Community bankers fight back


fight.jpgIt goes without saying that the regulatory regime in Washington, D.C., has not been friendly to banking lately. The Dodd-Frank Act, with its seemingly endless round of new rules for the financial industry, is limiting everything from debit card fees to the types of investments banks can make.

In an effort to fight back, the leaders of several state banking associations have formed their own fund to influence federal elections. The group, Friends of Traditional Banking, will ask supporters to contribute directly to candidates for federal election, instead of the group sending donations to candidates, says Howard Headlee, the president of the Utah Bankers Association.

“This is more a response to the treatment we received from the Dodd-Frank Act and the treatment Congress is imposing on community banks,’’ he says. “I’ve talked to so many community bankers across the country and they’re mad.”

He describes traditional banks as the ones whose business model is to take deposits and lend money in the local economies where they reside—banks he feels have been unjustly punished for the sins of the financial crisis.

Headlee wants to attract pledges from bank CEOs, directors and “anybody who understands we need community banks as a country to be successful and we have to stop burning them with outrageous legislation when they were not the problem [in the financial crisis]. No one claims we were the problem, but the level of regulation keeps going up and up to the point where these community banks are really struggling with a business plan going forward.”

Even though Headlee is a national political fundraiser for presidential candidate Mitt Romney in addition to his duties as president of the Utah Bankers Association, the group has not decided to endorse Romney, Headlee says. An advisory council that will recommend candidates is made up of 10 staff members of state banking associations, including the presidents of the banking associations in Idaho, Kansas, Michigan, Minnesota, Vermont, Utah and Oklahoma and the vice presidents of government affairs for New Jersey and Arizona’s state banking associations.

The group will not contribute directly to campaigns because such donations are limited by law, Headlee says.  Each state banking association already has its own state political action committee (PAC), and some have federal PACs, but because the state associations are affiliated with the American Bankers Association, those contributions as a group are limited.

Headlee hopes that by avoiding direct contributions, the group will be able to get more community bankers and their friends to contribute to more campaigns. 

The group is registered with the Federal Election Commission as a “separate segregated fund,” which means it is a fund affiliated with a group such as a corporation, non-profit or union. Headlee has been calling it a “SuperPAC,” an organization that has been getting a lot of attention during the early days of the 2012 election cycle for the unlimited amounts it can raise to try to influence campaigns.

“They are popular with corporations and labor organizations,’’ says Robert Pinson, an attorney with Bone, McAllester Norton PLLC in Nashville, Tennessee. “Some are funded by billionaires and they pool their money. There is easily going to more than $100 million spent on this presidential campaign in the next couple of months and we’ve barely got started.”

Friends of Traditional Banking has started small. Only about 56 people have pledged to spend $9,000 so far on candidates recommended by the group, Headlee says.

Joe Witt, the president and chief executive officer of the Minnesota Bankers Association, who helped organize the group, says he thinks the need to be active politically and give more to campaigns has intensified. Witt said in the 1990s, he’d need to rally bankers to lobby on an issue once every few years, and now it’s several times per year.

“There’s the expectation that you need to be there for your friends,’’ he says. “We’re conspicuous in our absence if we aren’t there for the political fundraisers and golf outings and all the things the politicians expect us to be at. People run for elections and elections cost money. It’s not a horrible thing.”

The Double-Barreled Regulatory Assault on Retail Banking


shotgun.jpgFollowing the financial crisis, one can cite any number of areas where the regulatory pendulum has swung too far.  Retail banking is one of those areas.  The Dodd-Frank Wall Street Reform and Consumer Protection Act ushered in a new—and an oddly schizophrenic—regulatory regime for retail bankers.

The premise of the new legislation is that, had the prior retail banking regulatory regime been different, material aspects of the financial crisis would have been averted.  In particular, proponents of the legislation asserted that federal bank regulators focused on safety and soundness considerations significantly to the exclusion of consumer protection.

Whether these problems were real or imagined, they were given a legislative “solution.”  Dodd-Frank created a new federal super-regulator for consumer financial services regulation, the Bureau of Consumer Financial Protection (CFPB).  With generous funding and a singular focus on consumer protection without regard for prudential considerations, the CFPB has a host of unprecedented powers, including:

  • rulewriting authority for 18 federal consumer credit laws;
  • authority to issue rules implementing the new consumer protections added by Dodd-Frank, most notably the statute’s open-ended proscription on unfair, deceptive or abusive practices;
  • direct compliance-related supervisory authority for banks with total assets of more than $10 billion.

In other parts of the Dodd-Frank legislation, however, Congress seems to have forgotten that the CFPB was the “solution” to the perceived problem of lax federal oversight.  Notwithstanding the CFPB’s creation, Dodd-Frank ushers in a wholly separate alternative “solution.”  Specifically, Dodd-Frank increased state enforcement authority.  State attorneys general, in particular, in effect have been deputized to enforce aspects of federal consumer financial protection law.  Dodd-Frank also erected an array of barriers to federal preemption, the principle by which banks that operate on a multi-state basis often are permitted to follow a single uniform federal standard rather than a hodgepodge of different and potentially inconsistent state laws.

Although federally chartered banks and thrifts will bear the worst of the new anti-preemption changes, state chartered banks also stand to lose some of the preemption efficiencies they have enjoyed.  Many preemption rules apply without regard to charter type and, even where preemption is specific to federally chartered banks, most states have some variety of “wildcard” statute offering state banks parity with their federal counterparts.

It was shortsighted to have concluded that preemption is always contrary to consumer interests and that rolling back preemption and hamstringing it in the future ensures better public policy.  Let us recall some examples from a prior financial crisis— the extraordinarily high interest rate environment of the late 1970s and early 1980s when the prime rate of interest, at its peak, skyrocketed to 21 percent.

  • Many state usury limits were set at well below market rates of interest.  Credit, particularly housing credit, was unavailable to consumers as banks were forbidden from charging rates at prevailing market levels.  The solution was federal preemption of mortgage loan interest rates.
  • In that extreme rate environment, banks and consumers alike often preferred adjustable rate mortgages.  ARMs would have reduced the bank’s risk of rate volatility, and consumers with immediate housing credit needs could have avoided locking in historically high rates for the long term.  Unfortunately, this was not possible in a number of states that mandated that loans have level payments that could not vary over the life of the loan.  The solution was federal preemption of these state rules.
  • Also during this era, consumers did not always get the rates and other mortgage loan terms they deserved based on their credit history.  Various states prohibited “due-on-sale clauses,” the contractual provisions permitting a bank to deem the entire note due and payable upon sale of the property.  Under these laws, mortgage loans became “assumable” by any purchaser of the property, including one less creditworthy than the initial borrower.  Hence, the initial borrower was forced to pay a risk premium even if he or she had no intentions of selling.  The solution, again, was federal preemption of state prohibitions on due-on-sale clauses. 

These examples demonstrate that states are not always the best source of enlightened retail banking public policy (or always nimble in making adjustments in a crisis).  These examples also show that preemption can be pro-consumer and an important tool in meeting an economic crisis.

Unfortunately, these policy lessons of the past seem to have been lost.  Retail bankers now face a double-barreled assault focused on consumer protection from the CFPB and the states.  Either one of these “solutions” to perceived regulatory failures of the past would have prompted bankers substantially to tighten their internal consumer compliance controls.  Facing both “solutions” simultaneously means that compliance must be a high priority at every level of the bank, starting at the board of directors.

OCC’s Walsh: “I feel your pain”


The Dodd-Frank Act is unlikely to be repealed, although it may be tweaked, according to John Walsh, the acting comptroller of the currency, who spoke before a crowd of about 400 bankers and bank directors at the 2012 Acquire or Be Acquired conference Monday in Phoenix.

The banking industry has been pushing for a repeal of Dodd-Frank, or at least major changes.

The Office of the Comptroller of the Currency (OCC) supervises about 2,000 banks and federal savings associations, most of them community institutions with less than $2 billion in assets. 

Walsh said he didn’t see how Dodd-Frank could be repealed because some of the work of implementing it has already been done, including the merger of the Office of Thrift Supervision and the OCC.

“We just spent a year and a half joining the OTS and the OCC,’’ he said. “I’m not sure how you just send everybody back to their two buildings.”

Walsh said there may be pieces that could be changed, although that would be up to Congress.

Even though many of Dodd-Frank’s new rules apply only to banks and thrifts above $10 billion in assets, some will impact community banks as well. For example, the new Consumer financial Protection Bureau (CFPB) will have minimum standards for mortgages, new disclosure requirements, a new regime of standards and oversight for appraisers and an expansion of the Home Mortgage Disclosure Act requirements for lenders.  The bureau also must define and ban “unfair or abusive” practices.

“Each change will have a proportionately larger impact on community banks due to their small revenue base,’’ Walsh said.

He said checking accounts will be impacted as debit card fee income falls as a result of the Dodd-Frank Act. Also as a result of the law, banks of all sizes will have to evaluate the quality of securities investments they make, without relying on the rating agencies to evaluate the appropriateness of such investments. Small, community banks don’t have the resources of larger banks to do such assessments in-house.

Walsh said economic weakness and regulatory burdens are putting more pressure on bank management and told the crowd: “Believe me when I tell you that I feel your pain.”

He also acknowledged that more decisions are being made in Washington, D.C., decisions that formerly would have been made in local OCC district offices when economic times were better.

“In difficult times or in particular when difficult decisions are being made…. we do subject more of those decisions to review,” he said.

Joe Kesler, the president and chief executive officer of First Montana Bank in Missoula, Montana, who attended the conference, said he would most like to have the Consumer Financial Protection Bureau disbanded.

Even though the CFPB’s rules are supposed to apply to banks of $10 billion in assets or more, and Kesler’s bank has about $300 million, he thinks the bureau’s decisions will trickle down to banks of his size. First Montana Bank has a mortgage business, and the CFPB has begun putting together new rules for residential mortgages.

“The big uncertainty cloud is the impact of the CFPB,’’ he says. “It’s troubling we can’t plan for the future.”

Regulatory Game Changers and How to Deal with Them


Banks have been struck with an avalanche of new regulations. Derrick Cephas with the law firm of Weil, Gotshal & Manges LLP talks about how banks can approach the new regulations in a constructive manner, and how the new rules have changed the regulatory landscape.

What are the new regulations for mid-sized and smaller banks that are really the game changers, in your view?

Although most of the major provisions of Dodd-Frank have the greatest impact on the very large banks, I think that as a matter of industry practice over time, a number of the Dodd-Frank initiatives will be made applicable to smaller banks. For example, the law provides that the Consumer Financial Protection Bureau will apply to banks with assets of $10 billion or more. I can’t imagine that if the CFPB decides that a practice is abusive or against the public interest, that banks below $10 billion in assets will be allowed to continue to engage in that practice. However the CFPB ends up reshaping consumer banking practices, the result is likely to have applicability to smaller banks as well.

The abolition of the Office of Thrift Supervision will also have broad implications for the thrifts, many of which are relatively small, because they will now be regulated by the Office of the Comptroller of the Currency and the Federal Reserve Board.

One of the changes that regulators have instituted over the last few years, with no change in statute, is to have raised the required minimum capital requirements substantially. Prior to the recession, regulators would find a leverage ratio of 6 to 6.5 percent to be acceptable. Now, through the supervisory enforcement process, regulators have effectively increased the minimum acceptable leverage ratio up to 8 percent, or 9 percent in some cases. That approach now has equal applicability, no matter the size of the bank. 

How should bank officers and board members try to tackle this labyrinth of new rules?

They need to establish a tracking system to identify the regulations and statutes that apply to them and what the bank needs to do to stay in compliance. Then they should appoint a senior person internally to be in charge of regulatory compliance on a day-to-day basis, such as a chief risk officer, chief compliance officer or general counsel. That person’s department should be adequately staffed and he or she should report to a committee of the board, either the risk management committee, compliance committee or a similar committee. That committee should report to the board, maybe monthly, maybe quarterly, depending on the severity of the problems.

At what point should a bank really push back against a regulator’s suggestions and input and at what point should it be more receptive?

A bank should always maintain a constructive dialogue with its regulators. If the bank believes that the regulator is taking an inappropriate approach, it should engage the regulator substantively on that issue. If the bank’s management team thinks there’s a better approach, it should make that suggestion to the regulators. But remember that at the end of the process, the regulator decides the issue and once the issue has been fully considered, the bank will then have to follow the regulators’ guidance on the issue. The banks that get in trouble with regulators are the ones that aren’t responsive to regulatory guidance. If regulators conduct an exam and produce a list of issues to be resolved and they come back the next year for another exam and find that the same issues have not been resolved, the message the bank sends is that it doesn’t take compliance seriously and can’t be relied upon to resolve outstanding regulatory concerns. Having a poor relationship with your regulators is not a good strategy. Very few banks achieve their objectives by having an adversarial relationship with the regulators.

Do you see regulation changing the focus for banks and thrifts, and if so, is that good?

Depending upon how long it takes for the economy to stabilize and then improve, I think you’re going to see an increased emphasis on regulation for the foreseeable future.  There will be a focus on asset quality, capital adequacy, basic risk management, risk reduction and liquidity requirements. Increased regulation has significant cost implications and also has an impact on bank profitability. If the economy stabilizes and starts to improve, the demand for quality loans starts to increase and the unemployment picture improves significantly, all of that will indicate that the economy has turned the corner and we would then expect to see moderation in the regulatory climate. I don’t expect to see that change in the next two or three years or so. The increased regulation that we now have did not occur in a vacuum. It came in response to a problem.

Why We Need the CFPB


capitol.jpgFew pieces of legislation in recent years have riled up the financial services industry as thoroughly as the Dodd-Frank Act. And the white hot center of that controversial law is probably the new Consumer Financial Protection Bureau (CFPB), which the Act created to police the marketplace for personal financial services. If you’ve been reading the news lately, you know that the CFPB has a new director—former Ohio Attorney General Richard Cordray—who received a sharply-criticized recess appointment recently from President Obama. Senate Republicans had refused to hold confirmation hearings on Cordray until certain changes were made to the agency’s organizational structure, and Obama finally lost his patience and made Cordray’s appointment official while Congress was in recess.

If you have been paying attention, you also know there’s a difference of opinion between Senate Republicans like Majority Leader Mitch McConnell (R-Kentucky) and the White House over whether Congress was technically still in session, so the legality of Cordray’s appointment might be challenged in court. It’s also entirely possible—perhaps even likely—that the CFPB will be legislated out of existence should the Republican Party recapture the White House and both houses of Congress this fall. No doubt many bankers, their trade associations and the U.S. Chamber of Commerce would like to see that happen.

On the other hand, if the president wins reelection, I am sure he would veto any such bill that might emerge from a Republican controlled Congress, should the Republicans hold the House and retake the Senate this fall, which is possible but by no means assured. And if you give Obama a 50/50 chance of being reelected—which is my guess at this point having watched the Republican presidential race closely—then you can reasonably assume the CFPB has a 50/50 chance of surviving at least until January 2016.

And I think that’s a good thing.

cfpb-richard-cordray.jpgThis probably puts me at odds with most of Bank Director magazine’s readers. There’s no question that Dodd-Frank, combined with a variety of recent initiatives that have come directly from agencies like the Federal Reserve, will drive up compliance costs for banks and thrifts. And the CFPB‘s information demands alone will be a component of those higher costs. However, I have a hunch that what scares some people the most is the specter of a wild-eyed liberal bureaucrat imposing his or her consumer activist agenda on the marketplace. I don’t think Cordray quite fits that description, based on what I’ve read about him, but obviously we won’t know for sure until he’s been in the job for a while, so the naysayers’ apprehension is understandable. At the very least he seems determined to get on with the job, so we should know soon enough what kind of director he will be.

Here’s my side of the argument. Among the primary causes of the global financial crisis of 2008, which was precipitated by the collapse of the residential real estate market in the United States, were some of the truly deplorable practices that occurred during—and contributed to—the creation of a housing bubble. Chief among them were the notorious option-payment adjustable rate mortgages and similar permutations that allowed borrowers to pay less than the amortization rate that would have paid down their mortgages, which essentially allowed them to buy more house and take out a bigger mortgage than they could afford to repay. Some of these buyers were speculators who didn’t care about amortization because they planned on flipping the house in two years. But many of them were just people who wanted a nicer, more expensive house than they could afford and figured optimistically that things would work out. And the expansion of the subprime mortgage market brought millions of new home buyers into the market just when housing prices were becoming over inflated.

I’m not suggesting that the CFPB, had it been in existence during the home mortgage boom, could have single-handedly prevented the housing bubble. The causes of the bubble and the financial panic that eventually ensued were many and varied, including the interest rate policies of the Federal Reserve, the laxness on the bank regulatory agencies when it came to supervising the commercial banks and thrifts, the laxness of the Securities and Exchange Commission when it came to supervising the Wall Street investment banks and the fact that no one regulated the securitization market. But an agency like the CFPB, had it been doing its job, would have cracked down on dangerous practices like the so-called liar loans, or loans that didn’t require borrowers to verify their income. It would have put an end to phony real estate appraisals that overstated a home’s worth, making it easier for borrowers to qualify for a mortgage. And it would have been appropriately suspicious of option-ARMs if a super-low teaser rate and negative amortization were the only way that a borrower could afford to buy a home.

The CFPB is not a prudential bank regulator and will not focus on bank safety and soundness like the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. But in cracking down on some of these dangerous marketplace practices, the CFPB might have reigned in institutions like Wachovia, Washington Mutual, IndyMac and Countrywide that ultimately failed, or were forced to sell out, because it would have discouraged many of the shenanigans that helped feed the housing bubble.

Of course, many of the unsound practices that helped inflate the bubble were widespread outside the banking industry, and one of the CFPB’s principal—and I would say most important—duties will be to regulate the mortgage brokers and nonbank mortgage originators who accounted for a significant percentage of origination volume during the housing boom. Banks and thrifts should benefit greatly from this effort if it leads to the creation of a level playing field where nonbank lenders can no longer exploit the advantages of asymmetrical regulation.

A truism of our financial system is that money and institutional power will always be attracted to those sectors that have the least amount of regulation. For all intents and purposes, both the gigantic secondary market and the large network of mortgage brokers and nonbank mortgage lenders went unregulated during the boom years, and this is where the greatest abuses occurred. (Dodd-Frank also addressed the secondary market, although the jury is out whether its prescribed changes will work. Indeed, at this point it’s unclear whether the secondary market for home mortgages will ever recover.)

In hindsight, having two mortgage origination markets—one highly regulated, the other unregulated—was asking for trouble. And that’s exactly what we got.

Which is why we need the CFPB.

Is the Grass Greener? Five Considerations before Converting your Charter


greener-grass.jpgBecause many banks continue to take a bruising from banking examiners, it should come as no surprise that some have considered a change of charter in hopes of finding a less overbearing overseer.

In particular, recent headlines have shown that a significant number of national banks have left a national charter for a state charter.  Since 2000, almost 300 national banks have made the switch. 

Provisions from a spate of recent Office of the Comptroller of the Currency consent orders may illustrate why, with some provisions requiring significantly higher capital ratios than other regulators have demanded from similarly situated state-chartered institutions as well as  other provisions essentially forcing national banks to either sell to new owners or face receivership.

If you are contemplating a charter conversion for your bank, there are a number of key issues to consider before you make the change.  These include:

Access to Government Officials:  Because state regulators are geographically closer and more familiar with the situation on the ground, channels of communication may be more open and less adversarial.  Likewise, small financial institutions may exert greater political influence either directly or through their state bankers’ association. 

However, in practice, most state regulators exercise great deference to the FDIC or Federal Reserve in both examinations and regulatory approvals, and for institutions seeking growth, dual application processes required by the state and federal regulator may raise more issues in connection with required regulatory approvals.

Reliance on Federal Preemption:  Many multi-state institutions rely on the federal preemption of state laws afforded national banks.  Although the Dodd-Frank Act has rolled back federal preemption in some respects, preemption remains effective in many areas crucial to national bank operations.  Consequently, conversion to a state charter could raise supervisory issues for certain product lines.   

While a 1997 Cooperative Agreement brokered by the Conference of State Bank Supervisors is intended to coordinate regulation and supervision among the states, certain state laws in jurisdictions outside of the bank’s home state continue to apply and may necessitate changes to various products to comply with consumer protection statutes and fair lending laws.  However, this concern is mitigated by parity or “wildcard” statutes enacted in many states, which allow state-chartered banks to engage in activities that would be permissible for a nationally chartered institution. 

The upshot, however, is that converting institutions in some cases may need to undertake burdensome surveys of state laws to ensure compliance with disparate local requirements.

Additional Powers and Restrictions:  State bank charters frequently feature notable differences in terms of the powers granted and restrictions imposed on bank activities.  These often include different legal lending limits, restrictions on sales of insurance, and ownership of banking premises.  For states that permit LLC banks, even the legal structure of an institution can be different.  A thorough understanding of these differences is important to ensure that the bank’s business plan following conversion will not be impeded.

New Requirements under Dodd-Frank: To eliminate perceived problems related to regulatory arbitrage, the Dodd-Frank Act generally precludes charter conversion whenever the converting institution is subject to a consent order or memorandum of understanding issued by its current regulator.  Although there is an exception to this rule if the converting bank seeks prior approval from its regulator and submits a written corrective-action plan, relief under this exception is rare and unlikely to be granted in most circumstances.

Conversion Expenses and Licenses:  State examination fees are generally less than those charged by the OCC, in part because state regulators share examination responsibility with either the FDIC or Federal Reserve, neither of which charge fees for their exams.  However, state regulators typically charge an application fee for a conversion plus additional fees based on things like the number of branches and the bank’s authorized capital stock.  In some states, bank directors and officers also may be required to obtain licenses, and in any jurisdiction, the bank likely will incur legal fees to prepare compliant board and shareholder resolutions, articles of incorporation, bylaws, publication notices, and other legal documents related to the conversion process.  As such, while banks should enjoy long-term savings, bankers should be cognizant of the up-front cost of conversion.

Charter choice remains a key consideration for bank operations.  Although historical benefits of the national bank charter continue, it appears that many are finding in the current regulatory environment that those benefits do not outweigh other considerations affecting bank performance. 

New Compensation Rules and Their Impact on Small Banks


The Dodd Frank Wall Street Reform and Consumer Protection Act has an expansive collection of provisions that impact financial institutions.  Perhaps the most hotly debated part of the legislation is Section 956, which addresses incentive-based compensation.  The requirements of Section 956 are applicable to banks and other financial institutions of $1 billion in assets or more.  So, does that mean that financial institutions of less than $1 billion are not impacted?

A key element of Section 956 is its reliance on current standards for all banks established under Section 39 the Federal Deposit Insurance Act (FDIA) relative to employee, executive and director compensation It requires federal agencies to establish standards prohibiting any unsafe and unsound practice relative to any compensatory arrangement that could lead to material financial loss to an institution, including standards that specify when compensation is excessive.

Some of the considerations of federal agencies in determining if compensation is excessive include:

  1. the combined value of all cash and noncash benefits provided to the individual;
  2. the compensation history of the individual and other individuals with comparable expertise at the institution;
  3. the financial condition of the institution;
  4. compensation practices at comparable institutions, based upon such factors as asset size, geographic location and the complexity of the loan portfolio or other assets;
  5. for postemployment benefits, the projected total cost and benefit to the institution;
  6. any connection between the individual and any fraudulent act or omission, breach of trust or fiduciary duty, or insider abuse with regard to the institution; and
  7. any other factors the agencies determine to be relevant.  

So, while institutions less than $1 billion in size currently do not have to comply with the specific rules of Section 956 of Dodd-Frank, the current guidelines for all banks would indicate that some Section 956-like actions are warranted in identifying excessive compensation.  Some of the technical aspects of Section 956 may seem burdensome; however, other requirements are practical and, in some cases, just good common sense.

Below are some of the key provisions of Section 956 that may not be enforceable for institutions under $1 billion but may serve as guidance for best practices:

The institution is required to adopt written policies and procedures to ensure and monitor compliance with the rules. 

Having written policies and procedures to provide guidance and maintain control of your compensation programs is a no-brainer.  Formally documenting your plans to address elements of risk and the guidance in the FDIA demonstrates to regulators you have a framework for meaningful and effective control.

Covered institutions are to submit an annual report to their primary regulator. 

A methodical and periodic review of your plans and documentation of their adherence to your policies and risk management procedures will demonstrate appropriate management oversight. 

Strong corporate governance and an active role by the compensation committee or board are required. 

Establish processes whereby your compensation committee or board takes an active role in all matters relating to compensation.  This will institute a best practices approach, providing for better risk management, effective internal controls and regulatory compliance.          

The proposed regulations provide suggested ways to balance risk and reward performance.

These approaches to balancing risk and rewarding performance make sense for banks of all sizes and will help limit risk as well as lessen the need for clawbacks.  Some of the suggested approaches include:

  • Payment Deferrals: allows for adjustment of the compensation through the deferral period;
  • Risk Adjustment: awards are adjusted to account for the risk posed to the bank;
  • Longer Performance Periods : longer measurement periods better reflect ultimate financial outcomes; and
  • Reduced Sensitivity to Short-Term Performance: reduced rates of reward for higher performance levels over the short-term.

Does Section 956 of Dodd-Frank apply to banks under $1 billion?  Technically, no.  However, banks under $1 billion should certainly be aware of its impact, since all financial institutions should adhere to established best practices.  The primary focus for bank compensation will continue to be safety and soundness, monitoring and controlling compensation programs, and managing risk while matching compensation to performance.

Now’s the Time to Identify Takeover Targets


Consolidation in the banking industry has ground almost to a halt. Stock prices have been tanking and few buyers or sellers seem interested in courting in this environment. But that might actually be a mistake, explains Steven Hovde, the founder, CEO and president of The Hovde Group, which provides investment banking, capital markets and financial advisory services focused exclusively on the banking and thrift industry. He speaks with Bank Director about what factors could change the merger environment going forward, and why bankers should be thinking about deals now.

Lots of people thought there would have been more mergers and acquisitions in the banking industry by now, but there hasn’t been. Why?

The drought in M&A activity is largely due to the remaining economic uncertainty and the inability of banks to grow revenues as a result. Furthermore, we’ve seen heightened uneasiness among investors due to the U.S.’s tumultuous political climate, as witnessed by the debt ceiling drama and the Federal Reserve’s several failed attempts to spur job growth through massive rounds of government stimulus. On top of these domestic issues, the European debt crisis has further increased investor anxiety. As long as the credit environment remains uncertain, M&A isn’t going to pick up to any significant degree.

What deals are getting done and what trends do you see there?

Deals are still getting done where the bank is small enough that the buyer can understand the loan portfolio and all potential credit issues. There have been a few larger deals, but that is not the norm. Bank recapitalizations will continue, assuming investors can get comfortable with the banks’ specific credit risks. However, most recapitalizations are of banks that have no option but to raise capital or risk failure, and are being done on terms that dilute existing shareholders down to a de minimis pro forma ownership.

What factors do you think would encourage more M&A?

The housing market must bottom out, or at least stabilize, for an extended period of time for bank M&A to return substantially. Until housing prices bottom, the overall economy will be troubled and loan portfolios will be scrutinized, particularly by buyers. Furthermore, because of economic and housing market uncertainty, the buyer’s credit marks, writing down the value of assets to fair market value, generally are too deep to negotiate a mutually agreeable transaction in today’s environment. A stable housing market—and ideally one in which housing values begin to increase—will break the dam for a gigantic M&A wave. However, with so many foreclosures in the pipeline and the uncertain debt markets in the U.S. and Europe, housing is unlikely to recover in the near-term.

What will be the impact of this environment on smaller banks, say below $500 million in assets?

Heightened regulation (e.g., the Dodd-Frank Act) will negatively impact banks and translate into reduced fees, higher expenses and reduced earnings for many community banks. Smaller banks, in particular, do not have the scale to absorb higher operating expenses and cannot generate sizable revenues from fee-based businesses like their larger brethren. Furthermore, small banks’ loan market shares have dropped, their balance sheets have become more liquid and their margins are shrinking. These trends have become so pronounced that even regulators have suggested many community banks will not survive the next few years.

What should banks keep in mind before they go down the M&A path?

Banks considering a merger or sale should understand their universe of potential buyers. Today’s operating environment is having the same negative impact on all community banks. The next M&A wave will come quickly with sellers flooding the market, ultimately resulting in a buyer’s market. Knowing the buyers for a particular bank will give bankers a leg up on timing the next wave. We often prepare our clients for sale well before they go to market. Knowing the buyer universe assists in the decision-making process. As many of today’s banks would attest, there is nothing worse than missing the market.

 

How to Avoid Minefields in a Merger or Acquisition


With hundreds of bank failures since the financial crisis began and many mergers and acquisitions taking place in an environment of financial and regulatory stress, Commerce Street Capital Managing Director Tom Lykos responds to written questions related to M&A in the face of shareholder activism and heightened judicial scrutiny.

Can you say a little about the regulatory and financial environment and how that is impacting banks?

The increased regulatory scrutiny that began with the crisis of 2008 has only been heightened by the increased regulatory burdens of the Dodd-Frank Act. However, there is a tension between the fiduciary duties owed to shareholders and the obligations directors owe to the FDIC and their primary regulator. At times, the director is caught between the need to accede to the “requests” and directives of regulators while vigorously advocating and advancing the interests of shareholders where the burdens of compliance seem excessive and adversely affect profitability. In such situations, engaging qualified and independent financial and legal advisors is justified given the nature, complexity and immediacy of the issues confronting management and directors. Reliance upon their advice is advisable given that the FDIC alleged, in its demand for payment of civil damages sought from certain officers and directors of BankUnited FSB in Florida, that they failed to heed the warnings and/or recommendations of bank consultants prior to the bank’s 2009 failure. 

How should bank directors approach M&A in the current environment?

In general, it is fair to state that the old standards still apply. However, the application of these standards has been more rigorous with regard to corporate governance in the context of both evaluating a bank’s strategic direction in general and especially in M&A transactions.  Officers and directors do not necessarily have to prove they received the “highest” or “best” price. Rather, they are charged with the duty of following a course or a process that leads to a reasonable decision, not a perfect decision.  In the context of a merger, an independent fairness opinion increases the probability that a board’s decisions will be protected by the business judgment rule and may also help facilitate shareholder approval of a proposed transaction.

If the old standards still apply, then how have the burdens on directors changed?

Although the standards have not changed, there is a higher level of scrutiny on directors now than at any time in the recent past. Increased regulatory oversight combined with increased shareholder activism has resulted in a corresponding increase in judicial scrutiny of the reasonableness of directors’ actions. The level of scrutiny is heightened in situations where an institution is not adequately capitalized, financial performance has lagged and shareholders have concerns about the bank’s strategic direction and the strategic options proposed by management. With regards to situations where subpar performance has led to shareholder activism, the creation of a special committee of the board and retention of an advisor to present strategic options are appropriate responses to address shareholder concerns. Without sounding alarmist, it may be that it is no longer enough for directors to satisfy their obligations to shareholders by negotiating a premium, hiring a financial advisor and obtaining a fairness opinion for a sale or acquisition. The courts have demonstrated an increased willingness to look behind the conclusions of a fairness opinion and board deliberations to determine if a transaction is fair from a financial point of view.

Can you give me an example?

Directors can look to recent court decisions to discern the inquiries relevant to appropriate director conduct. These include: Were the conflicts of interest adequately addressed and disclosed to shareholders, including those that may have unduly influenced directors, management and the financial advisor in the exercise of their judgment and discretion? Who took the lead in negotiating the transaction and what were their financial incentives for doing so? Was the process designed and implemented in a way intended to maximize shareholder value? Were there terms in the merger agreement and “deal protection devices” that were excessive or coercive in the context of the specific transaction? Was there adequate input from disinterested and independent directors? Was the fairness opinion truly independent or was the advisor’s fee contingent on a successful transaction, creating conflicts or “perverse incentives?” In short, both the courts and shareholders are focusing on the events and circumstances that lead to a transaction; the board process in evaluating a transaction (whether accepted or rejected); deal protection devices that may discourage or preclude the consideration of other offers; and the existence and disclosure of apparent or actual conflicts of interest among officers, directors and advisors that might impair their independent judgment.

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