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Monday, April 11 2011 | 03:46 PM
Chief Executive Officer & Co-Founder,
|There are several forces that might govern a bank’s behavior and keep it from taking reckless risks in lending and investing, possibly endangering the safety of its depositors and investors. First, there is the market: investors who don’t like lending policies can sell the bank’s stock and bonds, causing their prices to fall. Second, there is the oversight of the bank’s management. Third, there is the oversight of the bank’s Board of Directors. Fourth, bank regulators act as watchdogs, seeking to protect the interests of the depositors; this oversight is sometimes called “prudential supervision.”
In the wake of the recent worldwide financial crisis, it appears that the controls exerted on many banks by the market, by management, and by the board, were not enough to prevent gross excesses in bank lending, particularly in the real estate markets.
These problems quickly became those of the government and taxpayers, because of national systems of deposit insurance and the perception that some banks and financial institutions were “too big to fail.”
Consider our own country, where the federal government bailed out commercial banks such as Citibank, Wachovia, JP Morgan/Chase and Bank of America, as well as investment banks and other financial institutions, notably AIG. Similar dilemmas have faced the European Union, including Greece, Italy, Spain, Portugal and Ireland (and others, such as Iceland, which are seeking membership).
These shortcomings have led to calls for more stringent prudential supervision. In the United States, one aspect of the new environment is the far-reaching Dodd-Frank legislation. Internationally, the Basel Accords, promulgated by the Bank for International Settlements, are now entering a proposed third stage (Basel III).
The Dodd-Frank legislation is so far-reaching that banks are still scurrying around trying to understand how to comply. One striking aspect, as emerging in regulations under the 2010 Interagency Guidance Appraisal and Evaluation Guidelines, is that affected financial institutions will need to establish more objectively the value of their illiquid collateral, such as whole loans, real estate owned and derivatives, preferably by third party (arm’s length) evaluators ( disclosure: this is one area where my own firm consults). There has been militant talk by Republican Party spokesmen to roll back key provisions of the legislation, so the legal situation will remain in flux. Tea Party representatives particularly deplore the emerging Consumer Protection Agency.
As to Basel III, the proposed revisions are intended to increase the quantity of quality of banks’ required regulatory capital. More specifically, there will be greater clarity about eligible Tier I and Tier II capital, and the lowest quality category, Tier III, will be eliminated from eligibility. There will be required stress tests, which are hypothetical projections assuming adverse conditions such as economic recession and declines in real estate markets.
Of course, there are real questions about the ability of regulators to anticipate problematic lending, any more than stock investors, managers or boards. At the least, though, such regulators experience different economic incentives from the other players and may be more fearful of the inexpensive borrowing power that is available to depository institutions, multiplying the profit or loss from lending and investing activity.
Ron D'Vari CFA, CEO of NewOak Capital, and Andrew Szabo CFA, Managing Director of NewOak Solutions
0 Comment | Add Comment(s) | Federal_Government, Government_Bailout, Dodd_Frank, Investors, Basel_III, Regulation, |
Dodging a Bullet on the Oregon Trail
Thursday, March 10 2011 | 02:17 PM
SNR DENTON US LLP
|Readers of this blog were alerted last month to potentially ruinous legislation which had been introduced in the Oregon legislature. Senate Bill 892 would have overridden any contractual “hell or high water” clauses and permitted a lessee or buyer with any “dispute” with the seller or lessor--even if unrelated to the sale or lease contract--to deposit any “payments” (not just periodic installment purchase or rental payments) into an attorney trust account or a statutory escrow trust account, until the dispute had been “resolved”. There was no provision for the seller or lessor to receive interest on any amounts so escrowed.
The legislation also would have applied to lenders and securitization investors, so the Bill threatened to complicate any financing involving Oregon equipment or an Oregon lessee--and probably any Oregon seller, lessor or lender. But this week, face to face discussions by the Equipment Leasing and Finance Association (and member law firm Farleigh Wada Witt) with the sponsor of the Bill were followed by withdrawal of the legislation. Further discussions are expected because of the sponsor’s unsatisfactory experience with processing equipment acquired for use in his business, but it appears that the Senator is aware that legislation as originally introduced could have impeded the flow of capital to Oregon businesses.
0 Comment | Add Comment(s) | Bill_892, Legislation, Regulation, ELFA, Equipment_Leasing, |
New Regs Suggest Need for Independent Collateral Valuation
Thursday, March 10 2011 | 11:09 AM
Chief Executive Officer & Co-Founder,
|While much attention and scrutiny has been given to the effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act on the financial services industry, other recent regulatory changes will also have profound effects on the way financial institutions do business. One key trend: the need for independent collateral valuation, particularly regarding complex or hard to value collateral, such as many asset-backed securities, whole loans, real estate, pools of receivables and leases.
The motivation behind the new regulations is a perceived need for independent, conflict-free, professional judgment, without influence or pressure that could possibly be exerted by parties having an interest in the transaction. Driving this perception has been the massive federal loss exposure in the aftermath of the subprime financial crisis.
The portfolio valuation requirements of the 2010 Interagency Appraisal and Evaluation Guidelines (which replace the 1994 guidelines) flesh out the new federal expectations; these changes will have application to a wide variety of institutions, including: federally chartered banks and those accepting FDIC insured deposits; fund managers and others who make representations about collateral to public investors; investment bankers; and rating agencies.
Given the regulatory trend, it appears certain to us that the Agencies will follow the lead of the Financial Services Authority in the United Kingdom, which has required financial services firms to engage outside experts to provide independent, conflict-free valuation and risk analysis. This requirement provides an institution with a defendable (i.e., independent) valuation of the portfolio components.
Pursuant to the Guidelines, each financial institution must maintain policies and procedures which establish standards for obtaining current collateral valuation information. The institution may employ a variety of techniques for monitoring the effect of collateral valuation trends on portfolio risk associated with its lending practices.
Changes in market conditions underscore the importance of following sound collateral valuation practices and monitoring when originating or modifying real estate loans and evaluating portfolio risk.
The Agencies implicitly are addressing three major risk exposures that drive the government’s interest in objective third-party collateral validation practices:
1. The FDIC scheme of depository insurance, which depends crucially upon the soundness of bank lending practices.
2. Agency guarantees on mortgage-backed securities provided by Ginnie Mae, Fannie Mae and Freddie Mac.
3. The potential government responsibility to bail out financial institutions deemed “too big to fail.”
The drafting of the Guidelines is a joint effort of the Office of the Comptroller of the Currency, Treasury; Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation; Office of Thrift Supervision, Treasury; and National Credit Union Administration (collectively, the “Agencies”). The Agencies have committed to work together to ensure that real estate lending is conducted in a safe and sound manner.
Note: Contributors to this blog post include members of the NewOak Capital team.
0 Comment | Add Comment(s) | Dodd_Frank, FDIC, US_Economy, Regulation, Securities, OCC, Mortgage, |
Ending GSE Bailout is A Delicate Balancing Act
Thursday, March 03 2011 | 09:01 AM
Chief Executive Officer & Co-Founder,
|We agree to a well defined and transparent but gradual end to the bail out of GSEs. The process has to be designed with full understanding of the markets and free of political agenda.
On-balance sheet approach is a good aspiration but has its own pitfalls and challenges. The annual budgetary process for allocating on-balance and on-budget has proven to be problematic and has politicized the process as opposed to making it more effective and efficient. GNMA program history is a good case study.
We believe in the end there has to be two fluid markets existing side-by-side:
1) a revised conforming government guaranteed mortgage market,
2) standardized private non-agency market.
The underwriters of conforming mortgages should be more diversified than just the two GSEs. There is need for more of them and should be privately financed with some well defined tail risk protection from government. There should also be a limit on each conforming sponsor’s size to manage systematic risks and moral hazard. With that there would have be a non-risk-taking independent collateral agents to ensure transparency and uniformity. The underwriting guidelines should also be more dynamically adjusted through the economic cycle to minimize and protect against systematic risk. The independent collateral agents should be regulated but not part of direct government administration.
We do believe the securitization of non-agency market is critical but in this case uncertainty in well defined legal frame work and Dodd-Frank rules has severely been the bottleneck.
Significant unsold non-performing loans and REOs stock in the banking system will continue to be a major road block to the non-agency securitization.
We agree to a well defined and transparent but gradual end to bail out of GSEs. The process has to be designed very carefully. On-balance sheet approach is a good aspiration but has its own challenges. The annual budgetary process for allocating on-balance and on-budget has proven problematic and politicize the process as opposed to making it more effective and efficient. GNMA program history is a good case study.
We believe that there has to be two markets:
1) conforming government guarantee mortgage market,
2) non-agency market.
However the underwriters of conforming mortgages should be more diversified than just two agencies and these should be privately financed. Perhaps there should be a limit on each agency size due to systematic risk. With that there would have be a non-risk independent collateral agent party to ensure transparency uniformity. The underwriting guidelines should be more dynamically adjusted through the economic cycle to minimize and protect against systematic risk. The independent collateral agents should be regulated but not part of direct government administration.
We do believe the securitization of non-agency market is critical but in this case uncertainty in legal frame work has contributed to lack of market start.
Significant unsold non-performing loans and REOs continue to keep the non-agency RMBS a non-starter.
Standardized servicing need to also be addressed.
Lastly, lack of well defined rating criteria will be a problem to get the market started.
It is critical for US economy to have a well functioning residential mortgage markets and we believe it should be more of a national priority.
0 Comment | Add Comment(s) | GSEs, Mortgages, Regulation, Securitization, US_Administration, US_Economy, |
Ambushed on the Oregon Trail
Monday, February 28 2011 | 11:28 AM
SNR DENTON US LLP
|Senate Bill 892 was recently introduced in the Oregon legislature. It would affect any equipment sales or lease contract that contains a so-called “hell or high water”, or waiver of defenses clause and, by permitting the lessee or buyer to deposit payments into an attorney trust account or a statutory escrow trust account, would prohibit the lessor/seller or any assignee from enforcing the HHW clause or reporting the nonpayment “as a default or as information that may negatively affect the person’s credit rating…or ability to obtain credit.”
Commentators have identified at least one dozen defects or other problems with this Bill. One of them is that the Bill permits withholding of payments by reason of any “dispute” between the seller/lessor and the counterparty--not just a dispute over operation of the equipment or even a dispute relating to that particular contract. Another is that the Bill applies to any “payments”, so amount payable for maintenance, taxes, indemnities also could be placed in escrow, thereby forcing the lessor to pay property taxes or repair bills or else risk losing title to the equipment.
The Bill applies to assignees of the seller or lessor, so lenders, whole loan purchasers and securitizers would be prohibited from using the HHW clause to enforce payment. There is no provision for the lessor, securitizer or other assignee to receive interest, at the contract overdue rate, on the escrowed amounts.
In short, the proposal would undercut one of the linchpins of lease and securitized finance: the absolute and unconditional obligation of a lessee or purchaser to make payments. If enacted, it could force lenders, syndicators and securitizers to forbid any Oregon contract from being included in contract pools which they finance. Of course, the Bill is silent regarding which contracts would be affected, so the chilling effect on Oregon-related equipment would be even greater.
0 Comment | Add Comment(s) | Regulation, Securitization, Senate_Bill_892, Lease_Finance, Equipment, |
Monday, February 14 2011 | 01:10 PM
SNR DENTON US LLP
|On February 8, 2011, the Board of Governors of the Federal Reserve (the “Board”) issued a notice of proposed rule making under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The proposed rules establish criteria for determining whether a nonbank entity (1) is nonbank company that is “predominantly engaged in financial activities”, and (2) is a “significant nonbank financial company”. Both of these rules are important, because the Dodd-Frank Act gives the Financial Stability Oversight Council (the “FSOC”) the authority to determine whether a nonbank financial company shall be subject to the Board’s supervision, because it could pose a threat to the financial stability of the United States.
One of the necessary criteria for a company to be a “nonbank financial company” is that it be engaged “predominantly in financial activities”. Under the first proposed rule, a company would be “predominantly engaged in financial activities” if in either of its past two fiscal years, eighty-five percent of its consolidated annual gross revenues or consolidated total assets in that year were derived from or related to, respectively, “activities of a financial nature” or the ownership, control, or activities of an insured depository institution or any of subsidiary thereof. Additionally, the Board would have discretion to determine “based on all the facts and circumstances” that at least eighty-five percent of a nonbank company’s consolidated annual gross revenues or consolidated total assets are derived from or related to the aforesaid activities.
One factor, in determining whether a “nonbank financial company” is to be subject to the Board’s supervision, is the degree and nature of its connections with other significant nonbank financial companies and significant bank holding companies. In this regard, the second proposed rule defines a “significant nonbank financial company” as a nonbank financial company that is already supervised by the Board, or that had at least $50 billion of total consolidated assets as of the end of its most recently ended fiscal year. Furthermore, the FSOC may recommend to the Board that nonbank financial companies supervised by the Board report to the FSOC, the Board, and the FDIC on their credit exposure to other significant nonbank financial companies and significant bank holding companies. (A “significant bank holding company” is a bank holding company or foreign bank treated as a bank holding company that had at least $50 billion of total consolidated assets as of the end of its most recently ended fiscal year.)
These proposed rules are important to several companies in the equipment finance arena, because if any of those companies qualify as nonbank financial companies, then they could be subjected to supervision by the Board, similar to that imposed on bank holding companies, and could be required to report on their credit exposure to other significant nonbank financial companies and significant bank holding companies. It is as yet unclear how burdensome the increased regulatory oversight would be.
The deadline for comment is March 30, 2011.
0 Comment | Add Comment(s) | Federal_Reserve, Dodd_Frank_Act, FDIC, FSOC, Regulation, |