Why Community Banks Are Delisting From Exchanges

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There’s been a noticeable shift in the behavior of community and local banks in the United States: More and more banks are choosing to voluntarily delist from major exchanges like Nasdaq and the New York Stock Exchange, and deregister with the Securities and Exchange Commission (SEC).

Delisting is typically considered a cost-reduction measure or way for banks to reduce the complexity that comes with SEC registration. It’s clear that this trend is being driven by the economic environment: Higher interest rates, lower loan demand and slowed growth are driving community and regional banks to reconsider their exchange listings. Banks are looking at ways to maximize shareholder value, and are seeking alternatives to the traditional exchange model.

The pursuit of shareholder value and the impact of the 2023 Russell of its index have emerged as the primary drivers of banks switching trading venues. Community banks are scrutinizing the complexity, risk and the costs and benefits of being listed on major exchanges. Additionally, the June 2023 Russell Reconstitution set the entry point for inclusion in the index at a market capitalization of $160 million. As a result, many regional banks now fall just within the threshold for inclusion. Issuers that compose a relatively small share of the index and those that are not eligible face a real challenge in building visibility through their exchange listing. The banks that changed trading venues were all eligible to deregister from the SEC, as they were under the 2012 JOBS Act threshold of 1,200 shareholders of record. As profit margins continue to compress, banks are questioning the time and cost of being listed on an exchange.

Benefits of Voluntary Delisting
Voluntarily delisting allows community banks to transition their listing while maintaining their SEC registration and the accessibility of their financial statements and disclosures. Others choose to deregister and delist simultaneously. The transition to the OTCQX Market offers banks a more streamlined trading experience akin to that of an exchange, with the same strategies aimed at maximizing shareholder value. Further, a broker-driven market provides community banks with an improved trading experience, offering more time to react to orders and better price execution.

The trajectory of voluntary delisting and deregistration in the banking sector is poised to undergo even further evolution.

  • We anticipate the stability of trading volumes to persist, particularly for banks under $1 billion in assets. Competitive bid/ask spreads are also likely to endure, maintaining a favorable trading environment that caters to the interests of investors.
  • Community banks with a market capitalization under $500 million can expect to attract a similar pool of institutional investors, regardless of what market their shares trade. This consistency in investor interest contributes to the overall stability and appeal of the market.
  • Banks can streamline the format of their quarterly and annual reports while maintaining a commitment to transparency and disclosures to institutional investors. This can significantly reduce the administrative burden of reporting but maintains investor confidence with regulatory standards.
  • We expect that increasing shareholder value to remain a compelling factor for banks contemplating a transition. This approach can significantly bolster a bank’s financial position and enhance its strategic flexibility.

Banks choose to trade on the OTCQX Market, a viable alternative to Nasdaq, which enables them to maintain their public market status without the burden of SEC registration. The OTCQX Banks Index, which tracks the performance of U.S. banks traded on OTCQX, increased 34% between June 2020 and June 2023. compared with a 10% increase in the ABA Nasdaq Community Bank Index (ABAQ) over the same period. Banks have options to choose where they trade that best serves their shareholders while raising capital in their community, building their business and diversifing their investor base.

5 Things to Know About the New AML Whistleblower Law

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Among a bank board of directors’ many obligations is the responsibility to assure the bank complies with Bank Secrecy Act and other anti-money laundering laws and regulations.

This includes providing oversight for senior management and the BSA compliance officer, staying abreast of internal AML developments and reporting within the bank, and considering external market factors and regulatory developments. But even in a regulatory environment where penalties for BSA/AML violations have increased in amount, frequency and reputational importance, some boards are slowly reacting to recent Congressional legislation designed to further incentivize bank employees to blow the whistle on perceived or actual AML lapses. Here are five things bank boards need to know one year after the implementation of the Anti-Money Laundering Act of 2020 (AMLA).

1. Congress uncapped whistleblower awards
Congress enacted the AMLA in January 2021, which significantly revised the existing whistleblower provisions of the BSA and sought to bolster AML enforcement. Prior to the AMLA, the BSA’s whistleblower provisions were sparse and rarely invoked. The prior law allowed whistleblower rewards for information relating to a violation of the BSA, but capped the award amount at $150,000, which contributed to the law being underutilized. The new law removed that cap; now, whistleblowers who voluntarily provide original information to their employer or the departments of Treasury or Justice could collect up to 30% of amounts collected in actions where over $1 million in sanctions are ordered. As the industry knows, 30% of recent fines is substantial. If a whistleblower qualified in connection with the three 2021 actions from the Financial Crimes Enforcement Network, or FinCEN, their awards could have amounted up to $2.4 million, $30 million and $117 million, respectively.

2. Looking to prior precedent.
The new AML whistleblower program is largely modeled on the Securities and Exchange Commission’s successful program established under the Dodd-Frank Act, which may provide a window into the future of AML enforcement. The SEC’s program has been a resounding success over the past 10 years, resulting in more than 52,400 tips as well as $1.2 billion awarded to 238 individuals. According to the SEC’s recent Annual Report to Congress, fiscal year 2021 was a record-breaking year for the program in terms of tips received and amounts awarded to whistleblowers: $564 million was awarded to 108 individuals.

3. Employees can blow the whistle to their managers
Unlike the SEC’s program, a “whistleblower” under the new AML program includes employees who provide information to an employer — including as a part of their job duties — in addition to those who report to Treasury or DOJ. This means employees can blow the whistle if they observe compliance failures, and everyday interactions between management and financial intelligence unit investigators could be deemed whistleblower tips that trigger anti-retaliation protections and a possible award.

4. Tips are already being filed
Even though FinCEN has not issued rules implementing this new whistleblower law, tipsters do not need to wait to file a complaint with their employer or the government. Banks should react accordingly. In fact, it was recently reported that a tip has already been made to FinCEN detailing a wide-ranging money laundering scheme, and one lawyer has reported several inquiries received from internal compliance personnel interested in blowing the whistle. There is also recent precedent that the government does not need to wait until regulations are written to provide awards: In November 2021, the National Highway Traffic Safety Administration announced a $24 million award — its first ever — even though the agency is still writing its rules. In other words, the doors are open to AML whistleblowers now.

Number of SEC Whistleblower Tips

The table below shows the number of whistleblower tips received by the SEC on a yearly basis since the inception of the whistleblower program. (Source: SEC 2021 Annual Report to Congress, Whistleblower Program)

5. Boards should not wait to act
Boards should consider the implications and the expanded legal risk of the AMLA whistleblower law on their existing whistleblower programs. Among other steps that can be taken now, boards should provide oversight to senior management in:

  • Developing enterprise-wide training tailored to specific positions within the bank, including for directors, that covers how to identify a tip for purposes of the new AML law, how to respond to an internal whistleblower and best practices to protect the bank from retaliation lawsuits.
  • Reviewing and updating policies and procedures for internal whistleblowers.
  • Assessing internal reporting structures, including hotlines and other channels.
  • And triaging recent internal tips and conducting reviews of the response, where appropriate.

Creating a Comprehensive ESG Approach, From Compliance to Competitiveness

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Not only are investors increasingly incorporating environmental, social and governance, or ESG, factors in decisions about how to allocate their capital, but customers, employees and other stakeholders are also placing greater emphasis on ESG matters.

ESG will also continue to be a focus for regulators, with a particular emphasis on climate-related risks. It has rapidly evolved from a compliance matter to a strategic and competitive consideration; boards of directors and management teams should respond with both short-term action and preparation for the longer term. We review key developments and offer six steps that boards and management can take now to position a bank for the current ESG environment.

SEC’s Approach to Climate Change
The Securities and Exchange Commission has made considerations relating to ESG topics a top priority going forward, especially with respect to climate change-related issues. Chair Gary Gensler has charged SEC staff with developing a rule proposal on mandatory climate risk disclosure by the end of this year. Based on Gensler’s statements, the rulemaking is likely to be distinct from approaches developed by private framework providers and may not necessarily be tailored according to company size, maturity or other similar metrics.

Gensler has emphasized the importance of climate change disclosures generating “consistent and comparable” and “decision-useful” information. These disclosures may be contained in Form 10-K; given the tight timeframes associated with preparation of Form 10-K filings, this approach may require certain registrants to adjust their data collection and verification practices.

Bank Regulators’ Approach to Climate Change
Federal Reserve Chair Jerome Powell has indicated that he supports the Fed playing a role in educating the public about the risks of climate change to help inform elected officials’ policy decisions. The Fed established a Financial Stability Climate Committee to identify, assess and address climate-related risks to financial stability across the financial system, as well as the Supervision Climate Committee to help understand implications of climate change for financial institutions, infrastructure and markets.

The Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. are also taking climate risk seriously. In July, the OCC joined the Network of Central Banks and Supervisors for Greening the Financial System and announced the appointment of Darrin Benhart as its first climate change risk officer. Most recently, Acting Comptroller of the Currency Michael Hsu said the OCC is working with interagency peers to develop effective climate risk management guidance. The FDIC expects financial institutions to consider and address climate risks in their operating environment.

ESG as Competitive Advantage
Many companies have begun integrating ESG considerations into their products and strategies. Some research has shown that ESG can drive consumer preferences, with certain consumer demographics using ESG factors to differentiate among products. Younger demographics, for example, are choosing banks according to ESG credentials. Moreover, ESG considerations are becoming increasingly important to certain employee bases.

ESG issues are also top-of-mind for many investors, driven by prominent institutional investors that are linking a company’s ESG profile with its long-term financial performance and other stakeholders who want to align investments with social values and goals.

Directors and management teams should engage in an honest self-assessment of their bank’s ESG status, including determining which ESG matters are most material to their business. They should establish processes for board-level ESG strategy and oversight, along with clear management authority and reporting lines. They should also strengthen controls around ESG quantitative reporting. Ultimately, management should now consider whether and how to begin integrating ESG into commercial activities and overall strategy. With that in mind, here are six steps that boards and management can take now:

  1. Conduct a self-assessment on ESG matters, including on materiality, performance and controls.
  2. Begin preparations for an imminent SEC rulemaking on mandatory climate change disclosure that could potentially apply to Form 10-Ks in time for the 2022 fiscal year.
  3. Strengthen ESG processes and controls, while allowing flexibility for frequent reevaluation.
  4. Understand the key players in the ESG space and their varied perspectives.
  5. Establish responsibility for maintenance of a core ESG knowledge base and awareness of key developments.
  6. Monitor ESG developments as part of operational and strategic planning.

Practical Thoughts for the Evolving Role of the Compensation Committee

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Much has been written in recent months about the external forces accelerating investor, proxy advisor and employee focus on the topic of human capital management.

From the Securities and Exchange Commission Form 10-K human capital management disclosure requirement to a broader recognition from investors and insurers that people risk and opportunities are a material environmental, social and governance factor for every company — small and large — the compensation committee is even more central to a firm’s ESG strategy and journey than ever before.

Historically, the compensation committee charter duties were primarily focused on the chief executive officer’s  compensation and performance, as well as those elements for the broader executive officer population. However, as regulator and investor focus has shifted from executive compensation to broader human capital management, so too has the focus of many compensation committees.

In fact, many companies have changed the compensation committee name to reflect this expanded scope of duty: “Human Capital Committee” or “People Committee” are among some of the other derivations of these names. In fact, a majority of respondents in Aon’s Fall 2021 ESG Oversight Survey indicated that “human capital management” and diversity, equity and inclusion are formal duties of the compensation committee. Additionally, many companies have formally updated their charter documents to include oversight of human capital management and, increasingly, diversity, equity and inclusion related duties.

This expanded role into broader people risk and opportunities poses new challenges for the compensation committee. While compensation committees have gotten comfortable with external expectations surrounding executive compensation, the issue of broader workforce management requires a heavier coordination with corporate human resources teams. Like any  ESG topic, board or committee level oversight of a material ESG risk factor, such as human capital management, requires a clear definition of each group’s role, strong communication and information flow practices, along with an effective committee agenda list for each calendared meeting. The role of the compensation committee should not be to micromanage management teams on workforce planning, but to be informed enough on this topic to act as an independent, internal activist on the behalf of shareholders and employees.

Best Practice Considerations
With these aforementioned variables in mind, Aon recommends compensation committees consider the following best practice considerations heading into the 2022 proxy season:

  • Stay Informed. Stay current on regulations, investor expectations, and employee and market sentiment as it relates to the workforce. Use your compensation consultant or outside governance advisors to obtain necessary trends and information.
  • Ask the Right Questions. Be clear on what the company’s human capital and diversity, equity and inclusion-related goals are, and how they are tracking and defining success or failure. Know the extent to which such information is publicly disclosed or not, and understand if all such disclosures are consistent across all public forums.
  • Think Holistically. External observers are not looking at executive compensation decisions in isolation anymore. How your bank pays the CEO and other officers will be compared to how it treats the broader workforce. If you have lay-offs, furloughs or broader workforce compensation cuts, there will be an expectation that executive compensation be aligned with those broader actions. Stakeholders are evaluating executive compensation decisions in a broader context, so it is important to factor in all of these variables. It may also require greater coordination with the nominating and governance committee, if they own succession planning duties.
  • Give Yourself Credit. With human capital management being a material risk factor for virtually all industries, it is important to tell your story. If you do not proactively do this, someone else will — and it likely will not be favorable. Give yourself credit for the oversight, process, and practices that you have worked on with management to cultivate a meaningful human capital management strategy.

Cryptocurrency: The Risk Banks Already Have

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The cryptocurrency market continues to evolve: New companies launching coins, wallets, exchanges and applications seemingly emerge every day, and crypto founders were named to Time Magazine’s Most Influential List.

The total market capitalization of cryptocurrency eclipsed $2 trillion on April 5, 2021, and sat at $2.44 trillion as of Sept. 15, 2021. El Salvador became the first country in the world to make Bitcoin legal tender, with President Nayib Bukele saying, “Bitcoin would be an effective way to transfer the billions of dollars in remittances that Salvadorans living outside the country send back to their homeland each year.”

More importantly, financial regulators have taken notice. Make no mistake, regulation oversight is coming. Kenneth Blanco, director of the Financial Crimes Enforcement Network, said, “Banks must be thinking about their crypto exposure. If banks are not thinking about these issues, it will be apparent when examiners visit. In January, the Office of the Comptroller of the Currency published a letter clarifying the authority to participate in independent node verification networks (INVN) and use stablecoins to conduct payment activities and other permitted banking activities for national banks and federal savings associations, along with the instructions that in participating in this capacity, “a bank must comply with applicable law and safe, sound, and fair banking practices.”

Gary Gensler, the U.S. Securities and Exchange Commission chairman, is intimately knowledgeable of cryptocurrency, having taught a course called Blockchain and Money at the Massachusetts Institute of Technology. Sen. Elizabeth Warren (D-Mass.) has pressed Treasury Secretary Janet Yellen to use her position as the chair of the Financial Stability Oversight Council to “ensure the safety and stability of consumers and our financial system.”

A number of large, leading banks are evolving their crypto programs, testing their crypto infrastructure and readying their organizations for participation in the crypto marketplace, whether as a custodian, exchange, coin issuer, broker, payment processor or participant. Other banks are in the queue to be fast followers and/or limited participants. They want to see how the market develops and how regulators react to the initial wave of participation. Yet, other institutions look at cryptocurrency participation as either a long-term initiative, or an activity that does not fit their risk profile.

The fact of the matter is, likely every bank has exposure to cryptocurrency in some capacity. Approximately 13% of Americans bought or traded cryptocurrency in the past 12 months, and approximately 46 million Americans (17% of the adult population) own at least a share of Bitcoin. That means that about one in eight Americans actively participates in the crypto marketplace. Unless your bank has less than eight customers, the law of averages dictates that your institution has exposure and one or more of your customers has sent or received money to or from entities within the cryptocurrency marketplace.

The good news is there are tools to help banks identify current exposure, track payments and facilitate compliance monitoring and reporting needs. As with any tool, the effectiveness of those tools comes down to features and performance. Some tools use name matching to identify that participation. However, the ownership structure of many of these emerging companies use innocuous-sounding corporate holding company names for payment processing to their crypto companies, which can make these tools less effective — complicating the current struggle of evaluating false positives by name checking alone. There are also tools and services which can do advanced due diligence on virtual asset service providers and help identify crypto money service businesses and previously unidentified crypto payments. Once an institution can assess current state exposure, it can develop an action plan.

Acknowledging that willingly or otherwise, most financial institutions have been brought into the crypto ecosystem and should be developing a plan of action now. The first step is to identify and assess an institution’s current state of exposure to cryptocurrency. Next, it should develop a strategy defining the institution’s planned participation in this space. Key considerations include: how transactions outside the organization’s risk tolerance will be handled and how the governance, risk and compliance (GRC) programs of the organization need to be updated to reflect the current and future state of doing business.

As the crypto ecosystem and regulations continue to evolve, savvy institutions will ensure they understand their current exposure in the market and work toward a target future-state GRC program that addresses the risks to which the organization is exposed.

ESG Disclosure on the Horizon for Financial Institutions

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Over the last several years, investors, regulators and other stakeholders have sought an increase of environmental, social and governance (ESG) disclosures by public companies.

The U.S. Securities and Exchange Commission (SEC) has taken a cautious approach to developing uniform ESG disclosure requirements, but made a series of public statements and took preliminary steps this year indicating that it may soon enhance its climate-related disclosure requirements for all public companies, including financial institutions. To that end, the SEC’s spring 2021 agenda included four ESG-related rulemakings in the proposed rule stage, noting October 2021 for a climate-related disclosure proposed rule. The SEC is also sifting through an array of comments on its March 15 solicitation of input on how the Commission should fashion new climate disclosure requirements.

Recent speeches by Chair Gary Gensler and Commissioners Allison Herren Lee and Elad Roisman highlight some of the key elements of disclosure likely under consideration by the staff, as well as their personal priorities in this area. Commissioner Lee has asserted that the SEC has full rulemaking authority to require any disclosures in the public interest and for the protection of investors. She noted that an issue also having a social or political concern or component does not foreclose its materiality. Commissioner Lee has also commented on the disclosure of gender and diversity data and on boards’ roles in considering ESG matters.

Commissioner Roisman has noted that standardized ESG disclosures are very difficult to craft and that some ESG data is inherently imprecise, relies on continually evolving assumptions and can be calculated in multiple different ways. Commissioner Roisman has advocated for the SEC to tailor disclosure requirements, and phase in and extend the implementation period for ESG disclosures. Meanwhile, Chair Gensler has also asked the SEC staff to look at potential requirements for registrants that have made forward-looking climate commitments, the factors that should underlie the claims of funds marketing themselves as “sustainable, green, or ‘ESG’” and fund-naming conventions, and enhancements to transparency to improve diversity and inclusion practices within the asset management industry.

Significance for Financial Institutions
In the financial services industry, the risks associated with climate change encompass more than merely operational risk. They can include physical risk, transition risk, enterprise risk, regulatory risk, internal control risk and valuation risk. Financial institutions will need to consider how their climate risk disclosures harmonize with their enterprise risk management, internal controls and valuation methodologies. Further, they will need to have internal controls around the gathering of such valuation inputs, data and assumptions. Financial institutions therefore should consider how changes to the ESG disclosure requirements affect, and are consistent with, other aspects of their overall corporate governance.

Likewise, financial institutions should also consider how human capital disclosures align with enterprise risk management. Registrants will not only need to ensure that the collection of quantitative diversity data results in accurate disclosure, but also how diversity disclosures might affect reputational risk and whether any corporate governance changes may be needed to mitigate those concerns.

We recommend that financial institutions consider the following:

  • Expect to include a risk factor addressing climate change risks, and for the robustness and scope of that risk factor to increase.
  • Consider disclosing how to achieve goals set by public pledges, as well as whether the mechanisms to measure progress against such goals are in place.
  • Expect ESG disclosure requirements to become more prescriptive and for quantitative ESG disclosures to become more sophisticated. Prepare to identify the appropriate sources of information in a manner subject to customary internal controls.
  • Establish a strong corporate governance framework to evaluate ESG risks throughout your organization, including how your board will engage with such risks.
  • Incorporate ESG disclosures into disclosure controls and procedures.
  • Consider whether and how to align executive compensation with relevant ESG metrics and other strategic goals.

ESG: Walk Before You Run

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Covid-19 and last year’s protests over racial injustice added to the mounting pressure corporations face to make progress on environmental, social and governance (ESG) issues — but banks may be further ahead than they believe.

“ESG took on a life of its own in 2020,” says Gayle Appelbaum, a partner at the consulting firm McLagan. Institutional investors have slowly turned up the heat on corporate America, along with community groups, proxy firms and ratings agencies, and regulators such as the Securities and Exchange Commission, which now mandates a human capital management disclosure in annual reports. Customers want to know where companies stand. Prospective employees want to know if a company shares their values. And President Joe Biden’s administration promises to focus more on social and environmental issues.

Big banks like Bank of America Corp. and JPMorgan Chase & Co. have been responding to these pressures, but now ESG is trending down through the industry. With the right approach, banks may find that these practices actually improve their operations. However, smaller community and regional banks can’t — and probably shouldn’t — merely copy the ESG practices of their larger brethren. “People have to think about what’s appropriate for their bank, given [its] size and location,” says Appelbaum. “What are they already doing that they could expand and beef up?”

That means banks shouldn’t feel pressured to go big or go home when it comes to ESG. Begin with the basics: Has your bank reduced waste by encouraging paperless statements? How many hours do employees spend volunteering in the community? “When you sit down and talk to bankers about this, it’s interesting to see [their] eyes open,” says Brandon Koeser, senior manager and financial services senior analyst at the consulting firm RSM. The pandemic shed light on how banks support their employees and communities. “The reality is, so much of what they’re doing is part of ESG.”

Robin Ferracone, CEO of the consultancy Farient Advisors, tells companies to think of ESG as a journey, one that keeps strategy at its core. “You need to walk before you run. If you try to bite [it] all off at once, you can get overwhelmed,” she says. Organizations should prioritize what’s important to their strategy and stakeholders. ESG objectives should be monitored, revisited and adjusted along the way.

Stakeholders are watching. Glacier Bancorp CEO Randall Chesler was surprised to learn just how closely in a conversation with one of the bank’s large investors two years ago.

“One of our investors asked us, ‘Have you looked at this? We see your score isn’t very good; are you aware of that? What are you going to do about it?’ And that was the first time that we started to dig into it and realized that we were being scored by ISS,” says Chesler. (Institutional Shareholder Services provides an ESG rating on companies, countries and bonds to inform investors.)

It turned out that $18.5 billion Glacier was doing a lot, particularly around the social and governance aspects of ESG. The Kalispell, Montana-based bank just wasn’t telling its story. This is a common ESG gap for community and regional banks.

Glacier worked with consultants to develop a program and put together a community and social responsibility report, which is available in the investor relations section of its website, along with other governance documents such as its code of ethics. This provided the right level of information to lift Glacier’s score. “Our benchmark was, we want to be at our peer-level scoring on ESG,” says Chesler. “[We] ended up actually better. And we continue to watch our scores.”

“Community banks have the social and governance aspects covered better than many industries because [banks are] heavily regulated,” says Joe Scott, a managing director at Kroll Bond Rating Agency. Where they likely lag, he says, is around the environment; most are just beginning to assess these risks to their business. And it’s important that banks get this right as stakeholders increasingly focus on ESG. “We’re hearing that, beyond equity and debt investors, larger depositors — particularly corporate depositors, institutional depositors, state treasurers’ officers [and] others like that — are incorporating ESG into their considerations on who they place large deposits with. That could be a theme over time— other kinds of stakeholders factoring in ESG more and more.”

FASB Sheds Light On CECL Delay Decision

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CECL-8-15-19.pngSmall community banks are poised to receive a delay in the new loan loss standard from the accounting board.

The Financial Accounting Standards Board is changing how it sets the effective dates for major accounting standards, including the current expected credit loss model or CECL. They hope the delay, which gives some banks an extra one or two years, provides them with more time to access scarce external resources and learn from the implementation lessons of larger banks.

Bank Director spoke with FASB member Susan Cosper ahead of the July 27 meeting discussing the change. She shed some light on the motivations behind the change and how the board wants to help community banks implement CECL, especially with its new Q&A.

BD: Why is FASB considering a delay in some banks’ CECL effective date? Where did the issue driving the delay come from?
SC: The big issue is the effective date philosophy. Generally speaking, we’ve split [the effective dates] between [Securities and Exchange Commission] filers or public business entities, and private companies and not-for-profits. Generally, the not-for-profits and private companies have gotten an extra year, just given their resource constraints and educational cycle, among other things.

We started a dialogue after the effective date of the revenue recognition standard with our small business advisory committee and private company council about whether one year was enough. They expressed a concern that one [extra] year is difficult, because they don’t necessarily have enough time to learn from what public companies have done, they have resource constraints and they have other standards that they’re dealing with.

We started to think about whether we needed to give private companies and not-for-profits extra time. And at the same time, did we need to [expand that] to small public companies as well?

BD: What does this mean for CECL? What would change?
SC: For the credit loss standard, we had a three-tiered effective date, which is a little unusual. Changing how we set effective dates would essentially collapse that into two tiers. We will still have the SEC filers, minus the small reporting companies, with an effective date of Jan. 1, 2020.

We would take the small reporting companies and group it with the “all-other” category, and push that out until Jan. 1, 2023. It essentially gives the non-public business entities an extra year, and the small reporting companies an extra two years.

BD: How long has FASB considered changing its philosophy for effective dates? It seems sudden, but I’m sure the board was receiving an increasing amount of feedback, and identified this as a way to address much of that feedback.
SC: We’ve been thinking about this for a while. We’ve asked our advisory committees and counsels a lot of questions: “How did it go? Did you have enough time? What did you learn?” Different stakeholder groups have expressed concern about different standards, but it was really trying to get an understanding of why they needed the extra time and concerns from a resource perspective.

When you think about resources, it’s not just the internal resources. Let’s look at a community bank or credit union: Sometimes they’re using external resources as well. There are a lot of larger companies that may be using those external resources. [Smaller organizations] may not have the leverage that some of the larger organizations have to get access to those resources.

BD: For small reporting companies, their CECL effective date will move from January 2020 to January 2023. How fast do you think auditors or anyone advising these SRCs can adopt these changes for them?
SC: What we’ve learned is that the smaller companies wait longer to actually start the adoption process. There are many community banks that haven’t even begun the process of thinking about what they need to do to apply the credit loss standard.

It also affords [FASB] an opportunity to develop staff Q&As and get that information out there, and help smaller community banks and credit unions understand what they need to do and how they can leverage their existing processes.

When we’ve met with community banks and credit unions, sometimes they think they have to do something much more comprehensive than what they actually need to do. We’re planning to travel around the country and hold meetings with smaller practitioners — auditors, community banks, credit unions — to educate them on how they can leverage their existing processes to apply the standard.

BD: What kind of clarity does FASB hope to provide through its reasonable and supportable forecast Q&A that’s being missed right now? [Editor’s note: According to FASB, CECL requires banks to “consider available and relevant information, including historical experience, current conditions, and reasonable and supportable forecasts,” when calculating future lifetime losses. Banks revert to their historical loss performance when the loan duration extends beyond the forecast period.]
SC: There are so many different aspects of developing the reasonable and supportable forecast in this particular Q&A. We have heard time and time again that there are community banks that believe they need to think about econometrics that affect banks in California, when they only operate in Virginia. So, we tried to clarify: “No, you need to think about the types of qualitative factors that would impact where you are actually located.”

The Q&A tries to provide an additional layer of clarity about what the board’s intent was, to help narrow what a bank actually has to do. It also provides some information on other types of metrics that banks could use, outside of metrics like unemployment. It talks about how to do the reversion to historical information, and tries to clarify some of the misinformation that we have heard as we’ve met with banks.

BD: People have a sense about what the words “reasonable” and “supportable” mean, but maybe banks feel that they should buy a national forecast because that seems like a safe choice for a lot of community banks.
SC: Hindsight is always 20-20, but I think people get really nervous with the word “forecast.” What we try to clarify in the Q&A is that it’s really just an estimate, and what that estimate should include.

BD: Is the board concerned about the procrastination of banks? Or that at January 2022, banks might expect another delay?
SC: What we’re really hoping to accomplish is a smooth transition to the standard, and that the smaller community banks and the credit unions have the opportunity to learn from the implementation of the larger financial institutions. In our conversations with community banks, they’re thinking about it and want to understand how they can leverage their existing processes.

BD: What is FASB’s overall sense of banks’ implementation of CECL?
SC: What we have heard in meetings with the larger financial institutions is that they’re ready. We’re seeing them make public disclosure in their SEC filings about the impact of the standard. We’ve talked to them extensively about some of how they’ve accomplished implementation. After the effective date comes, we will also have conversations with them about what went well, what didn’t go well and what needs clarification, in an effort to help the smaller financial institutions with their effective date.

Boardroom on Fire: A Bank Chairman’s Painful Lessons from the Financial Crisis

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chairman-4-9-19.png“A sheriff’s car pulls up—the bank is on lockdown.” David Butler wistfully recalls that day in 2009; the day he lost everything.

“It was pretty traumatic,” he admits. “You have to ask tough questions. Can we survive it? What do we do? What’s our exit strategy?”

The events that transpired that fateful Friday afternoon send shivers down the spines of every bank director—the worst case scenario. No, not a robbery. The other worst case scenario.

“The FDIC comes in. They lock the doors and secure all our records before anyone’s allowed to go home.”

Butler was a founding board member of Western Community Bank. Western was big, state-chartered and publicly-traded. In 2007, they acquired a chain of banks with a sizable chunk of money tied up in Florida real estate. It was a ticking time bomb—and, spoiler alert: it was about to go off.

The early fallout of the housing market crash saw Western hemorrhaging $6 million a quarter, making Butler’s board an easy target for regulators.

“The FDIC wanted litigation wherever they could get it; half the time, even where they couldn’t,” he groans. “The public wanted heads to roll and we made perfect targets.”

Western had a clean public shell; no run-ins with the SEC—they were squeaky clean. But as the recession raged on, it became clear that “clean” didn’t cut it. “People were investigated, detained even, based on what? The suspicion of malfeasance? Yet we saw banks engaging in improper, verging on illegal activity walk away scot-free.”

This federal fishing expedition left Butler with a lingering paranoia; the fear that an army of pencil pushers sporting black suits and earpieces might knock on his door to have their Mission Impossible moment at his expense.

One month into 2009, Western’s shares plunged 95 percent. The finger of blame inevitably found a target. “Our CEO was a great guy, but the recession hit him like headlights on a deer,” Butler laments. “We asked him to resign. It was one of the most painful things I’d ever done.” The resulting shuffle in leadership landed David in the role of acting chairman.

“My job primarily became keeping morale up as we scrambled to find a partner,” he recounts. “We didn’t want depositors losing money, but we didn’t want to lose depositors. If they’ve got half a million in the bank, telling them to move it is hard, but it’s the right thing to do.”

Depositors weren’t the only people Western risked losing. The FDIC shot down attempts to offer retention bonuses, leaving Butler at the mercy of employees’ goodwill. “How do you ask someone not to jump ship when they’re waist-deep in water?”

As Butler fought to keep all hands on deck, Western’s board was rocking from the turbulence of days spent sparring over the bank’s balance sheet and late-night conference calls consumed by quarrels over how and where they would stretch its tier one capital.

“You can’t measure the character of your board until it’s been strained.”

“We had our share of those who didn’t stay the course,” he concedes. “Some resigned; some pointed blame—but then there were the ones who stuck it out. Even when it looked hopeless; even when tensions ran high, their commitment never wavered. I hold those people in the highest regard to this day.”

It was an act of bittersweet mercy when, in May 2009, the other shoe finally dropped.

A cease-and-desist order earlier in the year saddled Western’s board with a bureaucratic obstacle course of audits, reorgs, policy rewrites and loan appraisals; with no less than 15 deadlined reports to the state banking commission. One of the many hoops the board was forced to throw itself through required a reevaluation of Western’s loan loss reserves; an amount they determined to be $33 million. Butler was called to meet with the FDIC shortly thereafter.

“They sat me down and told me we needed $47 million,” he says. “I told them they were about to close my bank. We all sat there silently for a minute.”

Three months later, the state banking commission seized control of Western Community Bank, just $2 million shy of meeting its reserve requirement. The bank was turned over to the FDIC and sold to a local competitor for pennies on the dollar.

Where was Butler—the man who risked it all—that Friday afternoon when they came to take it all away?

“Our legal counsel advised us to stay away from the transition to avoid any situation where we might be questioned without an attorney present,” he explains. “So my wife packed a picnic basket and we drove to the beach.”

What about the anger, the resentment, the righteous indignation at the hopelessness of it all? “There was plenty of that to go around,” he admits. “The fact that we could fail was all they needed to treat us like we would. But you reach a certain age where you don’t have time to be angry. There’s no use holding onto all that bitterness.”

A decade has passed since that Friday afternoon when Butler lost it all. Murmurs of a looming recession seep from the rich vein of alarmist gossip to circulate amongst those with a finger on the pulse. “If those kind of whispers reach your ears, it means you’ve kept one to the ground,” Butler posits. “If you’re a bank director, you’ve got a choice. You can pick that ear up off the ground and look towards the future. Or,” he adds with a grin, “you can bury the rest of your head.”

Are the Ducks Quacking?

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IPO-5-17-18.pngAn initial public offering isn’t the only path to listing your bank’s shares on the Nasdaq or New York Stock Exchange, and gaining greater liquidity and more efficient access to capital via the public markets.

Business First Bancshares, based in Baton Rouge, Louisiana, opted for a direct listing on the Nasdaq exchange on April 9, over the more traditional IPO. Coincidentally, this was the same route taken a few days prior—with greater fanfare and media attention—by Swedish entertainment company Spotify. A direct listing forgoes the selling of shares, and provides an instant and public price for potential buyers and sellers of a company’s stock.

Business First’s direct listing could be seen as an IPO in slow motion. The $1.2 billion asset company registered with the Securities and Exchange Commission in late 2014, ahead of its April 2015 acquisition of American Gateway Bank. Business First then completed a $66 million private capital raise in October—$60 million of which was raised from institutional investors—before acquiring MBL Bank in January. The institutional investors that invested in Business First last fall did so with the understanding that the bank would be listing soon. “We actually raised money from the same people as we would have in an IPO process,” says Chief Executive Officer Jude Melville.

Melville says his bank took this slow route so it could be flexible and take advantage of opportunities to acquire other banks, which is a part of the its long-term strategy. Also, bank stocks in 2015 and 2016 had not yet hit the peak levels the industry began to see in 2017. The number of banks that completed an IPO in 2017 more than doubled from the prior year, from eight to 19, according to data obtained from S&P Global Market Intelligence.

“The stars aligned in 2017” for bank stocks, says Jeff Davis, a managing director at Mercer Capital. The Federal Reserve continued increasing interest rates, which had a positive impact on margins for most banks. Bank M&A activity was expected to pick up, and the Trump administration has appointed regulators who are viewed as being friendlier to the industry. “There’s a saying on Wall Street: When the ducks are quacking, feed them, and institutional investors wanted bank stocks. One way to feed the ducks is to undergo an IPO,” Davis says. Bank stock valuations are still high, and so far, 2018 looks to be on track for another good year for new bank offerings, with four completed as of mid-April.

The more recent wave of bank IPOs, which had trailed off in 2015 and 2016, was largely a result of post-crisis private equity investors looking for an exit. As those investors sought liquidity, several banks opted for life as a public company rather than sell the bank. That backlog has cleared, says Davis. “It’s still a great environment for a bank to undergo an IPO,” he says. “Particularly for a bank with a good story as it relates to growth.”

The goals for Business First’s public listing are tied to the bank’s goals for growth via acquisition. Private banks can be at a disadvantage in M&A, having to rely on all-cash deals. A more liquid currency, in the form of an actively-traded stock, is attractive to potential sellers, and the markets offer better access to capital to fuel growth. Melville also believes that most potential employees would prefer to work for a public versus a private company. “Being publicly traded gives you a certain stability and credibility that I think the best employees find attractive,” he says.

Business First’s delayed listing was a result of leadership’s understanding of the seriousness of being a public bank, and the management team focused on integrating its acquisitions first to be better prepared for the listing.

“You really have to want to be a public company and make the sacrifices necessary to make that possible,” says Scott Studwell, managing director at the investment bank Stephens, who worked with Business First on its pre-public capital raise but not its direct listing. “There has to be a lot of support for doing so in the boardroom.” The direct preparation for an IPO takes four to six months, according to Studwell, but the typical bank will spend years getting its infrastructure, personnel, policies and procedures up to speed, says Lowell Harrison, a partner at Fenimore, Kay, Harrison & Ford. The law firm serves as legal counsel for Business First. Roadshows to talk up the IPO and tell the company’s story can have executives traveling across the country and even internationally.

And the bank will be subject to Wall Street’s more frequent assessment of its performance. If a bank hits a road bump, “it can be a rough go for management in terms of looking at the stock being graded by the Street every day, not to mention all the compliance costs that go with being an SEC registrant,” says Davis. All of this adds more to the management team’s plate.

Considering a public path is an important discussion for boards and management teams, and is ultimately a strategic decision that should be driven by the bank’s goals, says Harrison. “What is the problem you’re trying to solve? Do you need the capital? Are you trying to become a player in the acquisition market? Are you just simply trying to create some liquidity for your shares?” Filing an IPO, or opting for a direct listing, should check at least two of these boxes. If the bank just wants to provide liquidity to its shareholders, a listing on an over-the-counter market such as the OTCQX may achieve that goal without the additional burden on the institution.

In considering the bank’s capital needs, a private equity investor—which would allow the bank to remain private, at least in the near term—may suit the bank. Institutional investors favor short-term liquidity through the public markets, which is why Business First was able to obtain capital in that manner, given its near-term direct listing. Private equity investors are willing to invest for a longer period of time, though they will eventually seek liquidity. These investors are also more actively engaged, and may seek a board seat or rights to observe board meetings, says Studwell. But they can be a good option for a private bank that’s not ready for a public listing, or doesn’t see strategic value in it.

Though Business First’s less-common path to its public listing is one that could be replicated under the right circumstances, the majority of institutions that choose to go public are more likely to opt for a traditional IPO. “The reality is that direct listings are very rare, and it takes a unique set of circumstances for it to make sense for a company,” says Harrison. While a direct listing provides more liquidity than private ownership, be advised that the liquidity may not be as robust as seen in an IPO, which tends to capture the attention of institutional shareholders. “Usually, it’s the actual function of the IPO that helps kickstart your public market activity,” he adds. And if the bank needs an injection of capital—and determines that a public listing is the way to do it—then an IPO is the best strategic choice.