What To Know About the New Fintech Charter


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Don’t expect an onslaught of fintech companies rushing to become banks. The recent announcement that the Office of the Comptroller of the Currency would begin accepting applications for special purpose national bank charters from fintech companies was met with gloom from some in the banking industry, and optimistic rejoicing from others.

For now, the impact on banking and innovation seems unclear, but the hurdles to obtaining a national banking charter will be significant, and include compliance with many of the same regulations that apply to other national banks, possibly dissuading many startup fintech companies from even wanting one. On the other hand, larger or more established players may find it worth the added regulatory costs to boost their marketing and attractiveness to investors, says Cliff Stanford, an attorney at Alston & Bird. Plus, fintech firms can avoid the m?©lange of state-by-state banking rules and regulations by opting for a national banking charter instead. So don’t be surprised if a Wal-Mart, Apple or Google decides to get a banking license, along with some other, less well known names. The online marketplace lender OnDeck has already said it was open to the possibility of a national bank charter.

The OCC is offering fintech companies the same charter many credit card companies and trust companies have. Basically, the institution has to become a member of the Federal Reserve, and is regulated as a national bank with the same capital standards and liquidity requirements as others. The company has to provide a detailed plan of what products and services it intends to offer, a potential hurdle for a nimble start-up culture more accustomed to experimentation than regulation. “They will have a high bar to meet and they might not be able to meet those requirements,” Stanford says.

However, if the special purpose bank doesn’t accept deposits, it won’t need to comply with the same regulations as banks insured by the Federal Deposit Insurance Corp., which means it is exempt from the Community Reinvestment Act (CRA). Although nondepository institutions would not have to comply with the CRA, the OCC described requirements to make sure the fintech companies follow a plan of inclusion, basically making sure they don’t discriminate, and promote their products to the underserved or small businesses. This has caused some consternation among community banks.

“Why should a tiny bank have to comply with CRA and a big national bank across America does not have to comply?’’ says C.R. “Rusty” Cloutier, the CEO of MidSouth Bancorp, a $1.9 billion asset bank holding company in Lafayette, Louisiana. “If they want a bank charter, that’s fine. Let’s just make sure they play by the same rules.”

The Independent Community Bankers of America, a trade group, put out a press release saying it had “grave” concerns about what it called a “limited” bank charter. “We don’t want a charter that disadvantages one set of financial institutions,’’ says Paul Merski, an executive vice president at the ICBA. “We aren’t against innovation. But we want to make sure some institutions aren’t put at a disadvantage.”

Richard Fischer, an attorney in Washington, D.C., who represents banks, says he doesn’t think a fintech charter is a threat to banks. The Wal-Marts and Apples of the world will do what they want to do, whether or not they have a bank charter. Wal-Mart, which abandoned attempts to get a special purpose banking charter in 2007, already has a sizeable set of financial services, although it partners with banks that do have a charter, such as Green Dot Corp. in Pasadena, California.

Could a new fintech charter lead to fewer bank partnerships with fintech companies, as the fintech companies can cut out the need for a bank? Possibly. But it could also lead to more bank partnerships, as some banks, especially small or midsized banks, become more comfortable with the risk involved in doing business with a fintech company that has a national banking charter.

Jimmy Lenz, the director of technology risk at Wells Fargo Wealth and Investment Management, a division of Wells Fargo & Co., says he’s optimistic that a charter could create more products and services.

“I don’t see this cutting the pie into smaller slices,’’ he says. “I think they will be cutting a bigger pie. I don’t see the banks coming out on the short end of this.” Others said that the competition to banks coming from fintech companies already exists, and won’t go away if you don’t offer a federal charter for fintech companies. “The competition is already there,’’ Stanford says.

Doing an Acquisition? Don’t Forget the CRA Rating


bank-ratings-9-2-15.pngAs we move further away from the recent economic crisis, an increasing number of financial institutions are considering becoming buyers or sellers. It is therefore important that potential acquirers position themselves to be attractive suitors, and sellers demonstrate that they are healthy candidates. Although much of this focus is directed toward an institution’s overall safety and soundness and numerous other factors, one issue that should not be overlooked is its record of meeting the credit needs of its local communities when measured against the requirements of the Community Reinvestment Act.

CRA Primary Factors
There are two relevant factors related to CRA. First, an acquiring institution’s CRA rating can dictate whether a potential deal will receive regulatory approval. Depending on the severity, a potential acquirer with a less than “satisfactory” rating, or even one with more narrow weaknesses in its CRA program, will find it difficult if not impossible to obtain regulatory approval for any transaction until it improves its rating and its internal CRA program. Also, the CRA condition of the seller is significant, and the buyer should determine how that will impact the bank after consummation.

Even an institution with an “outstanding” CRA rating can still face difficulties executing a transaction. The CRA allows individuals and community groups to take an active part in the regulatory application and approval process of a transaction by providing a mechanism for the submission of public comments regarding any perceived CRA compliance weakness or criticism of a party to the transaction. Because the CRA rating is publicly reported, unlike the institution’s other confidential examination ratings, this becomes an easy target. By taking advantage of the publicly available data concerning financial institutions, including CRA ratings, groups located far outside the acquirer’s market area can file comment letters that pass the very low threshold set by regulators to entertain these protests. In some cases, these activist groups have been able to extract significant commitments from acquirers just to get deals done.

Regulatory Approval Process
Most often, these public comments do not, in and of themselves, prevent an otherwise viable transaction from occurring. They can, however, significantly slow down a pending transaction. Under current procedures, written public comments are included as part of the record that the federal agencies review in the evaluation of an application for a transaction. In connection with these public comments, the regulators may make several requests for additional information before ultimately determining whether those public comments will impact their approval of the proposal. This process can take several months, and can even drag on for significantly longer. From deal uncertainty, to the potential that key talent will leave in the wake of a long transition, to the potential for major shifts in the market or rapid economic change, delaying the closing of a transaction while this process unfolds can be quite costly and damaging for the parties involved.

The importance of the CRA comment process to banking M&A has existed for decades, although historically, it generally has been confined to transactions involving very large financial institutions, such as the recent CIT Group-OneWest Bank acquisition. With the current paucity of larger bank transactions, smaller deals are attracting more public scrutiny and suffering significant delays of, in some cases, many months. Discussions and negotiations with the regulators on this issue may be difficult and frustrating. If CRA comments are submitted to regulators for a particular transaction, it is important to quickly develop with legal counsel a clear strategy to address and resolve any issues that have been raised.

Practical Takeaways
To mitigate the CRA risk in M&A transactions, the following are some strategies that an organization should consider, either as a buyer or a seller:

  • Continue to develop a strong CRA program and strategy.
  • Proactively develop or deepen relationships with local community groups.
  • Be extremely careful and consult with legal counsel when deciding whether and how to respond to broad “informational” questionnaires from community groups.
  • Engage with banking regulators early in the transaction process regarding each party’s CRA status, strengths and potential challenges.
  • In the transaction agreement, consider specifically providing for community-based outreach or support programs following the transaction.
  • Provide clear evidence of community support by both parties, pre- and post-transaction, in the deal announcement.
  • Take all protests seriously, and be cognizant that all communication and information may become public.

Could a Republican President Mean More M&A Activity?


Banking-Industry-8-12-15.pngWith the first prime time Republican primary debate of the 2016 election cycle in the rear view mirror, we have all gotten an inkling of what the candidates think about the banking industry. I did take particular note of Senator Marco Rubio when he stressed the importance of repealing the Dodd-Frank Act. As Commerce Street Holdings’ CEO shared in an article on BankDirector.com, “many bankers feel that given the legislative and regulatory environment coupled with low rates, low margins, low loan demand and high competition, growth is very difficult.”  So repealing Dodd-Frank is a dream for many officers and directors, and Rubio is echoing their concerns.

Senator Rubio’s comments build on those of former Texas Governor Rick Perry, who recently laid out a sweeping financial reform agenda earlier. He believes the biggest banks need to hold even more capital—or Congress should possibly reinstitute elements of the Glass-Steagall Act. While his campaign appears to be winding down, I do agree with his call for government to work harder to “level the playing field” between Wall Street banks and community institutions.

With so much political scrutiny already placed on banks, it is interesting to think of the pressures being placed on institutions to grow today. On one side, you have politicians weighing in on how banking should operate. On the other, regulatory and investor expectations are higher now than in recent years. Buckle up, because I believe the coming election will only further encourage politicians with opinions, but little in the way of detailed plans, about “revitalizing” the economy.

Against this political backdrop, today’s business environment offers promising opportunity for bold, innovative and disciplined executives to transform their franchises. But I believe regulatory hurdles are making it tougher to do deals. Indeed, the recently approved merger of CIT Group and OneWest Bank creates a SIFI [Systemically Important Financial Institution] which will have to submit to increased regulation and scrutiny. However, when the deal was first announced, CIT’s CEO, John Thain, suggested that his purchase of OneWest could spur other big banks to become buyers. A year later and such activity has yet to be seen.

I see the absence of bigger deals reflecting a reality where any transaction comes with increased compliance and regulatory hurdles. For CIT, going over the $50 billion hurdle meant annual stress tests will now be dictated by the government, as opposed to run by the bank. The institution will have to maintain higher capital levels. Thain seems to think that those added costs and burdens are worth it. By the lack of action, other banks haven’t yet agreed.

Without a doubt, regulatory focus has impacted strategic options within our industry. For instance, we learn about CRA [Community Reinvestment Act] impacting deals and also find fair lending concerns and/or the Bank Secrecy Act delaying or ending potential mergers. Consequently, deals are more difficult to complete. As much as a bank like CIT can add cost savings with scalability to become more efficient, you can understand why banks in certain parts of the country need to debate whether it is better to sell today or to grow the bank’s earnings and sell in three to five years.

The evidence is clear that big banks are not doing deals. Maybe a GOP victory in the next election will thaw certain icebergs, creating a regulatory environment more friendly to banks. While regulators have to comply with existing laws, the leadership of regulatory institutions is appointed by the president and the tone at the top is critical in interpreting those laws. Until we see real action replace cheap talk, I’m looking at CIT as an outlier and simply hoping that political rhetoric doesn’t give false hope to those looking to grow through M&A.

The Regulatory Agenda and the Board: Five Key Issues


2-17-14-Dinsmore.pngThe Dodd-Frank Wall Street Reform and Consumer Act has been in effect for nearly four years, and almost 75 percent of the required regulations have been written or proposed. Issued regulations help to clarify requirements, but the climate created by expectations of regulators continues to create additional challenges for boards.

Boards must first understand these regulatory expectations and then balance them against shareholder interests at a time when it is increasingly difficult to meet earnings expectations. As a result, financial institution directors are asking, “What should I know?” and “What may be coming next?” While it is impossible to know exactly what may be next, there are themes that are emerging from the current environment to which directors should pay particular attention.

Stress Testing
This will continue to evolve for the larger banks. Models for credit are changing to take into account improving credit statistics. Models for pre-provision net revenue and operational losses continue to be refined. Smaller banks without stress testing should be developing their testing. Banks with more than $10 billion in assets are required to stress test, so boards must ensure that their models continue to be challenged and validated. Simultaneously, similar testing for liquidity is being developed, and the regulatory pressure to understand liquidity positions and make progress toward achieving required liquidity ratios will be significant. The board should understand where the bank’s testing stands along the developmental curve and be prepared to challenge findings and address changing needs.

Compensation and Human Resource Practices
Dodd-Frank requires financial institutions to review incentive plans and eliminate rewards for risky activities. At the same time, the so-called horizontal review of pay practices at the largest financial institutions are creating regulatory expectations and standards that may not be as apparent, but will require more board involvement in pay decisions and structures. There is no area that will be more difficult to get right, as many of the regulatory requirements are inconsistent with the expectations and demands of shareholders. Risk and compensation committees will need to interact more as it relates to pay practices. The board should be prepared to challenge reporting structures that could increase risk or negatively impact controls in the financial institution.

Mortgage Lending Requirements and CRA Performance
It remains to be seen how the new ability-to- repay and qualified mortgage rules may impact a bank’s Community Reinvestment Act (CRA) performance. Directors will need to keep a close eye on CRA performance at their institutions, as it may be more difficult to generate loans in the more underserved communities.

Third Party Providers
Guidance issued by the Federal Reserve in December on managing outsourcing risk made clear that responsibility for the activities of third party providers remains with the financial institution. The board also must ensure that clear policies for managing these relationships are in place and followed. Less obvious are newly issued proposed rules related to diversity. These rules require boards to ensure that there are policies and practices in place to promote diversity in the supplier base as well as the financial institution’s workforce.

New Products and Services
As the earnings environment faces declining revenue streams (like mortgage) and increased compliance expenses, financial institutions will search for new ways to grow revenues. Boards will need to pay close attention to strategic plans and include risk reviews of strategies (including new products and services) to ensure that they align with their institution’s risk appetite.

Any of these topics could be the subject of its own article on the role of the board and its committees, and there are endless other issues that could (and must) be considered. It is clear that the responsibility and time commitment of boards of financial institutions will continue to expand and evolve at a rapid pace for the near future. Keeping abreast of regulatory interpretations and expectations has never been more important to the success of a financial institution and its board.

CRA Comes to Life

WK-CRA-WhitePaper.pngExecutive Summary

The Community Reinvestment Act (CRA) requires that every insured depository institution meet the needs of its entire community. It also requires the periodic evaluation of depository institutions’ records in helping meet the credit needs of their communities. Proactively monitoring CRA performance is important for several reasons. The record is taken into account when considering an institution’s application for deposit facilities, meaning it will directly impact any contemplated acquisitions and/or branch openings. Additionally, the record will be regularly examined by the federal agencies that are responsible for supervising depository institutions and a rating will be assigned. Since the results of the exam and the rating are available to the public—customers, competitors and community groups—an institution’s CRA performance can impact its reputation. Banks must understand the characteristics of their assessment area and regularly monitor their performance to ensure the equal credit extension throughout their entire customer base.

This paper will explain the purpose and requirements of CRA and how as a board member, you can provide oversight regarding your institution’s CRA obligation.