One of the ideas incorporated into the Regulatory Reform Act has been the so-called Volcker Rule, named after former Federal Reserve Chairman, Paul Volcker. Volcker’s proposal was that banks should not be engaged in speculative trading for their own accounts. For example, holdings in mortgage backed securities caused huge losses for the nation’s largest banks.
The rule has now made it into the conference committee’s version of the bill although in a somewhat watered down version of what Volcker had originally proposed. The bill in its current version would prohibit a bank from investing more than 3% of its tier 1 capital in a private equity hedge fund and would also prohibit a bank from owning more than 3% of the equity in such a fund.
As a practical matter, these limits probably work to the advantage of large banks. The limit still allows large financial institutions to invest billions of dollars of their own money in speculative trades. It may also have the unintended consequence of causing some institutions to move money that they currently have invested with hedge funds and managing the investments themselves.
(more…)
One of Silverton Bank’s line of business was making loans to bank directors secured by stock in the borrower’s bank or bank holding company. Upon the failure of Silverton the directors were informed that the FDIC did not have a then current intent to sell those loans as it was doing with all of the other assets held by Silverton.
Recently the contractor hired by the FDIC to manage those loans has indicated that there has been a change in plans and plans are being put in place to sell the loans through a DebtX auction. Many directors have concluded that it would be in their best financial interest to try and negotiate a discount on the loan prior to its being sold to a third party. While this may make short term financial sense, there is an issue lurking in the shadows that many directors are not aware of.
A senior FDIC official recently informed a group of bankers that the supervisory side of the FDIC would look disapprovingly on any directors who discounted their director loan with Silverton on the basis that to do so caused the FDIC insurance fund to suffer a loss. While it is difficult to predict how firmly the position may be held by the FDIC, the longer term consequences may be significant if that director seeks to become involved with another bank in the future. Thus, any director, particularly management directors, should carefully weigh all of their options and seek capable legal advice before seeking to discount their loan.
There may be strategies to minimize risk to the director but those require a case by case analysis of the facts and circumstances surrounding the loan. Please contact Jerry Blanchard (404.572.6804) or your regular Bryan Cave contact if you would like to discuss these strategies.
On February 9, 2010, a federal district court in Macon, Georgia issued a noteworthy decision in a dispute over a participation agreement finding the lead bank to have breached the agreement and ordering the lead bank to repurchase an interest from a participating bank.
The case of Sun American Bank v. Fairfield Financial Services, Inc. involved a claim by Sun American that Fairfield Financial had breached its obligations under a loan participation agreement involving a condominium project in north Florida. Sun American contended that Fairfield Financial had breached the agreement by failing to disclose to participants in a timely manner the downgrades in its credit relationship with the borrower and of circumstances that were likely to have a material, adverse effect on the loan. Sun American sought to compel Fairfield Financial to repurchase its interest in the loan as a remedy for the breach.
Judge Ashley Royal, of the United States District Court for the Middle District of Georgia, granted summary judgment in favor of Sun American finding that Fairfield Financial had failed to meet its disclosure obligations to the participants. Judge Royal noted that the disclosure requirement with respect to credit downgrades was particularly important given that the lead bank possessed substantial information regarding the borrower’s affairs that was not available to Sun American as a participant bank.
(more…)
On February 11, 2010, the Governor signed House Bill 926 (HB 926), an amendment to the Georgia legal lending limit statute, to permit banks to renew maturing loans without violating the legal lending limit statute. The Georgia legal lending statute is found at Ga. Code Ann.§ 7-1 -285. The statute is supplemented by the rules adopted by the Georgia Department of Banking and Finance, specifically Rule 80-1-5-.01(12). The amendment was proposed as a solution to a problem which many banks are currently facing due to a reduction in their capital base. At issue is the language in the Rule which states that a bank may not renew a loan which although proper when made would now no longer meet the legal lending limit requirement.
“(12) Where the “statutory capital base” as defined in Section 7-1-4(35) is reduced by operating losses, loan losses, or for other reasons, existing debt which was in conformity with the legal limitations at the time it originated shall not be construed to be non-conforming with new legal limitations resulting from the reduced statutory capital base; provided, however, in the absence of agreements to the contrary and originating at the time such debt originated regarding repayment programs for the debt in question, any extension, renewal, rollover or the like of the existing debt shall be determined to be a new loan and must conform to the new, lower lending limitations.” (emphasis added)
Due to a shrinkage in capital many banks are faced with loans which are maturing but that the regulations will not allow to be renewed. As a practical matter these loans are not subject to being repaid immediately due to lack of liquidity by borrowers nor are there any other financial institutions willing to take over the credits. Banks are forced to enter into forbearance type arrangements which does not result in the loan being renewed and must carry the loan on their books as past due.
(more…)
A number of banks have recently been examining the possibility of raising capital through the sale of a minority interest in a subsidiary set up to hold bank owned real estate such as bank headquarters and branches.
Part 325 of the FDIC Rules and Regulations indicates that Tier 1 Capital includes minority interests in equity capital accounts of those subsidiaries that have been consolidated for the purpose of computing regulatory capital, (except that minority interests which fail to provide meaningful capital support are excluded from the definition). Stock held by minority shareholders in a bank controlled subsidiary whose assets are consolidated with those of the bank are not generally recognized as equity capital under GAAP, but the bank regulatory agencies have in the past counted it as regulatory capital.
We have been informed by the FDIC that the current regulatory view of such transactions is not favorable. Their position is that subsidiaries typically are not normally formed for the sole intent of raising capital, and that minority interests usually arise when a bank acquires a pre-existing subsidiary. From a corporate perspective, the FDIC is currently taking the position it will not be allowing banks to transfer assets to a subsidiary for the sole intent of raising temporary capital, particularly if the investors have a preferred claim or return on such assets. Accordingly, institutions looking to raise capital are unlikely to find any relief by selling interests in the bank’s existing owned real estate.
Regulators and financial institutions have been trying for some time now to come to an understanding of what type of how workout strategies affect the classification of loans and the corresponding impact on estimates of loan losses. On October 30 the federal banking regulators published guidance on prudent commercial real estate loan workouts that addresses these issues. The guidance addresses some of the most contentious areas of disagreement between banks and examiners. One of those areas is the impact of a decline in value of collateral in situations where the borrower or guarantors have the ability to service the loan. The new guidance tells examiners that renewed or restructured loans to borrowers who have the ability to repay their debts according to reasonable modified terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the loan balance. This is a significant change from the manner in which examiners have been classifying acquisition and development loans in the past and time will tell exactly how the examiners will in fact deal with such loans in the future.
A problem loan workout can take many forms, including a renewal or extension of loan terms, extension of additional credit, or a restructuring with or without concessions. The key to any loan workout is that the renewal or restructuring should improve the lender’s prospects for repayment of principal and interest and be consistent with sound banking, supervisory, and accounting practices.
(more…)
Georgia Department of Banking and Finance Commissioner Rob Braswell has advised us that the Department’s announcement last week was intended to provide relief only in the context of “loan stacking” under the Department’s proposed new Rule 80-1-5-.11. Accordingly, the Department will permit renewals of loans which had originally been made in conformity to the loan to one borrower, but would otherwise not be in conformity with the loan to one borrower rule solely due to the the Department’s proposed new “loan stacking” rules.
Renewals and extensions of loans where the loan to one borrower issues arises solely because of capital losses since the loan was originally made are NOT covered by the Department’s announcement. We are continuing to pursue this issue with the Department, but in the meantime, our recommendation is that banks should NOT extend or renew loans to borrowers where the extension or renewal would violate the loan to one borrower rule as a result of reductions in the limit resulting from capital losses.
The Georgia Department of Banking and Finance (“DBF”), announced today a significant change in the way in which the legal lending limit will be applied in the context of loan renewals. Due to a shrinking capital base, a large number of banks have been struggling with the issue of what to do with loans whose renewal would cause a violation of the legal lending limit. These were loans that met the requirements when the loan was made but could not be made today due to the bank’s smaller capital position. The position of the DBF has been that a bank should not renew such a loan. In the current economic environment this places banks in an untenable situation because borrowers are unable to pay off the loans due to a lack of liquidity and no other financial institutions are willing to take over the credits. The only option left for a bank in such a situation is to enter into some sort of forbearance agreement with the borrower. The result of that, however, is that after 90 days the loan will need to be downgraded to substandard, regardless of whether the borrower is able to keep interest payments current.
Following direct discussions among GBA President Joe Brannen, GBA counsel Walt Moeling and Jerry Blanchard, Commissioner Rob Braswell, and the DBF Staff dealing with this issue, the DBF announced today that it shall be the position of the DBF that if loans are modified or renewed by the bank without any additional extension of credit outstanding, such loans will not be cited for a violation of the new rules of the Department contained in Rule 80-1-5-.11. The DBF goes on to note, however, that the fact that a violation of the lending limit rule is not being cited should not be interpreted as a finding of creditworthiness by the DBF. A decision to classify a credit or credit relationship is an independent process from the application of statutes and rules.
(more…)
On July 6, 2009, the FDIC published a set of Frequently Asked Questions relating to the Sweep Account Disclosure Requirements which recently went into effect. One of the issues addressed was what does the FDIC consider to be a perfected interest in a security. This issue first came up earlier this year when the FDIC took the position that many repurchase agreements were defective and that in a failed bank situation the FDIC would take the position that the funds subject to such an agreement never left the deposit account. One of the primary defects which the FDIC pointed out was the right of substitution found in many such agreements. This announcement caused many banks to modify their master repurchase agreements to delete that right.
The FAQ clarifies the FDIC’s position in several respects. It first addresses the basic question of when is a security interest perfected in a security. The FDIC generally considers three elements in determining whether the customer has a perfected security interest in a security subject to a repo sweep: (1) the particular security in which the customer has an interest has been identified, and this identity is indicated in a daily confirmation statement; (2) the customer has “control” of the particular security; and (3) there is no substitution of the security during the term of the repurchase agreement even if the agreement allows for substitution with the customer/buyer’s consent.
Identification of Securities
The element of identification is met by a confirmation identifying the security (i.e., CUSIP or mortgage-backed security pool number) and also specifying the issuer, maturity date, coupon rate, par amount and market value. Fractional interests in a specific security must be identified, if relevant. Importantly, the FDIC takes the position that an arrangement where bulk segregation or pooling of repurchase collateral without identification of specific securities does not result in the buyer receiving an identified interest in specifically identifies securities.
(more…)
Regulators Issue Statement on Lending to Creditworthy Small Businesses
On February 5, 2010, the federal banking regulators and the Conference of State Bank Supervisors issued an Interagency Statement on the Credit Needs of Creditworthy Small Business Borrowers. The Statement builds upon principles set forth in the October 2009 Policy Statement on Prudent Commercial Real Estate Loan Workouts. After noting the overall decline in loans to small businesses and the reasons for that decline the regulators suggested that lenders may have become overly cautious with respect to small business lending. They encourage lenders to engage in prudent small business lending and that that examiners will not criticize lenders for working in prudent and constructive manner with small businesses.
The decline in small business lending has many reasons, not the least of which is that loan demand is actually down. Lenders are also naturally cautious of lending to those businesses that are reliant solely on cash flow that has slowed due to the slowdown in consumer spending and the decline ion the personal wealth of the owners of the businesses. Despite the assertions to the contrary by the regulators, lenders are concerned that there is a disconnect between statements from Washington, DC and what actually happens in the field when examiners are onsite at financial institutions. Our experience seems to show that local federal regulators do not see any upside in being flexible when faced with making decisions about how to rate credits. Lenders are therefore naturally reluctant to maker decisions based on guidance until they see it actually implemented on the ground.