Are any of your bank branches and offices owned by directors? That could spell trouble but it can be handled well. Here’s how.
During the mid-2000′s, it was commonplace for a bank, particularly a de novo bank, to lease some or all of their bank facilities from an entity controlled by the bank’s directors. At the time, these arrangements truly represented a “win-win” situation. The bank was able to occupy built-to-suit facilities while conserving liquidity so that cash could be deployed through making loans with attractive yields. At the same time, the directors, many of whom were real estate professionals, were able to make a sound real estate investment with the knowledge that a very stable tenant would occupy the property.
As we know, much has changed since the mid-2000′s. Vacancies in commercial properties have caused market lease rates to plummet. Similarly, market values of commercial properties have decreased substantially. Many banks have excess liquidity caused by soft loan demand, making a potential investment in fixed assets more attractive.
Because many of these leases were written with five-year initial terms, a number of banks are now weighing their options with respect to renewal, extension or renegotiation of the leases. To make matters more complex, many director-controlled entities borrowed money to construct the bank facilities. If those notes had five-year terms, they are coming up for renewal, and the lending bank may be eager to move the commercial real estate loans off of its books.
This fact presents a particularly difficult challenge for the affected directors. Banking regulations require that transactions with affiliates be made on terms at least as favorable to the bank as those terms prevailing at the time for transactions with unaffiliated parties. Most bank directors understand their duty to act in the best interests of the bank, but they are also facing personal financial exposure if the lease is not renewed on terms that allow the entity to continue to service its debt obligations. In addition, given public scrutiny of directors and officers who are perceived to have profited at the expense of the bank they serve, creating a proper process to manage these situations has never been more important.
In recent exam cycles, bankers have generally been no strangers to heightened scrutiny by FDIC examiners on a variety of topics. In the past several months, the insurance policies carried by banks have been added to the list of potential hot-button items.
Specifically, FDIC examiners have begun to scrutinize bank insurance policies to determine whether the policies provide coverage for civil money penalties (“CMPs”) that may be assessed against bank officers or directors. If any bank insurance policies are found on examination to contain an endorsement extending coverage for CMPs to officers or directors, the FDIC is citing such policies as being in violation of Part 359 of the FDIC’s Rules and Regulations.
Part 359, among other things, prohibits banks and affiliated holding companies from making certain “prohibited indemnification payments.” These prohibited payments include any payment or agreement to pay or reimburse bank officers or directors for any CMP or judgment resulting from any administrative or civil action which results in a final order or settlement in which that officer or director is assessed a CMP, removed from office or ordered to cease and desist from certain activities. As a matter of public policy, this provision is designed to prevent banks from bearing the costs of penalties assessed against individuals for actions that could result in harm or potential harm to a bank or to the safety and soundness or integrity of the banking system more generally.
Part 359 explicitly permits reasonable payments by banks to purchase commercial insurance policies, provided that the policy not be used to pay or reimburse an officer or director the cost of any judgment or CMP assessed against him or her. However, Part 359 does permit the insurance paid for by the bank to cover (1) legal or professional expenses incurred in connection with such a proceeding and (2) the amount of any restitution to the bank, its holding company, or its receiver.
Today’s banking industry is constantly being buffeted by waves of financial, regulatory and operational challenges. The increased regulatory burden and related costs impact every financial institution in both the approach to doing business and the expense of doing business. The industry is in transition, with no clear path forward. As a result, there has never been a greater need for well functioning, informed and courageous boards of directors of banks and bank holding companies. There has also never been a more important time for board members to keep in mind that their responsibilities can be boiled down into one simple goal: the creation of sustainable long-term value for shareholders.
Achieving long-term value for shareholders may seem an elusive goal in the current environment. On more than one occasion, bank board members have commented to me that they feel they are now working for the benefit of the regulators. However, as with any time of turmoil and change, the challenges we now face will pass. As bank boards look for ways to strengthen their institutions, they should not overlook the opportunity to strengthen themselves as a group. One way of doing that is to adopt the practices of the most effective boards of directors.
Over the past several decades my partners and I have attended hundreds of bank board meetings, for institutions ranging in size from under $100 million in assets to well over $10 billion. Regardless of the size of the entity, we have noticed a number of common characteristics and practices of the most effective boards of directors. This is the first in a series of articles which will describe the 10 best practices we have observed among highly effective boards of directors. In this article I focus on two fundamental best practices — selecting good board members and adopting a meaningful agenda for the board meetings.
Best Practice No. 1―Selecting Good Board Members
Some of the most challenging and distracting issues a board can face are those related to its own members. These issues typically arise in connection with conflicts of interest between board members and the banks they serve, or when board members experience financial stress. They can also arise when there are personality clashes in the boardroom, or when one or more board members seek to dominate the conversation. The best time to avoid such issues is during the selection process for new directors. Compromise and wishful thinking in the selection of directors will almost always dilute the effectiveness of the board as a whole. Key characteristics of good directors include:
- Independence―being free of conflicts.
- Time to devote to the job — including time to gain a knowledge of the industry, to prepare for board meetings, and to participate in committees
- Attention — being fully engaged and proactive as a board member.
- Courage―having a willingness to deal with tough issues.
- Curiosity — possessing an intellectual curiosity about the bank, the financial services industry and the trends impacting both.
A group of good, solid and dependable board members is, in my experience, preferable to a big-hitter, all-star line-up of directors. A board is most effective when it acts as a group, with a culture in which all members can voice their opinions, and in which probing, and sometimes difficult questions can be asked. Dominant personalities and board cultures in which constructive debate never occurs have contributed to the demise of many banks in the current downturn. Careful selection of new board members, keeping in mind the strengths and weaknesses of the other members of the board, is well worth the time and effort involved.
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On Monday, October 27, 2008, as the TARP Capital Purchase Plan was still very much in formation, BankBryanCave.com was launched. As we noted in our launch announcement, at that time the banking world was “being changed daily by forces outside our control and in ways unimaginable just months ago.” I don’t know that any of us had the foresight to think that three years later we would still be dealing with many of the same outside forces, but we’ve enjoyed the opportunity to continue to share our insights as we go forward.
As the parent of a human two year-old, I’m quite happy to at least have this site exit its “terrible twos.” The site encountered some growing pains last year, but we’ve changed hosts, changed look, and driving forward.
Since its launch, BankBryanCave.com has hosted over 127 thousand visitors, and has delivered 277 thousand page views. Included in those visitors are a significant number of bank regulators and policy makers, including over 900 visits from the FDIC, 360 visits from the Treasury Department, 350 visits from the OCC, 290 visits from the US Senate, 260 visits from the U.S. House of Representatives, 160 visits from the Federal Reserve Board and 140 visits from the U.S. General Accounting Office.
As we noted in the beginning…
There is no fee of any sort connected with this site or its usage – it is another example of the many ways we try to give back to the industry that has been so good to us in so many ways. We hope you expect this kind of effort and contribution from us, since we have always considered our clients to be our partners in our industry. We hope you will continue to look to us in good times and bad.
A central premise of our financial institutions group is that sharing information collected from all of our attorneys creates significant intellectual power and value for our clients and each other. We look forward to continuing to share.
By now, many bankers have experienced the following situation: you have just left a management exit meeting with regulatory examiners, and you are stunned by the negative conclusions that the examiners have reached. In the wake of this disappointment, many bankers wait for the examiners to meet with their board and issue the Report of Examination before putting “their side of the story” on the record in a written response to the Report of Examination.
While we always recommend that bankers point out any factual inaccuracies in a Report of Examination via a written response, we believe that bankers may be able to help themselves by presenting additional information before the Report of Examination is issued. This approach may be particularly helpful if a bank believes its regulatory ratings are being downgraded as a result of inaccurate or incomplete findings by their examiners. As stated in a recent article by SNL Financial (subscription required):
[Danny Payne, former commissioner of the Texas Department of Savings and Mortgage Lending and now an industry consultant,] said there may be instances where examiners have been overzealous or harsh in their recommendations or findings. “But before the reports are issued, the pre-report communication processes and negotiations between the bank and examiners usually result in a fair ruling,” he said. “By the time issues reach the enforcement order stage, all subjective debates and negotiations typically have been completed and decided.”
We have found that many disagreements with examiners can be resolved through the presentation of additional information. At the very least, these discussions help bankers gain further understanding of the analysis by examiners.
As we move further into this economic cycle, we are seeing more “borderline” cases where presenting details to examiners can make a difference in the conclusions reached by examiners. As a result, we encourage bankers to communicate openly with examiners about the condition of their banks. If you would like to discuss these concepts, please contact any member of our Bryan Cave financial institutions group.
Each year it seems that someone or other will comment on the “green shoots” that seemingly presage the end of the banking crisis. More often than not, the green shoots were simply the product of an overactive imagination.
There was recent news from the FDIC though that I think qualifies pretty strongly as green shoots material. On September 14 the FDIC announced that it will be closing down its Midwest Temporary Satellite Office located in Schaumburg, IL toward the end of September 2012. The FDIC had previously indicated that the office would remain open until the end of the second quarter of 2013. The FDIC had announced earlier this year that its West Coast Satellite Office will close January 30, 2012.
The Southeast Temporary Satellite Office located in Jacksonville is theoretically scheduled to stay open until the end of 2013 due to the larger number of bank receiverships located across Georgia and Florida. I believe, however, there is a fair chance that the late 2013 date will, in fact, be moved up closer to early 2013 or even late 2012 based upon a review of the latest CALL Reports. While there are still a fair number of troubled banks moving through the FDIC pipeline toward receivership the numbers of troubled banks are definitely in the decline.
There is a corresponding decline in the number of new problem credits banks are seeing. Whereas a year ago bank special assets departments were bringing in two new credits for each one they resolved, now the ratio is one to one or even less. There is also much more internal pressure at institutions to rehabilitate credits if possible so that they can be moved out of special assets and back to the line.
Over the last few years, we have heard from many of our clients that statements and conclusions in their exam reports are unfair and inaccurate. It is important to understand that regulatory Reports of Examination based upon the data that is given to examiners and the examiners’ interactions with management during the exam process. As a result, we encourage bankers to prepare extensively for regulatory exams by creating presentations that tell the Bank’s story, especially highlighting improvements in the bank’s condition since the time of the most recent regulatory exam or visitation.
While the information in the presentations may seem obvious to bankers, the data reviewed by the examiners may not reveal important and helpful trends in the bank’s condition. For most of our clients, these trends are not obvious when reviewing financial statements and the other information typically provided to the bank’s regulators.
We are happy to share our experiences with approaches that have had a positive influence on the exam process and to refer bankers to resources that may help with preparation for regulatory exams. For more information, please feel free to contact any member of our Bryan Cave financial institutions group.
On August 16, 2011, the Financial Institutions and Consumer Credit subcommittee of the House Committee on Financial Services held a field hearing in Newnan, Georgia, with a stated topic of “Potential Mixed Messages: Is Guidance from Washington Being Implemented by Federal Bank Examiners?”
Representatives Shelley Moore Capito, Spencer Bachus, Lynn A. Westmoreland and David Scott each heard testimony from panels of federal banking regulators and Georgian bankers about the condition of banking in Georgia, including the effect that federal banking regulations, guidance, policies and actions have had on community banks. Copies of the written testimony submitted, including that of the FDIC, OCC and Federal Reserve are now available on the Subcommittees website.
Although it is hard to draw any overall themes from the hearings (other than possibly that the issues involved aren’t easily addressed in this format), there were several good points made.
From the FDIC’s written testimony, addressing the challenges faced by Georgia banks:
As the Subcommittee has discussed in previous oversight hearings, the collapse of the U.S. housing market in 2007 led to a financial crisis and economic recession that has adversely affected banks and their borrowers in Georgia and nationwide. Georgia’s economy was hit especially hard following years of strong economic growth characterized by rising real estate prices, abundant credit availability, and robust job creation. Financial institutions, whose performance is closely linked to economic and real estate market conditions, have been significantly affected by a rise in the number of borrowers who are unable to make payments.
Gil Barker, the Deputy Comptroller for the Southern District, specifically addressed many concerns expressed by bankers in his written testimony, including statements of regulators criticizing loans to a particular industry, performing non-performing loans, criticizing loans merely because of a decline in collateral value, and the second guessing of independent appraisers. While one can certainly question whether the interpretations provided by Mr. Barker line up with some of the actions of the on-site examiners, it is definitely a good read for anyone dealing with the OCC in the Southern District.
The loss share method of resolving closed institutions seems to have significant benefits over the FDIC retaining the assets for bulk sale, but there is significant disagreement as to whether the loss share agreements properly incent the acquiring bank with regard to working with borrowers to minimize losses. The representatives seemed particularly attuned to the additional issues related to loan participations where the lead bank has gone through receivership.
The failure of Congress to raise the debt ceiling should have no short-term impact on the ability of the FDIC to cover insured deposits.
The FDIC Deposit Insurance Fund (the “Fund”) is supported by assessments levied by the FDIC on individual banks. After experiencing above normal outflows from the Fund due to the recent spate of bank failures, the FDIC recently required banks to prepay three years’ worth of premiums in order to restore its financial strength. While the Fund has been running a negative balance on an actuarial basis for several quarters, the FDIC projected that the Fund would have a positive balance by the end of the second quarter.
At the end of the first quarter (the last date for which information is currently available), the Fund’s liquid assets, cash and marketable securities, totaled $45.5 billion. In addition, the FDIC has a $100 billion committed line of credit from the US Treasury as a backstop. We do not anticipate that the FDIC will have any problems meeting its obligations to cover any covered losses in insured deposit accounts.
The FDIC is an independent agency of the United States government. Both the FDIC and the Fund are paid for by the banking industry, and not from the U.S. taxpayers. A default by the U.S. government on its obligations will have no impact on the FDIC or the FDIC Deposit Insurance Fund. Since 1933, no depositor has ever lost a single penny of FDIC-insured funds.
In its press release issued on May 4, 2011, Bryan Cave client Brand Group Holdings, Inc. (the “Company”) announced the successful completion of its recapitalization. The total amount raised in the initial phase of this effort was $125 million, and the three largest investors in the recapitalization, affiliates of The Carlyle Group, The Stephens Group, and the Cousins’ family, invested approximately $96 million, with various other investors investing approximately $29 million. The investors have agreements in place with the Company to invest an additional $75 million in capital at a later date.
A unique feature of this transaction is a valuation adjustment that utilizes a stock escrow arrangement. Some of the purchased shares will revert from the new investors to the legacy shareholders if the existing loan portfolio performs better than the investors have projected.
As a result of the recapitalization, the Company is among the best capitalized financial institutions, among those with over $1 billion in assets, in Georgia. The Company’s Total Risk-Based Capital Ratio stands at over 24%. The Company anticipates that its wholly owned subsidiary bank, The Brand Banking Company, will use proceeds from the recapitalization to enhance its current offerings and expand into new banking services.