Analyst puts Doral order in perspective

In his latest research update, Gladue acknowledged that the order with the Federal Deposit Insurance Corp. (FDIC) and the Puerto Rico Financial Institutions Commissioner’s Office (Ocif by its Spanish acronym) is serious, but noted that it doesn’t require the local financial institution to raise capital.

“While this is a serious level of regulatory order, there are variations within this class. Doral’s order does not require them to raise capital. In fact, Doral’s capital ratios already exceed the capital targets in the order by a significant margin. In regards to asset quality ratios, it appears that Doral has already addressed this issue as well,” Gladue said in his research update.

In Gladue’s view, the imposition of the consent order may be somewhat backward looking.

“It is quite possible that the conditions under which this order was contemplated occurred prior to when Doral boosted its loan loss reserve and recorded significant net charge-offs in first quarter 2012. Many of the banks we follow have operated under consent orders during the most recent credit cycle. Some of these banks have been successful in meeting the terms of these orders and having them removed,” the B. Riley & Co. senior analyst said.

The consent order agreed on this week serves as the FDIC’s notification that it considered Doral Bank in troubled condition. The consent order requires Doral to maintain Tier 1 leverage, Tier 1 risk-based, and Total risk-based capital ratios of 8.0%, 10.0%, and 12.0%, respectively. The bank currently tops those targets.

In addition, the bank must seek approval before accepting new brokered deposits or extending credit to delinquent borrowers. The order requires Doral to undertake a review of its board and management, establish capital, profit and budget plans and establish acceptable policies and procedures for the loan loss reserve, loan policy, loan review, loan modification, appraisal compliance, and a strategic plan.

Doral expects to enter into a similar agreement with the Federal Reserve Bank of New York that will replace a cease and desist order that has been in place since 2006.

“Doral management notes that addressing the issues in the consent order will require significant resources in terms of management, additional staffing, and third party consultants,” Gladue said.

To put the consent order in context, Gladue explained there are several levels of regulatory orders that can be imposed on a bank.

At the low end, a board resolution is relatively minor and is often not even reported publicly by a bank. An MOU (memorandum of understanding) is a little more serious. It is still an informal agreement and may include some target levels for capital ratios.

“At the more severe end is a cease and desist order (C&D). A C&D is binding and often carries hard targets for capital levels and/or asset quality ratios. A consent order is similar to a C&D,” Gladue said.

Typically, one would not expect any change in a regulatory order until at least after the next annual regulatory exam.

“While we do not know when this will occur, it would probably be a year between exams. After the exam is completed, it may take several months before the final report is issued and any actions resulting from the exam occur,” he said.

Driven by a growth in expenses, Doral Financial Corp. reported Wednesday a net loss of $1.6 million for the second quarter (2Q) ended June 30, 2012, compared with a net income of $2.6 million in 1Q 2012 and a net income of $4.5 million in 1Q 2011.

Gladue pointed out that most of the operating metrics of Doral improved in 2Q. Among these were an expanded net interest margin, a growing loan portfolio, a better mix of deposits, and reductions in nonperforming assets, net charge-offs, and inflows to non-accrual.

On the earnings news, shares of Doral Financial Corp. lost 41 cents, or 28.08%, closing at $1.05 at the end of trading. Approximately 4,170,500 shares changed hands that, a 1,075.6 percent increase over its 65-day average volume. The stock (DRL) was trading at $1.06 on the New York Stock Exchange on Friday afternoon.