By Patricia Garner
We must have heard about the proverb “if it looks like a duck, quacks like a duck and acts like a duck, it
called a duck” but what if an institution looks like a bank and operates like a bank? Can you be sure to call it a bank? Well, not always! They're shadow banks. Shadow banks are financial intermediaries that transact credit, liquidity and maturity transformation without explicitly accessing the liquidity of the central bank and other public sector credit guarantees. These intermediaries contributed to appreciation of the asset price and the expansion of credit before the financial crisis. However, during the crisis, the vulnerabilities of the system were gradually exposed, therefore compelling and forcing the Federal Reserve to offer emergency support. Some examples of intermediaries that are not subject to Central bank regulation
are hedge funds, unlisted derivatives and any other unlisted instruments.Fed warns the shadow banking system due to ongoing risks
According to recent reports, the Chairman of Federal Reserve, Ben Bernanke said that the shadow banking system
posed a threat to the financial stability of the nation and the funding markets might not be able to tackle with a big default. In a speech where Bernanke spoke about the role of Fed in supervising and monitoring the health of the banking system, he also mentioned how the central bank looked at asset markets to locate signs of excessive risk taking. Although the shadow banking sector is small today as compared to what it was before the crisis, the private sectors and the regulators require addressing the remaining vulnerabilities.
In fact it was the credit meltdown of 2007-2009 and the collapse of Lehman Brothers that brought into light a small
group of companies and funding vehicles which came to be collectively known as the shadow banks, which were regulated poorly but which harbored a huge risk. In spite of the 4 1/2 year program of quantitative easing (QE), the US economy is still weak with the unemployment level still high enough and labor-force participation down. Although there is lot of money pumped into the economy, why isn't there a runaway inflation?
Ben Bernanke has admitted that the economy is going through a very poor phase and there are still lot of headwinds
that they need to overcome. But the common reasons are lack of lending options from the commercial banks, low government spending, Europe in a financial disorder and weak retail sales. Although the Fed has discussed an exit strategy, it has never explained the reason behind its buying spree leading to so little economic growth. The reason might be the distortions that most Americans have never heard of like “repos” or “repurchase agreements” which are nothing but a part of the shadow banking system.
In a nutshell, the policy of the Federal Reserve to stimulate lending and the nation's economy by buying Treasurys
and to keep stimulating until unemployment reaches lower than 6.5%, is creating a shortage in collateral, without which credit can't be created in the shadow banking system. In fact, the quantitative easing policy seems to be
self-defeating as it slows down the process of creating jobs and makes the economic growth sluggish.Patricia Garner is a financial writer who is specially fond of dealing with the banking industry. She is an avid reader and contributor of various financial and banking blogs that deals with core financial and banking topics. She contributes her articles to various personal finance blogs, communities and websites as well. Apart from writing informative financial pieces, she is also interested in guiding people with effective financial advice.
By Michael Iseyemi, Global Chief Security Officer at Aditya Birla
The Dodd–Frank Wall Street Reform and Consumer Protection Act
is the largest financial reform act in US history. Introduced amid the financial crisis of 2010, the act includes consumer protection reforms including a new consumer protection agency and uniform standards for products as well as strengthened investor protection, transparency of derivatives, and a new oversight council. While designed to introduce accountability, it has created a conundrum for financial institutions already mired in regulatory requirements. Under the watch guard of the Consumer Protection Act which has authority to oversee the regulations, Dodd-Frank has added an additional dimension of complexity for financial institutions and their entire supply chain.
The Act is designed to serve as an advance warning system of potential economic instability and promote accountability of financial institutions for new products. As such, it serves to protect both investors and consumers, provide oversight, and strengthen the power of regulators to aggressively investigate and prosecute financial malfeasance and fraud. Examination enforcement rules related to consumer protection are mandated and the Act consolidates the oversight roles of other institutions to allow fast action in the event of financial irregularities.
The complex and multi-layered Dodd-Frank Act’s oversight requirements introduce complexity to financial services businesses as well as uncertainty as to how to adhere to different requirements. In addition, any rules that apply to financial institutions also have a downstream and upstream effect which applies to vendors including outsourcers. Any compliance violation of a vendor or partner can have a negative effect on the financial institution itself, which means that financial institutions need to apply the same standards that govern their own business to their outsourcers and vendors. Financial institutions and any companies working in highly regulated industries have to be very cautious in choosing outsourcers. Any outsourcer that might be high risk would not add value to the relationship and to the brand and could increase reputational and regulatory risk.
To comply with Dodd-Frank, financial institutions must:
1. Develop a comprehensive enterprise risk management framework or program.
2. Ensure that their supplier governance programs contain the necessary requirements for due diligence, monitoring, communication, and reporting.
3. Ensure the financial viability of any outsourcers they add to their supplier networks.
4. Assess the information risk management strategy of the outsourcer and ensure that the suppliers commit to adequately maintaining the confidentiality of data in the event of compliance audits.
5. Ensure knowledge of personnel associated with the outsourcer and the flexibility to adapt to ever changing compliance requirements.
While additional measures need to be taken to manage risk when working with outsourcers, a large outsourcing firm can actually bring greater and stricter regulations. New regulations can seem daunting but it’s important for outsourcers to look at them as opportunities to showcase how they can bring better value to their clients. To protect your business from non-compliance with Dodd-Frank in an outsourcing relationship, ensure that you identify risks as part of the outsourcing arrangement and regularly monitor transactions and supplier performance. Above all, ensure that you partner with a company that has a demonstrated understanding of the complexity of the Act. At Minacs, our overall operational delivery model and the importance that the senior management team has placed on compliance has allowed us to adapt to new regulations. Minacs has responsibility for ensuring compliance to dozens of different acts spanning multiple industries as well as specific requirements regarding client contractual obligations. We’ve become an advisory arm to educate and make our clients more sensitive to the nuances of compliance.
By Barry Epstein
Establishing a de novo warehouse lending platform is twofold, staffing, and more importantly, risk. My comments on each are listed below:
Warehouse lending is one of the leading revenue producing lending platforms, as illustrated by the current ABA and SNL ratings. Of the 25 leading banks in NIM, ROA, loan growth and efficiency ratio, with assets of $500mm-$10B, 5 banks are warehouse lenders. It is really a form of asset based lending (ABL) as it provides the approved mortgage banker the capital they require to fund mortgage loan originations. The key to closing the transaction is a firm take-out from a major investor such as Wells Fargo and a short term, 2-15 day term loan, that constantly revolves with similar characteristics that is collateralized by a first lien on a residential property. The firm take-out is only accomplished from approved investors that only the warehouse bank approves.1. Staffing.
Only two full time employees will be required until volume on a monthly basis reaches $50mm+. It will take approximately 90 days to develop a de novo warehouse lending platform including policies and procedures, integrating the outsourced technology (Wells Fargo uses this technology). Within 15 months (including a 90 day ramp up) funded volume should reach at least $90mm per month and pre tax profits of $2mm with ROE of 21.63% and 2.27% ROA. Volume beyond the initial ramp up will depend on the business plan for the platform. Volume can easily reach $300mm a month (over $3B a year) within a 24-36 month period and show a minimum pre tax income of $8mm.2. Manage Risk.
a) Mortgage banker minimum net worth of $2.5mm, HUD approved. No adverse actions by HUD or any other agency, including state agencies. On a case-by-case basis may be adjusted to $1mm.
b) Loans to be funded, initially on a flow basis, and only with a firm take-out from an approved investor. Mortgage banker must have at least 3 approved investors for each type of mortgage loan. Set minimum net worth requirements for approved investors. Only major investors allowed. Bank to approve.
c) Loans to be funded at a discount. 96-98% of loan amount, unless the bank is the investor in which case it is 100%.
d) Require at least quarterly statements within 30 days of each quarter and annual audited statements, HUD approved, within 45 days of their calendar year.
e) Must be MERS (Mortgage Electronic Registration Systems, Inc.) registered.
f) Outside due diligence firm to review policies and procedures, initially and annually. Fee paid by mortgage banker.
g) Validation of CPL (Closing Protection Letter). Must approve all title companies.
h) Fraud Risk engines, MARI, Lexus Nexus, Core Logic.
i) E&O (Errors & Omissions) and Fidelity Coverage $1.25mm minimum, bank named as loss payee.
j) Use of Master Repurchase Agreement, loans BK (Bankruptcy) remote and eligible to use a collateral at the FHLB.
k) Guarantee from all individuals or owners of 20% of mortgage banker.
l) Minimum unrestricted free cash as a % of tangible net worth, usually 50%.
m) Mortgage banker never sees any money as proceeds from investor are deposited in treasury account at bank, and is used to pay principal interest and fees, and then any overages deposited in mortgage bankers DDA operating account at bank.
n) Additional leverage as loans can be participated out to community banks in your footprint.
For additional information on warehouse lending visit our Warehouse Lending
page on InsideBanking.net.
Barry Epstein is a senior executive with extensive bank experience as a chief lending officer in the residential mortgage and asset based lending sector, including warehouse lending on a regional and national basis. He is the Managing Director of Mortgage Warehouse Network, LLC.
By Kristen Stogniew, Esq
Last week, the Consumer Financial Protection Bureau published final rules that acknowledge the critical role that community banks and credit unions play in our economy through financing home loans.
We really should all be grateful.
In a move that American Banker magazine called a "Home Run," the Bureau crafted a few key exemptions to the Dodd-Frank Act's "ability-to-pay" rules that will become effective in January 2014. The rules as proposed would have opened community banks and credit unions up considerably to regulatory and legal attack on their portfolio loans, which, by definition, consists primarily of non-conforming, balloon mortgages, or loans that are higher-priced than those typically found in the residential secondary market. In response to the perceived regulatory burden (and, much to our chagrin, since we make it a priority to explain and document compliance requirements so they can be understood and applied on a day-to-day basis), many smaller institutions seriously considered getting out of residential mortgage lending, if they haven't already done so. That would be a shame for our communities and for those of us who don't fit "inside the box" of securitized financing.
The rule's final exemptions let the air out of the pressure cooker, and I hope the affected institution (under $2 billion in assets who originate less than 500 1st mortgage loans annually) understand that this is a competitive advantage....which is a very nice thing in this current environment.
Unfortunately, this hard-won award is not a cure-all for the regulatory burdens affecting residential lending. There are many regulatory changes coming next January thanks to the Dodd Frank Act. Truthfully, none are complex or deal-breakers, but their sheer numbers will present a challenge for residential lenders of all sizes to implement. In breaking them down, all can be managed by one or more common processes: (1) core or loan document system updates; (2) policy and procedure revisions and associated staff training; and (3) internal audit and monitoring program updates to periodically check under the hood.
A couple examples of the more onerous changes....ARMs (adjustable rate mortgage loans) will require significantly more advance notice of interest rate changes, and tellers and other employees who refer prospective home loan applicants for even a token referral fee (i.e., $25) will be considered "loan originators" for purposes of compensation and qualification requirements.
We will be providing support through these times to financial institutions via one-on-one and group workshops, so stay tuned. In the meantime, take a second to say "Thank You", then continue on the course (and, you may want to refer back to my prior "Inspirations" blog ... I'm just sayin').Founded in 1944, Saltmarsh, Cleaveland & Gund provides a full range of services, including auditing, accounting, management and marketing consulting, corporate and individual tax planning and preparation, business valuation, litigation support, financial and estate planning, computer systems evaluation, and employee benefits design, implementation, and administration. In the performance of these services, Saltmarsh maintains a high degree of shareholder involvement, which provides our clients with maximum assurance of quality.
Kristen J. Stogniew is a Shareholder of the firm and works out of the Tampa office in the firm's Financial Institution Advisory Group. She provides compliance risk management, policy and procedure drafting, and compliance reviews and monitoring in areas such as: BSA/AML, Loan and Deposit Compliance, Marketing and Retail Delivery, Trust, Governance, and ACH. Kristen also provides one-on-one mentoring and customized training to staff, management and Bank Directorate. She can be contacted at 813-287-1111 or firstname.lastname@example.org.
By: Bart Blechschmidt, Esquire
Starfield Smith, PC
Bart Blechschmidt, Esquire Unfortunately, all too frequently, after a loan is in default and the liquidation process has begun, the lender learns the real property collateral for the loan is environmentally contaminated. If this is the case, one should not automatically assume it is appropriate to abandon the collateral. Under the SOP 50 57, lenders must be prudent in their liquidation activities. In other words, they must take all commercially reasonable steps to affect maximum recovery.
One of the first steps in the liquidation process is the environmental investigation. The SOP requires an environmental investigation be conducted prior to any of the following:
* Accepting property as substitute collateral;
* Releasing a lien on collateral for substantially less than its estimated recoverable value based on unsubstantiated claim of contamination;
* Abandoning collateral;
* Acquiring title to property held as collateral (e.g., at foreclosure sale or accepting deed in lieu of foreclosure);
* Taking over operation of a business that uses hazardous substances or is located on contaminated property regardless of whether borrower owns the property;
* Selling REO or acquired personal property collateral for substantially less than the appraised value based on unsubstantiated allegations of contamination;
* Abandoning REO or acquired personal property collateral based on unsubstantiated allegations of contamination.
The determining factor for abandonment is based on the recoverable value of the property. Under the new SOP 50 57, it is appropriate to abandon personal property if the recoverable value is less than $5,000 and real property if the recoverable value is less than $10,000. Therefore, the prudent lender must look to the liquidation value based on the appraisal and then must factor in the cost to clean up and liquidate a contaminated property to determine the recoverable value.
Where this gets most tricky for the lender is determining the cost to clean up the property. Environmental companies certainly have the ability to provide an estimate of the costs, however, depending on the type of contamination, the expense associated with that may exceed the value of the property. For instance, the environmental company may do a phase one report that identifies contamination. In most cases, in order to get a reasonably accurate estimate to clean up the property, a phase two or sometimes even a phase three investigation needs to be done. In many cases, these additional investigations can have substantial costs. In the case of a property that has a low liquidation value, it can put the lender in a difficult situation.
However, there are potential solutions for the lender. First, one can look to the SBA for guidance on the appropriate course of conduct. Depending on the cooperativeness of the borrower, they may be convinced to sell the property avoiding the need for foreclosure. If the buyer is uncooperative the lender may want to have a receiver appointed (with prior SBA approval). If the expense of the receiver is too great to take over a going concern, the receiver may be appointed with his or her powers limited solely to listing and selling the property. Again, with any potential course of action in these scenarios, it is critical to first get SBA approval.
It is always challenging to liquidate collateral after default. It is even more difficult when the property is contaminated. The lender must make sure to comply with the requirements of the SOP and explore different options to insure prudent liquidation instead of simply abandoning any property that is contaminated.
For more information on liquidating environmentally contaminated property, contact Bart at 949-333-4108 or at email@example.com
By Mike Simmons, President - Plane Data, Inc.
There is a science experiment that demonstrates how an animal (including people) can be "boiled alive" without having a painful reaction. This situation can be accomplished when the temperature of the water is changed on a very gradual basis such that the animal doesn't notice it. The point is that the aircraft marketplace can be similar when the market appears "steady" over a very short time-frame thereby creating a misleading, comfortable situation but the cumulative effect over an extended period of time can be disastrous for anyone who depends on the aircraft's value being known and understood. Therefore, it is important to revisit the aircraft in your portfolio routinely to ensure that value issues haven't developed as a result of the market, the owner, usage of the aircraft or all of the above.
Not long ago, a previous client asked me to re-appraise his fleet. This client owned three aircraft and has been flying for many years. The need to understand the fleet's value involved insurance - a topic that I have mentioned in newsletters and on line before and I have an article
written by a well known insurance broker discussing the impact of over insuring aircraft. When I appraised his fleet about four years ago it was for the bank's financial analysis. The owner was planning on upgrading the avionics along with the engines and my reports attempted to help the banker understand what those improvements would do to the value of those aircraft at that point in time. Fast forward to 2013. The loan is paid off and the improvements have been installed. The owner is now facing a new problem regarding the insured value of the aircraft in that the insurance company believes the values to be excessive and they are requiring appraisals to justify the coverage levels. The changes of these three aircraft and the market were enlightening.
First, the overall market value for each of these aircraft fell by about 17% - 30% depending on the data source used and the specific make/model of aircraft. I mention this because if anyone asked - "How's the market doing?" at any point in time, it would have appeared somewhat "stable" on a month - to - month comparison as there have been no recent radical changes in the market over the past few years but the overall cumulative effect has been negative for these aircraft and the reasons vary - but now let's turn to the aircraft in question.
All three aircraft are maintained on a Part 135 Certificate (air taxi) and fly regularly. The objective of the owner was to equip all aircraft alike with a conversion from "steam gauges" to glass panels and install overhauled engines. The aircraft in question are all "early '80s" vintage and include a turbo prop, a piston twin and a piston single. After thousands of dollars on improvements, one aircraft actually lost 2% of its value over this 4 year period. The other two aircraft gained value but not as much as you might think. One aircraft increased its value by 24% while the other increased its value by 7% (this aircraft was particularly interesting because the Average Green Airframe Value
declined by 86% during this same period!). The aircraft in general were "over insured" but one in particular was insured for more than twice its current value! The owner (a knowledgeable and skilled pilot) was simply unaware of the factors that went into the evaluation of an aircraft and how these factors have changed over the past few years. The owner was not only overpaying for insurance but he was also most likely overpaying his taxes as well.
It is important to have the aircraft in your portfolio reappraised every so often and the amount of risk will dictate the time-frame. The example in this article is NOT unique. Once the deal is completed most banks/bankers file the report away and move on to the next deal never to revisit the aircraft or its value again. However, there are multiple parameters at work impacting the overall value of the aircraft over time - both positively and negatively. The usage of the aircraft may be "above average", the aircraft can become damaged in some way, improvements are added and so forth.
A legitimate risk management plan revisits the aircraft routinely to document and verify changes to the aircraft itself along with its market value (not to be confused with "book value"). It is important to ask - How old is the appraisal report you have on file and do you even have a certified appraisal report on file? Other questions include - How much trust and reliability do you place in the reports on file and/or the opinion of value? If you are unable to answer these questions, Plane Data, Inc. can help.
Plane Data, Inc. is a solutions based company and your current documentation can be reviewed on a confidential basis in order to recommend an appropriate strategy. Please call 800-895-1382
to get started. Mike Simmons is a frequent contributor to InsideBanking.net and to our LinkedIn Group, Inside Banking - Lending Group.
By: Camilla N. Andrews & Amy R. Brownstein
On January 14, 2013, in Riverisland Cold Storage v. Fresno-Madera Production Credit Assn., 2013 Cal. Lexis 253 (2013) ("Riverisland"), the California Supreme Court overturned Bank of America etc. Assn. v. Pendergrass,4 Cal.2d 258 (1935) ("Pendergrass") which, for nearly 80 years, has limited borrowers' ability to challenge contracts based on alleged oral promises made by a lender that contradict the terms of the loan documents. This change in California law will make it harder for California lenders to quickly dispose of such borrower allegations by demurrer or summary judgment, and is likely to result in increased litigation costs - and longer times to complete liquidation - for California lenders.
In Riverisland, the borrowers alleged that the lender's vice president had met with them two weeks before a loan modification agreement was signed, and that he represented to them that the lender would extend the loan for two years in exchange for two pieces of additional real property collateral. The borrowers further alleged that when they signed the agreement, which they did not read (although they initialed the pages setting forth the legal descriptions), the lender's vice president assured them that the term of the agreement was two years, and that the two additional pieces of real property were the only additional collateral being taken. In fact, however, the written agreement provided for only three months of forbearance by the lender, and identified eight additional pieces of real property collateral. The borrowers subsequently failed to make payments as agreed, and the lender recorded a notice of default. After the borrowers repaid the loan and the foreclosure proceedings were dismissed, the borrowers filed an action against the lender seeking damages for fraud and negligent misrepresentation. Causes of action included reformation of the restructuring agreement and rescission.
Under California law, the parol evidence rule (set forth in California Code of Civil Procedure §1856) prohibits the introduction of outside evidence, such as oral statements or earlier writings, to contradict the terms of a final written agreement. The parol evidence rule is subject to exceptions, however, and allows for evidence challenging the validity of an agreement, or evidence to establish fraud. The decision in the Pendergrass case limited the parol evidence rule's fraud exception, requiring that the evidence offered to show fraud relates to fraud in procuring the written agreement and not a promise that was different from the terms of the agreement.
In Riverisland, the lender filed a motion for summary judgment, seeking to have the case dismissed based upon the Pendergrass rule. The California Supreme Court overruled Pendergrass, finding it to be inconsistent with California law, an "aberration," and a potential shield for fraud. 2013 Cal. LEXIS 253, 25-27. Consequently, borrowers will be able to offer additional evidence, such as oral statements allegedly made by a representative of the lender as to the terms of loan documents, to support allegations of lender fraud.
What are the ramifications for lenders? Quite simply, lenders may be unable to quickly dispose of claims of oral promises differing from the terms of written loan documents through demurrer or summary judgment. Such claims will most likely result in time-consuming and costly litigation, with most cases brought by borrowers expected to include allegations of fraud, and more cases expected to go to trial.
What actions might a lender take to protect itself? While the facts of Riverisland indicate that the initialing of loan documents will likely not be sufficient to support a lender's defense that borrowers had knowledge of the contents of loan documents, there are a number of protective measures that lenders can take to protect themselves from allegations of fraud.
• Some experts have recommended the inclusion of arbitration or judicial reference clauses in loan documents which, if enforced, would allow the lender to have the dispute heard by an arbitrator or judge rather than a jury that might have more sympathy for a borrower.
• Experts have also recommended that loan documents be provided to the borrower in advance of closing to allow the borrower time to read the documents, possibly coupled with an acknowledgment that the borrower has been encouraged, and has been provided an opportunity, to have the documents reviewed by its own legal counsel.
• A lender might require the borrower to re-execute a commitment letter at closing, confirming the pertinent terms of the loan.
• A lender might obtain an affidavit, to be signed under penalty of perjury, which is read to the parties and signed by them prior to the execution of loan documents, to specifically disclaim reliance upon oral representations and warranties made by the lender.
• Lenders should ensure that their personnel, including outside brokers and agents, are aware of the state of the law on this issue. All employees and agents who interact with borrowers and other loan parties must understand that misrepresentations to these parties may result in a court determining that the borrower and other loan parties are not bound by the terms of the loan documents. Terms and conditions of a loan or loan documents should never be misrepresented to any borrower party.
Solutions will vary for each lender and each loan. Please feel free to contact Camilla at (949) 333-4108 or Amy at (215) 542-7070 for additional assistance in addressing this issue. firstname.lastname@example.org
Starfield & Smith, P.C. | Irvine, CA Office
2955 Main Street, Second Floor | Irvine, CA 92614
This article was republished with the permission of Camilla Andrews, Starfield & Smith, PC. For further information on Camilla visit our InsideBanking
By Theodore (Ted) J. Hamilton, Esq.
The debtor’s bank account is flush with cash! After months of searching and work you finally have it, a payday! You get the garnishment paperwork done the same day and serve it on the neighborhood bank. But the banker looks at it differently. The banker says, hold on a minute. What is wrong with my client? They can’t pay their bills? How did this judgment happen without my knowledge? What about me? What am I to do? Although that loan I have to the debtor isn’t in default and they are current, my loan documents say that a judgment or garnishment results in a default. I have to protect myself. As a result, when the banker receives the garnishment, they freeze the account and file a response to the garnishment stating there are no funds available due to the bank lien on the account. Who gets the money is what both the lawyer for the bank and the lawyer for the creditor are asked. The answer lies in the Uniform Commercial Code and in the facts of each case. A. Perfecting a security interest in a bank account.
The Uniform Commercial Code outlines how to perfect a security interest in a bank account. Particularly UCC section 9-314 states that a security interest in a bank account is perfected by control and the security interest is lost when control is lost. UCC section 9-104 defines control of a bank account and states as follows:
A secured party
has control of a deposit account
(1) the secured party is the bank
with which the deposit account
(2) the debtor
, secured party, and bank
have agreed in an authenticated record
that the bank will comply with instructions originated by the secured party directing disposition of the funds in the deposit account
without further consent by the debtor; or
(3) the secured party becomes the bank
's customer with respect to the deposit account
Thus, once the account is an account at the bank, the bank has control of the account sufficient to establish a security interest if the loan documents so provide for such a security interest. B. What controls the right of a Bank with a security interest to set off against the deposit account?
But what controls whether the bank can setoff the amounts in the deposit account against a debt due to the bank? Uniform Commercial Code section 9-340 gives the bank who has “control” over the deposit account the right to setoff amounts in the account against amounts due to the bank. C. When can the bank exercise its setoff rights?
If at the time garnishment hits, all loan amounts due to the bank are current, how can the bank claim a setoff right that would take priority over the garnishment lien on the account?
Assuming the bank’s documents give the bank the right to a setoff upon default and the loan is in default at the time of the garnishment, the bank will have the right to set off against the deposit account in the bank’s control.
But what if the loan is not in default at the time the garnishment hits? The language of the Bank’s loan document must be reviewed on a case by case basis to determine whether the bank takes priority. In the case of In re Szymanski
, the court found the term “material adverse change” as defined in loan documents did not allow the bank claim priority over a garnishment on a non-demand note where no evidence existed that the judgment impaired the debtor’s ability to pay the forty thousand dollar loan which happened to also be secured by real property worth over 1.2 million. In re Szymanski
, 413 B. R. 232 (Bankr. E.D. PA 2009).
Other courts have determined that only if the debt has matured can a setoff occur. See Carbajal V. Capital One
, 219 F.R.D. 437 (N.D. Ill E. Div , 2004). Some courts have said that if the debtor is insolvent the bank has a setoff right. Elizarraras v. Bank of El Paso
, 631 F.2d 366 (C.A.5. Tex., 1980).
In the case of All American Auto Salvage v. Camp’s Auto Wreckers and Citibank, South Dakota, N.A.
, the New Jersey Supreme Court considered whether the bank had the right to set off funds on deposit against the fees the bank charged on the account as a result of the execution writ hitting the account. 679 A.2d 627 (N.J. Sup Ct., 1996). The court, going through an excellent analysis of the right of the bank to setoff, determined that in equity the bank should have the right to set off for such fees. Id
. at 633.
The Florida court in the case of Barsco, Inc. v. H.W.W. Inc
., examined cases from both Florida and out of Florida for a determination as to whether a bank could prevail against a garnishment of an account. 346 So.2d. 134 (Fla. 1st DCA, 1977) In this case, the holder of the account was not in default on the loans at the time the garnishment hit. The court examined one line of cases involving the loans which gave the bank the right to off-set the depositor’s account without demand or notice. In such cases, this line of cases held the bank still has the duty to take some affirmative action to accelerate when the note has not matured prior to the time of the service of the garnishment writ. Id
. at 135. The Barsco
court found the UCC leaves it to the security agreement to determine what constitutes an event of default. The Court also found the bank note required the borrower not to dispose of the security without written consent of the bank. Ultimately, the court held the bank’s setoff right took priority over the right of the garnishee to the funds.
Each state will have a different version of the Code as adopted and may also have a specific code section dealing with the priority issue on a garnished bank account. These must be reviewed for the state at issue.
A levy or garnishment on a bank account may take priority over a bank’s set off claim against the account if the bank documents are not specific as to the right to set off when the loan is not in default. For bankers this means they must ensure their loan documents give them the right to set off upon a garnishment or execution. Loan documents should include broad language creating a security interest in the account and ensuring the entire amount of the loan will be due if the garnishment hits or if the banker is insecure in the discretion of the bank. The creditor attorney will want to review the loan documents and state law to ensure the bank has the right to set off and claim priority over the garnishment. In the end, the account may still be flush with cash and you may still be entitled to it.
Ted Hamilton is a frequent contributor to InsideBanking and Inside Banking - Lending Group on LinkedIn. Ted is AV Rated by Martindale Hubbell, its highest rating. His practice focuses on business representation, business planning, real estate transactions and litigation, commercial litigation, bankruptcy and business litigation, secured transactions and loan documentation and transactions.
Attorneys at Law
Theodore J. Hamilton, Esq.
P.O. Box 172727
Tampa, FL 33602
813-225-2918 ext 14
This article will appear in the Fall edition of the Commercial Law League publication, Commercial Law World.
Permission to reprint provided by Commercial Law World
By Jeffrey Feldman
There comes a time in every lender's portfolio when its workouts are no longer working out, and the only commercially reasonable course of action is to sue the obligors. When a lender participating in the SBA's 7(a) program sees that time approaching, it must work closely with its counsel to ensure that its litigation plans fully comply with the SBA's requirements.
The first step towards a valid litigation plan is the retention of qualified collections counsel. The SBA requires that the attorney hired by the 7(a) lender have expertise in debt collection and bankruptcy law, be licensed to practice law where the litigation will be conducted, maintain adequate malpractice insurance, and have no conflicts of interest. In addition, the attorney's fees must reasonable for the locality where the litigation is being brought, and his or her billing practices must conform to the SBA's requirements. A lender should confirm these understandings in its written engagement agreement with its counsel.
The most important threshold issue to be addressed by the lender and its counsel in formulating a litigation strategy on a 7(a) loan is whether it is necessary to submit a litigation plan to the SBA for approval. In general, a written litigation plan must always be prepared and submitted for approval in advance
by the SBA unless: (1) the litigation qualifies as "Routine Litigation," or (2) the SBA grants a limited waiver of the need for a litigation plan. "Routine Litigation" is uncontested litigation for which the estimated legal fees do not exceed $10,000 in the aggregate. A limited waiver of the written litigation plan requirement may be granted by the SBA in its discretion upon request if certain extraordinary circumstances exist that warrant granting a temporary waiver.
The form and content of any litigation plan submitted by a lender and its counsel should follow the template used in the SBA's official form, which is available at www.sba.gov
. Every section of the form should be completed in order to avoid delays in its processing. Although the form is completed by counsel, the lender is responsible for providing its counsel with a variety of information and documentation related to its loan that must be included in the plan.
If the litigation plan involves a bankrupt obligor or a claim against a deceased obligor's estate, the SBA requires that a specific series of steps be taken to protect the SBA's interests. Where applicable, lenders should ensure their proposed litigation plan references and fulfills those requirements. In addition, a lender should also review its litigation plan to ensure that it does not incur legal fees that the SBA either will not pay or has the discretion not to pay. Finally, the lender should also review any proposed pro-rata application of legal fees and recovery between the SBA loan and any other loans.
When the plan is complete, it should be promptly submitted to the SBA for approval via e-mail to email@example.com
. Once received, the SBA will generally approve or deny the litigation plan within 15 business days. If the SBA fails to do so, however, that cannot be deemed an implied consent by the SBA - it must provide its express consent to the lender in writing.
After the plan is approved, a lender must monitor its litigation to determine whether (a) it has taken any actions that materially deviate from, or were not included in, the original litigation plan, and/or (b) it has incurred any expenses that exceed the estimates in the existing plan by more than 15%. If either has occurred, the lender must submit an amended litigation plan to the SBA for approval prior to taking any further action. Similarly, a lender who has been pursuing Routine Litigation without an approved plan must submit a litigation plan when (a) it incurs legal fees in excess of $10,000 or (b) other changes occur that render its litigation "Non-Routine."
SBA lenders should select qualified litigation counsel who are experienced with the regulations governing the liquidation of SBA loans to ensure that their pursuit of the obligors' assets does not inadvertently jeopardize their own most valuable asset - the SBA's guarantee.
For more information regarding litigation plans, please contact Jeff at JFeldman@StarfieldSmith.com
Starfield & Smith, P.C. protects the interests of its lender clients through a staff of experienced attorneys and paralegal loan processors. Their expertise in SBA guaranteed loans encompasses the breadth of the SBA's lending options, including the 7(a), 504, Express and Export Working Capital programs. If you would like to learn more about Starfield and Smith, PC visit their website at http://www.starfieldsmith.com/.
A special thanks to Jeffrey
for sharing this article with our members and Camilla Andrews
who originally introduced us to this article on the Inside Banking - Lending Group.
By Kim Machotka
As of September 30, 2011 the FDIC reported over $50 Billion in Other Real Estate Owned (OREO) on the books of the 7,436 financial institutions it insures. That almost incomprehensible number is nearly five times more than the amount reported only four years ago. This figure includes a whopping 1.3 Million residential OREO properties for sale according to RealtyTrac. Banks have suddenly found themselves in the role of selling real estate instead of making loans to purchase real estate. As you can imagine, turning bankers into marketing experts overnight is not as easy as one might think. Banks have traditionally turned to the expertise of local real estate agents and attorneys that they have established relationships with to help them market and sell their OREO property. With the expansion of internet, and the explosion of OREO property on the books of banks, banks have expanded their OREO marketing strategies to include new online marketing services to capture a broader base of buyers and investors reaching across the globe.
After several years of unwanted experience, banks are now realizing the true cost of holding OREO property on their books. Although the cost of maintaining an OREO property varies by geographic location, the holding cost for a bank can be as high at 10% of the property value on an annual basis. This may seem high, however when you consider the many expenses a bank incurs during the process such as real estate taxes, heating, cooling, lawn care, snow removal, weekly or monthly property visits, appraisals, legal fees and additional bank staff, it is easy to see how the expenses add up to astronomical numbers. Given that the total value of OREO properties is $50 Billion plus in the United States, Banks are spending as much as $5 Billion annually to maintain their current OREO portfolios.
With such overwhelming expenses associated with maintaining OREO properties, it is not hard to understand why many banks are targeting the reduction of OREO properties as their number one priority for 2012. In some cases, OREO properties make up more than 10% of bank capital or equity. This causes a significant drain on bank earnings and on their ability to lend money that ultimately helps our economy grow. Banks with large OREO portfolios recognize that addressing this OREO problem is key to staying in business and to stimulating our stagnant national economy.
For this reason, banks are now more motivated to try new and creative ways to market their OREO properties. Some of the more efficient, effective and economical ways to market involve the internet in some type or form. Given the exponential increase in the use of the internet in recent years, it is not a surprise that 88% of US home buyers utilized the internet during their search to purchase real estate in 2011 according to the National Association of Realtors. Banks are paying attention to statistics like these and so is a growing cottage industry of online websites catering to OREO properties. Internet services available to buyers and sellers of OREO property vary widely, including some free and many fee based individual real estate agent websites, auction websites, specialized OREO listing services and even bank owned property lists on a banks own website.
In any case, an increased online OREO marketing effort, especially those that expand the marketplace for the bank, can provide an excellent Return on Investment for a bank. For example, a bank with $10 Million in OREO property could spend as much as $1,000,000 a year maintaining the portfolio. For as little as a few hundred dollars a month, a bank can expand its OREO marketing reach to a national and even international marketplace with the right online tool and marketing strategy.
With almost 40% of home sales in 2011 considered "distressed sales", it is evident that buyers and investors of OREO properties are active in the marketplace. Savvy investors and buyers are constantly looking for new ways to capitalize on the sometimes 20-40% discounts that bank owned property and repossessed assets can offer. Banks are sometimes willing to sell at these unadvertised stellar discounts due to the cost savings associated with not having to maintain the properties for an additional one, two or even three years. These deals can take some work to find as these somewhat ‘secret’ lists held at banks are not always available to the public and sometimes a buyer or investor will need to contact the bank directly to search them out. Nonetheless, finding the right online marketing strategy and website can be an effective, efficient and economical solution for connecting buyers and sellers of OREO property and reducing the burden of OREO property in the portfolios of banks across the country.
Article author Kim Machotka is an entrepreneur from Madison, Wisconsin and President and Founder of BankMarketplace.com, an online service that markets OREO properties and other repossessed assets for Banks and Credit Unions. Searching OREO property on the site is free to the public and offers direct access to bank owned property and repossessed assets including vehicles, real estate, equipment, recreational vehicles and more