Is the Grass Greener? Five Considerations before Converting your Charter

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

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

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

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

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

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

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

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

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

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

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

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

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

Will National Banks Lose the Protection of Federal Preemption?

justice.jpgIf you are the director of a nationally chartered bank or thrift, there’s a date coming up real fast that you must pay attention to. 

One of the many changes mandated by the Dodd-Frank Act is a significant restriction in the protection that banks and thrifts with national charters have enjoyed from many state consumer protection laws. That protection—under a legal principle known as federal preemption—is set to change significantly on July 21. While much angst has been expressed over the disruptive impact that the new Consumer Financial Protection Agency could have on the banking industry, that agency is still getting organized and its impact at this point is—at best—speculative. The end of federal preemption, on the other hand, could have immediate ramifications for national banks and thrift.

The idea of federal preemption in banking is a creature of the National Bank Acts (there were actually two, one in 1863 and another in 1864 which superseded the original law), which among other things created a federal charter for commercial banks and placed them under the control of the Office of the Comptroller of the Currency (OCC). Preemption received a huge boost in 1996 when the U.S. Supreme Court issued a landmark ruling that invalidated a state law that prohibited national banks from selling insurance in small Florida towns. 

And in 2004, under former Comptroller John D. “Jerry” Hawk, the OCC issued rules that preempted national banks and their operating subsidiaries from state laws that “obstruct, impair or condition” their ability to make loans and take in deposits, and also granted sole authority to examine and supervise national banks to—itself!

An apt description of this royal doctrine might have been: “The divine right of the OCC,” and it comes as no surprise that legitimate state interests have railed against the agency’s protective stance ever since. Consider this one example: During the home mortgage boom some years back, national banks doing business in Georgia were exempted from that state’s robust anti-predatory lending law while state chartered banks were forced to comply. Needless to say, state attorneys general and legislatures have been among the most vocal opponents of the OCC’s stand on preemption.

Although Dodd-Frank does not invalidate federal preemption altogether, it does state that the OCC can no longer issue sweeping rulings like it did in 2004, but instead will have to make preemption decisions on a case-by-case basis. It’s also possible that the scope of protection under federal preemption will end up being more narrowly constructed under Dodd-Frank, although it might take years of litigation before national banks and thrifts know exactly how much protection they have against state laws.

Who should be most concerned about the Dodd-Frank restrictions on federal preemption, set to take effect on July 21? Logically, it would be large national banks and thrifts with multi-state operations that include branch banking, home mortgages and/or servicing, home equity lending, auto finance, student lending and credit cards–in short, practically any consumer lending or servicing business.

Being forced to comply with multiple—and differing—state laws will drive up operating and compliance costs for large multi-state banks. Worse yet, it will expose them to the wrath of state attorneys general who couldn’t touch them before. As Arthur J. Rotatori, a Cleveland, Ohio-based member at the McGlinchey Stafford law firm puts it, “The purpose of this provision in Dodd-Frank is to empower state attorneys general to go after national banks.”

And no doubt they will.