Doctors recommend various self exams to catch disease early, so it can be treated before it’s too late. As it turns out, a self examination can be good for the health of a bank as well. My colleagues and I recommend that our banking clients and friends undertake a regular self examination in order to identify potential internal and external challenges that the bank may face. As discussed more thoroughly below, these self examinations can also be very helpful when the bank’s doctor (your friendly regulator) comes in for a check-up.
Enlist internal audit
To initiate the self examination, the audit committee of the bank’s board of directors should charge management with preparing a report that outlines the current and projected status of the bank’s key areas of risk. Ideally, the bank’s internal audit function will take the lead in performing the examination and preparing the related report. In order to maximize the value of this report, the audit committee should direct management to deliver the report at least 60 days prior to the bank’s next scheduled regulatory exam. The self examination report, in its most basic form, should cover the areas that are the focus of the bank’s regulators: CAMELS (capital, asset quality, management, earnings, liquidity and sensitivity to market risk). The report should also address any key areas of risk identified by the directors.
Analyze your market
In addition to analyzing the typical CAMELS components and other areas of risk, a very important part of the self examination process is a market study. The report should present facts, trends and projections related to the market area in order to define the opportunities and challenges being faced by the bank’s customers. While many bank directors have a good feel for market trends, we have found that this data, when presented with specific facts and trends, can inform the board’s discussions of a variety of topics a great deal. It can also provide the bank with support for dealing with its examiners, who conduct their own market analysis prior to each examination.
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.
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.
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.
Jerry Blanchard recently spoke to the national sales meeting of the Federal Home Loan Banks on the topic of How the Regulators View the FHLB’s.
The FHLB system has been a major source of liquidity to its over 8,000 members during the financial crisis and faces many challenges as the system deals with:
- shrinking demand for loan advances;
- losses incurred in mortgage backed securities that have led to a number of the FHLB’s having to enter into Consent Orders with their primary regulator; and
- greater Congressional scrutiny of all government sponsored entities.
Banking regulators deal with the consequences of FHLB policies and actions when financial institutions are taken into receivership. In some instances, the availability of FHLB advances may have led to some banks to incurring more risk than they would have otherwise incurred.
Jerry’s presentation addressed how the banking regulators view the role of the FHLB ‘s and how those views might affect bank examinations in the future. If you would like more information, a copy of Jerry’s FHLB presentation is available online, or reach out to Jerry Blanchard to discuss further.
There is a common presumption among community banks, and their directors, that D&O insurance coverage is a commodity. That presumption is inaccurate; there can be significant differences in the scope and quality of D&O coverage between policies and among carriers. D&O insurance policies can, and should, be negotiated to improve the coverage for directors and officers.
On March 24, 2011, the ABA’s Banking Journal published an article by Bryan Cave attorney Jim McAlpin, “How good is your bank’s D&O policy?”
In the article, Jim highlights ten possible enhancements that you may be able to obtain in your D&O coverage, including:
- limiting the definition of “Application” in the policy to public filings for the past 12 months;
- expanding the definition of “Claim” in the policy;
- obtaining non-rescindable Side A coverage;
- limiting insured vs. insured carve-backs for derivative suits and bankruptcy;
- carving back defense costs from regulatory exclusions; and
- including coverage for punitive damages.
If you’d like to discuss further, please consider reaching out to Jim McAlpin or any other member of Bryan Cave’s Financial Institutions practice.
On June 29, 2010, the Senate voted to commence debate on the Small Business Jobs and Credit Act of 2010, a bill passed by the House on June 17, 2010 which includes a $30 billion fund for small business lending through the provision of capital to community banks. This legislation would implement the program described in President Obama’s State of the Union address earlier this year. Obama has promoted the program by saying that it “takes money repaid by Wall Street banks to provide capital for community banks on Main Street” that can in turn help small businesses create jobs. In the latest version of the bill presented to the Senate, certain banks with less than $10 billion in assets would be eligible for government infusions of capital, dividend payments on which would decrease with increasing levels of small business lending. Banks are also generally permitted to use this capital to refinance existing TARP obligations. The substitute amendment currently before the Senate cuts out a provision of the House bill to permit eligible banks to amortize recent real estate loan losses over as many as 10 years.
The original Obama proposal called on Congress to transfer TARP money to create the fund, but the fund has evolved as a completely separate initiative. Acknowledging this possible confusion, Section 3111(a) of the bill specifically provides that the fund “is established as separate and distinct from the Troubled Asset Relief Program established by the Emergency Economic Stabilization Act of 2008” and that an institution “shall not, by virtue of a capital investment under the Small Business Lending Fund Program, be considered a recipient of the Troubled Asset Relief Program.” Proponents continue the political battle to detach this potentially negative association from a bill that would target recovery on Main Street.
The Small Business Lending Fund
Title III of the bill currently before the Senate establishes the fund and authorizes the government to make up to $30 billion in capital investments into eligible institutions. These investments would be similar to TARP infusions but would not result in executive compensation and other restrictions. Banks up to $10 billion in assets would generally be eligible to apply for funding. However, the Small Business Lending Fund will not be a source of capital for the banks most in need of additional capital. Banks on the FDIC’s Troubled Bank List (generally those with composite CAMELS ratings of 4 or 5) would be ineligible to participate. As with the Capital Purchase Program, the program is designed to provide assistance to otherwise healthy institutions. Each institution’s primary federal banking regulator will continue to have a significant say in whether the institution should receive any funds under the Small Business Lending Fund.
We understand that the FDIC is substantially changing the loss share formula structure, applicable to all bids made after March 31, 2010. The material changes include:
- Elimination of the “Stated Threshold” and 95%/5% loss sharing basis. Accordingly, all loss sharing will be at a constant 80%/20% split (FDIC/acquiring bank) for all covered assets and all losses.
- Bidders will now be expected to express the Asset Premium (Discount) component of their bid as a percentage of the book value of assets purchased, rather than a fixed dollar amount.
- The “First Loss Tranche” will now be an element to be bid, rather then an amount calculated based on assets acquired and liabilities assumed. Bidders will be expected to express the “First Loss Tranche” component of their bid as a percentage of the covered assets. The “First Loss Tranche” will continue to represent the amount of losses the acquirer will absorb prior to the commencement of loss sharing. Negative bids for the First Loss Tranche will not be accepted, although zero bids will.
- As the “First Loss Tranche” will now be separately bid, the net equity position of the failed bank may cause an initial payment to be due to the FDIC at closing, particularly when assets passing to the acquiring bank exceed the deposit liabilities. (Previously such an acquiring bank merely assumed 100% of the losses until the amount owed the FDIC was exhausted.)
- The Initial Payment will be the sum of the equity adjustment (assets – liabilities), deposit premium bid (in dollars), and the asset premium bid (in dollars). If the result of the calculation is positive, the acquiring bank will be required to wire the Initial Payment to the FDIC, while if it is negative, the acquiring bank will receive a wire of the Initial Payment from the FDIC.
We are aware of several fraudulent emails circulating purporting to be from the FDIC. Subject lines include: “FDIC has officially named your bank a failed bank” and “FDIC Alert: you need to check your Bank Deposit Insurance Coverage.”
These e-mails and the associated Web site are fraudulent. Recipients should consider the intent of these e-mails as an attempt to collect personal or confidential information, some of which may be used to gain unauthorized access to on-line banking services or to conduct identity theft.
The FDIC does not issue unsolicited e-mails to consumers. Financial institutions and consumers should NOT follow the link in the fraudulent e-mail.
The FDIC has released a special alert confirming that these announcements are not from the FDIC.
The official FDIC website does contain useful information if you have questions about FDIC insurance; alternatively, we encourage you to contact your bank if you have questions about whether your deposited funds are insured.
Background
On July 2, 2009, the Board of Directors of the Federal Deposit Insurance Corporation (“FDIC”) issued for public comment a proposed Statement of Policy that sets forth the qualifications for private equity investors in failed bank acquisitions (the “Proposed Policy”). The FDIC established a 30-day comment period and sought public comment on nine topics:
- definition of private equity investor and scope of the policy;
- permissibility of “silo” structures;
- capital requirements;
- applicability of the source of strength doctrine;
- imposition of cross-guarantee liability;
- restrictions on bidders from bank secrecy jurisdictions;
- post-investment holding period;
- possible limitations on 10% investors in failed institutions; and
- length of restriction period.
On August 26, 2009, the FDIC issued its Final Statement of Policy on Qualifications for Failed Bank Acquisitions (the “Final Policy”). The FDIC notes that the policy statement is just that—a statement of policy and not a statutory provision imposing civil or criminal penalties and that the requirements it imposes on investors only apply to investors that agree to its terms.
In response to 61 comment letters from a broad variety of interests, in the Final Policy the FDIC reduced the proposed capital requirements, removed the proposed “source of strength” requirement, and increased the ownership threshold for cross-guarantee liability. These changes are intended to make the failed bank acquisition opportunity more attractive for private equity investors, while retaining many of the other elements of the Proposed Policy that address the FDIC’s apparent concerns about such investors.
The Final Policy is relevant only to bidders for failed financial institutions. Investors seeking to acquire control of banks that have not failed should refer to the Bank Holding Company Act and the relevant regulations and policy statements issued by the Federal Reserve Board including, but not limited to, the policy statement issued by the Federal Reserve Board on September 22, 2008 that eased certain limitations on private equity investments in banks and bank holding companies. This policy statement is summarized in our prior client alert on private equity investments generally. Investors seeking to acquire control of federal savings institutions that have not failed should refer to the Home Owners’ Loan Act and relevant regulations issued by the Office of Thrift Supervision. These existing holding company statutes and regulations are not replaced or substituted by the Final Policy. The Final Policy merely adds additional limitations and requirements in the context of acquiring failed financial institutions.