[House Hearing, 113 Congress] [From the U.S. Government Publishing Office] STATE OF COMMUNITY BANKING: IS THE CURRENT REGULATORY ENVIRONMENT ADVERSELY AFFECTING COMMUNITY FINANCIAL INSTITUTIONS? ======================================================================= HEARING BEFORE THE SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER CREDIT OF THE COMMITTEE ON FINANCIAL SERVICES U.S. HOUSE OF REPRESENTATIVES ONE HUNDRED THIRTEENTH CONGRESS FIRST SESSION __________ MARCH 20, 2013 __________ Printed for the use of the Committee on Financial Services Serial No. 113-9 ---------- U.S. GOVERNMENT PRINTING OFFICE 80-875 PDF WASHINGTON : 2013 HOUSE COMMITTEE ON FINANCIAL SERVICES JEB HENSARLING, Texas, Chairman GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking Chairman Member SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York Emeritus NYDIA M. VELAZQUEZ, New York PETER T. KING, New York MELVIN L. WATT, North Carolina EDWARD R. ROYCE, California BRAD SHERMAN, California FRANK D. LUCAS, Oklahoma GREGORY W. MEEKS, New York SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York JOHN CAMPBELL, California STEPHEN F. LYNCH, Massachusetts MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia KEVIN McCARTHY, California AL GREEN, Texas STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri BILL POSEY, Florida GWEN MOORE, Wisconsin MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota Pennsylvania ED PERLMUTTER, Colorado LYNN A. WESTMORELAND, Georgia JAMES A. HIMES, Connecticut BLAINE LUETKEMEYER, Missouri GARY C. PETERS, Michigan BILL HUIZENGA, Michigan JOHN C. CARNEY, Jr., Delaware SEAN P. DUFFY, Wisconsin TERRI A. SEWELL, Alabama ROBERT HURT, Virginia BILL FOSTER, Illinois MICHAEL G. GRIMM, New York DANIEL T. KILDEE, Michigan STEVE STIVERS, Ohio PATRICK MURPHY, Florida STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio RANDY HULTGREN, Illinois DENNY HECK, Washington DENNIS A. ROSS, Florida ROBERT PITTENGER, North Carolina ANN WAGNER, Missouri ANDY BARR, Kentucky TOM COTTON, Arkansas Shannon McGahn, Staff Director James H. Clinger, Chief Counsel Subcommittee on Financial Institutions and Consumer Credit SHELLEY MOORE CAPITO, West Virginia, Chairman SEAN P. DUFFY, Wisconsin, Vice GREGORY W. MEEKS, New York, Chairman Ranking Member SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York GARY G. MILLER, California MELVIN L. WATT, North Carolina PATRICK T. McHENRY, North Carolina RUBEN HINOJOSA, Texas JOHN CAMPBELL, California CAROLYN McCARTHY, New York KEVIN McCARTHY, California DAVID SCOTT, Georgia STEVAN PEARCE, New Mexico AL GREEN, Texas BILL POSEY, Florida KEITH ELLISON, Minnesota MICHAEL G. FITZPATRICK, NYDIA M. VELAZQUEZ, New York Pennsylvania STEPHEN F. LYNCH, Massachusetts LYNN A. WESTMORELAND, Georgia MICHAEL E. CAPUANO, Massachusetts BLAINE LUETKEMEYER, Missouri PATRICK MURPHY, Florida MARLIN A. STUTZMAN, Indiana JOHN K. DELANEY, Maryland ROBERT PITTENGER, North Carolina DENNY HECK, Washington ANDY BARR, Kentucky TOM COTTON, Arkansas C O N T E N T S ---------- Page Hearing held on: March 20, 2013............................................... 1 Appendix: March 20, 2013............................................... 43 WITNESSES Wednesday, March 20, 2013 Brown, Richard A., Chief Economist, Federal Deposit Insurance Corporation, accompanied by Doreen R. Eberley, Director, Division of Risk Management Supervision, Federal Deposit Insurance Corporation, and Bret D. Edwards, Director, Division of Resolutions and Receiverships, Federal Deposit Insurance Corporation.................................................... 7 Evans, Lawrance L., Director, Financial Markets and Community Investment, U.S. Government Accountability Office.............. 10 Rymer, Hon. Jon T., Inspector General, Federal Deposit Insurance Corporation.................................................... 8 APPENDIX Prepared statements: Evans, Lawrance L............................................ 44 Joint FDIC statement......................................... 62 Rymer, Hon. Jon T............................................ 84 Additional Material Submitted for the Record Capito, Hon. Shelley Moore: Letter from the National Association of Federal Credit Unions (NAFCU), dated March 19, 2013.............................. 91 Maloney, Hon. Carolyn: Letter to Federal Reserve Chairman Ben Bernanke, FDIC Chairman Martin Gruenberg, and Comptroller of the Currency Thomas Curry from Representatives Carolyn Maloney and Shelley Moore Capito, dated February 19, 2013.............. 97 Westmoreland, Hon. Lynn: Written statement of Representative Tom Graves............... 99 Evans, Lawrance L.: Written responses to questions submitted by Representative Capito..................................................... 101 Written responses to questions submitted by Representative Posey...................................................... 102 Written responses to questions submitted by Representative Westmoreland............................................... 104 FDIC witnesses: Written responses to questions submitted by Representative Bachus..................................................... 117 Written responses to questions submitted by Representative Capito..................................................... 118 Written responses to questions submitted by Representative Pearce..................................................... 123 Written responses to questions submitted by Representative Westmoreland............................................... 125 Rymer, Hon. Jon. T.: Written responses to questions submitted by Representative Posey...................................................... 141 Written responses to questions submitted by Representative Westmoreland............................................... 142 STATE OF COMMUNITY BANKING: IS THE CURRENT REGULATORY ENVIRONMENT ADVERSELY AFFECTING COMMUNITY FINANCIAL INSTITUTIONS? ---------- Wednesday, March 20, 2013 U.S. House of Representatives, Subcommittee on Financial Institutions and Consumer Credit, Committee on Financial Services, Washington, D.C. The subcommittee met, pursuant to notice, at 10:02 a.m., in room 2128, Rayburn House Office Building, Hon. Shelley Moore Capito [chairwoman of the subcommittee] presiding. Members present: Representatives Capito, Miller, McHenry, Campbell, Pearce, Posey, Fitzpatrick, Westmoreland, Luetkemeyer, Duffy, Stutzman, Pittenger, Barr, Cotton; Meeks, Maloney, Watt, McCarthy of New York, Green, Capuano, Murphy, Delaney, and Heck. Ex officio present: Representative Hensarling. Chairwoman Capito. The subcommittee will come to order. Without objection, the Chair is authorized to declare a recess of the committee at any time. Also, without objection, members of the full Financial Services Committee who are not members of the subcommittee will be allowed to sit on the dais and participate in today's hearing. Without objection, it is so ordered. This morning's hearing is the first hearing for the Financial Institutions and Consumer Credit Subcommittee in this Congress. I would like to welcome our new members to the subcommittee, as well as the new ranking member, Mr. Meeks. I think we will work very well together. As chairman, I intend to highlight the many challenges being faced by our community financial institutions and the communities they serve across the country. This should not be a partisan issue. It is my goal to work with the ranking member to identify areas of agreement for fostering a regulatory environment for community financial institutions that promote economic growth and access to a wide range of consumer credit products. The focus of this hearing--I forgot to yield myself 3 minutes. So, the focus of this morning's hearing is on three important studies on the state of community banking. Two of the studies were products of legislation that Mr. Westmoreland of Georgia authored last Congress. As many of my colleagues know, the State of Georgia led the Nation in the number of bank failures between 2008 and 2011. Mr. Westmoreland and Mr. Scott, also from Georgia, have been tireless advocates for the struggling financial institutions and their districts in the State of Georgia and the communities that have been adversely affected. At the behest of Congress, the Inspectors General of the FDIC and the GAO conducted studies on the FDIC's handling of the failed community banks and lessons from community bank failures. This subcommittee first began examining these issues at a field hearing in Mr. Westmoreland's district in Newnan, Georgia, in August of 2011. And I look forward to learning more about the progress being made by the regulatory agencies to mitigate the adverse effect of community bank failures on local communities. The third study to be discussed this morning is a study that is a thoughtful contribution to the discussion that we began in the last Congress on the importance of community financial institutions and how the current regulatory environment affects the viability of community financial institutions and their role--and their model. We heard countless anecdotal stories last Congress from community bankers expressing despair and frustration about the future prospects for a vibrant and diverse financial services system that features community banks. The FDIC study highlights many areas that demonstrate the importance of community banks to the U.S. banking system. The study points out that in many rural areas, such as the one I represent, local community banks are the only source of banking services for members of the community. Although larger institutions may choose to enter these markets, they will not maintain the same level of personal service and understanding that the community--the local community banks can offer. This element of relationship banking is critical in rural communities like those I represent in West Virginia. Lenders not only know their customers, but they know their extended families and the businesses they operate in these communities. It is this level of understanding that allows the lender to sit down with the borrower and develop alternative financial strategies when economic downturns occur, or if there is a life-changing event that might impact the borrower in some way. Rural communities will not be well-served if the current regulatory environment forces lenders to move away from relationship banking and make decisions on a one-size-fits-all form of regulation and compliance. The FDIC study also attempts to quantify the growing burden of complying with the myriad of financial regulations for community institutions. I think we found in the study it is difficult to quantify. In January of 2001, just 6 months after Dodd-Frank, we learned from a community banker in West Virginia that they have already had to hire an additional primary compliance officer. I understand that it is a difficult figure to quantify, but we must keep up the discussion amongst policymakers, regulators, and community bankers about ways to reduce this growing burden. We need to have safely run financial institutions in our local communities. But we must ensure that any cost of compliance does not outweigh the benefits and the regulations emanating from Washington. I would like to thank our witnesses for being here this morning to update the subcommittee on these important studies, and at this time I would like to recognize the ranking member, Mr. Meeks, for 3 minutes for the purpose of giving an opening statement. Mr. Meeks. Thank you, Madam Chairwoman, for holding this hearing today. And as you have indicated, this is the first hearing of the Subcommittee on Financial Institutions and Consumer Credit during the 113th Congress. I want to express how pleased I am to be working with the chairwoman on this subcommittee. I know that we will find areas of cooperation, and I look forward to collaborating with the Chair on many areas of common interest, including regulatory relief for smaller banks and credit unions and mobile payment services, and the associated electronic payments field and many other consumer protection issues. And I know that we are going to be working very closely together. While it is not explicitly the topic of today's hearing, but since this is our first hearing of the subcommittee, I want to state now that I am concerned about the impact that Basel III can have on community banks. Previous iterations of Basel have excluded smaller institutions from their capital requirements, which are better designed to address the risk portfolios of larger financial institutions. And of course, smaller institutions must have adequate capital for their activities. But it appears that Basel III takes a one-size- fits-all approach. I am concerned that Basel III is too complicated and does not offer the appropriate risk ratings to different classes of assets. For example, it would apply a discount to any asset that isn't sovereign debt in the U.S. Treasuries or cash. This means a bank that specializes in mortgages, for example, may have to hold a lot more capital against those mortgages to satisfy minimum capital requirements. However, I would think that we learn to start to make sure capital requirements don't stifle small banks in even medium-sized or regional banks institutions that don't engage in the exotic activities that some of the larger institutions do. As we learned in the FDIC's Community Banking Study, smaller and regional institutions are the engines of economic growth in this country because they lend to their neighbors in their communities to keep their farms or their small businesses going, or to hire employees. In fact, the study noted that though community banks hold only 14 percent of the banking industry's assets, they make 46 percent of the smaller denomination loans to farms and small businesses. Along with credit unions, they are often the sole source for mortgage financing and therefore the lifeline of the housing industry in our communities. It was not their activity that blew up the global banking system. And I think the capital requirements we place on banks should recognize that. I want to work with the chairwoman on that issue. A concern that I often hear from my community banks is the lack of certainty. And much of this arises from the timing of rules on which the argument about uncertainty has credence. I would hope that we would make sure that we start and do not cut off funding for regulators, including the SEC, the CFTC, and the CFPB, all of which creates additional regulatory uncertainty. A common complaint I hear from businesses when I am in New York is on the timing of rulemakings. Businesses in the market will adjust to rules and regulations, but they need to know what they are. It is time to fully fund our regulators so they can complete the process of implementing Dodd-Frank and therefore restore confidence to the marketplace. I look forward to hearing about the other issues that are the focus of this hearing, including what I hope is a robust discussion on the good things that the FDIC is doing in protecting the Deposit Insurance Fund, and therefore taxpayers. In reviewing the FDIC's programs in preparation for this hearing, I was pleased to learn of some of the efforts the agency has made to engage in mortgage modifications, something I hope the industry proactively addresses further. And I also hope we can explore some of the recommendations of the FDIC Inspector General and how the FDIC is implementing them. I look forward to the testimony. Thank you, Madam Chairwoman. Chairwoman Capito. Thank you. I would like to recognize Mr. Duffy for 1\1/2\ minutes for the purpose of an opening statement. Mr. Duffy. Thank you, Chairwoman Capito. I appreciate you calling this very important hearing. And I appreciate the panel for coming in and talking about our community banks and their health, and how we can make sure we have a strong community bank system throughout our country. Many of us know that our small community banks or credit unions are the lifeblood of economic growth in our small communities across this great country. And it is those very institutions that get capital out to our small businesses which are starting up or that small business or that manufacturer which is going to expand their business and create jobs across the country. They are the institutions in rural America which get dollars out to our families who are going to buy a home or buy a car; and if our community banks are failing, so too are our small communities. So I am pleased that the OIG and the GAO studies address some of the issues that we have known for quite some time affect our small community banks. Clearly, they face a lot of challenges in this hyper-regulatory environment. And small banks are constantly being forced to deploy resources, money, time, and personnel towards regulatory compliance instead of focusing on their traditional role of lending and serving our customers. I look forward to your testimony and the conversation we are going to have today about the health of our small financial institutions. I yield back. Chairwoman Capito. Thank you. I would like to recognize Mr. Westmoreland for 2 minutes. Mr. Westmoreland. Thank you, Madam Chairwoman. I would like to ask for unanimous consent to enter into the record a statement from Representative Tom Graves, and some written questions for the witnesses. Chairwoman Capito. Without objection, it is so ordered. Mr. Westmoreland. I want to thank the chairwoman for having this hearing. This hearing is especially important to me because I and others worked hard to authorize it last Congress. I read the studies with interest, but unfortunately they seemed to raise more questions than answers. I think the biggest thing to come from these studies is finally an admission that what my Georgia banks have been saying is true, that acquiring banks will maximize their expiring loss share agreements for commercial assets. Unfortunately, the studies show the FDIC has no plan for dealing with the potential new bubble in the commercial real estate market. I am hearing from acquiring banks that they really don't know what to do with their expiring loss share agreements. I am also hearing stories from borrowers in Georgia whose acquiring bank will not negotiate reasonable modification terms. This is a special concern since the studies also noted examiners' ongoing failure to follow the spirit of the 2009 guidance on commercial loan modifications. And as if these problems were not enough, the GAO study recognized that bank examiners negatively classify a collateral-dependent loan simply because the value of the collateral has declined. Further, there are serious problems in the way appraisals are handled by examiners and the application of impairment accounting standards in the examination process. The IG found examiners do not properly document appraisals or evaluation for the best use of the underlying collateral. To me, this is code for examiners to be able to do what they want in terms of valuing collateral, but not having to justify it to the bank or their bosses. The FDIC IG found examiners do not have the necessary training or background in appraisals, yet are relying on their experience in this field during bank exams. The studies make it very clear that the FDIC, the OCC, and the Federal Reserve have had trouble handling the boom-and-bust cycles over the last 25 years. They are repeating the same patterns over and over, but expecting different results. And again, I would like to just thank the chairwoman for having this hearing. It is very important to the constituents and the bankers in Georgia. Chairwoman Capito. I am glad you got that last line in. I would like to recognize Mr. Watt for 1 minute. Mr. Watt. Thank you, Madam Chairwoman. I want to join the other members of the subcommittee in applauding you and the ranking member for convening this hearing. This is a subject that all of us are hearing about regularly. And I especially want to applaud the composition of this panel, because we hear the community banker side, and I am sure that is an important perspective. But it is also important to hear the perspective of the regulators and to understand whether what we are hearing from the banks is a regulatory matter or whether it is a matter of legislative significance. When it is our responsibility as legislators, we need to know that. And when we can push the regulators to be more prompt as regulators in promulgating rules, we need to push that. So, it is especially important and I appreciate the opportunity to express that. I yield back. Chairwoman Capito. Thank you. I would like to recognize Mr. Miller for 1 minute. Mr. Miller. Thank you, Madam Chairwoman. The environment within which the regulators work today should basically encourage innovation and growth rather than to stifle it, but that is not what is happening. The government is acting to help banks. But what they should do is serve their customers. Instead, banks are having an onslaught of new regulations they are having to deal with. We certainly need a well-functioning regulatory system, but it should facilitate growth, not stifle it. We are starting to see a basic turnaround in the housing market today. But what is stifling that ability to get loans? AD & C loans are just not available to many builders today, especially the smaller builders. Banks are being held back from doing what they want to do. And because of regulations placed upon them, you are seeing a certain group in the marketplace who are just avoiding getting involved. Representative Carolyn McCarthy and I introduced the Home Construction Lending Regulatory Act today that addresses overzealous regulators. It lets you do your job, lets you make loans to well-qualified builders who have good projects but are being held back today. And it is an issue I think we need to bring up in this committee to basically turn the economy around. And it is an issue I think is important to banks and to builders. I yield back. Chairwoman Capito. The gentleman yields back. Mr. Fitzpatrick for 1 minute. Mr. Fitzpatrick. Thank you, Madam Chairwoman. First of all, I want to say I am looking forward to being a part of this subcommittee in the 113th Congress. Among the important responsibilities of the subcommittee is to work with consumer financial institutions to find ways to provide credit for small businesses and families who inject capital into our communities. In just the first few weeks, this Congressman made a point to meet with representatives from some of the financial institutions that serve my district in Pennsylvania. On a recent conference call with community bankers, I was reminded again about the grinding process and progress of our economy and of the housing market, and how those factors more than any others are dragging our communities down and causing high unemployment in the communities. And of course, I heard about regulations and financial supervision, which are onerous and burdensome. We all agree that we need oversight and regulation of financial institutions. But the point is to be smart about it and not to stifle economic growth. And this is, of course, why we are here today. So I look forward to the hearing, and I yield back. Chairwoman Capito. The gentleman yields back. I believe that concludes our opening statements. So, I would like to welcome our panel of distinguished witnesses. My understanding is that Mr. Brown will give the statement from the FDIC, and then Ms. Eberley and Mr. Edwards will be here to answer questions for us. So, I appreciate that. I will introduce all three of you, and then let Mr. Brown make the statement. Mr. Richard Brown is the Chief Economist and Associate Director of the Division of Insurance and Research for the FDIC. Ms. Eberley is the Director of the Division of Risk Management Supervision, welcome. And Mr. Bret Edwards is the Director of the Division of Resolutions and Receivership. Welcome. Mr. Brown? STATEMENT OF RICHARD A. BROWN, CHIEF ECONOMIST, FEDERAL DEPOSIT INSURANCE CORPORATION, ACCOMPANIED BY DOREEN R. EBERLEY, DIRECTOR, DIVISION OF RISK MANAGEMENT SUPERVISION, FEDERAL DEPOSIT INSURANCE CORPORATION, AND BRET D. EDWARDS, DIRECTOR, DIVISION OF RESOLUTIONS AND RECEIVERSHIPS, FEDERAL DEPOSIT INSURANCE CORPORATION Mr. Brown. Chairwoman Capito, Ranking Member Meeks, and members of the subcommittee, I appreciate the opportunity to testify on behalf of the FDIC regarding the FDIC Community Banking Study. This research effort was begun in late 2011 to better understand the changes that have taken place among the community banking sector over the past quarter century. The effort was motivated by our sense of the importance of community banks to small businesses and to local economies in every part of the country, and by our understanding that community banks face some important challenges in the post- crisis financial environment. Our research confirms the crucial role that community banks play in our financial system. As defined by our study, community banks make up 95 percent of U.S. banking organizations. It has been mentioned that they hold 14 percent of U.S. banking assets, but make 46 percent of small loans to farms and businesses. While their share of total deposits has declined over time, community banks still hold the majority of bank deposits in rural and other non-metropolitan counties. Without community banks, many rural areas, small towns, and urban neighborhoods would have little or no physical access to mainstream banking services. The study identified 629 counties where the only banking offices are those operated by community banks. Our study examined the long-term trend of banking industry consolidation that has reduced the number of banks and thrifts by more than half since 1984. But the results cast doubt on the notion that future consolidation will continue at the same pace, or that the community banking model is in any way obsolete. Since 1984, more than 2,500 institutions have failed, with most of the failures taking place during 2 crisis periods. To the extent that future crises can be avoided or mitigated, bank failures should contribute much less to future consolidation. About 80 percent of the consolidation that has taken place has resulted from eliminating charters within bank holding companies or from voluntary mergers. And both of those trends were facilitated by the relaxation of geographic restrictions on banking that took place in the 1980s and the early 1990s. The pace of the voluntary consolidation has slowed over the past 15 years as the effects of these one-time changes were realized. The study also showed that community banks which grew prudently and which maintained either diversified portfolios or otherwise stuck to core lending competencies exhibited relatively strong and stable performance over time, including during the recent crisis. By comparison, institutions which pursued more aggressive growth strategies underperformed. With regard to measuring the cost of regulatory compliance, the study noted that the financial data collected by regulators does not identify regulatory costs as a distinct category of non-interest expenses. As part of our study, the FDIC conducted interviews with a group of community banks to try to learn more about regulatory costs. Most of the participants stated that no single regulation or practice had a significant effect on their institution. Instead, most said that the strain on their organization came from the cumulative effects of a number of regulatory requirements that have built up over time. Several of those interviewed indicated that they have increased staff over the past 10 years to support their responsibilities in the area of regulatory compliance. Still, none of the interview participants said that they actively track the various costs associated with compliance, citing the difficulties associated with breaking out those costs separately. In summary, despite the challenges of the current operating environment, the study concludes that the community banking sector will remain a viable and vital component of the overall U.S. financial system for the foreseeable future. The FDIC's testimony today also summarizes the congressionally mandated studies by the GAO and the FDIC Office of Inspector General. These studies provided valuable information on the causes of the recent crisis and the FDIC's response. The Inspector General also made several useful recommendations that are highly relevant to the FDIC's efforts to address the issues arising from the crisis. The FDIC concurs with all of the OIG recommendations, and is now in the process of implementing them. I am joined today by Doreen Eberley, Director of the FDIC Division of Risk Management Supervision; and Bret Edwards, Director of the Division of Resolutions and Receiverships, who can address your questions about how the FDIC is implementing these recommendations. Thank you for the opportunity to testify, and we look forward to your questions. [The joint prepared statement of Mr. Brown, Ms. Eberley, and Mr. Edwards can be found on page 62 of the appendix.] Chairwoman Capito. Thank you, Mr. Brown. Our next witness is the Honorable Jon T. Rymer, the Inspector General for the FDIC. Welcome. STATEMENT OF THE HONORABLE JON T. RYMER, INSPECTOR GENERAL, FEDERAL DEPOSIT INSURANCE CORPORATION Mr. Rymer. Thank you, Madam Chairwoman. Madam Chairwoman, Ranking Member Meeks, and members of the subcommittee, I appreciate your interest in the study conducted by my office as required by Public Law 112-88. I ask that the report entitled, ``Comprehensive Study of the Impact of the Failure of Insured Depository Institutions,'' issued on January 3rd of this year, be made a part of the hearing's official record. The report may be accessed at the following link: http://www.fdicoig.gov/reports13%5C13-002EV.pdf In the wake of the financial crisis of the 1980s, the Congress passed two laws: FIRREA, passed in 1989; and the FDIC Improvement Act, passed in 1991. These laws drove the closure and resolution processes used in the most recent crisis. Taken together, these laws amended the FDI Act and required, among other things, that: (1) financial institutions maintain minimum capital levels; (2) regulators promptly close critically undercapitalized institutions; and the FDIC resolve banks in the least costly manner. In response, banking regulators issued rules, regulations, and policies that pertained to many of the topics discussed in our report. In my time today, I would like to highlight the two overarching conclusions we reached, and then talk about four specific observations. The events leading to the financial crisis and the subsequent efforts to resolve it involve the dynamic interplay of laws, regulations, and agency policies and practices with the real estate and financial markets. Banks expanded lending using rapid growth in construction and real estate development. Many of the banks that failed did so because management relaxed underwriting standards and did not implement adequate oversight and control. For their part, many borrowers did not have the capacity to repay the loan, and sometimes pursued projects without properly considering risk. During the financial crisis, the regulators generally fulfilled their responsibilities by using risk-based supervision to react to a rapidly changing economic and financial landscape. Chairwoman Capito. Excuse me. Pull the microphone just a little bit closer. Mr. Rymer. Yes, ma'am. Chairwoman Capito. Our ears are getting old up here. Mr. Rymer. Yes, ma'am. That said, however, most material loss reviews conducted by the three banking regulatory IGs found that regulators could have provided earlier and greater supervisory attention to troubled banks and thrifts. The four specific observations I mentioned earlier are as follows. First, the FDIC's resolution methods, including the shared loss agreements, were market-driven. Often, failing banks with little or no franchise value and poor asset quality did not attract sufficient interest from qualified bidders for the FDIC to sell the bank without a loss share guarantee. The FDIC used these agreements to leave failed bank assets in the banking sector, thereby supporting asset value and reducing losses to the Deposit Insurance Fund, or DIF. Second, most community bank failures were the result of aggressive growth, asset concentrations, deficient credit administration, and declining real estate values. These factors led to write-downs and charge-offs on delinquent loans and non- performing real estate loans. Third, we found examiners generally followed and implemented longstanding polices related to problem assets, appraisal programs, and capital adequacy. We also found that examiners did not always document the examination procedures that they performed. And fourth, the FDIC has investment-related policies in place to protect the DIF, and to assure the character and fitness of potential investors. By their nature, such policies are going to impact FDIC decisions on proposed private equity investments. Finally, I would like to express my appreciation to the regulators for making their staffs and the information we requested readily available to us. I would also like to thank those in my office who contributed to this study for their dedicated efforts to comply with the law. That concludes my prepared statement. I look forward to answering your questions. Thank you. [The prepared statement of Inspector General Rymer can be found on page 84 of the appendix.] Chairwoman Capito. Thank you very much. And our next witness is Mr. Lawrance L. Evans, the Director of Financial Markets and Community Investment at the U.S. Government Accountability Office. Welcome. STATEMENT OF LAWRANCE L. EVANS, DIRECTOR, FINANCIAL MARKETS AND COMMUNITY INVESTMENT, U.S. GOVERNMENT ACCOUNTABILITY OFFICE Mr. Evans. Thank you. Chairwoman Capito, Ranking Member Meeks, and members of the subcommittee, I am pleased to be here this morning as you examine issues related to bank failures in community banking. Between 2008 and 2011, over 400 banks in the United States failed. Almost all of these failures involved smaller banks which had less than $10 billion in assets and often specialized in providing credit to local communities. My remarks today are based on our January report, and I will briefly share some of the key findings. First, failures of small banks were associated with high concentrations in CRE and ADC loans. These loans grew rapidly as a percentage of total risk-based capital and exceeded the regulatory thresholds for heightened scrutiny by a significant margin. Heavy ADC and CRE concentrations were often associated with aggressive growth, poor risk management, weak credit administration, and the use of riskier funding sources, namely broker deposits. Second, we found that fair value losses related to some mortgage-related assets were a factor in a limited number of failures. But overall, fair value accounting standards were not a major driver. In fact, our analysis found that most of the assets held by failing institutions were not subject to fair value accounting. The biggest contributor to credit losses at failed institutions was non-performing loans recorded at historical costs. However, declining collateral values related to these non- performing loans contribute to credit losses and surfaced issues between examiners and some bankers over appraisals and the classification of certain loans. Following accounting rules, regulators will require that impaired collateral dependent loans be written down to the fair value of the collateral. State banking regulators in bank associations we spoke with said that given the significant decline in real estate values, these impaired loans resulted in significant reductions to regulatory capital. Two State banking associations maintained that the magnitude of these losses was exaggerated or exacerbated by Federal bank examiners' adverse classification of performing loans, and by their challenging of appraisals used by banks. This is at odds with regulatory guidance issued in 2006 and clarified in 2009. Third, loan loss reserves were not adequate to absorb credit losses, in part because the current accounting model for loan loss provisioning is based on historical loss rates or incurred losses. As a result, estimated losses were based on economic conditions that understated default risk and led to insufficient reserving. This left banks vulnerable to the sustained downturn that began in 2007 as credit losses ate through reserves and depleted regulatory capital. A more forward-looking model that focuses on expected losses could reduce the need to raise capital when it is most difficult to do so and encourage prudent risk management practices. Accounting standard-setters are taking important steps in this direction, and GAO will continue to monitor development in this area. Fourth, driven by market conditions, FDIC resolved nearly 70% of bank failures between 2008 and 2011 using shared loss agreements to minimize the cost to the DIF. While estimated losses are expected to be roughly $43 billion, FDIC estimates that loss share agreements saved the DIF over $40 billion when compared to the estimated cost of liquidating the banks. Lastly, we found that the impact of failures on communities may have been mitigated by the acquisitions of failed banks by healthy institutions, although significant negative effects are likely in a few areas of the country. Bank failures, by their very nature, can impact consumers who rely on local banks through their effects on the costs and availability of credit. Our analysis of market concentration in geographic areas that experience failures found that only a few local markets raise these concerns. Some of these areas were rural counties which were serviced by one bank that was liquidated or where few banks remain. Our econometric analysis found that failing small banks extended progressively less credit as they approached failure, but that acquiring banks generally increased credit after the acquisition, albeit more slowly. Several acquiring and peer banks we interviewed in Georgia, Michigan, and Nevada noted that conditions were generally tighter in the period following the financial crisis, making it difficult for some borrowers to access credit, particularly in CRE and ADC markets. Econometric analysis also shows that on average, bank failures in a State were more likely to affect housing prices than unemployment or personal income. These results could be different at the local level and do not capture any changes in the patterns of lending or philanthropic activity that might be material for a community. That concludes my opening statement. I will be happy to answer any questions that you may have. [The prepared statement of Mr. Evans can be found on page 44 of the appendix.] Chairwoman Capito. Thank you. I would like to thank the witnesses. And I will begin the questions with Mr. Brown. We talked about relationship lending, how it defines what a community bank is, and how important it is to certain areas. I fear that as the CFPB drafts more regulations, this type of relationship lending will cease to exist. I am already concerned that the recent QM rule that the CFPB promulgated will be unworkable for many of our rural lenders. And they will get out of the mortgage business, which will cut out a lot of our constituents from being able to obtain a mortgage. What steps are you taking as a regulator to ensure that these rules are workable for smaller institutions? Mr. Brown. Madam Chairwoman, your sense of the importance of relationship lending to community banks is something that was borne out in our study. They do lending on a completely different business model in terms of how credits are evaluated, and I think that will remain their niche, their specialty in the future. That is the thing that our study points out to us most clearly of all. In terms of rules coming about through Dodd-Frank, there is concern that has been expressed by community banks in some of the roundtables that we have conducted and the interviews that we have conducted about rules in certain areas, including mortgage rules. And I think that there are some community bankers who have expressed that they might not plan to go on in those lines of business, depending on how those rules are promulgated. So I do think that taking care to make sure that those rules do not disadvantage community banks and their particular business model, their way of doing business, is something that is very important and that the regulators are taking into account as the rules move forward. I will allow my colleagues to chime in if they have something to add. Chairwoman Capito. Did you have a comment, Ms. Eberley? Ms. Eberley. Sure. We can just add that we did have the opportunity to consult with the CFPB on the rulemaking process. And we were able to share the concerns that we heard from community bankers through our Community Bank Initiatives Roundtables and other venues. And we do believe that had an impact on the final rule. Chairwoman Capito. Are you presently using the FDIC's Advisory Committee on Community Banking as a liaison to the CFPB? Is this an ongoing relationship? Or is this just kind of one phone call and then back to your relative responsibilities? There is an advisory committee on community banks within the FDIC. Are they coordinating with the CFPB and others to show the effects that these regulations are having on our smaller institutions? Ms. Eberley. Our Community Bank Advisory Committee does not coordinate directly with the CFPB, but they do inform us of concerns that we share with the CFPB. So we essentially serve as the liaison with the CFPB--between community bankers and the CFPB. Chairwoman Capito. Did you have a comment? Yes? Mr. Rymer. Yes, ma'am. I would just like to add one thing. We, at the OIG, do have some concerns. I want to make sure that there is not overlap between the FDIC's Division of Consumer Protection and the CFPB. Some of the initial work we will be doing in the Division of Consumer Protection will be to try to identify overlap. Chairwoman Capito. I welcome that. I think that was one of our ongoing concerns with the creation of the CFPB. At the beginning, it was supposed to rid the silos and all the prudential regulators were supposed to cede this authority. And I think in actuality that is not occurring, which bears out in your report. Let's get to the cost of compliance. I know it is hard to quantify. That is in your reports. But anecdotally, whether it is hiring a single compliance officer in the smaller institutions, maybe your chief lending officer, your HR person, your vice president for community affairs, whatever officers you have there, and having to devote more of their time to the issue of compliance, is there anybody at the FDIC who looks at, as the regulations come forward, the cost to the community institutions? Mr. Brown. During the process when the regulations are considered and promulgated, the FDIC solicits input from the industry on the costs of implementing the regulations. And also about alternatives, different ways that the regulations could be devised or implemented that could mitigate those costs. And so that is a dialogue that happens not just through our more informal processes such as our roundtables, and our Advisory Committee on Community Banking, but specifically during the rulemaking process. And we receive thousands of letters on that topic that are carefully considered during the rulemaking process. Chairwoman Capito. My last question--or my last comment because I have only 12 seconds left--would be that no new bank charters were chartered in 2012, according to the FDIC. We have seen all the closures. We have talked about how important to the fabric of lending to small businesses and farmers and the agricultural community and rural areas, and that these institutions do for our constituents. I would just launch a concern. When you see everything closing and nothing opening, that to me is a red flag which we need to monitor. And I hope that you will join us in that effort. I will now go to Mr. Meeks for questions. Mr. Meeks. Thank you, Madam Chairwoman. Let me start with, I guess, Mr. Brown. As I stated in my opening statement, that community bank study showed that community banks hold 14 percent of the Nation's banking assets, while they offer 46 percent of small business and farming loans. So would you agree that it seems as though community banks are playing an outsized role in terms of the impact on the economy? Please give me your thoughts on that. Mr. Brown. Yes. I think that is our clear sense. It was our sense going into the project that obviously small businesses are very important to job creation, creating two-thirds or more of new jobs. Small businesses were hit hard by the recession, and they depend on community banks as a source of credit. Surveys over time have shown that small businesses prefer to do business with small banks who understand their needs, can customize their products, that sort of thing. So, that tight connection between small businesses and and community banks was borne out, I think, by the data that you are citing. Mr. Meeks. And so now we are trying to make sure, I think, that we get this balance right with reference to regulation in this sector. Clearly, there is some compliance cost to regulation. But what would you think the marketplace looks like for consumers without regulations such as the Equal Credit Opportunity Act, or similar fair lending bills? Mr. Brown. Part of the stability of the banking industry is a regulatory environment that maintains safe and sound banking and that maintains fair treatment for consumers. The confidence that bank customers have in their institutions comes about in part because of standards that the institutions follow for fair business practices, disclosure, things that give consumers and borrowers confidence in that institution. And so, safety and soundness and consumer protection are really two sides of the same coin, and it is something that is a strength of the banking industry. Mr. Meeks. Let me ask Mr. Evans, one of the criticisms of the shared loss agreements, one of the shared loss agreements, really quick, is that banks are incentivized to dump assets which allegedly depress housing and commercial real estate markets. Did either the GAO study or the FDIC IG study turn up any evidence of that occurring, to your knowledge? Mr. Evans. I think-- Mr. Meeks. Mr. Edwards? Okay. Mr. Evans. The FDIC IG's study covered those issues in much greater depth. All we can say is what we heard. We talked to some banks and they were concerned that was occurring. But we also heard from acquiring banks who said something different. But that is about the extent of what we did in that particular area, so I guess I will just-- Mr. Meeks. Mr. Edwards? Mr. Edwards. Sure. Of course we are concerned any time we hear that. We believe the way we structure the agreements incentivizes the banks not to do that, and in fact there are a lot of controls in place, including regular compliance reviews by our contractors and our staff, to ensure that kind of thing is not happening. The premise for these shared loss agreements really was to allow the private sector, i.e., the banks that are acquiring these failed banks, to work these assets appropriately and maximize the value of the assets. And specifically, we have provisions in the agreement that if an acquiring institution wants to do a single note sale, they have to get our permission. And certainly if they want to attempt to do any bulk sales, they have to get our permission. But our intent was for them to work these assets, and we believe, especially early on in the crisis, that we did not want these assets put out for sale because we felt they were trading below their intrinsic value. Mr. Meeks. Have the shared loss agreements saved the Deposit Insurance Fund any money, and ultimately the taxpayers, over the course of liquidation? And if so, what is your estimate today? Mr. Edwards. The estimate is a little over $40 billion, as was noted earlier. And what that is, at the time that we do a cost test, when we bid the failed bank out, we are required under the statute to resolve the bank in the least costly manner to the DIF. So the baseline case is if we had to liquidate the bank, pay out all the deposits, and take all the assets back ourselves. That is one cost. That is generally the worst-case scenario. Any other deal we have, i.e., a whole bank transaction where we sell the failed bank to an acquiring institution with a loss share agreement, if that saves us money then we count that as a savings. So when you added up all the savings, it was about $40 billion, because liquidating a bank and paying out the deposits and putting the assets in the government's hand is always going to be the worst-case scenario. Chairwoman Capito. Thank you. I now recognize Mr. Miller for 5 minutes for questions. Mr. Miller. Thank you very much. I enjoyed your presentation today. If you look at 2008 to 2011, lenders went through a very, very tough time, especially rural banks. If you look at their AD & C loans, when the regulators were forced to apply mark-to-market and the SEC would not modify it, you put many of these loans in a poor asset quality category and they were forced to sell them off. It is sad because most of those loans are probably worth 3 times today in value than what they had to sell them off for, and it is really sad to see. But it doesn't seem like after the economy really got to where it was starting to pick up again, and builders were starting to build again, which is going to take builders putting houses out that will help the economy return, it doesn't seem like the banks are being allowed to make the loans they should. Mr. Brown, what is your assessment of the current state of lending for the construction industry today? Mr. Brown. Real estate construction lending has declined. The volume outstanding has declined quite a bit during the crisis. And the loan charge-offs in that sector have exceeded $70 billion since the end of 2007 to the present. So there have been heavy losses in that area really associated with the large declines in the market value of residential and non-residential real estate assets. Mr. Miller. No, I understand. That was what I said in my statement. We have gotten to the bottom. Those assets have been sold off. Those banks have taken a hit. Many of them are gone today. But the market is starting to build again. We are dealing with today. What do you see occurring today and in the future? We know it has been bad. We know it has been awful. We are past that. Mr. Brown. Right. We are seeing some rebound in prices in some of the formerly hard-hit markets like Phoenix, Las Vegas, and Atlanta, where we saw a double-digit increase according to the Case-Shiller Home Price Indices last year. But those market prices, those indices remain far below their peaks from before the crisis. Mr. Miller. Yes. But what we are seeing out there is the regulators are basically requiring banks to go above required capital as far as lending. If you take the system that they face today, say a bank had $50 million in deposits, required reserves of $1,500,000, they are not allowed to lend about $3 million to $800,000. And that is about--that is 100 percent, and it used to be 300 percent. Ms. Eberley, how would you say that is working today in the system? Ms. Eberley. In our guidance, we encourage banks to make loans to creditworthy borrowers, including homebuilders. And there is no prohibition on making loans in the Acquisition, Development and Construction sector. The thresholds that you cite, the 100 percent and 300 percent, appear in guidance that we issued in-- Mr. Miller. Well, 300 percent was before, but the regulators today are not allowing anybody to exceed 100 percent. And that is stifling the industry. Ms. Eberley. So we don't have any rules like that. Mr. Miller. But the regulators are--there are no rules, but the regulators are applying this in the banks. I have talked to too many banks that keep coming back and saying the same thing. And I think the regulators are being overly restrictive because of the market situation in 2008-2011, which I am not saying wasn't bad. It was horrible. Banks lost tremendous amounts of money. But you are seeing throughout different regions in this country that the markets coming back. People are buying new homes. When they buy new homes, the current value of existing homes is going up with them. But builders who have qualified credit and good projects can't get lenders to lend above this 100 percent because the regulators won't allow them to do that. Ms. Eberley. I can just tell you that we do not have a prohibition for institutions to make acquisition development loans above 100 percent of their capital. To the extent that you have an institution that is doing that or an examiner who is telling an institution to do that, we would of course be interested in hearing the specifics on that. Mr. Miller. I probably have a room full of bankers who can give you specifics on that. And that is the problem we are facing. It seems like we are forcing and mandating a restriction on lenders that currently does not exist in law. And I understand the regulators are being cautious because of what many banks went through. If we would have modified mark- to-market, a lot of those banks would still be out there today. If we would have modified mark-to-market and not forced them to take respective losses, many of those banks could have held those loans, and today, in a better marketplace, could have sold those off. I am not blaming you for that. We did nothing to modify it. I got language to the SEC to have them look at that issue and they came back and did nothing. So I am not blaming you. We didn't do our job to allow you to do your job. But what we are facing out there to ensure that bank examiners on the ground know that they are not empowered to enforce that I think is something we need to work on internally because it is occurring. There is no doubt that it is occurring. And there is no doubt that it is not restricted and regulated by law for them to do that. But when you look at the situation they were allowed, going to 300 percent of that and now they are forcing the 100 percent guidelines as a standard and not letting people exceed that. It is just something that I--we introduced a bill to directly deal with that. But it would be nice if you could internally look at that and understand that system doesn't work in a recovering market. And the market is recovering. I see my time has expired, and I thank the chairwoman for her generosity. Chairwoman Capito. Thank you. Mr. Watt for 5 minutes. Mr. Watt. Thank you, Madam Chairwoman. I am always interested in some of the unintended consequences of the decisions we make here. I noticed that Mr. Brown, and I think Mr. Evans, talked about how the bulk of the failures that we have experienced, or a large part of them, resulted from aggressive expansion. And I think Mr. Brown testified about a change we made in the law at some point which made it easier for community banks to expand by lifting geographic restrictions. First of all, Mr. Brown, tell me again what that change was and when we made it. Mr. Brown. Yes. Traditionally, there were restrictions on branching at the State levels. Some banks were in unit banking States. They really couldn't have branches. And those were relaxed at the State level in the early 1980s and early 1990s, allowing some banking organizations then to consolidate their charters and run them as branches. Moreover, restrictions on interstate banking at the State level were essentially undone or relaxed through the Riegle- Neal Act of 1994, and after that interstate banking became much more prevalent. And both of those deregulation events facilitated the consolidation of charters within bank holding companies and also voluntary mergers across State lines. Mr. Watt. And of course, I was here in 1994, so I am sure I supported that change. So, an unintended consequence of that is aggressive mergers, aggressive growth, and aggressive growth is what led to a number of the bank failures during the economic downturn. I want to pick up on that. Tell us again what part of these failures and forced consolidations resulted from larger banks acquiring or other banking groups acquiring those failed banks' assets. What part of that resulted, based on your study, from aggressive growth? Mr. Brown. First, it was really the non-community banks, the 558 charters in 2011 that did not meet our community banking definition. They held $12 trillion in assets. They had gained $6 trillion in those assets through direct acquisitions, almost 2,500 acquisitions. So, they really grew their share of industry assets to 86 percent through acquisitions and through retail lending and consumer lending for the most part. Community banks, on the other hand, tended to grow more organically-- Mr. Watt. And which ones of those had been community banks before that as opposed to the category that you just described? Mr. Brown. I am not sure if I have that information at my disposal. We probably could calculate it from the data that we collected. Mr. Watt. Mr. Evans, you referred to something called ``forward-looking'' rather than retrospective accounting. How would that look? What kinds of things are the accounting standards people are talking about that would allow us to be more forward-looking in the accounting principles that are applied? Mr. Evans. Right. So, instead of estimated losses being based on historical losses or losses that have been incurred to date, you would consider current market conditions and other factors-- Mr. Watt. How can an accountant do that? I guess I think of accountants as being--they keep track of the numbers as they are. What would be the theory on which an accounting standard change would address that issue? Mr. Evans. The accountant would be doing the auditing and the attestation. This is what bankers would be doing who have knowledge of what current conditions look like and what they anticipate going forward. It would be embedded in the updated standards that will allow them to do that. Mr. Watt. So you are talking about the audit standards as opposed to actual accounting standards then? Mr. Evans. That is right. [Mr. Evans submitted the following clarification for the record: ``This is an update of current accounting standards.''] Mr. Watt. My time is about to expire, so I will yield back. Chairwoman Capito. Thank you. Mr. Campbell for 5 minutes. Mr. Campbell. Thank you, Madam Chairwoman. I want to step back and do a little 20,000-foot kind of view here. It seems to me, and I will ask you to comment on this, that there are two problems facing community banks. One is the squeeze on margins, which has to do with monetary policy, which has nothing to do with any of you at that table or any of us up at this dais. And in recent testimony before this committee or subcommittee, other subcommittees that are a part of this overall committee, even those who advocate the current loose monetary policy would agree with it and admit that there is a tremendous pressure and squeeze on margins at the community bank level because larger banks can borrow from the Fed under the Treasury and make a spread that is completely without risk. And that is limiting margins at the community bank level. Then on the other end, we have this increase, although unquantifiable, so it seems. But this increase in cost at the community bank level due to regulatory restrictions. So, if you look at that, if you have declining margins and increasing costs, we see this reflected in very few new bank charters and consolidations at the community bank level. And so from where I sit I look and I say all right, we actually have a current regulatory environment that is damaging the very sector that we are supposed to be protecting, that is causing there to be a shrinkage and, sure, maybe not failures in the classical sense of failures, but a failure of the overall sector because they just can't make it with increasing regulatory costs and shrinking margins. Would any of you like to comment on that? Mr. Brown. The importance of net interest income to the earnings of community banks is absolutely an accurate assessment. We have looked at changes in their efficiency ratio over time, that is, the ratio of their overhead expenses to their revenues. And it has deteriorated over the last 15 years. But more than 70 percent of that deterioration came about due to a shrinking of net interest income. And only a small portion, 20 percent, came from higher expenses. Those are expenses of regulatory and non-regulatory. We can't separate those out. The community banks fund themselves through deposits. That is a very good funding model during periods of normal interest rates. High interest rates you can get some discounts there, but during a period of low interest rates, it is not necessarily the cheapest source of funds for them. Mr. Campbell. Other comments? Mr. Rymer? Mr. Rymer. Yes, sir. I would just like to point out that there is some cyclicality to this. Prior to the crisis, there was an extraordinarily large number of de novo banks, new banks formed. Unfortunately, I think the crisis certainly has dissuaded potential bank investors from investing in new banks at this point in the cycle. But prior to the crisis, particularly in Georgia and California, lots of new banks were formed. Mr. Campbell. Okay. So the monetary policy as we discussed the shrinking margins is the two-thirds or three-quarters of their problem. But the regulatory costs are still part of the problem. Do you all believe, and I only have a minute or so left, that we can--I could rattle through, they are all in here, all the different regulations that we have passed just in the last 10 or 15 years, many of which are overlapping or duplicative. Do you all believe that we can relieve this regulatory--that there is a way to pull this stuff back in order to give some relief to this sector so that the regulation isn't forcing the sector down without adding significantly to the failure risk? Ms. Eberley. I might just say that what community bankers have asked us to do is to help them in understanding the regulatory environment and framework. So through our Community Bank Initiative, there were a couple of very specific requests that were made for us to help reduce burdens at community banks. One was to increase our outreach and training. Our Director's College Program and other outreach was cited as being very valuable to bankers. They use it to help train their staff, make sure their directors understand their roles and responsibilities. And they have asked us to expand those opportunities where possible, including the ways that deliver the programs. And so, we are working on that. The second was to give them line of sight for the regulations coming down the pike. So what is out there, what is proposed, does it apply to them, how would it apply to them. And we have developed a Web-based tool to bring all of that together and help community bankers gain an understanding. Mr. Campbell. Thank you. My time has expired. Chairwoman Capito. Thank you. Mrs. McCarthy for 5 minutes. Mrs. McCarthy of New York. Thank you. And thank you for having this hearing. I find it fascinating. I want to follow through a little bit with what Mr. Miller had started to talk to you about. We have been looking at the GAO report and we know that many residential builders in this are small businesses owners who rely on the community banks to finance their acquisition, development, and construction activities. The financing options are tight and sometimes nonexistent that we have seen, and I have seen it in my own area in New York. But looking at the GAO report, commercial AD & C financing combined with weak underwriting, insufficient capital, and high concentration have proven to be risky and have led to some bank failures. If the oversight and the prudent management were in place, what, if anything, could make commercial AD & C loans risky? Ms. Eberley. What makes acquisition, development, and construction loans risky is the length of time before the project comes to completion and it is the risk of economic changes during that time when the construction is taking place. But you raised a couple of interesting points. Our Inspector General conducted an evaluation and issued a report a little bit earlier this year that covered institutions that did have concentrations that exceeded the thresholds that are included in our regulatory guidance, at which point we expect heightened attention and risk management practices by institutions. And so, there were institutions that exceeded these thresholds, but weathered the crisis in good shape. There were other institutions that got into trouble, but managed their way back out without failing. And the principles that you outlined were the ones to which they actually adhered. They had strong risk management practices in place. They paid attention to market fundamentals, and when their market appeared to be overheated, they pulled back. And they had strong board governance around their credit administration practices. So those were the things that made a difference for institutions that were concentrated at high levels that made it through the crisis okay. Mrs. McCarthy of New York. From what I understand, obviously with the commercial loans the banks took, which are usually higher amounts of loans and there is a certain limit on what banks would possibly put out there for what they might consider a risky loan, that kind of left our smaller residential builders with no place to go. Am I correct in interpreting it that way? Ms. Eberley. I am not sure I understand your question. Mrs. McCarthy of New York. From what I understand, the bank has a--if they are going under risk management and if they are looking at how many loans they have out there and they have a lot of commercial loans, which usually are large pieces of property, more expensive to build. And if they start to go under, as we saw going back a few years ago, there wasn't any money left over for the small businesses. That is what we are trying to look at, how we can make sure our small businesses that are residential builders, that don't need as much money as the commercial. And once they reach that limit, there was nothing left for the small businesses to get. Ms. Eberley. Again, I would just say that our guidance doesn't set limits on commercial real estate lending or acquisition, development, and construction lending. It sets thresholds beyond which we expect institutions to have heightened risk management practices. So that means our expectations about how the banks are going to manage that portfolio, we expect to see more due diligence around it. We expect to see greater levels of understanding of the marketplace fundamentals, monitoring of the marketplace fundamentals, stress testing of the portfolio to determine impacts on capital or borrowers, or changes in interest rates or changes in economic fundamentals. So, that is our expectation. We don't place limits on the amount of lending an institution can do in a portfolio like that. Mrs. McCarthy of New York. I have a few more questions, but I don't think I can get them answered in 46 seconds, so I yield back. I will ask for written responses to my-- Ms. Eberley. Oh, certainly. Certainly. Chairwoman Capito. Mr. McHenry for 5 minutes. Mr. McHenry. Thank you. And I want to thank all of you for your service to our government and to our people. Now look, I have met with a lot of community bankers, as most members of the committee have. And they tell me stories about an inconsistent, overly stringent examination process; that this is a hyperreaction by the FDIC to the crisis, an overreaction, in their words. Now certainly, they are regulating, but it is consistent with the FDIC study that we are talking about today. You have also reached out to various consultants and contractors for these community banks. And I know the FDIC is in an ongoing process of doing that. But I wanted to share with you a couple highlights of criticisms of the FDIC that I have which they don't receive: ``We have received examination criticisms that were inconsistent with what prior examiners found, inconsistent with what was found in prior examinations by the same examining body, and inconsistent with guidance from our regulator. The inconsistency of the examination has made it extremely difficult for us to understand what is expected of us and to comply with expectations of our examiners.'' Another one, ``My financial institution has not tried to appeal a decision from our regulator. The appeals process does not appear to us to be independent. The appeals process appears to be similar to being bullied in elementary school and your only appeal is to the bully's mother.'' ``Typically, in the past, if the examiners found areas of concerns they would identify the area of concern and make suggestions on how to improve in these areas. Now minor infractions are met with severe criticisms and/or penalties.'' Likewise another one, ``Our exam this past summer was a dual exam. The exam included compliance, CRA, and fair lending. The exam lasted 4 to 5 weeks, and the number of people ranged from six to eight. We had an excellent rating prior to this exam. The compliance examiners came in with unlimited budgets and correspondingly unlimited time to search our files for errors to prove exactly what?'' I had another banker say that your agency used to be one to fix problems and to repair wounds, but that has changed to a mindset of bayoneting the wounded. Now, I understand there is a reaction to lax exams prior to the crisis. But this overreaction leads me to ask one simple question. I will begin with you, Ms. Eberley, because exam process is certainly key to this. How are community banks expected to exist under this hostile regulatory environment? Ms. Eberley. I would start by saying that we expect our examiners to examine banks in a fair and balanced manner, and to remain professional throughout all of their dealings with institutions. I take great pride in the professionalism of our examination staff and I do believe that we have a number of programs in place to ensure that we have consistency on a nationwide basis. We have a national training program for examiners and a stringent commissioning process. We undertake internal reviews of our examination program through each of our regional offices. And we engage in extensive-- Mr. McHenry. So things are good? Ms. Eberley. I would just tell you that we work very hard to-- Mr. McHenry. No, I appreciate you working very hard. I acknowledge that. And I certainly appreciate your service. But these are the criticisms I am receiving and I am hearing. Are they wrong? Ms. Eberley. They have not come to me. I would ask that-- Mr. McHenry. Right. So they are going to come to the regulator. They are going to come to, in these words, this appeals process which they think doesn't work. Let me just ask another question. At the November meeting of the FDIC Advisory Committee on Community Banks, there was a question on the ongoing examinations and reports and after- examinations. Have you implemented any policies or procedures to improve this process? Ms. Eberley. We have undertaken a number of initiatives. We did engage in training with our entire examination workforce in 2011, I believe, about the examination approach. In terms of communication with institutions, we issued a Supervisory Insights Journal article last year talking about the risk management examination process and what bankers should expect in terms of communication throughout the process. We issued a financial institution letter in 2011 reminding bankers about examination processes again, and the appeal programs. We do encourage institutions to try to resolve issues while the examination is open, with the examiners. But if that can't be done, we can disagree professionally. And we encourage bankers to talk to us. We don't know that there is a problem unless there is a communication of the issue. And so they can talk to the field supervisor, regional office management, and me. I have a dedicated mailbox that is listed out in that financial institution letter. One of the things that we are going to do through the Community Bank Initiative Project is institute an information packet, essentially, for community banks that will be mailed out to all of the community banks that we regulate, reminding them about all of these processes and encouraging them to take advantage of the process. I mean that with all sincerity that we want to communicate. We want to know if there are issues. And we want the opportunity to fix them if that is the case-- Chairwoman Capito. I am going to step in here, because the gentleman's time has expired. Ms. Eberley. I apologize. Chairwoman Capito. And we will move on to the next questioner, Mrs. Maloney. Mrs. Maloney. I would like to thank Ranking Member Meeks and Chairwoman Capito for calling this really important hearing on the status of community banks in our financial system and its service in our communities. I am pleased to have joined Mr. Westmoreland in support of his two studies, and in support of really looking at ways we can help community banks. They are critical. And I would say regional banks too. They are critical to our financial system, and really unique in America. In many of the foreign countries, they have very large banks. They don't have community banks. And my first concern was on the Basel III capital requirements. Chairwoman Capito and I wrote a letter to the regulators, Mr. Bernanke, Mr. Curry, and others, expressing our concern that the requirements for international global banking, huge banks, were the same for the community banks. Community banks are not involved in global financing. And the requirements in Basel III, according to many community banks in the district I am privileged to represent, would force them to merge or literally go out of existence. So I am going to be reworking this letter. I would like unanimous consent to place it into the record. Many Democrats have come to me and asked to go on it. Since we already sent it out, I think we should work on another, so that others can express their concern. And so I ask-- Chairwoman Capito. Without objection, it is so ordered. Mrs. Maloney. I also want to reference the chairwoman's mention about how important community banks are to rural areas. I would say they are just as important in urban areas. During the financial downturn, when many of our extremely important financial institutions that were larger were facing great stress, the only service that was there for the community in any type of loan and bank processing were regional and community banks. They would continue to do the mortgages. They would continue to do the small loans. So they are absolutely critical to our banking system, and to services in many areas. Constituents would come to me and say, ``My rating is perfect, I am making zillions of dollars, but I can't refinance my home, I can't take out a mortgage. What do I do? I have been to every major bank in New York.'' I would say, here is a list of community banks, regional banks, try them. And they would be able to get the services they needed. So I think that supporting them is very, very, very, very important. And in that vein, the chairwoman and I introduced a bill last year that responded to some of the concerns that community banks brought to our attention. And we are working on reintroducing it over this break. I hope that our staffs can meet with the FDIC. The FDIC was not supportive of the bill. I am very supportive of regulators. And I certainly want regulators to support efforts that we have. And we need to do it in a reasonable way. But one of the areas was the appeal process where they feel that their appeals are not listened to, they are not taken into consideration. And often I feel a disconnect when I talk to regulators, whom I respect. They say, we are there, we are helping, we are doing everything. And then you talk to community banks that because they are in the community, you know what they are doing, you know them, they know all the communities, just really know your customer. They know your customers and the customers know them. And they were saying that they did not feel that their appeals were listened to or that they were treated fairly. I feel that this is an area where we have to work together to make it work better. We are unique in having the community banking system. It is not the same in Europe. And that is why Basel III is not sensitive to the community banks. I personally think that community banks should be exempted from the Basel III requirements or have a different standard because they are not global competitors. They don't need to have the same standard as a global competitor. They are not global competitors. They are community banks helping communities. I just have great respect for them because they are there for the communities I represent. And people tell me, thank God for bank such and such, a little community bank that was there to help them. So, what my basic question is that I would like to submit to the FDIC, and I see the panel is basically all FDIC primarily, the bill that we did, and have your input on it. Because I think that we do need to have some relief for the community bankers. And my first question is on Basel III. Chairwoman Capito. Your time has expired. Mrs. Maloney. Okay. Anyway, I will give you a copy of it and the letter and I would love to see any comments that you have. But I think this is a very important hearing. I want to thank the ranking member; I know he pushed hard for it, and thank the chairwoman for having it. Chairwoman Capito. Thank you. Mr. Fitzpatrick? Mr. Fitzpatrick. Thank you, Madam Chairwoman. I will actually follow up on that question and ask Mr. Brown or Ms. Eberley, do you agree with the gentlelady's assertion or question that community banks should be exempt from Basel III? Ms. Eberley. I would say that we received more than 2,500 comments from community banks about the Basel III and the standardized approach capital rulemakings that we put out for a notice of proposed rulemaking. We are in the process of considering those and take very seriously the comments and concerns that community banks have raised. It is not our intent to have an unintended consequence on the community banking-- Mr. Fitzpatrick. So what are those comments indicating? And what is your position on that question? Ms. Eberley. We are in the rulemaking process, so we can't talk about our position. But the comments that have been raised fall into three areas primarily. One has already been mentioned, and it is the implications for mortgages. It is the risk weighting for mortgages through the standardized approach. Another is the treatment of trust preferred securities. And a third would be the treatment of accumulated other comprehensive income, which is a fancy way to say depreciation or appreciation on securities. So, those were the three primary issues that were raised. We are taking all of the comments into account. We are reading every comment letter and working with the other agencies as we go through the process to come up with a final rule. Mr. Fitzpatrick. Mr. Brown, you indicated in your written testimony--I think you may have been quoting the FDIC community banking study--that the surveys of the community bank presidents indicated that it wasn't a cost of any single regulation that was going to break the bank, but that it was a cumulative cost of everything put together, which is exactly what I am hearing from the community banks in my district in Pennsylvania, especially around Bucks and Montgomery Counties. They are saying that they have to hire compliance people that they didn't have a couple of years ago, they need to train their employees. They are now responsible for outside consulting fees, bringing folks in, increased costs of both internal and external auditing. And of course, all this is taking away from their ability to make the loans and their ability to have the capital to make those loans. It is a distraction. What is your plan over the course of the next year to address those issues? And when might this subcommittee hear back on that plan? Mr. Brown. Our entire Community Banking Initiative is designed to learn more about these issues. Those were some of the things that we have learned thus far. And on the supervisory side, to try to address them through some of the technical assistance and other initiatives that Ms. Eberley has described thus far. Ms. Eberley, I don't know if you want to elaborate on some of the steps in the Community Banking Initiative that we are undertaking. Ms. Eberley. The ones that I mentioned were bankers who did ask us for more technical assistance. They expressed that they valued the director's colleges that we put on. These are training sessions that we offer through trade associations in each of our regions for bank directors to participate in and learn about emerging issues. We host teleconferences. We have had workshops where we will focus on a specific topic like allowance for loan and lease losses, and troubled debt restructuring. Those have received high praise. And we have been asked for more and we have committed to do more. We are trying to look at ways to make those offerings available more broadly, like a Web-based offering so that it could be available on-demand, in order to provide that kind of training so that institutions don't have to rely on outside assistance to get that. Mr. Fitzpatrick. Is there a specific work plan for this year, for 2013, to address the cumulative impact of all those regulations on community banks? Ms. Eberley. The specific work plan that we have in place is geared toward the technical assistance offerings, and we do have a work plan, yes. Mr. Fitzpatrick. I agree with what Mrs. Maloney indicated that during those very difficult economic times this past couple of years, it was community banks that were literally holding the communities together. They were the ones that were making the mortgage loans. They were the ones making the small business loans. What do the statistics show during those last couple of years in a number of those small community banks, the charters have gone out of business versus new startups? Are we seeing more community banks go out of business and fewer starting up? Ms. Eberley. We have seen that. And that is consistent with the economic cycle. We saw it during the last crisis as well. We are starting to hear discussions from consulting groups that are representing groups of organizers that are interested in chartering community institutions. Mr. Fitzpatrick. What are you doing to encourage more charters? Ms. Eberley. To encourage more charters? We are open to receiving applications for deposit insurance. It really is more of an economic fundamental and we are waiting for groups to come forward. We try to be supportive of the banking industry through our Community Bank Initiative and our other outreach efforts. Chairwoman Capito. Thank you. The gentleman's time has expired. Mr. Scott for 5 minutes. Mr. Scott. Thank you. Let me start, first of all, because my colleague from Georgia, Congressman Lynn Westmoreland, and I put forward a very important bill that I think you all are aware of. Are you not? You are not aware of the bill we put forward? I certainly hope that you will soon become aware of it because you all are the source of this bill. I am surprised that you do not know of our work, which begs the question as to why community banks might be suffering unnecessarily. Just to refresh your memory, Congressman Westmoreland and I represent the State of Georgia. And Georgia has unfortunately led this Nation in bank closures. Many of us feel that some of those bank closures were not necessarily caused by the external strong winds of the economy, but in many respects by not the proper type of regulation, perhaps overaggressive regulations. In other words, we wanted to find out why these banks failed. And you all play a very important role in that. So you can see why I am very disappointed that you all have no idea of this law and this bill that we passed. Let me refresh your memory just for a second to explain to you what it is so you understand my very serious disappointment. We introduced Public Law 112-88 to address the concerns that our constituents in Georgia have that they are facing not only more regulations, but more aggressive enforcement, not being sensitive to those situations. They have had increased costs unnecessarily. So we wanted to take a look at it, and we directed the Office of Inspector General of the FDIC--are you here? Mr. Rymer. Yes, sir. I am right here. Mr. Scott. All right. So this law affected you. And the GAO, are you here? Okay. To thoroughly study, which obviously you have not done, and report on a wide range of policies and procedures used by the FDIC in its supervision of troubling and failing institutions. We specifically instructed you to address the following: the effect of loss sharing agreements; the significance of losses; the consistency of procedures used by examiners for appraising collateral values; the factors examiners consider when assessing capital adequacy; the success of FDIC field examiners in implementing the FDIC guidelines for commercial real estate workouts; the impact of cease-and-desist orders on troubled institutions; the FDIC's procedure for evaluating potential private investment in insured depository institutions; and the impact of the FDIC's policy on private investment in insured depository institutions. This is serious. Our community banks deserve better. They only control 14 percent of the total banking assets in this country. But yet they account for 46 percent of all of the small business loans, all of the farmer's loans. So you can see why this is serious business to us in Georgia. And we don't just sit here to pass these laws like this that are directed towards you to respond to. And so I certainly hope, with all due respect, that you will find the time to look at the legislation that my colleague, Mr. Westmoreland, and I worked so feverishly on, and to try to examine. I yield back, Madam Chairwoman. Chairwoman Capito. The gentleman yields back. I ask unanimous consent to insert into the record a letter from the National Association of Federal Credit Unions. Without objection, it is so ordered. Mr. Westmoreland for 5 minutes. Mr. Westmoreland. Thank you, Madam Chairwoman. And I want to personally thank Mr. Edwards and his staff for the accessibility that they have given me and my office to address our constituents' questions and concerns. We haven't always agreed, but we have had some great conversations. And I want to thank him publicly for that. Ms. Eberley, let me say that I got a call from one of my community bankers who said he had been in the banking business for 35 years. He is going through an examination. He said he had never really had an examination like this that was more nitpicking, with incompetent regulators. Yet, he did not want to come forward because of fear of retaliation. And so, I think that is something that you need to look at. And the fact that this bank is finally making money, but it said it seemed like the regulators wanted to look in the rearview mirror rather than looking forward into what they had done to actually begin making money in saving their bank. So-- Chairwoman Capito. Will the gentleman yield? Mr. Westmoreland. I will. Chairwoman Capito. I want to underscore what he is saying because I think it is a very serious issue. And when I would talk to banks, and as I understand it we cannot appeal to you for an individual bank, we can only appeal in a policy way, that is why we wrote our letter, or rather our bill. Many of them would say they couldn't appeal because they were afraid of retaliation. They feel that if they raise something, they are going to be punished. And I think we have to get rid of that. Anyway, I yield back. Mr. Westmoreland. Yes, but-- Chairwoman Capito. Your point is a very important one. Mr. Westmoreland. Reclaiming my time, I guess this would be to Mr. Brown or anybody from the FDIC who wants to take it. Coming from the State of Georgia, and even despite the crisis that we have had, we are still one of the fastest-growing States in the Nation. And to accommodate that growth, it is important that we do have the financing in place to develop real estate. Leading up to the downturn, the community banks, as you probably know, paid the largest amount of attention to being able to lend so we could develop. But because a lot of these real estate loans tanked, the economy tanked. They were having to write down these loans immediately, and acquire more capital, which was hard to do. But the studies showed that the construction activity is essential to economic activity, and I think Mr. Evans will agree with this, in your community. It is certainly true in my district. And the further research--you have to establish a balance between the social benefits and the social costs of the commercial real estate. We are beginning to see the first signs of some new construction activity in my district. And my fear is that the examiners will not allow these community banks to participate in this economic comeback that we are having in Georgia, especially in my district. So, could you describe any new guidance that you might have that you could provide to these banks to help them, and to give us the assurance that they can get back into this type of lending? Ms. Eberley. I think that probably falls more in my camp. We don't have any new guidance planned, but I would say that the existing guidance that we issued throughout the crisis stands. And we have encouraged institutions to make loans to creditworthy borrowers. We have issued a couple of different statements in that regard, in addition to encouraging institutions to work out credits with troubled borrowers. So, we keep repeating that. I can reemphasize it with the staff in the Atlanta region, and I am happy to do that, and in fact the staff nationwide. But that is our policy. Mr. Westmoreland. Thank you. The other thing I hope that you all will look at is the appraisal situation, because if you look at the loss share banks and they get an appraisal, it is far lower than what a non-loss share bank appraisal would get because that means that loss share bank would get more reimbursement from the government, which is really costing the taxpayers money. And we have appraisal problems that go far beyond that, though, in the fact that we are now having to use appraisers from different parts of the State. As you know, real estate is location, location, location. And if these appraisers aren't familiar with the location and the benefits that it has, then they really can't do a firm appraisal. So I hope that the FDIC in total will look at the appraisal process and some of the problems that are coming from it. With that, I know I am over my time, and I yield back. Chairwoman Capito. Thank you. Mr. Green for 5 minutes. Mr. Green. Thank you, Madam Chairwoman. And I thank the ranking member as well. I think this is a very timely hearing. I thank the witnesses for appearing today. We all have community banks in our districts, and sometimes we call them neighborhood banks. They are referred to as small banks. We have many names, and I am not sure that we all have the same thing in mind when we use this terminology. So let me, if I may, bring us to a more mundane question. There are a lot of lofty ideals to be considered today, but there is something as simple as, how do you define a community bank so that I may understand that you and I are thinking of the same institution when we use the terminology? Mr. Brown, you have said that they have created a niche for themselves. You indicated that they have a different business model. So would you kindly give us your definition of a community bank, as we have been discussing things today, please? Mr. Brown. Yes, Congressman. Previous studies have tended to just rely on asset size as a definition of community banks. We thought that did not quite capture their nature as relationship lenders. Mr. Green. Let me quickly intercede and ask this: In terms of asset size, because that was one of the things I was going to inquire about, what is the asset size of a community bank? Mr. Brown. Many studies use an asset size of $1 billion and below as the definition of a community bank. But we went beyond that to look at their lending and deposit gathering activities, and the scope of their geographic footprint to try to come up with a better definition of a community bank. Mr. Green. Could you give us a little bit more information on it, please? Mr. Brown. Yes. We excluded institutions that had no loans, no core deposits, that were specialty banks or that had foreign operations greater than 10 percent of assets. We then included institutions that had loans to assets greater than a third of the portfolio, core deposits greater than half the portfolio, had fewer than 75 offices, no more than 2 large metropolitan areas where they did business, and no more than 3 States where they did business, and no single branch more than $5 billion. So, these tend to look at the activities of the institution, look at the geographic spread of the institution, and try to capture its local nature and its relationship nature through those attributes. Mr. Green. Would anyone else like to comment on the definition of a community bank? Or have you all agreed that this is the definition that we should work from? Thank you. It is nice to see that there is agreement on something today. I will be meeting with community bankers. And I, like other members of the subcommittee, hear quite regularly this notion that we are inundated with paperwork; and I am simplifying what they say. Permit me to ask you to tell me what I should ask them when I talk to them, given that they will surely bring this up. I plan to have them take me through the bank, show me whatever it is that they want me to see, because I want to clearly hear and understand their side of this. When they come into my office here in Washington, D.C., we have extensive conversations. But I think it is time for me to go out and have a firsthand look at community banking. And I have asked that this be accorded me. And I have been told that this is something that I can do. So, what should I ask? What should I say to them pursuant to what the regulators think? Here is something that I would like for you to explain to me. Mr. Brown. In the roundtables conducted as part of the FDIC Community Banking Initiative, we talked to the bankers about their view of the future of the industry, its future viability in their mind, its connection to small business lending, how they view their niche in the financial industry, and also how they view loan demand, how their customers are doing, and how the state of their customers has changed over the course of the recession. In addition, we talked a lot about the regulatory side, some of the concerns they had about regulation and about their perception of the cost of regulation. Those are very important issues. Mr. Green. With the little time that I have left, about 29 seconds, what is the smallest bank that we have? How many employees does the smallest bank have? Ms. Eberley. I believe I am aware of a $4 million institution and it has 4 employees, I believe was the number. Mr. Green. Four. With four employees, is Basel III or let's just say a small number of employees, is it difficult to comprehend and work through these regulations when you have few employees? Let's not use a number, but few? Ms. Eberley. That is certainly what bankers have told us, that it is the breadth of regulatory requirements and rules and regulations that is very difficult for them to absorb. And they have asked for our assistance. Mr. Green. Do we have a means by which we can accord assistance to these banks such that they know that there is a space or place that they can tap into? Ms. Eberley. Yes. We have established a Web tool to help institutions manage rules and regulations that are coming down the pike. And we have also committed to expanding our educational offerings for community banks to assist with training on existing rules and regulations. Mr. Green. Thank you, Madam Chairwoman. I will yield back, and simply say that I will probably have more questions after I have talked to my community bankers. Thank you. Chairwoman Capito. Thank you. Mr. Duffy for 5 minutes. Mr. Duffy. Thank you, Madam Chairwoman. I would join Mr. Green, Ranking Member Meeks, Mrs. Maloney, and Mr. Fitzpatrick in piling on my concern with Basel III. I, too, hear constantly from my community banks what impact this potential rule will have on them. And I guess first off, do we have a timeline of when we think the rule is going to come out? Ms. Eberley. We are working diligently with the other regulators to finalize the process as soon as possible. We know what the uncertainty of delays means to institutions. Mr. Duffy. Do you have anything more specific than, ``We are working on it?'' Ms. Eberley. I do not. Mr. Duffy. Fair enough. And I know you are not going to comment on the rule. I think it was Mr. Fitzpatrick who talked about exempting our community banks, which I think is reasonable. But if it is not an exemption, maybe a tiered structure would at least be considered for smaller community banks. Just one other point: if you look at the conversation we are having today, the difficulty of our community banks with the burdensome regulations that are being piled upon them, and we look forward to Basel III and QM, the burden isn't getting lighter. It is getting heavier. And so hopefully, you will all take that into consideration as we try to make sure we have a structure in place that allows a healthy and vibrant community bank structure across the country. So, I didn't want to pile on, but I guess I did. I want to quickly move over to new charters. I know it was touched on, I think by the chairwoman. But listen, we haven't had any new charters in 2012, right? In 2011, we had three, and in 2010, we had nine. So as we move away from the financial crisis, we did have a bottom and then it started to recover. We actually have continually gone down since the crisis. Is there an explanation for why that is taking place, why we haven't bottomed out and come up since the crisis? Ms. Eberley. I would say that the industry lags the economy, in terms of its overall condition and performance. And so I think that is what you are seeing is that we have hit zero. And we would anticipate that we would move up from here. As the industry is starting to improve, we would expect to see additional activity or new activity. Mr. Duffy. And if you look at the recession in the early 1990s, we never bottomed out--never came to zero. Maybe there is a difference between a recession and a financial crisis. Is that the answer? Mr. Brown. Yes. Just that the new charters have always been highly cyclical. This has been a particularly severe cycle with regard to the effect on the financial industry and their customers. And so, I think that explains some of the severity of the cycle. There were nearly 5,000 new charters for the industry during the period of our study, and we anticipate that chartering activity will pick up with the economy and with the recovery of the industry. Mr. Duffy. So do you think it is more the cycle in a crisis as opposed to the new rules and regulations that have come from Dodd-Frank and others? Mr. Brown. Our experience through history is that it has been highly cyclical. So, we would anticipate a rebound. Mr. Duffy. But is it this cyclical in the sense that when we are 4 years, 3 years from the crisis we have not started to recover and come up, we are actually still going down? Mr. Brown. As was indicated, the performance of the industry tends to lag the recovery of the economy. The recovery of the economy itself has been somewhat muted, again, going to the severity of the financial crisis. Mr. Duffy. Okay. And I wanted to give a few minutes or a minute-and-a-half back to the gentleman from Georgia. So I would yield my time to him. Mr. Westmoreland. Thank you for yielding. Let me say that I think Basel III would be the last nail in the coffin for a lot of our community banks. So I hope you will take that into consideration. Mr. Evans, in your report you noticed what I have been saying for a while, that some of the acquiring banks had driven down the real estate values by selling at depressed prices. Do you see that the FDIC can handle what I am anticipating is a second wave of this, when these loss share agreements expire? If they are not extended for some point in time, there is going to be another selloff, which will depress the markets even more, which would cause even more community banks to fail. Mr. Evans. Thank you. We did hear from one bank who expressed those issues. We also, I should point out, heard from other acquiring banks who said the loss share agreements gave them time to work out loans. And so, I think the verdict is still out; more work needs to be done to try to figure this out. Certainly given what we have heard, it is something that you might want to consider looking into in greater depth. Mr. Westmoreland. I yield back. Chairwoman Capito. Thank you. I would like to welcome to the subcommittee a new member, and recognize him for questioning, Mr. Heck from Washington. Mr. Heck. Thank you, Madam Chairwoman, very much. I believe this question is most appropriately directed at Mr. Edwards. Sir, could you, as succinctly and clearly as possible describe for us, help us better understand the division in decision-making responsibility and authority when it comes to the acquisition of a failing bank, between headquarters and regional offices? As you might imagine, that question stems from circumstances in the congressional district I have the honor to represent, where the decision-making process kind of went on and on. And losses mounted. And when finally it came down and it was never clear where the decisions were being made, the evidently self-qualified local investors took a walk on the 70 stipulated new conditions. So, help us describe that division if you would please, sir. Mr. Edwards. Sure. And I will ask Doreen to pipe in as well. So, when somebody is trying to be qualified to bid on a failing bank, they have to go through the Division of Risk Management Supervision and get approved to bid. I will let Doreen describe how that works. But essentially, they have to be in good financial shape and they have to be deemed to be qualified to take that failing bank over and be successful. Otherwise, we wouldn't want that transaction to go forward. Doreen, do you want to add to that? Mr. Heck. And that is done at headquarters? Ms. Eberley. No. The process is handled in the region. Essentially for an institution to be on the bid list for a failing bank transaction, we have to be able to know ahead of time that we can resolve the statutory factors that would be required to be considered for a merger transaction-- Mr. Heck. So the regional offices are the ones who make the decisions, not here? Ms. Eberley. The regional-- Mr. Heck. Is that correct? Ms. Eberley. Right. The regional office-- Mr. Heck. Including the formulation of new conditions or conditions, is that made at the general office? Ms. Eberley. Yes. For an institution to become listed on the bid list and be able to participate in a failing bank transaction, that happens at the region. So, other transactions occur as well on an open bank basis. And those considerations may involve the Washington office on a parallel basis in considering things like change of control of an institution that is open and troubled before failure. Mr. Heck. So there is a division of responsibility? Ms. Eberley. For certain transactions, yes. That is an open bank transaction for a recapitalization of an institution through a change of control. Mr. Heck. And then that decision is made here? Ms. Eberley. It is not made here. There is discussion back and forth. There is consultation. Mr. Heck. Between corporate headquarters, as it were, and the regional bank? Ms. Eberley. Yes. Mr. Heck. I see. I don't know to whom I should ask this question, but I am trying to put myself in the shoes of a community banker who is running a pretty well-run shop and is looking at admittedly the fairly low cost of money right now that he or she has to pay to depositors, and looking forward at the prospect, which seems to me to be inevitable that interest rates will rise again. And I am wondering if you agree that, in and of itself, was an inherent impediment to aggressive loaning for what would otherwise be qualified borrowers insofar as the amount of money you lock in long-term and low-cost returns, confronts a changing interest rate environment you may be stuck. And I guess as a part of that question it makes me wonder when you evaluate bank portfolios, what is your forecast, what is your outlook for the interest rate environment? Mr. Brown, I thought I should ask that question of you, upon reconsideration. Thank you. Mr. Brown. First of all, our historical experience has been that lending tends to expand somewhat during periods of rising interest rates. That is the part of the economic cycle when the economy is expanding and the monetary authority feels it is okay to raise interest rates from the recession lows. Mr. Heck. Excuse me, sir. Do you not agree, then, that it would be an impediment to more lending? We had a lot of discussion here about not being able to get as many dollars out there circulating as possible. But if you are confronting increasing interest rates, how much today do you want to put on your books that is low return? Mr. Brown. Historically, lending has increased more in periods of rising interest rates. Periods of very low interest rates have been associated with less vibrant economies, slow growth like we have seen recently. And a lot of the bankers we have talked to in the roundtables and other venues have cited a lack of loan demand in the current environment, that entrepreneurs are not eager to expand their operations. Chairwoman Capito. The gentleman's time has expired. Mr. Heck. Thank you. Chairwoman Capito. Thank you. And I would like to welcome a new member to our committee, and a new Member to Congress, Mr. Pittenger from North Carolina. Welcome. Mr. Pittenger. Thank you, Madam Chairwoman. Thank you for calling this important hearing. And I thank the witnesses for being here with us today and responding to our questions. I would like to follow up on Mr. Duffy's questioning and also Mr. Westmoreland and others. I served on a community bank board for about 14 years, from the early 1990s until the mid- 2000s. It was an exciting time. It was a great time for investors to invest in community banks. It was a great time of growth. And our community banks played a significant role in our region. I live in the Charlotte, North Carolina, area. And our bank grew. We ended up selling to a regional bank. We had our typical requirements, CRA and loan loss reserve issues that we were accountable to. We had the audits that came in. We got a clean bill of health most all the time. It was a good environment. It was very positive, and frankly, it was a great learning curve for me. But today, of course, the environment has changed, and the impediments are out there in a greater way. I met with seven of our community bank presidents a couple of weeks ago, and they expressed to me just more of an oppressive atmosphere, totally different than what I had the privilege of being involved in during those 14 years. And clearly, Basel III was a major concern, just the high regulatory effect and the cost of compliance, the attention that is given to it. The concerns are getting capital. And the difficulty there where some banks were forced to look for private equity. And as such, the only exit for private equity is to sell a bank and consolidate more, which is worse for the market, and worse for competition. So, all this leads us to believe that the need for relief today, to create that same environment that we had back during those positive years and to recognize that perhaps what we are doing today through the regulations is creating more difficulty and impediments than protection. And maybe the pendulum just swung way too far and maybe if we can come back. I speak on their behalf, and frankly, on the behalf of communities all over the country that there would be very serious consideration to giving relief to these community banks, which in our region I--we probably had six community banks that grew and now they are all have consolidated or sold out. It is pretty sad. But I believe we can see this again if we have some thoughtful, prudent reevaluation of the requirements they are having to live under today. If you would like to comment, I would be glad to hear from you. Mr. Brown. I think the topics that you raised obviously are of concern. They have been raised as concerns to us in our interactions with the bankers. I would point out that in terms of the evolution of the industry, the industry's financial condition and performance is improving, and that includes small institutions. And the return on assets has increased for each of the last 3 years, and the return on equity. Non-current loans have gone down. This repairing of the balance sheet and the earnings capacity of small banks has proceeded slower than the economic recovery, perhaps also slower than the larger banks in terms of their recovery. But it is taking place. And I think that you also mentioned access to capital. We found that just under half of all of the additions to capital during our study period relate to retained earnings. And of course, that requires a healthy level of earnings to gain that capital. So, the restoration of that earning capacity is very important for access to capital for the industry. That is what our study-- Mr. Pittenger. Sir, I would just say to you that I think it is a compelling statement that there are no new charters. So it is a much different climate today. And that is reflected in the absence of those who want to get back and engaged in this business as they were before. I yield back my time. Thank you. Chairwoman Capito. The gentleman yields back. Mr. Posey for 5 minutes. Mr. Posey. Thank you, Madam Chairwoman. Mr. Rymer, on Page 59 of your report you note that the historical cost was proving to be poor measurement approach in inflationary markets. Is it fair to say that the impaired accounting and fair value accounting is a poor measurement in bubble markets? As briefly as possible, please. Mr. Rymer. Yes, sir. In terms of fair value accounting related to bank portfolios, we didn't find that fair value accounting was-- Mr. Posey. Can you just answer my question? You agree with me or you don't agree with me? Mr. Rymer. Sorry. If you could repeat it, sir; I have a little bit of a hearing problem. Mr. Posey. Is it fair to say that the impairment accounting and fair value accounting is a poor measurement in bubble markets? Mr. Rymer. Public markets? Mr. Posey. In bubble, B-U-B-B-L-E markets. Mr. Rymer. I don't think you can apply fair value accounting to bank lending. It doesn't fly. Mr. Posey. Very good. Thank you. A question for each of you, just a yes or no if you would, do you think it is possible through overregulation to bankrupt or make insolvent lending institutions? Let's start with Mr. Brown. Mr. Brown. That has not been the experience of the study. Mr. Posey. Is that a ``yes?'' Mr. Brown. I think that would be a ``no.'' Mr. Posey. A ``no.'' So it is impossible to overregulate a business out of business. Okay. Thank you. Yes, ma'am? Please speak up. I can't hear you up here. Ms. Eberley. The question was, is it possible to overregulate a business out of business? Mr. Posey. Yes. Ms. Eberley. I-- Mr. Posey. It is a tough question. I understand that. Especially for people who work for the government. No insult intended. So, you don't know whether it is possible to overregulate anybody out of business or not. Okay. Mr. Edwards, how about you? Mr. Edwards. Is it theoretically possible? I would concede it is theoretically possible. In my experience, have I seen that? No, I have not. Mr. Posey. Okay. Mr. Rymer? Mr. Rymer. I would agree with Mr. Edwards. I think theoretically, it is certainly possible. Mr. Posey. Okay. Mr. Evans. I agree as well. Theoretically, it is possible. It is possible to overregulate a business. Mr. Posey. Do you think it would be possible if regulators put 55 percent of a bank's loans on nonaccrual? Let's start with you, Mr. Brown. Mr. Brown. If they put 55 percent of loans on nonaccrual-- Mr. Posey. Wrongfully. Mr. Brown. Wrongfully? Mr. Posey. Yes. Mr. Brown. Then what is the question? I'm sorry. Mr. Posey. Do you think they could put a bank out of business like that? Mr. Brown. It is possible a bank could go out of business if it had 55 percent of loans on nonaccrual. Mr. Posey. Okay. But the last time you said it wasn't possible to overregulate them out of business. But you think if they did that, it would be possible. Mr. Brown. If they had 55 percent of loans on nonaccrual, it is possible they could be. Mr. Posey. Okay. Ms. Eberley. I don't think regulators could inappropriately put loans on nonaccrual. Mr. Posey. I can't--you are going to have to speak into the microphone, please. Ms. Eberley. I don't think that a regulator could inappropriately place a loan on nonaccrual. So I don't believe that would cause an institution to inappropriately go out of business. I think that if loans need to be on nonaccrual, they should be on nonaccrual, and the accounting guidance is fairly clear. It is clear that institutions-- Mr. Posey. Okay-- Ms. Eberley. --nonperforming loans. Mr. Posey. You said, ``no.'' That is good. Mr. Edwards? Mr. Edwards. Yes. I have to agree with Ms. Eberley that it is hard for me to understand a circumstance where the regulators would-- Mr. Posey. Okay. That is good. Mr. Rymer? Mr. Rymer. First of all, it is the bank's responsibility initially to make the nonaccrual judgments. It is not the regulator's responsibility. Mr. Posey. All right. So is that a yes or a no? Mr. Rymer. If-- Mr. Posey. Just yes or no, just really simple. Mr. Rymer. I would say from the work that we did, I did not see such a circumstance. Mr. Posey. Never mind. Thank you. Yes, sir, at the end? Mr. Evans. Nonperforming loans would be a significant driver of bank failures. And that is what we found in our report. But the classification issue, I will pass on that. Mr. Posey. For Ms. Eberley's benefit, I know of an instance where regulators took a first mortgage with--on a hotel actually, about a 30 percent loan-to-value ratio, about 7 years mature, never been a day late. And the regulator said, we don't think in this market they should be able to make their payment. They have never been 1 second late in the history of the loan, a well-secured loan. Some people think it might be entirely appropriate to put that on nonaccrual. And some people trying to use a little bit of commonsense think it would be highly inappropriate. Mr. Rymer, let's see, Mr. Evans, from your research do you believe impairment accounting as applied in the examination process fuels the various spiral of negative balance sheet pressures, leading to more failures and write downs? Mr. Rymer. Our study did cite some issues. Mr. Posey. Okay. That was a ``no.'' That is good enough because I have a lot of ground I would like to cover, and I am running out of time. Mr. Rymer. --regulatory issues. Mr. Posey. I am out of time. Chairwoman Capito. You are out of time, sorry. Mr. Posey. Thank you, Madam Chairwoman. I would sure love a lightning round if we had 2 minutes left. Chairwoman Capito. Thank you. Mr. Barr, I would like to welcome you to the committee, and I recognize you for 5 minutes for questioning. Mr. Barr. Thank you, Madam Chairwoman. Ladies and gentlemen, a president of a small community bank in Central and Eastern Kentucky told me that it used to be that his bank made a business decision about whether to make a loan to a borrower and what the terms of that loan would be. Today, that same banker tells me that the government makes that decision for them. With that troubling anecdote in mind, I want to focus my questions on the costs imposed by regulations and the costs imposed by increasingly aggressive enforcement by supervisory agencies like the FDIC. First of all, just a quick yes or no answer from Mr. Brown, Ms. Eberley, and Mr. Edwards. Do you think it is important to perform cost-benefit analysis as a predicate to promulgating rules and regulations? Mr. Brown. Yes, and that is our practice. Ms. Eberley. I agree. Mr. Edwards. Yes, I concur with that. Yes. Mr. Barr. Okay. And Mr. Brown, you testified earlier that you solicit input from industry regarding regulatory costs through informal practices and also in the notice of comment process. Ms. Eberley, you noted that your agency was engaged in technical assistance, Web seminars, training sessions for bank directors, workshops. And I applaud the agency for taking those actions. But the FDIC study that you all refer to in your testimony, Mr. Brown specifically, you indicated that most interview participants stated that no single regulation or practice had a significant impact on the institution, but that the cumulative effects of all regulatory requirements have built up over time. Several other members on this panel have mentioned that earlier today, that increased staff is something that you are observing compliance staff in these community banks. But that it is so time- consuming, so costly, and so interwoven into the operations that it would be too difficult to break out these specific costs. With that testimony in mind, how can the analysis be done, the cost-benefit analysis be done properly if you acknowledge that the true costs associated with regulatory compliance cannot be captured? Mr. Brown. I think the difficulties in making a precise quantification of the costs and the benefits of specific regulations is something that has been noted by the GAO and other sources. We are very mindful of the balance between wanting to get information on the costs, regulatory cost, but also imposing the burden of additional regulatory reporting on the industry, which in itself can be a burden. So we maintain that balance. That is why we rely on input from the industry, especially during the rulemaking process, to try to get better information. We think that industry is in the best position to understand their cost structure. Mr. Barr. Given that compliance costs are increasing, and the study corroborates that and you acknowledge that increasing compliance staff is something that is happening in the industry, that the fastest growing area of banks is not in loan officers or in lending, but in compliance staff. How is the FDIC tracking, if at all, the increased compliance costs, increased costs of employing compliance officers as part of, as you acknowledge, your important cost-benefit analysis? Mr. Brown. I don't believe the responses indicated that compliance costs were the fastest growing cost element of those institutions. They had indicated that it had increased over a long period of time in response to a large number of regulatory changes over time. But there was no indication that it was the fastest growing area. Mr. Barr. Okay. On top of compliance costs, I also want to just briefly explore the issue of regulatory clarity. And the example that I will cite to you is a compliance officer in a very reputable and growing community bank in Central Kentucky who tells me that her most pressing concern is the mixed signals that she receives from regulators. Specifically, on the one hand, they are told that they need to be prudent and responsible with their loans in order to ensure safety and soundness. That comes from you all typically. Yet on the other hand, the Community Reinvestment Act wants banks to reach out to riskier, low-income borrowers who don't meet creditworthy borrowing criteria. So the question is, is the FDIC sensitive to this concern? And what is the FDIC doing to address the contradictory mandates imposed on community banks from safety and soundness examinations on the one hand and CRA audits on the other? Ms. Eberley. The consumer protection examinations are not under my purview, but I do know that we don't believe that the Community Reinvestment Act requires institutions or directs institutions to make loans that are not creditworthy. So I would disagree with the stipulation that there is-- Mr. Barr. What would you say to that particular compliance officer who doesn't understand the government's direction to the bank? Ms. Eberley. We need to have a discussion with the banker. And they need to seek clarity, and I would encourage them to seek clarity from their supervisor, from their field supervisor, from their regional office. Both the consumer protection function and the safety and soundness function report up to one regional director in the field. For Kentucky, that is Anthony Lowe out of our Chicago office. Mr. Barr. I would just--my time is up. But I would just like to encourage the FDIC to take that concern very seriously, that there is a serious lack of clarity on the part of well- meaning, well-intentioned compliance officers in these community banks. And your sensitivity to that would be appreciated. Chairwoman Capito. Thank you. Mr. Pearce for 5 minutes. Mr. Pearce. Thank you, Madam Chairwoman. Just following up on Mr. Posey's statements, and then the discussion of whether it was theoretically possible for the government to regulate out of business. Now I am taking a broader view than just the banking industry. But I would direct you to my State, where we used to have 123 timber mills. And because of one regulation, all but one are shut down today, and 23,000 farmers in the San Joaquin Valley all gone because of one regulation. The banks in the area, by the way, became unstable. Suicides rose to an all-time high for any place in the country because of one regulation. So, when you are unable to find in your own experience, come on to New Mexico. Come out to the West and we will show you a lot of areas that have been regulated out of existence. Following up on what Mr. McHenry was talking about, I suspect that he may have been listening in on the meetings with our bankers. I hear the same complaints there, that in the past, regulators came in and they were interested in safety and soundness. And today, they come in and they are 90 percent compliance. And so, Mr. Brown, you had said earlier in your testimony that safety and soundness, that was your charter. Do you have any idea on the budget for safety and soundness versus the budget for compliance, and the number of hours spent yearly in compliance versus safety and soundness? Does anyone on the panel have that? Mr. Brown. Congressman, I don't believe we have those numbers-- Mr. Pearce. I would like to get them. Mr. Brown. We can certainly get back to you on that. Mr. Pearce. Now, keep in mind that every time I ask questions like this, we have a lower rate of getting back to me than the U.S. Postal Service. So I would really appreciate if you would follow up on that. Now, Ms. Eberley, you were talking about how you have deep interest in making sure that there is not any hostile environment. Do you have a--last weekend, I was going to check into the Hampton for coming up, and I was able to go online and I was able to get five stars or three stars. This hotel, this one at this place rated three stars, four stars, five stars. And then, I could get comments from people who had stayed there. Do you have anything like that for your process for your examiners so that bankers anonymously--because you heard the hostility, no they are not going to come to you. They are scared out of their minds. They are afraid that you are going to take them over and that you are going to do something. And I think that they have a valid reason, looking at the 123 mills that used to be in New Mexico and they are gone. So, do you have a process for feedback where you can rate-- or where your people get rated five stars, four stars or three stars? Do you have anything like that? Ms. Eberley. We do have an examination survey process. So at the end of every examination when we mail out the report of examination, we mail a survey to the institution and ask them to complete it. I think the scale is 1 to 10-- Mr. Pearce. And it talks about the individual regulators themselves? Ms. Eberley. Yes-- Mr. Pearce. The individual regulators. Ms. Eberley. The-- Mr. Pearce. And what percent of those do you get back? Ms. Eberley. Pardon me? Mr. Pearce. What percent of those do you get back? Ms. Eberley. I don't know the exact percentage, but we get a fairly good number, and-- Mr. Pearce. Pretty good number? Ms. Eberley. Yes. And they go to our Division of Insurance and Receivership, so they don't--I am sorry, Insurance and Research. They don't come to my division. So that division compiles the information for me and gives it to me on an aggregate basis with trends by region so that I can see what the results are. Mr. Pearce. Do you make that information available to the banks so that they know when someone is coming in what sort of examination that the last people received? Ms. Eberley. No, it is not made available today. Mr. Pearce. I keep in mind that I can get that, paid $2.99 online for some program last night and I am able to get that information for $2.99. Yet you all control the banking industry of the world and they are sitting out there alarmed at what you are doing. In New Mexico, we don't get many floods. We get 9 inches of rain a year. And yet, the flood insurance is a piece that is hammered down in New Mexico and people--the bankers express alarm about that. Now, in a recent compliance review, one of the banks got a $15,000 fine because the names did not match exactly the IRS names. Can't you--again, on that $2.99 program I filled out last night, if I didn't fill it out correctly, it just wouldn't accept it. Can't you give a bank something where if they don't fill it out correctly--why did you stick somebody $15,000 for not--there were less than 100 of those names. Ms. Eberley. So was this on their HMDA? Mr. Pearce. It is on the loans and-- Ms. Eberley. Yes. So probably the-- Mr. Pearce. And it didn't match the IRS? Ms. Eberley. Right. Mr. Pearce. Those used to be letters. And you sent them a letter of concern. And now, you are sticking people with fines that are very tough for small institutions, trailer houses. You are making it tough to lend money on trailer houses and on--I will be finished in just a second, Madam Chairwoman, you are very patient. New Mexico is 47 per capita income. If you can't lend for trailer houses and if you can't lend for consumer stuff, what purpose is there in New Mexico? That is us. We are at the bottom of the heap. You guys are making it very tough for New Mexico to get access to loans. Thank you, Madam Chairwoman. Chairwoman Capito. The gentleman yields back. The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to these witnesses and to place their responses in the record. Also, without objection, Members will have 5 legislative days to submit extraneous materials to the Chair for inclusion in the record. The hearing is adjourned. [Whereupon, at 12:11 p.m., the hearing was adjourned.] A P P E N D I X March 20, 2013 [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]