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Why Your Board Should Stop Approving Individual Loans

In this the new era of banking, our clients are continually looking for ways to enhance efficiency and effectiveness at all levels of their organizations. This line of thinking has led to the revolution of the bank branch and the adoption of many new technologies aimed at serving customers and automating or otherwise increasing process efficiency. Perhaps most importantly, however, banks have begun to focus on optimizing their governance structures and practices, particularly at the board level.

(A print version of this post if you’d like to print or share with others is available here.)

As we discuss this topic with our clients, the conversation quickly turns to the role and function of the bank’s director loan or credit committee, which we refer to herein as the “Loan Committee.” We continue to believe that Loan Committees should move away from the practice of making underwriting decisions on individual credits absent a specific legal requirement, and here we set forth the position that this change should be made in order to enhance Board effectiveness, not just to avoid potential liability.

Ensuring Board Effectiveness

Whenever we advise clients with regard to governance, our fundamental approach is to determine whether a given course of action helps or hinders the Board’s ability to carry out its core functions. Defining the core functions of a Board can be a difficult task. Fortunately, the staff of the Board of Governors of the Federal Reserve System recently outlined its view of the core functions of a bank Board. We agree with the Federal Reserve’s outline of these functions as set forth in its proposed guidance regarding Board Effectiveness applicable to large banks, which was based on a study of the practices of high-performing boards. Based on our experiences, many of the concepts expressed in that proposed guidance constitute board best practices for banks of any asset size. The proposed guidance indicates that a board should:

  • set clear, aligned, and consistent direction;
  • actively manage information flow and board discussions;
  • hold senior management accountable;
  • support the independence and stature of independent risk management and internal audit; and
  • maintain a capable board composition and governance structure.

We believe that an evaluation of the board’s oversight role relative to the credit function is a necessary part of the proper, ongoing evaluation of a bank’s governance structure. As it conducts this self-analysis, a board should evaluate whether the practice of underwriting and making credit decisions on a credit-by-credit basis supports its pursuit of the first four functions. We believe that it likely does not.

Considering Individual Credit Decisions May Hinder the Committee’s Ability to Set Overall Direction for the Credit Function.

We have observed time and time again Loan Committee discussions diving “into the weeds” and, in our experience, once they are there they tend to stay there. In most Loan Committee meetings, the presenting officer directs the committee’s attention to an individual credit package and discusses the merits and challenges related to the proposal. Committee members then typically ask detailed questions about the particular financial metrics, borrower, or the intended project, assuming that any discussion occurs at all prior to taking a vote.

While it may sometimes be healthy to quiz officers on their understanding of a credit package, focusing on this level of detail may deprive the Loan Committee of the ability to focus on setting direction for the bank’s overall loan portfolio. In fact, in many of the discussions of individual credits, detailed questions about the individual loan package may in fact distract from the strategic and policy questions that really should be asked at the board level, such as “What is the market able to absorb with regard to projects of this type?” and “What is our overall exposure to this segment of our market?”

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Counterpoint: Why Sane People Serve as Bank Directors

Bank directors have played a crucial role in the turnaround of the banking industry, an accomplishment that deserves recognition in light of the fact that it has been done under tremendous regulatory burden and tepid economic growth.  Given that, why do we continue to question why the country’s most respected business people would be willing to serve as bank directors?  Respected attorney and industry commentator Thomas Vartanian recently asked in an opinion piece in The Wall Street Journal, “Why would anyone sane be a bank director?”  Well, sane people are serving as bank directors every day, and in doing so they are benefiting the economy without exposing themselves to undue risk.

(A print version of this post if you’d like to print or share with others is available here.)

The regulatory environment for bank directors is clearly improving. The Federal Reserve’s recent proposal to reassess the way in which it interacts with boards is appropriate if overdue, and the other banking agencies should follow the path that the Federal Reserve has set forth.  We also witnessed the FDIC acting very aggressively in pursuing lawsuits against directors of failed banks in the wake of the financial crisis.  However, suggesting that the FDIC relax its standards for pursuing cases against bank directors is not only unrealistic, it misses the greater point for the industry in that it needs to continue to refine its governance practices in order to provide for better decision-making by bank directors and to enhance protections from liability for individual directors.

In order to fully understand the point of this position, it is important to clear up a couple of commonly-held misconceptions.  First, when the FDIC sues a bank director after a bank failure, it does so for the benefit of the Deposit Insurance Fund, which is essentially an insurance cooperative for the banking industry.  As a result, the FDIC should be viewed as a purely economic actor, no different from any other plaintiff’s firm in the business of suing corporate directors.  Lawsuits by FDIC should not be given any higher profile or greater credibility than any number of other suits against corporate directors that inevitability occur during market downturns.  There should be no additional stigma, and certainly no additional fear, with regard to a claim by the FDIC on the basis that it is “the government.”

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Do you have an ATM-oriented board in an increasingly iPhone-oriented world?

In the run up to the Fourth of July holiday, you may have missed that June 27 was the 50th anniversary of the first ATM and June 29 was the 10th anniversary of the first iPhone.  I was struck by the coincidence of these two anniversaries occurring in the same week.  It also caused me to revisit in my mind a concern that has been growing for some time.

During several recent bank board retreats and strategic planning sessions, I’ve witnessed the challenging dynamics that occur when leaders begin the process of “board refreshment.”  Board refreshment is the current euphemism being used by consultants (and by the proxy advisory firms) to refer to the need for a closer match between the strategic goals of banks and the skill sets of board members.  This need is especially apparent in the boards of many mid-sized regional and community banks.

We are living in a time of increasing change in the demographics (gender, race and age) of the customer base of banks, coupled with rapid technological developments which impact the ways in which commercial customers conduct their businesses and interact with other businesses, including with their banks.  The typical board of a mid-sized regional or community bank, however, consists of men in their mid to upper-sixties who share similar backgrounds and whose perspectives were shaped during a different era for both business and banking.  The concern I have is that continued adherence by banks to such board composition will result in competitive disadvantage.

I’ve been practicing law and advising banks for over 30 years, and for most of that period I don’t think it mattered as much how strong the typical community bank board was.  What mattered was the strength and competency of the CEO, and it was a bonus if the bank had an energetic and engaged board of directors.  I believe there is now an increasing need for stronger boards.  Take a moment and consider how well equipped your board is to help guide your bank through the period of rapid change that is on the near term horizon.

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Mobile Wallets and Tokenization: Banks are Catching On

On April 20, 2017, the American Banker reported that U.S. Bank’s new high-end credit card features an interesting differentiator from the high-end cards recently introduced by other large credit card issuers.  U.S. Bank’s new high-end credit card significantly incents mobile usage over conventional swipe or chip dip for purchases.  While the other card offerings typically provide triple miles for travel and entertainment purchases, the U.S. Bank “Altitude Reserve Visa Infinite” card puts its money on getting cardholders to enroll their cards in mobile wallets – Apple Pay, Android Pay, Samsung Pay and Microsoft Wallet.

For a generation of customers who want to do everything, or as much as possible, on their phones, millennials have not adopted mobile payments as quickly as expected. Personally, I constantly encourage everyone to enroll their cards in the mobile wallet on their phone ASAP and use it that way at every opportunity.

I do that for two reasons –  1) it is much more secure than swiping your stripe or dipping your chip and 2) it is much faster than inserting your chip card at the terminal to complete the transaction.

Plus, it looks really cool to wave your phone at the terminal and “boing” you’re done. I smugly watch the people in line behind me watching this transaction with interest.

The transaction is more secure because the phone wallets keep card credentials in a secure element on the phone, which is highly resistant to hacking, and more importantly, does not transmit real card credentials to the merchant. Instead, the merchant only receives a one-time use tokenized version of your card credentials. This means that if the merchant’s database is hacked, the tokenized version of your card credentials that are exposed are just useless gibberish.

This saves the card issuer from eating losses under Reg Z for unauthorized transactions and crediting your account for charges the hacker racked up on a spending spree for fenceable goods. Actually, most of those unauthorized charges flow back to the merchant who was hacked, but the issuers whose cards are exposed typically do not recover their full costs.

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Landscape of the U.S. Banking Industry

(A print-ready version of this post is also available: Landscape of the U.S. Banking Industry.)

From 2006 through 2016, the number of insured depository institutions in the United States has fallen from 8,691 charters to 5,922, a decline of 2,769 charters or a 32% loss.  This headline loss number is worth talking about, but is neither news nor new.  The loss of charters is a frequent source of discussions around bank board rooms, stories from trade press, and chatter at banking conferences.  The number of insured charters has also been in steady decline, with at least 33 years of declining numbers.

However, a deeper dive into the numbers reveals some unexpected trends below the headline 32% loss of charters.

the-bank-accountNote:  We’ve also recorded an accompanying podcast for The Bank Account on the Truth About Industry Consolidation.  The podcast contains additional analysis to the numbers presented here, and is a useful addition, but not a substitute, to this content.  In addition to listening to this episode, we encourage you to click to subscribe to the feed on iTunes, Android, Email or MyCast. It is also now available in the iTunes and Google Play searchable podcast directories.

Links to items mentioned in the podcast, or otherwise potentially of interest on the topic:

 

State of Banking Landscape as of December 31, 2016

As of December 31, 2016, we had 5,922 institutions with $16.9 trillion in total assets.

The four largest depository institutions by asset size (JPMorgan, Wells Fargo, Bank of America and Citi) hold $6.84 trillion in assets, or 40.5% of the industry’s assets.

There are 111 additional banks that have assets greater than $10 billion, holding $6.98 trillion.  That’s 1.9% of the total charters, holding 81.9% of the aggregate assets.

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Dodd-Frank Act Reforms

Dodd-Frank Act Reforms

March 23, 2017

Authored by: Robert Klingler

Much of the discussion we’re having with our clients and other professionals relates to the prospects for financial regulatory reform.  To that end, and looking at it from the political rather than industry perspective, Bryan Cave’s Public Policy and Government Affairs Team has put together a brief client alert examining the political, legislative and regulatory issues currently under consideration.

In his first weeks in office, President Trump has taken steps to undo or alter major components of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). These include delaying implementation of the “Fiduciary Rule,” which regulates the relationship between investors and their financial advisors, directing the Treasury Secretary to review the Dodd-Frank Act in its entirety, and signing a resolution passed by Congress that repeals a Dodd-Frank regulation on disclosures of overseas activity by energy companies.

Read the rest of this alert on Bryan Cave’s homepage.

We’ve also posted about the impact of the proposed regulatory off-ramp on community banks, recorded a podcast episode on the Financial Choice Act, and discussed some of the causes, including hopes for regulatory relief, of the rise in bank stock prices in our podcast episode on the issues associated with elevated stock prices in bank mergers and acquisitions.

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Trump May Not be the Only Catalyst for Administrative Reform

In the past few months, there has been a lot of speculation regarding the future of many administrative agencies under Trump’s administration. However, two current cases pending in the D.C. Circuit have the potential to have a dramatic impact on administrative agencies and past and present regulatory enforcement actions by such agencies.

In Lucia v. SEC, the SEC brought claims against Lucia for misleading advertising in violation of the Investment Advisers Act of 1940. The enforcement action was initially resolved by an administrative law judge (ALJ); however Luica was later granted a petition for review based on an argument that the administrative hearing was unconstitutional because the ALJ was unconstitutionally appointed. The issue made it up to the U.S. Court of Appeals for the D.C. Circuit who recently held that the ALJ was constitutionally appointed because the judge was an “employee”, not an officer. However, other courts have held just the opposite. In December, the 10th Circuit held in Bandimere v. SEC that ALJs were “inferior officers” and thus must be appointed pursuant to the Appointments Clause. A rehearing en banc has been granted in Lucia to address this issue.

On the heels of Lucia, in PHH v. CFPB, the CFPB brought claims against PHH for violations of the Real Estate Settlement Procedures Act. Similarly, this enforcement proceeding was originally decided by an ALJ. However, PHH appealed the ALJ decision for a multitude of reasons and the appeal has also made it up to the D.C. Circuit where a rehearing en banc was granted last month. In the court’s order granting a rehearing en banc, the court ordered, among other things, that the parties address what the appropriate holding would be in PHH if the court holds in Lucia that the ALJ was unconstitutional.

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Walt Moeling Always Has a Story

The February/March 2017 edition of Banking Exchange contains a lengthy interview between Bank Exchange’s Executive Editor, Steve Cocheo, and our own Walt Moeling.  Framed in the context of seven questions asked of Walt, the interview does a great job illustrating Walt’s use of stories to prove a point.

Talking to banking attorney Walter Moeling about an organization that forbade talk about mergers and acquisitions—because it may make folks unhappy—leads to his gentle scoff: “There’s nobody involved in banking who is not interested in mergers.”

And then, in typical Moeling fashion, a short point brings him to a story. Walt Moeling always has a story—nearly always with a point or moral for the listener to let sink in.

“I was called upon to do a board session, a strategic planning meeting. I told the CEO I was going to talk about mergers. ‘Oh, you don’t need to do that,’ he told me. ‘My board isn’t interested in mergers.’

“I told the CEO, ‘If I’m going to talk about strategy, I’m going to talk about M&A. You can’t plan a strategy without knowing where you are heading.’”

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Parents, not Banks, Should Aim For Empty Nests

I recently happened to find myself among a group of young professionals who had grown up in the same rural area of Georgia, but had dispersed to not only different parts of the state, but also different parts of the country and even at times, the world. At some point in the evening, it became the topic of conversation that one of the members of this group still banked at his hometown community bank despite no longer living there and spending almost a decade traveling the world. His childhood friends were shocked, uttering things like “Wait, you still bank there?” and “Isn’t it time you leave the nest?”

As someone who did not grow up in Georgia and thus was an outsider to the conversation, I really began to think about this. Why should you have to leave the bank you’ve grown up with and trusted for years just because you have left the proverbial nest?

Admittedly, when I left for college, it was before the advent of mobile banking and federal preemption of interstate branching restrictions. When I moved out of state I was forced to switch banks so that I could actually deposit checks and bank efficiently. However, legislative changes, combined with drastic changes in technology, have eliminated the necessity for young adults to switch banks when they move away from home.

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Core Principles for Financial Regulation

On February 3, 2017, President Trump issued an executive order setting forth his administration’s core principles for the regulation of the U.S. financial system.  While generally touted as the administration’s first affirmative steps to dismantle the Dodd-Frank Act, the executive order actually does little to implement any immediate change but says a lot about the overall framework by which the Trump Administration intends to approach financial regulation.

In addition to standard executive order boilerplate, the executive order sets forth two specific actions.  First, it establishes the “principles of regulation” that the administration will look at in evaluating regulations.

Section 1. Policy. It shall be the policy of my Administration to regulate the United States financial system in a manner consistent with the following principles of regulation, which shall be known as the Core Principles:

(a) empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth;

(b) prevent taxpayer-funded bailouts;

(c) foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry;

(d) enable American companies to be competitive with foreign firms in domestic and foreign markets;

(e) advance American interests in international financial regulatory negotiations and meetings;

(g) restore public accountability within Federal financial regulatory agencies and rationalize the Federal financial regulatory framework.

Notwithstanding partisanship biases, I think most of these principles express ideas that most Americans could support, even if some would say there are additional principles (such as protecting consumers) that might also be relevant.  Even with some “norms” going out the window, I think everyone should be able to get behind the concept that our financial regulations should seek to “prevent taxpayer-funded bailouts.”  If nothing else, the Core Principles reflect generally mainstream Republican views of the goals (and implied limitations) of federal regulations.

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