Posts Tagged ‘Safety and Soundness’

Anonymous Banker : Bank of America and Chase commit to increase lending to Small Business through unsafe and unsound, deceptive and unfair credit card practices

Wednesday, December 16th, 2009

As you all know, I’ve been an ongoing supporter of the need for banks to step up to the plate and lend to Small Business.   Credit availability to the small business sector is a necessary component to our nation’s economic recovery. 

The History of the Small Business Credit Line

But I am also a banker, and as such, recognize the need for safety and soundness in lending.  I blasted the industry over the last decade when they foolishly disregarded prudent lending practices, leaving the door open for  business “liar loans”.  During that time, a business owner could obtain a small business revolving credit line for up to $100,000 by completing a one page application.  They didn’t have to provide any verification of personal income or business revenue.  They didn’t have to substantiate a profit or the ability to repay the debt.  The loan commitment was based almost entirely on the credit score of the individual owner/guarantor.  In that era, if you had a pulse and a credit score of 700, you could go into any big bank and get a loan for up to $100,000.   Well, okay, there was  one other criteria:  the loan amount was typically limited to 25% of the businesses STATED revenue.  Everyone knew that if you STATED that you had $400,000 in business revenue, you could qualify for a $100,000 business credit line.

Additionally, the banking industry abandoned all forms of public filings on these credit applications.  What does that mean?  Well, first, because the loan was “to the business entity”, the line of credit did not appear on the individual owner/guarantor’s  personal credit report.  The bank also didn’t file a UCC filing on the business assets – the cheapest and easiest way to let other lenders know that one bank already has a loan out to a potential  business borrower.  So the line of credit became invisible to other potential lenders.

The result of these imprudent lending practices was that the business owner could go from bank to bank and accumulate credit lines.  Banks had no way of knowing if that Small Business was applying for their first line of credit or their third, fourth or fifth  line of credit.

These Small Business loans were rarely, if ever,  sold through the securitization process.  That meant that the entire credit risk was held on the books of the bank.  When the economy began to crash and burn, so did the “liar loan” portfolios.  Inside the industry, bankers scrambled   to understand exactly how much exposure they had in this market. 

Throwing the baby out with the bathwater:  Banks withdraw from the Small Business Lending Market

In response to the economic crisis, the very first thing banks did was limit business revolving credit lines to Small Businesses to 15% of gross revenue.  And thankfully, banks finally began to apply some level of credit underwriting to loan requests up to $100,000, requiring borrowers to submit tax returns to support the information they provided on the application. 

At the same time, banks assumed that every loan they had on their books was a “liar loan”.  So they systematically cancelled these credit lines to small businesses across our nation,  stripping the businesses of working capital for salaries, inventory, rent and receivables.  These businesses received no prior notice.  The banks simply froze the credit line and sent the customer a letter, after the fact.  

The banks did make one small concession to their small business borrower.  They allowed them to apply to have their lines reinstated.   These requests for reinstatement were subject to the “new” credit criteria.  So in a year of often declining revenues, the banks applied their new guideline, limiting the borrowing to 15% of gross revenue.  Many viable businesses no longer qualified under the stricter criteria and still found themselves without a line of credit. 

At present, viable businesses have lost their access to working capital and  banks simply don’t want to grant business working capital lines and retain the risk.

Did bankers learn their lesson?  I think not!

You’d  think that the banks would have learned a lesson on the importance of income verification from this.  Unfortunately, they have not.  The banks are promising a new round of lending to Small Business, and they will meet this obligation through  Small Business Credit Cards. 

Want a credit card with a line up to $50,000?   Check out Bank of America or Chase Bank.  Here’s how their process works:

  1. You will be asked to STATE your  “household income”.  Tell them whatever you want.  They won’t even ask for a tax return.
  2. Business Revenue:  Banks don’t ask and they don’t care.  If they do ask, they won’t verify it.  So feel free to lie.
  3. Credit reporting?  Sure, the bank will pull your credit report to get your credit score.  But then, just like the old days, the line will disappear from the radar screen.  At Chase Bank, it appears that management encourages their business bankers to sell their Small Business Credit cards by advising the business owner of the benefits afforded to them when their new credit card is  NOT  reported on their personal credit report.  The invisible business loan all over again. Shame on them!
  4. If you have a good credit score and a personal card from Bank of America, give them a call.  Perhaps they will offer you the same deal they offered me. When I called customer service,  The BofA representative offered to convert my personal credit card to a business credit card because I was such a valued customer!  When I assured her that I didn’t own a business, she insisted that I didn’t need one to get a business credit card.  Perhaps our regulators would like to monitor the prevalence of this practice throughout the industry and prohibit the banks from circumventing the spirit and intent of the Credit Card Act.

The Question is….  WHY are banks doing this?   Greed!  (Of course)

Why would banks continue to lend without regard to any of the time-honored traditions of safety and soundness.  First, unlike  Revolving Small Business Credit lines,  banks DO sell-off  credit card exposure through securitization.   The bankers, together with Wall Street, devised a way to reap the profits  while, at the same time, absolving themselves of any losses.  Securitization rules, in their current form, empower and even encourage banks to violate all prudent lending practices.

Despite warnings released in the OCC’s Survey of Credit Underwriting Practices 2009, stating:

A key lesson learned from the financial market disruption is the need for bankers to apply sound, consistent underwriting standards regardless of whether a loan is originated with the intent to hold or sell. The OCC reminds bankers that underwriting standards should not be compromised by competitive pressures or the assumption that the loan will be sold to third parties.

banks continue to apply lower credit standards to forms of credit they will sell off in the market than they do to credit they will retain on their books.  Just compare the banks requirements for a $50,000 Business Credit Card to a $50,000 small business revolving line of credit.  The first fails to verify ANY financial information and is sold.  The second verifies financial information and the risk is held by the bank. 

Business Credit Cards are a profitable and huge market for big-banks.  Here are a few statistics from Creditcard.com:

  • In 2008, JPMorgan Chase was the largest issuer of small business credit cards with $34.5 billion in total card volume. Bank of America is second with $26.31 billion and Capital One is third with $20.7 billion. (Source: Nilson Report)
  • Credit cards are now the most common source of financing for America’s small-business owners. (Source: National Small Business Association survey, 2008)
  • 44 percent of small-business owners identified credit cards as a source of financing that their company had used in the previous 12 months —- more than any other source of financing, including business earnings. In 1993, only 16 percent of small-businesses owners identified credit cards as a source of funding they had used in the preceding 12 months. (Source: National Small Business Association survey, 2008)

Congress Empowers Bankers to be greedy and deceptive to Small Business

Our Congressional leaders failed to include Small Business Credit Cards in the new protective laws provided under the Credit Card Act of 2009.   Do our government leaders actually believe that it is okay for banks to practice deceptive and unfair lending against Small Businesses, but not consumers? 

Many of the provisions of this Act do not go into effect until 2010 (giving the banks plenty of time to jack up everyone’s credit card rates to almost 30%).   Buyer Beware!  Small Business owners need to know that Small Business Credit cards are not protected from deceptive and unfair credit card banking practices, such as:

  • Interest Rate Hikes – any time for any reason
  • Universal Default
  • How banks apply your payments - Lowest Interest Balances Paid First
  • Limits on over-limit fees

I suspect, that absent a change in regulation, the following disclosure from Chase Bank’s new INK  Small Business Credit Card will remain the same long after the provisions of the Credit Card Act go into effect. Perhaps the disclosure should be called “Chase Bank’s transparent disclosure of deceptive and unfair credit card practices, rather than:

Pricing and Terms –Rate, Fee and other Cost Information

  1. You authorize us to allocate your payments and credits in a way that is most favorable to or convenient for us. For example, you authorize us to apply your payments and credits to balances with lower APRs (such as promotional APRs) before balances with higher APRs.
  2. Claims and disputes are subject to arbitration.
  3. As described in the Business Card Agreement, we reserve the right to change the terms of your account (including the APRs) at any time, for any reason, in addition to APR increases that may occur for failure to comply with the terms of your account.  (emphasis in original)

Conclusion:

Our government leaders and our regulators failed to protect this country from unsafe and unsound lending practices, which brought our economy to the brink of collapse.  As they develop their new-found focus on Small Business lending,  they need to ensure that credit, in every form, adheres to the principles of safety and soundness and of honesty and integrity throughout our financial system.  These principles must be adhered to by BOTH the borrowers and the banks.  And sadly, perhaps neither can be trusted to simply “do the right thing”.

Yes, we certainly do need to make loans to the small business community.  I feel their pain.  But, America, as a world leader,  needs to set an example and do it right and do it NOW.  The securitization market isn’t going to magically improve because our tax dollars temporarily guarantee the risk to investors (TALF).  And without a strong securitization market, credit in this country will remain frozen.  Lending will only improve when we implement strict and meaningful regulations that govern the safety and soundness in our lending system for all forms of credit.  The ultimate investors in these loans must feel secure in the likelihood that these loans will be repaid.  It’s an issue of confidence.  Banks and Wall Street have a long way to go in winning back the trust of the public.  I don’t think they can get there on their own.  I think we need to bring them there  (and they’ll be kicking and screaming all the way). 

For your reading pleasure:

National Small Business Administration Survey 2008

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Anonymous Banker: The foundation of this Economic Crisis: The Community Reinvestment Act or the Regulators that enforce it?

Sunday, October 4th, 2009

Several months back, I wrote an article:  Our Nation’s Ball-less Wonders in which I lambasted our Regulators for not enforcing Federal Reserve Regulation H  that governs safety and soundness in lending.  That regulation sets forth guidelines that banks must follow in evaluating mortgages.  I proposed that it was our Regulators’  failure to enforce these guidelines that caused our nation’s economic crisis.

Over the last months, as I listened to various news interviews on our economy, I kept hearing commentary on how the CRA, the Community Reinvestment Act, played a large role in this crisis.  For the most part, I discounted this as rhetoric.

Then, while clicking around various government sites, I accidentally came upon a “corrective action directive” put out by the Office of Thrift Supervision.  Reading this document brought my focus to bear down on CRA’s possible effect on the state of our economy.  Before I share my findings, I must first apologize to the now defunct Guaranty Bank of Austin, Texas.  This bank is the winner of my web-surfing lottery.

Follow me on this:

The Community Reinvestment Act is intended to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low-moderate income neighborhoods, consistent with safe and sound banking operations.  It was enacted by Congress in 1977.

It is a good Act that prevents banks from red-lining and discrimination.  It ensures that low-income communities will be afforded access to banking services, including loans.  The banks receive CRA ratings from their respective Regulatory agency:  FDIC, OTS, FRB and OCC If the bank receives a good report card, then the regulators support, for example, the bank’s applications to open or close branches or to merge with or acquire other financial institutions.  Conversely, if a bank receives a bad report card, they are prohibited from merging with or acquiring other banks.  Over the last fifteen years, with the birth of regional and national banks, getting a good CRA report became an ever-increasing priority within the banking industry as it was a key to their ability to expand through acquisition.

What the Regulating authorities fail to remember is that the Community Reinvestment Act was designed to ensure that low to moderate income neighborhoods, previously abandoned by most banking institutions, would have equal access to financial services.  But at CRA’s core, in each pronouncement of its rules and intent, it states that the bank’s practices must be “consistent with safe and sound banking operations”.

Reflecting on this, CRA was to-be to lending in the low to moderate income communities what the SBA is to Small Business Lending.  The SBA doesn’t allow banks to abandon all reasonable credit criteria.  Quite the contrary. They relax certain standards to make it easier for the small business owner to obtain financing, perhaps extending repayment terms or providing lower rates.  SBA borrowers still must be able to support their ability to repay these loans. 

Likewise, CRA standards, as I remember them, provided for lower down-payments (10% instead of the conventional 20%), lower rates and lower closing costs.  The borrower still needed to show their capacity to repay.  It was never intended to be,  by any stretch of the imagination of our dillusional regulators, a give-away program.  It was designed to help a lot of worthy, qualified low to moderate income people buy their first home.

In fact, the regulation itself  states,

“Banks are permitted and encouraged to develop and apply flexible underwriting standards for loans that benefit low- or moderate-income geographies or individuals, only if consistent with safe and sound operations.”

It was the banks greed that morphed this excellent law into the disaster that occurred over the last years.  Where were the regulators, the protectors of the public, in this equation?  It remains my humble opinion that our Regulators WERE INDEED our nation’s ball-less wonders.  They allowed the banks to take this perfectly sound and necessary program and bastardize it into a free-for-all by the greedy bankers.

Not only did our regulators fail to impose penalties on the banks that continually reduced all reasonable loan evaluation criteria in violation of Federal Reserve Regulation H, they praised them for it.

Take the CRA report, dated December 28, 2007 issued by the Office of Thrift Supervision for Guaranty Bank in Austin, Texas.   The first interesting observation is the disclaimer that appears on the first page of the report: 

“The rating assigned to this institution does not represent an analysis, conclusion, or opinion of the federal financial supervisory agency concerning the safety and soundness of this financial institution.”

Come ON!!!!!  Our regulator’s first priorty is to ensure the safety and soundness of our financial system.  They can’t be out there writing reports on CRA compliance that issue disclaimers for themselves.  How utterly ridiculous, not to mention dangerous.

In this CRA report, Guaranty Bank received the HIGHEST CRA rating.  Overall rating:  Outstanding.  Lending test rating:  Outstanding.  Remember, this report covered the time period from January 1, 2005 to June 30, 2007 and was released on December 27, 2007.

We all know the financial world has changed dramatically.  I just had to know how Guaranty Bank fared through this crisis after receiving such glowing CRA reports from the Office of Thrift Supervision.  In August 2009, the OTS issued the sad-but-true “prompt corrective action directive”.  Guaranty Bank was failing.  They were prohibited from making most loans.  One exception was that they could originate Qualifying Mortage loans underwritten in accordance with criteria established for residential loans eligible for purchase by the FHLMC or the FNMA.  But they were prohibited from participating in any Sub-prime Lending Program.

This directive equates to closing the barn door after the horse already ran off.  I understand the need for the regulators to have taken these steps.  After all, this institution was FDIC insured and was clearly at risk.  Still, it is my belief that, today, the regulators are being reactionary to the crisis they themselves created.  Instead of always remaining centered on reasonable core practices that ensure safety and soundness in lending, they’ve swung the pendulum so far in the opposite direction that the banks are unable or unwilling to meet the credit needs of ANY community, never mind low and moderate income communities.  It’ll be interesting to see the CRA ratings of the banks across our nation that cover the years 2008, 2009 and 2010.  I’ll be watching for these reports.

The ultimate fate of Guaranty Bank

“On Friday, August 21, 2009, Guaranty Bank, Austin, TX was closed by the Office of  Thrift Supervision, and the Federal Deposit Insurance Corporation (FDIC) was named Receiver.

All deposit accounts, excluding certain brokered deposits, have been transferred to BBVA Compass, Birmingham, AL (”assuming institution”). 

I had to look further.  I could not help myself.  Interestingly, Compass Bank received a CRA rating of  “Satisfactory” from their regulator, the Federal Reserve Board.  This was one notch below the “Outstanding” rating received by the now defunct Guaranty Bank.

I’ll be doing more homework on this new theory I have:  Perhaps the banks that received lower CRA ratings remain in a position to acquire the failing bank institutions that received the highest CRA ratings.  Perhaps our regulators created a crisis that can be directly measured, even anticipated, by reviewing the CRA reports they themselves produced.  The higher the CRA rating, the more likely the bank is to fail.  The lower the CRA rating, the more opportunity a bank will have today of obtaining approval to merge and acquire other banks. 

This would be a situation that is in direct conflict with what CRA intended.  And it’s all the regulators’  fault!!!  The ball-less wonders!

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