On July 21, the Office of Thrift Supervision ceased to exist and about 700 trust banks, thrifts and other institutions entered a brave new regulatory world.

The good news is that their new watchdog, the Office of the Comptroller of the Currency, has so far vowed to let them continue with business as usual.

The bad news? Nobody expects the status quo to last very long — maybe a year or two — and there are still some big question marks.

“What I’m getting is that at this point nobody is going to go in and tell anyone, ‘The OTS said you can do this, but this is a new regime and you can’t,’” says Bernard Garbo, publisher of Trust Regulatory News.

“That’s simply not going to happen, at least initially.”

Voting with their feet?

It’s clear that plenty of thrifts have not been eager to hang around and find out. There were 745 institutions under OTS supervision back in January. Now there are barely 700.

In what some considered a final show of force, the traditionally laissez-faire OTS shut down five of its charges over the last six months.

Another 40 transferred their charters to the FDIC or state regulators.

But the remaining 700 institutions now under the OCC’s eye include nationally known independent trust companies like Montana-based Davidson Trust and National Advisors Trust Co., as well as giant Northern Trust.

Many of the big brokerage houses, insurance carriers and money managers also have OTS charters:  Edward Jones, Fidelity, Franklin Templeton, MassMutual, TIAA-CREF.

For these giants, the OCC is probably still the only game in town unless they really want to get into the banking business or swap the state regulators with branching applications.

State charters are an option for the non-giants, says attorney James Rockett, who helped Davidson set up its OTS charter in the first place.

“The states definitely have certain levels of consistency to them compared to the questions around the OCC,” he explains.

“They might be an appropriate course of action while the dust settles.”

Picking through the gray areas

Rockett says one of the biggest mysteries right now is what happens to institutions that were formerly under the OTS but might now see their operating units move to the OCC while the holding company actually shifts to Federal Reserve supervision.

“Limited purpose trust companies can easily fall into this category,” he says. “There’s just no clear guidance on that.”

Bernard Garbo sees the potential headaches getting even bigger if these former thrifts have depositary arms that now need to get their insurance from the FDIC.

“That’s probably the area of most discomfort, dealing with three regulators,” he says. “Even if everything works absolutely smoothly, moving from one entity regulating you to three is a big shift.”

And not even the OCC knows yet what will happen when its mandate contradicts the legacy OTS rules.

So far, government lawyers have been busy enough simply combing through the two sets of regulations and deleting everything that the OTS was doing exactly the same way that the OCC already does.

“Blended” examinations and ultimate convergence

There are no formal plans to migrate any OTS-chartered institutions to OCC rules immediately, so everyone is effectively grandfathered into their current way of doing business for an unspecified period of time.

But down the road, the people I talked to is sure that there will be a slow consolidation around OCC policies — and that’s a matter of attrition as much as inter-agency politics.

As institutions get bought out, shift business models or simply fail, their thrift charters will likely vanish over time. And no new thrift charters will be issued.

Eventually, Garbo suspects, there might be “subtle suggestions” to the remaining thrifts that the OCC would rather see them adopt a normal national bank charter instead.

One thing we do know: the examination system will definitely take its cues from the OCC side, which has a reputation for being more exacting than the OTS was.

The honeymoon will be relatively brief, Rockett says.

“My view is that the OCC will work toward integrating the examination process as quickly as possible,” he says.

“It may take longer than they might like, but the OCC processes will definitely be those that are implemented going forward.”

On the positive side, Rockett dismisses fears that the OCC will say no to regulated trust companies trying to branch out across state lines.

As he points out, the regulator has already lost friends in jurisdictions like Missouri and Texas for overruling state statutes prohibiting out-of-state trust and other fiduciary activities.

Garbo agrees that the OCC has a track record of being friendlier toward branching than some might think.

But he admits that it’s still too early to tell.

“Be careful if you are fully relying on the old OTS regulations,” he warns Trust Advisor readers.

“Things may be okay now, but it might be like a tax audit: you do something this year and don’t hear back from the IRS for two years.”

Scott Martin, senior editor, The Trust Advisor Blog. Jerry Cooper and Steven Maimes contributed to the research.

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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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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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