Getting Friendly With Your Regulator

4-27-15-Jack.png“The regulatory environment today is the most tension-filled, confrontational and skeptical of any time in my professional career.” – H. Rodgin Cohen, senior chairman, Sullivan & Cromwell LLP

Six years after the worst financial crisis since the Great depression, bankers and their advisors are still complaining about regulation and the regulators. Cohen, who some people consider to be the dean of U.S. bank attorneys, made that statement back in March at a legal conference. Is the regulatory environment today really that bad? There are really two banking industries in this country—the relative handful of megabanks that Cohen has spent the better part of his career representing, and smaller regional and community banks that make up 99.99 percent of the depository institutions in this country.

There is no question that the megabanks have remained under intense regulatory scrutiny well after the financial crisis ended and the banking industry regained its footing. Overall, the industry is profitable, well capitalized and probably safer than before the crisis. But the regulators, led by the Federal Reserve, have never relaxed their supervision of the country’s largest banks, including the likes of JPMorgan Chase & Co., Bank of America Corp. and Citigroup. If the senior management teams and boards at those institutions are feeling more than a little paranoid, it’s probably for good reason. Joseph Heller, the author of Catch-22, wrote in his novel, “Just because you’re paranoid, doesn’t mean they aren’t after you.” The regulators might not be “out to get” the megabanks, but they clearly see them as a systemic threat to the U.S economy, and for that reason, have kept them on a short leash.

What about the rest of the industry—the other 99.99 percent? Has the regulatory environment improved for smaller banks? Based on comments that I hear at our conferences and elsewhere, I would say it has. The cost of regulatory compliance has increased for all banks, including even the smallest of institutions, in part because there are more regulations, but also because regulations are being enforced more strictly than was the case prior to the crisis.  In an interview that I did in the first quarter 2015 issue of Bank Director magazine with Camden Fine, chief executive officer at the Independent Community Bankers of America, Fine pointed to a general improvement in the level and tone of supervision throughout much of the country. Five years ago, bank examinations were “very harsh and inflexible,” to quote Fine. Now, exams generally seem more reasonable—which is understandable since the industry is in much better shape than it was six years ago.

But the regulatory environment might never be as relaxed as it was prior to the financial crisis. Today, the regulators want to be informed of any major decision, such as a potential acquisition or the launching of a new business line, which could impact the safety and soundness of the bank. You might not have thought that you had a “relationship” with your bank’s regulator, in the same way that you have a relationship with your outside legal counsel, investment banker or any number of consulting firms that management or the board might turn to for advice, but you do. That relationship certainly isn’t consultative in the sense that they won’t necessarily help you fix a problem, although it isn’t entirely authoritarian either, because you’re not necessarily asking permission, for example, to acquire another bank. Based on what I’ve been told by lawyers and investment bankers, regulators might express some concerns about the acquisition you have in mind, and they might even outline some areas of specific concern (like pro-forma capitalization). They might say it would be hard to approve the deal if those issues aren’t addressed, but they probably wouldn’t forbid you from going through with it.

I would say that managing the regulatory relationship is one of the key responsibilities for your bank’s CEO. Kelly King, the chairman and CEO at BB&T Corp., told me during an interview last year that he meets regularly with BB&T’s primary federal regulator—the Federal Deposit Insurance Corp.—and keeps it well appraised of the bank’s acquisition plans, which are key to its overall growth strategy. There is also an important role for the board to play—particularly the nonexecutive chairman or lead director—in maintaining a strong regulatory relationship. Those individuals might want to meet periodically with the bank’s regulator as well to drive home the point that the bank’s independent directors are engaged in the affairs of the bank.

I am sure that many older bank CEOs and directors resent the fact that the regulators have intruded so deeply into the business of the bank, but it’s a fact of life in the post-crisis world of banking—and an important relationship that needs to be carefully managed.

M&A 101 for the Board

Whether your financial institution is looking to buy or sell, the board of directors has several important responsibilities during an M&A transaction. In this video, Steve Kent of River Branch Capital LLC outlines the board’s role in the M&A process including negotiations, due diligence and after the deal is done.

What You Don’t Know Can Hurt You: 10 Things to Watch When You’re on a Bank Board

8-8-14-alston-bird.pngThe legal and regulatory climate for a bank is changing on a weekly basis. At least in part due to this, the expectations and liability risk of a bank director are not the same as a year ago, let alone five years ago. To help address this, we crafted a list of some broad themes we believe bank directors should be particularly attuned to now.

Enterprise Risk Management
Risk management is a function, not a committee. Boards need to implement a process to ensure that risks are properly identified and addressed in such a way that the board can demonstrate a “credible challenge” to management. And, beyond creating an effective corporate clearing house for risk, boards need to ensure that the bank possesses a management team capable of carrying out this function.

Third Party Risk
Vendor management has become a hot-button for all banks, as formal and tacit guidance continues to emerge. In addition to performing and memorializing due diligence around vendor selection, banks need to be in a position to understand and properly supervise the work of any vendors. This means having a properly qualified and trained management team that addresses the operational, compliance and other risks potentially resulting from reliance on third parties.

Trust Preferred Securities (TRuPS)
Many banks were forced to defer payments on TRuPS in the aftermath of the 2008-2009 crisis period. With the five year TRUPS deferral period now coming to an end, many bank holding companies don’t possess the funds (and cannot compel a bank dividend) to bring the TRuPS current. Further, regulators have insisted that any proposed capital raise be sufficient not only to pay off the TRuPS, but also to result in a composite CAMELS 2 rating for the bank. Your board needs to understand the resulting threats and opportunities.

Deferred Tax Asset Preservation
Bank regulatory agencies have begun to take issue with rights plans that are designed to preserve deferred tax assets (DTAs), citing the safety and soundness concerns that such plans could present by complicating future capital raises. As regulatory guidance on this point appears imminent, your board needs to understand the implications for your bank and your competitors.

Director Liability
Boards should ensure that they have the benefit of up-to-date exculpation and indemnification provisions in the bank’s charter and bylaws, as well as a robust directors and officers (D&O) insurance policy that is not rendered useless by a host of exemptions. In addition, with so much of the recent banking litigation being focused on process, your board should reconsider and redefine the way that your bank makes, records and polices its deliberations and decisions.

Role of Directors in Lending Decisions
Clearly, directors should be involved in defining the scope of a bank’s lending activities, the delegation of lending authority, and the monitoring of credit concentrations and other risks. But should directors serve on loan committees, and make the actual lending decisions? It’s time to reassess this important issue. Directors making day-to-day lending decisions can blur the lines of proper governance and needlessly expose directors to additional liability risk.

Charter Conversions
Each of the banking agencies seems to be developing a different regulatory mood on key issues, such as business plans, consumer compliance and risk-based regulation. In this post-crisis environment, it is important that you consider whether your bank is appropriately chartered in light of its strategy. Put another way, the trends have changed, and you should consider how these changes affect your bank.

Growth Strategies in a Tough Lending Climate
With traditional loan growth being slow, banks continue to reach for less traditional loan products, such as asset-based lending, factoring, lease finance, reverse mortgages, premium finance, indirect auto lending, warehouse facilities, etc. As always, these products must be considered in light of concomitant compliance risks and capital requirements. Directors should ensure that management performs thorough risk assessments alongside their profit/loss projections.

The Effects of Basel III
Depending upon the size and makeup of your bank, the January 2015 Basel III changes will impact your bank’s regulatory capital position. At a minimum, directors need to understand from the bank’s CFO and auditors that there is a plan anticipating what the pro forma capital position is expected to be under Basel III.

Compliance Issues Can Sink a Strategy
Too many banks with solid strategies have seen their bank’s growth hindered by compliance failures. Bank Secrecy Act/anti-money laundering rules, consumer protection regulations, and poor oversight of third parties can result in enforcement actions and derail growth until the issues are remediated, which can take years. Boards must set a tone at the top with regard to the compliance culture of the bank.

The themes above are top of mind for us, but the environment remains dynamic. This list likely will look very different in another year.