THANKFULLY SHOPPING FOR LESSONS LEARNED

As you prepare to enjoy Thanksgiving with family and friends tomorrow and gear up for Black Thursday / Friday, we leave you with a few more interesting facts to consider. Our recommended strategy to gain maximum attention is to ask for the mashed potatoes to be passed your way and when they reach you, raise the spoon, go in for a big scoop and then clear your throat loudly to draw attention. Once conversation stops around the table, announce to everyone that they might find it interesting there are 46mm frozen turkeys eaten every Thanksgiving, that it takes about 5 days to thaw a 15 pound frozen turkey in the refrigerator and that seven other nations also celebrate an official Thanksgiving Day (Argentina, Brazil, Canada, Japan, Korea, Liberia & Switzerland), albeit not on the same day. Enjoy the fun tomorrow. As you do, consider the lessons you may have learned during this week about Thanksgiving. In a similar fashion, bank regulators apply a specific process to most significant events called "lessons learned." It examines the root causes, looks for commonalities and is designed to be sure bad things don't happen again. Then, regulations, processes and training are updated and depending on the severity of the matter(s), examiners will make it a point to focus on these at upcoming bank examinations. Take for instance some of the lessons we learned over the past few years that are rolling out across the system. One of these relates to paying loan officers commissions based on origination volume. A study by the FRB Chicago and Ohio State University finds commission based loan officers are 19% more likely to accept loan applications, 23% more likely to approve larger loan amounts and that those and other factors result in observable credit quality of loans booked by these loan officers that were 28% more likely to default. In addition, the research found the increase in default occurs mostly for the population of loans that would not have been accepted in the absence of commission based compensation. Simply put, compensation structures tied to short-term revenue generation, rather than long-term profitability over a cycle led banks to take on too much risk because customer facing teams were compensated that way. This is a lesson learned by both bankers and regulators and is one reason why so many banks have instituted claw-back features and made other changes around compensation plans. Another takeaway is how important it is for banks to have a diversified funding strategy and strong risk management to go with it. The FDIC is certainly one agency that looked closely at brokered CD funded growth strategies at failed banks to see if there were any lessons that could be learned. Doing so found that as capital levels deteriorated in a credit crisis environment, banks exposed to higher levels of brokered CDs were not able to roll them over, leading to a liquidity squeeze. It is easy for CD investors to leverage the internet and online services to shop rates and identify the highest yielding deposits. The lesson from that is these customers can be much less stable than a more typical relationship deposit customer. When banks fail or when market conditions change significantly, regulators have seen these customers rapidly transfer funds elsewhere, adding strain to funding sources. As such, focus is heightened on banks that use significant amounts of brokered (or rate sensitive) deposits and examiners will test concentrations, review overall limits, risk management processes and capital structures to ensure adequate safeguards are in place. Banks that lack expertise in wholesale funding; are young; have few relationship deposits; are growing quickly; have inadequate internal audit; have inadequate information systems or controls; have a strategy that does not support using rate sensitive funding; have a management team focused on rates over liquidity; weak liquidity policy limits; or have increased loan delinquencies are all likely to receive particular regulatory attention in this area. Whatever lessons you have learned in your banking career, forget about it all as you enjoy the holiday tomorrow. We will be back on Friday with another edition, to help keep bankers informed and laughing for those who will be in the office.