Regulatory Actions Hit a Record Level in '09

WASHINGTON — Bank regulators issued 1,143 formal enforcement actions against banks and their holding companies last year, a new record and more than double the 2008 tally.

Informal actions by the agencies, which are not made public and often go untracked, also doubled during that time, reaching 1,099 last year, according to data provided to American Banker.

An increase in enforcement activity during the financial crisis was to be expected, but even longtime industry observers were caught off guard by the explosive growth and sheer number of actions.

"This is almost an unprecedented leap in enforcement actions," said Tom Vartanian, a partner at Fried Frank Harris Shriver & Jacobson. "When you combine the formal and informal actions, you can conclude there is a large segment of the banking agency under scrutiny at this point. … I find it surprising that the numbers are as high as they are."

Experts offered a host of reasons behind the dramatic increase, including a poor economy, continuing asset and capital problems at institutions and pressure from lawmakers who blamed regulators for not being tough enough in the lead-up to the crisis.

"It is clear that a lot of banks are having issues relating to not only borrowers having difficulty paying, but vastly declining collateral values," said Ellen Seidman, director of the Financial Services and Education Project at the New America Foundation and a former director of the Office of Thrift Supervision. "At least some of the banks were weakened going in because of the hit on Fannie and Freddie stock, and I think it's fair to say regulators have upped the ante on provisioning and capital requirements, because as the recession has gone on things have snowballed."

All four banking and thrift agencies more than doubled their level of formal enforcement actions in 2009, with the Federal Deposit Insurance Corp. leading the pack at 551, up from 273 in 2008.

At the Federal Reserve Board, which has been severely criticized for paying too little attention to bank regulation, formal enforcement actions nearly quadrupled last year, to 191.

The central bank also led the agencies in the number of informal enforcement actions, typically memorandums of understanding between a regulator and a bank that do not have to be reported publicly. The Fed filed 467 such actions in 2009, versus 216 in 2008.

Of the four regulatory agencies, only the Office of Thrift Supervision refused to disclose its level of informal enforcement actions, saying such data was private and could not be made public even under the Freedom of Information Act.

"The OTS does not consider information about informal enforcement actions to be public information," said William Ruberry, a spokesman for the agency.

Vartanian, who tracks enforcement numbers, said many recent orders point to banks' capital and asset-quality problems. A common characteristic has been a requirement for increased capital.

"There are two predominate issues impacting financial institutions around the country," he said. "One is capital adequacy and one is asset quality. … In these times there is no doubt if you get an asset-quality problem and a problem with capital adequacy that regulators are at least looking for informal memorandums of understanding."

Cornelius Hurley the director of the Morin Center on Banking and Financial Law at the Boston University School of Law, agreed.

"I would think the main driver for them is capital deficiencies and the capital deficiencies are probably a result of poor asset quality … and when you have those two going against you management takes a hit," he said.

While the number of enforcement actions struck observers as significantly high, many also saw a correlation to the problem-bank list. At the end of 2009 there were 702 "problem" institutions, 150 more than in the third quarter and the highest level since June 1993. Experts said that most of those institutions were hit with enforcement actions.

Regulators also may be trying to make up for lost time, arguing that enforcement levels before the crisis were too low. The Fed issued only 54 formal enforcement actions in 2008, while the OTS issued 68.

"It's a delayed reaction," said Bert Ely, a bank consultant in Alexandria, Va. "The question is, should there have been more orders in 2007 and 2008?"

Lawmakers and the agencies' inspector generals have criticized regulators for being slow to react, particularly with troubled or failing institutions.

"A large part of the increase is probably due to the agencies' concern about possibly having missed problems in the past and trying not make sure they do not overlook problems that exist now," said Brad Sabel, co-leader of Shearman & Sterling LLP's Economic Stabilization Advisory Group and a former New York Fed official. "There is probably also an element of examiners wanting to protect themselves against criticism in the event their bank develops a problem in the future."

Bob Clarke, a senior partner at Bracewell & Giuliani LLP and former comptroller of the currency, said the orders were a reaction to IG scrutiny.

"For the bank failures that have occurred so far, every one of the large loss reports the inspector general has done or any GAO investigation has concluded the reason the bank has failed is the regulator did not take early enough action or severe enough action," Clarke said. "So the regulators have decided they are not going to subject themselves to that anymore, so they are going to put banks under the most severe enforcement actions they can justify."

The spike in enforcement also comes as Congress crafts regulatory reform, deciding how much enforcement power each agency should gain or lose. Lawmakers have been particularly critical of the agencies for their failure to crack down on banks' underwriting practices during the housing boom.

"The regulators were asleep for 10 years during the boom and there's now this remarkable turf war under way with regulatory reform," said Chris Low, chief economist for First Horizon National Corp.'s FTN Financial. "Any regulator who doesn't appear aggressive now is going to have a tough time convincing Congress that they are the ones who should be in charge of bank regulation."

Andy Sandler, a partner at BuckleySandler LLP, said that, because regulators have received much of the blame for the crisis, they are compensating with consumer protection enforcement orders.

"If you look behind the numbers you will see consumer actions are driving a lot of the jump, and it's certainly not the case banks are getting worse in their treatment of consumers," Sandler said. "The numbers are being driven by the political reaction of the regulators to the pressure they have been under."

In something of a Catch-22, the spike in enforcement orders may only anger Congress further. After complaining that regulators were not tough enough before the crisis, many lawmakers now say the agencies are being too tough, causing banks to curtail credit availability.

"They could potentially hurt the regulators in their battles on Capital Hill … because they play into the narrative that regulators were behind the curve and they reacted too late," said Brian Gardner, a political analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc. "I don't think this helps them."

Bankers are likely to seize on the data in an effort to press their case with Capitol Hill that regulators, not institutions, are to blame for credit drying up.

"There is a consistent comment for regulators that the pendulum has swung too far," said Diane Casey-Landry, senior executive vice president and chief operating officer of the American Bankers Association. "No one is asking for easy supervision, but we need a balance. The pendulum has swung too far, and it's inhibiting not only banks' ability to lend, but to manage their business."

Chris Cole, regulatory counsel for the Independent Community Bankers of America, said increased enforcement activity "is one of the reasons you are not seeing a brisk recovery."

Regulators defended their actions, saying this is a natural response to the economy.

"Historically, enforcement actions increase as one would expect during periods of economic stress," said Kevin Mukri, an OCC spokesman. "They are a plan that both the bank and regulator have agreed to bring the bank into full compliance with bank regulations."

Ruberry, the OTS spokesman, said its agency was simply doing its job.

"Many of these orders outline steps that thrifts need to make to operate safely and soundly," Ruberry said. "These orders are an essential part of the OTS mission of ensuring the safety and soundness of the thrift industry."

Regardless of who's to blame — the banks or regulators — Vartanian predicted aggressive regulatory reaction would continue through this year.

"In 2010, from what we see now, I expect to see numbers as high or higher than 2009," he said. "I think that poor economic times are generally a lagging indicator for banks.

"With the unemployment rates still relatively high, you can assume until that starts going down, defaults on loans are not going to turn around. So I think banks are still dealing with relatively high defaults and problem-loan issues, and that makes them prime candidates for these enforcement actions."