Superintendent Neiman Addresses FDIC New Directors' Meeting on Current Issues Facing Community Banks
RICHARD H. NEIMAN
SUPERINTENDENT OF BANKS FOR THE STATE OF NEW YORK
FDIC New Directors’ Meeting
on Current Issues Facing Community Banks
March 6, 2008
Good afternoon. I’m delighted to join you today for this important conference, and to present a state regulator’s perspective on current issues facing community banks.
I appreciate the remarks from the federal side earlier this morning. As I have said many times in the past, this is a critical time when regulators at all levels of government need to work together, to restore market discipline and investor confidence.
Conferences like this provide unique opportunities for that needed regulatory dialogue, as well as for sharing with industry. My thanks go out to the FDIC for arranging this event, in connection with the New York Bankers Association.
These are challenging but exciting times to be part of the banking industry in our state. And a quick scan of today’s agenda reveals the varied risk areas that bank directors need to manage, from BSA to information technology. Each of these areas is a specialty in its own right- and yet the effective bank manager needs to master them all.
That’s a big task, but it’s one in which our banks are not alone- the Department is looking to be an engaged partner with you, as you design your compliance strategy and assess performance.
For our part, we are active on several fronts to enhance the value of our supervision in addressing these market challenges. And that supervisory responsibility includes working to ensure that we remain the charter of choice for community banks.
As we respond to current competitive challenges, however, it is vital that we never lose sight of our over-arching mission: to ensure the safety and soundness of the financial system, while providing second-to-none consumer protections.
That’s why I’ve laid out a five-pronged approach in developing our agency priorities for 2008. We’re working to:
- Promote the dual banking system and enhance the state charter;
- Protect consumers;
- Expand community development;
- Recruit and train staff; and
- Modernize our regulatory framework.
These initiatives help position the banking industry in New York for sustainable success. Even banks with a national charter benefit indirectly from this state oversight, through the checks and balances in the dual banking system - which works to restrain excessive regulation by either level of government. And we realize that the current turmoil in the mortgage market will put all of our supervisory skills to the test.
In the midst of this complex compliance landscape, I will speak to you today about mortgage crisis, with special emphasis on issues related to community banks. And, I’d like to address this from two angles:
- First, the impact of the crisis on community banks, and;
- Second, the potential for community banks to take a leadership role in stabilizing the mortgage market.
A. THE IMPACT OF SUBPRIME ON COMMUNITY BANKS
While headline losses have been registered by some of the world’s largest financial institutions, the entire industry has been affected to some extent. As we begin to quantify this variable scope of the subprime problem- an ongoing task- I find it useful to differentiate between primary effects and the subsequent stages of spillover.
1. Primary effects and spillover
To start with, the sudden increase in subprime defaults hit the market like a lead balloon. Subprime mortgage bankers with unfunded pipelines and commercial banks deeply involved in mortgage securitization were at the epicenter of the impact. Some originators declared bankruptcy; other investors downgraded or sold off portfolios. But everyone was waiting for the other shoe to drop, not least of all community banks.
And the ripples from this primary impact have indeed spread out across the industry at large. Perhaps one of the more troubling aspects of this crisis, at least from a market oversight perspective, has been the insidious way in which the subprime problem has undermined the stability of seemingly unrelated business lines.
The “subprime signature” seems to be hiding behind every new negative financial ratio that we’re confronted with, almost on a daily basis. It’s this chameleon-like quality to the subprime crisis that helps fuel talk of recession.
2. The impact on construction and commercial real estate
It’s true that community banks generally were not heavily involved in subprime as originators or securitizers. But other risk areas may be waiting in the wings, driven by the subprime issue indirectly.
For example, a potential concern is the uptick in delinquent loans for new home construction and commercial real estate. It could set the stage for the next wave of spillover.
Defaults among subprime residential borrowers were the initial impact. And if the securitization fallout was the secondary effect, we may be seeing the emergence of a “third wave” of impact with construction and commercial real estate loans. This possibility should be of vital interest to you, since these loan types are more typical components of a community bank’s business model.
Also, unlike subprime originations, the issue here is less one of credit standards and more a case of general economic factors- the shrinking of the subprime sector has simply meant fewer consumers are looking to buy.
In turn, the housing market has cooled - effecting housing prices in general and new home construction in particular, since construction lags demand. If builders don’t have a ready market for their inventory, we can expect delinquency rates for this group to increase over time.
3. The picture for New York
These broader economic factors driving losses in sectors such as construction and commercial real estate require an even more comprehensive perspective - it’s not just a matter of strengthening underwriting standards, which are factors within an individual lender’s control.
Which isn’t to say that a continued unfurling of the subprime mess is unstoppable; on the contrary, there are also some positive signs that banks are taking real steps to staunch the flow and reverse the tide. And the general economic picture for New York is more positive than for many other regions of the country.
In New York, we haven’t seen the drastic downturn in housing permits for residential real estate - we’re down less than one percent compared to last year, whereas nationally total permit activity has plunged nearly 25 percent in the same time period.
Even so, I’ve asked my research staff to make analysis of construction and commercial real estate lending patterns a high priority. We want to stay ahead of the curve and anticipate where new risks may develop, so that we can offer the right regulatory guidance to support industry’s evolving needs.
But I’m pleased to say that despite the range of negative market conditions associated with the subprime problem, the overall health of our community banks in New York is still strong. I attribute that to two factors in particular-
- first, historically, community banks did not chase after the high-return- but even higher risk- subprime products that precipitated the crisis, and;
- second, community banks have been innovative in identifying untapped niche markets where there is still plenty of room for disciplined and profitable growth.
And it’s those market opportunities- some of which the subprime crisis has actually highlighted- that I’d like to focus on in my time remaining.B. OPPORTUNITIES FOR COMMUNITY BANKS IN MARKET STABILIZATION
The first thing I would encourage community banks to do when confronted with the turbulence in the market is this- don’t over-react.
1. Perform a self-assessment
By all means, though- do take a hard look at your own exposure levels and assess the strength of your compliance program and the quality of services you receive from any third parties. Perform a self-assessment. The tools from this conference will be a valuable resource for you in that process.
But once you’ve had that tune-up, I expect you’ll find that you are in a solid position from which to meet urgent credit needs within your communities.
2. Continue to originate residential mortgages
So I strongly urge you to continue to originate residential mortgages. This crisis has revealed that there are many consumers who were placed in subprime or other nontraditional products who would have qualified for a prime loan. That’s a tragedy for consumers as well as a lost marketing opportunity for community banks.
One way for you to reach this untapped market is to participate in economic development initiatives sponsored by the Banking Department, such as the Banking Development District (BDD) program. This program provides significant incentives, such as CRA credit and below market rate deposits from the State Comptroller, for opening branches in underserved neighborhoods.
3. Develop innovative refinance programs
We are also looking to award CRA credit to banks that develop innovative refinance programs, to help existing borrowers with unaffordable mortgages to avoid foreclosure. While community banks may not be the current holder or servicer of these subprime loans, and so might not be at the forefront of the loan modification issue, there is still plenty of room- as well as need- for creative and responsible refinance options.
And as you consider creating special refinance programs, the state is looking to partner with you and share the risk of expanding your eligibility criteria. There is an existing infrastructure for government-insured loans- whether at the state level through SONYMA, or at the national level through FHA- that quite frankly is being underutilized.
I encourage you to become a SONYMA and an FHA-approved lender, if you are not one already. And if you are already a participating lender- well, participate! There is a huge market here. And the bank that offers these safe and affordable government-insured refinances to homeowners saddled with unaffordable mortgages can expect significant consumer loyalty and increased cross-selling opportunities.
4. Provide input on proposed subprime solutions
And finally, I hope that you will maintain an open dialogue with the Banking Department as we explore regulatory and legislative solutions to the subprime problem. You input is critical if we are to design strategies that support the market without choking innovation.
And, as I am sure you aware, in light of the Governor’s announcement of his proposed subprime legislative bill on Tuesday, the time for us to talk is NOW.
We have two priorities in crafting any government response - immediate need to help existing borrowers remain in their homes, as well as prevent the type of undisciplined market behavior that precipitated the crisis in the first place.
Even though you share those goals, I realize that there are a variety of views on the means for achieving them. And that is why I hope that you will communicate with your regulator, as new standards for the industry are considered- whether it’s the proposed federal revisions to HOEPA, our ideas to expand New York State’s anti-predatory lending statute, or other regulatory and legislative proposals.
Since many of the proposals being discussed at both the state and federal levels cover the entire mortgage market to some degree, it’s understandable if you have questions or concerns. After all, if you didn’t cause the problem, why are community banks being included in the rules designed to solve it?
Well, let me say this- the type of underwriting requirements we think would benefit the entire residential lending industry are in fact the same sound standards that you already adhere to- such as ensuring the borrower has an ability to repay the debt.
So requiring that responsible lending behavior actually helps community banks by leveling the playing field- we don’t want community banks, which already have high standards, to be at a disadvantage compared with less scrupulous competitors who are prepared to “look the other way” on income and rely on collateral value instead.
Our intention is for solutions to the subprime problem to strengthen the relative market position of community banks. So tell us if you think we struck that right balance, and give us the benefit of your suggestions. We are mindful of the impact on community banks, as well as parity issues in general, as we respond to the subprime crisis.
I’ve made striving for parity, both among charter types and between depository and non-depository institutions, one of my top agency priorities, as I mentioned at the opening of my remarks.
Whether it’s the new wild card authority- with enhanced ability to initiate changes to bring state banks parity with national banks- or multi-state efforts- like the regional pact we’re announcing with New Jersey and Pennsylvania to eliminate state-level regulatory overlap- we genuinely want to create standards and processes where industry and consumers can succeed together.
I appreciate the opportunity to speak with you today, to renew my invitation to dialogue and answer any questions you may have. Thank you.