The Trouble That Johnny Allison Sees

Johnny Allison, chairman and chief executive officer at Home Bancshares in Conway, Arkansas, prides himself on running a very conservative institution with a strong credit culture. And Allison has not liked some of the behavior he has witnessed in other bankers, who are slashing their loan rates and loosening terms and conditions to win business in a highly competitive commercial loan market.

Allison says those chickens will come home to roost when the market eventually turns, and many of those underpriced and poorly structured loans go bad.

“Now is a dangerous time to be in banking, in my opinion. It is a scary time because our people want to match what somebody else did,” said Allison during an extensive interview with Bank Director Editor in Chief Jack Milligan for a profile in the 1st quarter issue of Bank Director magazine. (You can read the story, “Will Opportunity Strike Again for Johnny Allison?” by clicking here.)

Allison feels strongly enough about the credit quality at $15 billion asset Home that he’s willing to sacrifice loan growth, even if it hurts his stock price. In the following excerpt, Allison — whose blunt and colorful talk has become his trademark — opens up about the challenge of maintaining underwriting discipline in a highly competitive market.

The Q&A has been edited for brevity, clarity and flow.

BD: You said some very powerful things in your third quarter earnings call. And you said it in sort of the Johnny Allison way, which makes it fun and entertaining. But you were fairly blunt about the fact that you see stupid people doing stupid things. That has to have an impact on your performance in 2019. You’re letting certain kinds of loans run off because you don’t like the terms and conditions and the pricing. That impacts your growth, which then impacts your stock price. That has to be a difficult choice to make.
JA: It’s extremely tough, because my people in the field are seeing dumb stuff being done. “Well, so and so did this, or so and so did that, and, Johnny, they gave him three-and-a-half fixed for 10 [years], and interest only, and nonrecourse.” I mean, there will be a day of reckoning on those kinds of bad decisions, in my opinion. Am I going to write at three and a quarter [percent] fixed for 10 to 15 years? I’m not going to do that. Do I not think I’ll have a better opportunity coming next year to where I haven’t spent that money, and I spend it next year? So, my attitude is [to] take what they give us. Stay close to your customers, support your customers. It is extremely tough. It is one tough job keeping the company disciplined. Don’t let it get off the tracks. We’re known as a company that runs a good net interest margin. We’re known as a company that has good asset quality, that runs a good ship.

BD: If you were more aggressive on loan growth, if you were willing to play the same game that other banks were playing and not worry about the future so much, would your stock price be higher today?
JA: We don’t believe that. If I loan you $100 and I charge you 6%, or I loan you $100 and I charge you 3%, you’ve got to do twice as many loans just to keep up with me. And there’s a limit to how much you can loan, right? We got $11 billion worth of loans. We’re about 97% loan-to-deposit [ratio]. Could we go up to 100%? Sure. We were at [100%] over six years ago. The examiners fuss at you a little bit. But we’ve got lots of capital. So, we kind of run in those areas close to 100% loan to deposit. But we’ve got $2.7 billion worth of capital, so we can rely on that. Plus, the company makes a lot of money.

BD: You said in the earnings call that you were building up the bank’s capital because you didn’t quite know where the world was going, or you weren’t quite certain about the future. So, how do you see the future?
JA: I’m very positive with the future, except the fact I keep hearing these naysayers on and on. We’re optimistic people. I’m rocking with the profitability of this company, and [people] tell me the world’s coming to an end. Then the [bank’s] examiner came in during [the] third quarter and said, “The world’s coming to an end, Johnny. Get ready. Be prepared. Get your reserves [up].” We didn’t ever see it. It didn’t happen. Could somebody be right? Could there be a hiccup coming? Let me say this, and I said it on the call, banks are in the best financial condition that they’ve ever been in.

Someone said, “Boy, you give the regulators credit for that.” I said, “Regulators had nothing to do with it. Absolutely nothing to do with it.” What did it was [the financial crisis in] ’08, ’09, and those people who wanted to survive, and those people who wanted to keep their companies and don’t want to cycle through that again. What’s happening is, the shadow banking system is coming into the [market], and they’re taking our loans. How many [loan] funds are out there? They all think they’re lenders. Every one of them think they’re lenders. And they’re coming into the bank space. Where we’re at 57% loan to value, they’re going to 95% loan to value.

There’s the next blow up, and that’ll hurt us. We’re going to get splashed with it. We’re not going to get all the paint, but we’re going to get splashed with that.

That’s the next problem coming, these shadow bankers, the people chasing yield. REITs. Oh, God. REITs. I’m in at $150,000 a key in Key West, Florida, with a guest house owner who is a fabulous operator. We financed her for years and years, and she’s built this great program with these guest houses. She sold it to an REIT for $500,000 a key. Now, let me tell you something, you can’t have an airplane late getting into Key West. There can never be a wreck on [U.S. Highway 1]. And there can never be another hurricane. Everything has to be hitting on all cylinders and be perfect to make that work. That’s kind of scary to me. We’ve seen several of these REITs coming [in with] so much money. They won’t give any money back to the investors. They won’t say, “We failed.” Instead, they’ll go invest that money. And they’re just stretching that damn rubber band as far as they can stretch it, and I think some of those rubber bands are going to pop.

[Editor’s note: An REIT, or real estate investment trust, owns and often operates income-generating real estate.]

So, I think that’s the danger. I don’t think it’s the normal course of business. I think those things are the danger. And when it slows down a little bit like it did, these bankers panic. They just panic. “What can we do to keep your business? What can we do?” They just lay down and play dead. “What can I do? What can I do? Two and a half? Okay, okay, okay. We’ll do [loans at] two and a half [percent].” We just got back from a conference, and they’re talking in the twos. Bankers are talking in the twos. I don’t even know what a three looks like, and I sure don’t know what a two looks like. So, I can’t imagine that kind of stupidity.

BD: So, where are we in the credit cycle?
JA: Well, two schools of thought. One, that we’re in a ten-year cycle, and it’s time for a downturn.

BD: Just because it’s time.
JA: Just because it’s time. Johnny’s thought is that we were in an eight-year cycle with [President Barack] Obama, and he didn’t do one thing to help business. Absolutely zero things to help any kind of business at all. Didn’t know what he was doing. Nice guy. Be a great guy to drink beer with. Had no clue. And then here comes [President Donald] Trump. So, did the cycle die with Obama and start with Trump? That’s my theory. My theory is that [the Obama] cycle died, and we’re in the Trump cycle. Now, if we have a downturn, if something happens somewhere, he’s going to do everything he can to get reelected, right? So, he’s going to try to keep this economy rolling. But if we have a downturn, it’s not going to be anything like ’08, ’09.

The regulators blame construction for the [financial crisis]. It wasn’t construction that caused the crash. It was the lenders and the developers that caused the crash, because nobody put any money in a deal. Nobody had any equity in a deal. I remember many times, my CEO, I’d say, “See if you can get us 10%.” No. [The customer] got it done for 100% financing. If you want the deal, they give it to you. But it’s 100% financing. There wasn’t any money in the deal. There was no money in those deals, and when the music stopped, they just pitched the keys to the bankers, and here went the liquidation process. I was involved in it, too. I did some of it myself. So, I’m not the brilliant banker that skated that. I was involved in it. Not proud of that, but I learned from that lesson. I learned from that lesson.

Now is a dangerous time to be in banking, in my opinion. It is a scary time, because our people want to match what somebody else did. That’s my toughest job. And a lot of them think I’m an ass because I hold so tight to that. Now, let me tell you. This is my largest asset. This is my baby in lots of respects. I have lots of my employees that are vested in this company. I have lots of shareholders, local Arkansas shareholders that are vested. We have created more millionaires in Arkansas than J.B. Hunt [Transport Services], or Walmart, or Tyson Foods. Individual millionaires, because they believed in us and invested with us, and I am very proud of that.

The Year Ahead in Banking Regulation

Although it is difficult to predict whether Congress or the federal banking agencies would be willing to address in a meaningful way any banking issues in an election year, the following are some of the areas to watch for in 2020.

Community Reinvestment Act. The Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. issued a proposed rule in December 2019 to revise and modernize the Community Reinvestment Act. The rule would change what qualifies for CRA credit, what areas count for CRA purposes, how to measure CRA activity and how to report CRA data. While the analysis of the practical impact on stakeholders is ongoing and could require consideration of facts and circumstances of individual institutions, the proposed rule may warrant particular attention from two groups of stakeholders as it becomes finalized: small banks and de novo applicants.

First, for national and state nonmember banks under $500 million, the proposed rule offers the option of staying with the current CRA regime or opting into the new one. The Federal Reserve Board did not join the OCC and the FDIC in the proposed rule, so CRA changes would not affect state member banks as proposed. As small banks weigh the costs and benefits of opting in, the calculus may be further complicated by political factors beyond the four corners of the rule itself.

Second, a number of changes in the proposed rule could impact deposit insurance applicants seeking de novo bank or ILC charters, including those related to assessment areas and strategic plans.

Brokered Deposits. The FDIC issued a proposed rule in December 2019 to revise brokered deposits regulations. While the proposed rule does not represent a wholesale revamp of the regulatory framework for brokered deposits — which would likely require statutory changes — some of the changes could expand the primary purpose exception in the definition of deposit broker and establish an administrative process for obtaining FDIC determination that the primary purpose exception applies in a particular case. Also, the new administrative process could offer clarity to banks that are unsure about whether to classify certain deposits as brokered.

LIBOR Transition. The London Interbank Offered Rate, a reference rate used throughout the financial system that proved vulnerable to manipulation, may no longer be available after 2021. The U.K.’s Financial Conduct Authority announced in 2017 its intention to no longer compel panel banks to contribute to the determination of LIBOR beyond 2021. In the U.S., the Financial Stability Oversight Council has flagged LIBOR as an issue in its annual Congressional report every year since 2012. Its members stepped up their rhetoric in 2019 to pressure the financial services industry to prepare for transition away from LIBOR to a new reference rate, one of which is the Secured Overnight Financing Rate, or SOFR, that was selected by the Alternative Reference Rates Committee.

For banks in 2020, it is likely that federal bank examiners, whose agency heads are all members of the FSOC, will increasingly incorporate LIBOR preparedness into exams if they have not done so already. In addition, regulators in New York are requiring submission of LIBOR transition plans by March 23, 2020.

The scope of work to effectuate a smooth transition could be significant, depending on the size and complexity of an institution. It ranges from an accurate inventory of all contracts that reference LIBOR to devising a plan and adopting fallback language for different types of obligations (such as bilateral loans, syndicated loans, floating rate notes, derivatives and retail products), not to mention developing strategies to mitigate litigation risk. Despite some concerns about the suitability of SOFR as a LIBOR replacement, including a possible need for a credit spread adjustment as well as developing a term SOFR, which is in progress, LIBOR transition will be an area of regulatory focus in 2020.

Avoid the Risk of Complacency


growth-5-10-19.pngBank directors have a golden opportunity to position their banks for future growth and prepare them for change—if they can resist the lull of complacency, according to speakers at the opening day of Bank Director’s 2019 Bank Board Training Forum on May 9.

The current economic environment remains benign, as regulators have paused interest rate increases and credit quality remains pristine, says Joseph Fenech, managing principal and head of research at Hovde Group. Further, he argues that banks today are better equipped to withstand a future economic downturn.

But speakers throughout the day say the risk is that board members may feel lulled by their banks’ current performance and miss their chance to position these institutions for future growth.

“We’re going through the good years in banking. I would argue your biggest competitor is complacency,” says Don MacDonald, chief marketing officer at MX Technologies. He adds that bank boards needs to be asking hard questions about the future despite today’s positive operating environment.

Banks are grappling with the rapid pace of change and technology, shifting customer demographics and skills gaps at the executive and board levels. Speakers during the conference provided a variety of ways that directors can address these concerns with an eye toward future growth.

One way is to redefine how community banks think about their products and their markets, according to Ron Shevlin, director of research at Cornerstone Advisors. Shevlin says many community banks face competition from firms outside of their geographic marketplace. In response, some community banks are moving away from a geographic community and toward affinity, or common bond, groups. These firms have identified products or loans they excel at and have expanded their reach to those affinity customers. He also advises banks to examine how their products stack up to competing products. He uses the example of checking accounts, pointing out that large banks and financial technology firms sometimes offer rewards or personal financial management advice for these accounts.

“Everyone talks about customer experience, but fixing the customer experience of an obsolete product is a complete waste of money,” he says.

Another challenge for boards is the makeup of the board itself. Directors need to have a skill set that is relevant to the challenges and opportunities a bank faces. Today, directors are concerned about how the bank will respond to technology, increase the diversity of their boards and remain relevant to the next generation of bank customers, says J. Scott Petty, managing partner of financial services at Chartwell Partners, an executive search firm.

He challenges directors to consider the skills and experiences they will need in a few years, as well as how confident they are that they have the right board and leadership to run the bank.

“Change doesn’t happen overnight. It has to be planned for,” he says. “Board composition should reflect the goals of the financial institution.”

Banks can resist complacency with their culture, according to Robert Hill, Jr., CEO of South State Corp. Hill says there is never a point in time when “you’ve got it made and your bank is cruising.” Various headwinds come and go, but the overarching theme behind the bank’s challenges is that pace of change, need for customer engagement and competition are all increasing.

In response, Hill says the bank is very selective about who they hire, and looks for passion, values and engagement as well as specific skills. South State prioritizes soundness, profitability and growth—in that order—and wraps its cultural fabric around and throughout the company. A large part of that is accomplished through leadership, and the accountability that goes with it.

“If the culture is not strong and foundation is not strong, it will be much harder for a company to evolve,” he says.

Will More Banks Form this Uncommon Board Committee?


committee-2-22-19.pngIt wasn’t in response to a cybersecurity event or a nudge from regulators that prompted Huntington Bancshares’ board to create a Significant Events Committee in early 2018.

Instead, says Dave Porteous, lead director at the $108 billion bank based in Columbus, Ohio, it was old-fashioned governance principles that drove Huntington’s board to establish the ad hoc committee responsible for responding to the biggest risk faced by banks today: cybersecurity threats.

“Particularly over the last 10 years, the world is changing so quickly it has really become incumbent upon all boards, in my view, to continually be evaluating their governance structure and whether or not they need to make adjustments … to how the world is changing,” Porteous says.

Ask any bank executive or director right now to name the things that cause them to lose sleep at night and cybersecurity will almost invariably be at the top of the list.

Millions of personal records have already been compromised globally, and it can cost even a small bank millions of dollars to rectify a single cyber event. Yet, while it is a common topic in boardrooms, it hasn’t yielded widespread governance restructuring at banks across the United States.

Bank Director’s 2018 Technology Survey found that 93 percent of the 161 chief bank executives, senior technology officers and directors said cybersecurity is an issue of focus by their board.

But a 2018 analysis by Harvard Law School found that just 7 percent of all S&P 500 companies have separate technology committees, though 29 percent of large public bank holding companies above $10 billion in assets have set up just such a thing. This is significant because, as the study noted, cybersecurity is often the responsibility of the technology committee.

Significant events have over time produced mandated changes in corporate structure, like the requirement in Dodd-Frank requiring banks above $10 billion in assets to have a separate risk committee, or the requirement in Sarbanes-Oxley that an audit committee oversee a bank’s independent auditor.

But Porteous argues that banks should not wait for changes in the law to force them into structural changes. The changes should emerge instead from ongoing conversations at institutions about new trends and threats.

“To me the critical thing is constantly be assessing and challenging yourself as a board on the way in which you govern and not to be afraid to make adjustments,” Porteous says. “In other words, create committees to address the current or upcoming issues that enhance the focus (of the board).”

For Huntington, the establishment of the Significant Events Committee was years in the making, but finally came after the board realized it was having similar discussions about the same topic at the board level and in separate committees.

It was a natural thing for us to take these discussions we were having, both at the board meeting and various committee-level meetings, and then decide that we were spending a significant amount of time in those discussions that it was going to be critically important,” Porteous says.

When formed, the committee included Huntington CEO Stephen Steinour, who chaired the committee; the lead director; the chairs of the technology, risk and audit committees and the “lead cyber director,” the 2018 company proxy said. The committee has since been folded into the broader Technology Committee because of overlapping skill sets, Porteous says, but the bank can reestablish it or other ad hoc committees as necessary.

One such committee was Huntington’s Integration Committee, created when the bank acquired FirstMerit Corp. in 2016. The committee met three times in 2017 after the acquisition and was later dissolved.

But it’s not just cybersecurity or M&A that should qualify as a significant event worthy of a board’s attention. Recurring natural disasters, for instance, including hurricanes in the Southeast and wildfires in the West are examples that might merit a similar response.

Whatever the issue, Porteous suggests boards continually assess their governance structure through annual board-level assessments or just paying attention to what’s in the newspaper every day.

“It’s critical to make those adjustments or adapt to the changing world,” Porteous says.

A Regulator’s Advice on Vetting Tech Companies


regulator-12-13-18.pngAs a microcosm of the banking sector and the broader economy, North Carolina provides an interesting glimpse at some of the trends and issues impacting banks nationwide.

“North Carolina’s banks are strong and benefiting from a robust economy,” says Ray Grace, who has served as the North Carolina Commissioner of Banks since 2013. “A sign of the good times for banking here is the interest we’ve seen in this cycle from out-of-state banks buying their way into North Carolina markets.”

Out-of-state banks making recent acquisitions in North Carolina include Columbia, South Carolina-based South State Corp., Pittsburgh, Pennsylvania-based F.N.B. Corp., and two Tennessee banks: Pinnacle Financial Partners, in Nashville, and First Horizon National Corp., in Memphis.

As the state’s banks consolidate, there is interest in opening new banks—the first since the financial crisis.

North Carolina also boasts a burgeoning technology sector, including the bank operating system nCino, based in Wilmington, and payment solutions provider AvidXchange, digital banking provider Zenmonics and IT consulting firm Levvel—all based in Charlotte.

In this interview, which has been edited for length and clarity, Grace explains why he’s seeing more interest in opening de novo banks in the state, shares his advice for banks exploring fintech partnerships and weighs in on prospective challenges for the industry.

BD: North Carolina just chartered its first de novo bank in a decade, with American Bank & Trust in Monroe, North Carolina. The Charlotte Observer reported you believe there’s more interest in opening new banks in your state. What’s driving that interest, and do you expect more activity to result from that interest?

RG: During the so-called Great Recession, the traditional economic drivers for bank formations disappeared. The economic downturn increased credit risks from borrowers, monetary policy wrung the margins out of lending, and the predictable tightening of the regulatory screws increased both the cost and the complexity of banking. Normally, we would have seen a faster return of de novo activity, but this was of course no normal recession, and fittingly, it was no normal recovery. Rather than the “V-shaped” recovery we had seen following previous downturns, this was the dreaded “L-shaped” variety, prolonging the drought.

On the heels of an epic consolidation trend, many North Carolina markets, including some that had been historically very supportive of community banks, lost those banks. As with previous consolidation episodes, this has left voids in these markets, particularly in rural areas. At the same time, we have seen a strong, decisive uptick in the economy through much of the state, a gradual return to normalizing interest rates, and, mirabile dictu, the beginnings of a swing of the regulatory pendulum toward a somewhat less restrictive environment. All these factors have contributed to the return of industry profitability and made the banking model attractive once again.

BD: Banks have been increasingly working with fintech firms to better expand and improve their own products and services, but properly vetting younger tech companies can be tricky. Do you have any advice for banks exploring fintech partnerships?

RG: Banks will need to embrace new technologies if they are to remain viable. That said, they need to focus on being cutting edge, but not bleeding edge. There is a dizzying array of gee-whiz products being introduced now, and it’s important to be careful in what you choose to implement.

Like a lot of advice, mine is more easily given than followed, but start with the fundamentals. What [or] who are your markets? What are you offering those markets and customers in the way of products and services, and why? What is trending, and in what directions? How does all this fit in with your business plan? Does your business plan still make sense? If not, change it.

In light of the foregoing, is your management team and board adequate to your bank’s current and future needs? For example, do you have a chief technology officer? A tech-savvy director or two?

Know what is available, [and] study and carefully assess the alternatives that fit the needs of your business plan. Discard applications or products that do not enhance customer value and the quality of their experience—while not breaking the bank.

What existing bank systems must be accessed by the new application? What firewalls or other protections are provided for access, data and systems security?

What is the financial strength of the company you are contracting with? What is their capacity to support the application? Do they have a track record with other banks? What would be the consequences to your operations in the event of failure of the vendor? Who owns the code in that event, and who could take over support?

Not long ago, there were any number of fintech startups with interesting offerings but limited resources and infrastructure, which made them risky to engage with. The good news is that’s changing, and clearly it is better to deal with companies that have some legs, financially and organizationally.

BD: Is there anything else you think is important that boards be aware of heading into 2019?

RG: Change, or the failure to meet its challenges, is the single greatest existential risk to banking as we know it. However, boards cannot afford to lose focus on more traditional risks. There is an old banking axiom that the worst of loans are made in the best of times. These are some pretty good times, and we are beginning to see some troubling signs that memories are short. Among those I would cite are the rising prevalence of “covenant light” loans and other structural concessions on the commercial side, and 100 percent financing in both the commercial and mortgage lending spaces. Some in Washington are again talking about the need to increase access to affordable housing. Déjà vu all over again?

Interest rates are likely to continue to rise, albeit at a modest rate. I think this is a good thing for the industry and the economy, but it will require an increased emphasis on sound funds management policies and practices on both sides of the balance sheet.

Our banking industry has always faced challenges: the Great Depression, disintermediation and the thrift crisis of the 80s, the repeal of Regulation Q, the Great Recession and resultant Dodd Frank Act, and a host of others. Yet, the industry has survived and reinvented itself time and again. Unfortunately, banks have also been the target of damaging criticism from Washington, sometimes for good reason but too often for political motivation. Restoring the public trust tarnished by this criticism will play a critical role in ensuring the industry’s future. We need to be reminded that banks are special. That they are the only industry that “creates” money. And that they are the place where people have traditionally gone when they wanted to buy a home or a car, or start a business. In a very real sense, banks are where people go to make their dreams come true. That’s a powerful story. It’s up to banks to tell it and to make it so.

Should You Buy, Sell Or Do Neither?


acquire-10-23-18.pngShould you acquire or be acquired? Some community banks are electing to do neither, and instead are attempting to forge a different path – pursuing niche business models. Each of these business models comes with its own execution and business risks. All of them, however, come with the same regulatory risk – whether the bank’s regulators will challenge or be supportive of the changes in the business model.

Some community banks are developing partnerships with non-bank financial services, or fintech, companies – companies that may have created an innovative financial product or delivery method but need a bank partner to avoid spending millions of dollars and years of time to comply with state licensing requirements. These partnerships not only drive revenue for the bank, but can also – if properly structured – drive customers as well. WebBank is a prime example of the change this model can bring. As of the close of 2007, WebBank had only $23 million in assets and $1 million in annual net income. Ten years later, WebBank had grown to $628 million in assets and $27.5 million in annual net income, a 39 percent annualized growth in both metrics.

Following the recession, bank regulators have generally been supportive of community banks developing new business models, either on their own or through the use of third party technology. As the OCC notes, technological changes and rapidly evolving consumer preferences are reshaping the financial services industry at an unprecedented rate, creating new opportunities to provide customers with more access to new product options and services. The OCC has outlined the principles to prudently manage risks associated with offering new products and services, noting that banks are motivated to implement operational efficiencies and pursue innovations to grow income.

Even though the new business model may not involve an acquisition, the opening of a new branch, a change in control, or another action that requires formal regulatory approval, a bank should never forge ahead without consulting with its regulators well before launching, or even announcing, its plan. The last thing your board will want is a lawsuit from unhappy investors if regulators shut down or curb the projected growth contemplated by a new business model.

Before introducing new activities, management and the board need to understand the risks and costs and should establish policies, procedures and controls for mitigating these risks. They should address matters such as adequate protection of customer data and compliance with consumer protection, Bank Secrecy Act, and anti-money laundering laws. Unique risks exist when a bank engages in new activities through third-party relationships, and these risks may be elevated when using turnkey and white-label products or services designed for minimal involvement by the bank in administering the new activities.

The bank should implement “speed bumps” – early warning indicators to alert the board to issues before they become problems. These speed bumps – whether voluntary by the bank or involuntary at the prompting of regulators – may slow the bank’s growth. If the new business model requires additional capital, the bank should pay close attention to whether the projected growth necessary to attract the new investors can still be achieved with these speed bumps.

Bank management should never tell their examiners that they don’t understand the bank’s new business model. Regardless of how innovative the new business model may be, the FDIC and other bank regulators will still review the bank’s performance under their standard examination methods and metrics. The FDIC has noted that modifying these standards to account for a bank’s “unique” business plan would undermine supervisory consistency, concluding that if a bank effectively manages the strategic risks, the FDIC’s standard examination methods and metrics will properly reflect that result.

Banks also need to be particularly wary of using third-party products or services that have the effect of helping the bank to generate deposits. Even if the deposits are stable and low-cost, and even if the bank does not pay fees tied to the generation of the deposits, the FDIC may say they are brokered deposits. Although the FDIC plans to review its brokered deposit regulations, it interprets the current regulations very broadly. Under the current regulations, even minor actions taken by a third party that help connect customers to a bank which offers a product the customer wants can cause any deposits generated through that product to be deemed brokered deposits.

Community banks definitely can be successful without acquiring or being acquired. However, before choosing an innovative path a bank should know how its regulators will react, and the board should recognize that although regulators may generally be supportive, they do not like to be surprised.

Protecting Elderly Customers from Financial Abuse


regulation-2-28-18.pngRegulators across the financial services industry remain keenly focused on protecting the interests of an aging population, especially where there may be signs of diminished cognitive capacity. Banks should consider various operational and compliance measures to guard against elder financial exploitation. While bank staff are on the front lines in protecting elderly customers, bank directors play a pivotal, top-down role in emphasizing a culture of vigilance, and in defining policy and strategy to combat elder financial fraud.

Be Aware of the Problem
Frontline personnel in branches and call centers are the first and last lines of defense to prevent elder financial exploitation. These personnel are the most likely to interact with elderly clients, many of whom are more inclined to conduct their financial transactions in a branch or over the phone, rather than electronically. Conducting periodic training that highlights real-world scenarios will help personnel recognize the signs of elder financial exploitation. An additional training element that may prove beneficial, but that often goes overlooked, is educating personnel on the psychological and emotional aspects of elder fraud. A customer’s diminished cognitive capacity or potential confusion, fear or embarrassment may be central to a perpetrator’s ability to prey on an elderly client.

Empower Employees to Speak Up
Identifying signs of potential financial exploitation of elderly clients is a great start. However, it is critical that personnel escalate suspicious activity through the proper channels within the bank. Personnel may be reluctant to follow through with escalating an event that is not blatantly fraudulent, perhaps out of fear of delaying a transaction or potentially embarrassing or even angering a client. However, speaking up is prudent, even when in doubt.

Develop the Three Ps
Banks should develop policies, processes and procedures that are easy to understand and follow.

Policies: Clearly define your organization’s views, guidelines and stated mission with regard to elder financial fraud.

Processes: Identify the mechanisms in place to effectively carry out the bank’s stated policies. This may include pre-set withdrawal limits (either daily or monthly), disbursement waiting periods or communications with external sources, such as a trusted contact person for the client, local adult protective services (APS) or law enforcement.

Procedures: Describe the precise steps that personnel should follow to execute the identified processes. What must a teller do in the event that a withdrawal request exceeds an established limit? Who does a call center representative contact in the event of suspicious activity, and what information should be provided? What information should personnel provide to a trusted contact person? What reports must be filed with authorities?

Report Suspected Exploitation
Banks are subject to various reporting requirements at the state and federal levels that relate to suspected elder financial fraud. National banks, state banks insured by the Federal Deposit Insurance Corp. and other financial institutions must file a suspicious activity report (SAR) with the Financial Crimes Enforcement Network (FinCEN) upon detection of a known or suspected crime involving a transaction. FinCEN has provided related guidance, and the electronic SAR form includes an “elder financial exploitation” category of suspicious activity. Several states’ laws and regulations also require that banks report suspected elder abuse to APS or law enforcement.

Banks may consider permitting clients to identify a “trusted contact person” that the bank may contact upon reasonable suspicion of potential exploitation. This is consistent with a March 2016 advisory from the Consumer Financial Protection Bureau (CFPB). Privacy concerns exist when disclosing customer information to a third party. However, the Gramm-Leach-Bliley Act (GLBA) permits disclosure of nonpublic personal information with customer consent. Regulation P under GLBA also grants an exception to the notice and opt-out requirements to protect against fraud or unauthorized transactions, or to comply with federal, state or local laws, rules and other applicable legal requirements. Additionally, 2013 Interagency Guidance “clarifies that reporting suspected financial abuse of older adults to appropriate local, state or federal agencies does not, in general, violate the privacy provisions of the GLBA or its implementing regulations.” A safe harbor from liability also exists for a bank that voluntarily discloses a possible violation of law or suspicious activity by filing a SAR. Bank personnel are also protected from liability in this situation.

Regulators at all levels of, and sectors within, the financial services industry continue to prioritize the interests of elderly customers, especially where there may be signs of diminished cognitive capacity. The banking community has gone to great lengths to support these efforts, and bank directors will continue to play an important role in defining internal policies and emphasizing the importance of vigilance in this area.

2018 Bank M&A Survey: Will Bank M&A Pick Up?


merger-survey-12-4-17.pngDriven in part by expectations for modest growth in the U.S. economy, almost half of the bank executives and directors participating in the 2018 Bank M&A Survey believe that the current environment for bank M&A is more favorable for deals, and 54 percent say their institution is likely to purchase another bank by the close of 2018. U.S. banks announced 191 deals through October 27, 2017, according to S&P Global Market Intelligence, and is on track to close the year on par with 2016, which closed with 241 deals. With that in mind, it’s perhaps no surprise that 40 percent expect a stagnant deal environment.

The 2018 Bank M&A Survey, conducted through September and in early October of 2017, is sponsored by Crowe Horwath LLP. It features the views of 189 chief executive officers, directors and senior executives of U.S. banks on the U.S. economy, the bank M&A environment and their own M&A strategies.

The unfettered optimism felt by the banking industry in the wake of the election of expected deregulator-in-chief Donald Trump has been tempered with the reality that regulatory relief largely hinges on the actions of the U.S. Congress. One-third of bank executives and board members lack confidence that the Republican majority will be able to push through regulatory relief for the banking industry by the end of 2018. But hope springs eternal for most bank leaders. Fifty-nine percent expect modest relief for the industry.

Where President Trump and his administration can best impact the nation’s banks is through his appointment of regulators. Fifty-eight percent believe that Donald Trump has had a positive impact on the banking industry. As of November 30, 2017, Trump has appointed Randy Quarles, who’s viewed as a moderate deregulator, as vice chairman of supervision for the Federal Reserve, and former OneWest CEO Joseph Otting as Comptroller of the Currency. Janet Yellen will leave the Fed when she is replaced as chairman by current Fed board member Jerome Powell in February 2018. Trump has nominated economist Marvin Goodfriend to fill an open seat on the Fed Board of Governors, and announced he will nominate Fifth Third Bancorp Chief Legal Officer Jelena McWilliams to chair the Federal Deposit Insurance Corp. The permanent leadership of the Consumer Financial Protection Bureau—not addressed in the survey—is also in flux. Ninety-seven percent of respondents believe that these regulatory appointees will be more sympathetic to the banking industry.

Additional Findings

  • Forty-four percent indicate that rising bank valuations have made it more difficult for their bank to compete for or attract suitable acquisition targets.
  • When asked about the kinds of acquisitions the bank is willing to make, 83 percent say their board and management team would consider a market extension, and 78 percent an in-market deal. Twenty-eight percent would consider an out-of-market deal.
  • Few—just 7 percent—are likely to acquire a fintech company by the end of 2018.

To view the full results to the survey, click here.

Confidential Supervisory Information in M&A


merger-6-28-17.pngAll of us have heard the horror stories about banks announcing a merger or acquisition, only to have the deal languish for months awaiting regulatory approval or, even worse, having the deal break apart because of a regulatory issue.

Sometimes the issues only become apparent after regulatory approval applications are filed. Since the financial crisis, some regulators have used the applications review process as a “second look” at the parties involved. This is especially true if the transaction would result in an institution that will cross a supervisory threshold (whether $50 billion, $10 billion, or $1 billion in assets), or if a protest is filed in response to the transaction.

But sometimes the issues would be readily apparent if all relevant information regarding the parties could be freely shared during due diligence. Unfortunately, applicable law imposes restrictions on the ability to share confidential supervisory information (CSI) during the due diligence process. In this article, I’ll describe what CSI is and the limits on sharing it, as well as some alternatives to allow parties to move forward without it.

What Is CSI?
The definition of CSI and the rules regarding its disclosure vary between each federal and state regulatory agency. But generally, CSI includes any information that is prepared by, on behalf of, or for the use of, a federal or state regulator, including information in any way related to any examination, inspection or visitation of a bank, its holding company or its subsidiaries or affiliates. CSI generally includes documents prepared by the regulator or by the examined entity relating to the regulator’s supervision of that entity. Some examples of CSI include exam and inspection reports, supervisory ratings, non public enforcement actions and commitment letters, such as a memorandum of understanding or board resolutions adopted to address supervisory concerns, as well as any related communications with a regulator and progress reports required by an enforcement action.

What Is Not Confidential Supervisory Information?
Certain regulatory actions must be disclosed under applicable law. These include cease and desist orders (or related consent orders), prompt corrective action directives, termination of FDIC insurance, removal or suspension of an institution affiliated party, civil money penalties and any written agreement for which a violation may be enforced by the federal regulator, unless that regulator determines that publication would be contrary to the public interest. Each federal regulatory authority maintains a website at which this information and the relevant documents may be obtained.

Who Can Give Approval to Disclose CSI?
The regulators take the position that all CSI, whether prepared by the regulator or the bank, is the property of the regulator, not the bank. As such, CSI may only be disclosed with the prior written approval of the regulator, and each of the federal regulators have adopted regulations setting forth procedures for how to request disclosure of CSI.

What About Sharing CSI in Mergers or Acquisitions?
While there are some exceptions to the general rule that a bank can’t disclose CSI, including permitting disclosures to directors, officers, employees, auditors and, in some instances, legal counsel, almost all regulators take the position that a bank can’t share CSI with acquirers or targets in merger or acquisition transactions without prior approval. Further, some regulators, including the Federal Reserve, take the position that disclosure requests in these contexts are denied absent unusual circumstances.

This is a very different stance from other highly sensitive information, such as a consumer’s nonpublic personal information, which may be disclosed in connection with a proposed merger or acquisition.

What Are the Risks of Failing to Comply?
Failure to comply with regulator requirements regarding CSI can be a violation of law and could subject a person or entity to supervisory action, including the imposition of civil money penalties. In some instances, disclosure of CSI could also expose a person to criminal penalties.

So How Do the Parties Work Around This?
While CSI itself can’t be shared, other reports likely address criticisms arising in an examination. Under generally accepted accounting principles, the bank’s audit will likely describe any informal administrative action to which the bank is subject, and if the bank is a public company, its securities filings will likely describe administrative proceedings and any progress in complying with them. But if a bank is acquiring a bank in troubled condition, there is likely no substitute for seeing the administrative action to which the bank is subject. In that instance, the parties should build into their timetable the request for obtaining that information from the relevant regulator.

Fintech Action Cools in U.S., Soars Elsewhere


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Looking back over the last year, it is apparent that the fintech industry has become mainstream just as fintech investing cools. What I mean by this is that fintech has matured in the last five years, going from something that was embryonic and disruptive to something that is now mainstream and real. You only have to look at firms like Venmo and Stripe to see the change. Or you only have to consider the fact that regulators are now fully awake to the change and have deployed sandboxes and innovation programs. Or that banks are actively discussing their fintech innovation and investment programs. Or that institutions are being created around fintech like Innovate Finance or the Singapore Fintech Festival. Fintech and innovation is here to stay.

For me, the biggest impact has been how busy 2016 has been. Each year is busy, but this year has been amazing. A great example is that I travelled to four continents in six days recently. That’s unprecedented and, a century ago, wouldn’t have been possible. Today, it’s easy. We just jump on and off aircraft and go. What is particularly intriguing for me—and telling—is where I go. After all, as someone at the center of fintech, where I go shows where the action is. In 2016, I’ve been to Singapore, New York and, most recently, London, which are the three fintech hubs for Asia, America and Europe, respectively. But I’ve also been to Nairobi, Hong Kong, Washington and Berlin, all key fintech focal points. Nascent centers in Abu Dhabi, Dubai, Bangkok, Kuala Lumpur also are on the radar. So, too, are are Mexico City, Sao Paolo and Mumbai.

In fact, what intrigues me the most is the fact that fintech has bubbled over in 2016. The latest figures show that U.S. investing in fintech slowed in 2016, while Chinese investments went up. And that is probably the most sobering thought as we head towards the holiday season. Fintech reached its zenith in the U.S. in 2016. Prosper and Lending Club started to have to answer some hefty questions about their operations, and there is no major new digital bank in the U.S. Meanwhile, Chinese fintech investments soared in 2016, and Ant Financial, which operates the Alipay payment platform for the Chinese Alipay Group, has become one of the most talked about IPOs of the year.

In other words, China, India and Africa are where we are beginning to see the most amazing transformations through technology with finance. China has more fintech buzz than anywhere at the moment thanks in large part because of Ant Financials’ innovations. India is doing amazing things with technology, and Africa has seen the rise of mobile financial inclusion that is changing the game for everyone.

The key here is to keep your eyes and ears open to change. Too often, I encounter people—senior banking people—who believe that developments in economies they see as historically poor being irrelevant. They don’t recognize that those historically poor economies are becoming presently wealthy and future rich. They are missing a trick.

In fact, I would go as far as to propose that the economies that were historically poor are the ones that are reinventing banking and finance through technology. They have no legacy and have no constraints, so they are rethinking everything. Eventually, their ideas will become things we all use so ignore them at your peril.

Happy New Year!