How the New FDIC Assessment Proposal Will Impact Your Bank


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


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?


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


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?


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


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.

Why Small Banks Will Consolidate


While announced deal volume continues at a tepid pace, key drivers of M&A activity are starting to emerge. With more than 90 percent of the banking companies nationwide operating with assets of less than $1 billion, it is inevitable that consolidation will be concentrated at the community bank level. Six factors that point to a pick-up in M&A activity in this space are as follows:  

1. Bank equity prices are rising with an increasing valuation gap between small and large banks. Bank stocks overall have increased nearly 30 percent in 2013; however, banks with less than $1 billion in assets continue to trade at significant discounts compared to larger banks.   

Austin---Price-Tangible.png

As the chart above indicates, the valuation gap has widened for larger banks, which enjoy a median 51 percentage point premium as of August 31, 2013. Larger banks can use this valuation advantage to present attractive deal pricing to smaller banks.    

2. Very few FDIC-assisted transactions remain. Since 2008, 485 banks have failed representing nearly 7 percent of banking companies in the U.S., according to the Federal Deposit Insurance Corp. Essentially; FDIC-assisted transactions filled the void of traditional open-bank deals. With troubled bank totals dwindling and only a few significantly undercapitalized banks remaining, FDIC-assisted deals are diminishing. Acquisitive companies have moved on from this once lucrative line of business to evaluate more traditional deals.

3. Improved asset quality is leading to reduced credit marks. While merger discussions have occurred in recent years, the due diligence phase often brought deal negotiations to a screeching halt. With elevated credit marks (in some cases exceeding 10 percent), parties were unable to bridge the valuation gap. Over time, banks have made significant progress in reducing classified assets and writing down assets that more closely approximate fair value. With credit marks now modestly exceeding the target’s allowance for loan and lease losses, capital and book value can be preserved, which in turn, translates to more favorable deal pricing.

4. Several high profile deals have been announced at attractive premiums. Achieving certain benchmark pricing levels in M&A often is a catalyst for deal activity. Sellers are always looking for market information to help formulate a strategy on whether or when to sell. On the other side, buyers do not want to be perceived as overpaying, which is usually viewed in the context of pricing relative to other recent deals. Transactions like MB Financial’s acquisition of Cole Taylor Group at 1.82 times tangible book value and Cullen/Frost Bankers’ acquisition of WNB Bancshares at 2.84 times tangible book have already spurred discussion inside many boardrooms.  

5. Economies of scale in the banking industry have never been more crucial. The need and desire to grow exists at virtually every institution. As the chart below indicates, efficiency ratios have remained consistently lower at larger banks.

Austin---Efficiency-Ratio.png

Whether driven by regulatory costs, technology, marketing, pricing power, expanded lines of business/other revenue sources, larger banks appear to have clear performance advantages. This increasingly important trend will spur institutions to grow via acquisitions in order to spread certain fixed costs over a larger asset base and thereby improve operating efficiencies.  

6. Mergers among community banks. None of the preceding points are intended to suggest that banks under $1 billion will not participate as buyers of other community banks. In fact, since 2010, banks of less than $1 billion in assets have announced or completed 280 acquisitions, comprising more than 41 percent of the deal activity during that period.  A recent example of this type of deal involved Croghan Bancshares, which has $630 million in assets and is headquartered in Fremont, Ohio. Croghan is buying Indebancorp, which has$230 million in assets and is headquartered in Oak Harbor, Ohio. After considering other alternatives, Indebancorp chose Croghan, a larger community bank, as a partner. The deal was structured with 70 percent of the consideration in Croghan stock and priced at 134 percent of Indebancorp’s tangible book value. The deal value per share was 28 percent higher than Indebancorp’s stock trading price and cash dividends to Indebancorp shareholders will increase by almost 200 percent. On a pro forma basis, Indebancorp shareholders will own approximately 26 percent of Croghan’s shares following the deal.  

Making M&A predictions is always challenging, but here at Austin Associates, we believe many community banks will make the decision to sell within the next few years. When M&A returns to full capacity, expect at least 300 transactions per year, or 20 percent consolidation of the industry within five years. Pricing will continue to increase, but do not expect to see pre-crisis multiples any time soon. Moreover, pricing will be highly dependent on the target’s unique profile (size and performance), as well as local and regional market factors. 

Update on FDIC Lawsuits: Pace Increases While Few Settle


9-18-Cornerstone-Research.pngThis is the sixth in a series of reports that analyzes the characteristics of professional liability lawsuits filed by the Federal Deposit Insurance Corporation (FDIC) against directors and officers of failed financial institutions (D&O lawsuits). *

  • At least 32 FDIC D&O lawsuits have been filed in 2013: 10 in the first quarter, 15 in the second quarter, and seven so far in the current quarter. The pace of filings in the second and third quarters of 2013 has exceeded the rate of new filings compared with any equivalent period in the previous three years. If the filing of new lawsuits in 2013 continues at the pace observed through August, 53 lawsuits will be filed this year—more than double the 26 filed in 2012. Since 2010, the FDIC has filed 76 lawsuits against the directors and officers of failed institutions.
  • Financial institution failures were most common between the third quarter of 2009 and the third quarter of 2010. Given the three-year statute of limitations for tort lawsuits and the likely existence of tolling agreements allowing the FDIC additional time to determine if it will file a lawsuit, this year has seen, as expected, an increased amount of filing activity. Of the 32 lawsuits filed so far in 2013, nine were against institutions that failed in 2009 and the remaining 23 were against institutions that failed in 2010.
  • Of the 76 filed lawsuits, 10 have settled and one has resulted in a jury verdict. Three settlements have occurred this year, with four in 2012, and three in 2011.
  • Chief executive officers continue to be the most commonly named defendants. They have been named in 88 percent of all filed complaints and 28 of the 32 lawsuits in 2013. Chief financial officers, chief credit officers, chief loan officers, chief operating officers, and chief banking officers are also commonly named defendants. Outside directors have been named, frequently along with inside directors, in 75 percent of all filed complaints and 24 of the 32 lawsuits filed in 2013.
  • To date, the FDIC has claimed damages of $3.6 billion in the 69 lawsuits that have specified a damages amount. The average damages amount has been $53 million, with a median value of $27 million. Lawsuits filed in 2013 have had a lower average claim than lawsuits filed in 2011 and 2012. In the aggregate, the largest claims have related to the failure of California institutions, while the largest number of D&O lawsuits have targeted failed institutions in Georgia.
  • Of the failed financial institutions in 2009, the directors and officers of 57, or 41 percent, either have been the subject of an FDIC lawsuit or have settled claims with the FDIC prior to the filing of a lawsuit. For institutions failing in 2010, the comparable figure is 39, or 25 percent.
  • FDIC seizures of financial institutions continued to decline in 2013 compared with 2012. After only four seizures in the first quarter of 2013, there were 12 in the second quarter and four in the third quarter through August 27, 2013. In total, 20 institutions have been seized so far in 2013 compared with 51 in 2012. Since 2007, 488 financial institutions have failed.

For a full report, click here.

*The FDIC may also file lawsuits against other related parties, such as accounting firms, law firms, appraisal firms, or mortgage brokers, but we generally do not address such lawsuits here.

Bank M&A Midyear Update: Consolidation Pace Remains Lower Than Expected


Many people expected the pace of bank mergers and acquisitions in 2013 to pick up as a result of pressures from regulatory burdens, lack of growth in existing markets, and boards and management teams that had grown weary of banking.

However, deal activity for the first six months of 2013 indicates a consolidation pace consistent with 2012. The pace is ahead of 2011 and 2010 levels but still below levels seen before the credit crisis. Deal volume in 2012 was bolstered by a considerably vibrant third-quarter deal flow. Unless the same deal volume is experienced in the third quarter of 2013, the yearly deal count could slip below 2012 levels.

Number of Deals by Quarter
Year Q1 Q2 Q3 Q4 Totals
2008 45 38 36 24 143
2009 24 34 19 41 118
2010 27 52 49 50 178
2011 35 43 32 37 147
2012 55 51 73 56 235
2013 50 51 101

Credit Quality Concerns Still Affecting Deal Volume

In a survey on merger and acquisition conditions jointly conducted by Bank Director and Crowe Horwath LLP in October 2012, one of the primary impediments to consolidation reported was the credit quality of potential sellers. While current-year levels of nonperforming assets by sellers are better than they were at the peak of the credit crisis, levels are still high compared with historical norms.

Average Nonperforming Assets/Total Assets of Sellers (%)
Year Q1 Q2 Q3 Q4 Totals
2008 1.69 1.15 0.81 2.14 1.40
2009 2.45 2.64 3.23 4.46 3.32
2010 4.07 4.21 4.52 4.13 4.25
2011 4.42 6.49 3.71 4.24 4.84
2012 2.95 4.25 3.78 3.29 3.57
2013 3.28 3.85 3.57

* Totals are weighted averages.

History indicates that when credit problems are prevalent in the banking industry, both the number of deals and pricing are negatively affected.

Pricing for deals announced in the first half of 2013 are consistent with the overall pricing for 2012 and up slightly from the second half of 2012. Credit quality would appear to be dampening overall pricing.

Average Price/Tangible Book Value (%)
Year Q1 Q2 Q3 Q4 Totals
2009 101.48 123.27 125.62 107.24 113.73
2010 147.78 123.49 105.56 111.67 118.39
2011 112.11 105.93 108.88 107.15 108.48
2012 128.88 113.83 109.24 107.55 114.30
2013 115.97 112.53 114.25

* Totals are weighted averages.

FDIC Deal Volume Drops 

Although the Federal Deposit Insurance Corporation (FDIC) continues to work with institutions, deal flow for assisted transactions has diminished from its peak in 2010. Asset discounts, the bid amount for an institution divided by the assets sold, have settled in at around 16 percent, likely the result of the FDIC offering deals without the benefit of a loss-sharing agreement. The average deposit size of the institutions sold has also decreased.

FDIC-Assisted Deals
Year # of Deals Average Deposits
Assumed ($000s)
Average Asset
Discount %
2010 147 403,975 10.83
2011 90 319,549 15.70
2012 47 205,398 15.63
2013 YTD 16 107,881 15.94

Branch Deal Volume Slightly Lower Than Prior Years

Branch deal volume is on pace to be slightly lower in 2013. Deposit premiums dipped in 2012 but have rebounded back to 2010 and 2011 levels in the first six months of 2013. For many community banks, a small one- or two-branch network might be the only feasible acquisition opportunities. While deposit premiums are up in 2013, they still are at a reasonable level and in some regions are still well below the average. As larger and regional bank holding companies continue to evaluate their branch networks, there likely will continue to be acquisition opportunities available.

Branch Deal Volume
Year # of Deals Average Deposit
Premium %
2010 78 3.22
2011 81 3.33
2012 88 2.53
2013 YTD 27 3.40

Possible M&A Indicators for the Next 12 Months

While deal volume has been steady these past several years, it is still at a pace well below the predictions from various industry pundits. The past two Bank Director/Crowe Horwath merger and acquisition surveys highlighted concerns about credit quality, the economy, and regulatory issues as major causes of the slowdown.

While credit quality has been improving in the industry, the levels of nonperforming assets are still high compared to historical averages. Based on the correlation between deal volume and credit quality, the overall level of nonperforming assets will need to improve significantly before deal volume will increase. Economic indicators have been improving, but there are still unknowns both in the U.S. economy and worldwide, which suggests that uncertainty is still at levels that make it difficult to do deals.

The regulatory environment has stabilized some now that regulatory agencies have taken industry concerns into consideration and revised their Basel III rules, but the overall level of concern over regulatory issues is still high. Issues implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act and the new rules from Consumer Financial Protection Bureau are challenging banks as they try to comply with the onslaught of new rules.

As a result, it appears as though bank merger and acquisition levels will remain constant and more moderate than the levels predicted over the past several years.

Final Basel III Rules Revealed: Community Banks Aren’t Completely off the Hook


7-19-13_Naomi.pngThe Basel III final rules recently released make clear one thing: Small, community banks are getting a break. It may not actually feel that way. In fact, community bank CEOs across the country tell me they are very frustrated with new regulation, with Basel III, with the Dodd-Frank Act and with examiners scrutinizing their banks and coming up with problems that never seemed to be a problem before. The overarching theme is that more regulation is coming down the pike, Basel III’s final rules are just one part, and they will be burden to digest and implement.

“It’s a massive rule where they consolidated three notices of proposed rulemakings,” says Dennis Hild, a former Federal Reserve bank examiner and Crowe Horwath LLP director. Even though Hild is based in Washington, D.C. and it is his job to understand this stuff, even he admitted he had a lot of reading to do. So it will be a bundle for a small bank CEO to figure out, too. “There is still much to learn. We need to dig through it. We need to find out what’s important.”

The news in late June and early July that the Federal Reserve Board, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corp. (FDIC) would jointly mitigate some of the proposals most onerous to community banks was a welcome, if small, relief in a heavily regulated industry.

Under the final Basel III rule:

  • Banks under $15 billion in assets can continue to count trust-preferred securities—known as TRuPS—as Tier 1 capital.
  • Banks can continue to risk-weight residential mortgages as they had under the original Basel I regime. The final rule abandons a proposal to institute a complicated formula of risk weights for residential mortgages.
  • All but the largest banks (above $250 billion in assets) can keep available-for-sale securities on the balance sheet without having to adjust regulatory capital levels based on the current market value of those securities. Banks have a one-time opportunity to opt-out on their first regulatory call report after Jan. 1, 2015 from what’s called the accumulated other comprehensive income (AOCI) filter. If they miss doing so, they can’t opt-out later.

FDIC Chairman Martin J. Gruenberg specifically said in a press release that changes to the final rule had been made because of community bank objections. The Federal Reserve even published a guide just for community banks to explain the new rules. The Independent Community Bankers of America (ICBA) acknowledged the gesture on behalf of community banks but said in a statement that it still supported an outright exemption from Basel III capital standards for community banks.

It doesn’t appear that community banks will be getting that. The goal of the new rules is to improve the quality and quantity of capital maintained by banks, should another financial crisis take place.

Most community banks will have to comply with the higher regulatory capital standards under the Basel III final rules. Small bank holding companies with less than $500 million in assets are exempt, but their depository institutions must comply. Thrifts and thrift holding companies also must comply with the new rules. The FDIC estimated that 95 percent of insured depository institutions already meet the capital standards required under the final rules. Still, bank management teams, and the bank boards that oversee them, will have to figure out if their banks need to raise capital, and if so, how.

Many other aspects of Basel III will impact community banks as well. Bank officers have been calling consultants and law firms to figure out the impact of the new rules.

One of the biggest questions has been how an acquisition might subject a bank to new rules under Basel III, say if an acquisition bumps the bank above $15 billion in assets. How will the TRuPS on the merged companies’ books be treated?

The biggest banks might feel deterred from M&A if it propels them into the ranks of “advanced approach” institutions, which are those with more than $250 billion in assets or more than $10 billion in on-balance sheet foreign exposure, such as foreign government debt. Such a category subjects those banks to special Basel III rules and higher standards. Also, under yet another proposed rule from all three federal banking regulators, bank holding companies with more than $700 billion in combined total assets or $10 trillion in assets under custody must maintain double the current minimum leverage ratio of 3 percent to be considered “well capitalized.” Regulators estimate only eight institutions in the country would be subject to this leverage requirement.

One aspect of Basel III that might impact community banks is exposure to certain “high volatility” commercial real estate loans, usually acquisition and development loans, which will require higher risk weights. There also will be limitations on certain kinds of deferred tax assets, says Hild.

His advice? Don’t freak out right now. Banks will have time to figure this out.

Although banks with more than $250 billion in assets will have to comply with new capital rules during a phase-in period that starts January 1, 2014, smaller institutions have until January 1, 2015 to begin phasing in the new standards. That will certainly be enough time to figure out if Basel III is a non-event for your organization.