One thing that’s clear from the examination feedback I’ve received from financial institutions in 2013 is that examiners are spending less time in their safety & soundness examinations on the CAMELS “C”, “A”, & “L” (capital, asset quality and liquidity) issues, and more time on the “M” & “E” (management and earnings) issues. (There was some additional guidance released on the “S” issue by the FDIC in October, but so far we haven’t seen “sensitivity to interest rates” become a big deal for examiners.)
I’ve taken a deep dive into the 2013 FDIC financial institution data, and the following charts explain why I believe the trend towards less C, A & L, and more M & E scrutiny will continue. The first chart is a count of total failed institutions per year since 2007:
So 2013 saw a return to pre-crisis levels of bank failures, which, while still somewhat high by historical standards, definitely reduced the pressure somewhat. In the next graph I plot the number of “problem banks” (defined here) over the same period , which should give us some indication of the overall health of the banking industry:
As you can see, problem banks are not quite at pre-crisis levels but do show a definite downward correlation with bank failures, and I believe we’ll see that trend continue.
This next chart depicts average net operating income (left scale) against total count of unprofitable institutions (right scale):
As you can see, both indicators are trending in the right direction, which should indicate a continued de-emphasis on C, A & L in future examinations…and increased earnings pressure. Notably however, smaller institutions are likely to face more earnings scrutiny than larger institutions, because although they did not experience the same level of losses early on as larger institutions, they are also taking longer to return to profitability:
So how will all of this impact institutions going forward? If you’ve had a federal examination in the last 6-9 months you’ve probably already heard some variation of the following from your examiner: “Great, your problem assets are under control, now why aren’t you profitable (or more profitable)?” (Of course at this point you might be tempted to mention things like increased deposit insurance assessments, reduced fee income, and increased regulatory burden, but you know it won’t matter…) So certainly the increased focus on “E” will continue, but because the number of institutions still losing money is inversely proportional to size, the smaller you are the more “E” scrutiny you’re likely to get.
However regardless of asset quality or earnings, I believe that increasingly “M” will begin to take center stage in 2014, because at the end of every banking crisis since 1980 there has been a post-mortem analysis of the causes and the regulatory gaps that should be addressed going forward. And that always leads back to “M”, because ultimately regulators believe that all problems facing financial institutions should have be foreseen and avoided by competent management taking a more active role in the affairs of the institution. More on that, and how to prepare for it, in a future post.