Anyone in the financial services industry who was paying attention in 2009 recognized that it was an unusually harsh bank regulatory and examination environment.  It also was clear that this new exam regimen was imposed from the top down as a reaction to congressional and commentator criticism of the bank agencies' prior years' performance as financial industry supervisors. Determined to avoid that same fate going forward, their denials notwithstanding, the agencies overcompensated and landed hard on supervised banks with severe exam ratings and follow-up formal enforcement agreements and orders. Most bankers and industry observers expect more of the same in 2010. Areas that are sure to continue receiving the most intense review are asset quality, capital adequacy and liquidity.

How to cope

Complaining to onsite examiners is unlikely to provide relief. Because of the pressure from their agency superiors, examiners have less onsite discretion than in earlier days. Bank trade associations, most notably ICBA, have aggressively pressed the bank agencies and the administration for relief and have received some conciliatory responses. However, unless and until agency pressure is reduced, the only effective means to assure the best possible result under the worst possible circumstances is thorough preparation.

Thorough and effective preparation means that the bank has examined the bank before the examiners examine the bank.  If the bank is aware of serious issues that will be discovered and criticized by examiners, independent third party assistance is advisable. If those issues are potentially life-threatening, assistance is mandatory.

The Pre-Examination

The most important thing to any examiner is that the bank demonstrates recognition of its problems and has in place a reasonable plan of action which was thoroughly discussed and approved by the board. The very worst situation for the bank is when examiners identify material problem areas as to which the bank appears unaware or is defensive.

An effective pre-examination review consists of a comprehensive, unified independent loan portfolio and management and corporate governance review. The product of the independent review should be a confidential, comprehensive written report to the board which identifies critical issues and makes specific recommendations for improvement and resolution. That report should be fully discussed by the board, and in large part should form the basis of a written Action Plan which adopts the report's recommendations and includes a timeline for implementation. The Action Plan should be a thorough, candid analysis of problem areas with   documentation to support its conclusions (e.g., on problem loans) and proposed remedial actions. Although it is an internal Plan, it should be written as if it were a report to examiners. Importantly, the Action Plan should be provided to examiners and discussed with them in advance of a scheduled exam. This will accomplish several things. First, it will serve to focus examiners' attention on those areas that the bank has itself identified as problem areas, and for which the bank has already developed remedial plans. Secondly, the formal Action Plan is a clear indication to examiners that the bank is willing to recognize its problems, and is a substantive demonstration of management's and the board's competence and sincere commitment to problem resolution.

Although there is some cost in connection with retaining an independent consultant and counsel, the cost to the bank of a harsh examination result and accompanying formal written agreement, or other enforcement action, with onerous monthly or quarterly progress reports, outside risk assessment reviews and appraisal of management, as well as potential civil money penalties, most certainly will be much greater.