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What Do Regulators Look For?

In April, the California Department of Financial Institutions closed First Bank of Beverly Hills in Calabasas, and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. The closure was the 28th FDIC-insured institution to fail this year in the U.S. and the fourth in California. Regulators closed County Bank in Merced and Alliance Bank in Culver City on Feb. 6, and 1st Centennial Bank in Redlands on Jan. 23. Are more closures in store? What are the red flags regulators are looking for? And when a financial institution gets in trouble, what steps are they taking to shore up their balance sheets? “The pace of bank failures will increase (nationally), and it’s just a matter of working through the cycle,” said Andrew Gray, director of public affairs for the FDIC. The FDIC works closely with regulators such as the California Department of Financial Institutions and Office of Thrift Supervision (OTS) to monitor the financial health of institutions and intervenes as necessary. While each bank failure is unique, the industry has been hit hard by the economic downturn, housing market crisis and deterioration in the construction loan business, said Gray. Insured commercial banks and savings institutions in the U.S. experienced a net loss in revenue of $32.1 billion in the fourth quarter of 2008, according to the FDIC. It was the first time since the fourth quarter of 1990 the industry posted an aggregate net loss for a quarter. In order to keep banks in check, examiners assess their capitalization, assets, management, earnings, liquidity and sensitivity to financial risk. Institutions are graded on a risk scale. And if an institution falls below a certain level, scrutiny increases and the FDIC may work with regulators to nurse the business back to health, said Gray. “These processes can often be worked through, and just because institutions receive a cease and desist order does not mean failure is imminent,” he said. Re-capitalization or acquisition is often what’s needed. In the case of First Bank of Beverly Hills, no other financial institution stepped-in to acquire the bank. The FDIC has a “watch list” of troubled banks, said Gray, but the information is not public. Regulatory agencies and the FDIC, however, publish banks’ financial data quarterly. FirstFed Financial Corp is one example of what happens when regulators step-in. On Jan. 26, the OTS issued a cease and desist order to the company, which owns First Federal Bank of California and has branches in Agoura Hills, Encino, Tarzana, Thousand Oaks and Westlake Village. The bank proceeded to cut 62 jobs, approximately 10 percent of its workforce. The reductions primarily affected its single family lending and commercial lending operations and some support positions. The bank had twice the amount of capital required by regulators at one point in 2008, said bank CEO, Babette Heimbuch. But more than half of its lending portfolio is in single family homes. “That’s basically our issue is people defaulting on single-family homes,” said Heimbuch. “The drop in home values was devastating.” The defaults hit in two waves, she adds, the first being people who speculated on their homes and eventually couldn’t afford them, and the second being customers who defaulted because of unemployment. Among a list of steps the bank was required to take to comply with the OTS, it had to submit a capital plan within fifteen days of the order to address how it will remain well capitalized through Dec. 31, 2011. It also set-up a “modification group” to help customers stay in their homes and initiated other cost cutting measures, said Heimbuch. “It’s not pleasant and obviously unfortunate to have to lay people off,” said Heimbuch. “The other hard part is working with regulators to figure out what they’re looking for.” FirstFed Financial Corp. experienced a net loss of $53.4 million or $3.90 per diluted share of common stock in the first quarter of 2009. But the parent company and bank were in compliance with minimum capital ratios required by the OTS. “Lots of banks had a bad year,” said James Avery, a consultant who specializes in organizing new banks and helping banks raise capital, adding construction loans have been a headache for many banks. “The key is having adequate capital.” Troubled financial institutions need to first decide whether they want to stay in business or sell to another bank, he said. If they need more capital, Avery helps them price shares. He said selling stock to locals is one way to raise capital and develop a loyal customer base. Avery also helps banks write strategic plans, which may include closing branches, hiring a rainmaker, raising capital and launching other cost-saving measures. A lot of the changes are forced by regulators, he said. “These days it’s more about asset quality,” said Avery. “It’s easy to fault management, but management isn’t always the problem. Part of it is the times.” Are more closures and/or cease and desist orders in-store? “Probably,” said Avery.

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