Researchers say the food dye that gives blue M&M's their color may also help mend spinal injuries. Apparently, the dye blocks a chemical that kills healthy spinal cord cells around the damaged area. We don't know if eating M&M's will help bankers get through their next regulatory examination, but it certainly can't hurt. Along those same lines, following the outcome of regulatory orders for other banks can help protect you. Those reports show regulators are cracking down hard and changing the industry. Here are some significant changes you should be aware of:
Capital ratios have been increased. While the "official" capital ratios required to be considered "Well Capitalized" still remain 10% for Total Risk-Based, 8% for Tier 1 Risk-Based and 5% for Tier 1 Leverage, the "unofficial" capital ratio requirements (based on C&Ds and regulatory discussions) have become 12% for Total Risk-Based and 8% to 9% for Tier 1 Leverage.
Wholesale reliance is not allowed. While there are no "official" statements on the absolute level of wholesale funding a bank can utilize, recent orders appear to place the number somewhere around 5% to 20%, depending on overall liability structure. Banks in excess of those levels should not be surprised to see greater scrutiny from regulators and increased pressure to "raise funding locally" (regardless of pricing disparity to possibly less expensive wholesale options).
Earnings still matter. When calculating appropriateness of loan loss reserve levels and earnings, regulators will often look at the budget forecast through the remaining portion of the year. If there are enough projected earnings to support ongoing loan loss reserve increases through year-end, then things are good. If not and the bank is below peers (with ALLL) on a relative basis, expect pressure to be applied aggressively.
Troubled-debt can be trouble. Trouble debt restructurings (TDRs) are inherently complex beasts, given all the moving parts. That said, we were shocked to hear from bankers that they were getting pressure from regulators to place all TDRs in nonaccrual status. We find this amazing when you consider the Obama administration's request that banks work with troubled borrowers instead of foreclosing. If TDRs are all going to be nonaccrual anyway, you may as well consider foreclosing and removing the problem from your balance sheet once and for all. We'll keep asking around on this one, but be very careful and tread lightly with any potential TDRs.
Strategic planning is important. Regulators expect banks to have a 3Y strategic plan that includes specific goals for the dollar volume of total loans, total investment securities and total deposits. In addition, plans are expected to specify the anticipated average maturity and average yield on loans and securities; the average maturity and average cost of deposits; the level of earning assets as a percentage of total assets; and the ratio of net interest income to average earning assets. Be prepared, be thorough and avoid future problems.
Detailed contingency funding plans (CFPs) are mandatory. Given all the stress in the industry, regulators are requiring banks to prepare a CFP. At a minimum, the CFP should includes an analysis of additional liquidity sources; adverse scenario analyses (to assess possible liquidity events that may be encountered); identification of responses as a result of the potential impact of such events; as well as short, intermediate and long-term liquidity analysis.
Tighter board oversight is required. It is clear regulatory agencies feel the industry would not be in all this mess if boards had maintained proper oversight. Regulators want boards to regularly review reports on adversely classified assets, ALLL, capital, liquidity and earnings at a minimum.
Whether you like to eat green, red or blue M&M's, having protection of any kind in this environment is welcome.