Crapo Bill Only a Drop in Bucket for Deregulation

regulation-8-29-18.pngThe bipartisan “regulatory relief” bill that was adopted by Congress and signed by President Donald Trump earlier this year is a positive development for the banking industry, and it continues a string of good news for banking (and, by extension, the economy at large) since the passage of the Dodd-Frank Act. Banking is highly regulated, and it should be, because most banks’ balance sheets are funded with federally insured deposits to the tune of 90 percent.

The Economic Growth, Regulatory Relief and Consumer Protection Act is not all that the industry had hoped for in a regulatory relief bill, but it is not a complete giveaway to the big banks as some suggested. For the really big banks in this country, the bill does not change much at all.

One of the best things about the legislation is the House and Senate came together to pass a bill that makes sense. On the other hand, the bill seems to further engrain buckets of banks based on asset sizes that have no meaningful support. So, we should get used to the notion that a bank with assets over $10 billion is somehow a “large” bank and that banks with over $250 billion in assets are “systemically important.”

At a high level, the substantive provisions of the new law are relatively brief, when compared to the expanse of Dodd-Frank. Arguably, the mortgage-related provisions of Dodd-Frank did more harm than good because plenty of smaller lenders got out of the housing finance business rather than risk the penalties of noncompliance.

The recent legislation provides that banks with assets of $10 billion or less can avoid some of the more cumbersome qualified mortgage rules under Dodd-Frank, provided that the loans are originated by the bank and kept in the bank’s loan portfolio. Banks that made fewer than 500 mortgage loans in each of the last two years will be exempt from Dodd-Frank’s expanded reporting under the Home Mortgage Disclosure Act as long as the bank has a satisfactory or better Community Reinvestment Act rating.

The new legislation also directs the federal banking agencies to adopt a “Community Bank Leverage Ratio” that will exempt most banks with assets of less than $10 billion from the risk-based capital rules of Basel III. This safe harbor capital requirement is to be not less than 8 percent and not more than 10 percent, and it is going to require an interagency rule-making process, which can take many months to accomplish. So don’t throw away your Basel III models just yet. Most of these so-called small banks will also be exempt from the Volcker Rule, but that too is going to require promulgating rules. It is just going to take time for to reach consensus on what the regulations should say.

A couple of provisions of the new law beneficial to smaller banking organizations should be implemented fairly quickly and without much controversy. The threshold for a “small” bank holding company for purposes of the Fed’s policy statement on the capital and leverage requirements for such entities has been raised from $1 billion to $3 billion. This means bank holding companies with less than $3 billion of total assets will not be subject to capital requirements on a consolidated basis, and allows those holding companies to borrow money at the holding company level and inject it into their subsidiary banks as equity capital. In addition, the exam cycle for well-managed and well-capitalized banks with assets of $3 billion or less has been extended to 18 months. These two provisions could amount to meaningful relief for the banking organizations that can avail themselves of the flexibility afforded by the new law.

For those of us who appreciate the important role that a properly functioning banking system plays in the U.S., our elected officials deserve credit for making changes to Dodd-Frank. But we should not lose sight of the fact that the new law is merely a drop in the bucket of work to be done around bank regulation in the U.S.

Whose Refund Is It Anyway?

6-2-14-crowe.pngRecent developments are shining light on the sometimes confusing practice of settling the cash for tax payments and refunds between members of a consolidated banking group. Here’s what you should know.

The “Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure,” issued in 1998 by the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Fed), the Federal Deposit Insurance Corp. (FDIC), and the Office of Thrift Supervision (OTS), embodies the regulatory directive that depository institutions filing consolidated tax returns with their parent holding company and other affiliated entities should make tax payments and receive tax refunds in the same amounts and timing as if the institution filed separate returns with only its own subsidiaries (in other words, at the call report level).

To illustrate, suppose that in year one, Bank X would have had a $5,000 tax liability had it filed its own federal tax return. Its holding company, Parent Y, had a tax loss (as holding companies typically do), which reduced the actual consolidated return liability to $4,200. Parent Y would have collected $5,000 of tax payment from Bank X and submitted $4,200 to the IRS, pocketing the $800 difference as payment for the use of Parent Y’s loss. Now suppose that in year two Bank X had a tax loss large enough that, if it had filed its own returns, it would have carried the loss back to year one and received a refund of the entire $5,000. In reality, Parent Y carries the consolidated loss back and receives a refund for the $4,200 year one consolidated tax. Not only must Parent Y pay the entire $4,200 to Bank X, but it also owes Bank X another $800.

This scenario played out multiple times during the recent economic crisis, causing considerable angst to cash-strapped holding companies. In extreme cases, failing banks’ assets were seized by the FDIC, and the holding companies, left with little but debt, filed bankruptcy. Some holding companies also filed bankruptcy in order to facilitate the sale of their distressed banks before FDIC seizure. These situations often involved carrybacks of tax losses and outstanding refunds to be received from tax authorities. Legal battles arose over whether each refund, when received, was due immediately to the bank or whether it belonged to the parent’s bankruptcy estate, leaving the bank as just one more unsecured creditor. Since 1993, at least 11 court cases have decided this issue, some in favor of the bank, but many determining the bank was just another creditor, despite the fact that the regulatory policy statement clearly says that a parent receives a consolidated tax refund as agent on behalf of the group members.

In response to this chain of events, the Fed, OCC, and FDIC in December 2013 proposed an addendum to the policy statement to clarify that an agency relationship (rather than a debtor-creditor relationship) exists between a holding company and its subsidiary banks. The proposed addendum would require bank holding companies to review their consolidated tax-sharing agreements and add clear language on the agency issue. Comments were due by Jan. 21, 2014. No final version has yet been issued.

So if your bank is financially healthy and you don’t anticipate a bankruptcy filing, what does this have to do with you? In addition to anticipating a likely upcoming review and revision of your tax-sharing agreement, now would be a good time to review existing practices for settling taxes among entities. A common problem is failure to true up cash payments between entities when returns are actually filed. Take the earlier example of Bank X (with its $5,000 liability) and Parent Y (with an $800 benefit), and throw in another Parent Y-owned entity, Subsidiary Z, with a $2,000 liability, making the net amount due to the IRS $6,200. Now suppose that throughout the year the following estimated payments were made: $5,800 from Bank X to Parent Y, $1,700 from Subsidiary Z to Parent Y, and $6,600 from Parent Y to the IRS. When the return is filed, the $400 overpayment to the IRS is carried forward to apply to year two. At the same time, Parent Y should refund $800 to Bank X, collect $300 from Subsidiary Z, and treat the $400 IRS overpayment as applied to its own account. Common errors are not collecting the $300 from Subsidiary Z or not paying $800 to Bank X but instead just crediting the $400 IRS overpayment to Bank X. If this happens over multiple years, with many different entities and amounts, settlements can become very inaccurate, leaving one to wonder who owes whom.

Don’t wait for the next financial crisis to get your tax settlement house in order. Review practices now to make sure your banks are protected.