Current Compliance Priorities in Bank Regulatory Exams

Updated examination practices, published guidance and public statements from federal banking agencies can provide insights for banks into where regulators are likely to focus their efforts in coming months. Of particular focus are safety and soundness concerns and consumer protection compliance priorities.

Safety and Soundness Concerns
Although they are familiar topics to most bank leaders, several safety and soundness matters merit particular attention.

  • Bank Secrecy Act/anti-money laundering (BSA/AML) laws. After the Federal Financial Institutions Examination Council updated its BSA/AML examination manual in 2021, recent subsequent enforcement actions issued by regulators clearly indicate that BSA/AML compliance remains a high supervisory priority. Banks should expect continued pressure to modernize their compliance programs to counteract increasingly sophisticated financial crime and money laundering schemes.
  • In November 2021, banking agencies issued new rules requiring prompt reporting of cyberattacks; compliance was required by May 2022. Regulators also continue to press for multifactor authentication for online account access, increased vigilance against ransomware payments and greater attention to risk management in cloud environments.
  • Third-party risk management. The industry recently completed its first cycle of exams after regulators issued new interagency guidance last fall on how banks should conduct due diligence for fintech relationships. This remains a high supervisory priority, given the widespread use of fintechs as technology providers. Final interagency guidance on third-party risk, expected before the end of 2022, likely will ramp up regulatory activities in this area even further.
  • Commercial real estate loan concentrations. In summer 2022, the Federal Deposit Insurance Corp. observed in its “Supervisory Insights” that CRE asset quality remains high, but it cautioned that shifts in demand and the end of pandemic-related assistance could affect the segment’s performance. Executives should anticipate a continued focus on CRE concentrations in coming exams.

In addition to those perennial concerns, several other current priorities are attracting regulatory scrutiny.

  • Crypto and digital assets. The Federal Reserve, the Office of the Comptroller of the Currency, and the FDIC have each issued requirements that banks notify their primary regulator prior to engaging in any crypto and digital asset-related activities. The agencies have also indicated they plan to issue further coordinated guidance on the rapidly emerging crypto and digital asset sector.
  • Climate-related risk. After the Financial Stability Oversight Council identified climate change as an emerging threat to financial stability in October 2021, banking agencies began developing climate-related risk management standards. The OCC and FDIC have issued draft principles for public comment that would initially apply to banks over $100 billion in assets. All agencies have indicated climate financial risk will remain a supervisory priority.
  • Merger review. In response to congressional pressure and a July 2021 presidential executive order, banking agencies are expected to begin reviewing the regulatory framework governing bank mergers soon.

Consumer Protection Compliance Priorities
Banks can expect the Consumer Financial Protection Bureau (CFPB) to sharpen its focus in several high-profile consumer protection areas.

  • Fair lending and unfair, deceptive, or abusive acts and practices (UDAAP). In March 2022, the CFPB updated its UDAAP exam manual and announced supervisory changes that focus on banks’ decision-making in advertising, pricing, and other activities. Expect further scrutiny — and possible complications if fintech partners resist sharing information that might reveal proprietary underwriting and pricing models.
  • Overdraft fees. Recent public statements suggest the CFPB is intensifying its scrutiny of overdraft and other fees, with an eye toward evaluating whether they might be unlawful. Banks should be prepared for additional CFPB statements, initiatives and monitoring in this area.
  • Community Reinvestment Act (CRA) reform. In May 2022, the Fed, FDIC, and OCC announced a proposed update of CRA regulations, with the goal of expanding access to banking services in underserved communities while updating the 1970s-era rules to reflect today’s mobile and online banking models. For its part, the CFPB has proposed new Section 1071 data collection rules for lenders, with the intention of tracking and improving small businesses’ access to credit.
  • Regulation E issues. A recurring issue in recent examinations involves noncompliance with notification and provisional credit requirements when customers dispute credit or debit card transactions. The Electronic Fund Transfer Act and Regulation E rules are detailed and explicit, so banks would be wise to review their disputed transaction practices carefully to avoid inadvertently falling short.

As regulator priorities continue to evolve, boards and executive teams should monitor developments closely in order to stay informed and respond effectively as new issues arise.

Legal Protections for Acquiring Banks



Due diligence just doesn’t tell an acquiring bank everything that should be known about a target—the process also shows that the acquirer’s team is committed to the deal. In this video, Stinson Leonard Street Partner Adam Maier explains how to protect the bank from potential losses in M&A.

  • The Roles of Due Diligence vs. Representations and Warranties
  • Addressing Risks Found in Due Diligence
  • Protecting the Buyer from Financial Loss

Redefining the Meaning of a Customer Relationship


relationship-3-12-18.pngFor most people, brick and mortar branches have become remnants of prior generations of banking. In the digital age of mobile deposits and non-financial, non-regulated companies like PayPal there is little incentive to walk into a local branch—particularly for millennials. This presents an anomaly in the community banking model. Community banks are built upon relationships, so how can the banks survive in an era so acutely inclined towards, and defined by, technology seemingly designed to eliminate “traditional” relationships?

The solution is to redefine the term “traditional” relationship. While customers may not want to walk into a branch to deposit a check, they still want information and advice. Just because a millennial does not want to deposit a check in person does not mean that he or she will not need to sit with a representative for guidance when applying for their first home loan. Using customer segmentation and understanding where there are opportunities to build relationships provides an opportunity to overcome the imminent threat of technology.

If information and advice are the keys to building relationships, it becomes imperative that bank employees are fully trained and knowledgeable. It is crucial that community banks spend time hiring the right people for the right position and then train and promote from within. Employees must fully understand, represent and communicate a brand. That brand must be clearly defined by executive management and communicated down the chain of command. It is incumbent upon the leaders of the organization to first set an example and then ask their employees to follow suit. Some of the most successful community bank CEOs can recognize their customers by name when they walk into a branch. These are not the biggest clients of the bank, but they are probably the most loyal because of the quality of the relationship.

The focus needs to switch from products and transactions towards specific relationships with specific customer segments. Customer-centric banking strategies will improve the chances of survival for community banks. Those that are not able to adapt will be eclipsed by the recent revival of de novos or will be acquired by institutions that are embracing this customer-centric approach. A customer-centric approach is critical to drive value whether pursuing organic growth or M&A. For banks evaluating an acquisition, there are additional considerations that need to be addressed prior to entering into a transaction, in order to safeguard the customer relationships that the bank has built and ensure that the deal enhances the bank’s brand and business model, while also building value.

If you are one of the survivors and are engaged in an acquisition, what does all of this mean for you?

  1. FinPro Capital Advisors Inc. advocates having strict M&A principals and parameters when evaluating the metrics of a deal, which will vary from bank to bank. This concept extends to culture and branding as well. A good deal on paper does not necessarily translate to a successful resultant entity. If a transaction will dilute your franchise, disrupt your culture or business model, or in any way undermine the brand and customer base you have built, do not pursue it.
  2. Signing a definitive agreement is not the same thing as closing a transaction. Integration begins as soon as the ink dries on the contract. Planning should have occurred well in advance. Management needs to focus on employee, customer and investor reception of the deal, along with regulatory approvals and strategic planning. A poorly executed integration can provide an inauspicious start culturally and can increase merger costs substantially.
  3. Retain the best talent from each institution and take the time to ensure that the employees are in the right position. Roles are not set in stone and an acquisition provides the perfect opportunity to re-position the bank’s staffing structure. This includes implementing management succession and talent management plans for the new entity. Develop an organizational structure for the future, not just for today.
  4. Communicate effectively throughout the entire process. Be transparent and be honest. Bolster relationships and foster enthusiasm in the new entity from day one. Corporate culture is one of the most difficult attributes to quantify but it is palpable and can either energize every person in the company or rapidly become toxic and disruptive.

For all banks, the brand and culture that you build will directly impact your customer base and define the banking relationships you create. To build meaningful relationships with your customers, banks must first build meaningful relationships within the organization. In so doing, banks will be able to redefine their model by focusing on relationships instead of transactions, customers instead of products, and eliminate isolated divisions to create integrated organizations. The traditional banking model may be dead but banks with strong leadership and corporate culture will recognize the new paradigm and enact change to evolve accordingly.

Well Conceived and Executed Bank Acquisitions Drive Shareholder Value


acquisition-2-21-18.pngRecent takeovers among U.S.-based banks generally have resulted in above-market returns for acquiring banks, compared to their non-acquiring peers, according to KPMG research. This finding held true for all banks analyzed except those with greater than $10 billion in assets, for which findings were not statistically significant.

Our analysis focused on 394 U.S.-domiciled bank transactions announced between January 2012 and October 2016. Our study focused on whole-bank acquisitions and excluded thrifts, acquisitions of failed banks and government-assisted transactions. The analysis yielded the following conclusions:

  • The market rewards banks for conducting successful acquisitions, as evidenced by higher market valuations post-announcement.
  • Acquiring banks’ outperformance, where observable, increased linearly throughout our measurement period, from 90 days post-announcement to two years post-announcement.
  • The positive effect was experienced throughout the date range examined.
  • Banks with less than $10 billion in assets experienced a positive market reaction.
  • Among banks with more than $10 billion in assets, acquirers did not demonstrate statistically significant differences in market returns when compared to banks that did not conduct an acquisition.

Factors Driving Value

Bank size. Acquiring banks with total assets of between $5 billion and $10 billion at the time of announcement performed the strongest in comparison with their peers during the period observed. Acquiring banks in this asset range outperformed their non-acquiring peers by 15 percentage points at two years after the transaction announcement date, representing the best improvement when compared to peers of any asset grouping and at any of the timeframes measured post-announcement.

Performance-chart.png 

Acquisitions by banks in the $5 billion to $10 billion asset range tend to result in customer expansion within the acquirer’s market or a contiguous market, without significant increases in operational costs.

We believe this finding is a significant factor driving the value of these acquisitions. Furthermore, banks that acquire and remain in the $10 billion or less asset category do not bear the expense burden associated with Dodd-Frank Act stress testing (DFAST) compliance.

Conversely, banks with nearly $10 billion in assets may decide to exceed the regulatory threshold “with a bang” in anticipation that the increased scale of a larger acquisition may serve to partially offset the higher DFAST compliance costs.

The smaller acquiring banks in our study—less than $1 billion in assets and $1 billion to $5 billion in assets—also outperformed their peers in all periods post-transaction (where statistically meaningful). Banks in these asset ranges benefited from some of the same advantages mentioned above, although they may not have received the benefits of scale and product diversification of larger banks.

As mentioned earlier, acquirers with greater than $10 billion in assets did not yield statistically meaningful results in terms of performance against peers. We believe acquisitions by larger banks were less accretive due to the relatively smaller target size, resulting in a less significant impact.

Additionally, we find that larger bank transactions can be complicated by a number of other factors. Larger banks typically have a more diverse product set, client base and geography than their smaller peers, requiring greater sophistication during due diligence. There is no substitute for thorough planning, detailed due diligence and an early and organized integration approach to mitigate the risks of a transaction. Furthermore, alignment of overall business strategy with a bank’s M&A strategy is a critical first step to executing a successful acquisition (or divestiture, for that matter).

Time since acquisition. All three acquirer groups that yielded statistically significant results demonstrated a trend of increasing returns as time elapsed from transaction announcement date. The increase in acquirers’ values compared to their peers, from the deal announcement date until two years after announcement, suggests that increases in profitability from income uplift, cost reduction and market expansion become even more accretive with time.

Positive performance pre-deal may preclude future success. Our research revealed a positive correlation between the acquirer’s history of profitability and excess performance against peers post-acquisition. We noted this trend in banks with assets of less than $1 billion, and between $1 billion and $5 billion, at the time of announcement.

This correlation suggests that banks that were more profitable before a deal were increasingly likely to achieve incremental shareholder value through an acquisition.

Bank executives should feel comfortable pursuing deals knowing that the current marketplace rewards M&A in this sector. However, our experience indicates that in order to be successful, acquirers should approach transactions with a thoughtful alignment of M&A strategy with business strategy, an organized and vigilant approach to due diligence and integration, and trusted advisers to complement internal teams and ensure seamless transaction execution.

Strengthening Your Bank’s M&A Strategy



Bank M&A activity will likely increase in 2018, but many banks don’t have the in-house expertise and procedures to successfully navigate a deal. Phil Weaver of PwC explains the factors that will fuel deal volume and why banks need to update their M&A playbooks.

  • Why 2018 Will See More Deals
  • Beefing Up the Bank’s M&A Playbook
  • Talent Considerations in Executing a Deal

Handling the Risk of M&A



Atlanta-based State Bank Financial Corp. is fairly unique in that it uses a corporate psychologist who helps the bank assess the personalities that are the right fit for State Bank. Steven Deaton, the executive vice president and enterprise risk officer of State Bank, talks with Bank Director digital magazine’s Naomi Snyder about how the bank approaches due diligence and the risk of M&A.

He describes:

  • the importance of assessing culture in the organization you acquire
  • how the bank uses a corporate psychologist
  • the bank’s approach to M&A strategy
This article first appeared in the Bank Director digital magazine.

Credit Unions Challenge Bank Buyers for M&A Deals


merger-9-15-17.pngA new front has developed in the ongoing battle between banks and credit unions. While relatively unheard of in prior years, credit unions have been aggressively pursuing bank acquisitions over the last three years, winning over sellers with large cash premiums and frustrating potential bank buyers that cannot bid competitively. Given the competitive advantage that credit unions have in the bidding process, this trend is expected to continue for the foreseeable future.

Since 2011 there have been 16 acquisitions of banks by credit unions nationally, including several transactions that are currently pending. Initially starting as a trickle, the pace has been picking up steam in recent years. There were a handful of deals between 2011 and 2014, three deals announced in 2015, four in 2016, and four in 2017—and the year is not over. Many industry experts believe that several additional transactions will be announced before year-end. Much of this activity has been in the Midwest and Southeast, which traditionally have been large markets for credit unions.

Credit unions are cash buyers and have two big advantages over banks during the bidding process. First, because they have no shareholders looking over their shoulders, credit unions can more aggressively price a transaction without fear of shareholder retribution. Second, credit unions can offer a far higher premium than bank suitors since credit unions are exempt from federal and most state taxes.

What does this mean? On one hand, banks that want to cash out are able to obtain a higher premium for the institution, which ultimately is good for shareholders. However, banks that want to grow through acquisition could miss out on attractive acquisition opportunities that only a few years ago would have been within their grasp. The tax advantage enjoyed by credit unions poses a significant hurdle for traditional bank bidders. Even banks sitting on the sidelines will be affected by this trend, as local competitors are acquired by credit unions.

If the banking industry determines that bank acquisitions by credit unions are, on balance, a net negative, one solution is to advocate for an “acquisition tax” to be paid by credit unions at the state and/or federal level at the time of acquisition. Such a tax could help level the playing field and protect taxpayers (at least in part) from the loss of tax revenue generated on income of the bank going forward.

Another strategy is for banks, either individually or together with other institutions, to explore the possibility of turning the tables and acquiring a credit union. Such a transaction would eliminate a credit union competitor and also give credit union members a one-time payment, compensating them for the loss of any perceived benefits that a credit union may have with regard to more favorable customer interest rates and fees. Challenges abound with this strategy, including finding a suitably motivated credit union, navigating a very complex structuring and regulatory approval process, and retaining the credit union’s members as customers.

Regardless of the industry response to this issue, selling banks need to understand and appreciate the complexity posed by a credit union acquisition. Since a credit union cannot acquire a bank charter, the transaction needs to be structured as a purchase and assumption transaction, in which assets and liabilities need to be individually transferred and assigned. This is a costly and burdensome process and requires, among other things, consents from vendors and service providers, the preparation of mortgage assignments and allonges, and the filing of deeds and other documents related to the transfer of real estate.

Since the transaction must be structured as a cash asset sale, the transaction is taxable to the bank and shareholders. Additionally, the selling bank and, if applicable, its bank holding company, has to go through a liquidation and dissolution process, which is further complicated if there is outstanding debt at either the bank or holding company level. All of these costs need to be considered in determining the adequacy of the final bid. Finally, in our experience, the regulatory approval process is much longer than a traditional bank acquisition.

Whatever your bank’s situation, it is important to understand that credit unions and their investment bankers are actively and aggressively searching for banks to acquire, adding a new and rapidly expanding dimension to credit union competition.

Nine Steps for Getting Your Contracts Aligned with Your Acquisition Strategy


acquisition-8-2-17.pngAs banks contemplate future mergers and acquisitions, we are hearing a common question in our vendor contracts practice: “What should I do in my contracts to prepare for an acquisition opportunity?”

The truth is that whether buying or selling, there are many steps bankers can take to prepare for an acquisition, but they need to be taken well in advance. Here are some secrets from behind the curtain.

For banks that are serial acquirers:

1. Perform serious due diligence on the target’s technology contracts and your own.
Review the large technology agreements of the target bank using the 80/20 rule–80 percent of your spending is going to be in a handful of agreements. When you’re done reviewing the target’s contracts, review your own. This will provide a high-level view of your entire vendor relationship. Reviewing the target’s contracts will show your costs to exit their agreements. Looking at the target’s contracts in relation to your own will show opportunities for consolidating vendors and services at reduced rates.

2. Look for opportunities where you can take advantage of your vendor relationships.
If you use one vendor for core processing and you are buying a bank that uses another vendor, your onetime costs for the technology conversion and ongoing expenses will be entirely different than if you are both using the same vendor. Understand your leverage in these situations. If your target is using different systems than you are, an acquisition takes a competitor out of business. If your target is using the same systems as you are, then you are going to be paying for processing the same accounts twice for a period if you don’t negotiate differently.

3. Have pricing established that takes advantage of acquisition volume growth.
As the acquirer, you need to establish pricing that decreases on a per-customer basis as you grow. Negotiating tiers for your major pricing components is a basic requirement. Your goal should be to negotiate tiers that are market priced and are commensurate with the volume that will be loaded on during a five-year term. This could be substantial if you are in an aggressive growth mode.

4. Establish a firm understanding with your vendor about staffing conversions.
Moving quickly during acquisitions is par for the course. Your vendor’s ability to convert your target’s accounts to your system in a timely manner is vital. Best practice would be to negotiate with your vendor in advance for professional services to support your acquisition plan. This could include negotiating for a fixed number of conversions per year along with expectations for how long a conversion will take.

5. Manage your termination costs for acquired technology.
Smart buyers know that a vendor is due a fair share of its committed revenue and reasonable termination costs and no more. Negotiate with your current vendor for language that recognizes when you acquire a bank using their technology, you should only have to pay for any given account once. This can materially reduce your liquidated damages and termination penalties when you buy a bank using your vendor’s technology.

For banks that wish to be acquired:

6. Keep your contract terms to two or three years at most.
It’s never good to have long terms for your technology contracts if you are looking for a buyer. Even suitors using technology that is similar to yours will not want to pay for your commitments.

7. Keep your terms aligned.
I’ve seen a target bank’s contracts with a mix of long and short durations. This can look bad to a potential suitor.

8. Use standard technologies.
Buying a one-off solution or technology to get a competitive edge or save a few dollars is a non-starter if you are looking to sell. Software, services or equipment that can’t be reused or interfaced with the new bank’s core will run up your acquirer’s costs.

9. Negotiate decent pricing and known exit costs.
Keeping your costs in line is very important. Even if your contracts will be superseded by your buyer’s contracts, the liquidated damages to shut down your contracts are directly related to your pricing. If your pricing is three times market pricing, your buyer’s costs to get out of your agreement are going to be three times market. Your costs to de-convert from the system should be plainly laid out along with a clear and fair definition of what your liquidated damages will be.

Growth that comes to your vendors through acquisition increases their market share without the usual upfront costs associated with bringing on business. They want to see you succeed, so work closely with them to make it happen.

M&A Readiness: Making Sure Your Bank Can Do Acquisitions


acquisitions-5-10-17.pngWith many financial institutions benefiting from increased stock values and renewed optimism following the November election, merger activity for community banks is on the uptick. Successful acquirers must remain in a state of readiness to take advantage of opportunities as they present themselves.

Whether a prolonged courtship or a pitch book from an investment banker, deals hardly, if ever, show up when it is most convenient for a buyer to execute on them. As a result, buyers need to develop a plan as to what they want, where they want it and what they are willing to pay for it, long before the “it” becomes available. M&A readiness equates to the board of directors working with management to have a well-defined M&A process that includes the internal and external resources ready to jump in to conduct due diligence, structure a transaction and map out integration. Also, M&A readiness requires that buyers have their house in order, meaning that their technology is scalable, they have no compliance issues and the capital is on hand or readily available to support an acquisition.

Technology. In assessing the scalability of an institution’s technology for acquisitions, a buyer should review its existing technology contracts to see if it has the ability to mitigate or even eliminate termination fees for targets that utilize the same core provider. Without this feature, some deals cannot happen due to the costs of terminating the target’s data processing contracts. Cybersecurity is another key element of readiness. As an institution grows, its cybersecurity needs to advance in accordance with its size. Buyers need to understand targets’ cybersecurity procedures and providers in order to ensure that their own systems overlap and don’t create gaps of coverage, increasing risk. Additionally, buyers should understand existing cybersecurity insurance coverage and the impact of a transaction on such policies.

Compliance. Compliance readiness, or lack thereof, are the rocks against which even the best acquisition plans can crash and sink. Ensure that your Bank Secrecy Act/anti-money laundering programs are above reproach and operating effectively, and that your fair lending and Community Reinvestment Act policies, procedures and practices are effective. Running into compliance issues will cause missed opportunities as the regulators prohibit any expansion activities until any issues are resolved.

Conducting a thorough review of compliance programs of a target is critical to an efficient regulatory and integration process. A challenge to overcome is the regulators’ prohibition on buyers reviewing confidential supervisory information (CSI), including exam reports as part of due diligence. While the sharing of this information has always been prohibited, the regulatory agencies have become more diligent on enforcement of this prohibition. Although it is possible to request permission from the applicable regulatory agency to review CSI, the presumption is that the regulators will reject the request or it will not be answered until the request is stale. As such, buyers should enhance their discussions with target’s management to elicit the same type of information without causing the target to disclose CSI. A simple starting point is for the buyer to ask how many pages were in the last exam report.

While stress testing may officially apply to banks with $10 billion or more in assets, regulators are expecting smaller banks to prevent concentrations of risk from building up in their portfolios. The expectation is for banks to conduct annual stress tests, particularly among their commercial real estate (CRE) loans. Because of these expectations, buyers need to know the interagency guidance governing CRE concentrations and how they will be viewed on a combined basis. Reviewing different stress-test approaches can help banks better understand the alternatives that are available to meet their unique requirements.

Capital. An effective capital plan includes triggers to notify the institution’s board when additional capital will be needed and contemplates how it will obtain that capital. Ideally, the buyer’s capital plan works in tandem with its strategic plan as it relates to growth through acquisitions. Recently the public capital markets have become much more receptive to sales of community bank stock, but this has not always been the case. In evaluating an acquisition, the regulators will expect to see significant capital to absorb the target as well as continue to implement the buyer’s strategic plan.

The increase in financial institution stock prices has increased acquisition opportunities and M&A activity since the election. Opportunistic financial institutions have plans in place and solid understandings of their own technology needs and agreements, regulatory compliance issues and capital sources. Although it sounds simple, a developed acquisition strategy will aid buyers in taking advantage of opportunities and minimizing risk in the current environment.