Executive Benefit Plans in 2016: Emerging Trends

Written by


benefit-plan-1-27-16.pngSince the credit crisis, most community banks have been able to grow and improve their financial condition. According to the Federal Deposit Insurance Corp. (FDIC), almost 60 percent of community banks reported higher year-over-year earnings for the period ending in the third quarter of 2015. In addition, community banks have increased assets by 5.6 percent and total loans and leases by 8.5 percent for the same period adjusted for mergers. While these growth numbers do not represent the pre-credit crisis years, the industry is showing an improvement. The percentage of unprofitable community banks are at the lowest level in many years. Community banks are defined by the FDIC Community Bank Study, December 2012, and one of the criteria is that these banks are “likely to be owned privately or have public shares that are not widely traded.”

What do improving conditions mean to banks and their compensation plans? Some banks have seen challenges in retaining key officers given increased competition for top talent, while other bankers believe they are now in a position to invest in additional key talent to grow their organization. For banks that have implemented various types of compensation plans, it may mean including an additional key officer in these plans. Attractive executive compensation plans include market-based salary, annual bonus based on performance, stock options or restricted stock (where applicable), reasonable contributions to a 401(k) or other qualified retirement plan, medical care and other standard benefits, change- in-control agreement and a custom-tailored nonqualified retirement plan.

Another important trend is the disruption created in many markets by mergers. The purchasing bank wants to retain the top lenders and others revenue generators, but the change in ownership can cause those individuals to consider other options. Competing banks that have developed a game plan for such situations will be positioned to hire some of these talented individuals. A nonqualified plan (customized for each executive) can play a vital role in attracting and retaining these individuals.

Another trend that has been taking place is an increase in the number of community banks that previously only offered salary and annual bonus plans, but are now providing more comprehensive compensation packages for key executives. This is a result of increased competition for executives as well as improved earnings.

Nonqualified plans need to be tailored to meet the needs of the individual. For example, a younger officer in his or her 30s may not see the value of a retirement benefit targeted at age 67, but would see value in a plan that allows for earlier cash distributions to pay for a child’s college education or that allows for early retirement at age 55. Many organizations use a combination of plans and approaches to attract and retain their key people. Here are some examples of situations and challenges bankers have faced when contemplating compensation plans:

  1. You have an executive in his mid-50s who has contributed to leading and growing the organization but has not yet been rewarded for his efforts. This executive’s compensation focus is now being more directed at retirement and wealth building rather than solely increases in current cash compensation. Consider a supplemental executive retirement plan (SERP) plan and perhaps a long-term incentive plan. He may also be interested in deferring current salary.
  2. You have young officers in their 30s and 40s who are high producers and need to be compensated for their efforts with more than just base salary and annual bonus amounts. Consider a performance-based nonqualified benefit plan or a combination of a SERP and performance-based nonqualified plan. It is important to tie these individuals to your bank if you remain independent, but it can also enhance the sales price if these individuals stay with the purchasing bank in the event your bank is sold. Properly designed nonqualified plans can substantially increase the probability they will stay in either scenario.
  3. For closely held banks that would like their management team to think like owners, consider nonqualified plans using a phantom stock or stock appreciation rights approach or, if another type of deferred compensation plan is adopted, consider linking the interest credited to the executive’s account to the bank’s return on equity.

Summary
With an improving economy and asset growth of community banks, along with a higher than normal level of merger activity, banks have been adding officers to existing long term incentive and nonqualified benefit plans or developing and implementing new plans to compete with other banks for talent. Utilizing more than one compensation strategy or plan can be an important element in attracting and retaining talent. The bank’s franchise value is dependent on its level of success in attracting and retaining key executives.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.

Making the Tough Call on Trust Preferred Securities

Written by


In recent months, three bank holding companies in or nearing default on the payment of deferred interest on trust preferred securities have elected to sell their institutions under Section 363 of the U.S. Bankruptcy Code. While this certainly must have been a difficult step to have taken, it does suggest that the boards of directors of these companies are making appropriate, though wrenching, choices to protect their bank subsidiaries, the communities they serve and the FDIC insurance fund. However, there are many similarly situated companies that are delaying taking their medicine, and these companies may be placing their banks at risk.

Before the onset of the economic crisis, many institutions, seeing growth opportunities ahead, established trust subsidiaries that issued trust preferred securities. The trust subsidiaries used the proceeds to purchase subordinated debt from their holding companies, which then contributed the proceeds to their bank subsidiaries to increase capital to support anticipated growth. In order to treat the subordinated debt as capital, the instruments were required to permit issuers to defer the payment of interest for up to 20 consecutive quarters.

When the economy soured, many of these holding companies had to exercise their deferral options. Most holding companies in this predicament now have regulatory agreements that prohibit the payment of dividends by their bank subsidiaries and the payment of interest on trust preferred securities without approval. These companies are now nearing, or in some cases have already reached, the end of their 20-quarter deferral periods and are in danger of defaulting.

There are remedies available for these companies, although many of them are difficult to accomplish or could be unpalatable. Most desirable is obtaining regulatory approval to pay a dividend from the bank and use the proceeds to pay deferred interest on the trust preferred securities. Before granting approval, regulators will want to see a reliable earnings stream and sufficient remaining capital at the bank.

Other remedies are less appealing. A company may seek to raise capital. However, it can be difficult for troubled institutions, especially smaller community banks, to raise capital from institutional investors, and a capital raise is also likely to be highly dilutive to existing stockholders.

Other companies may find themselves forced to seek a merger partner with the resources to assume the company’s obligations under its trust preferred securities. While eliminating default risk, a merger results in the loss of independence.

Companies also may seek to negotiate a resolution with creditors. This is extremely difficult, if not impossible, to accomplish, given that most trust preferred securities are held by special purpose entities, many of which are not actively managed.

When all else fails, creditors can be forced to accept a sale of the bank under Section 363, an action that often will achieve little or no value for stockholders.

It is natural for boards of directors to resist diluting or wiping out stockholders or surrendering their independence. However, the consequences of failing to act can be severe. Regulators are keenly aware when bank holding companies are nearing default and will strongly pressure their boards of directors to take action. And once a company is in default, creditors can act to recover their principal and may even act in ways that may not seem economically rational but make sense to them if they are more concerned about their entire portfolio of companies than they are about any single company. Indeed, we have seen two situations where creditors have filed petitions for involuntary bankruptcy.

Even where boards of directors decide to act, it can take time to accomplish any transaction, so it is critical to act sufficiently in advance of the default date. Once default occurs, if creditors choose to take action unilaterally, boards of directors could lose control of their destinies, and key decisions may end up in the hands of creditors or judges. These types of disputes can harm a bank’s reputation and, in extreme cases, create liquidity risk.

So for companies with a default date looming, it is critical to accept reality and then plan and act well in advance of the default date. The action may be difficult to accept, but in the long run it might be the best thing for the bank and its customers.

How Banks Can Improve Crisis Planning

Written by


We discovered last month that cyber risk was the thing most directors worried about when we informally polled members of our bank services program. This month, we decided to poll experts on what banks could do to improve crisis planning. Not surprisingly, cyber risk planning came up often as an area that could use some improvement. Several of the people polled think banks could benefit from role playing exercises that would walk employees and the board through possible scenarios. The Federal Deposit Insurance Corp. has a few videos that help banks imagine some scenarios. Although planning documents are widely recommended, one consultant says they are pretty useless in a real emergency. Below are their responses.

How Could Banks Improve Crisis Planning?

Mills-Scott.pngCrisis planning is getting more attention these days because we are constantly reminded of events that could not only impact our business, but have significant impact on our reputations. One data breach and we stand to lose faith in our ability to safeguard our clients’ money. While planning is expected, bankers could really get value from practice in two areas: 1) tabletop exercises and 2) media training. Tabletop exercises are role playing crisis scenarios whereby bank management gets on a conference call and develops responses, assigns roles, identifies tasks and develops timelines. Banks would benefit from doing this on a quarterly basis. Media training allows bank executives to learn how to look and respond appropriately to a tense situation only after they learn how to answer questions and the ground rules for working with the media. Turn on a video camera and see how well your team does. Crisis planning is better if treated as an ongoing discipline.

—Scott Mills is president of the William Mills Agency, a public relations and marketing firm specializing in financial services

Taylor-Nathan.pngTesting, testing and more testing! Banks typically have multiple plans that can be triggered in the event of a significant cyber-related “crisis,” including, for example, a business continuity plan, incident response plan and crisis communication plan. Multiple groups within a bank likely have responsibility for these plans. And, the plans may not be aligned from a response standpoint with respect to significant cyber events. In the event of such a crisis, it is critical for a bank to be able to respond in a uniform and effective way at the enterprise level. Bringing a bank’s various teams together to test or tabletop a significant cyber event can shed light on how the bank’s various plans (and teams) will work together. This will also provide a valuable opportunity for refinement and alignment of the bank’s related response plans.

—Nathan Taylor is an attorney and cybersecurity expert at Morrison Foerster LLP

Miller-RaeAnn.pngBusiness continuity and disaster recovery considerations are an important component of a bank’s business model. In addition to preparing for natural disasters and other physical threats, continuity also means preserving access to customer data and the integrity and security of that data in the face of cyberattacks. For this reason, the FDIC  encourages banks to practice responses to cyber risk as part of their regular disaster planning and business-continuity exercises. They can use the FDIC’s cyber challenge program, which is available on the FDIC website. Cyber challenge was designed to encourage community bank directors to discuss operational risk issues and the potential impact of information technology disruptions.

—Rae-Ann Miller is associate director of the FDIC’s Division of Risk Management Supervision

Sacks-Jeff.pngBanks can improve planning by developing a crisis plan ahead of a data breach or cybersecurity issue. These action plans should include:

  1. Determining data to be protected along with the protection level required.
  2. Classifying incidents or scenarios into categories.
  3. Understanding threats the bank may face, starting with known threats, then creating on-going monitoring for emerging threats.
  4. Determining the stakeholders and defining the incident response team.
  5. Setting up a command center and appointing a command center leader.
  6. Developing an incident plan, including a containment and investigation strategy.
  7. Executing a communication plan to customers, media and agencies.
  8. Testing and training end users in the application of the incident response plan.
  9. Conducting a “lessons learned” session and updating [Incident Response Plan] procedures.

—Jeff Sacks is a principal in Risk Consulting for Crowe Horwath LLP, specializing in technology risk

McBride-Neil.pngThough banks understand the risk of cyberattacks, many are unprepared to act quickly and effectively to mitigate damage when faced with a serious cyber breach. To improve crisis planning, banks should consider conducting simulated cybersecurity exercises involving key personnel. Moving quickly following a cyber breach is critical to limiting unauthorized access to sensitive data and the resulting harm. Such exercises demonstrate why an effective cybersecurity program is more than an “tech issue,” and requires coordinated institutional mobilization across business segments, with oversight from senior management. Most banks will eventually find themselves in a hacker’s crosshairs no matter how advanced their defenses, and a coordinated, rapid response will not only limit short-term data loss and legal exposure, but will also help preserve a bank’s reputation and customer relationships.

—Neil MacBride is a partner at Davis Polk & Wardwell

Carroll-Steve.pngPlanning activities generate lots of documents, which are fascinating to auditors but useless in an emergency. You don’t have to give planning reports to your response team. Your phone is a perfect emergency communications console. Social media, including Twitter, YouTube and even Facebook, are indispensable as communications tools. You can monitor events as they unfold or push messages out to staff and public. Cyber is the new disaster. Compare today’s threat assessment with one from 2010. Notice that blizzards and hurricanes have dropped out of the top ten, replaced by data breaches and identity theft.

—Steve Carroll is a director with Cornerstone Advisors, a consulting firm specializing in bank management, strategy and technology advisory services

Time to Develop an M&A Survival Strategy

Written by


Thirty years ago there were a record high 18,000+ banks in the United States. We’re now down to around 6,700 with all indications pointing to further consolidation. Meanwhile, new bank charters have dwindled to near non-existence with one new bank opened between the end of 2010 and 2013.

  20 years ago 10 years ago Today
 Total number of institutions 12,644 9,129 6,739
 Total number of banks $1 – $50B in assets 554 553 642
 Total number of banks $50B+ in assets 8 27 37
 Total number of banks less than $500MM in assets 11,688 8,022 5,382

Between the number of industry disrupters trying to win a slice of the traditional banking business and the plethora of investment opportunities in other industries with less regulation, it’s easy to imagine the number of banks falling by a full 50 percent in the next 20 years.

For better or worse, banking has become a scale business. The costs of regulatory compliance, necessary investments in new technology, physical and digital channels, and thinning industry margins mean banks will either need to be of a certain size or have a defensible niche built on knowledge rather than transactions.

For the better part of the past decade, the folks at Cornerstone have touted the $1 billion asset threshold as a marker of scale. Because of our friends in Washington and the dizzying pace with which technology has changed our industry, I think the new threshold to reach in the next five to seven years is more in the $5 billion asset neighborhood. If my prediction bears out, the vast majority of M&A activity and consolidation will take place in the midsize bank space ($1 – $50 billion), either with smaller midsize banks buying community banks or banks at the upper end acquiring $5 and $8 billion banks.

I have always been a proponent of having a solid organic growth strategy, but midsize banks will need to develop AND execute upon a solid M&A strategy to survive. Most banks lamely describe their M&A strategy as “opportunistic,” which is code word for: “waiting for the investment banker to call with a proposed deal.” This simply won’t cut it in the fast-consolidating, commoditized industry we call banking today. Here are some key areas your M&A strategy should address.

  • Define Your Value Proposition. Define in financial AND human terms what makes you an attractive acquirer. The list of possibilities are endless: opportunities for stock value gains, opportunities for employee growth at a larger bank, track record of performance, a willingness to negotiate system choices, or a holding company type business model that allows the acquired bank to maintain its brand and management team.
  • Identify M&A Partners. Define filters to narrow down what targets make the list including qualities like geography, asset size, branch network, balance sheet mix, capital levels and niche businesses. Tools like the Federal Deposit Insurance Corp. website or SNL Financial can easily help you produce your target list. Stack rank your target list starting with the most attractive to the least by assigning weighted values to your filters.
  • Cultivate the Courtship. If you are the acquirer, you need an active outreach program that includes management, directors and shareholders, with the mix changing depending on the target. Your outreach program needs to involve a consistent manner of communicating your value to your targets. Get creative. Courtship could involve providing shared services for a common core platform, inviting select management and directors to your strategic planning session, or offering to outsource from your niche expertise like trust and wealth management platforms.
  • Define the Merger Value. Once you find a receptive bank, you will need to paint a clear picture of the value a merger will bring to shareholders and management of the target bank that goes beyond the pro forma financial model. The target bank will want to know about management team composition, board seats, branch closures, surviving systems and products, efficiency targets, headcount reductions, and branding, to name a few.
  • Conduct Due Diligence and Begin Negotiations. If you’ve made it this far, the M&A strategy and framework you have laid out is obviously working. Now, the formal process begins.

At the end of the day, midsize banks have two choices: rely on a decades-old organic growth strategy combined with opportunistic M&A, or get in the game and execute upon a carefully defined M&A strategy. The risk of being left behind as other midsize banks scale up is not one I would want to take with my bank.

How the New FDIC Assessment Proposal Will Impact Your Bank

Written by


growth-strategy-8-14-15.pngIn June, the Federal Deposit Insurance Corp. (FDIC) issued a rulemaking that proposes to revise how it calculates deposit insurance assessments for banks with $10 billion in assets or less. Scheduled to become effective upon the FDIC’s reserve ratio for the deposit insurance fund (DIF) reaching a targeted level of 1.15 percent, these proposed rules provide an interesting perspective on the underwriting practices and risk forecasting of the FDIC.

The new rules broadly reflect the lessons of the recent community bank crisis and, in response, attempt to more finely tune deposit insurance assessments to reflect a bank’s risk of future failure. Unlike the current assessment rules, which reflect only the bank’s CAMELS ratings and certain simple financial ratios, the proposed assessment rates reflect the bank’s net income, non-performing loan ratios, OREO ratios, core deposit ratios, one-year asset growth, and a loan mix index. The new assessment rates are subject to caps for CAMELS 1- and 2-rated institutions and subject to floors for those institutions that are not in solid regulatory standing.

While the proposed assessment rates reflect a number of measures of an institution’s health, provisions relating to annual asset growth and loan mix may influence a bank’s focus on certain categories of loans and the growth strategies employed by many community banks in the future. We’ll discuss each of these new assessment categories in turn.

One Year Asset Growth
Under the proposed assessment rules, year-over-year asset growth is subject to a multiplier that would have, all other things being equal, the effect of creating a marginal assessment rate on a bank’s growth. In the supporting materials for the FDIC’s rulemaking, the FDIC indicates that it found a direct correlation between rapid asset growth and bank failures over the last several years. But while organic asset growth is subject to the new assessment rate, asset growth resulting from merger activity or failed bank acquisitions is expressly excluded from the proposed assessment rate. This approach is somewhat counterintuitive in that most bankers would view merger activity as entailing more risk than organic growth or growing through the hiring of new teams of bankers. While the new assessment rate might not be significant enough to impact community bank growth strategies on a wide scale, it may offset some of the added expense of a growth strategy based upon merger and acquisition activity.

Loan Mix Index Component
This component of the assessment model requires a bank to calculate each of its loan categories as a percentage of assets and then to multiply each category by a historical charge-off rate provided by the FDIC. The higher the 15-year historical charge-off rate, as weighted according to the number of banks that failed in each year, the higher the assessment under the proposed rules. Unsurprisingly, the proposed rules assign the highest historical charge-off rate (4.50 percent) to construction and development loans, with the next highest category being commercial and industrial loans at 1.60 percent. Interestingly, the types of loans with the lowest historical charge rates are farm-related, with agricultural land and agriculture business loans each having a 0.24 percent charge-off rate.

While the new loan mix index component is a clear reflection of the impact of recent bank failures on the current assessment rates, it may also create economic obstacles to construction lending, which continues to be performed safely by many community banks nationwide. Despite these positive stories, there is no doubt as to the regulators’ views of construction lending—in conjunction with the new Basel III risk-weights also applicable to certain construction loans, community banks face some downside in continuing to focus on this category of loan.

However, when considering the asset growth and loan index components together, community banks that have a strong pipeline of construction loans may have added incentive to complete an acquisition, particularly of an institution in a rural market. Not only can the acquiring bank continue to grow its assets while incurring a lower assessment rate, it can also favorably adjust its loan mix, particularly if the seller has a concentration of agricultural loans in its portfolio. In general, acquirers have recently focused their acquisition efforts on metro areas with greater growth prospects, but the assessment rules may provide an incentive to alter that focus in the future. In many ways, the proposed assessment rates provide bankers an interesting look “behind the curtain” of the FDIC, as this proposal clearly reflects the FDIC’s current points of regulatory concern and emphasis. And while none of the components of the proposed deposit insurance assessments may have an immediate impact on community banks, some institutions may be able to reap a substantial benefit if they can effectively reflect the new assessment components in their business plan going forward.

Why Community Banks Matter, and Will Survive

Written by


2-2-15-KPMG.pngDrive into most any town in America and you’re bound to spot one fairly quickly. Whether on Main Street or tucked in a shopping center on the edge of town, a branch of one the country’s 6,600 community banks probably is nearby.

As institutions that offer much-needed credit to small businesses, make mortgages that turn the American dream into reality, and support public projects that enhance our daily lives, community banking’s impact on our country’s economic growth and stability cannot be overstated. While strengthening these institutions is in everyone’s interest, those at the senior level—management and boards—are facing tough choices and challenges as they attempt to modernize, streamline and digitize their banks.

Although there are 57 percent fewer community banks today compared to the number in business when I began my banking career 26 years ago, and the percentage of overall U.S. banking industry assets they hold has declined from about 40 percent to about 14 percent in that period, today’s community banking system is no less vital to consumers and businesses.

A Federal Deposit Insurance Corporation (FDIC) report shows that community banks make up about 45 percent of the industry’s small loans to farms and businesses. Small business is the backbone of America and community banks are the engine that drives small business. Further, the FDIC report indicates that in 20 percent of America’s counties, there would be no banking offices if not for community banks. Those communities would tell you how fortunate they are to have community banks to provide credit and other needed financial products. They would point out local public projects that wouldn’t have happened without community bank support. They would tell you they are also grateful for the leadership community bank executives provide in the business, philanthropic and public realm, and for funds they donate to local nonprofits.

Community banks epitomize all that is important in our industry—the personal touch. Yes, banking is quickly becoming a digital business. And, yes, banks will need to ramp up their mobile and social-media capabilities for reasons of competition and connectivity. Still, banking comes down to making connections with people.

Think what these statistics say about the importance of face-to-face interaction with banking customers: From 2002 to 2014, the number of commercial banks and savings institutions has declined by 2,700 to about 6,650. But in that same timeframe the number of bank branches increased by 9,400; from 86,500 to 95,900, according to the FDIC.

When community banks succeed, they are staffed by individuals who share a sense of the bank’s strategy of offering customers the products and services they want, when they want them. Today, that mandate might mean banks will need to offer such services as new apps on smartphones or they may need to lean more heavily on cloud computing as a means to reduce cost. Regardless of the need, community banks cannot lose sight of the customer, who is becoming much more demanding with the introduction of each new technology. They have become accustomed to a one-click, right-now retail environment, and they expect banks to act in the same manner.

A community bank’s shared sense of strategy hinges not only on how well its leaders read and quickly adapt to their customers’ demands, but also their ability to clearly articulate the bank’s mission and purpose to employees and customers. Those same leaders also must be able to accept change when transformation is necessary.

Nothing stifles potential growth quicker than an inability to accept that some traditions and ways of working must be set aside for the sake of progress and connectivity. When resistance to change is permitted to exist inside the walls of a bank, little good can come of it. 

Some may believe that the United States is headed for a time when community banks will vanish and be replaced by just a handful of megabanks. There is no question in my mind that community banks will remain a vibrant segment of the industry, if for no other reason than they continue to make the personal connections that any business requires. We may, however, see the number cut in half again by the time I retire from my career. Those that survive will be the ones that give total attention to the customer, focus on agility and differentiate themselves with the best talent.

Is The Time Right for De Novo Banks?

Written by


1-23-15-BryanCave.pngTen years ago, business was booming for community banks—profitability driven by a hot real estate market, a wave of de novo banks receiving charters, and significant premiums paid to sellers in merger transactions. Once the community bank crisis took root in 2008, however, the same construction loans that once drove earnings caused significant losses, merger activity slowed to a trickle, and only one new bank charter has been granted since 2008. But as market conditions improve and with Federal Deposit Insurance Corporation’s (FDIC) release of a new FAQ that clarifies its guidance on charter applications, there are some indications that an increase in de novo bank activity may not be far away.

To understand the absence of new bank charters in the last six years, one must look to the wave of bank failures that took place between 2009 and 2011, which involved many de novo banks. Many of these banks grew rapidly, riding the wave of construction and commercial real estate loans, absorbing risk to find a foothold in markets saturated with smaller banks. This rapid growth also stretched thin capital and tested management teams that often lacked significant credit or loan work-out experience. When the economy turned, these banks were not prepared for a historic decline in real estate values, leading to a wave of FDIC enforcement actions and bank failures.

In light of these factors, as well as heightened regulatory expectations for operating financial institutions, many observers have questioned whether regulatory or market demands would allow for any new bank charters. Senior FDIC officials have maintained in public comments that there is no moratorium in the approval of de novo applications and that they would consider all new applications that were consistent with FDIC policy. These officials have also indicated that interest in de novo banks typically increased when acquisition pricing  reached roughly 1.25 times book value. With acquisition premiums trending upward in response to greater deal activity, the new FAQ is well-timed to anticipate additional de novo applications in the coming years.

With much having changed since 2007, what would a viable de novo bank look like in 2015? The FDIC’s current guidance, as well as its enforcement actions with respect to some troubled banks, may provide a blueprint:

  • Increased capital will slow aggressive growth. In the public comments of its senior supervisory officials and its recent FAQ, the FDIC indicates that a viable de novo charter will not be required to exceed a Tier 1 Leverage Ratio of more than 8 percent, provided the proposal “displays a traditional risk profile.” In our reading, de novo institutions focused on construction lending or with a concentration in commercial real estate lending will likely be required to maintain a leverage ratio more in line with those imposed by FDIC consent orders, which is typically at least 10 percent. The net effect will be to moderate business plans that call for higher-risk lending or growth in excess of market rates.
  • Business plans and market footprint. As noted in the FDIC’s FAQ, de novo applications must contain only a three-year business plan, rather than a seven-year business plan. Although there is often little value to projections that fall outside of this three-year window, applicants should make sure that their business plans describe a distinct need for a new bank in the market that can generate a sustainable pattern of growth and earnings into the future. Identifying strong community support, a healthy market footprint, and a clear niche for the bank will be integral to any business plan.
  • Experienced management a must. While the FDIC’s guidance does not place any added emphasis on the senior management of a proposed de novo bank, we expect significant scrutiny to be devoted to the qualifications of the applicant’s management team prior to a de novo application being approved. In the wake of the crisis, de novo banks will need to demonstrate they have strong leadership to weather a potentially volatile market.

In light of the FDIC’s new guidance and its public comments, we believe that as market conditions improve and merger activity continues, de novo banks will begin to re-appear. However, with higher regulatory expectations and without double-digit annual growth, these new banks will need to grow more slowly, gaining a foothold in their market footprint organically. This focus on the generation of franchise value will distinguish these new banks from many of the de novo institutions of ten years ago.

Getting Insurance for Civil Money Penalties

Written by


9-17-14-AHT.pngFor 20 years, banks have been buying insurance that covers civil money penalties (CMP) levied against directors and officers, the fines regulators sometimes impose on individuals and institutions for alleged wrongdoing. Commonly, this coverage is offered under the bank’s directors and officers (D&O) liability policy with a sub-limit of $100,000 per individual with a $1 million total limit and no deductible. Interestingly enough, the entire time this coverage was being offered, Part 359 of the FDIC Act has been in effect, stating that these penalties can’t be insured or indemnified by the bank. Then, in October of 2013, the Federal Deposit Insurance Corp.’s FDIC letter FIL-47-2013, made it explicitly clear that the bank can’t insure or indemnify civil money penalties on the bank’s D&O policy, leaving every bank director and officer exposed. This letter was sent by the FDIC to all institutions with total assets of less than $1 billion.

Insurance Reaction
The D&O insurance carriers came up with a solution at the time. They reiterated that the CMP endorsement was applicable to state and regulatory laws and that they would be happy to remove the endorsement at the request of the insured. Simply removing the CMP endorsement does accomplish two goals:

  • The bank’s D&O policy thereby becomes compliant with the FDIC letter.
  • Since a CMP would be considered a formal proceeding, the policy would offer legal costs coverage associated with the defense of the CMP. This extension of defense costs coverage would be available for the entire D&O policy’s limit of liability but only after the applicable deductible amount has been reached (which typically ranges from $25,000 to $100,000 for banks with less than $1 billion in assets).

Considering that the median CMP assessed against an individual D&O within the past 18 months was $25,000, there still was a demand for another option. Many carriers were willing to create a new CMP endorsement. The endorsement was similar to the original in that it continued to offer $100,000 of protection for each insured person with a $1 million aggregate for the entire board. The endorsement would specifically state that coverage was afforded for defense costs, but not for the penalty itself and it was available with either a $0 deductible or a very low deducible amount. The benefits of this type of endorsement is that it is in compliance with the FDIC letter since it specifically states that the penalty is not covered and it offers coverage after a very low deductible amount. The downside of this endorsement versus having no endorsement on your D&O policy is that there are lower limits for the CMP coverage ($100,000 per individual versus the full policy limits). Most banks I work with recognize that CMPs are much more likely to get resolved at a low dollar amount and thus they prefer the lower deductible/lower limit option. However, regardless the option, there was still a void of coverage for the actual penalty itself; that is until recently.

New Coverage Available
AHT and Lloyds of London recently began offering a third option: a separate policy that does cover CMP. What distinguishes this policy is that it is bought and paid for by the director or officer wishing to get insurance to cover his or her personal liability, not the bank. This new policy is structured as follows:

  • The policy will be in the name of the individual and would cover all of the bank boards he/she sits on
  • The policy is written with a $0 deductible and offers limits ranging from $50,000 to $250,000
  • The policy covers only the penalty and does not include defense costs coverage

The application must be completed by the individual. Coverage would not be in place until the premium is paid (by the individual) after which a policy will be issued to either the individual’s home address or personal e-mail address. Here is a sample of the policy wording. So bank officers and directors do have options now if they want some kind of coverage for civil money penalties. The liability of serving on a bank board these days is significant, and it pays to research your options.

Has Consolidation Killed the Community Bank?

Written by


4-21-14-jacks-blog.pngAn argument that I hear occasionally is that consolidation of the U.S. banking industry has put community banks on a path towards extinction. Two economists at the Federal Deposit Insurance Corp. (FDIC) have shot down this theory in a new research study whose findings are counterintuitive.

On the face of it, the industry’s consolidation over the past 30-plus years has been pretty dramatic. The FDIC says there were approximately 20,000 U.S. banks and thrifts in 1980, and this number had dropped to 6,812 by the end of 2013. A variety of factors have been at work. The biggest contributor, according to the study, was the voluntary closure of bank charters brought by deregulation, including the advent of interstate banking. A lot of the “shrinkage” that occurred between the mid-1980s and mid-1990s wasn’t so much the disappearance of whole banks as it was the rationalization of multiple charters by the same corporate owner to save money.

A couple of recessions—from 1990-1991, and again from 2007-2009—also played a role in the industry’s downsizing. The FDIC says that bank failures accounted for about 20 percent of all charter attrition between 1985 and 2013—a culling of the herd which is painful but ultimately healthy since it tends to eliminate the weaker management teams.

Interestingly, the study did not look at how many bank charters were eliminated through acquisition, although I think we can safely assume that this has played an important role, particularly among the larger banks. In 1990 the 10 largest U.S. banks controlled 19 percent of the industry’s assets; by the end of 2013 their share had climbed to 56 percent. That increase in financial concentration is almost all the result of acquisitions of large banks by even larger banks, much of which occurred in the 1990s.

While the big banks just got bigger, the really small banks mostly disappeared. In what I thought was the study’s most interesting finding, the number of banks with less than $100 million in assets dropped by a stunning 85 percent from 1985 to 2013. For banks under $25 million, the decline was 96 percent. Again, the FDIC doesn’t say why, although I think we can assume that acquisitions, charter rationalizations and failures all played a role.

A central point of the study is that there are still plenty of community banks around, especially if you define them not by an arbitrary asset size, but rather by what they do and how they do it. Community banks, according to the FDIC, “tend to focus on providing essential banking services in their local communities. They obtain most of their core deposits locally and make many of their loans to local businesses.” Most banks in the U.S. would meet this definition of “community,” including a great many that are well over $1 billion in assets.

How might consolidation affect community banks going forward? The FDIC study ends with the upbeat assessment that community banks will continue to be an important source of funding to local businesses, and I would agree in part because I am uncertain about how much more consolidation is likely to occur.

I pointed out in a February 4 blog that there were 225 healthy bank acquisitions in 2012 and 224 in 2013, according to SNL Financial. And I offered a prediction that there would be between 225 and 250 acquisitions this year and perhaps as many as 275 in 2015. That still sounds about right, and it would put the pace of consolidation back to where it was in 2007—or a year before the financial crisis. Many of those deals will likely involve community banks, and while that would lead to a decline in their overall population, it would also create “local” institutions that are larger in size. It certainly won’t decimate the ranks of community banks.

I don’t believe that community banks are facing extinction, but they are facing some very significant challenges in the years ahead—and not from consolidation. The sharply increased cost of regulatory compliance might lead some community banks—say, those under $100 million in assets —to sell out if they can find a buyer; others will respond by trying to get bigger through acquisitions so they can spread the costs over a wider base.

Gaining access to capital will also prove to be a huge challenge for many smaller banks. By “smaller” I am thinking of institutions with $1 billion in assets or less, although the cutoff point might be higher. The higher capital requirement that has been established under the Basel III agreement is a permanent minimum expectation. Traditionally, banks have had the freedom to manage their capital to fit the environment they found themselves in, preserving it when times were bad and leveraging it when times were good and they wanted to grow. Now, banks that want to grow might need to raise additional capital to support a larger balance sheet. But as the banking industry’s capital level has grown, its return on equity has declined (a function of simple math) and not all investors will be interested in a small bank offering limited returns. I believe there will be a great deal of competition between banking companies to attract capital, and there will be winners and losers.

A third challenge is the dependency that many community banks have on commercial real estate lending, a historically volatile asset class that resulted in hundreds of bank failures in the early 1990s, and again during the most recent financial crisis. The most enduring community banks could be those that are able to diversify into other loan categories so they are not at risk when the next commercial real estate crash occurs. But diversification will require the acquisition of talent and skill sets that most community banks do not possess, so it’s a strategy that must be pursued with purpose.

The challenges facing community banks today are real, but consolidation isn’t one of them.

This article originally appeared on The Bank Spot and was reprinted with permission.

FDIC D&O Lawsuits Surge in 2013

Written by


2-19-cornerstone-research.pngFederal Deposit Insurance Corporation (FDIC) litigation activity associated with failed financial institutions increased significantly in 2013. The FDIC filed 40 director and officer (D&O) lawsuits in 2013, compared with 26 in 2012, a 54 percent increase from 2012. The pace of new lawsuits in 2013 slowed in the fourth quarter to only three, however, compared with 10, 15, and 12 in the preceding quarters. 

These findings are included in “Characteristics of FDIC Lawsuits against Directors and Officers of Failed Financial Institutions—February 2014,” a Cornerstone Research report.

Analysis
The surge in FDIC D&O lawsuits in 2013 stems from the high number of financial institution failures in 2009 and 2010. Of the 140 financial institutions that failed in 2009, the directors and officers of 64 (or 46 percent) have either been the subject of an FDIC lawsuit or have settled claims with the FDIC prior to the filing of a lawsuit. For the 157 institutions that failed in 2010, 53 (or 34 percent) have either been the subject of a lawsuit or have settled with the FDIC.

The FDIC’s D&O lawsuits in 2013 particularly focused on the largest institutions that failed in 2010. Of the largest 20 failures in 2010, 15, or 75 percent, have already been subject to FDIC lawsuits or settled claims with the FDIC.

Claimed Damages
From the beginning of 2010 to the end of 2013, the FDIC has filed 84 D&O lawsuits. It has explicitly stated damages amounts in 77 of the 84 complaints against directors and officers of failed financial institutions, for a total of at least $3.8 billion in claimed damages. While nearly half of the 84 lawsuits were filed in 2013, only $1.2 billion, or 32 percent of the FDIC’s claimed damages, is attributable to the lawsuits filed in 2013. This pattern mirrors the relatively smaller size of the institutions that that were the subject of 2013 D&O lawsuits.

Defendants and Charges
Inside and outside directors, together, have also routinely been named as defendants in FDIC D&O lawsuits. This pattern continued in 2013 (75 percent of lawsuits filed in 2013). Outside directors were exclusively named as defendants in rare instances and only in lawsuits filed in 2013 (8 percent). Somewhat more common were lawsuits in which only inside directors were named (15 percent of 2013 lawsuits, compared with 23 percent of lawsuits filed before 2013).

Chief executive officers continue to be the most commonly named officers in FDIC D&O lawsuits. The FDIC named CEOs in 83 percent of the complaints filed in 2013. In contrast, chief credit officers, chief loan officers, chief operating officers, or chief banking officers were named in 43 percent of the 2013 lawsuits.

All 40 lawsuits filed in 2013 included allegations of gross negligence, and 32 included additional allegations of negligence. Thirty-five of the 40 lawsuits included allegations of breach of fiduciary duty.

Settlements
Of the FDIC’s 84 D&O lawsuits, at least 17 have settled in whole or in part and one has resulted in a jury verdict. The FDIC has also settled disputes with directors and officers prior to the filing of a complaint. Settlement agreements published by the FDIC indicate that in at least 82 instances, the agency has resolved disputes with directors and officers. In these settlements, as many as 38 agreements, or 46 percent, required payments by the directors and officers. Directors and officers agreed to pay at least $34 million in these cases. 

Future Trends
While the FDIC’s filings of new D&O lawsuits hit a lull in the fourth quarter of 2013, new filings are unlikely to continue at such a slow pace in the first half of 2014. Three lawsuits have already been filed in January, and as motions and discovery unfold in existing lawsuits, this year will be interesting to follow. For example, a recent ruling in the U.S. Court of Appeals for the Eleventh Judicial Circuit pertinent to the many Georgia-based lawsuits allows directors and officers to assert defenses related to the FDIC’s post-receivership conduct that will directly affect loss causation and damages arguments. These types of judicial rulings may greatly influence the relative negotiating strength of the FDIC and defendants. How this ruling and others like it affect the likelihood of settlements may determine whether we see protracted litigation in the FDIC’s D&O lawsuits or movement to settle cases earlier.