The 2nd meeting of the Interim Joint Committee on Banking and Insurance was held on Monday, August 25, 2008, at 4:00 PM, at the Galt House in Louisville in conjunction with the Kentucky Bankers Association Annual Convention. Senator Tom Buford, Chair, called the meeting to order, and the secretary called the roll.
Present were:
Members: Senator Tom Buford, Co-Chair; Representative Tommy Thompson, Co-Chair; Senators Julian M. Carroll, Julie Denton, Dorsey Ridley, Dick Roeding, Dan Seum, and Tim Shaughnessy; Representatives Sheldon E. Baugh, James R. Comer, Jr., Ron Crimm, Mike Denham, Ted Edmonds, Tim Firkins, Danny Ford, Jim Gooch, Jr., Jeff Greer, Mike Harmon, Jimmy Higdon, Dennis Horlander, Dennis Keene, Adam Koenig, Rick Rand, Steve Riggs, Arnold Simpson, John Tilley, Ken Upchurch, and Susan Westrom.
Guests: Charles Vice, Commissioner, Department of Financial Institutions, James Chessen, Chief Economist and Group Director, American Bankers Association, Ballard Cassady, Jr., Chief Executive Officer, Kentucky Bankers Association, John Cooper, Government Affairs Consultant, Kentucky Bankers Association, and John McCarthy, McCarthy Strategic Solutions.
Chair Buford also recognized in the audience Jim King, President of Louisville Metro Council and a past president of KBA; Nancy Roeding, Senator Roeding’s wife; Becky Barnes, Senate Leadership; and Secretary Bob Vance, Public Protection Cabinet.
LRC Staff: Rhonda Franklin, Chad Collins, and Marlene Rutherford.
The minutes of the July 29, 2008, meeting were approved.
Ballard Cassady, Chief Executive Officer of the Kentucky Bankers Association (KBA), recognized Denny Dorton, President, Citizens National Bank, Paintsville and Chairman of the Kentucky Bankers Association; Pedro Bryant, Louisville Community Development Bank and incoming Chairman of the Government Relations Committee of the KBA. Mr. Cassady introduced Charles Vice, the newly appointed Commissioner of Financial Institutions. Mr. Vice was an FDIC examiner for eighteen years serving out of the Lexington Field Office and served as that office’s expert on subprime lending and capital markets; was in charge of the examination of troubled financial institutions and of the information technology operations of three banks; and has received numerous awards. He also introduced James Chessen, Chief Economist and Group Director of the American Bankers Association (ABA). In this capacity he oversees three divisions, Economic and Policy Research which monitors the financial performance and condition of the banking industry and studies legislative and regulatory issues as they pertain to the banking industry; the E-Strategies Group which coordinates payment systems and e-commerce policy initiatives of the ABA, and the Surveys and Statistics Group which collects, compiles, and analyzes information on topics and issues related to bank operations, performance, and industry trends. Mr. Chessen writes on banking issues and has provided testimony before Congress and federal regulatory agencies on economic and banking issues. Prior to joining the ABA in 1988 he was a financial economist at the FDIC and was a Professor of Economics at Lake Forest College, Lake Forest, Illinois.
Mr. Chessen discussed the global issues on banking and what is occurring nationally and economically with the housing market. Mr. Chessen provided a PowerPoint presentation of the national housing outlook. He said that between 2002 and 2006 the biggest housing appreciation occurred on the west coast, Florida and mid-Atlantic. The states that have the biggest problems and suffering most today are those same states. Kentucky is doing well in home price index. He provided a chart of information reflecting housing starts in 1968 to present. This chart showed that for each period there was a severe decline in housing starts, there has been a recession which impacts the economy greatly.
Mr. Chessen also discussed delinquent loans providing numbers from the Mortgage Bankers Association. He said Kentucky has done better than the national average. There are two issues, subprime loan delinquencies and adjustable rate mortgage delinquencies. Subprime loans represent approximately eleven or twelve percent of all loans outstanding but are about forty-five percent of all foreclosures. Unemployment is a big issue of what is occurring in the housing markets. He said that before the first re-set on adjustable rate mortgages that one third of the loans set to re-set in the current year were already delinquent before the first re-set. The good news is that there are less subprime loan problems.
Mr. Chessen said that the number one factor in consumer delinquencies and foreclosures is job loss, followed by healthcare expenses and divorce, which is becoming a big issue. He said the reasons the country is not in a recession today is because of strong exports and the fact the dollar has also improved. He also said that it was good news that the Federal Reserve would not be increasing rates until approximately August of next year.
He said that Kentucky is far ahead of the national average in core capital. The Return on Assets (ROA) in Kentucky is very strong compared to nationally. Kentucky also has fewer problem loans compared to nationally and that the net charge-offs as a loss in Kentucky are less than the rest of the nation.
Charles Vice, newly appointed Commissioner of Financial Institutions, focused on Kentucky’s banking industry. He said that some investors and bankers forget that there is a strong correlation between risk and return. In earlier discussions with the KBA, he talked about Risk Management 101 and the benefits of diversification. Recently the collateralized mortgage obligations that drove the mortgage market was trying to disperse risk but not dissipating risk at the same time. He assured everyone that the Kentucky banking system remains sound. There are challenges but the department will continue to track and report to the committee as needed. He agreed that Kentucky’s return on assets is much better than nationally. For the second quarter 2008, the ROA declined from over one percent on an aggregate national basis to sixty basis points or .6%, however large banks are affecting this number dramatically. On an aggregate basis in Kentucky, the ROA in 2006 was 1.1%, in the second quarter 2008, it was 1.0%, well above national averages. Kentucky also has a better than average ROA than surrounding states. The net interest margin in Kentucky in 2006 was 4.2% compared to 3.9% in the second quarter 2008. He said Kentucky banks are well capitalized but they need to take this economic “slow down” period to improve risk management practices. This will allow early identification of risk, which is critical; will result in less loss; and allow for more resolution options. Risk management practices need to be improved as a result of increased credit risks in the market because of unemployment, foreclosures, limited liquidity in the financial market and the impact of rising gas and oil prices. The real estate market has also slowed and Kentucky banks have limited exposure to liar loans, subprime loans, and initial loan-to-value (ILTV) loans.
In conclusion, Mr. Vice said that the Kentucky banking system is sound due to higher capital levels; less margin compression; a diverse economic base; less credit risk, particularly as it relates to real estate loans; reduced level of ILTV, fraud and liar loans; and positive influence of the auto industry in Kentucky.
Senator Seum asked what the percentage of failure would be if a bank had 100,000 mortgages. Mr. Chessen indicated that most of the information read about does not indicate final foreclosure but are in the process of being foreclosed upon. Nationwide, especially for subprime loans, it could be twenty percent or more of all subprime loans. He also pointed out that many of the foreclosures particularly in Nevada and California were investor loans, not owner-occupied. He said the biggest problem in a loan modification is reaching the borrower. He also pointed out that Realty Trac, a company that tracks foreclosures, reports every notice or legal action on a foreclosed property as a foreclosure when in fact it is on the same property which exaggerates the number of foreclosures. Senator Seum also asked about the reduction in the federal rate which has not been reflected in mortgage rates. Mr. Chessen said that mortgage rates are tied to ten year treasury notes. One of the biggest problems currently is that the secondary market is leery of taking mortgage backed securities which limits the supply of mortgage money and makes it difficult for rates to decrease significantly.
Representative Comer asked why the inflation rate was not higher based on various factors as reported in the media. Mr. Chessen indicated that the media talks about headline inflation which includes all the different factors and then core inflation which omits energy and food prices. When factors that are the most volatile are omitted it results in a lower number. The Federal Reserve tends to not look at the volatile components but the core components. Representative Comer also asked how Congress was proposing to pay for the bailout of Fannie Mae and Freddie Mac. Mr. Chessen was not aware of how it would be paid but would obtain more details. Mr. Cassady said it would appear that Congress will need to talk to the banking industry and institutional brokerage houses to determine where the debt lies and what happens when the debt is written down. Mr. Chessen stated that banks are writing off a significant portion of those type loans and will suffer a loss.
Representative Baugh pointed out that write off loans have residual value that financial institutions can eventually sell and recoup some of the loss. Mr. Chessen said that securities backed by subprime loans and ILTV loans were difficult to value and that write downs did occur. The accounting rules, fair value accounting, which forces those markdowns to a market even though a market does not exist, creates problems with how those assets are valued and at the appropriate level. Representative Baugh also asked if there are any banks in Kentucky that have ceased to exist. Mr. Vice indicated that to his knowledge there were none.
Senator Carroll asked if companies are taking advantage of the market situation and aggressively taking advantage and filing foreclosure actions. Mr. Chessen indicated most banks are doing everything they can to keep owners in their homes rather than foreclosing and that part of the problem is that non-bank brokers made many of the original loans that were sold off to the secondary market. Senator Carroll also asked what the current atmosphere has done to the lending attitude of Kentucky banks for consumer loans. Mr. Vice indicated that it had impacted two areas, the production and resolution. Mr. Cassady noted that the problem is being created by unscrupulous lenders.
Representative Thompson noted that one of the central pieces of the mortgage relief bill (HB 552) passed in the 2008 Regular Session was the creation of a Homeownership Protection Center and that there is now an 800 number that borrowers around the Commonwealth may contact who are concerned about their ability to meet their mortgage obligations and to learn of options and alternatives, other than foreclosure.
The meeting adjourned at approximately 5:20 p.m.