Bank Lawyer's Blog

FDIC: Bring Me Your Tired, Your Poor, Your Huddled De Novos, Yearing To Be Free

2016-04-10T21:50:00-05:00

Last week, FDIC Chairman Martin Greunberg announced that the FDIC was rescinding a policy that it instituted during the depths of the last recession, of requiring heightened scrutiny of de novo banks during their first eight years of existence, and was returning to the policy of the "good old days," when new banks suffered life under an regulatory electron microscope for only three years. Gruenberg claims that "the FDIC welcomes applications for deposit insurance, and we clearly have a role to play in facilitating the establishment of new institutions." He also claimed that the reason that de novo applications have slowed to "a trickle" since the start of the Great Recession is because of economic factors, not a real or imagined FDIC moratorium on insurance of accounts for de novo banks.

I should note that establishing even a small community bank is a challenging endeavor. Developing a sound business plan, raising the needed financial resources and recruiting competent leadership and staff takes work and we want to ensure that every new institution that is established is in a position to succeed.

But we are very committed to working with and providing support to any group with an interest in starting a community bank. To that end, we are developing a handbook to guide applicants through the review process.

There is ample room for new community banks with sound funding and well conceived business plans to serve their local markets. It is essential that they have a clear path to approval.

This all sounds well and good on the surface. However, I'm with attorney Charles Horn who, writing in the National Law Journal, indicates that he is, like me, from Missouri on this matter.

That said, the dearth in new deposit insurance approvals in recent years has, to some extent, become a self-fulfilling prophecy in that a perceived FDIC reluctance to approve new deposit insurance applications has helped suppress industry interest in establishing new banks. Chairman Gruenberg is correct, in part, in attributing the decline in deposit insurance applications to post-financial crisis economic conditions. At the same time, experience has shown us that persons wanting to organize a new insured depository institution have been discouraged by the FDIC’s failure to approve more than a small handful of new deposit insurance applications in the past few years (none so far in 2016, two in 2015, none in 2014, three in 2011, and two in 2010, according to the FDIC’s website).

While we state the obvious in saying that the best way for the FDIC to encourage the formation of new banks is to approve more deposit insurance applications, the point here is that it is actions—not words—that will speak the loudest on this subject.

There is no question that these are still difficult times to make money in the community banking business, no matter how much lipstick Gruenberg paints on the lips of the community banking business in the course of his address (and he lathers it on in rosy red hues in the linked article). A good portion of that difficulty is due to the small interest rate spreads and low interest rates imposed by the Federal Reserve's policies over the past nine years, which, as of today, seem rooted in place. Nevertheless, as the Federal Reserve's own economists have noted, the dearth of de novos is also due to the regulatory burdens placed on the small banks by the FDIC, FRB, and OCC. Greunberg does state that a "gentler approach" and "tiered regulation" are on the way. If true, this relief will be welcome.

We'll have to wait and see whether this promise of more de novos is true or false. As we noted just a few months ago, even those applicants who have weathered the storm and made it over the finish line have painted a grim picture of the time and expense required, as well as of much higher capital requirements (which means reduced return on equity). If organizers expect to pay consultants and attorneys hundreds of thousands of dollars to assist them in raising capital, creating extensive business plans, and preparing detailed applications for insurance of accounts, I think that they want to feel more confident that they will have a decent shot at approval.

As Horn observes, in this area, actions will speak louder than words.

Barney Bites Bernie (And Neel)

2016-03-27T22:07:00-05:00

Now that hell has frozen over, I find that all kinds of amazing things are occurring, one of which has created the danger of ripping a huge hole in the space-time continuum: I find myself in agreement with Barney Frank.

While watching the PBS News Hour this past Thursday night, who should pop up but the former House Banking Committee Chair and favorite Bank Lawyers Blog Bullseye, Barney, who was interviewed by Jeffrey Brown about Frank's reaction to statements by Neel Kashkari, currently president of the Federal Reserve Bank of Minneapolis and former Bush Bailout TARP Toolmaker, and the ever-cranky Bernie Sanders, Gen Y's favorite "Democratic Socialist," about "To Big To Fail Banks." Sanders also alleged that the way to break up big banks is to reimpose the Glass-Steagall on commercial banks. Frank, now that he's out of the political arena and no longer feels compelled to be what every politician feels he or she must be, i.e., a caster of shade upon of the truth, was remarkably critical of two gents who are spouting the Democrat Party line about the evils of Wall Street's "TBTF" banks.

Barney may have gained some objectivity, but he's lost none of the pungent-tongued arrows from his verbal quiver.

In the first place, both Senator Sanders and Mr. Kashkari continue to evade the biggest question. That is, how big is too big? The crisis which touched off when Lehman Brothers couldn’t make its payment, Lehman Brothers was about $650 billion in assets. We have banks four and five times that size

And the question is, does everybody have to be smaller than Lehman Brothers is today? But that would have consequences. Getting there would be a problem. By the way, it should be very clear, Glass-Steagall doesn’t do it. There is a disconnect between Senator Sanders insisting that the banks be broken down to the point where they won’t by their own size threaten, if they have too much debt, to undermine it.

And Glass-Steagall — Glass-Steagall would reduce — it wouldn’t do anything to Goldman Sachs and to Morgan Stanley, which are almost Glass-Steagall-ized themselves. But looked at Citicorp, or J.P. Morgan Chase, or Bank of America, Wells Fargo, even if they were subject to Glass-Steagall, they would still be well beyond the size that Lehman Brothers was.

There is just a disconnect between saying we’re going to do Glass-Steagall and getting the banks down to a size where, if there was a complete failure, you would get damaged by it.

The entire response above by Frank is remarkable for the fact that he's right. It's obvious that he's not been spending his time since retirement sampling the wares of Mar Jane-related "legal" businesses in Colorado.

Frank also jumped all over Kashkari's comparison of the 2008 meltdown to the S&L crisis of the 1980s, and Kashkari's statement that the reason the S&L crisis didn't bring the economy down was because none of the S&Ls was "too big to fail." Again, Frank asks why Kashkari won't tell us how big is too big? He also correctly notes that the bailout of the S&Ls cost a lot more than the bail out of big banks in 2008, although he does not also observe that this was because the 2008 TARP allowed the big banks to survive, while the S&L "bailout" allowed them to fail (or most of them, at any rate (outside the Southwest Plan thrifts), and established the Resolution Trust Corporation, staffed by the FDIC, to liquidate their assets. If the politicians, including Frank, had stayed out of it in the 1980s and let the initial bailout template concocted by the former Federal Savings and Loan Corporation play out, there's a chance that the money from that bailout might also have been largely repaid.

Frank says the primary risk is not size but "indebtedness," and on this point he's got a point. However, I disagree with his assertion that his bloated namesake, Dodd-Frank, has dealt successfully with the risk of bank's engaging in excessive borrowing and hinky derivatives that made "The Big Fail" such a hit (his misapprehension of the effect of the Volcker Rule has been lambasted previously), and his assertion that now, no bank is too big to fail.

If a large institution can’t pay its debts, it fails. It is not too big to fail. It is put out of business, by law. No federal official can advance any money to pay its debts under the law until it is dissolved.

TARP also required legislation to create, and the wide-open authority it provided the federal government to bail out banks was induced by panic among folks at the highest levels of the federal government (including Frank) of immanent widespread economic collapse. We'll see how effective Franken-Dodd is when the next crisis hits, as it inevitably will. There's no prohibition on a future panicked Congress changing the rules on the spur of the moment to do what Frank claims can never again be done.

To prove that I haven't completely turned to the dark side, I think his statements about overturning Citizens United are bunk. Nevertheless, all-in-all, startlingly, he makes a lot of sense.

Regulatory Abuse: Let's Make It More Transparent

2016-03-20T21:48:00-05:00

Last week's release of a report by the FDIC's Inspector General that outlined the allegedly thug-like behavior of some FDIC lawyers and supervisory personnel against banks that dared to engage in tax refund anticipation lending, a business that the Care Bair found distasteful on moral grounds (notwithstanding that the line of business was legal), generated the expected smoke, blown up the public's backside by all the usual suspects. A couple of articles in the American Banker (paid subscription required) by reporter Lalita Clozel nicely outlined the sturm und drang for those of us with short attention spans.

The agency allegedly used a number of strong-arm tactics -- including rigged examination reports, selectively leaking information to a competitor, and hampering a firm's acquisition plans -- in order to force the banks from offering such loans.

The inspector general's report concluded that the actions "involved aggressive and unprecedented efforts to use the FDIC's supervisory and enforcement powers, circumvention of certain controls surrounding the exercise of enforcement power, damage to the morale of certain field examination staff, and high costs to the three impacted institutions."

Among the criticized actions of the FDIC were the actions of an FDIC attorney, who allegedly "abusively threatened" banks in person and on the phone. I'm not sure what "abusively threatening" a person entails in this case, but in my 41+ years of practicing law, most of it representing financial institutions, I've been threatened on rare occasions by government attorneys, and invariably the person doing the threatening is what is often referred to in legal circles as a "classical parum canis asinum" ("punk ass little bitch"). People with actual courage don't threaten, they simply "do." With a few notable exceptions, the overwhelming majority of bank regulatory agency attorneys I have dealt with over the years have not been "abusively threatening," and among those few that have issued threats, some of have done so under what they thought was the protection of anonymity.

Clozel sets forth a bullet point list that summarizes many of the other criticized actions of the FDIC against the banks in question and against the FDIC's own examination staff. The FDIC disputes almost all of the allegations of the inspector general, although it does assure the IG that it will take several steps "to improve both internal and external communication." In other words, when the boys and girls in D.C. tell the field staff to screw a bank, they'll make sure that it's communicated clearly. The FDIC also alleged that it will update its "appeals process" so that banks that are being shot at by FDIC supervisory and legal staff can appeal up the food chain to the officials who set the rein of terror in motion in the first place, so that they can say that the agency paid lip service to due process while they all sit around and laugh at the appeal.

The FDIC also claimed that it "does not condone" the "aggressive behavior of at least one employee" and that this employee "has since left the agency." No doubt to join ISIS. It's comforting to know that when it comes to taking action on abusive action of one of its employees, the FDIC is always quick to throw under the bus those who are no longer employed by the agency.

In a Congressional hearing, at which the IG testified about the matter, Republican and Democrats split predictably. The Republicans were "troubled" by the alleged abuse, while the Democrats were "troubled" by tax refund anticipation loans themselves. As we've seen with both parties, depending on the issue, each believes that in some cases, the ends justify the means.

Fred Gibson, the FDIC's Inspector General, expressed an additional concern that many share, and that may apply with even more force to the CFPB. He said that the FDIC should have released guidance, rather than create "rules by enforcement." This concern was echoed by Rep. Sean Duffy, the Chairman of the House Subcommittee that conducted the hearing.

"It is hard enough to comply with rules that are put out that people are trying to read and try to comply with but it is even harder when you have a regulatory body of our financial industry that tries to enforce first and give guidance later. We should know what the rules are, the rules of the game should be clear."

If you make the rules of the game clear, then (A) people can challenge them on the basis that they are arbitrary or lack substantial support, or (B) the agency is then bound by the rules in lieu of personal taste (or, in the case of tax refund anticipation loans, distaste). That takes all the found of regulating.

This all was nice theater, and you have to give the Mr. Gibson and his staff a hat-tip for spitting into the wind. Nevertheless, if anyone thinks this will change the FDIC's conduct going forward, your smoking some of that legal/illegal Colorado hemp. The only thing that will do that is a change in the White House in November. Then again, Sheila Bair, who started this "trickle down" abuse in 2008 (according to the IG's report) was a Bush II appointee.

Stressing Stress Testing

2016-03-13T21:29:00-05:00

A recent White Paper from the consulting firm Invictus discusses what those of us who represent community banks have been aware of for some time now: the requirements for "stress tests" that were supposed to apply only to those "Too Big To Fail" banks are "trickling down" to community banks. The buzzwords that apply to banks both large and small are "forward-looking risk analytics." While Invictus notes that bank regulators initially publicly stated that stress testing was only for the Big Guys, their actions belied their words (or, they simply changed their minds).

Regulatory actions in the waning months of 2015 should serve as notice that ignoring forward-looking analytics will lead to lower CAMELS scores, more examiner scrutiny and higher regulatory capital requirements. The new current expected credit loss model (CECL), which is expected early in 2016, is also a forward-looking tool.

Behind the scenes, however, regulators began changing their own methods for examining community banks, relying more and more on forward-looking analytics. In recent months, with signs that community banks are again accumulating higher concentrations of risky commercial real estate loans, regulators are reminding community banks that stress testing is indeed required to manage concentration risk in their portfolios and to develop realistic scenarios for interest rate risk management.
Regulatory actions in the waning months of 2015 should serve as notice that ignoring forward-looking analytics will lead to lower CAMELS scores, more examiner scrutiny and higher regulatory capital requirements. The new current expected credit loss model (CECL), which is expected early in 2016, is also a forward-looking tool.
The large banks have already adopted forward-looking risk analytics and are using the results with regulators. Although community banks are not subjected to the same stress testing requirements as the large banks, the regulatory trend is in the same direction. Those community banks that fail to incorporate new analytics into their risk management systems will find it difficult to communicate effectively with regulators.

The White Paper traces recent public issuances by the FDIC, FRB, and OCC in this direction. A specific red flag is the December 2015 joint agency guidance on CRE concentrations. Those of us who represented community banks and their directors in the aftermath of the last meltdown, when commercial real estate brought a number of community banks to grief, took special note of that guidance. It's "guidance" in the same way vendor management guidance is merely "guidance." Try violating it and see how "sticky" the wicket gets. You'll be up to your eyeballs in MRAs on the your next report of examination...or worse.

Even if you thinkl your CRE isn't all that "concentrated," Invictus thinks that you ought to seriously consider hoping on this forward-looking train.

Even if your bank doesn’t have CRE concentrations, use forward-looking risk analytics to stress test your capital, your strategic plans and any potential acquisition you might be considering. Present the results to regulators. Invictus’ clients that have used stress testing results with examiners have seen their capital requirements decrease, their management piece of their CAMELS composite increase, and their strategic plans win fast regulatory approval.

At the very least, it's worth pausing for a moment and, while you stoop to smell the roses, thinking about whether you might benefit from this approach (if you haven't already adopted it).

Ex Post Facto Expertise

2016-03-06T21:55:00-06:00

Several years ago, I expressed some amusement (in a "gallows humor" sense, I admit) about the fact that the CFPB was sending attorneys to classes to obtain basic knowledge about bank law after they were hired. Ideological purity, I assume, was the primary job qualification. Therefore, I take it as a perversely encouraging sign that the Adjustment Bureau's former General Counsel and Acting Deputy Director (a different position than "In Real Life Deputy Director") last week announced that she was quitting the agency and jumping feet first into the dung heap of the financial services business.

Meredith Fuchs, who recently stepped down as acting deputy director of the Consumer Financial Protection Bureau, is joining Capital One as the bank’s senior vice president and chief counsel on regulatory issues, according to a report from TheHill.com.

Fuchs served as general counsel at the CFPB before she was named acting deputy director in July 2015 after Steve Antonakes stepped down as deputy director.

The revolving door between the regulator and the regulated is so common in the fever-ridden Potomac Tidal Basin that it hardly raises an eyebrow in a cesspool that might soon be ruled by a man possessed of aeronautically engineered hair and the debonair demeanor Al Bundy. Still, there is something just a bit askew when the resume of the person who was the General Counsel and then Acting Deputy Director of an agency with such extensive power and authority over financial services lists a single job in the financial services industry after she leaves that agency. Perhaps you can find such a job there.

I'm sure that Capital One is looking for "insight" into the attitudes and workings of the CFPB and, when ethical waiting periods have expired, access and even credibility, when necessary, to perhaps lessen the impact of the next blow from the CFPB's cudgel. I'm sure that Ms. Fuchs will provide it. Her resume marks her as an extremely bright and talented lawyer. Let's hope that when the door swings back to the regulatory side and she re-enters government service, she has a lot more hands-on experience with the financial services businesses that she's regulating than she had the first time around the block. Maybe she'll start a trend at the CFPB: know something about the business before you start regulating it. The regulated might want to see if things improve with an approach other than on-the-job training.

False Promise

2016-02-28T21:57:00-06:00

Former FDIC Chairman Bill Isaac once called Franken Dodd "the worst piece of financial legislation in modern history" and blasted the law's "Durbin amendment," in particular, as "pure and simple, special-interest politics."

I think the Durbin amendment is really a terrible precedent," Isaac says. "It weakens the banking industry at a time when we need it strong, and the folks who supported the Durbin amendment should be ashamed of themselves."

The subsequent cap placed on interchange fees by the FRB in response to Turban Durbin's amendment caused many bankers and credit union executives, and their trade group representatives, to predict that the only result would be to fatten the pockets of retailers at the expense of both financial institutions and their customers. Over five years down the road, that dire prediction appears to have been spot on, according to a recent opinion piece in the American Banker by the CEOs of the ICBA, CUNA, and NAFCU (people who sometimes are at each others throats on bank vs. credit union issues).

The price controls lawmakers were able to impose on those providing electronic payment options have resulted in an $8 billion annual handout to retailers that they have not passed on to consumers. Five years after the Federal Reserve issued a rule to implement the amendment, retailers have kept most of this revenue — an estimated $32 billion — for themselves.

While Congress may have thought this legislation would provide a benefit to consumers, data from a survey of merchants contained in a recent Federal Reserve Bank of Richmond study indicates that the amendment is simply not working as intended. The report found that "few merchants are found to reduce prices or debit restrictions as debit costs decrease." This just reinforces the argument that the Durbin amendment is essentially a merchant handout from Congress.

Consumer research echoes the reality that retailers are not passing on this revenue in the form of savings for customers. In September, Phoenix Marketing International conducted its fourth annual survey of nearly 2,000 consumers and found that the vast majority of shoppers have not experienced a price drop at the point of sale. In fact, in each of the 15 categories measured, at least 92% of shoppers reported that prices rose or stayed the same over the past year.

The authors further assert that the retailers' trade association claims of several years ago that retailers were passing along the savings to customers, and, more recently, that the fee reduction benefited banks and credit unions, as bald-faced lies.

A study released last week by the Credit Union National Association reported estimated reduced revenue of $1.1 billion for credit unions resulting from Dodd-Frank's regulatory costs, all of which the report attributed to the swipe fee provision. Real data in the form of costs of processing changes and declining fees since 2011 debunks claims that credit unions and small banks below $10 billion in assets are not feeling the pinch. Further, there has been a decline in the interchange rate since the price controls went into effect. It continues to remain around 4 or 5 cents below where it was pre-Durbin, according to a survey by the National Association of Federal Credit Unions.

The authors conclude that rather than trying to blow smoke up the nether regions of financial institutions and consumers, perhaps retailers' time would be better spent figuring out ways to pass along the savings on interchange fees to consumers. Don't believe that conclusion any more than you should the retailers' claims. What financial institutions really want is the repeal of the Durban amendment and the Fed's limit on interchange fees. That won't happen in 2016, but perhaps the next Pontifex Maximus of the Disunited States of America can spare a moment from building "the greatest border wall of all time, a wall that will make the Great Wall of China look like Tom Sawyer's picket fence" to promote some Republican-sponsored legislation to benefit community banks and credit unions for a change, instead of the Wal Marts and Home Depots of the world.

Yes, I know: and perhaps pigs will sprout wings.

Trickle Down Guidance

2016-02-21T21:30:00-06:00

From the FDIC's Office of Inspector General comes an interesting little tale that may have slipped by your attention while you and the family were reveling in the latest bloviations from the walking, talking hairdo that is THE GREATEST SHOW ON EARTH, I PROMISE YOU!!!

The entire incident was triggered by a false alarm about a possible security breach of a third party service provider (TSP) that turned out to be some pesky adware. However, the FDIC IG, operating on the premise that no (non)crisis should ever go to waste, used its investigation of the incident to uncover sloppy security breach incident response policies and procedures by all concerned, including not only the bank and TSP, but by the FDIC's own Risk Management Supervision field office (RMS) as well.

The entire "Case Study" by the IG is less than two pages long, so I won't reiterate it in detail. However, I will use it to bleat about a couple of additional points of my own. The first concerns the application of the FFIEC Interagency Guidelines Establishing Information Security Standards to TSPs.

The Case Study observes:

The InteragencyGuidelines require FIs to develop and implement a risk-based response program to address incidents of unauthorized access to customer information. The Interagency Guidelines also provide that FIs’contractual arrangements shall require that TSPs implement appropriate measures to meet the Interagency Guidelines objectives.

I recently had a TSP respond to a financial institution's request that its agreement for technology services with the TSP (which services would give the TSP access to nonpublic personal information (NPI) of the bank's customers) contain a provision pursuant to which the TSP agreed to protect the security of the NPI with the brilliant argument that the TSP was not a financial institution and, therefore, was not required to comply with the Interagency Gudelines. I not-so-patiently relied that the Guidelines "recommended" that my client make them apply to the TSP via a contractual provision and, since my client took such "recommendation" seriously and incorporated such a requirement into its vendor management policy, if the TSP wanted to do business with the financial institution, its could either agree to the provision or not do business with the institution. The TSP's business people conceded the point and it added a provision to the agreement designed to meet this requirement.

This seems like a fairly common requirement, yet the TSP was a technology service provider that does a lot of work with banks. In the course of the discussion on this point, it was evident that if the vendor's representatives were telling the truth (I accepted their assertions at face value, since it did not alter my client's position whether or not they were truthful), we were the only bank to ever ask for this provision. If that is correct, then the regulators need to be a lot more diligent in their vendor management reviews, because there are a lot of agreements with this TSP that don't comply with the "recommendations" of the Interagency Guidelines. On the other hand, it was the TSP's lawyer putting forth this position, so maybe it was a bald-faced lie.

The IG's Case Study also noted that "[t]he Interagency Guidelines The federal banking agencies, including the FDIC, conduct periodic information technology (IT) examinations at FIs and their TSPs." Other regulatory guidance, such OCC Bulletin 2013-29, "recommends" that financial institutions place in their agreements with TSPs an acknowledgment by the TSP that such examinations are permitted and that the TSP will cooperate in the conduct of the same. I have always considered this a "belt-and-suspenders" approach, designed to ward off unnecessary delay, since the Bank Service Company Act gives the federal bank regulators this power to examine third party service providers. On the other hand, I have had a contract negotiator for one of the country's largest technology service providers tell me that their attorneys have taken the position that the law does not require the TSP to allow the bank's regulator to conduct such an examination. The TSP only permitted them out of the goodness of its heart, I suppose. Regardless, the agreement with the TSP should always have a provision that requires that the TSP to permit, and to provide reasonable cooperation in connection with, such examinations.

A final few nuggets I gleaned from the Case Study: (1) a contract with a TSP needs to require full cooperation with the financial institution in the event of security breach and other provisions that are designed to permit the financial institution to be able to meet its obligations the recommendations under another set of guidelines, the Interagency Guidance on Response Programs for Security Breaches; (2) as part of their initial and ongoing due diligence and monitoring of technology services providers, institutions would be well-advised not to neglect the TSP's security breach incident response programs, and make sure that the TSP complies with "cybersecurity best practices;" and (3) just as the bank has a regulator looking over its shoulder and second-guessing it, so does the regulator. I'm not claiming that this is necessarily a bad thing, but you wonder how much of the effort in this area is directed toward placating Monday Morning Quarterbacks.

Rent-a-Charter vs. Strategic Alliance

2016-02-15T21:58:00-06:00

In June 2004, I wrote a post about schemes by non-bank lenders, especially payday lenders, to "partner" with banks and thrifts in ways that would allow the non-banks to use the bank's or thrift's status to "preemept" "inconvenient state laws, such as those pesky usury limits. As I said at the time:

Apparently, the state-chartered banks involved in this practice are counting on the continued lack of objection by the FDIC, and the continued sympathy of state banking regulators who are eager to increase the number of state-chartered institutions that they regulate. In my opinion, this is a risky course.

I also pointed out at the time that national banks and federal savings banks could rest assured that their primary federal regulator would be scrutinizing their business arrangements with non-banks like Elizabeth Warren looking under her bed every night for a bad banker looking to steal all the cash she has hidden in the sock that she keeps under her pillow.

According to a recent client alert from Chapman and Cutler LLP, this bad old idea not only refuses to die, but has engendered state officials to take action to stop it in its tracks. While the alert discusses the State of Pennsylvania going after payday lenders who've aligned themselves with Native American tribes (which has been a problematic marriage for quite some time), it has wider implications for similar arrangements. In this instance, the Commonwealth of Pennsylvania alleged that the "true lender" for regulatory purposes was not a bank in Delaware that would have been exempt from Pennsylvania usury limits and licensing requirements but the non-bank website "originator" that did most of the origination work and derived most of the economic benefits from the loans. The authors note that in other jurisdictions, the court decisions have not been in lockstep on the issue of preemption, arrangements like the one challenged here are likely always to put the lenders in the regulatory crosshairs.

No clear rule has emerged although regulatory challenges almost certainly are more likely to be made when excessive interest rates and/or abusive sales or collection practices are involved. In this case, the loans imposed interest rates of 200% to 300%.

The alert notes that even though the court's decision involved only a motion to dismiss Pennsylvania's action, and that is a long way from a judgment on the merits, the red flags for financial institutions involved in such relationships are clear "because it demonstrates that plaintiffs will continue to raise the “true lender” theory and courts will not necessarily dismiss at an early stage (for failure to state a claim upon relief can be granted) “true lender” claims solely because a bank is the named lender on the loans, at least where there are allegations that the originating bank does not have substantive duties or an economic interest in the program."

In order to mitigate the risk of claims based on the “true lender” doctrine, companies that engage in internet-based lending programs through an arrangement with one or more banks should consider how the programs are structured. For example, consideration should be given to operations where the bank has substantive duties and/or an economic interest in the program or loans. We are aware that some internet-based lending programs are considering structural changes of this nature.

The firm also advises institutions to make certain that they comply with regulatory guidance governing relationships with service providers. They cite FIL-9-2016 and related FDIC guidance. I'd also suggest taking a look at the OCC's Bulletin 2013-29.

Or, for a change of pace, a bank considering one of these schemes might decide to take its entire capital to The Bellagio in Vegas, walk up to nearest roulette wheel, and lay it all on "00." I mean, if you like dancing along the razor's edge with insured deposits, you might as well go all-in. Plus, you get free booze as long as your money lasts. To hedge your bet, you might want to hold back enough to buy a one-way ticket to Havana (regular flights from the States start soon) just in case that method of income-generation doesn't work out as well as a strategic alliance with a non-bank payday lender.

Activist Investors Betting On Bank Mergers

2016-02-07T22:01:00-06:00

It appears that "activist" investors are turning to banks because they, like many of the rest of us close to the banking sector, think that there will be continued consolidation of the banking industry in the U.S., and what better way to make yourself some hard-earned profits than buying shares in a business and then pushing its board to sell the family farm so you can cash out. Some of you may remember that this model business plan was why the FDIC apparently soured on relying on "private equity" investors to help it clean up the mess after the last banking meltdown.

According to reporters in the St. Louis Post-Dispatch, "[a]ctivist investors are putting the U.S. banking sector in their crosshairs, betting that headwinds whipping through the industry will accelerate consolidation among lenders." The authors cite the rapid uptick in such "activist campaigns" in the financial sector last year, and observe that the "activists" are turning their attention from insurance companies and other non-bank financial businesses to commercial banks.

Hedge funds such as Ancora Advisors, Clover Partners and Seidman & Associates are buying up stakes in lenders across the U.S., from community banks to large regional lenders.

Driving these investments is the view that ultra-low interest rates, lagging returns on equity and tough regulations will push more banks to merge, with buyers willing to pay a hefty multiple to a bank’s tangible book value. Activist investors interviewed by Reuters say another factor is exposure to energy-related loans, which is driving down the valuations of certain banks and making them all the more vulnerable to a takeover.

“Bigger banks are back in the market doing deals,” said Ralph MacDonald, a partner at law firm Jones Day, who specializes in mergers and acquisitions.

U.S. bank mergers and acquisitions volume rose 58 percent last year to $34.5 billion, according to Thomson Reuters data.

The authors think that Zions and Comerica are likely targets. Both "Systemically Important Financial Institutions" had under performing returns on equity last year. That alone makes them prime targets for "activists."

The firm believes that any bank earning a 12 percent or less return on tangible common equity needs to consider whether it can prosper as an independent institution, PL Capital co-founder Richard Lashley said in an interview.

A bank’s exposure to falling energy prices makes it even more vulnerable, he noted. But another key factor is a bank’s ability to maneuver through a climate where low rates are compressing net interest margins, and stricter regulations are increasing costs.

“Management teams and boards are just exhausted,” said Lashley, who is based in New Jersey. “It’s not fun to run a bank anymore.”

However, the article also contains a quote from a community bank chief that indicates that the trend to consolidate is not just for SIFIs.

“My phones are ringing off the hook with calls coming in from banks wanting to sell,” said Pat Hickman, the CEO of Happy State Bank, a lender in the Texas panhandle. “And one of the primary reasons is regulation.”

Yes, it's not fun to run ANY bank anymore, not just the large ones. Whether your a big bank or a small one, publicly traded or privately held, pressured by "activist" investors or simply by the facts of life: as we said a few weeks ago, 2016 will very likely be the year of the bank merger.

Yes, Virginia, There Is A Regulatory Burden On Small Banks

2016-01-24T21:38:00-06:00

Preston Ash of the Federal Reserve Bank of Dallas, sent me (on New Years Eve, no less) an article co-authored by Preston and Christoffer Koch and Thoma F. Siems of the Dallas Fed, entitled "Too Small to Succeed?--Community Banks in a New Regulatory Environment." Notwithstanding my semi-inebriated initial misunderstanding as to whether or not Ash was calling me out for stealing his idea for an article, it quickly was made clear to me that the authors wanted to share their thoughts with me because we all are thinking along the same lines (as evidenced by my blog post of December 27, 2015) to wit: the regulatory burden on community banks is reducing their number.

An excerpt from their article:

In 1992, community banks accounted for 64 percent of $4.6 trillion in total banking assets. By 2015, their market share had dropped to 19 percent of $15.9 trillion in total assets (Chart 1). Despite this decrease, community banks still account for the largest share of small-business loans. Currently, small- and medium-sized banks hold 55 percent of small-business loans and 75 percent of agricultural loans.

In twenty-three years, total assets of financial institutions in the U.S. have nearly quadrupled, yet community banks share of that total has shrunk from nearly two-thirds to less than one-fifth. At the same time that the big banks were getting bigger, they were leaving it to the incredibly shrinking community banking segment to make the majority of small business loans and three-quarters of all agricultural loans. The large banks are growing ever larger, yet are failing to serve the majority of the nation's main job creators, small businesses, leaving that task to the ever-decreasing number of remaining community banks.

After noting what we (and many others) have observed, that the lack of new charters since 2008 is an "alarming" contributing factor to decreasing the total number of community banks, the authors state that from their own conversations with bankers in their district, bankers seem to believe that the top reason for the shrinkage is "regulatory burden." The authors ask, "Are their concerns justified?" Among the factors that lead them to conclude in the affirmative are the following:

Call reports have grown from 30 pages in the 1980s to 84 pages today.
"At the end of 1970, Call Reports contained 53 items that banks filled out; this past quarter's filing included 2,379 items, with recent additions of more off-balance sheet and memoranda items."
"From 2001-10, 10 major banking acts became law, totaling 1858 pages."
"Feldman, Schmidt and Heinecke (2013) at the Federal Reserve Bank of Minneapolis find that the median reduction in profitability (return on assets) for the smallest banks—those banks with assets less than $50 million—is 14 basis points if they have to increase staff by one-half of a person and 45 basis points if they increase staff by two people." In other words, the smaller the bank, the more of a proportionate burden it is to hire the staff to comply with increased regulatory compliance and reporting requirements.

The authors conclude that community bankers have a legitimate beef.

[S]maller community banks appear to have a valid concern that their compliance burden is rising and the playing field is becoming more uneven. Regulatory oversight should match the level of risk an institution poses to the financial system and economy at large. Otherwise, more banks may become too small to succeed.

It's not just bloviating bloggers who are sounding the trumpet for regulatory relief. Some actually responsible regulators are also playing the same tune. Of course, it's a presidential election year and the masters of gridlock in D.C. are not likely to cooperate on much until the grass crown is awarded to the next Cynic-in-Chief. Still, bank lobbyists need to use this ammunition to fire away at their senators and congresspersons, because this is a trend that will not likely reverse itself of its own accord.