For bank boards, ‘Red Flags’ a must-read

“Good decisions begin with good information,” the introduction to a federal manual for board directors leads off.

Apparently, there are few better sources of information than the “Detecting Red Flags for Board Directors” report from the federal Office of the Comptroller of the Currency (OCC).

Eight years after its initial publication, the “Red Flags” report remains the most downloaded publication from OCC”™s website, ahead of documents to come out in the past year such as OCC”™s ombudsman”™s report and one chronicling permissible activities by banks under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The 80-page “Red Flags” document covers reports governing financial performance, credit risk management, derivatives and “off-balance sheet” transactions, among a range of topics both pedestrian and esoteric.

At many Fairfield County community banks, boards include both finance industry professionals presumably seasoned enough to spot irregularities; but also community representatives from area businesses who lack the expertise to spot problems well before they mushroom into problems threatening a bank”™s viability.

As for the red flags themselves? They include:

Ӣ declining capital levels or ratios;

Ӣ dividend payout ratios significantly higher than peers;

Ӣ concentration in nontraditional activities;

Ӣ growth in off-balance-sheet activities;

Ӣ increase in loans-to-total assets ratios;

Ӣ significant changes in a bankӪs portfolio mix;

Ӣ high growth rates in total loans or within individual categories;

Ӣ loan yields significantly higher than a bankӪs peer group;

Ӣ personnel expenses deviating significantly from peer banks; and

Ӣ significant volumes of retail loans that have been extended or deferred.

“Red Flags” remains a figurative federal best seller even as Richard Cordray, director of the new Consumer Financial Protection Bureau, promised vigorous oversight of banks in addition to that by OCC and other federal agencies.

“Our supervisors will be going on-site to examine their books, ask tough questions and fix the problems we uncover,” Cordray told the U.S. House of Representatives”™ Committee on Financial Services, whose members include Congressman Jim Himes. “We plan to use all of the tools available to us to ensure that everyone respects and follows the rules of the road. Where we can cooperate with financial institutions to do that, we will; when necessary, however, we will not hesitate to use enforcement actions to right a wrong.”

For his part, Himes has advocated loosening rules that restrict smaller community banks from raising cash via initial public offerings of stocks and other means.

Separately, a co-founder of Greenwich-based Renaissance Technologies agreed that the IPO market is essentially closed today to small investors, in March testimony to the U.S. Senate Banking, Housing and Urban Affairs committee.

“An extended period of positive returns for IPO investors is the most powerful solution to increasing IPO market activity leading to a greater presence of smaller, sub-$50 million issuers,” said Kathleen Shelton Smith, chairman of Renaissance Capital. “In the meantime, policies that assist these smaller IPOs to lower the cost of accessing the IPO market and improve IPO allocation to attract a broader base of long-term investors could provide some helpful relief.”