Weighing the Benefits of a State Charter


charter-11-17-17.pngWithin the past year, several national banks and federal savings banks have come to realize the benefits of converting to a state bank charter. This is not a new concept. Since 2000, hundreds of national banks and federal savings banks across the country have converted to state charters. These banks typically cite three reasons for converting: cost savings and increased earnings, regulatory access and relationships, and the dilution (or disuse) of national bank powers.

1. Lower Expenses & Increased Earnings
Most national banks pay significantly higher regulatory and examination fees than their state bank peers. Depending on the state, a $250 million asset national bank may save $25,000 to $50,000 or more in annual supervisory assessment fees by converting. In addition, banks in many states may see their legal lending limit increase, allowing them to better compete for loans and reduce participations.

However, the conversion process is not free. Each state has a filing fee, and the applicant must pay for legal costs, a state regulatory examination and the costs of rebranding the institution to remove any references to being a national bank. Even with these costs, several banks have found that the costs of converting are justified when compared to the aggregate costs saved and the potential for increased earnings.

2. Improved Regulatory Access and Relationships
In the current regulatory environment, banks are increasingly attuned to the benefits of having local access to their primary regulators. In certain parts of the country, the Office of the Comptroller of the Currency has been experiencing significant turnover, thus making it hard for some banks to establish and maintain continuity with their regulatory contacts. In some areas, seemingly routine matters are being handled through a regional or national office. Further, the OCC has been rotating examination staff around different areas of the country. This constant change in examination staff may impact the examiners’ ability to gain a thorough understanding of the bank, its markets and culture.

With a state charter, all decision makers are local and should be better aware of the issues affecting banks in their state. That being said, with a state charter, the bank will now have two regulators: the state, and the Federal Deposit Insurance Corp. or the Federal Reserve. Even so, for many it is appealing to be able to visit the state’s banking commissioner face-to-face on relatively short notice to discuss the bank, appeal a finding, or seek guidance and assistance.

3. Dilution of National Bank Powers
Historically, a primary benefit of a national bank charter was the broad federal preemption of state laws that the charter offers. This was especially important for banks operating in multiple states, as they did not need to comply with many aspects of the differing laws in the states where they operated. However, the enactment of the Dodd-Frank Act resulted in significant cutbacks and a reduction in the availability of federal preemption. In addition to narrowing the differences between state and national bank charters, the majority of national banks are community banks that do not actually operate nationally. Therefore, national banks should consider whether the availability of federal preemption is truly benefiting the bank, and what other real or perceived benefits the national charter carries.

Each state will have its own statute providing the authority for converting from a national bank to a state bank. It is important that the board and management team of a bank considering a conversion determine whether its current charter is best suited for its business model, goals and objectives. If the state agency believes that the bank is just forum shopping for regulators in order to avoid difficulties with the OCC, the agency will be more likely to decline the conversion application.

Note that Dodd-Frank generally restricts the charter conversion of troubled banks, including a bank with any formal enforcement order or memorandum of understanding. Dodd-Frank also requires a bank seeking a conversion to file its application with both its current and its prospective regulator. Therefore, be aware that the OCC will know in advance of the plan to convert.

Overall, the combination of reduced costs, potential for increased earnings, easier access to regulators and favorable state laws make the conversion to a state charter an enticing choice for many financial institutions. If your bank has a national charter, it is something to consider.

What to Know: The Yield Curve is Squeezing Banks, and Other Topics


governance-9-28-17.pngOne of the biggest challenges of serving as a bank director is understanding all of the changes that are occurring in a very complex and highly regulated industry. Most independent directors do not have a career background in banking, and while they usually bring an experienced and thoughtful perspective to their board service, they still have to learn about the industry and stay abreast of the many changes that are occurring.

This week Bank Director held the 2017 Bank Board Training Forum in at The Ritz-Carlton Buckhead in Atlanta, where 225 attendees comprised of independent directors, chairmen, lead directors and chief executive officers met for a day and a half to hear presentations on the latest industry developments, discuss their common problems in peer collaboration sessions and network at refreshment breaks throughout the day and at the Monday evening reception. This is the fourth year that we have held this event and the attendance has more than doubled over that period of time, which I think is a strong indication that directors view professional education as an important process. The agenda included presentations and panel discussions on audit, compensation, risk and technology, as well as the industry’s recent performance.

This year we also invited chairmen, lead directors and CEOs to meet separately on the first day in small group peer exchanges where they were able to share their experiences, discuss a variety of issues they have in common and learn from each other.

Some of the topics under discussion included the disappointing trajectory of interest rates, and proposed Federal Reserve supervisory guidance that will clarify the role of the bank board.

In the opening presentation, John Freechak, a principal at the investment banking firm Piper Jaffray Companies, reported on how a flattening yield curve in recent months is a sign that the industry’s margin pressure from low interest rates might not be easing any time soon. Freechak explained that interest rate spreads had widened following the victory by Donald Trump in the 2016 presidential election. Early market optimism that the Trump Administration would be able to achieve meaningful regulatory reform and tax cuts helped maintain those spreads into early spring, but the well documented legislative struggles by the administration and Republican-controlled Congress has led to an erosion of confidence. The Federal Reserve has said it intends to gradually raise rates, but long-term rates have yet to move appreciably. “The dwindling spread has hurt the profitability of banks as they reach for yield in a low interest rate environment,” said Freechak.

And proposed guidance on supervisory expectations for bank boards of directors, released by the Federal Reserve Board in August and intended to pertain only to banks with assets of $50 billion or more, could end up having a wider application, according to Jim McAlpin, a partner at the law firm Bryan Cave, in a presentation on board culture. “While initially applicable only to the largest banks, application of these expectations would likely spread to all banks,” McAlpin said. One of the core board responsibilities defined in the proposed guidance is to oversee the development of the bank’s strategy. “Much of what passes for strategic planning in banks is actually operational planning and budgeting,” McAlpin said. “High performance boards have a strong sense of ‘we,’ coupled with an expectation of success. This leads them to become more proactive and assertive in the strategic planning process.” Bank Director digital magazine’s November issue will discuss this issue in greater depth.

The 2018 Bank Board Training Forum will be held September 10-11 at the Four Seasons Hotel in Chicago.

Derivatives Education for Boards: Weighing the Whys Along With the Why Nots


swaps-7-12-17.pngWell-documented stories of speculators using derivative structures to gamble and lose their firms’ capital, along with Warren Buffett tagging them as “financial weapons of mass destruction” have made interest rate swaps a non-starter for many community banks. It seems that the preponderance of evidence against derivatives has led many community bank boards to view the issue as an open and shut case, rather than carefully considering all of the facts before passing judgment on these instruments. But questioning the four most common objections to swaps uncovers some overlooked truths that may motivate your board to take a fresh look at derivatives.

1. I know someone who lost money on a swap…but why?
Putting aside situations where derivatives were sold inappropriately, the claim, “I know a customer who got burned using a swap,’’ is simply the banker stating that the borrower utilized an interest rate swap to lock in borrowing costs. A borrower who chose the certainty offered by a swap over uncertain variable interest payments ultimately paid more because interest rates went down instead of up, and then stayed low. In reality, the borrower was burned by the falling rate environment while the interest rate swap performed exactly as advertised, providing known debt service, albeit higher than the prevailing rates. It looked like a bad deal only with 20-20 hindsight.

With the Federal Reserve now moving short-term rates higher while market yields remain close to historic lows, the odds begin to favor the borrower who uses a swap to hedge against rising rates. Whether or not the swap pays off, the certainty that it delivers becomes more attractive as rates become volatile and their future path remains uncertain.Federal-Funds-Rate.png

2. Regulators don’t want community banks using swaps…or do they?
When looking at the topic of interest rate risk, regulators began sounding alarm bells for banks in the years following the crisis on the premise that there was nowhere to go but up for rates. In a 2013 letter to constituents, the Federal Deposit Insurance Corp. (FDIC) re-emphasized the importance of prudent interest rate risk oversight and issued this warning:

“Boards of directors and management are strongly encouraged to analyze exposure to interest rate volatility and take action as necessary to mitigate potential financial risk.”

When it came to outlining mitigation strategies in this letter, rather than banning derivatives as intrinsically risky, the FDIC specifically mentioned hedging as a viable option. They did, however, sound a note of caution:

“…institutions should not undertake derivative-based hedging unless the board of directors and senior management fully understand these instruments and their potential risks [emphasis our own].”

Compared with other risk management tactics, derivatives offer superior agility and capital efficiency along with new avenues to reduce funding costs. Accordingly, it may behoove banks to heed the FDIC’s exhortation and implement derivatives education for directors and senior management.

3. My peers don’t use swaps…why should I?Swaps.PNG

If you are not hedging with swaps and your total assets are between $500 million and $1 billion then you are in good company; seven out of eight banks your size have also avoided their use. But if your growth plans anticipate crossing the $1 billion asset level, more than one in four of your new peers will be using swaps. Once you cross the $2 billion mark more than half of your peers will be managing interest rate risk with derivatives, while institutions not using swaps become a shrinking minority. For the many institutions serving small communities and not expecting to cross the $500 million asset level in the foreseeable future, derivatives are not typically a viable solution. But if your growth will soon push you into a new group of peers with more than $2 billion in assets on the balance sheet, then having interest rate swaps in the risk management tool kit will become the norm among your competitors.

4. Our board doesn’t need derivatives education…or do we?
After digging below the surface we learn that most of the instances where derivatives left a bad aftertaste were caused by an unexpected drop in rates rather than a product flaw. We also learn that in urging banks to take action to mitigate interest rate risk, the regulators are not anti-derivative per se; they simply lay out the reasonable expectation that the board and senior management must fully understand the strategy before executing. Taking the time to educate your board on the true risks as well as the many benefits provided by interest rate hedging products may help to distinguish them as powerful tools rather than dangerous weapons.

What Recent Deals Say about the Federal Reserve’s Focus on Fair Lending


lending-5-31-17.pngFair lending compliance and community benefit plans are increasingly important factors in the merger and acquisition (M&A) approval process. In 2016 and the first quarter of 2017, the Board of Governors of the Federal Reserve System (Federal Reserve) approved 20 bank or bank holding company M&A applications. Fair lending compliance history was an essential element of the regulatory analysis in these cases. While the Federal Reserve focused on compliance issues beyond fair lending —such as the Bank Secrecy Act, overdraft policies, residential servicing, commercial real estate concentration, and enterprise risk management—fair lending was one of the hottest compliance issues that arose from the merger approval process. Regulators also are reviewing applicants’ combined compliance programs and controls to ensure that the resulting institution will be properly suited to protect against the new risks created through the transaction, particularly where the transaction will result in an acquirer crossing a key regulatory growth threshold. For example, the Bank of the Ozarks received regulatory approval for two M&A transactions in early 2016 and crossed the $10 billion asset threshold while both acquisition applications were pending. As evidenced by the Bank of the Ozarks approval order for the larger acquisition, fair lending compliance was a significant factor in the Federal Reserve’s evaluation of the transaction.

Moreover, many of the institutions that obtained Federal Reserve approval for an acquisition during this period demonstrated a commitment to fair lending compliance beyond receipt of a satisfactory or outstanding Community Reinvestment Act (CRA) rating. Nearly all approved applicants had a designated CRA officer and/or CRA committee, and several applicants described detailed plans for improving community lending in particular assessment areas.

Community Benefit Plans Emerge as Important Factor for Regulatory Approval
The 2016 and 2017 M&A approvals also revealed the role of formal community benefit plans, as most clearly demonstrated in KeyCorp’s acquisition of First Niagara Financial Group, and Huntington Bancshares’ acquisition of FirstMerit Corporation. These two transactions received a considerable number of public comments focused on CRA and fair lending, and these large financial institutions used community benefit plans as an effective tool to demonstrate their commitment to fair lending compliance.

KeyCorp worked closely with various community organizations to develop a community benefit plan that was announced in March 2016, prior to KeyCorp’s receipt of regulatory approval for its merger. Under the KeyCorp plan, KeyCorp committed to lending $16.5 billion to low- and moderate-income communities over a five-year period, with up to 35 percent of the total commitment targeted at the areas where KeyCorp and First Niagara overlapped in New York, and to maintaining a vital branch and administrative footprint in western New York. Similarly, after submitting its merger application, Huntington adopted a community benefit plan committing to invest $16.1 billion in its communities, including low- and moderate-income communities, over a five-year period.

Notwithstanding the Federal Reserve’s reliance on the KeyCorp and Huntington community benefit plans in concluding that the relevant institutions are meeting the credit needs of the communities they serve, the Federal Reserve noted in the Huntington approval order that “neither the CRA nor the federal banking agencies’ CRA regulations require banks to make pledges or enter into commitments or agreements with any organization.” Accordingly, the Federal Reserve likely will not require a bank to make any community investment pledge to any organization in the absence of significant negative comments or, more importantly, adverse examination findings or a pending enforcement action. Nevertheless, given their apparent benefits, both for Federal Reserve applications and for general community and regulator relations, community benefit plans likely will remain a factor in the approval process for bank mergers that attract community groups’ attention—and likely will help expedite the approval process in the face of adverse community group comments.

Outlook
The 2016 and early 2017 merger approvals make clear that a comprehensive fair lending strategy, which may or may not include a community benefit plan, is likely to be well received by the regulators and considered in applicable approval analyses. We expect the regulatory staff of each of the federal banking regulators to continue to focus on fair lending compliance and that community groups will continue to comment actively on the fair lending compliance issues of bank M&A acquirers and attempt to influence their activities.

Three Ways to Increase Shareholder Value


shareholder-5-3-17.pngWith the Federal Reserve due to raise interest rates again this year and an administration focused on domestic issues and reducing regulation, community bank stocks are in high demand. The OTCQX Banks Index, a benchmark for community banks traded on the OTCQX market, gained 30 percent in the past 12 months, compared to 15 percent for the S&P 500. How can community banks leverage this positive trend and deliver greater value to their shareholders?

First, achieve a fair valuation for your shares. Fair market value is the price at which a person is willing to buy a company’s stock on the open market. Determining fair market value for a publicly traded stock is relatively straightforward and can be done by, for example, taking the average of the highest and lowest selling prices for the stock that day.

Figuring out fair market value for a stock that is not traded on a public market is a little more complex. For privately held community banks, this typically requires the chief financial officer to call around to multiple investors to negotiate prices in bilateral transactions. Not only is this process opaque and inefficient, but it generally doesn’t yield the highest value for shareholders.

For a publicly traded community bank, achieving fair market value is also a factor of the market on which it is traded and how much information it makes available to investors. A bank that trades on an established public market like OTCQX or OTCQB is helping maximize the value of its shares by providing transparent pricing, access to liquidity and convenient access to its news and financial disclosure.

Second, reduce the risk of owning your securities. Community banks can also maximize shareholder value by reducing the risk of trading their securities. A privately-held bank that trades its stock out of a desk drawer opens itself up to additional risks related to pricing, holding and clearing its securities. In contrast, a bank that trades on an established public market reduces risk for shareholders by allowing them to freely get into and out of its stock.

Public market standards can also help lower shareholder risks. In the OTC markets, the top two markets—OTCQX and OTCQB—have verification processes which allow banks to demonstrate to shareholders that they have met certain standards and that there are risk controls around their securities. In contrast, there is no such verification process for companies on the bottom Pink market, which increases the risks—and costs—of owning these securities.

Third, embrace technology. As community banks struggle to replace an aging shareholder base, technology will play a key role in attracting and retaining a new generation of millennial investors. Millennials, aged 18 to 34 years old, get most of their news online and on their phones, so banks need to embrace technology to make sure their financials and news are widely disseminated.

Trading on an established public market like OTCQX and OTCQB can help community banks ensure their news and disclosure is seen by broker-dealers and investors wherever they analyze, value or trade its securities. OTC Markets Group also works with Edgar Online to provide non-Securities and Exchange Commission reporting banks conversion and distribution of their fundamental data in XBRL format, so it can be more easily consumed and analyzed by investors.

With community bank stocks receiving positive attention, now is the time for banks to capitalize on market demand. Think about your shareholders and what’s important to them. Whether your bank has $100 million in assets or $3 billion, your shareholders should be treated like customers and you need to put their needs first.

A Modest Yet Welcome Thaw for Banking M&A and Financial Stability


mergers-4-18-17.pngAs part of approving the merger of $40.6 billion asset People’s United Financial Inc., with $2 billion asset Suffolk Bancorp, the Federal Reserve stated that, “[t]he [Federal Reserve] Board’s experience has shown that proposals involving an acquisition of less than $10 billion in assets, or that result in a firm with less than $100 billion in total assets, are generally not likely to create institutions that pose systemic risks” and that the Federal Reserve Board now presumes that such a proposal does not create material financial stability concerns, “absent evidence that the transaction would result in a significant increase in interconnectedness, complexity, cross-border activities, or other risk factors.”

Before the recent action, the Federal Reserve had since 2012 imposed very low thresholds under which it would presume no financial stability concerns exist. It only exempted acquisitions of less than $2 billion in assets or where the resulting firm would have less than $25 billion in total assets. Only a small number of transactions met these thresholds. The Federal Reserve reiterated its position, however, that it maintains the authority to review the financial stability implications of any proposal, specifically noting any acquisition regardless of size involving a global systemically important bank.

Through this action, the Federal Reserve has not only liberalized the key asset thresholds it previously established in 2012 for its evaluation of the financial stability factor in banking M&A, but also delegated authority to approve applications and notices that meet the newly revised thresholds to the Federal Reserve Banks. This revision has obvious parallels to recent statements from Chair Janet Yellen, Governor Tarullo and other Federal Reserve officials over the past few years (including as recently as December 2016) that the current $50 billion threshold for designation of a financial company as a systemically important financial institution (SIFI) may be too low. We believe that the delegation of authority to the Federal Reserve Banks could be at least as important, if not more important, as revisions to the financial stability thresholds because delegation should increase the chance that M&A transactions would proceed without the long delays that have recently been the norm in Federal Reserve Board reviews. Of course, all of the other requirements for delegation would also have to be met.

In support of this liberalization, the Federal Reserve cited its approval of a number of transactions over the past two years, including several transactions where the acquirer and/or resulting firm were over $100 billion or where the firm being acquired was over $10 billion and thus exceeded the newly revised financial stability thresholds. The increased thresholds and the delegation of authority to Federal Reserve Banks to process filings are welcome developments, especially for regional and community banking organizations that may be looking to acquire or be acquired. We would not, however, read the Federal Reserve’s actions as a strong signal that it expects or desires increased financial industry acquisitions or consolidation. The financial stability factor is only one of many that must be evaluated and questions will persist over how Community Reinvestment Act or fair lending concerns, anti-money laundering compliance, competition, general supervisory issues or public comment may affect a particular transaction. This action may, however, represent more formal support from the Federal Reserve for efforts to raise the $50 billion thresholds for SIFI designation and other purposes with a financial stability component under the Dodd-Frank Act.

Note: Another version of this article was initially published as a blog post on the Davis Polk FinRegReform blog on March 18, 2017.

Did Regulatory Concerns Torpedo the New York Community/Astoria Merger?


merger-1-6-17.pngIt’s highly unusual for the partners in a bank merger to terminate an agreement that they’ve already made public, so the recent announcement that New York Community Bancorp in Westbury, New York, and Astoria Financial Corp. in Lake Success, New York, would abandon their proposed $2 billion deal led to immediate speculation that the regulators had secretly torpedoed the proposed transaction. The banks did not give a reason in their joint statement in December 2016.

Announced in October 2015, the deal was supposed to close in December 2016. But New York Community issued a statement in November 2016 that “based on discussions with its regulators, it does not expect to receive the regulatory approvals required to consummate the proposed merger …by the end of 2016.” Instead, the banks agreed to terminate the merger agreement effective January 1, 2017.

The voluntary termination of a publicly announced bank merger because of regulatory complications is unusual because acquirers generally do their best to anticipate any possible roadblocks before entering into a formal merger agreement. This generally includes informal discussions with their primary regulator about any potential issues that could be problematic. Although these discussions should not be construed as a kind of pre-approval, it would be unusual for an acquirer to proceed with a proposed merger if its principal regulator expressed serious concern about any aspects of the deal in private.

It is unknown whether New York Community and Astoria decided to pursue their merger despite concerns that might have been voiced privately by their regulator, or if serious regulatory issues surfaced later upon a formal review. However, according to the investment banking firm Keefe Bruyette & Woods, the percentage of M&A applications to the Federal Reserve that have later been withdrawn have been on the rise in recent years, jumping from 15 percent in 2013 to 23 percent in 2015, and to 22 percent in the first six months of 2016. This increase occurred while annual M&A deal volume was growing at a much slower rate, which would suggest that the Fed has been taking a more critical perspective during its review process.

Issues that could have complicated the New York Community/Astoria deal include a high concentration of commercial real estate assets that would have comprised the combined entity’s balance sheet. New York Community is one of the top multifamily housing lenders in the country, while commercial real estate, multifamily and residential mortgages account for the majority of Astoria’s total loan portfolio.

Another factor that most likely complicated the deal’s regulatory approval process is that the combined bank would have crossed the $50 billion asset threshold level—New York Community had $49.5 billion in assets as of September 30, 2016, while Astoria had $14.8 billion. At this point, it would have become a Systemically Important Financial Institution, or SIFI, which would have exposed it to higher capitalization requirements and tougher regulatory scrutiny than are applied to smaller banks. The regulators generally require banks to have a SIFI compliance plan in place before crossing the $50 billion threshold, so New York Community most likely had already been preparing for this transition. However, the elevated SIFI requirements, combined with the bank’s significant commercial and residential real estate concentrations, might have made it difficult to gain regulatory approval in a timely manner.

In a research report published subsequent to the announced termination, KBW expected both banks to continue to seek out a merger combination. New York Community would seem to face the greater challenge in terms of finding an acceptable partner that won’t magnify its own commercial real estate concentration issues, and also because the bank’s organic growth trajectory will probably take it past the $50 billion threshold in 2017. Life as a SIFI grows more challenging—merger or no merger.

What to Know About the New Fintech Charter


fintech-12-13-16.pngDon’t expect an onslaught of fintech companies rushing to become banks. The recent announcement that the Office of the Comptroller of the Currency would begin accepting applications for special purpose national bank charters from fintech companies was met with gloom from some in the banking industry, and optimistic rejoicing from others.

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

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

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

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

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

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

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

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

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

What To Know About the New Fintech Charter


fintech-fxt.png

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

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

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

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

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

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

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

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

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

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

Bank M&A Update: Oil Prices and Low Interest Rates May Be Hurting Deals


The state of the bank merger and acquisition (M&A) market thus far in 2016 has been tepid compared to prior years. 2015 began the same way, but was helped by a tremendous fourth quarter in which the number of deals announced was more than 25 percent higher than the average of the first three quarters of the year. At the end of 2015, many bankers and industry experts hoped that the euphoria from the fourth quarter would carry over into 2016. Instead, the first quarter of 2016 saw M&A deals retreat to the moderate levels experienced in the first three quarters of 2015, with a modest increase in the second quarter giving way to a much lower third quarter. Year-to-date, announced deals are down a modest 5.6 percent compared to the same time period last year.

M&A Activity by Region

Quarter Mid Atlantic Midwest Northeast Southeast Southwest West Other* Total Deals
2015-Q1 7 26 2 12 10 8   65
2015-Q2 5 27 5 14 11 7   69
2015-Q3 9 24 3 9 12 6 1 64
2015-Q4 13 30 3 24 6 7   83
2016-Q1 4 38 1 10 5 5 1 63
2016-Q2 6 29 2 14 7 8   66
2016-Q3 4 25 1 14 6 7   57

*No geography listed
Source: SNL Financial, an offering of S&P Global Market Intelligence

The Midwest has been bolstering the modest numbers experienced year-to-date. This impact on the overall percent change in M&A activity for 2015 and the first three quarters of 2016 is apparent when compared to the other regions.

Indicators Affecting Bank M&A
Oil prices have had an impact on the number of deals in the Southwest. Credit quality does have an impact on deal volume, but between Jan. 1, 2015, and June 30, 2016, credit quality has been fairly good compared to the levels experienced in years 2008 to 2010.

The decline in longer-term interest rates could have an impact on buyers’ perceptions of banks’ future earnings prospects with already compressed net interest margins. The 10-year U.S. Treasury constant maturity rate has flattened in 2016, and this could be a contributing factor in the number of announced bank M&A deals.

As shown below, average deal pricing has declined, which also could be contributing to the decline in the number of M&A deals announced.

Pricing Over Time

Pricing ratios.PNG

Although not shown, a review of the trailing 12-month return on assets for the selling banks and also the level of tangible equity and tangible assets shows they are fairly consistent quarter to quarter, so these financial metrics are not responsible for the decline in either pricing ration.

An overrepresentation of the banks in the Midwest also has had an impact on why the median pricing ratios have declined. The sellers in this region tended to be smaller, and the size of the seller does affect the price realized:

Median Price/Tangible Book Value Jan. 1, 2015, through Sept. 30, 2016

Asset Size of Seller Mid Atlantic Midwest Northeast Southeast Southwest West Total
<$50 Million N/A 121.9% NA 96.9% 115.3% 50.1% 115.3%
$50M – $100M 129.1% 108.4% 146.7% 96.3% 132.7% 128.1% 114.4%
$100M – $500M 122.6% 126.2% 142.6% 136.2% 150.1% 133.5% 133.3%
$500M – $1B 161.5% 136.0% 125.7% 161.4% 165.8% 178.7% 157.7%
$1B – $5B 152.8% 179.3% 164.2% 194.9% 156.9% 222.1% 179.3%
$5B – $15B 219.4% 155.7% N/A 233.0% N/A N/A 219.4%
>$15B 159.8% 199.3% N/A 151.5% N/A 272.1% 171.4%

More than 80 percent of the transactions announced involve sellers with less than $500 million in assets, which explains the lower realized pricing ratios. The Midwest contains a significant number of bank charters with less than $500 million in assets and, as a result, if this region’s total deal volume is up and the rest of the regions are down or flat, the impact on the overall pricing still will trend down.

Looking Ahead
The big questions remaining are what will happen in the fourth quarter of 2016 and whether the industry’s experience this year will be a predictor for 2017.

None of the economic factors are expected to materially improve for the fourth quarter. The Federal Reserve is expected to increase interest rates modestly, but there are Fed governors who favor no interest rate increase this year. As a result, it appears unlikely that the compression of net interest margin will improve drastically over the next 15 months. What does seem likely to occur is consistent quarter-to-quarter deal totals, although a reduction in the number of deals in the Midwest region could lead to even lower M&A totals for 2017.