Federal regulators seized Charter Bank in New Mexico this week as its capitalization fell below requirements, making it the latest of scores of banks to have failed in the economic crisis. However, the Albuquerque Journal reports that Charter faced a very low default rate on residential loans and no commercial failures, either — until the Office of Thrift Supervision, its regulator, demanded that Charter increase its declared risk fivefold (hat tip HA reader Super5):
Federal authorities on Friday closed Charter Bank, a closely held, family-run financial institution known for its financing of low-income housing in New Mexico and for the philanthropy of its owners. …
Last fall, Office of Thrift Supervision examiners, responding to the national collapse of real estate development, ordered Charter to increase its allowance for loan losses from $10.8 million to $55.4 million, even though Charter had no delinquent commercial construction loans and only .34 percent of the loans in its commercial real estate portfolio were behind on their payments. That order reduced the level of capital Charter had on its books.
Last Wednesday, OTS ordered Charter to find new capital as a buffer against insolvency or face closure.
Charter had hoped to find a buyer, but none appeared. The owners’ stake in the company was wiped out by the forced closure.
How involved were they in low-income lending? The head of New Mexico’s MFA makes it clear:
Charter became a major real estate lender and was especially active in underwriting and servicing mortgages for low-income housing. It worked closely with the Mortgage Finance Authority, which was established by the State Legislature to help finance low-income housing construction. According to MFA executive director Jay Czar, Charter services about 95 percent of the mortgages issued through the agency.
“They are just class bankers,” Czar said. “These are guys who quite frankly really look out for the state of New Mexico. They do business larger banks wouldn’t even consider.”
What triggered the OTS action? Reporter Winthrop Quigley followed up in today’s edition:
Charter’s management, led since 2001 by bank President Glenn Wertheim, insisted that loans, mostly commercial real estate loans — which OTS said were troubled — were, in fact, being paid on time. OTS disagreed and ordered tens of millions of dollars of those loans to be classified as toxic.
That classification, recorded as an entry on the bank’s balance sheet, on paper lowered Charter’s capital (money regulators require banks to make sure their deposits are safe) to levels well below those regulators regard as sound, even though virtually all of Charter’s commercial real estate borrowers continued to pay their bills on time.
Something sounds extremely fishy in Albuquerque. If the loans were getting paid on time, why did OTS demand that Charter increase its declared risk-hedging last fall? A 99.66% rate seems pretty good to me.
This looks very suspicious, as if OTS either wanted to keep conducting social engineering despite the ruination it caused, or more maliciously wanted to redistribute Charter Bank to other owners. Perhaps reporters from other national media outlets will take the time to contact Winthrop Quigley and shine a little more light on Charter’s seizure.
Update: On second look, it seems like a flat-out disagreement on what constituted risk in the commercial lending system, and not an order to increase risky lending, as I had originally thought. The earlier order did not intend to force Charter to assume more risk, but to put more risk on its books than was warranted, reducing their capitalization. I’ve edited the post above to recast the article in those terms. The OTS still appears to have shut down a bank despite the fact that its loans were working properly (99.66% of all commercial loans paying on time) for reasons that don’t really seem to have much to do with an actual risk of collapse on Charter’s side.
And please still note that Charter took those low-income-loan risks to meet federal and state regulators’ expectations of community service — and they got repaid with what clearly looks like a premature seizure. It’s still a damned-if-you-do, damned-if-you-don’t scenario for Charter.
Update II: For an administration supposedly working to correct the rise of “too big to fail” financial institutions, their OTS doesn’t seem to have a problem forcing banking consolidations as happened this week in New Mexico.
Update III: Longtime reader The Banking Guy says there’s probably less to this than thought:
I work at a (big) bank, and have done so for 25 years. I don’t know the bank in New Mexico, or any of the details of this situation beyond your post. However, my 25 years give me reason to think that this is just standard banking regulation with no political overtones. Here’s why (with lot’s of simplifying assumptions, for clarity).
Many banks, particularly small ones, have huge bets on the real estate markets, whether residential, residential construction, or commercial property, or all of the above. It sounds like this bank was one such bank. Assuming that this bank has an outsized commercial real estate portfolio, I can see that it might have a terribly risky loan book, even though less than 1% of the loans are past due (which I admit is typically very good).
For simplicity’s sake, let’s assume that the bank had one loan, a $1MM construction loan on a commercial property. Let’s further assume that the property is under construction, with an “interest reserve” to pay the current loan interest during the construction period, so that the loan is indeed current. Let’s further assume that the property had a tenant lined up to move in at completion, and that the property appraised on an “as completed” basis for $1.25MM at loan inception. All that sounds good.
Now fast forward to today. Let’s assume that that the tenant is bankrupt and won’t move in. Let’s also assume that the property now appraises in a horrible market for $800M (and that both appraisals were “accurate”–that is, the best possible reflection of values at the time that they were done). So the loan is current, but the prospects that it will continue to be current are very low, because once the interest reserve is depleted there is no cash flow to pay the loan at all. So the loan is “Classified” by regulatory definition, and quite likely will require a charge off that would probably be $200M (the current loan amount less the current appraisal). Now if this bank had $100M in capital, or 10% of its loans, that would be very high (i.e., good) for a bank. But it would also be inadequate by $100M to even keep the bank’s capital at break even (which is itself of course way too low).
Now, this is a greatly oversimplified example. But replicate that loan in the portfolio of a real small (or large) bank, and add in, for example, a similar loan for a property to be “built on spec,” with no tenants lined up. What seemed (clearly incorrectly in hindsight, or even with forethought but that’s a different post) to be a reasonable assumption on leasing at the time of origination doesn’t work anymore. Add in other similar stories, such as completed buildings whose tenants have closed up shop such that the building owners (and our borrowers) are just about out of cash themselves.
Writ large this is the problem with commercial real estate, coming on the heels of the residential bust. So banks are struggling, and many will fail. Some of those will even, superficially, appear to be solvent. I’m no fan of bank regulators (again, another post), but I haven’t heard about them trying to close solvent banks. They might make bad decisions, and be too tough or too lenient (and the bias now is clearly to be too tough), but I don’t see them closing down solvent institutions.
Fair enough, but let’s put this in perspective. The reason Charter made these bets in the first place was because of the state and federal regulators pressuring and/or incentivizing banks like Charter to do so. The MFA acknowledged that Charter has serviced 95% of its loans with no problems so far. Even with all of these points made by The Banking Guy (and they are excellent background points to consider), the fact is that the only reason the bank became insolvent is because OTS made the risk look worse on paper last fall. Their loans were being paid back at a high rate, probably better than most that OTS allows to continue operations. OTS appears to have set up Charter to fail with its new risk declarations.
Even if OTS is clean in this case, it should serve as an object lesson for banks that may decide to cooperate with efforts like MFA and the CRA. And if their loan delinquency was really only 0.34%, the seizure still seems very, very strange.