Twas the Night Before the Examiners

'TWAS THE NIGHT BEFORE THE EXAMINERS

'Twas a bright Monday morning and all through the bank,

We awaited the examiners, our spirits were dank,

The policies were bound in a book with great care,

Now all we could do was just mutter a prayer.

The staff was so nervous just thinking of Feds,

While visions of violations danced through their heads.

With the Chairman in Vegas, the President in Vail,

Would they come back to find us in jail?

When out in the lobby there arose such a clatter,

We sprang from our desks to see what was the matter.

And what to our unlucky eyes should appear,

But a man with a badge and eight of his peers.

With computers and briefcases and faces so numb,

We knew in a flash that our time had just come.

More rapid than soldiers he filed in his clan,

And he gathered them all in an office to plan.

"Be picky, be thorough, be tough, use your weight,

To let them all know you have control of their fate.

To Credit, to Audit, go make them feel small,

Now dash away, dash away, dash away all."

And then in a twinkling we heard through the door,

The sharpening of dozens of claws on the floor.

And as the door opened, our eyes grew quite large,

Out came the head honcho, the Examiner-in-Charge.

He was dressed up like Rambo, from his head to his feet,

He looked like he craved a good piece of raw meat.

A bundle of printouts he held close to his chest,

For two long weeks the copier would not rest.

His eyes did not twinkle; his brows did not bend,

Is there anyone out there this man could call friend?

He was calm and collected, so passive and cold,

He backed down to no one but God we are told.

The stub of a pencil he held tight in his teeth,

From his belt hung a calculator tucked in a leather sheath.

But first to the break room to fill up his large belly,

Free coffee and soft drinks and donuts with jelly.

He'd work for an hour and then break for some lunch,

Where he went for two hours, we don't have a hunch.

For the rest of the day he would talk on the phone,

And tie up the line 'til the time to go home.

For weeks this routine just seemed to drag on,

When finally his troops had even all gone.

And then the day came when he said we should meet,

We entered "his" office; he said "take a seat."

Regs have all changed, your policy stinks,

Our file samples should be doubled methinks.

Looking at HMDA, it's not your best year,

You need creative underwriting, it's all crystal clear.

Your Reg. DD schedule is wrong; you must cut your fees,

What do you mean who is TiLA, rethink your compliance strategies.

But what we won't stand for is legal infractions,

If you don't add controls, we could take further actions.

Now don't feel so badly, such problems aren't rare,

But I still feel impelled to give you a good scare."

He spoke no more words, but walked straight out the door,

We followed him wondering if he would be telling us more.

He then shook his finger at us from afar,

And nodding his head he got into his car.

And we heard him exclaim as he opened a beer,

"You passed your exam; I'll see you next year!"

Whistleblower

“Do you have information about a company that you think has violated federal consumer financial laws? Are you a current or former employee of such a company, an industry insider who knows about such a company, or even a competitor being unfairly undercut by such a company? If so, the CFPB wants to hear from you.”
- Recent CFPB blog post.

Like a siren’s song, the lure of tips from a whistleblower has sunken many a governmental investigatory ship. A scene like this will be sure to follow the CFPB’s post.

This is the city. There are thousands of stories here, and this is one.

It’s a rainy night in the big city. Under a dimly lit streetlight in the bad part of town, two characters in trench coats meet. One is nervous, chain-smoking, oblivious to the downpour. The other is me. I work here. I carry a badge and work for the CFPB. My name is Thursday.

“Psst. Thursday?”

“No, it’s Wednesday, why do you ask?”

“No, are you Thursday, the guy I talked to on the phone? I’ve some news for youse.”

“Oh. Yes, I’m Thursday. What do you have? Just the facts.”

“I hoid that Wurst National Bank sometimes pays customers into overdraft status and then charges them a fee for doing so.”

“You don’t say.”

"Yeah, and that’s not all. Some of them fat cat bankers have been seen driving new Lincolns. I think the bank is making a profit”

“What? Are you sure about this?”

“I seen it with my own eyes. I even got a free checking account there to see if it was true. I wrote a check when I didn’t have no money in the account, and they charged me a fee.”

“Was it reasonable? Was it representative of the actual cost to the bank for handling an NSF item or was it exorbitant, indicating unfair, deceptive, and abusive acts and practices? You know, UDAAP.”

“Huh?”

“Never mind. How much was the fee?”

“5 fins. $25 clams.”

"Huh?"

"$25."

“Those lowlifes! Don’t they know that you are underemployed due to the failed economic policies of Reganites and can’t afford the luxury of paying a fee for simply overdrawing your account, even though it was intentional?”

“Huh?”

“Never mind. What else you got for me?”

“Well…they gave me a toaster for opening the account, but it’s only a two-holer and a bagel won’t fit in it.”

“I knew it! I’m taking down those crooks. When bankers start handing out free toasters and without considering that you might need a bagel toaster for toasted bagels to go with your morning espresso, that makes my blood boil.”

“What are you going to do, Thursday?”

“Enforcement; outreach to civil rights, community, and industry groups; and consumer education and engagement. That’s what I do. Those bums will never know what hit them.”

“So, like is there a reward or something in this for me? You know I put myself out there for you. I might not be able to open another free account for six months.”

“Don’t worry, buddy. The CFPB will get you a new ID. We have ways of going around the CIP rules.”

“Great! I gotta go now. I don’t anyone to catch me standing around a G-man.”

“Wait. Where will I find you if I need you to answer some more questions?”

“10th tent down on the left at Occupy Wall Street. It’s right next to the free wireless tent and across from the free Starbucks tent.”

Thursday pulls the coat tighter around him and watches his tipster walk away into the dark, all the while knowing that he had used the man. Yes, it was heartless and cruel, but the CFPB doesn’t cater to weaklings. There are bad bankers out there, it was Thursday’s job to ferret them out and put them out of business, whatever the cost.

Faster than a speeding bullet. More powerful than a locomotive. Able to leap tall buildings in a single bound. Look! Up in the sky! It's a bird. It's a plane. It’s…OK, maybe ABS’ training isn’t able to save the world, but we think it’s “Super”. And, if the response to the recent Real Estate Lending Basics class was any indication, our banks do too. Community banks still want and need quality, cost-effective training, and ABS is pleased to deliver.

In this most recent group of participants, over half the class were either new to lending responsibilities or new to banking. The remainder simply wanted to refresh themselves in light of the many regulatory changes. With the recent deluge of new banking rules, regulations, guidance, and interpretation, bankers are more and more challenged with making sure that they know how to comply with the regulatory changes and still providing the great, timely service that their customers have come to expect. ABS remains a reliable training resource for bankers in the ever-changing environment of banking regulation. In addition, we provide regulatory compliance auditing and consulting services to assist our clients with their compliance responsibilities.

So, if your banking world is in need of some speeding-bullet and leaping-tall-building type help, it would be “super” if you would give us a call. We’d love to partner with you. Our 2012 training calendar is in process of being developed, so let us know what you’d like to see in the way of training.

If Regulators Were Football Conferences (An Imaginary Interview)

ABS commentators Jay Bruce and Mikel Dunnagan recently sat down with a representative from Conference CFPB to talk about the upcoming season.

ABS, “As you all know, the new conference alignments have the CFPB, OCC, FDIC, FRB, and NCUA all vying for the big prize. OTS merged, willingly or unwillingly, with the OCC, and CFPB was recently added. We’re here with a representative of the new CFPB Conference. Tell us, what’s it like to be the “new guy on the block””?

CFPB, “We are excited about the privilege and challenge that this new conference brings about. We promise our fans, all fans of regulations, really, that we’ll leave it all on the field, no holding back.”

ABS, “Tell us about how the change came about, you coming in and OTS getting merged.”

CFPB, “Well, we’re only concerned about how well we perform. Yesterday doesn’t matter. How the conferences looked last year won’t determine how well we can compete today.”

ABS, “We understand that CFPB got a lot of money to come aboard this alignment. How much?”

CFPB, “Look, we’re here to compete. The money and all is nice, but the main reason that we formed this conference is the chance to compete with the “big boys” and show everyone that we're for real”.

ABS, “Any idea how the old OTS teams will fare this year?”

CFPB, “At this point, it’s anybody’s guess how they’ll do in the OCC conference, especially since their referees will be calling their games a lot tighter than they are used to.”

ABS, “How have the teams in your new conference responded to you?”

CFPB, “At the heart of it all, they’re predators, I mean, competitors going for the same big prize. There’s going to be some trash talking and jawing; you know it’s coming. Once they get on the field, our referees will be there to make sure the game is played fair…for the little guy…the fan. Our goal as a conference is to make sure that fans out there have fair and equal access to the games and not just limit it to those millionaires and billionaires making over $250,000.”

ABS, “What is toughest on the conference, not having a commissioner, having all new players, animosity from the rest of the conferences?”

CFPB, “Even though the conference is new, we’re all seasoned veterans. We have the best training facilities, the best fans, you know. I’m sure the Commissioner, whoever he or she is, will be the best for the conference and the little guy. This conference didn’t happen by accident. Everything about us was carefully thought out and planned. We’re what “hope” and “change” is all about.”

ABS, “The FRB wrote some proposed rules with the final comments due 2011. When do you think you’ll finalize these?”

CFPB, “Look, we like rules as much or more than the next conference, but we’re not going to be backed into a corner and throw out some arbitrary date. We’ll finalize them when we finalize them. You’ll be the first to know when we apply them retroactively.”

ABS, “Won’t doing that change the scores of the games that have already been played and are in the books?”

CFPB, “Hey, a game’s not over ‘til our Commissioner sings.”

ABS, “How do you think your refs will call big games? Will they over-penalize some teams?”

CFPB, “As Voltaire said of the English, “They occasionally would shoot a general just to get the other’s attention.” That goes for banks, too.”

ABS, “Your primary charge is to regulate the large teams. Are you afraid that the smaller ones are too quick for you, that you can’t handle their speed?”

CFPB, “Look, we can regulate with anyone. Fast, slow, big, small, it doesn’t matter. Once we get going, we can’t be stopped; we won’t be stopped. You've got to either get on our side or get out of the way! One day, there will be on, just one, Super Conference. Then we’ll see who regulating the little guy, I mean the little teams.”

ABS, “And there you have it. Sounds like Conference CFPB has the confidence to make it to the big game this year and for many years to come.”

Hear Ye, Hear Ye...Thoughts on Proclamations

On August 25, 2011, the OCC issued a “Proclamation” authorizing national banks and federal savings associations to close in the “wake” of Hurricane Irene. This got me to thinking on this Friday, August 26…Why a Proclamation?

Proclamation. It sounds so regal, more befitting a King or Queen than a Comptroller (no offense to Comptrollers intended). In fact, a quick search of the Internet confirms this. In former times, and still today, banks in the UK observe holidays so declared by Royal Proclamation.

ROYAL PROCLAMATION. The Bank Holidays Act. 1871, enacted that it shall be lawful for His Majesty, as to His Majesty may seem fit, by proclamation to appoint a special day to be observed as a bank holiday, and any day so appointed shall, as regards bills of exchange and promissory notes, be deemed to be a bank holiday for all the purposes of the Act.

The following is the Royal Proclamation of King George V making December 27th. 1910, a bank holiday:

"We, considering that it is desirable that Tuesday, the Twenty-seventh day of December next, should be observed as a Bank Holiday throughout those parts of Our United Kingdom called England and Wales, and Ireland, and in pursuance of the provisions of ' The Bank Holidays Act, 1871.' do hereby, by, and with the advice of Our Privy Council and in exercise of the powers conferred by the Act aforesaid, appoint Tuesday, the Twenty-seventh day of December next as a special day to be observed as a Bank Holiday throughout England and Wales, and Ireland, and every part thereof, under and in accordance with the said Act, and We do, by this Our Royal Proclamation, command the said day to be so observed, and all his loving subjects to order themselves accordingly.”

Given at Court at St. James's, this Seventh day of November, in the Year of our Lord One thousand nine hundred and ten, and in the first Year of Our Reign.

"GOD SAVE THE KING."

And so, the United States – not to be outdone by our friends across the pond – likes to make “Proclamations” regarding bank closings. In fact, by law, it must be by Proclamation.

12 USC 95(b)(1) says, in part, “In the event of natural calamity, riot, insurrection, war, or other emergency conditions occurring in any State whether caused by acts of nature or of man, the Comptroller of the Currency may designate by proclamation any day a legal holiday for the national banking associations located in that State.”

So, when a proclamation is given to close banks, let us say to ourselves,

“GOD SAVE THE COMPTROLLER.”

How to Read a Regulation

1. First ask your spouse, co-worker, or friend to feel your forehead to see if you are feverish. Often the onset of a catastrophic illness will affect the mind to the point where reading regulatory gibberish becomes a strong desire if not an addiction.
2. Next, acquire a bottle of liquor and take several large drinks.
3. Finally, sit in a straight, comfortable chair in a clean, ventilated, well-lighted place with plenty of freshly sharpened #2 pencils. (Wait a minute, that’s from my college term paper days…never mind)
4. Now, finally, open up the “BOOK OF RULES”.
5. You can find a summary of the regulation near the beginning of the Federal Register’s rendition of the new regulation. You should read this as it’s akin to looking over a course map of a new golf course before you play. You want to get a lay of the land.
6. Understand that you and I think differently than the folks who wrote the “BOOK OF RULES”, so it’s important to understand their language. We, unlike most of them, have actually been in a bank at one time, understand the difference between a debit and a credit, and have seen an actual customer in their native habitat. One of the best ways to understand the language is by reading the definitions contained in the regulation. Most regulations have lots of definitions, and one would think that all the regulations would agree on what the terms “business day” or “dwelling” mean. WRONG! Just like two opposing football teams having guys with the #12 on their jersey, and those two guys with the same number are different people, the same word or phrase in one regulation may mean something different in the regulation you are reading. Don’t presume that you understand what the rule-writer is saying until you learn the language. After reading the regulation’s definitions, you just might find that the regulation doesn’t even apply to your situation.
7. Take a couple more large swigs from your bottle. Tell yourself that you can do this.
8. Curse yourself for not taking that opportunity to go to law school.
9. Read, think, read, think, read, think. Take another swig. Let your eyes glaze over after reading several thirteen line sentences complete with commas, semi-colons, parentheses, double parentheses, brackets, reference citations to multitudes of other places in the regulation, and italicized words.
10. It is now 1:30 a.m. as you curse the government out loud and wake up your spouse, child, or pet.
11. Make a note to call American Bank Systems tomorrow morning and let their team of experts, as Kris Kristofferson so aptly penned it, "Help You Make It Through the Night".

At American Bank Systems and ABS Consulting, we have the tools and expertise to bring sense out of nonsense. We’ll save you time, money, and wear and tear on your liver.

“SAME OLD, SAME OLD” SAYS OCC TO OTS THRIFTS…OR NOT

The OCC Senior Deputy Comptroller Jennifer Kelly, in a recent interview with the ABA, offered the following comments concerning the on-going integration of the OTS into the OCC that warrant further comment.

“We also conducted a series of examinations at both national banks and federal savings associations that were staffed with a combination of examiners from the two agencies earlier this year to help us prepare for the integration.”

According to unofficial reports, this joint endeavor resulted in significant differences in what ratings were to be issued for the institutions examined.  Typically where the OCC examiners opinions were consulted, the suggested ratings for an OTS institution were lower than those where OTS personnel had the final say.  This is to be expected as the OCC has an approach that is less tolerant of component deficiencies in compliance, as opposed to the OTS emphasis on overall and comprehensive conformity to the regulations.  Seeing the forest for the trees approach…or not.

“We do not anticipate any changes in the compliance examination experience for our community banks. As discussed in our thrift outreach sessions and similar to OTS, the OCC integrates consumer compliance work into the safety and soundness examination and issues a single report of examination.”

The changes will be anything but ordinary.  Specifically for small and medium-size institutions as concerning the Risk Assessment process, the changes will be huge.  Moreover, the Consumer Compliance portion of an examination can no longer rest upon it’s isolated standing but will now be mingled with the Safety and Soundness exam, being bruised collectively by the deficiencies in capital and credit standards greatly increased by our current declining economic conditions.  Single report examination thriving like a family who all eat dinner together…or not.

“The Portfolio Manager (PM) for a bank is the examiner who is assigned primary responsibility for the ongoing supervision of that institution… Between exams, the PM monitors performance trends and tracks progress on any Matters Requiring Attention and compliance with outstanding enforcement actions. The PM will touch base with bank management at least quarterly and is the “go-to” person for any questions that a banker or director has between examinations.”

“Ongoing Supervision” takes on new meaning for former OTS institutions.  For those Compliance departments used to an annual or even 18 month examination cycle with little to no examiner contact in the interim, those were the good old days.  Expect quarterly communication with the OCC, the absence of outstanding report issues notwithstanding.  Rather than the OCC Portfolio Manager (PM) being the “go-to” person for interim questions, rest assured the PM will be your “hide-from” person as they investigate and solicit from management what new problems are developing for OCC focus and attention.  Moreover, have a vacant office available for occupancy by an OCC representative who may become your onsite neighbor year-round.  Donuts optional.

A MODERN VERSION OF HOME ON THE RANGE

Dr. Brewster M. Higley penned the words to the 1872 poem which later was set to music as Home on the Range and became the official State Song of Kansas. I offer, in advance, my apologies to him and all Kansans for my brief rendition of “Home on the Range”, with added regulatory language accompaniment. The home ownership rules of Dr. Higley’s time would be much too simple for a complex society such as ours, so vast improvement in the rules had to be made.

Oh, give ( or, at least allow me to qualify for, only as much home as I can reasonably afford when taking into account any balloon payments, variable rate adjustments, and potential income shortfalls that I may encounter in the future and if my consumer credit transaction is secured by my principal dwelling with an annual percentage rate that exceeds the average prime offer rate for a comparable transaction as of the date the interest rate is set by 1.5 or more percentage points for loans secured by a first lien on a dwelling, or by 3.5 or more percentage points for loans secured by a subordinate lien on a dwelling, then additional lending restrictions and disclosures will apply)

me a home (which is defined as a residential real property of twenty-five acres or less upon which there is located or, following settlement, will be constructed, a structure or structures designed principally for occupancy of from one to four families (including individual units of condominiums and cooperatives and including any related interests, such as a share in the cooperative or right to occupancy of the unit); or located or, following settlement, will be placed a manufactured home)

where the Buffalo roam; Where the Deer and the Antelope play; (however, no animal of any kind shall be raised, bred or kept on any portion of a property owner's property for any commercial purpose, but the following species of livestock animals may be kept on a lot: horses, mules, donkeys, llamas. A property owner may keep other species of livestock animals on the property owner's property only as permitted by the Association, and only in accordance and with rules, regulations and standards adopted from time to time by the Board of Directors of the Association.)

Where never is heard a discouraging word, (and you shall not make any oral or written statement, in advertising or otherwise, to applicants or prospective applicants that would discourage on a prohibited basis a reasonable person from making or pursuing an application)

And the sky is not clouded all day. (Contrary to the words of the song and given the uncertainty in the regulatory and real estate lending landscapes, the outlook is, as a weather person might say, mostly cloudy.)

With our preeminent compliance software, CompliancePro, compliance consulting services, and compliance training, American Bank Systems and ABS Consulting can help bring sunshine to your clouded real estate lending future and help make sense out of confusing lyrics.

Mikel Dunnagan

Evaluating the Impact of the Proposed Risk Retention

Comprised of nearly 400 pages and requesting responses to close to 200 questions, the April 29, 2011 Credit Risk Retention proposal is overwhelming. In consideration of the enormity of the request, the American Bankers Association has requested an extension of the comment deadline from June 11 until July 22, 2011. Whether the extension request will or will not be honored is yet to be seen; however, prudence dictates that community bankers begin to analyze the impact on their credit activities of the proposal. Of specific concern is whether or not current product offerings, both consumer and commercial, will fall under the category of “qualified” thereby being exempt from the proposed risk retention requirement.

The proposal includes criteria under which the various types of credit are evaluated for the purpose of being “qualified” and, thus, exempt from the risk retention requirements. The criteria proposed for each of the product types fall into the same broad categories, but differ somewhat based on the specific type of credit and borrower. The proposal also provides specific exemptions from risk retention, in general relating to collateral and/or loan guarantee programs.

The process of evaluating the impact on the institution will begin with an inventory of the credit products offered. Clearly those products that meet the exemption based on collateral or guarantee programs can be excluded from further analysis. Similarly, the institution may exclude credit products that will not be sold from the analysis. The remaining credit products will need to be evaluated under the product-specific criteria of qualified credits. In this preliminary analysis a comparison of the proposed thresholds to the institution’s underwriting criteria should be completed and documented.

This analysis provides two results: first, credit products with underwriting standards in contravention of the proposed standards will be identified; second, the process will help to identify criteria may need to be evaluated on a procedural or a loan-by-loan basis. In the first result, for example, a residential purchase money mortgage program including a junior lien to reduce the down payment will absolutely not meet the proposed qualified standard. Under the second, the analysis will identify those criteria under a low-doc loan program where further analysis is needed.

Early identification of the credit products that may be in jeopardy, all be it under proposed criteria, allows management to explore the balance sheet implications of continuing to offer non-qualified products and, if needed, to identify the availability of alternate products to meet the credit needs of their customers. When the criteria is finalized, any changes from the proposed criteria should prove relatively easy to integrate, allowing you to focus on implementing the new products and/or processes you’ll need to continue to serve the credit needs of your customers.

The Proper Care and Feeding of a Risk Assessment

Now that the Board has reviewed and approved the institution’s new or revised risk assessment, it can be shelved until the examiners ask to see it or it’s time for the next annual update, right? Absolutely not! The risk assessment itself provides a snapshot of the institution’s risk profile at a given point in time; but, with proper care and feeding, the risk assessment provides the basis for an ongoing process whereby the institution can monitor its risk profile on an ongoing basis. And, through proper care and feeding, the next annual revision will be a significantly streamlined process.

To increase the power of your risk assessment, begin by implementing a process to update the assessment with the results of your monitoring activities as those results are published. Be sure to incorporate the results of any related audits and regulatory examinations, too. These results, whether validating the effectiveness of existing controls or identifying areas for improvement, impact the institution’s risk profile and provide direction in the effective deployment of scarce resources. If you are using an automated risk assessment tool, this functionality should be available. In a manual process, you’ll need to review and revise the risk and control values associated with those areas covered in the audit, examination, or monitoring reports.

Updating the risk assessment to reflect the impact of new or revised products, services, and regulations is equally important. Establishing a change management process that mirrors your risk assessment process and includes an evaluation of the associated risks and controls allows for easy integration of the results. Feeding these results into your risk assessment increases your ability to manage the institution’s overall risk profile, on a real-time basis. Again, an automated risk assessment tool should include this functionality; in a manual process, the risk and control values associated with the activity will need to be revised as necessary to reflect the change.

In conjunction with these ongoing updates, expanding your risk assessment process to include other key risk indicators enhances your ability to monitor and manage the institution’s level of risk. Risk levels are impacted by various factors, not all of which are associated with a specific change in products, services, or regulations. Defining and monitoring indicators are vital steps to an effective risk management process.

Indicators may be internal, including activities such as training, staffing expertise and sufficiency, effectiveness of management information systems, and customer communications and complaints. Although generally incorporated into the change management process, these indicators should be continually monitored for changes occurring independent of new or revised products, services, or regulations. For example, the departure of key personnel can have a significant impact on risk and will probably occur outside of an event captured by the change management process.

Monitoring external indicators such as economic conditions and industry-wide litigation or enforcement actions will also increase the power of your risk assessment. Re-evaluating risks and controls associated with areas of increased regulatory focus, as identified by an increase in enforcement actions, affords an institution the opportunity to adjust its program to close potential gaps before they pose significant impact.

Clearly, the requirement to implement an effective risk management process is not going away. Institutions devote significant time and effort in performing and documenting their risk assessments. Yet most institutions are not maximizing the value of the risk assessment process. Through proper care and feeding, you can streamline the process and achieve up-to-the minute results from your risk assessment.

Managing the Risk of Change

In his January 7, 2011 testimony before the Committee on the Budget, Federal Reserve Chairman Ben S. Bernanke presented a cautiously optimistic economic outlook, stating that “Overall, the pace of economic recovery seems likely to be moderately stronger in 2011 than it was in 2010.” As reported in the American Banker newspaper, Bernanke also expressed concern about overburdening community banks with regulations targeted at larger institutions. "The intent of both Basel III and the Dodd-Frank Act is to focus on the largest, so-called 'too big to fail' banks and to make them not 'too big to fail,'" Bernanke said, "We want to make sure we do all we can not to increase the regulatory burden that small banks face."

While the intent may have been to focus on the largest banks, the reality is that neither excludes community banks from the requirements. And, waiting for exclusionary amendments is simply not a prudent option. With changes to everything from deposit insurance coverage and the regulatory structure to capital, privacy, anti-money laundering, community reinvestment, and much, much more, compliance officers and risk managers are facing an unprecedented amount of work over the next three years. The key to success – and survival – is an effective change management process!

Although not a new concept, change management, as set forth by the Office of the Comptroller of the Currency in OCC 2004-20 is generally associated with new, expanded, or modified bank products and services. However, the due diligence process defined by the OCC in this bulletin is equally effective when applied to regulatory changes. The three stated goals of an effective risk management system are: 1) performing adequate due diligence prior to introduction, 2) developing and implementing controls and processes to ensure risks are properly measured, monitored, and controlled, and 3) developing and implementing appropriate performance monitoring and review systems.

Developing and maintaining a calendar of expected regulatory amendments is the first step in the process. Once the timelines have been determined, the due diligence process begins. For each amendment, the first step is to identify the existing products, services, and processes that will likely be impacted by the change. Enlist the help of representatives from the relevant functional areas, such as credit, compliance, accounting, audit, risk management, legal, operations, and information technology, to analyze the affect of each amendment, the scope of impact, the timeline and resource needed to complete implementation of the requirements, and any third-party or vendor relationships that may be impacted (existing) or needed to accommodate the change (new). This evaluation will identify the changes to the inherent risks associated with each activity (at a minimum, an increase in inherent risk associated with the regulatory change will be noted) and provides the basis for the next phase.

The internal controls associated with the identified products, services, and processes were evaluated in your initial risk assessment. A preliminary new residual risk level can be calculated using the revised inherent risk values against your initial mitigating controls. This preliminary residual risk should be compared against the institution’s defined risk appetite. The results of this comparison will serve to highlight those changes that have the most significant impact on the institution’s risk profile, thus assisting in effective allocation of limited resources toward enhancing your control environment.

As during your initial risk assessment, each associated control activity will be reviewed to identify enhancements needed to accommodate the regulatory changes. This review will include policies, procedures, personnel, and internal controls. The review provides an identification of the specific action steps needed to implement each regulatory revision within the risk parameters established by the institution.

An evaluation of the existing monitoring and review systems should also be completed to identify changes needed to these systems to support the regulatory revisions. During this phase of the process, you will examine existing systems to verify that risks associated with the new regulations are captured in the ongoing process. This process will include: revisiting the key assumptions, data sources, procedures, and risk indicators currently employed; analyzing accountability and exception monitoring, management information systems reporting, integrating the changes into existing audit and compliance processes; and evaluating the effectiveness and timeliness of reports and other communications to management and the board. And, again, this process provides a road map of revisions needed to maintain the institution’s risk profile.

Of utmost importance throughout this process is the timely and continual flow of information to management and the board. Given management’s and the board’s responsibility to establish and maintain a comprehensive and effective risk management program, a thorough understanding of the risks is vital. Apprising them of proposed amendments, the potential risks associated with each, and the planned enhancements to controls provides them the tools they need to execute their responsibilities. Importantly, it also provides them with a detailed understanding of the challenges you face, and promotes an increased awareness of the level of resource needed to succeed.

It's A Wonderful Life!

Ah, the old Building and Loan! The nation’s first thrift, Oxford Provident Building Association, was established in 1831 to provide a means to finance the great American dream – homeownership. By the early 1920s there were more than 12,000 savings institutions (known by various names, including savings and loans, building and loans, thrift and loans, thrifts, savings banks, building associations, thrift associations and savings associations). These institutions were established in response to a significant increase in the demand for housing as rural Americans migrated to urban areas in pursuit of the Dream. The Great Depression of the 1930s and the associated housing market crash prompted Congress to establish the Federal Home Loan Bank System, followed by the creation of the Federal Home Loan Bank Board, the predecessor agency to the Office of Thrift Supervision (OTS), and the establishment of the Federal Savings and Loan Insurance Corporation (FSLIC).

Throughout the next several decades, it truly was a wonderful life. Thrifts originated roughly two-thirds of the nation’s mortgage loans. But with the increasing interest rates, and the resulting federal ban on adjustable rate mortgages in the 1970s, thrifts struggled to remain profitable. Rising interest rates continued through the 1980s; the government deregulated the lending and investment powers of thrifts, but profitability struggles led to many thrifts engaging in aggressive and risky lending and investment strategies. Hundreds of thrifts closed or failed, and Congress responded by merging the FSLIC into the Federal Deposit Insurance Corp. (FDIC) and creating the OTS to supervise, charter and regulate the thrift industry.

Bedford Falls or Pottersville? Responding to the 2008 financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. Title III of the Act abolished the OTS, authorizing the Office of the Comptroller of the Currency (OCC) to assume responsibility for examination, supervision, and regulation of federal savings associations (state savings Associations are transferred to the FDIC, and savings association holding companies are transferred to the Federal Reserve) effective July 21, 2011. “Well, whaddya know about that!!!” said George Bailey.

Well, we know:

• Many OTS examiners have transferred onto the OCC examination team. Thrifts can rest assured that upcoming examinations will be jointly staffed with OCC and former OTS examiners, wherever possible.
• The July 31, 2011 Thrift Assessment is deferred to September 30, 2011, and is based on June 30 data. Assessments for September 2011 and March 2012 will be calculated under both the OTS and the OCC schedules and institutions will pay the lesser of the two fees. The September 2012 assessments will be calculated under a single assessment schedule, regardless of charter.
• The Thrift Financial Report (TFR) will be phased out and merged into the FDIC Call Report process beginning with the March 2012 reporting period. In the interim, TFR reporting and data analysts will begin working with the FDIC during the 2011 second quarter reporting period.
• The Uniform Thrift Performance Report (UTPR) will be replaced by the Uniform Bank Performance Report (UBPR) once the Call Report transition is complete.
• The OCC, FDIC, and FRB will identify the OTS regulations that will continue to be enforced and will publish the list in the Federal Register no later than the July 21, 2011 transfer date. Proposed rules and finalized rules not yet in effect will be reviewed and transferred to the appropriate agency, as applicable.
• 2012 examination plans and supervisory strategies for federal savings association will be jointly developed by the OCC and OTS.
• On November 3, 2010, a Deputy Comptroller for Thrift Supervision, reporting to the Senior Deputy Comptroller for Midsize/Community Bank Supervision, was added to the OCC to lead the integration planning, coordinate the network of Senior Thrift Advisors, and act as key advisor to other Deputy Comptrollers on large and problem thrifts.
• The OCC is adding a Senior Advisor for Thrift Supervision in each district officer and in Special Supervision. This position reports to the Deputy Comptroller and serves as a key member of the District’s senior management team.

Clarence! Clarence! Help me, Clarence. Get me back. The situation is not as desperate as it was for poor George Bailey, and Clarence the angel probably won’t step in to help you. But there are some steps you can take in preparation for your transition from the OTS to the OCC:

• Review the OCC’s history, mission, objectives, and strategic plan; familiarize yourself with all that’s available at http://www.occ.treas.gov./
• Become acquainted with the OCC’s current communications publications, including but not limited to: News Releases; Bulletins; Alerts; and Consumer Advisories. Also review historic communications on relevant topics.
• Go through the appropriate Handbooks to gain an understanding of the OCC’s examination philosophy and approach. Invite all departmental managers to review the Handbooks covering their areas of expertise – develop a list of clarifications needed and opportunities for enhancement.
• Once identified, make contact with your institution’s OCC Portfolio Manager. Be sure to inquire about obtaining access to BankNet, the database of resources for National Banks.
• Introduce your Directors and senior management to the resources available (Directors Toolkit and the available workshops) designed to assist them in understanding and executing their roles.
• Network with colleagues from existing National Banks to compare notes.

And remember: Risk management is all about managing change. Applying some of the standard principals you use in managing risk on a day-to-day basis will ensure a smooth transition. And, like George – just think what life would be like at your institution if you had never been born to manage risk. It truly is A Wonderful Life!

DODD-FRANK, CREDIT RATING AGENCIES AND YOU

Seen as the most significant financial reform bill since the Great Depression, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 requires massive restructuring of financial regulatory agencies, directs the creation of innumerable new rules, commissions countless studies and reports, and impacts not only U.S. financial institutions, but financial institutions and other commercial companies throughout the world. Aimed at protecting the economy from a repeat of the financial crisis of 2007, the impact of this legislation on the industry is beyond measure. Many believe that large, complex financial institutions will bear the brunt of the impact; however, it appears that community banks will bear more than their fair share. Clearly the expected volume of new banking regulations is staggering; the potential impact of the new Consumer Financial Protection Bureau is daunting; the magnitude of new disclosure and reporting requirements overwhelming; but community bankers should not discount the unexpected consequences of requirements that, at face value, have little to do with traditional community banking. Consider the changes made to the regulation of credit rating agencies set forth in Subtitle C of Title IX of the Act.

Some History on Credit Rating Agencies

Credit rating agencies independently evaluate the credit-worthiness of debt-issuers, including corporations, financial institutions, and governmental entities. Based on this evaluation, the agency assigns a rating which investors use to determine whether or not to invest and the market utilizes to establish the value on the investment given the debt instrument’s interest rate and the credit-worthiness of the issuer. Investors who are risk-averse opt for those obligations with the “best” ratings and are content to earn the lower rate of return associated with these “safer” investments.

While other investment advisors are closely regulated, credit rating agencies have been subject to minimal regulation. Beginning in 1975, the SEC established a process to identify certain credit rating agencies as “nationally recognized statistical ratings organizations” (NRSROs), agencies that issued ratings upon which other SEC-regulated entities could rely to satisfy their own due-diligence requirements. In 2006, the Credit Rating Agency Reform Act (CRARA) was enacted to improve ratings quality for the protection of investors by requiring the SEC to draft and implement rules governing the registration, reporting, and oversight of NRSROs. However, the CRARA specifically prohibited regulation of the credit rating processes and methodologies.

Rationale for this lack of regulation of NRSROs was based on the expectation that market and competitive forces would promote accurate and reliable ratings. Instead, investment banks routinely steered issuers to those agencies most likely to provide favorable ratings, rather than to an agency with a reputation and history of issuing reliable ratings. Not surprisingly, NRSROs altered their rating methodologies to attract future business and increased fees. As the complexity of investments increased, investor due diligence was replaced with investor reliance on NRSRO ratings. The result, seen as one of the primary factors in the current economic crisis, was the downgrade of the triple-A rated subprime mortgage-backed securities to junk status.

Dodd-Frank Changes

Under Dodd-Frank, the SEC will establish a new Office of Credit Ratings with responsibility for exploring the feasibility of standardizing ratings, issuing rules relating to the determination of ratings, and examining and reporting on NRSRO compliance. NRSROs are required to have a board of directors, half of whom are independent, to appoint a compliance officer independent of the rating process or financial performance, to implement and maintain an effective system of internal controls for determining ratings, and to file reports with the SEC attesting to compliance, including changes in compliance controls, code of ethics, and recent employment history of senior officers. NRSROs will also be subject to increased liability for their actions. Additionally, within one year of enactment, federal statutes referencing credit rating agencies and acceptable ratings must be revised to replace these references with defined standards for determining credit-worthiness.

These new requirements will have a clear and significant impact on the NRSROs and other credit rating agencies, as well as on investment banks and large financial conglomerates that participate in securities underwriting and offerings. But how and to what extent will they impact community banks?

The agencies have already published an advanced notice of proposed rulemaking (ANPR) aimed at eliminating the dependence on credit ratings in the risk-based capital standards and Basel. While the standardized approach under the Basel Accord relies extensively on credit ratings to risk weight exposures, operational criteria requiring institutions to independently analyze the credit-worthiness of securitization exposures were subsequently published. These criteria require a bank to have a comprehensive understanding of the risk characteristics of its individual securitization exposure, be able to access performance information on the underlying pools on an on-going basis in a timely manner, and have a thorough understanding of all structural features of a securitization transaction. Although one of the objectives of the agencies’ evaluation of alternative credit-worthiness standards is to “be reasonably simple to implement and not add undue burden on banking organizations” the ANPR acknowledges that the goal may be “achievable only at the expense of greater implementation burden.”

The OCC published an ANPR relating to other regulations that currently rely on credit ratings, including regulations regarding permissible investment securities, securities offerings, and international activities. The regulations surrounding investment securities use credit ratings as a factor for determining the credit quality, liquidity/marketability, and appropriate concentration levels of securities purchased and held by national banks. While the ANPR stresses the fact that institutions should be investing consistent with safe and sound banking practices, the reality is that many institutions were relying primarily on the ratings established by NRSROs in evaluating investments. The ANPR sets forth three alternatives going forward: Credit Quality Based Standard; Investment Quality Based Standard; and Reliance on internal risk ratings. The common theme within these alternatives is the requirement that banks document their credit assessment and analysis of the investment.

These ANPRs clearly indicate that banks will, as a result of Dodd-Frank, devote more resources to activities surrounding capital and investments; resources that are already scarce in community banks. But wait, could there be more …..

The market for mortgage-backed securities is all but extinct; and while securitized credit card receivables continue to be viable, there still remain the underlying risks stemming from the lack of transparency in the credit rating process. How does this risk impact a funding channel utilized by many institutions to regenerate lending capacity? The answer is yet to be seen.

The introduction of regulation to a previously unregulated industry segment will increase the cost of, and most likely extend the timeline for, issuing securities. The amount of information required in underwriting by the agencies will undoubtedly increase, as will the staff required to analyze this information. Rating agencies will increase fees to cover increased administration costs.

The courts are evaluating the issue of reliance on credit rating agencies, and some have ruled in favor of investors. Liability is being assigned to banks that invested client money without performing their own due-diligence based on a breach of fiduciary duty. And, credit rating agency liability is a key component of the Act. Rating agencies will increase fees to cover these costs, too.

Moreover, banks aren’t the only financial intermediaries who have historically relied on credit agency ratings. Investors have enjoyed an increase in the range of available investments; broker-dealers, money funds, pensions, insurance companies, and governments relied on the ratings to reduce the cost of managing their investment portfolios. These market efficiencies favorably impacted the cost and availability of funding for all borrowers. These benefits will likely diminish in the future.

The introduction of higher costs, both from increased administrative expenses and potential liabilities of rating agencies, coupled with increased litigation risks and the regulatory expectation that entities evaluate and demonstrate the appropriateness of their investments, either directly or through the utilization of a third party, will significantly influence the cost and availability of investments and funding. Accordingly, the combined ramifications of Dodd-Frank related to credit ratings agencies will have far reaching effects on a community bank’s business model, encompassing everything from the bank’s own capital, investments, and employee benefit plans, to client activities including lending, trust, insurance, and investments.

From the OTS to the OCC - Are You Ready?

From the OTS to the OCC - Are You Ready?

With CompliancePro^® from American Bank Systems Your Answer is YES!

As a result of the Dodd-Frank Act, which became law in 2010, all OTS thrift institutions will come under the oversight of the OCC on July 21, 2011. You may be unclear as to some of the differences between these two regulators. Below are some of the questions you should be asking yourself to assess your state of preparedness for this change, along with answers that we believe you should consider.

Should we expect a higher level of scrutiny according to OCC examination philosophy?

Maintaining satisfactory or better compliance examination ratings is essential to financial institution stability, especially in our current and expanding regulatory culture. The OCC has a reputation of being more assertive and intense than the OTS. They place a lot of weight on the institution’s internal compliance audits with emphasis also on written policies and procedures, and training. Comparatively, the OCC performs very little transactional testing, especially if they have confidence in the institution’s compliance risk management system and controls. Whereas the OTS may look at thirty loans during an examination, the OCC may look at as few as five. However, if deficiencies are discovered, the OCC will typically provide lower examination ratings. CompliancePro® is a time tested and proven tool to strengthen regulatory compliance programs, and ready financial institutions for examination preparedness.

Are we prepared to meet the OCC’s supervisory expectations for compliance risk management?

The OCC employs a risk-based supervisory philosophy focused on evaluating risk, identifying material and emerging problems, and ensuring that individual institutions take corrective action before problems compromise their safety and soundness. Institutions are expected to have a compliance risk management system which assesses risk by products/services offered and which monitors and manages compliance risk by performing regular monitoring between examinations. CompliancePro® can help you meet these expectations with its risk assessment and monitoring and issue management capabilities which provide for regular and consistent review and testing for all consumer regulated activity across lines of business, bank products and regulation.

Will our risk assessment process meet the standards of the OCC?

Simply speaking, the OCC’s focus on risk management is huge. This is their starting point for examinations. Whatever policies, procedures, training, or controls you have in place; it has to follow the risk assessment. While regulatory consumer compliance risk processes in large institutions are relatively well established, some small and medium sized institutions may need to improve upon their risk assessments to satisfy the OCC. If your current risk process is informal, rudimentary and undocumented, the CompliancePro® Risk Module is what you need to prepare a sound risk assessment process with our Inherent Risk and Risk Mitigation Analysis functionality, reporting and dashboard capability.