Current Banking Issues in California A DFI Perspective

1. Current Banking Issues in CaliforniaA DFI Perspective By John T. Ross Deputy Commissioner Southern California Region Department of Financial Institutions Scott D. Cameron Deputy Commissioner Northern California Region Department of Financial Institutions

2. The Department has four office locations: Total number of employees 219 Total number of examiners in all divisions and offices 130 Number of Bank Examiners 92

3. Department History In 1909, the Bank Act was passed in California, creating the State Banking Department. On July 1, 1997, the DFI was formed to combine the responsibility for the safety and soundness of California’s depository institutions under one roof. DFI is better able to reduce unneeded regulations and costs for state-chartered commercial banks, trust companies, and other licensees formerly regulated by the State Banking Department, as well as savings and loan associations formerly regulated by the Department of Savings and Loans, and industrial loan companies and credit unions formerly regulated by the Department of Corporations.

4. Licensee Services The Department currently grants licenses to conduct financial services business in California under nine different sets of statutes: bank and trust, savings associations, credit union, industrial loan, foreign banks, business and industrial loan, transmitters of money abroad, payment instruments, and travelers checks.

5. DFI Top Priorities 2007-2010 Performance Management and Information System Improvements • The Department actively manages its performance improvement initiatives, and evaluates its staff pursuant to these objectives. • The Department is currently working on certain information system improvement initiatives, such as the capability of electronic filing of applications, in order to provide better service to our licensees. • The Department has recently developed a new financial institutions management information system (FIMIS), a major database improvement initiative that provides: • Enhanced ability to track and deploy our examination resources. • An early warning system that enhances our ability to evaluate the risks of our licensees. • These initiatives enhance our effective deployment of resources and increase our ability to efficiently meet our mission of ensuring the safety and soundness of state chartered financial institutions.

6. DFI Top Priorities 2007-2010 Recruitment and Retention • The Department needs to continue to attract, train and retain highly qualified financial institutions examiners. • The Department needs to enhance the level of our examiner compensation in order to narrow the pay gap between our examiners and their Federal counterparts in order to facilitate the retention of trained and experienced staff. • The Department will be submitting pay enhancement proposals to the California Department of Personnel Administration in order to establish pay differentials for competency certifications and to establish additional classifications based on experience and expertise.

7. DFI Top Priorities 2007-2010 Regulatory Streamlining • The Department has two bills pending in order to streamline and relieve regulatory burdens on our licensees and provide for flexibility in the examination process. • AB 1301 would eliminate certain applications that are no longer deemed necessary, or that are more suitable for notification only as opposed to approval. This bill can also be used to facilitate the electronic filing of applications. • SB 1037 makes changes to the definition of what constitutes engaging in trust activities, as well as other technical clarifications.

8. DFI Top Priorities 2007-2010 Succession Planning Establish a robust plan for developing the future leaders of the Department in order to ensure a succession plan with qualified individuals to eventually become the Department’s future executive management team. This succession planning will include training in following areas: • Leadership skills, • Employee supervision, • Interpersonal skills, • Teamwork and integrity, • Openness in communication, and • Technical skills.

9. DFI Top Priorities 2007-2010 Promote the State Charter as a Viable Alternative • Continue to improve our efforts to be the regulator of choice for California financial institutions by providing open communication, appropriate guidance, timely responses, and quality supervision of our licensees. • Develop a state-wide campaign to educate the public about the role of the Department and the importance of the state’s role in supervising financial institutions. • A part of this education campaign would focus on the importance of, and the advantages of, the dual banking system, including the flexibility and the strength that it provides.

10. De Novo Banking Activity New State Chartered Banks opened in California between 2003 and 2006

11. De Novo Banks Opened in Past Four Years * 11 banks opened for business in 2004, but two of them have merged with other banks since then.

12. Percentage of Banks Chartered in Past Four Years As of 4/30/07, there were 206 state-chartered banks in California. 75 of them have opened just in the past four years (over 1/3 of our current bank licensees).

13. New Bank Opening Activity

14. New Bank Opening Activity

15. De Novo Bank Activity • As of 4/30/07, ten (10) new commercial banks were in the process of organizing, and six (6) new bank applications were pending. • It appears that the peak activity in de novo bank formation is likely behind us. However, we are still getting inquiries. We are still having pre-filing meetings, and receiving applications, but not at the level that it reached in the past two years.

16. Factors that DFI is required to investigate and consider pursuant to the California Financial Code • Public convenience and advantage will be promoted by the establishment of the proposed bank. • The proposed bank will have a reasonable promise of successful operation. • The proposed capital structure is adequate. • The proposed officers and directors have sufficient banking experience, ability and standing. • The character, reputation, and financial standing of the organizers and incorporators, and their motives in organizing the proposed bank, must also be considered.

17. New Bank Application Process • Initial inquiry/meeting • Pre-file meeting • Application Review Process • Each step, we try to be proactive in providing feedback, discussing concerns, asking questions, and seeking clarification.

18. Issues and Concerns in de novo banks • Qualifications and abilities of management and the Board • Difficulty locating and recruiting qualified management. • New and inexperienced executive management teams. Sometimes executive officers may not have had prior experience in their respective positions.

19. Qualifications and abilities of management and the Board Mentor program has been used on occasion to compensate for an inexperienced executive officer. New and inexperienced Board Lack of breadth and diversity in Directorates High turnover rate at the senior management level Some dysfunctional Boards of Directors Issues and Concerns in de novo banks

20. Issues and Concerns in de novo banks • Difficulty implementing the bank’s business plan • Lack of success in originating loans and raising core deposits • Lack of prudent diversification in the loan portfolio • Deposit and loan pricing and market competition • Have been some recent examples of difficulty in raising minimum initial capital

21. Issues and Concerns in de novo banks • Pressure to rapidly deploy the bank’s capital in order to achieve profitability and a return for shareholders. • Asset growth (quantity vs. quality) • Unacceptably high level of adversely classified assets due to underwriting and credit administration weaknesses • Increasing competition, particularly in certain geographic and target markets • Inadequate risk assessment and internal controls • Poor funds management practices • High pre-opening expenses • Processes for insider loans and insider transactions

22. Lessons Learned in de novo activity • Re-emphasized the importance of a strong management team • Importance of a qualified CEO • Importance of a qualified CFO • Proper internal controls must be established • Importance of qualified lending personnel • Credit Administration • Business Development • Re-emphasized the importance of a qualified directorate • Importance of proper Board oversight • Importance of a Board with prior banking experience • Importance of a Board with diverse breadth of experience • When we approved applications where we had some concerns, the concerns more often than not have turned out to have been well founded.

23. DFI’s Supervisory Goals • Maintain a conservative approach to the issue of approving new charters • Insist that the board and management team of new banks are sufficiently qualified for their proposed positions • Maintain open communication with the applicants and consultants • Identify and address concerns and issues at the earliest possible stage • Provide appropriate feedback and guidance • Provide a genuine service to the public and to our licensees by promoting the integrity and stability of California’s financial services system through the appropriate regulation and supervision of state chartered financial institutions

24. The Department Policy on Chartering New Banks “We recognize the fact that the current prosperity and expansion of business has been accompanied by a substantial increase in applications for the establishment of new banks…” “The proper administration of this phase of supervising requires the highest type of judgment, discretion and administrative teamwork.” “Accompanying the rise in the national economy, the number of newly chartered and opened banks has continued to rise in the United States as a whole.”

25. The Department Policy on Chartering New Banks “In arriving at a decision as to whether or not the charter should be issued, …we must give careful consideration to the many factors we are required to investigate by the provisions of the Banking Law.” “We are particularly concerned that public convenience and advantage will be promoted …and that the community in which the bank … will operate shall afford reasonable promise of successful operation.” “The proposed capital structure must be adequate, and the proposed officers and directors must have sufficient banking experience, ability and standing, to afford reasonable promise of successful operation.” “…we must also consider the character, reputation, and financial standing of the organizers …and their motives in organizing the proposed bank.” “It is only after full and complete …analysis …is made…that we take final action either in the negative or affirmative on any application.”

26. The Department Policy on Chartering New Banks “The policy of this department concerning the chartering of new banks …will continue to be conservative.” “We believe in competition in the banking business and stand ready to establish a new bank where there is room for another institution, but our conclusion and policy is that overbanking in any community makes for unsoundness in banking operations, particularly in the making of bad loans which later develop into losses that imperil the safety of the bank…” “By following a conservative policy in the establishment of new banks …, by insisting that the founders of new banks shall be … of highest integrity and sound financial standing and ability, … the Banking Department will render a genuine service to the public, the importance of which will be recognized in the years that follow.”

27. The Department Policy on Chartering New Banks Excerpts from a speech given by William A. Burkett Superintendent of Banks to a conference of the State Banking Department January 16, 1956

28. QUESTIONS