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Policy Statement on Prudent Commercial Real Estate Loan Workouts

November 1, 2009

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Regulators and financial institutions have been trying for some time now to come to an understanding of what type of how workout strategies affect the classification of loans and the corresponding impact on estimates of loan losses. On October 30 the federal banking regulators published guidance on prudent commercial real estate loan workouts that addresses these issues. The guidance addresses some of the most contentious areas of disagreement between banks and examiners.  One of those areas is the impact of a decline in value of collateral in situations where the borrower or guarantors have the ability to service the loan. The new guidance tells examiners that renewed or restructured loans to borrowers who have the ability to repay their debts according to reasonable modified terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the loan balance. This is a significant change from the manner in which examiners have been classifying acquisition and development loans in the past and time will tell exactly how the examiners will in fact deal with such loans in the future.

A problem loan workout can take many forms, including a renewal or extension of loan terms, extension of additional credit, or a restructuring with or without concessions.  The key to any loan workout is that the renewal or restructuring should improve the lender’s prospects for repayment of principal and interest and be consistent with sound banking, supervisory, and accounting practices.

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Georgia DBF Clarifies Guidance on Loan Renewals

August 10, 2009

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Georgia Department of Banking and Finance Commissioner Rob Braswell has advised us that the Department’s announcement last week was intended to provide relief only in the context of “loan stacking” under the Department’s proposed new Rule 80-1-5-.11.  Accordingly, the Department will permit renewals of loans which had originally been made in conformity to the loan to one borrower, but would otherwise not be in conformity with the loan to one borrower rule solely due to the the Department’s proposed new “loan stacking” rules.

Renewals and extensions of loans where the loan to one borrower issues arises solely because of capital losses since the loan was originally made are NOT covered by the Department’s announcement.  We are continuing to pursue this issue with the Department, but in the meantime, our recommendation is that banks should NOT extend or renew loans to borrowers where the extension or renewal would violate the loan to one borrower rule as a result of reductions in the limit resulting from capital losses.

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Georgia DBF Provides Guidance on Legal Lending Limits for Loan Renewals

August 6, 2009

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The Georgia Department of Banking and Finance (“DBF”), announced today a significant change in the way in which the legal lending limit will be applied in the context of loan renewals.  Due to a shrinking capital base, a large number of banks have been struggling with the issue of what to do with loans whose renewal would cause a violation of the legal lending limit.  These were loans that met the requirements when the loan was made but could not be made today due to the bank’s smaller capital position. The position of the DBF has been that a bank should not renew such a loan.  In the current economic environment this places banks in an untenable situation because borrowers are unable to pay off the loans due to a lack of liquidity and no other financial institutions are willing to take over the credits.  The only option left for a bank in such a situation is to enter into some sort of forbearance agreement with the borrower.  The result of that, however, is that after 90 days the loan will need to be downgraded to substandard, regardless of whether the borrower is able to keep interest payments current.

Following direct discussions among GBA President Joe Brannen, GBA counsel Walt Moeling and Jerry Blanchard, Commissioner Rob Braswell, and the DBF Staff dealing with this issue, the DBF announced today that it shall be the position of the DBF that if loans are modified or renewed by the bank without any additional extension of credit outstanding, such loans will not be cited for a violation of the new rules of the Department contained in Rule 80-1-5-.11.  The DBF goes on to note, however, that the fact that a violation of the lending limit rule is not being cited should not be interpreted as a finding of creditworthiness by the DBF. A decision to classify a credit or credit relationship is an independent process from the application of statutes and rules.

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Additional FDIC Guidance on Modification of Repurchase Agreements

August 5, 2009

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On July 6, 2009, the FDIC published a set of Frequently Asked Questions relating to the Sweep Account Disclosure Requirements which recently went into effect.   One of the issues addressed was what does the FDIC consider to be a perfected interest in a security.   This issue first came up earlier this year when the FDIC took the position that many repurchase agreements were defective and that in a failed bank situation the FDIC would take the position that the funds subject to such an agreement never left the deposit account.   One of the primary defects which the FDIC pointed out was the right of substitution found in many such agreements.  This announcement caused many banks to modify their master repurchase agreements to delete that right.

The FAQ clarifies the FDIC’s position in several respects.  It first addresses the basic question of when is a security interest perfected in a security.  The FDIC generally considers three elements in determining whether the customer has a perfected security interest in a security subject to a repo sweep: (1) the particular security in which the customer has an interest has been identified, and this identity is indicated in a daily confirmation statement; (2) the customer has “control” of the particular security; and (3) there is no substitution of the security during the term of the repurchase agreement even if the agreement allows for substitution with the customer/buyer’s consent.

Identification of Securities

The element of identification is met by a confirmation identifying the security (i.e., CUSIP or mortgage-backed security pool number) and also specifying the issuer, maturity date, coupon rate, par amount and market value. Fractional interests in a specific security must be identified, if relevant.  Importantly, the FDIC takes the position that an arrangement where bulk segregation or pooling of repurchase collateral without identification of specific securities does not result in the buyer receiving an identified interest in specifically identifies securities.

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Modification of Repurchase Agreements May be Required

June 3, 2009

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Earlier this year the FDIC published its Final Rule on Processing Deposit Accounts in the Event of an Insured Depository Institution Failure.  One of the requirements of the Rule is that financial institutions are required to provide sweep account customers with information about what would happen to the customer’s funds in the event the institution failed.  As a byproduct of the attention being paid to the new sweep account disclosure rules, the FDIC has also focused on the terms of the Master Repurchase Agreement used in certain sweep arrangements where the institution serves as the customer’s custodial agent for securities held at another financial intermediary.

The standard industry Repurchase Agreement contains a provision which allows the financial institution to substitute the originally purchased securities with different securities of the same type.  The FDIC has recently taken the position that the right of substitution renders a Repurchase Agreement used in connection with such a sweep account defective based on the fact that the institution retains excessive control over the securities.   The result of this is that the customer’s funds will be treated as if they never left the deposit account from which they originated.   This could be devastating to a customer in the event of the failure of the institution.

In addition to the risk which a customer runs of having significant uninsured deposits, the financial institution runs the risk that the funds should have been reported on a Call or Thrift Financial Report as deposits for purposes of reserves and assessments. This then in turn raises issues of whether the financial institution has been in violation of Reg Q  which prohibits the payment of interest on demand deposits.

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Summary of the FDIC's Master Agreement

December 5, 2008

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The Master Agreement, which the FDIC has created for use with the Debt Guarantee portion of the Temporary Liquidity Guarantee Program, provides an outline for how the guarantee program operates if the FDIC is called upon to honor the Guarantee.  The operative provisions are found in Articles II, III, IV and V.

Article II describes how payments would be made in the event the Guarantee is called upon.  The Section also contains language typically found in a letter of credit reimbursement agreement whereby the Issuer agrees to reimburse the FDIC immediately for any payments made by the FDIC.  The “Reimbursement Payment” will bear interest, if not paid immediately, at a rate equal to the non-default rate of interest on the Senior Unsecured Debt plus 1%.   As a practical matter, this is advantageous for the Issuer since a failure to reimburse would normally trigger a higher rate of interest in similar reimbursement agreements.

Article II also provides that the Issuer waives any defenses to the enforcement of the Senior Unsecured Debt once the FDIC has paid out under its guarantee.  The FDIC is subrogated to the rights of the holder of the Senior Unsecured Debt and does not want the Issuer to raise lender liability defenses to the enforcement of the Debt which might likewise provide a defense to collection of the Reimbursement Payment.  One of the documents found in the Annex to the Agreement is an Assignment by which the lender seeking payment from the FDIC assigns the promissory note or other evidence of indebtedness to the FDIC.

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Commentary: Tightening of TARP Capital Standards

November 21, 2008

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Conversations with each of the federal banking regulators over the last several days confirm what we have heard elsewhere: the distribution of TARP Capital that started out with a more liberal bias has now turned more conservative.  Regulators have recently indicated that institutions with a CAMELS rating of 1 and 2 are almost certainly likely to receive an investment, while 3-rated institutions are now described as “perhaps” receiving an investment.  4 and 5-rated banks are unlikely to receive any TARP Capital, absent unique circumstances.  (Just a few weeks ago, these same regulators were telling us that a 3-rated institution would be treated more like a 2-rated institution, and that 4-rated institutions would “perhaps” receive an investment.)  This shift is certainly an outgrowth of Treasury’s position that the main test of which institutions will receive capital investments is assured long term viability.

What does this mean for the thousands of banks that will not receive funding?  They certainly need to be considering a public relations initiative to manage or preempt the questions that will come at them from shareholders and the local media.  Perhaps the conversation could be along the following lines: “(i) the banking industry did not ask for this plan (which has changed dramatically since it was first proposed); (ii) an investment by the Treasury in a bank is not an automatic guarantee that a particular bank will be successful and neither is a decision not to invest some sort of condemnation; (iii) our loan portfolio reflects our community and the real estate lending which helped our community grow is suffering; and (iv) we are here for the long run and look forward to meeting the credit needs of our customers for years to come.  Together we will both survive the current economic challenges.”

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