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.

Evaluate the bank

In the report, management should report on the current status of the various risk areas (for example, capital levels and levels of problem assets), comparisons to peers and steps being taken to improve the current status. While it may be difficult for the officers of the bank to evaluate the bank’s management in the way that the bank’s examiners would, the management portion of the report should address the organizational chart of the bank to ensure that appropriate resources are allocated to each of the bank’s functions. After reviewing the draft report, the audit committee can evaluate the need for further analysis before presenting the final report to the full board. This report should give the audit committee, and eventually the full board, good perspective on the condition of the bank and the need for corrective actions.

Use self exam in multiple ways

The final self examination report should be clearly organized and comprehensive, though concise. The report can be used to color a variety of discussions that the board may have in the normal course of overseeing the bank’s operations. It can serve as the basis for strategic planning discussions in analyzing the opportunities in the bank’s market and the adequacy of the bank’s earnings. It can also be a guide to more basic discussions, such as the pricing of deposits, based on the information related to the bank’s liquidity and opportunities for loan growth. Essentially, the report provides a comprehensive guide to the current and projected health of the bank that the bank’s directors can use for a quick point of reference in making their decisions.

Prepare a presentation for regulators

In addition to business planning purposes, the self examination can be a key tool in preparing for a regulatory examination. Using the results of the self examination, management should prepare a presentation for the examiners that highlights the bank’s key metrics, areas of progress and actions taken to address areas of concern. The market analysis portion of the self examination can be a key component of this presentation. While the bank’s examiners should be generally familiar with the bank’s market, they will not have the specific and direct perspective that the self examination report can provide. Using this market data, the bank can provide factual, documented support for its projections and for any actions it is taking. This presentation should be conveyed to the bank’s examiners at the initial meeting related to the exam, at which a representative of the board should be present. By alerting the bank’s examiners to the focus of the board on the bank’s condition and the steps being taken to improve the bank’s condition, the bank increases the likelihood that the examiners will conclude that the board is performing its duties and that the bank’s internal controls are adequate.

The self examination report can be a very useful tool for bank directors. At its best, it will provide a roadmap for making key strategic decisions. In its most basic form, it documents the board’s focus on oversight of the bank. While producing such a report will use management resources, much of the analysis that should be included in the report can be extracted from management’s ongoing reports to the board. Producing and discussing the self examination report is a healthy exercise, and the bank’s examiners will agree.

This article was first published on BankDirector.com.

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.

For individuals serving as officers or directors of banks, CMP assessments represent a potential risk to personal assets. In addition, CMPs are generally assessed not through the civil litigation process, but rather through an administrative proceeding or enforcement action, where burdens of proof and standards of review generally favor the assessing agency, and intent to violate the rule giving rise to a CMP assessment is not necessarily required in order for the penalty to be assessed. As a result, there has been a long-standing demand for some form of coverage for bank officers and directors to address this risk. A solution used by the insurance industry for decades has been to offer CMP coverage by way of a separate endorsement to the D&O insurance policy purchased by the bank. This endorsement is then invoiced separately, and the individuals covered under the endorsement pay the premium associated with the endorsement out of their own pockets.

However, in recent months, this approach has been criticized by the FDIC, which has cited any policy written in the name of the bank or its holding company that, by endorsement, provides CMP coverage for individual officers or directors, regardless of who actually paid the premium associated with such coverage.

In response, as policies with CMP endorsements begin to expire, insurance carriers are likely to begin pulling the CMP endorsements from these policies on renewal. While Part 359 would not prohibit individual officers and directors from independently purchasing their own policies for CMP coverage, outside of the framework of the bank’s base policy document, insurance professionals have indicated that such stand-alone policies are not generally available at the present time. Given the generally low premiums historically associated with CMP coverage in the community bank space, carriers will not necessarily have strong economic motivation to rush to develop stand-alone CMP products for community bankers. In addition, a stand-alone CMP product, if and when created, may likely carry with it a somewhat elevated premium, as carriers would need to recover the incremental costs of that product’s development.

Even with strong economic motivation, it would likely take time for such products to be developed, resulting in an intermittent period where coverage remains unavailable and this risk to officers and directors remains unmitigated. As a point of comparison, products designed over the past several years to address the shortfalls in the regulatory coverage being offered by primary carriers only began to appear in the community bank space some months after shortfalls in regulatory coverage began to become a widespread phenomenon, notwithstanding that the premiums associated with regulatory coverage products were proportionally much larger than CMP coverage premiums.

A stopgap solution could be for carriers to restrict the definition of losses covered under the CMP endorsement to account for “defense costs” and reimbursement to the institution only — those items specifically carved out by the language of Part 359 – but such an approach, from the perspective of the individual, would not mitigate the risks to personal assets posed by the CMPs themselves.

Exactly how things will develop on this front remains to be seen. However, the likely net result of this trend – at least in the near term – will be increased costs to individuals serving as officers and directors of financial institutions, whether actual or contingent. The general trend of increasing exposure for bank officers and directors continues notwithstanding that salaries and fees for services rendered by officers and directors remain subject to increased scrutiny and, in many cases, are being frozen or cut proactively in the interests of cost savings. In addition, officers and directors continue to face elevated demands on their time as they seek to navigate the challenging economic waters and ensure the safe and sound operation of their institutions. At some point, finding or retaining qualified individuals who are willing to bear the costs associated with service – particularly service as a director – may become a challenge for some financial institutions.

The specific terms and scope of coverage provided by insurance policies vary widely, and bankers with questions about their specific insurance policies should contact their insurance professional or coverage counsel.

]]> http://bankbryancave.com/2011/12/fdic-criticizes-civil-money-penalty-insurance/feed/ 0 http://bankbryancave.com/2011/10/green-shoots-redux/ http://bankbryancave.com/2011/10/green-shoots-redux/#comments Thu, 13 Oct 2011 21:45:31 +0000 Jerry Blanchard http://bankbryancave.com/?p=6367 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.

Banks clearly face tremendous challenges due to the sluggishness of the national economy and lack of new loan demand.  There are other challenges as well as banks move out of real estate and into C&I lending and we all deal with the deleveraging that the American consumer is experiencing. Even acknowledging all of those issues, however,  over the next twelve months we should see much less focus on Texas ratios and much more attention on how do banks grow business after having survived the great financial panic of 2008.

Boards and senior management need to be focused on the issue of organic growth and how to best accomplish it.  In some cases it may be more appropriate to consider strategic acquisitions. In any event, the role of careful strategic planning on the part of boards and senior management has never been so important. Whether you do it with a banking consultant that you have dealt with for years or one of our experienced lawyers, the key is to plan now in order to control your future.

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 often excessively harsh language of examination reports, especially to the extent they don’t match up with the exit meetings of regulators was frequently mentioned.  It was also noted that the written reports, which ultimately form the official record, fail to acknowledge the bank’s history and any progress that the bank has obtained. We believe the harsh language is unnecessary in motivating banks to resolve their issues and the failure to acknowledge progress ultimately hurts the credibility of the regulators.  It was also pointed out that management ratings have frequently fallen from excellent to horrible without any change in the management or the board.

A common solution, to the apparent surprise of several on the banking panel, was that regulators, especially local regulators, need to be given more discretion and flexibility to assist institutions recover.

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.

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.

Read the complete article on the ABA’s website for all ten possible enhancements, as well as additional information regarding potential improvements to your bank’s D&O insurance coverage.

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.

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.

The investment vehicles, which could take the form of preferred stock, equity equivalent capital or debt, would have a ten-year repayment schedule and carry interest, an element proponents say will lead to taxpayer profit in the long run. To incentivize the use of this capital for small business lending, the dividend payments owed to the government on its investment would decrease with increasing use of the funds for such purposes.  Specifically, Section 3103(d)(4)(A) of the bill provides for an adjustment to the payable dividend rate within the first two years of the government’s investment from an initial 5 percent to as little as 1 percent.  That decrease would be triggered by a 10% or more increase in the bank’s small business lending during that period.  Smaller, incremental reductions are also contemplated.  Changes would be measured against the bank’s average amount of “small business lending” during the four quarters immediately prior to the bill’s enactment, minus adjustments for small business loan chargeoffs and gains due to merger, acquisition, or purchase.  Under the bill, “small business lending” generally includes all commercial, industrial, and agricultural loans for less than $10 million except any loan to a business with more than $50 million in revenues.

Institutions with less than $1 billion in assets would be limited to a capital infusion not greater than 5 percent of risk-weighted assets, less any TARP investment.  The cap would be 3 percent, less TARP funds, for the larger eligible banks ($1-10 billion).  Holding company limits would be based on consolidated asset totals.  Any funds could generally be used to refinance existing TARP investments, however (i) TARP recipients that are now on the Troubled Bank list would not be eligible for funds, and (ii) TARP recipients are not permitted to refinance if they have missed more than one dividend payment due under the CPP.

Loss Amortization Under the House Bill

Under the version of the bill passed in the House, “eligible” institutions would also be permitted to amortize losses and write-downs.  Accordingly, the capital hits resulting from losses and write-downs could be offset in future periods by future earnings. Importantly, the substitute amendment introduced by Sen. Harry Reid (D-NV) does not contain a comparable provision, the most significant departure from the bill adopted by the House.

Set forth in the House bill’s Section 113, the loss amortization provision would permit banks to amortize or write-down losses on certain OREO and NPAs secured by real estate on a quarterly straight line basis over—depending on measured increases in small business lending—between six and ten years.  Loans eligible for this amortization would be those originated between January 1, 2003 and January 1, 2008.  However, as discussed above, any bank on the FDIC’s Troubled Bank list would be ineligible to amortize losses or write-downs.  Accordingly, even if the Senate ultimately adopted the House provision, troubled institutions would not benefit.

Proponents have attempted to distinguish this specific proposal from the widely available and poorly supervised “forbearances” launched at the failing savings and loan industry in the 1980s.  Added by an amendment sponsored by Rep. Ed Perlmutter (D-Co.), supporters say this GAAP sidestep would have broad-reaching stabilizing effects on the economy at a fraction of the cost of TARP.  However, the ultimate impact would appear to be minimal given the exclusion of currently troubled banks.

Future of the Plan

As Congress considers this plan, regulators and commentators will continue to debate an underlying question:  is weak demand for small business loans the primary explanation for declines in such lending activity?  Other parts of this bill would extend $900 million to state programs encouraging small business lending, and a companion bill increases the permissible tax deduction for small business “start-up” expenses.  Some estimates are that banks could use the proposed fund to leverage up to $300 billion in small business loans.  All together, this proposal should generate an interesting follow-on debate to the “big bank” discussion that has dominated the larger and still-pending Dodd-Frank bill.

• 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.

There will also be changes in the shared loss exhibits, primarily clarifications, with conforming changes made to the Purchase and Assumption Agreement.  The calculation of the “true-up” will also be modified to incorporate the absence of a published Stated Threshold.

We believe these changes increase the risk associated with bidding on loss share transactions, and may thus result in further widening of the negative bids received by the FDIC.

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.

You have the right to:

1. Automatic deposit insurance coverage when you open a deposit account at an FDIC-insured bank, with no additional action on your part.
2. Separate FDIC insurance coverage for deposits held at different FDIC-insured banks.
3. Confirm that a bank is insured by using the FDIC’s Bank Find or by calling toll-free 1-877-ASK-FDIC.
4. FDIC insurance coverage of at least $250,000 for your deposits at an FDIC-insured bank.*
5. Deposit insurance coverage of more than $250,000 at a single bank when your deposits are held in different “ownership categories,” such as single, joint and trust accounts.*
6. Confirm that your deposits are within the insurance limits by using EDIE The Estimator or by calling 1-877-ASK-FDIC.
7. Be informed when a financial product offered by your bank is not covered by FDIC insurance.
8. Prompt access to your insured deposits in the event your bank fails.
9. Receive distributions from the receivership if you are an uninsured depositor, as the sale of assets permits.
10. Sleep well, knowing that since the creation of the FDIC 75 years ago, no depositor has ever lost one penny of insured deposits.

* The standard insurance amount of $250,000 per depositor is in effect through December 31, 2013. On January 1, 2014, the standard insurance amount will return to $100,000 per depositor for all account categories except for IRAs and other certain retirement accounts, which will remain at $250,000 per depositor.

FDIC Chairman Sheila Bair has also published a video explaining how deposit insurance works, and assuring consumers that insured deposits are 100% safe.

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.

Applicability and Scope

The restrictions set forth in the Final Policy apply to the following (referred to herein as “Covered Investors”):

• private investors in a company, including any company acquired to facilitate bidding on failed banks or thrifts, that is proposing to assume deposit liabilities and/or acquire assets from a failed depository institution;   and
• applicants for insurance in the case of de novo charters issued in connection with the resolution of failed insured depository institutions.

“Shelf charter” entities are specifically referenced in the Final Policy.  “Inflatable” banks—healthy banks acquired with the intent to acquire the assets of other banks—presumably would be covered as well.

The Final Policy does not apply to:

• an investor, following approval by the FDIC, in an existing financial institution or bank or thrift holding company, provided the financial institution subsidiary has maintained a composite CAMELS 1 or 2 rating continuously for seven years;
• investors in partnerships or similar ventures with an existing bank or thrift holding company where the existing holding company has a strong majority interest in the acquired bank or thrift and an established record for successful operation of insured banks or thrifts;  or
• investors with 5% or less of the total voting power of the institution, as long as the investor is not acting in concert with one or more other investors.

Such partnerships or similar ventures between private equity investors and existing holding companies are “strongly encouraged.”

Investment Requirements

The FDIC will apply the following requirements to Covered Investors:

Capital Commitment. A Covered Investor will be required to initially capitalize the acquiring entity at a minimum Tier 1 common equity to average assets ratio of 10% and maintain that capital ratio for a period of three years from the time of acquisition.  The FDIC may increase the required capital to a level higher than 10% in certain situations.  Investors must maintain the bank at “well capitalized” levels for the remaining period of their ownership.  Failure to satisfy these requirements will result in the institution being treated as “undercapitalized” for purposes of the prompt corrective action provisions, which would trigger a number of significant restrictions on operations.

Source of Strength. The Final Policy eliminated the proposed requirement that a Covered Investor’s organizational structure be expected to serve as a source of strength for its subsidiary depository institutions.

Holding Period. Covered Investors are prohibited from selling or otherwise transferring their interests in the subject holding company or depository institution for a three-year period, without FDIC approval.

Cross-Guarantee Liability. Covered Investors whose investments constitute 80% percent or more of more than one depository institution will be expected to pledge to the FDIC their interests in each such institution to pay for any losses to the deposit insurance fund that result from the failure of, or assistance provided to, any other such depository institution.

Affiliate Transactions. All extensions of credit by the acquired depository institution to its Covered Investors and their affiliates are prohibited.  For purposes of the Final Policy, an “affiliate” is any company in which an investor owns 10% or more of the equity of that company for at least 30 days.  Most existing extensions of credit are grandfathered.

Covered Investors Utilizing Bank Secrecy Jurisdictions. Covered Investors utilizing investment vehicles domiciled in bank secrecy jurisdictions  are ineligible to own a direct or indirect interest in an insured depository institution unless the Covered Investors are subsidiaries of companies that are subject to comprehensive consolidated supervision as recognized by the Federal Reserve Board and agree to certain information sharing arrangements.  A bank secrecy jurisdiction is a country that applies a bank secrecy law that limits bank regulators from determining compliance with U.S. laws or prevents the regulators from obtaining information or otherwise does not provide for the exchange of information with U.S. regulatory authorities.

Bidder Limitations on Existing 10% Owners. Covered Investors who held 10% or more of the equity or debt of a bank or thrift that goes through receivership are not be eligible to bid on that institution through the failed bank resolution process.

Silo Structures. Ownership structures in which the beneficial ownership is difficult to ascertain with certainty, the decision-making parties are not clearly identifiable, and ownership and control are separated, are prohibited.  This would likely apply to any private equity “silo” ownership structure, where a private equity firm or its sponsor creates multiple investment vehicles funded and apparently controlled by the firm to acquire ownership of an insured depository institution.  The FDIC is concerned that the purpose of such structures is to artificially separate the non-financial activities of the firm from its banking activities and allow the firm to avoid registration as a holding company.

Disclosure. Covered Investors will be expected to submit to the FDIC information about the investing entity and all entities in its ownership chain, including the size of the capital fund or funds, its diversification, return profile, marketing documents, management team and business model.  Confidential treatment is available.

On a case-by-case basis, the FDIC may waive provisions of the Final Policy and has indicated that it will revisit the Final Policy in early 2010 to assess whether the rules are deterring investment or if other features need to be altered.

Conclusion

The substantive changes from the Proposed Policy to the Final Policy indicate some desire on the part of the FDIC to attract traditional private equity investors to participate in the failed bank resolution process.  However, the Final Policy continues to reflect the FDIC’s concern that private equity investors in failed financial institutions present unique supervisory risks, warranting additional restrictions on such investors.

Bryan Cave’s Private Equity and Financial Institution groups have extensive experience in advising private equity firms and banking organizations in change of control transactions involving bank holding companies, banks, and thrifts.