material loss reviews – Compliance Guru

I made a similar post last year about this time, so I thought I would continue the “Thanks-giving” tradition here…and no, I haven’t completely lost my mind about Dodd-Frank. Let me explain. Over the past year I’ve had the opportunity to give several presentations to various groups on the impact of Dodd-Frank (DFA) on community financial institutions, and I know the attitude out there on DFA ranges from cautious optimism to dread, but “Thankful”?!? Actually so far, overall, the impact had been negligible to slightly positive for community financial institutions (defined as <$1B in assets). But there is also reason for caution.

Reasons to be thankful

First and foremost among these are lower assessment rates. Lower deposit insurance assessments mean that the vast majority of community banks will see 30% – 40% decreases in their fees paid to the FDIC. And at the same time the amount of deposit insurance coverage has increased to $250,000. Getting more for less is always a good thing.

Although we can’t really credit this to Dodd-Frank, we can nevertheless also be thankful that financial institutions are for the most part healthier than they were last year at this time:

Another reason to be thankful is that the provision limiting debit card interchange fees does not apply to institutions with less than $10B in assets. In fact the vast majority of DFA provisions will only apply to institutions larger than $1B in assets, which as of June 2011 is only 8.9% of all financial institutions:

Reasons to be cautious

But as I said, there are still reasons to be cautious. According to DavisPolk in their latest Dodd-Frank Progress Report, 326 of the 400 rules required by the law have not yet been enacted, which, (regardless of whether or not community institutions will ultimately be affected) still leads to a climate of regulatory uncertainty. And there are couple of other more obscure provisions that will affect all institutions, like the Source of Financial Strength provision, and the requirement for risk committees to have outside directors, and of course whatever burdens the CFPB brings…stay tuned!

I mentioned previously that one of the reasons that I’m NOT thankful for DFA is that it raises the threshold for triggering a Material Loss Review from $25M to $200M, so we’ll have fewer post-failure reports to review. I believe the best way to avoid repeating the mistakes of the past is to learn from them, and the MLR’s were a great way to do that. I think they can also predict future examination trends…which is a preview of my next 2012 Trends post!

(I’d be remiss if I didn’t take this opportunity to express thanks for all the blog readers out there…over 11,000 visits since this time last year! THANK YOU!!)

I asked in my previous post whether or not the regulators should share any of the blame when institutions fail, and if so, should they shoulder any of the liability? The thought occurred to me as I was reviewing some recent Material Loss Reviews.

A Material Loss Review (MLR) is a post-mortum written by the Office of Inspector General for each of the federal regulators with oversight responsibility after a failure of an institution if the loss to the deposit insurance fund is considered to be “material”. (The threshold for determining whether the loss is material was recently increased by the Dodd-Frank Act from $25 million to $200 million, so we are likely to see fewer of these MLR’s going forward.) All MLR’s have a similar structure. There is an executive summary in the front, followed by a break-down of capital and assets by type and concentration. But there is also a section that analyzes the regulator’s supervision of the financial institution, and I noticed a recurring theme in this section:

…(regulator) failed to adequately assess or timely identify key risks…until it was too late.
…(regulator) did not timely communicate key risks…
…Regulator should have taken “a more conservative supervisory approach”, and used “forward-looking supervision”.
…examiners identified key weaknesses…but…they did not act on opportunities to take earlier and more forceful supervisory action.
…serious lapse in (regulator’s) supervision
…(regulator), in its supervision…did not identify problems with the thrift
…(regulator) should have acted more forcefully and sooner to address the unsafe and unsound practices
…(regulator) did not fully comply with supervisory guidance

There were also many references to the responsibilities of the Board, which I addressed here, but in almost every case the regulator was found at least partially responsible for the failure of the institution.

Here is where you can find the reports for each regulator:

I encourage you to take a look at these and draw your own conclusions as to the issues of responsibility and liability. But clearly there are lessons to learn from any failure, and one lesson that I think we should all learn from this is that regulators will be pressured to be much more critical going forward. (I.e. quicker to apply “Prompt Corrective Action“.) After all, no one likes to be called out for doing a bad job.

One other part I found interesting (in the sense that it perfectly fits the narrative) is where the review lists all examination CAMELS ratings in the periods immediately prior to the failure. What struck me was how many times institutions scored 1’s and 2’s just prior to the failure, and then dropped immediately to 4’s and 5’s in a single examination cycle. Again, the lesson is that there will be tremendous downward pressure on CAMELS scores. And don’t think that just because you are healthy you’re immune from the additional scrutiny. As one MLR stated “…a forceful supervisory response is warranted, even in the presence of strong financial performance.”

Tag: material loss reviews

Thankful for…Dodd-Frank?

Reasons to be thankful

Reasons to be cautious

Material Loss Reviews: Does responsibility = liability?