Ron Paul Testifies Before Federal Reserve and FDIC
Yesterday I had the privilege of testifying before approximately 100 people associated with the Federal Reserve and the FDIC.
I chose to focus my comments on two issues of particular importance to community banks. One relates to recent rules (commonly called Basel III) that require additional capital to be maintained at the bank to cover what are viewed by regulators as “high volatility commercial real estate loans.” Categorizing loans as such increases the cost to the bank of making these types of construction loans – and therefore either increases the cost to the borrower or diminishes the bank’s interest in making them. EagleBank has clearly demonstrated that loans can be made and monitored prudently. Accordingly, these loans are not “one size fits all” and individual bank track records and the factual circumstances of each loan should be weighed before making such a categorization.
Banks are also frowned upon when they take in what is viewed as too many deposits that are not “core.” As you may be aware, the CDARS program, for example, offers a depositor the ability to bank with EagleBank yet maintain full FDIC coverage for deposits in excess of the $250,000 per bank limit. The depositor lives right here in our backyard and has a personal relationship with the bank. But because such a certificate of deposit is brokered through the Promontory CDARS network, it is not viewed by regulators as “core.” Such deposits should not be frowned upon.
The panel consisted of:
Martin J. Gruenberg, Chairman, FDIC
Thomas J. Curry, Comptroller of the Currency, Office of the Comptroller of the Currency
Daniel K. Tarullo, Governor, Board of Governors of the Federal Reserve System
E. Joseph Face, Jr., Commissioner, Virginia Bureau of Financial Institutions
Stephen C. Taylor, Commissioner, District of Columbia Department Of Insurance, Securities and Banking
And was moderated by:
Rae-Ann Miller, Associate Director, Division of Risk Management Supervision, FDIC
After giving my remarks, a number of questions were asked that helped further illuminate the issues. I’ve attached a copy of my testimony below.
Comments to the Board of Directors
Federal Reserve Board of Richmond
December 2, 2015
I am Chairman/CEO of EagleBank and am pleased to be with you today and greatly appreciate the invitation. By way of background, EagleBank is a $5.8 billion community bank headquartered in and focused on serving the Washington metropolitan area. We are 18 years old, and have a very successful track record of profitability, with a strong balance sheet, demonstrated growth and excellent credit quality as demonstrated by both levels of non-performing assets and net charge-offs. I am pleased to tell you that we have reported 27 consecutive quarters of record, increasing earnings dating back to 2008. Despite our high concentration in Commercial Real Estate our charge off’s have been negligible. Since the recession of 2008, we have averaged 27 basis points of annualized net charge offs to average loans with the highest point being 47 basis points. We have achieved these results through our consistent approach to quality, local lending, generating core deposits and always maintaining strong capital ratios.
In my comments this morning, I would like to address two recent developments that are impacting community banks like ours. The first is capital requirements and in particular, Basel III. I think we all understand that the intention of Basel III was to raise the bar on capital levels across the industry and fully agree with the intent. At EagleBank, we understand the importance of maintaining a strong capital position and have always done so.
EagleBank is an active and successful commercial real estate (“CRE”) lender. Your regulatory teams can vouch for the credit quality of our loan portfolio and the consistent low levels of charge-offs. However, in its calculations for capital ratios, Basel III penalizes banks with local CRE and construction loans … without considering the historic track record or the current portfolio quality of the individual bank. This higher capital weighting and the cash equity requirements for those loans defined as HVCRE loans appear to have been intended to discourage banks away from CRE lending. We feel that is short sighted, because as we have proven, it can be an attractive profitable business for a well run bank and has a dramatic impact on our local economy.
We are most troubled by the onerous requirement that a real estate secured loan must be considered a high volatility commercial real estate (“HVCRE”) loan, and therefore subject to the 150% capital weighting, unless the borrower has a 15% cash equity injection in the project for the entire life of the loan. There are many good loan opportunities where the presence of a 15% cash injection is irrelevant.
- Should a loan on a 20-year old property with significant appreciation and little cash needed for development fall under HVCRE?
- Should a loan on a piece of ground that was originally zoned farmland but subsequently entitled to a much higher use, with a dramatically higher value, be considered HVCRE?
- Should a vacant office building that has been re-tenanted qualify as HVCRE?
- Should a 5-unit multi-family property with significant appreciation be treated differently than a 4-unit multi-family project?
- Should a borrower be permitted to roll a property that has been successfully repositioned into a committed term-out or should they be required to re-finance and incur significant transaction costs for the mere purpose of avoiding HVCRE?
These are examples, and there are many more, of how the Basel III treatment of CRE loans have created an inefficient and very costly capital structure for our community banking system. If this is all about mitigating risk, which we all agree it should be, why doesn’t the capital weighting analysis consider appraised values, loan-to-value ratios, debt service coverage and other matrixes as regulators customarily do in all other credit quality evaluations?
The Basel III methodology will cause banks to both raise the price of CRE construction loans and constrict the level of CRE lending. This has the doubly negative impact of driving attractive loan business to our non-bank competitors or reducing the amount of real estate investment activity, which is such an important driver of job creation and related economic activity in communities across our country. For example, in Montgomery County, MD, where our bank is headquartered, the construction trades have the highest unemployment level of any industry in the County. Restricting real estate lending will also reduce the quality of the commercial building and housing stock in many communities, further impacting their economies.
The second topic I would like to address this morning is the subject of wholesale deposits and specifically reciprocal deposits. At EagleBank, like most community banks, we focus on generating core deposits from our local customers as our primary source of funding and liquidity. However we also use wholesale deposits as an ancillary funding source on occasion to balance with our loan funding needs and maintain appropriate on-balance-sheet liquidity. In evaluating our non-core funding sources, we limit the use of wholesale deposits but often find them to be an attractive source of funding as compared to advances from the Federal Home Loan Bank. The process is more efficient and these deposits provide a lower cost of funds across the yield curve. We reserve our FHLB availability as a future contingent source of liquidity.
More importantly, I want to state emphatically that reciprocal deposits should not be considered as wholesale deposits for regulatory calculation purposes. Let me explain why. At EagleBank, we have $4.9 billion in deposits. We serve 12,000 customers through 22 branch offices. About 12% of our deposits are held in fully FDIC insured reciprocal deposit accounts. This is not an alternative source of funding, but accounts that have been opened with us by our local customers. These accounts include checking accounts, money market accounts and certificates of deposit and are held by our customers including individuals, small and medium sized businesses, non-profit organizations and local government agencies. Many of these customers are required to have FDIC insurance on their deposits. For example, one of our longest term customers is a local law firm which is often required by the court system to hold their clients’ escrow funds in a fully FDIC insured account. They currently have approximately $80,000,000 in deposits: $250,000 held at EagleBank and $79,750,000 held in reciprocal deposit accounts. Are these funds wholesale funds? Clearly not. The customeruses these reciprocal deposit products not because of any esoteric features, but because they present no risk, due to the FDIC insurance feature.
These reciprocal deposits are not “hot money” and are not sourced through brokers. These accounts are a key component of our relationships with core customers. The bottom line is that these customers are placing these deposits because of the safety offered by the FDIC insurance. If unlimited FDIC insurance was available to all customers, there would be no need for reciprocal deposit products and the funds would all be considered core deposits. We would ask for your support in urging the FDIC to reconsider its position regarding its consideration of reciprocal deposits as wholesale deposits.
Thank you for the opportunity to appear before you and provide these comments. I would be pleased to answer any questions.