We are receiving quite a few calls regarding the recent activity surrounding trust preferred securities, including voluntary and involuntary bankruptcies, restructurings, acquisition opportunities, and potential personal liability of directors. Given this level of interest, Bryan Cave attorneys will be presenting at the Georgia Bankers Association Trust Preferred Town Hall Meeting in Macon, Georgia on August 6, 2014. A flyer and agenda for the event is linked here, and you can register by clicking here. The town hall format of the event will allow for interaction with the presenters and with the other attendees. We will share ideas that will benefit those who are looking for alternatives to work out their trust preferred obligations, those who hold trust preferred securities, and those looking to better understand the landscape to take advantage of opportunities. We hope you will join us for this unique opportunity.
On July 21, 2014, the FDIC issued a Financial Institutions Letter (FIL) on the impact of the capital conservation buffer restrictions under Basel III on S Corporation banks. The guidance essentially states that, even though Basel III restricts an S Corporation bank’s ability to pay tax distributions if it does not maintain the full capital conservation buffer, the FDIC will generally approve requests to pay tax distributions if no significant safety and soundness are present. The succinct guidance probably raises more questions than answers. Among those questions are the following.
- Would a bank that does not meet the capital conservation buffer requirements ever really be 1 or 2 rated and experiencing no adverse trends?
- Does the FDIC believe Obamacare and the related net investment income tax will be repealed? What about state income taxes? The factor limiting the dividend request to 40% may ignore what is actually required to allow shareholders to fund their tax liabilities.
- What is an “aggressive growth strategy?” Is it the same as an intentional growth strategy?
- If your institution is a national bank, a Fed member bank, or a bank holding company with more than $500 million in consolidated assets, will the Fed and the OCC follow suit and issue similar guidance?
At the end of the analysis, the guidance is probably similar to the current capital rule stating that 1 rated institutions may have a leverage ratio as low as 3.0% and still be considered “adequately capitalized.” That rule has little practical impact in that it is awfully hard to find an institution with a 3.0% leverage ratio that is 1 rated. Similarly, we believe any institution that meets the guidelines set forth in the FIL would almost certainly have no need to make this request. Indeed, the FIL itself seems to acknowledge that fact.
When a lender underwrites a loan application it examines the borrower’s business and makes a decision about whether the business model is acceptable to it, whether cash flows are adequate and whether sufficient collateral exists to secure the loan. If the borrower is expanding its business operations the lender may decide whether the new operations make sense to it. Likewise, if a borrower is purchasing a major piece of equipment the lender might indicate that it does not finance certain items or it might say that it only finances such equipment on certain terms. The point is that the terms of what the lender finds acceptable will be contained in a commitment letter setting out all of the terms of the loan or in the actual loan documentation. As part of that process the lender may be a part of conversations the borrower has with various vendors such as ones selling major pieces of equipment or building major projects.
What happens if the lender decides that it wants to communicate directly with the vendor to ask questions about the product being sold? What if they have objections about the contract itself, can they express those directly to the vendor as opposed to dealing directly with the borrower? Can they request that changes be made to the contract without consulting with the borrower? Even if they can do it from a pure legal standpoint, is it a good idea? A recent case (Velocity Press v. Key Bank, N.A., 2014 WL 2959460 (CA10 2014)) would suggest that engaging in such behavior is problematic.
The lender agreed to provide a line of credit to a company in order to purchase a custom printing press from the manufacturer for $1,797,229. Under its arrangement with the manufacturer the borrower was scheduled to make several progress payments: 30% down, 30% halfway through manufacturing, 35% when the press was completed and operating on the manufacturer’s floor and the final 5% when installation of the press was finished at the borrower’s plant.
Out of the original investment of $204.9 billion in 707 institutions under the TARP CPP program, the U.S. Treasury currently only holds its original investment in 44 financial institutions representing a total outstanding investment of $422 million. In other words, the Treasury still holds its investment in about 6% of the financial institutions invested in through the CPP program, but those institutions represent only 0.2% of the amount invested. As the U.S. has already collected $225.9 billion in total TARP CPP proceeds, the ultimate disposition of the remaining 44 financial institutions will have no material impact on the $20 billion gain recognized by the U.S. Treasury through the TARP CPP program.
The 44 remaining TARP CPP investments range from $1 million to just over $50 million, with an average original investment of $9.6 million. 35 of the 44 remaining institutions have missed dividend/interest payments, with a total of $72 million in missed dividend payments (which includes $20 million in missed non-cumulative dividends that the institutions have no obligation to repay). Overall, the remaining portfolio investments have missed 11.5 quarterly dividend payments, but if you exclude the 9 institutions that remain current, the average investment has missed 14.5 quarterly dividend payments.
The Georgia Supreme Court issued its long-awaited decision in FDIC v. Loudermilk on Friday, addressing whether the FDIC’s ordinary negligence claims against former directors and officers of failed banks are precluded by the business judgment rule. There is a lot to digest in the Court’s 34-page opinion, but here are our initial thoughts.
The upshot for bank directors and officers in Georgia is that the business judgment rule is very much alive, and applies to banks to the same extent as other corporations. That itself is big news—the Georgia Supreme Court had never addressed whether the business judgment rule exists in any context, and the FDIC had argued that if the rule existed at all, it did not apply to banks because the Banking Code imposes an ordinary negligence standard of care. Much of the Court’s opinion is devoted to explaining how the business judgment rule developed as a common law principle and refuting the argument that the statute trumps the rule.
The Court explained, however, that the business judgment rule does not automatically rule out claims that sound in ordinary negligence. It distinguished claims alleging negligence in the decision-making process from claims that do no more than question the wisdom of the decision itself. A claim that a directors disregarded their duties by failing to attend meetings, for instance, could survive a motion to dismiss. A claim that the decision itself was negligent, without any allegation relating to the process leading to the decision, will not survive.
One of the most dramatic tools a lender can use in the collection of a loan is the involuntary bankruptcy case. It is dramatic because of the implications for both the debtor and the lender who files the case. If a bankruptcy court determine that the petitioning creditor has not met the statutory requirements it may require the creditor to pay the debtor’s costs and attorneys fees in defending the petition and if the court finds that the petition was filed in bad faith it can award compensatory and punitive damages. The consequences for the debtor are that if the creditor is successful, the debtor’s business and assets are now subject to disposition under a frameworks found in the Bankruptcy Code which may involve the appointment, at least initially, of a bankruptcy trustee to administer the debtor’s estate. Even if the debtor is successful in fighting off the petition it may suffer dramatic reputational risks that might affect its continued viability. Think of it then as the “nuclear” option.
This tool has now been used at least twice in connection with the enforcement by holders of Trust Preferred Securities (“TruPS”) against bank holding companies (“BHCs”). TruPS are hybrid securities that are included in regulatory tier 1 capital for BHCs and whose dividend payments are tax deductible for the issuer. In 1996 the Federal Reserve Board’s decided that TruPS could be used to meet a portion of BHCs’ tier 1 capital requirements. Following that decision many BHCs found these instruments attractive because of their tax-deductible status and because the increased leverage provided from their issuance can boost return on equity.
Smaller BHC’s typically did not bring TruPS to the market themselves, rather they were issued into a collateralized debt obligation (“CDO”) which in turn purchased TruPS from many different BHCs. According to Fitch since 2000 over 1,800 entities issued roughly $38 billion of TruPS that were purchased by CDO’s. In addition, many federally insured institutions held TruPS themselves once the banking regulators determined that TruPS were an acceptable investment.
On May 9, 2014, the Georgia Securities Division issued a proposed rule to create a formal process for fairness hearings to be conducted by the Georgia Commissioner of Securities. The proposed rule would establish procedures for administrative hearings to determine the fairness of certain mergers and other business combinations in which securities are issued. If the Commissioner determines that the terms of the proposed transaction are fair to the shareholders receiving securities, the issuer would be able to claim an exemption from the registration requirements of the federal Securities Act of 1933 for the securities to be issued. Specifically, Section 3(a)(10) provides an exemption from the registration requirements of the federal Securities Act for securities issued in a transaction determined to be fair pursuant to a fairness hearing by a governmental authority. The exemption from registration with the SEC is particularly valuable for companies that are not currently subject to the periodic reporting requirements under the Securities Exchange Act of 1934.
In our view, fairness hearings conducted by the Georgia Commissioner will make it easier for private bank holding companies to use stock to fund the purchase price for acquisitions. Not only will the hearing process allow companies to avoid filing a Form S-4 registration statement for the acquisition with the SEC, it will also allow the companies to avoid triggering the significant ongoing expense associated with the periodic reporting and disclosure requirements of the Securities Exchange Act of 1934 and the Sarbanes-Oxley Act. We have seen circumstances in which the registration and ongoing reporting requirements have discouraged a company from using stock as a currency for an acquisition.
States such as California and North Carolina have conducted state fairness hearings similar to those described in the proposed rule for some time. Following the re-write of the Georgia Securities Act in 2008, Georgia has only conducted one fairness hearing, which involved the merger of two financial institutions in late 2013. The proposed rule would provide more clarity and certainty with respect to the fairness hearing process in Georgia.
How a bank compensates mortgage loan officers can present legal risk for the bank. Banks need to make sure their compensation practices comply with the federal Fair Labor Standards Act and related state laws, as well as Regulation Z.
Threshold Question: Are Loan Officers Exempt or Non-Exempt?
The exempt / non-exempt status of mortgage loan officers has been heavily-litigated in recent years and has been the subject of several Department of Labor opinion letters. The inquiry remains very fact-specific and depends on what the loan officers actually do not just on their job descriptions. Relevant questions include:
- How the mortgage loan officers are compensated (salary basis, hourly basis, commissions, etc.)
- How much time (hours/week) the loan officers spend in the office (including a home office)
- What the loan officers do while in the office.
- What they do while working outside of the office.
- How involved the loan officers are in generating sales. (e.g., meeting with prospective borrowers at their homes or other locations, meeting with referral sources such as real estate agents, developers, etc.)
- How much time (hours/week) the loan officers spend generating sales.
- Others duties and responsibilities of the loan officers.
- How much time (hours/week) loan officers spend on those other duties and responsibilities (e.g., completing loan applications, gathering credit information and other documentation for the loan application process, etc.)
- How much judgment and discretion the mortgage loan officers exercise.
- How much flexibility the mortgage loan officers have in setting work hours and schedules.
With attorneys and staff worldwide, Bryan Cave attorneys are often quoted in the news. Recent mentions of Financial Institutions group attorneys include:
Walt Moeling in American Banker
Walt Moeling was quoted May 8 by American Banker concerning an uptick in interest from outside investors in the Florida banking industry. A number of banks in the Midwest and elsewhere poured money and resources into Florida a decade ago, only to absorb large losses when the housing market collapsed. “That was an interesting phenomenon,” Moeling said. “The theory is that Florida has good deposits and is a good growth market . . . But those who fail to learn from history are doomed to repeat it. The truth of the matter is it is very hard to be successful in a totally different market where you don’t have a lot of experience.”
Judith Rinearson and John ReVeal in Pay Magazine
Judith Rinearson and John ReVeal authored an article for the spring edition of PayBefore’s Pay Magazine concerning the importance of crafting agreements between banks and their third-party vendors that will withstand the scrutiny of regulators. “Recent regulatory publications, examinations and enforcement actions suggest that the standards and expectations by which regulators evaluate banks’ third-party relationships now are significantly more exacting,” they wrote. “They’re digging deeper on how banks select their third-party vendors, and the scope of their review is extending to more and more vendors. This increased focus makes it critically important for banks and their partners to get their relationships right from the start by setting their own appropriate expectations and establishing standards for oversight, access and follow through. And, the contract is the key. Click here to read their full article.
Margo Strahlberg in Paybefore News
Margo Hirsch Strahlberg was quoted April 29 by Paybefore News regarding a qui tam action involving the state of Delaware relating to claims that nearly two dozen well-known retailers avoided escheating unused gift card balances to the state through the use of special purpose entities organized in other states. Delaware law enables the state to collect unclaimed property, including gift card funds that have gone unused after five years, from companies incorporated in the state. Strahlberg said Delaware’s pursuit of legal action in this case doesn’t mean other states will follow the strategy of seeking court intervention. “The states will still continue to pursue legislation in their attempt to grab at unclaimed funds,” she told the publication. “Delaware always has been known as an aggressive state with respect to unclaimed property, so its willingness to rely on the courts comes as no surprise.”
On May 6, 2014, the CFPB issued proposed amendments to the mortgage rules under the Truth in Lending Act (TILA) affecting Regulations Z and X. The proposed amendments affect the small servicer/small creditor exceptions to the mortgage rules and the “Qualified Mortgage” determination. The CFPB proposes to partially re-define who may qualify as a “small servicer” under § 1026.41 of Regulation Z (incorporated by cross reference in Regulation X), revise the scope of the nonprofit small creditor exemption from the ability-to-repay rule in § 1026.43(a)(3)(v)(D) of Regulation Z, and establish a limited cure procedure where a creditor inadvertently exceeds the “Qualified Mortgage” points and fees limits.
Amendment to the “Small Servicer” Definition: The CFPB originally presumed that most nonprofits would qualify for the “small servicer” exemptions. However, during implementation of the mortgage rules, the CFPB learned that certain nonprofits might not qualify as “small servicers” because they were part of a larger association of nonprofits that are separately incorporated but that may operate under mutual contractual obligations, share a charitable mission, and use a common name or trademark. In order to save resources, such associations sometimes consolidate servicing activities, with one of the associated entities providing loan servicing to one or more others, for a fee. Under current rules, such nonprofit servicers would not qualify for the “Small Servicer” exemptions because they service, for a fee, loans on behalf of a non-“affiliated” entity. The CFPB proposes to amend the definition of “Small Servicer” so as not to exclude qualified nonprofit entities within such formal associations where certain requirements are met. Related changes to the section’s formal comments are also proposed.