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  1. 1. House Committee on Pensions, Investments & Financial Services Department of Banking Commissioner Charles G. Cooper April 2, 2009 Savings and Mortgage Lending Commissioner Douglas B. Foster
  2. 2. Topics of Discussion <ul><ul><ul><li>Historical perspective on the banking crisis of the 80’s and early 90’s. </li></ul></ul></ul><ul><ul><ul><li>Overview of current economic and regulatory environment for Texas banks. </li></ul></ul></ul><ul><ul><ul><li>Effect of mark-to-market accounting on bank financial statements and capital adequacy. </li></ul></ul></ul><ul><ul><ul><li>Legislative assistance for community institutions and communicating concerns to congressional delegation </li></ul></ul></ul><ul><ul><ul><li>Role of community banks in strengthening their local economies through responsible lending. </li></ul></ul></ul><ul><ul><ul><li>Current initiatives by the FDIC with regard to assessments that will impact bank earnings and thus capital </li></ul></ul></ul>Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  3. 3. Banking and S&L Crisis of the 80’s & 90’s <ul><li>Deposit-interest rate ceilings phased out. Federal Reserve Bank restricted the growth rate of money supply and interest rates increased dramatically. </li></ul><ul><ul><ul><li>Mortgage rates peaked at 15.5% in 1982 </li></ul></ul></ul><ul><ul><ul><li>The prime rate peaked at 20.5% in 1981 </li></ul></ul></ul><ul><li>Deregulation of S&L powers, allowing for increased risk taking. </li></ul><ul><ul><ul><li>Savings and loans were given the capabilities of banks, without imposing the same regulations as banks. </li></ul></ul></ul><ul><ul><ul><li>Removal of statutory restrictions on real estate lending. Regulatory relaxation permitted lending, directly and through equity participations. </li></ul></ul></ul><ul><li>Proliferation of state and federal bank charters in Texas between 1975 – 1990 totaled 802 . </li></ul>Contributing Factors: Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  4. 4. Banking and S&L Crisis of the 80’s & 90’s <ul><li>Raised deposit insurance limit from $40,000 to $100,000. Allowed the expansion of brokered deposits. (1980) </li></ul><ul><li>Regulatory agencies and regulatory systems not prepared to identify risk in era of deregulation. </li></ul><ul><ul><ul><li>Staff experience declined and the understanding of risk in the industry was inadequate. </li></ul></ul></ul><ul><li>Changes in federal tax laws . </li></ul><ul><ul><ul><li>Tax Reform Act of 1986 removed many tax shelters, especially for REITs. The Act reduced the value of these investments by limiting the extent to which losses associated with them could be deducted. </li></ul></ul></ul><ul><li>Volatility of oil prices. </li></ul><ul><ul><ul><li>Prices plummeted from $70 (1981) to $20 per barrel (1986) </li></ul></ul></ul><ul><ul><ul><li>Texas did not have a diverse economy and had an extreme dependence on oil. </li></ul></ul></ul>Contributing Factors (Continued) : Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  5. 5. Historical Bank and S&L Failure Data <ul><li>Results: </li></ul><ul><li>Total Bank and S&L failures between 1943-1979: 168 </li></ul><ul><ul><li>Texas Banks and S&Ls accounted for 30 of these failures. </li></ul></ul><ul><li>Total Bank and S&L failures nationwide between 1980-1994: 1,600 </li></ul><ul><ul><li>Bailout of $160 billion– These funds were dedicated to the failure of the Federal Savings and Loan Insurance Corporation (FSLIC). </li></ul></ul><ul><ul><li>Texas banks and S&Ls accounted for 599 or 37 % of these failures. </li></ul></ul><ul><li>Texas Bank and S&L failures as a percentage of U.S. total </li></ul><ul><li>Legislative and Regulatory Response: </li></ul><ul><ul><li>Branching restrictions lifted in Texas. </li></ul></ul><ul><ul><li>Southwest Plan. </li></ul></ul>Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  6. 6. Recent and Current Economic Environment <ul><li>Subprime Mortgage Lending Crisis. </li></ul><ul><ul><li>Credit enhancements like credit default swaps allowed mortgage loans to be securitized and sold in secondary market; off balance sheet liabilities increased highly leveraging many financial companies. </li></ul></ul><ul><ul><li>Real estate bubble was created (pronounced in CA, NV, AZ, GA, FL). </li></ul></ul><ul><ul><li>Losses were experienced by banks that originated, securitized or traded mortgage backed securities. </li></ul></ul><ul><ul><li>Texas banks were not a major participant in the secondary market who generally maintained safe and sound underwriting standards. </li></ul></ul><ul><ul><li>Texas home equity laws establish borrowing restrictions. </li></ul></ul><ul><li>Created national recession which officially began in December 2007. </li></ul><ul><li>Current Texas economic status. </li></ul><ul><ul><li>The FRB’s Texas Business Cycle Index is trending downward. </li></ul></ul><ul><ul><li>The change in the FRB’s Texas Leading Index is negative. </li></ul></ul><ul><ul><li>Employment growth in the major metro areas is weakest in Dallas, Ft Worth and El Paso. </li></ul></ul><ul><ul><li>Energy prices and the Texas rig count are down. </li></ul></ul><ul><ul><li>Softening of commercial real estate is affecting the buying and selling of commercial properties. </li></ul></ul><ul><ul><li>Residential real estate construction and sales are down dramatically . </li></ul></ul>See Appendix for timeline of events A Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  7. 7. <ul><li>Concerns </li></ul><ul><li>Concentrations in: </li></ul><ul><ul><li>Interim Construction </li></ul></ul><ul><ul><li>Land Development </li></ul></ul><ul><ul><li>Commercial Real Estate </li></ul></ul><ul><li>High level of volatile funding sources: </li></ul><ul><ul><li>Brokered deposits </li></ul></ul><ul><ul><li>Internet deposits </li></ul></ul><ul><ul><li>FHLB borrowings </li></ul></ul><ul><li>Shortage of experienced bankers and regulatory examiners </li></ul>Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009 <ul><li>Responses </li></ul><ul><li>Horizontal or targeted reviews </li></ul><ul><li>More frequent exams </li></ul><ul><li>Enhanced off-site monitoring </li></ul><ul><li>Increased use of enforcement </li></ul><ul><li>Expanded use of supervisor program </li></ul><ul><li>Requesting authorization to hire additional senior level examiners </li></ul>Regulatory Concerns and Responses
  8. 8. Federally Insured Depository Institutions Assets Under Supervision in Texas $725.2 Billion See Appendix for market share information B Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  9. 9. Texas Faring Better Than Other States <ul><li>While no longer robust, the Texas economy continues to show signs of stability and resiliency. </li></ul><ul><li>Texas banks and thrifts continue to be better capitalized than U.S. banks as a whole, and have been able to better absorb the impact of the financial market disruptions. </li></ul><ul><li>Maintaining prudent lending standards and benefiting from lessons learned from the bank and S&L crisis two decades ago, asset quality of Texas banks and thrifts continues to hold up comparatively well. </li></ul><ul><li>In February 2009, Sheshunoff and Co. Investment Banking, a bank advisory firm, released a report that states Texas banks carry fewer problem loans and have more capital than banks elsewhere in the nation. </li></ul><ul><li>Of the 25 bank failures in 2008, two were in Texas. </li></ul><ul><li>Of the 21 bank failures in 2009, none have been in Texas. </li></ul><ul><li>In March 2009, one Texas state-chartered bank acquired a failed Colorado financial institution. </li></ul>Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  10. 10. Commercial Bank Performance and Condition Ratio Comparison (State and Federal Charters) Source: FDIC As of 12-31-08 Texas Nation Texas Nation Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009 12/31/2008 12/31/2008 12/31/1988 12/31/1988 Number of Banks 594 7,085 1,492 13,123 Total Assets ($ in millions) $273,498 $12,312,914 $162,010 $3,029,212 % of Unprofitable Institutions 14.14% 21.85% 40.48% 14.68% Net Interest Margin 3.82% 3.23% 2.98% 4.02% Return on Assets 0.82% 0.21% -1.28% 0.82% Return on Equity 7.85% 2.11% -24.74% 13.19% Net Charge-Offs to Loans 0.50% 1.31% 2.84% 1.00% Earnings Coverage of Net Loan Charge-Offs (x) 5.00 2.17 0.27 2.74 Efficiency Ratio 64.73% 58.30% 88.82% 66.17%
  11. 11. Source: FDIC As of 12-31-08 Texas Nation Texas Nation Commercial Bank Performance and Condition Ratio Comparison (State and Federal Charters) Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009 NA NA 14.00% 25.03% % CRE to Total Loans 12/31/2008 12/31/2008 12/31/1988 12/31/1988 Loss Allowance to Loans 1.31% 2.28% 3.47% 2.41% Noncurrent Assets Plus ORE to Assets 1.14% 1.82% 5.09% 2.14% Noncurrent Loans to Loans 1.43% 2.90% 6.18% 2.92% Core Capital (leverage) Ratio 8.94% 7.42% 4.63% 6.16% Equity Capital to Assets 10.40% 9.45% 4.71% 6.28% Tier 1 Risk-Based Capital Ratio 10.62% 9.75% NA NA Total Risk-Based Capital Ratio 12.67% 12.75% NA NA Net Noncore Funding Dependence 15.95% 22.49% NA NA Total Bank Failures and Assistance Transactions 1 18 175 280
  12. 12. Thrift Performance and Condition Ratio Comparison (State and Federal Charters) Source: FDIC As of 12-31-08 Texas Nation Texas Nation Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009 12/31/2008 12/31/2008 12/31/1988 12/31/1988 Number of Thrifts 50 1,220 1,697 16,561 Total Assets ($ in millions) $91,561 $1,534,369 $269,563 $4,569,456 % of Unprofitable Institutions 38.00% 32.46% 44.25% 16.78% Net Interest Margin 2.25% 2.77% 1.69% 3.29% Return on Assets -0.15% -0.57% -2.41% 0.44% Return on Equity -1.96% -6.15% -98.68% 7.87% Net Charge-Offs to Loans 0.98% 1.13% 1.88% 0.67% Earnings Coverage of Net Loan Charge-Offs (x) 1.85 1.36 -0.38 -2.99 Efficiency Ratio 68.37% 66.21% 113.76% 68.82%
  13. 13. Source: FDIC As of 12-31-08 Texas Nation Texas Nation Thrift Performance and Condition Ratio Comparison (State and Federal Charters) Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009 NA NA 10.70% 4.22% % CRE to Total Loans 12/31/2008 12/31/2008 12/31/1988 12/31/1988 Loss Allowance to Loans 1.93% 1.64% 3.79% 1.95% Noncurrent Assets Plus ORE to Assets 1.87% 2.38% NA NA Noncurrent Loans to Loans 2.89% 3.10% 12.16% 3.26% Core Capital (leverage) Ratio 8.09% 8.09% 4.63% 6.21% Equity Capital to Assets 7.66% 9.04% 1.41% 5.54% Tier 1 Risk-Based Capital Ratio 12.03% 12.10% NA NA Total Risk-Based Capital Ratio 13.60% 13.34% NA NA Net Noncore Funding Dependence 27.64% 26.04% NA NA Total Thrift Failures and Assistance Transactions 1 7 81 190
  14. 14. Texas vs. Nation on Foreclosures Source: Mortgage Bankers Association As a percentage of mortgage loans Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  15. 15. A problem bank is defined as an institution with a safety and soundness CAMELS rating of 3, 4 or 5. Problem Texas State-Chartered Bank and Thrift Projections Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  16. 16. Accounting and Capital Treatment for Bank Assets <ul><li>Mark-to-market or fair value accounting refers to the accounting standards of assigning a value to a position held in a financial instrument based on the current fair market price from the instrument or similar instruments. </li></ul><ul><li>Mark-to-market accounting has been a recent concern because of the unprecedented intersection of two factors – accounting guidance and market segment breakdowns. </li></ul><ul><li>The accounting guidance involved includes FASB 115 and FASB 157. </li></ul><ul><li>FASB 115 has (for over 15 years) directed that any temporary depreciation (or ‘impairment’) in investments be reflected as a deduction from book capital accounts but is added back for bank regulatory capital. This deduction does not affect earnings or regulatory capital adequacy. </li></ul><ul><li>However, FASB 115 also directs that any “other than temporary impairment” (OTTI) is to be written off through earnings, with a resulting reduction in regulatory capital. </li></ul><ul><li>FASB 157 (issued about 2 years ago) addressed the difficult valuation process for the many new types of investments which were often not widely traded with a 3-tiered pricing system. </li></ul><ul><ul><li>Level I securities were widely-traded securities (such as US Treasuries) with ready market quotes; prices were readily discernible from recent arms-length sales in the normal course of business. </li></ul></ul><ul><ul><li>Level II securities are less widely-traded, and are valued by comparing them to recent market sales of ‘similar instruments’. </li></ul></ul><ul><ul><li>Level III securities are often exotic, and are so thinly-traded that they are valued via models, from a set on internal assumptions. This is clearly a much more abstract approach, and difficult to validate in the market. Collateralized debt obligations (CDOs), backed with derivative collateral such as credit default swaps, are an example of this type. </li></ul></ul>
  17. 17. Accounting and Capital Treatment for Bank Assets <ul><li>The ‘market segment breakdown’ began about 18 months ago, when the markets for many of these new, more exotic securities began to freeze up due to general concerns about credit exposure and liquidity. The lack of ‘transparency’ in the valuation process also made potential buyers of these securities more cautious. </li></ul><ul><li>The usual ‘market valuation’ process for the great majority of more ‘traditional’ securities was not affected. These included US Treasury and Agency bonds, municipal bonds, bonds backed by Fannie Mae or Freddie Mac guaranteed mortgages, and corporate bonds. </li></ul><ul><li>But as arms-length transactions dried up for other types of bonds, more and more types of securities became nearly impossible to value via the traditional ‘market sales’ approach. In Texas banks, these types have most often been auction rate securities (ARS) and private-label collateralized mortgage obligations (PL CMOs). </li></ul><ul><li>The problem became acute when the valuation process, set forth by FASB 157, was issued in 2007. Under its direction, the ‘fire sale’ prices received by sellers under duress were being used as the only market sales available by which to set values. </li></ul>Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  18. 18. Accounting and Capital Treatment for Bank Assets <ul><li>Then, per FASB 115, it appeared that in some of these securities there was loss that might in essence be permanent or ‘OTTI’. The depreciation in such cases was to be written off as a loss through earnings. </li></ul><ul><li>There was no accounting mechanism in place to differentiate between the probable credit losses (such as writing off some of the bad mortgages behind the PL CMOs) and the extraordinary liquidity depreciation that was present in the ‘frozen’ markets. Several Federal Home Loan Banks, for instance, took very large OTTI losses on their PL CMOs in late 2008 for this reason. </li></ul><ul><li>FASB’s proposed ‘fast-track’ revisions to both FASB 157 and FASB 115 are efforts to remedy the current situation. </li></ul><ul><ul><li>Securities whose markets have ‘frozen’ can now be valued as Level III, based on assumptions that presume non-distressed sales. </li></ul></ul><ul><ul><li>The identified ‘credit loss’ portion of any OTTI is still to be charged off through earnings, but the ‘liquidity depreciation’ will be reflected as a deduction from book capital accounts but is added back for bank regulatory capital, without affecting earnings or regulatory capital adequacy. </li></ul></ul><ul><li>FASB is meeting on April 2, 2009, to decide whether these revisions are to be enacted, so the situation is fluid, but moving very fast. </li></ul><ul><li>    </li></ul>Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  19. 19. Accounting and Capital Treatment for Bank Assets Source: Office of the Comptroller of the Currency Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009 Changes recognized in capital through earnings Changes recognized in earnings Fair Value Trading Changes in fair value are not reflected. Impairment is recognized in capital through earnings based on incurred credit losses. Changes in fair value are not reflected. Impairment is recognized through earnings based on incurred credit losses. Amortized Cost Held for Investment Declines below cost recognized in capital Declines below cost recognized in earnings Lower-of-cost-or-fair-value Held for Sale Direct Investment in Loans Changes not recognized unless OTTI Changes in fair value not recognized unless OTTI Amortized Cost Held to Maturity Changes not recognized until sold or OTTI Changes reflected in other comprehensive income. No effect on earnings until sold or “other than temporary” impairment (OTTI). Fair Value Available for Sale Debt Investments Effect of Changes in Fair Value on Tier 1 Regulatory Capital Effect of Changes in Fair Value in Financial Reporting under GAAP Balance Sheet Valuation Criteria Asset Type
  20. 20. TARP – Capital Purchase Program Participating State-Chartered Banks and Thrifts Total Number of State-Chartered Banks And Thrifts Applying: 67 Amount of Capital Requested: $3.2 Billion Number of State-Chartered Banks And Thrifts Receiving Capital To Date: 17 Amount of Capital Received To Date: $2.8 Billion Source: U.S. Department of Treasury Office of Financial Stability Information as of March 30, 2009 and Texas Savings and Mortgage Lending survey of Texas state-chartered thrifts. Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009 As of March 27, the Treasury Department had disbursed $303.4 billion of the $700 billion in Troubled Asset Relief Funds with about $199 billion going to purchase preferred shares of 532 financial institutions under the Capital Purchase Program, the General Accountability Office said in a report released on Tuesday, March 31, 2009.
  21. 21. Support for Financial Institutions and Agencies <ul><li>The Department of Banking and Department of Savings and Mortgage Lending (SML) need legislative support to: </li></ul><ul><ul><li>Ensure adequate long-term funding and personnel resources for the agencies that: </li></ul></ul><ul><ul><ul><li>Maintain an experienced staff that can identify and respond to institutional weaknesses; </li></ul></ul></ul><ul><ul><ul><li>Understand, monitor and manage institutional operating patterns and risk exposures; and </li></ul></ul></ul><ul><ul><ul><li>Sustain staff development and encourage qualified candidate recruitment. </li></ul></ul></ul><ul><li>Communicate with the congressional delegation about the importance of community financial institutions and the dual banking system. </li></ul><ul><li>The Texas Finance Commission adopted a resolution December 19, 2008, supporting the dual banking system (See Appendix ). </li></ul><ul><li>Commissioner Cooper and Commissioner Foster spoke at several trade association events, briefing participants (typically bankers) on events impacting the industry and offering their support. </li></ul><ul><li>SML held Thrift Industry Day, an opportunity for thrift executives to hear presentations from SML staff and to network with each other. </li></ul><ul><li>Several organizations provide support for regulators including: </li></ul><ul><ul><li>Conference of State Bank Supervisors (CSBS) - Promotes the preservation of the states’ authority in financial supervision (See Appendices and ). </li></ul></ul><ul><ul><li>American Council of State Savings Supervisors </li></ul></ul>Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009 C D E
  22. 22. Community Banks and Local Economy <ul><li>Small businesses are the heart of the American economy. They are responsible for half of all private-sector jobs and they created approximately 70% of all new jobs in the past decade. Government initiatives to reduce or waive SBA loan fees and increase loan guarantee levels should allow community banks to help boost credit markets and small business lending. Source: White House press release </li></ul><ul><li>Meeting community lending needs through small business, home, commercial, and consumer loans; </li></ul><ul><li>Offering depository accounts and other products and services; </li></ul><ul><li>Purchasing debt obligations of local municipalities; </li></ul><ul><li>Providing community leadership and civic activities; and </li></ul><ul><li>Contributing to charitable organizations . </li></ul>State-chartered financial institutions are important to the economic viability of their local communities by: Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009 F See Appendix for state-chartered financial institution loan growth in 2008 and 2007
  23. 23. <ul><li>FDIC deposit insurance available per depositor up to $250,000 through the end of 2009. </li></ul>FDIC Deposit Insurance Increase Source: FDIC Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  24. 24. Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009 Affects of New FDIC Assessment Analysis of the affect of the FDIC’s new and one-time assessments on all state-chartered banks and thrifts. bp= basis point In thousands
  25. 25. Affects of New FDIC Assessment bp= basis point In thousands Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009 Analysis of the affect of the FDIC’s new and one-time assessments on a median state-chartered bank and thrift.
  26. 26. Appendices 2008 Timeline of Events Deposit Market Share in Texas Finance Commission Resolution Supporting the Dual Banking System CSBS Letter to Governor’s Association CSBS Letter to States to Send to Their Congressional Delegation State-Chartered Bank and Thrift Loan Growth for 2007 and 2008 A C D E F B
  27. 27. 2008 Timeline of Events A Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  28. 28. 2008 Timeline of Events A Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  29. 29. 2008 Timeline of Events A Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  30. 30. Deposit Market Share in Texas B Source: FDIC Offered by: Texas Department of Banking and Texas Savings and Mortgage Lending April 2009
  31. 31. C
  32. 32. D
  33. 33. E CSBS Letter for States to Send to Their Congressional Delegation
  34. 34. Texas State-Chartered Bank and Thrift Loan Growth F Adjusted for major mergers and acquisitions Source : FDIC Statistics on Depository Institutions

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