December 16 – More than 400 such failures since 2007 have cost the fund, which is fed by banks and backstopped by taxpayers, an estimated $88 billion. That volume shows the need for more transparency in bank regulation, which is largely conducted in the dark, said Paul Atkins, a former Republican commissioner at the Securities and Exchange Commission.

“Transparency is vital,” said Atkins, the managing director at Patomak Partners LLC, a financial services consulting firm in Washington. “It helps make regulators accountable and helps taxpayers better judge what their liabilities might be.”

At least 1,400 times last year, federal examiners told a bank to fix a problem that could imperil its health, according to data from the three agencies that regulate banks. The agencies didn’t reveal the names of the troubled banks or the nature and severity of their concerns. That information is kept from investors, customers and the public unless securities laws force the bank itself to disclose.  Such secrecy is needed to prevent panic that might result in bank runs or investor sell-offs, making problems far worse.

“Ninety-five percent of the corrective action we want to get from an institution, we get seamlessly and efficiently, and sometimes it involves nothing more than a bank examiner whispering in the ear of a compliance officer,” said Dan Stipano, deputy chief counsel at the OCC. “That kind of thing unfortunately for us is invisible and not necessarily measurable. You don’t see scalps on the wall.”

Examiners weren’t always as tough as they needed to be from 2006 through the third quarter of 2010, according to a June report by the Government Accountability Office, an investigative arm of Congress. “Regulators generally were successful in identifying early warning signs of bank distress, but the presence and timeliness of subsequent enforcement actions were often inconsistent,” according to the report.

Enforcement has gotten tougher since the 2008 credit crisis, said Ralph “Chip” MacDonald III, a partner at the Jones Day law firm in Atlanta who represents banks.

“Regulators are doing a good job, they are pretty much on top of their game,” MacDonald said. “The bias is toward acting quicker, as opposed to holding off.”

Most public oversight of bank examiners takes the form of post-mortem reviews: Inspectors general for the three regulatory agencies are required by law to audit any bank failure that costs the FDIC’s insurance fund more than $200 million. While that fund has a $100 billion line of credit with the U.S. Treasury, the FDIC can increase assessments on banks to keep it solvent.

Regulators’ main job is to ensure lenders’ safety and soundness through on-site examinations that involve looking through their books, assessing the risk they’ve taken on and monitoring their capital reserves. Examiners also gauge the acumen of the firms’ management teams. The largest banks have examiners on premises full time. Some banks are also reviewed by state authorities.

The Fed supervised 829 state member banks last year, along with more than 5,000 bank holding companies. The OCC oversees about 1,400 national banks, 631 federal savings associations and 48 branches of foreign banks. The FDIC regulates 4,715 institutions.  [see Bloomberg for additional text]

Source: Bloomberg

Posted by Steven Maimes, The Trust Advisor.

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While South Dakota’s bank regulators are at least officially sticking to the sidelines as United Western Bancorp’s fight with the national supervisory agencies drags on, longtime observers warn that “corrective action” could be on the horizon.

The situation heated up back in January when the Office of Thrift Supervision shut down United Western’s $2 billion thrift unit and named the FDIC as receiver. It’s happened to a lot of institutions over the last few years.

But where the heads of those institutions went quietly, United Western CEO Guy A. Gibson fired back with a press release blasting the action as both “precipitous” and unnecessary, following it up a month later with a full-fledged federal lawsuit against the FDIC and OTS citing the closure as “arbitrary and capricious.”

Since then, the company’s affiliated trust services unit has remained open under its South Dakota charter and — as of now — still seems to be willing to accept new business.

But although state regulators currently refuse to speculate or otherwise comment on the trust company’s fate, industry experts warn that historically scandal-sensitive South Dakota will act decisively if it sees a problem.

“They can simply issue an informal cease and desist order preventing the trust company from taking any new clients,” says one longtime observer who talked to us only on condition of anonymity.

With its reputation on the hot seat as the trust firms owner delisted from the Nasdaq, the regulators could also have grounds to wonder whether United Western Trust can continue as a going concern with the current owner, our source added.  In addition, according the United Western’s website, the firm is contemplating a bankruptcy filing. All of this may influence the South Dakota bank regulator.

A new bank charter elsewhere is probably not an option any time soon. The FDIC has a 15-month window for filing a new administrative action — this one potentially targeting the officers of the South Dakota trust company — and no state regulator is likely to invite that kind of risk to the table.

Expect more sudden moves ahead

In the meantime, hair-trigger bank closures could become standard operating procedure as the regulators adopt a “no mercy” policy to what they consider potential sources of trouble even before they become a problem.

United Western Bank, famously, had $400 million in cash and was on the edge of closing another $200 million in fresh capitalization when its total capital ratio dipped below the OTS minimum.

Punishment was swift and, for those who considered the OTS a relatively lenient regulator, unexpected.

“The reality is that the regulators have been chastened by what we’ve seen and they are looking to put the weakest institutions out of business,” says Jim Bauerle, head of bank consulting group FiCap Strategic Partners.

“You have not seen the end of this,” he added.

If so, it may be time for trust companies across the country to reevaluate their banking relationships to ensure their accounts don’t trigger an FDIC-driven administrative nightmare.

Part of the controversy surrounding United Western was the status of its three anchor customers — all trust companies — which accounted for 74% of its deposits.

The OTS and the FDIC classified these relationships as brokered “hot money” accounts, which provoked additional scrutiny on the bank on the premise that they might pull out at any time and create a liquidity crisis, simply because they were so big.

In reality, United Western notes, these were simply long-term institutional accounts, going back as much as 13 years.

If the line between institutional accounts and hot money is now so blurry, trust companies need to be even more careful picking a place to park their funds.

“Casual depositors may view all banks as being alike, but fiduciaries looking to place meaningfully sized deposits in particular should be careful to do their own analysis to ensure that an institution is not only ‘sound enough’ but has a significant margin for error,” Bauerle says.

Scott Martin, contributing editor, The Trust Advisor Blog. Jerry Cooper and Steve Maimes contributed to the editing and research.

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When Wilmington Trust sold itself to Buffalo-based M&T Bank a month ago, industry observers were shocked to see the high-end business go to a retail-oriented competitor — and investors balked at the steeply discounted price.

But SEC filings confirm that Wilmington management really didn’t have a choice if they wanted to keep scandal-wary clients on board.

As it turns out, after regulators discovered that the bank had failed to mark down its deteriorating loan portfolio, they basically gave management an ultimatum.

“Without a strategic translation acceptable to its regulators, Wilmington Trust would likely face significant regulatory actions in the near term, which would likely result in a significant impairment of its business prospects,” the latest filing, released November 18, reveals.

Management knew that a formal enforcement action would cause “serious deterioration” to its crown jewel — the still-lucrative trust business the du Pont family built back in 1903 — and so in order to shield that franchise, they started courting offers.

M&T won the day with a $350 million offer that enraged shareholders by asking them to take a 46% haircut on the deal.

Multiple pension funds and smaller investors have already sued, alleging that Wilmington’s accounting methods hid the impact of its failing commercial loan portfolio until it was too late.

If so, they’d might as well sue the Office of Thrift Supervision and the FDIC too for giving the bank the chance to ride its losses until they exploded.

“They thought they could wait it out until things got better, but that’s just not what happened,” says analyst Tom Alonso, who covers the banking sector for Macquarie Equity Research.

“When it became apparent they couldn’t take the pain, the regulators stepped in,” he adds.

Tightening the screws

From January to September, Wilmington had to divert a staggering $564 million in cash flow to its reserves to protect itself from bad loan losses. Since the entire operation only brought in $510 million over the same period, the situation was clearly getting dangerous.

Meanwhile, the regulators were clamping down. In August, Wilmington got word that any new executive appointments would have to get watchdog approval, and that Washington would not welcome any efforts to grow the bank out of the crisis.

The message was clear: “sell out or find an investor by your next earnings release, or your credit rating will crash, your clients will leave, we will make a match for you and your shareholders will be unhappy anyway.”

Unfortunately, while management scrambled to set up talks with at least two potential partners, the offers came with too many strings and weren’t big enough to stop the bleeding — and the clock was ticking.

As of October 18, two weeks before Wall Street expected Wilmington’s earnings, the best deal to emerge was for $269 million and maybe some added cash down the road. Since that was only 37% of what the stock was company was worth at the time, the bank kept looking.

The next day, the regulators told Wilmington to skip its next dividend payment. With blood in the water, the offers shrank to practically insulting levels.

On October 27, five days before the unofficial deadline, M&T stepped up with a promise to pay fair book value, or roughly $3.84 a share for the now-dying bank.

Disgruntled shareholders may want to consider the fact that by that point, bids had shrunk to the level of 50 cents a share in cash and a piece of whatever income the loan portfolio could generate.

As of November 1, Wilmington had a new corporate parent and M&T had won one of the best franchises in the trust business.

Going forward

Since the regulators were intimately involved with this particular merger — consider it an unofficial FDIC sale with dignity, if you like — everyone involved expects it to sail through the approval process fairly fast.

Mark Graham, who runs Wilmington’s wealth advisory services operation, says his team is currently working hard to fit their business around M&T’s retail banking network by the middle of next year.

Now that the shotgun wedding is on the books, he notes that it’s actually a pretty good match because the two institutions come out of such different cultures.

“M&T has a strong community banking footprint and we’re certainly a major player in the national large family office business,” he explains.

“There are some interesting opportunities here to reach small business owners in particular that we frankly haven’t had before,” he adds.

Retail Wilmington branches will switch to the M&T name when the deal closes, but Graham confirms that there aren’t any plans to retire the Wilmington brand in either the corporate or private trust sides.

Changing the name risks alienating existing high-net-worth clients — including some of the du Ponts, after all these years — while doing little to help sell higher-end services to the entrepreneurs that M&T currently focuses on

And since Wilmington is known for its high-touch offering, M&T is taking a hands-off approach to the people who work closely with those wealthy accounts.

“The people at M&T have been very vocal with our folks about wanting them to stay exactly where they are,” Graham says. “Clients will not see any unusual interruptions in their relationships during the transition or after.”

Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research and reporting.

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President Obama signed sweeping changes to  federal financial regulation this week, signaling perhaps the Democrats’ last major legislative victory before the midterm elections in November.

After over a year of bickering about everything from toasters to options trading, the financial reform bill is now a reality and the 20-year-old Office of Thrift Supervision’s days are numbered.

Starting next summer, the OTS will fold into the Office of the Comptroller of the Currency, which will take over supervision of about 745 thrift-structured lenders, trust companies and other institutions. Click here to request an Excel listing of all 745 OTS thrift institutions.

But, what won’t be folding anywhere are the existing powers thrifts have to operate in all 50 states.  They will, however, have to comply with new, more stringent capital rules regarding problem loans.

According to the OTS and the new rules,  no new national thrift charters will be issued anymore.

“We are changing regulators but still have a valid thrift charter,” explains Art Sims, president of Davidson Trust, which got an OTS charter in 2000. “That is not going away.”

With a year to consider their options, holders of national thrift charters are mulling their next moves carefully, Sims says. Some are considering asking the OCC to convert them into banks, but Davidson at least will probably stay right where it is.

No reason to change?

As Sims points out, these institutions went down the thrift route in the first place because the distinct advantages that operating model offered outweighed the downside.

Everyone I talked to while putting this story together told me that the OTS unified holding company rules made it easier to branch out. As long as you didn’t break any state statutes, all you really needed was a national thrift charter and you could set up remote offices instantaneously.

“It was a distinct advantage,” says Scott Walshaw, regulatory advisor of Advisors Institutional Services. “Presuming the regulatory provisions those charters are operating under right now are grandfathered, it will continue to be an advantage.”

One reason Davidson Trust went with the OTS when it was picking a charter was because the thrift system let it operate under the same rules wherever it chose to do business.

That uniformity has saved endless headaches as the company serves the customers of its corporate parent, the Davidson Companies, which does business in 15 states beyond its native Montana.

If anything, people who have worked with both OTS and OCC charters say that the national thrift charter is now not only an endangered species but a hot commodity.

“The people who are holding those federal charters will have a distinct valuable asset,” Walshaw says.

State charters are in play

Other OTS-chartered trust companies are weighing their choice as well.

One source close to an OTS trust bank–talking on condition of confidentiality–tells me that the institution started making plans to move to a state trust charter back in June in order to avoid having to deal with the overhaul.

For industry giants that, like Northern Trust, already have both thrift and banking charters, there is no reason to switch. If anything, having one less regulator to deal with simply streamlines the compliance process.

More locally focused players may find the idea of dealing with the OCC a little daunting, especially if rumors that the bank regulators are going to get stricter on thrifts come true.

Right or wrong, the OTS had a reputation for being a bit more lenient with reserves and the way it priced non-performing assets.

Since the old savings & loans had most of their portfolios tied up in real estate, a more flexible regulatory model made sense—at least in theory. But a lot of today’s thrift-chartered lenders are carrying a lot of bad debt on their books that might have passed OTS muster but not the OCC.

These lenders may be looking at converting to a state charter. In the new environment, the FDIC will still regulate state thrifts and the various state watchdogs will supervise trust companies.

Scott Walshaw wouldn’t be surprised if state thrift charters make a comeback as both new and established lenders opt for local regulation. For trust companies, of course, leverage and non-performing loans are both non-issues.

A nationally chartered trust company would probably find moving to state regulation to be more of a step backward than just going across to the OCC, Art Sims believes.

“A state charter can entail more effort and more cost to keep up with the state regulator, much less rethink what a change would mean for every location where you do business,” he explains. “It is less likely that people who have already committed to a national charter are going to want to go back to a state charter.”

When the rubber hits the road

As anyone who deals with regulators knows, all of this is still largely hypothetical.

OTS spokeswoman Janet Frank was able to point The Trust Advisor readers to the two sections of the 2,300-page Dodd-Frank rules that affect trust companies (here and here), but she admits that as yet nothing is set in stone.

“So much is up in the air right now and there are so many moving parts,” she says. “Guidance will be coming out as appropriate to tell our trust companies how the transfer will work, but I don’t know how or when that guidance will move.”

While the OTS is currently scheduled to disappear next July, Congress has the option to extend its life another six months if the transition bogs down. This means that an institution may not even deal with the OCC until 2012 at the earliest.

By that point, the OCC, OTS and the Federal Reserve should have had plenty of time to sit down and come up with a system for affected trust companies to follow.

“Naturally, I would hope they do it soon in order to eliminate uncertainty and give people time to rethink their business plan,” Scott Walshaw says. “But it could take two years for the dust to settle, and in the meantime it’s anybody’s guess.”

Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research and the editing.

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Experts recommend wealth managers conduct due diligence before sending a client to a bank’s trust dept.

With 700 banks still on the FDIC’s secret “problem list” and banks getting shut down on almost a weekly basis, the financial sector is still in its worst shape since the early 1990s.

But until recently, relatively few people worried what would happen if fiduciaries started failing along with banks.

FDIC spokeswoman LaJuan Williams-Young told me, advisors recommending a bank to hold client assets should be on guard.

The good news is that no federally insured financial institution with the legal power to operate as a trust company failed in either 2008 or 2009. However, this year five banks with trust assets have been taken over by the FDIC.

“There are definitely banks that have considerable problems and some of them have trust departments,” she said.

She wouldn’t single out any trust banks in particular, but said the ones the regulators have their eyes on generally have a lot of problem loans and a track record of enforcement actions against them.

Cracking the Code

L. Scott Walshaw, Nevada’s former banking commissioner and regulatory advisor with Advisors Institutional, says sending a client to a bank that wind ups failing can affect the relationship. It’s better to do some homework. Figuring out which banks are in bad shape can be a matter of “reading the tea leaves,” but he gave me more specific pointers for spotting serious trouble ahead of time.

While most of the steps leading up to the FDIC taking a bank over are hidden from the public, a bank usually gets an official cease and desist order—usually a last warning to clean up its lending habits and beef up its balance sheet. If it fails to comply or improve on its own, it’s a strong candidate for getting sold off.

These orders are part of the public record, so anyone can check the FDIC website to see whether a bank’s condition has deteriorated to that point. So far this year, 40 banks have gotten the orders, but only 7 have had trust departments: Cowlitz Bank in Longview, WA; First Security Bank & Trust in Norton, KS; State Bank of Burnettsville in Burnettsville, IN; Clarke County State Bank in Osceola, IA; Security State Bank in Scott City, KS; Bank of Smithtown in Smithtown, NY; and Citizens Union Bank of Shelbyville in Shelbyville, KY.

All have relatively small trust departments. The biggest, Cowlitz Bank, has a total of $70 million in fiduciary assets.

Knowing the Risks

When a federally insured fiduciary fails, its trust accounts are currently protected up to $250,000 per qualified beneficiary, LaJuan Williams-Young at the FDIC says.

While that may scare some advisors whose clients have put millions of dollars in stock or real estate into trust at a weak bank, it may not necessarily be a big deal, Scott Walshaw told me.

That’s because the FDIC insurance limit only applies to products issued by the bank that failed. Certificates of deposit held within the trust account are subject to the $250,000 limit. Stocks and real estate aren’t.

As long as the assets are managed properly and your clients’ trust bank is FDIC-insured, Walshaw says, it won’t matter whether it fails or not. The fiduciary assets simply roll over to the financial institution that takes it over and, as Walshaw puts it, “Nobody’s even going to get a haircut.”

In the worst case scenario, he says, the FDIC will simply liquidate the bank and turn insured cash and other assets back to the outside trustee, who now needs to find a new trust company.

“Other than perhaps the inconvenience of having to move from one institution to another—which is normally done for you by the FDIC—that’s it,” he told me. “There’s really little if any risk to the beneficiaries as long as the limits are satisfied.”

However, some experts warn that failure to satisfy the limits does expose advisors to some degree of reputation risk if the bank fails.

According to a report the Virginia State Bar Association did a few years ago, lawyers may not be immediately liable if trust assets are lost in a bank failure; after all, there are hundreds of non-FDIC-insured trust companies out there, and some legal precedent for holding the advisor blameless when those companies go under.

Still, James Barr, the association’s ethics counsel, warned Virginia lawyers that leaving even a small part of their clients’ assets in weak banks outside the FDIC’s protection can damage their reputation and isn’t really good practice.

“Regardless of possible malpractice or disciplinary exposure, good lawyers take reasonable measures to prevent or mitigate financial loss to clients,” he said.

Trusts not the Problem

In any event, banks with trust departments tend to be more stable than those that focus exclusively on lending. Nobody I talked to had ever heard of a trust department dragging down a bank.

Usually, it’s the other way around, says Mike Heller, president of a company called Veribanc, which provides independent bank safety ratings.

“Most of the FDIC-insured trust companies have a much broader portfolio,” he told me. “I don’t know of a single bank that’s failed because of the trust department.”

For Northern Trust and other huge trust banks that analyst Dick Bove at Rochdale Securities covers, the trust business itself is not part of the problem. The big risk to worry about is litigation, he says.

“Unless the bank gets sued for things that have to do with trust activity, the trust department isn’t really in a position to create risk,” he told me. “If anything, trust accounts can help a bank weather the credit cycle by giving them earnings when the lending market does poorly.”

Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research and editing.

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