Monday, October 20, 2014
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Many bank boards are considering a sale of their institution for a variety of reasons—heightened regulatory burdens, board and management fatigue, or an opportunity to partner with a growing bank are just a few. But while the financial crisis has taught important lessons about bank management, for many bank directors, the sale of their financial institution is uncharted territory. As you typically only have one opportunity to get it right, directors considering a sale should focus first on establishing a sound process around the board table.

Although it is rational for directors to worry more about specific aspects of the proposed deal than procedural matters, we have found that establishing an appropriate process for considering a possible transaction is often a prerequisite for success on the business issues. Moreover, in today’s world of heightened scrutiny of board actions, Directors cannot neglect procedure and expect to fulfill their duties of loyalty and due care.  In most states, fulfilling those duties gives directors the benefit of the business judgment rule, which insulates directors from liability provided the decision is related to a rational purpose.

In the context of a sale, most directors can meet their duty of loyalty by acting in good faith to achieve the best result for the company and its shareholders and by disclosing any conflicts of interest to the board prior to the beginning of the deliberations. But with respect to the duty of care, establishing a thorough process leading to a sale is key. A recent court case decided in Georgia provides a helpful roadmap.

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Wednesday, October 8, 2014
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Adding or upgrading mobile banking is a major project, as is simply changing a bank’s vendor or service provider for mobile banking. This article summarizes the steps involved in doing so.

The banking regulators have all issued guidance on outsourcing activities to third parties. By any measure, a mobile banking service provider is a significant or critical relationship for a bank. The data security demands are significant and the bank is subject to significant strategic, reputation, operational, transaction, and compliance risks, among other risks.

Time may be the single most important consideration. To get the best deal for your bank, start the process of evaluating potential providers, selecting a vendor and negotiation a services agreement 12-18 months before an existing contract is due to renew or before your bank needs to launch a new service.

Due to the significant and high risk nature of mobile banking services, a bank should engage in comprehensive due diligence of its proposed service providers. (And yes, it is recommended that the bank engage in due diligence with more than one service provider, both to ensure it understands the marketplace and also to ensure that it gets a “market” level of service and healthy competition for its business.) Comprehensive due diligence means reviewing financial statements, verifying the vendor’s relevant experience (success in implementing mobile banking for comparable banks) and reputation with comparable banks, the vendor’s regulatory relationships, results of past exams and audits, litigation history, performance issues, data security issues, and consumer complaint history. If the vendor will subcontract or outsource any part of the services, the bank should perform comprehensive due diligence on those subcontractors as well.

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Monday, September 8, 2014

In companion opinions issued on August 19, 2014, the Supreme Court of Missouri held that unfair practices associated with residential foreclosures occur “in connection with” the original sale of a mortgage loan and therefore fall within the scope of the Missouri Merchandising Practices Act (“MMPA”).  See Conway v. CitiMortgage, Inc., — S.W.3d —-, No. SC 93951, 2014 WL 4086671 (Mo. banc Aug. 19, 2014); Watson v. Wells Fargo Home Mortg., Inc., — S.W.3d —-, No. SC 93769, 2014 WL 4086486 (Mo. banc Aug. 19, 2014).  In Watson, however, the court also held that unfair practices associated with loan modification negotiations between a lender and borrower do not occur “in connection with” the original sale and cannot form the basis for an MMPA claim.

The MMPA is a consumer fraud statute that provides both the Missouri Attorney General and consumers the right to bring actions against individuals who engage in unfair or deceptive practices “in connection with” the sale or advertisement of merchandise.  See R.S. Mo. § 407.010, et seq.  The statute permits consumers to recover damages for “ascertainable losses,” as well as punitive damages and attorneys’ fees.

In Conway and Watson, the Supreme Court of Missouri considered whether mortgage lenders may violate the MMPA by virtue of either: (1) their foreclosure-related practices, or (2) their loan modification negotiations with borrowers.  In Conway, the court concluded that, with respect to mortgage loans, the original “sale” continues throughout the life of the loan by virtue of the long-term relationship between the parties and the duties imposed upon each party by the loan documents.  As a result, the court held that any unfair practices associated with residential foreclosures occur “in connection with” the original sale even when the foreclosure occurs years afterward.  Furthermore, the court held that third parties who did not originate the loan, but only acquired the loan years later, could still be held liable under the MMPA.

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Wednesday, September 3, 2014
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On August 29, 2014, Judge John T. Laney, III, the Chief United States Bankruptcy Judge for the Middle District of Georgia, issued an order denying FMB Bancshares’ motion to dismiss the involuntary bankruptcy petition filed by its TruPS creditor, Trapeza CDO XII.  Among other conclusions, Judge Lacey found that the restrictions contained in FMB Bancshares’ written agreement with the Federal Reserve constituted a a restriction on the company’s ability to pay, rather than its legal duty to pay.  While detrimental to FMB Bancshares’ motion to dismiss, this conclusion should reinforce the ability of third parties to enter binding contractual arrangements with bank holding companies, which should be of great relief to those willing to lend to bank holding companies.

As reflected in the opinion and other court documents, FMB Bancshares issued $12 million in Trust Preferred Securities to Trapeza CDO XII in 2006.  Starting in March 30, 2009, FMB Bancshares elected to defer payments under its TruPS, and on March 30, 2014, FMB Bancshares exhausted the twenty consecutive quarter deferral period.  Trapeza has alleged that FMB Bancshares was non-responsive to Trapeza’s efforts to find an out-of-court solution, and declared the TruPS in default on April 7, 2014, causing an acceleration of all principal and interest.  On June 9, 2014, Trapeza filed an involuntary bankruptcy petition for FMB Bancshares, indicating that it believed an auction under Section 363 of the Bankruptcy Code would maximize its return.  On July 3, 2014, FMB Bancshares filed a motion to dismiss the bankruptcy petition, arguing (1) that Trapeza did not have the right (or standing) to institute an involuntary bankruptcy under the terms of the TruPS, (2) that FMB Bancshares was unable to pay because of its regulatory obligations with the Federal Reserve Bank of Atlanta, resulting in the debt being legally contingent, and (3) that the bankruptcy court was not the right venue for the disagreement.

In a 20-page opinion, Judge Laney succinctly rejected each of FMB Bancshares’ arguments.

With regard to Trapeza’s standing to institute the involuntary bankruptcy filing, Judge Laney found that the terms of both the Indenture and Amended Trust Agreement provided Trapeza CDO, as the the holders of the Trust Preferred Securities, with broad powers to enforce their rights against FMB Bancshares directly following the event of default (the occurrence of which was conceded by FMB Bancshares).  Specifically, both the Indenture and Amended Trust Agreement provided, following an event of default, that any holder of TruPS had a contractual right to institute a suit or proceeding directly against FMB Bancshares for enforcement of payment.  Judge Laney found that  an involuntary bankruptcy case could be properly construed as a suit for enforcement of payment, noting that bankruptcy cases in other jurisdictions reached the same conclusion.

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Tuesday, September 2, 2014
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Over the past several years reports of someone extending credit to a community bank holding company were similar to sightings of the Yeti in the Himalaya, you might hear about it but you never actually saw one. The number of bank failures and the consequent insolvency of many bank holding companies has led to a natural reluctance on the part of many lenders to provide such financing. The losses that many lenders suffered on such loans has raised some interesting questions about the loans were structured to begin with. The typical loan documentation for such a credit usually has traditionally had only a few financial covenants. The obligation to maintain well capitalized status for both the bank holding company and the subsidiary bank has been the primary focus on the assumption (not altogether incorrect) that maintaining a strong capital base cures many sins. Other covenants might address the ratio of non-performing loans to total capital, the ratio of the Allowance for Loan and Lease Losses to classified assets or simply the bank’s Texas ratio.

Historically, banks generally use financial covenants in loan documents as a signal to either cause the borrower to take immediate action to right the ship or to allow the lender to exit the relationship.  In theory, the “early signal” approach works in many types of businesses and industries. It has proven, however, to be problematic in the banking industry. The issue that lenders have run into is that a loan to a bank holding company is unlike any other type of loan they might make. In a nonbanking environment the lender might seek to take control of the assets and liquidate them.  At the end of the day the lender is free to liquidate assets and apply the proceeds toward the loan within a broad framework provides by general contract law and the UCC. A loan secured by a controlling interest in a bank presents a different situation.

When the subsidiary bank gets into financial distress the lender to the bank holding company can be presented with a difficult dilemma. During this past recession, it was not unusual to see banks downgraded from 2 to 5 on the CAMELS ratings in one examination cycle and to fall from being well capitalized very quickly. Thus, the early warning nature of the traditional financial covenants were of almost no assistance whatsoever to the lender. Once the subsidiary bank was considered “troubled” and prevented from making dividend payments to the holding companies, bank holding company loans quickly moved into default and in many cases had to be written off completely. Another particularly damaging element was the use by banks of  interest reserves for loans in the ADC portfolio. Interest reserves served to mask a decline in the quality of the underlying loans in that a loan may show as current on the bank’s books while in reality the real estate project has stalled.

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Thursday, August 21, 2014
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FinCen Updates Customer Due Diligence Requirements

Modern entertainment, whether it be books or movies,  oftentimes grapple with the issues of “who are you?” As a story line develops the audience is kept guessing as characters turn out to have different motivations or identities than what they were first perceived to have. Political thrillers oftentimes involve agents of shadowy groups behind which the true masterminds operate. How much effort will it take to reach the truth? FinCEN has recently come out with some proposed guidance that addresses this issue in the context of the legal entities that financial institutions do business with.

In a proposed rulemaking published in late July, FinCEN proposed a new regulatory requirement to identify beneficial owners of legal entity customers. Going forward, the essential elements of customer due diligence will include: (i) identifying and verifying the identity of customers; (ii) identifying and verifying the identity of beneficial owners of legal entity customers (i.e., the natural persons who own or control legal entities); (iii) understanding the nature and purpose of customer relationships; and (iv) conducting ongoing monitoring to maintain and update customer information and to identify and report suspicious transactions.

The first element is already something which financial institutions address as part of their customer identification program (“CIP”). The second element is the subject of the proposed rulemaking. In order to identify the beneficial owner, a covered financial institution must obtain a certification from the individual opening the account on behalf of the legal entity customer (at the time of account opening). The certification form  requires the individual opening the account on behalf of a legal entity customer to identify the beneficial owner(s) of the legal entity customer by providing the beneficial owner’s name, date of birth, address and social security number (for U.S. persons). Significantly, the rule also requires financial institutions to verify the identity of the individuals identified as beneficial owners on the certification form. The procedures for verification are to be identical to the procedures applicable to an individual opening an account under the existing CIP rules.

The proposed definition of “beneficial owner” includes two independent prongs: an ownership prong (clause (1)) and a control prong (clause (2)). A covered financial institution must identify each individual under the ownership prong (i.e., each individual who owns 25 percent or more of the equity interests), in addition to one individual for the control prong (i.e., any individual with significant managerial control). If no individual owns 25 percent or more of the equity interests, then the financial institution may identify a beneficial owner under the control prong only. If appropriate, the same individual(s) may be identified under both criteria.

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Tuesday, August 5, 2014
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Revised Guidance on Third Party Payment Processors

The FDIC issued a “clarification” on July 28 to the effect that banks had gone overboard in their reaction to the FDIC’s expressed concerns about third party payment processors. The pressure the banks have been subjected to is related to “Operation Choke Point” where the Justice Department, with the assistance of the federal bank regulators, have attempted to block of the flow of funding to certain businesses such as payday lenders by attacking the ability of third party payment processors who deal with the targeted businesses to maintain deposit accounts  with commercial banks. The expressed regulatory reason for this was that banks were exposed to undue reputational risk by assisting such companies to stay in business. While the ability of some of the underlying companies to operate across state lines is currently being litigated by various parties across the US including local cities, the FTC and the New York Attorney General, the businesses for the most part conduct businesses where they are located.

Operation Choke Point has received a great deal of publicity, particularly since it seeks to cut off funding to businesses whose operations are not illegal. The rub being that regardless of what you believe the merits of payday lending to be, once an agency of the federal government decides to put the squeeze on one line of commercial business, what stops them from picking on other lines business. In other words, why do they get to pick and choose who the winners and losers might be and isn’t there some risk that politics can raise its ugly head in the process.

The FDIC and the OCC published Guidance in November of 2013 where they define Reputation Risk as:

Reputation risk is the risk arising from negative public opinion. Deposit advance products are receiving significant levels of negative news coverage and public scrutiny. This increased scrutiny includes reports of high fees and customers taking out multiple advances to cover prior advances and everyday expenses. Engaging in practices that are perceived to be unfair or detrimental to the customer can cause a bank to lose community support and business.

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Monday, August 4, 2014
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With attorneys and staff worldwide, Bryan Cave attorneys are often quoted in the news.  Recent mentions of Financial Institutions group attorneys include:

Jerry Blanchard in the Atlanta Journal-Constitution

Atlanta Partner Jerry Blanchard was quoted July 18 by The Atlanta Journal-Constitution on reasons behind the shrinking number of banks in Georgia. The state, which led the nation in bank failures stemming from the real estate bust, has seen an increase in the number of banks being bought up at a rate of about one a month as healthy banks grow through the acquisition of other healthy banks. Blanchard said the question on many bankers’ minds is, “Can you survive the recovery? It’s hard to make money.” Click here to read the full article.

Rob Klingler in American Banker

Atlanta Partner Robert Klingler was quoted July 1 by American Banker concerning the trend among trust-preferred creditors of telling deadbeat banks that they must negotiate repayment or be forced into liquidation. Trapeza Capital Management filed legal documents recently to force FMB Bancshares in Lakeland, Ga., into involuntary bankruptcy. Trapeza, which manages a collateralized-debt obligation containing FMB’s trust-preferred securities, said in its filing that it is owed $13.6 million in unpaid debt and interest. FMB is the second lender to face involuntary bankruptcy over unpaid trust-preferred dividends. “Involuntary bankruptcies send a clear signal that doing nothing does not appear to be a good strategy,” Klingler said. “When you’re in default and tell your creditors you can’t do anything, you’re asking for an involuntary bankruptcy.”

Walt Moeling in SNL Financial

Atlanta attorney Walt Moeling was quoted July 10 by SNL Financial regarding the increase in bank M&A in Georgia this year. These recent transactions are simply logical, said Moeling, who noted that acquirers today have excess capital and outstanding commitments to put those funds to work, and they often are looking to rationalize fragmented franchises. Moeling agreed buyers are becoming more assertive and attributed some of the increased confidence to the fact that potential sellers are sitting on firmer ground. “They’re picking up a much smaller amount of problem assets and so there is a willingness to be a little more aggressive in doing acquisitions and again that’s only logical,” he said.

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Friday, July 25, 2014
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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.

Tuesday, July 22, 2014
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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.

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