: Due to rounding, the columns may not add up correctly. 8 | Central Banker www.stlouisfed.org Outstanding Estimated lifetime investment balance gain (loss) (billions) (billions) $2.84 0.00 19.87 0.00 — $22.72 $23.93 3.36 (14.98) (15.18) (37.67) ($40.54) FIGURE 1 Aggregate TARP Fund Originations by County, Institutions under $10 Billion NOTE: Each dot represents the sum per county of TARP funds originated to institutions with less than $10 billion. The largest dot represents $700 million. 5 percent for five years and 9 percent thereafter. In addition, the Treasury Department received warrants to purchase stock or other securities. According to the Treasury Department, $2.8 billion of the $245 billion dispersed under the bank investment program remains outstanding today, primarily from the CPP.3 As of Sept. 30, 15 percent of the initial CPP recipient institutions remained in the program. Conclusion The Treasury Department continues to unwind most of its TARP programs. Only TARP’s housing initiatives are actively funded. Cash collections under TARP’s bank investment programs represent more than 100 percent of the original Treasury investment. This level of repayment exceeds original expectations for the five components of TARP’s bank investment programs. Overall, relative to original expectations and perhaps to public perception, TARP’s bank investment programs appear to have been successful in stabilizing banking conditions and at a cost far less than originally projected. Gary S. Corner is a senior examiner at the Federal Reserve Bank of St. Louis. ENDNOTES 1 For further explanation of the TARP programs, refer to http://www.treasury.gov/initiatives/ financial-stability/TARP-Programs/Pages/ default.aspx. FIGURE 2 Status of Institutions under CPP 230 Full repayments 137 Exchanged for Small Business Lending Funds 707 Institutions funded under CPP 28 Exchanged for Community Development Capital Initiative Funds 173 Treasury sold or auctioned investments 27 In bankruptcy / receivership 4 Merged institutions 108 Total remaining CPP institutions SOURCE: Office of Financial Stability TARP Report, Oct. 18, 2013 2 The other four programs are the Supervisory Capital Assessment Program, the Asset Guarantee Program, the Targeted Investment Program and the Community Development Capital Initiative. The Supervisory Capital Assessment Program was a supervisory stress-test exercise performed on the nation’s 19 largest, most systemically important institutions. The aim was to restore market confidence; however, Treasury was not required to make any supporting investments. The Asset Guarantee Program and Targeted Investment Program provided assistance to two institutions: Bank of America and Citigroup. Both programs closed in 2009 at a net gain to taxpayers of about $7 billion. The Community Development Capital Initiative provided funding to qualified community development institutions. Funding for this program was completed in 2010. 3 This includes $2.2 billion refinanced out of the Capital Purchase Program and into the Small Business Lending Fund. In addition, $363 million in funds were exchanged from Capital Purchase Program funds into the Community Development Capital Initiative. Central Banker Fall 2013 | 9 Could Rising Municipal Securities Holdings Increase Community Banks’ Risk Profiles? By Gary S. Corner, Emily Dai and Daigo Gubo C ommunity banks in the U.S. have significantly increased their municipal securities holdings since the onset of the financial crisis. Increased holdings of municipal bonds mean possible increases in interest rate risk, credit risk and liquidity risk. Without a well-considered asset/liability management strategy, these risks may manifest themselves at just the wrong time. An analysis of call report data reveals that U.S. commercial banks’ municipal securities as a percentage of total assets have elevated significantly since the financial crisis, especially for community banks (Figure 1).1 The trend also holds in the Eighth District as shown in Figure 2. Since the onset of the financial crisis, community banks’ balance sheets have seen greater investment in municipal bond holdings. While favorable tax treatment and yield opportunity nudged community banks in this direction, the potential risk buildup should not be ignored. Reasons for Increased Muni Bond Holdings Several factors may have contributed to community banks’ increased municipal exposure. A provision of the American Recovery and Reinvestment Act of 2009 (ARRA)2 increased the tax efficiency of municipal bonds issued in 2009 and 2010. This tax treatment change provided a strong incentive for banks to deploy funds into municipal bonds holdings. This trend continued in 2011, 2012 and 2013, even though banks no longer benefited from the favorable tax treatment. Thus, seeking yield may be another factor behind the increase in municipal securities hold- 10 | Central Banker www.stlouisfed.org ings. In a low interest rate environment, banks are under pressure to find sources of additional earnings. With ample funds to deploy and reduced lending opportunities, municipal bonds remained attractive compared to other lower-yielding assets. Potential Risk Significant municipal bond holdings bring increased risk in several areas. One is interest rate risk, a major threat to all fixed income securities holders. At the end of the first quarter, for banks with total assets under $10 billion, the unrealized gain from their municipal securities portfolios was $4.7 billion. By the end of the second quarter, the gain slid to less than $0.4 billion. The $4.3 billion decline in value of the municipal securities was equivalent to 1.9 percent of these banks’ tier 1 capital. Community banks with significant municipal bond holdings also face potential credit risk and liquidity risk. Financial stress on state and local governments has increased since 2008. Local governments continue to face significant challenges: a slow economic recovery, mounting pension and health care liabilities, and continued decreases in funding from federal and state governments. However, extremely distressed state and local governments are outliers and are not reflective of the overall credit profile of the municipal bond market, especially the general obligation debt market. On the other hand, community banks’ holdings include a significant amount of smaller, infrequently traded municipal issuances for which liquidity risk cannot be ignored. Municipal bond holders also face potential structural changes in the municipal bond market. The city of Detroit’s recent bankruptcy filing created significant anxiety in the municipal bond market. Detroit’s appointed emergency manager has proposed classifying some general obligation unlimited tax (GOULT) bonds as “unsecured” debt. Rating agencies usually give GOULT bonds high ratings because municipal governments gener- 2 The American Recovery and Reinvestment Act of 2009 (ARRA) is also known as the Stimulus. It was an economic stimulus package signed into law on Feb. 17, 2009. 8 7 Percent 6 5 4 3 2 2011 2012 2013 2011 2012 2013 2010 2009 2008 2007 2006 2005 2003 0 2004 1 FIGURE 2 Municipal Securities as a Percent of Total Eighth District Banking Assets 9 8 7 6 5 4 3 2 KEY 2010 2009 2008 2007 0 2006 1 2005 1 Community banks are generally defined as banks with total assets under $10 billion. 9 2004 ENDNOTES Municipal Securities as a Percent of Total U.S. Banking Assets 2003 Gary S. Corner is a senior examiner, Emily Dai is an economist, and Daigo Gubo is a policy analyst, all with the Federal Reserve Bank of St. Louis. FIGURE 1 Percent ally attach these bonds with unlimited property taxing authority to fulfill the obligations of these bonds. An unfavorable court ruling for bond holders in this case may have a far reaching effect on the credit ratings and ultimately the prices of municipal bonds. Although banks are now required to assess the credit quality of municipal bonds independently, many other municipal bond market participants rely on the ratings. Since the onset of the financial crisis, community banks’ balance sheets have seen greater investment in municipal bond holdings. While favorable tax treatment and yield opportunity nudged community banks in this direction, the potential risk buildup should not be ignored. The municipal bond market also might have structural changes in the near future as long-held assumptions on the credit strength of general obligation bonds are being tested. These factors increase the need to monitor municipal bond portfolios closely. Banks under $1 billion Banks $1 billion to $10 billion Banks above $10 billion SOURCE: Call Reports Dodd-Frank continued from Page 5 adverse and severely adverse—on their consolidated losses, revenues, balance sheets (including risk-weighted assets) and capital. The proposed guidance indicates that these companies should apply each scenario across all business lines and risk areas, so that they can assess the effects of a common scenario on the entire enterprise. Results of the company-run stress tests will be reported using the FR Y-16 reporting form and are due on March 31. Companies do not have to publicly disclose the results of their 2013 stress tests, but they will be required to publicly disclose the “severely adverse scenario” results beginning with the 2014 stress test. In preparation for the Oct. 1 stresstesting start date for midsized institutions, the Fed announced an interim final rule on Sept. 24 that clarifies how companies should incorporate the Basel III regulatory capital reforms into their DFA stress tests. The interim rule provides a one-year transition period requiring most midsized institutions to calculate their stress-test projections using the Board’s current regulatory capital rules during the 2013 stress test to allow time to adjust their internal systems to the revised capital framework. Mike Milchanowski is a manager at the Federal Reserve Bank of St. Louis. Central Banker Fall 2013 | 11 FIRST-CLASS US POSTAGE PAID PERMIT NO 444 ST LOUIS, MO Central Banker Online See the online version of the Fall 2013 Central Banker at www.stlouisfed.org/cb for regulatory spotlights, recent St. Louis Fed research and additional content. NEW BANKING AND ECONOMIC RESEARCH • Housing Rebound Broadens the Wealth Recovery But Much More Is Needed • The Economic and Financial Status of Older Americans: Trends and Prospects • There Are Two Sides to Every Coin—Even to the Bitcoin, a Virtual Currency • Student-Loan Debt in the District—Reasons behind the Recent Increase • Economic Recovery— Slow and Steady, or Full Steam Ahead? RULES AND R E G U L AT I O N S • FRS, OCC Release Final Rules Implementing Regulatory Capital Rules • Higher Taxes for Top Earners: Can They Really Increase Revenue? printed on recycled paper using 10% post-consumer waste COMMUNIT Y BANKING CONFERENCE We are pleased to announce that the next conference will be held in 2014 at the St. Louis Fed. For research and videos from the 2013 conference, visit www.stlouisfed.org/ CBRC2013. The publication “Community Banking in the 21st Century: Opportunities, Challenges and Perspectives” compiles community bankers’ thoughts on a wide range of industry issues, including the most pressing challenges and opportunities. To download the publication, visit www.stlouisfed.org/CBRC2013/ town-hall.pdf (PDF). C E N T R A L B A N K E R | FA L L 2 0 1 3 https://www.stlouisfed.org/publications/central-banker/fall-2013/recent-st-louis-fed-banking-and-economic-research Recent St. Louis Fed Banking and Economic Research Housing Rebound Broadens the Wealth Recovery But Much More Is Needed In the November 2013 issue of In the Balance, read about how the housing recovery is improving household net worth, but may be favoring higher-priced houses and, thus, wealthier families. The Economic and Financial Status of Older Americans: Trends and Prospects (PDF) The global financial crisis and ensuing Great Recession reduced the income and wealth of many families, but older families generally fared better than young and middle-aged families. There Are Two Sides to Every Coin—Even to the Bitcoin, a Virtual Currency Central to Bitcoin is its independence from any institution or government, allowing anyone to engage in a direct transaction at a low cost. So, what exactly is it, and how does it work? Higher Taxes for Top Earners: Can They Really Increase Revenue? Raising income taxes for top earners is controversial. As a starting point for discussing tax policy in the U.S., we examine the calculations used in a study that recommends such a tax increase. Student-Loan Debt in the District—Reasons behind the Recent Increase An examination of student-loan debt in the Eighth District evaluates why the amount of debt has expanded and considers how differences in tuition and college-enrollment growth can cause state-to-state variations. Economic Recovery—Slow and Steady, or Full Steam Ahead? Positive, albeit modest, signs indicate the U.S. is on the road to economic recovery. But what can we expect moving forward? Will the economy plod onward like the tortoise or speed ahead like the hare? Does the Economy Need More Spending Now? Economic growth requires more labor, more and better capital, and up-to date technology—what might be collectively referred to as social infrastructure—to support entrepreneurship and efficient markets. It is hardly surprising that periods of more-rapid economic growth include invention, innovation, new methods of production (e.g., the assembly line, robotics), and entrepreneurship. Agricultural Finance Monitor (PDF) The latest issue of Agricultural Finance Monitor reports that Eighth District farmland values and cash rents were down in the third quarter, but farm incomes rose modestly across the District. Understanding and Improving the U.S. Payment System The latest “Dialogue with the Fed” examines findings of recent research on gaps and opportunities for improvement to the U.S. payments system and shares a vision on the direction the payments system needs to take in the next 10 years. C E N T R A L B A N K E R | FA L L 2 0 1 3 https://www.stlouisfed.org/publications/central-banker/fall-2013/frs-occ-release-final-rules-implementing-regulatory-capital-rules Rules and Regulations: FRS, OCC Release Final Rules Implementing Regulatory Capital Rules Agencies Request Comments on the Following Proposed Rules Several agencies propose standards for assessing diversity policies The FRS, the CFPB, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corp. (FDIC), the National Credit Union Administration (NCUA) and the Securities and Exchange Commission (SEC) are jointly proposing standards for assessing the diversity policies and practices of the entities they regulate, pursuant to Section 342 of the Dodd-Frank Act. The standards relate to 1) organizational commitment to diversity and inclusion; 2) workforce profile and employment practices; and 3) procurement and business practices (supplier diversity). Comments are due by Dec. 24, 2013. NCUA proposes stress testing and capital plan requirements for credit unions The NCUA proposes to conduct annual stress tests of federally insured credit unions with assets of $10 billion or more and to require those credit unions to develop and maintain capital plans. Comments are due by Dec. 31, 2013. FDIC proposes restrictions on sales of assets of a covered financial company The Dodd-Frank Act prohibits certain sales of assets held by the FDIC in the course of liquidating a covered financial company, including sales of equity stakes in subsidiaries. This proposed rule prohibits individuals or entities that have, or may have, contributed to the failure of a "covered financial company" from buying a covered financial company's assets from the FDIC. The proposed rule establishes a self-certification process that is a prerequisite to the purchase of assets of a covered financial company from the FDIC. While similar, this proposed rule is distinct from a current FDIC rule on restrictions on the sale of assets. Comments are due by Jan. 6, 2014. Final Rules OCC issues final guidance on annual stress test scenarios The OCC previously issued a final rule requiring national banks and federal savings associations with total consolidated assets of more than $10 billion to conduct annual stress tests using scenarios provided by the OCC. On Nov. 15, 2012, the OCC published interim guidance explaining how the OCC would develop stress test scenarios. The OCC is now adopting the interim guidance and the final rule articulates the principles that the OCC will apply to develop and distribute the stress test scenarios for covered institutions by November 15 of each year. This rule was effective Nov. 27, 2013. FCA issues final rule repealing mortgage loan originator registration rules On August 20, 2013, the Farm Credit Administration issued an interim rule repealing its regulations governing the registration of residential mortgage loan originators to avoid duplication with the S.A.F.E. Act. The FCA is now adopting the interim rule as final, effective Oct. 14, 2013. FRS and OCC issue final rule implementing regulatory capital rules On August 30, 2013, the FDIC, FRS and OCC issued three regulatory capital rules proposing: revisions to riskbased and leverage capital requirements consistent with Basel III, a standardized approach for calculating riskweighted assets, and revisions to the advanced approaches and market risk capital rules. In this final rule, the OCC and FRS are consolidating and adopting the three proposed rules, with some modifications. This rule is effective Jan. 1, 2014. CFPB issues final rule amending Regulations B, X and Z In 2013, the CFPB issued several final rules and amendments concerning mortgage markets, found in Regulations B, X and Z. On July 2, 2013, the CFPB published a proposed rule to amend several of the mortgage market rules. This final rule adopts the proposed rule with some revisions and additional clarifications. These amendments focus primarily on (1) loss mitigation procedures, (2) amounts counted as loan originator compensation to retailers of manufactured homes and their employees for purposes of applying points and fees thresholds, (3) exemptions available to creditors that operate predominantly in “rural or underserved” areas, (4) application of the loan originator compensation rules to bank tellers and similar staff, and (5) the prohibition on creditor-financed credit insurance. The CFPB is also adjusting the effective dates for certain provisions of the loan originator compensation rules and makes technical corrections to Regulations B, X and Z. The final rule is effective Jan. 10, 2014 with some exceptions for amendments. FHFA issues orders regarding reporting requirements for regulated entities undergoing stress testing The Federal Housing Finance Agency (FHFA) is ordering a reporting requirement for Fannie Mae, Freddie Mac and each of the 12 Federal Home Loan Banks to submit regular or special reports to the FHFA. The order also establishes remedies and procedures for failing to make the reports required by the order. The order is accompanied by the Dodd-Frank Stress Tests Summary Instructions and Guidance. This rule was effective Oct. 28, 2013. FHFA issues final rule implementing stress testing of regulated entities This final rule requires Fannie Mae, Freddie Mac and each of the 12 Federal Home Loan Banks with total consolidated assets of more than $10 billion to conduct annual stress tests to determine whether the companies have the necessary capital to absorb losses as a result of adverse economic conditions. The proposed rule was published on Oct. 5, 2012 and comments were received by Dec. 4, 2012. This rule was effective Oct. 28, 2013. FRS issues final rule implementing supervision and regulation assessments for certain BHCs and savings and loan holding companies This final rule implements Section 318 of the Dodd-Frank Act, which requires the Federal Reserve Board (Board) to collect assessments, fees and other charges to cover the Board's incurred expenses associated with its supervisory and regulatory responsibilities. The assessments and fees are assessed against 1) BHCs and savings and loan holding companies with total consolidated assets of $50 billion or more, and 2) nonbank financial companies designed for Board supervision by the Financial Stability Oversight Council. This rule was effective Oct. 25, 2013.
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