Exam Season for Banks

The stepped-up federal intervention in the banking system is likely to drive ripple effects in the future, industry experts have said. Bankers are likely to face deeper and more frequent examinations, which could make them even more cautious about lending, thwarting the government’s goal of thawing the credit freeze.

Concern about the financial condition of banks, coupled with equity stakes the government is taking in some financial institutions, likely will lead to a jump in bank examinations, said Kevin Cummings, chief executive officer of Investors Bancorp Inc. in the Short Hills section of Millburn, parent company of Investors Savings Bank.

“When you’ve got the government as a partner, you can expect more scrutiny,” Cummings said.

“We may not see many new regulations, but the intensity of bank examinations will likely increase. Bank examiners may exhibit a heightened sense of skepticism, and look more closely at loan rating and other issues.”

The U.S. Treasury Department has said it will purchase billions of dollars of stock in major banks under a provision of its Troubled Assets Relief Program, or TARP. But the snowballing problems facing the financial markets were underscored last week when Treasury did an abrupt about-face on one part of the program, announcing it would not repurchase illiquid mortgage-related items under TARP, but instead try to increase consumer access to credit.

Still, banks remain concerned about any strings attached.

“There’s always a concern about politicizing the banking process if the government gets deeply involved,” said Michael Horn, chairman of the Federal Home Loan Bank of New York and a banking partner in the Newark law firm McCarter & English LLP. “I don’t disagree with the government’s response to this once-in-a-lifetime financial crisis, but we do need to quickly return to clear separation between government and private ownership.”

Horn, a former New Jersey bank commissioner and state treasurer, said in the short term he thinks banks will be more cautious about making loans, “but financial institutions need to have some risk in their portfolio in order to make money.”

The federal government has so far encouraged, but not required, banks to lend the money they receive from the U.S. Treasury.

In recent weeks, Wayne-based Valley National Bank announced plans to sell $330 million in nonvoting senior preferred stock to Treasury under TARP, and Bayonne’s Pamrapo Bank said it applied to sell up to $11.4 million of stock under the program. Both banks said they are healthy, and seek the capital to expand their operations.

If history is any guide, “loan activity will slow somewhat, but will eventually pick up as it did after the credit crunch of the late 1980s through early 1990s,” Cummings added. “The pendulum always swings a bit too far one way, and then corrects itself.”

New Jersey will also see some changes in bank names after the fall announcements of Wells Fargo buying Wachovia, J.P. Morgan Chase & Co. purchasing the assets of Washington Mutual and Spain’s Banco Santander planning to buy out Sovereign Bancorp.

Cummings said he expects to see more consolidation among the bigger banks, fueled to a degree by the injection of funds under TARP, but “New Jersey does not have many troubled institutions, so we shouldn’t see much consolidation between locally based banks.”

For the most part, community banks did not get deeply involved with subprime and other exotic loans, which means they are more likely to be able to make loans than some of their competitors, said Burton Zwick, a lecturer at Fairleigh Dickinson University’s Silberman College of Business. But they face increased competition from financial institutions that get an injection of federal funds, he added.

“It is hard to argue that [TARP and other programs] do not provide some unfair advantage to large banks,” said Zwick. “I’m not yet sure just what the effect may be, although the big banks may use federal capital to buy up smaller, healthy banks.”

In the near term, as investors seek safety in FDIC-insured accounts and banks are able to pay interest rates as low as 2 percent on their money, some financial institutions may use their spare funds to buy government securities instead of making loans, said Christopher Kinslow, a finance and legal studies professor at Seton Hall University’s Stillman School of Business in South Orange.