Jeremiah S. Buckley
Over the last two years, banking lawyers have experienced a sharp uptick in legal and regulatory issues that cut to the very heart of their clients’ ability to survive. As usually happens in periods of economic stress, bank regulators have become more intense in their examinations of banks and more stringent in the types of remedial agreements they require banks to sign. The old joke that a regulator’s job is to come through when the battle is over and shoot the wounded is an unfair gibe, but the fact is, bank regulators are imposing stricter rules than at any time in recent memory. Here are five leading questions that banks are calling on their lawyers to help them address:
How should our bank respond to demands that it increase its capital?
As loan losses have mounted and loan quality has deteriorated, provisions for losses have caused many banks’ risk-weighted and core capital ratio positions to decline. This has led regulators to require banks to enter into agreements that they will restore their capital position, often to levels markedly in excess of well capitalized. In the current environment, we have in some situations seen regulators move to close banks whose tangible capital ratio is above 2%. These requirements come at a time when the bank’s condition makes raising capital difficult. However banks can negotiate terms that meet the regulator’s requirements. Some banks have sold branches or loans, or restructured their investment portfolio into lower-risk-weighted assets, as interim measures, while others have worked with investment banks or private equity investors to shore up their positions. The Federal Deposit Insurance Corp. has not approved proposals for open-bank assistance. But the Treasury Department has at times been willing to restructure Tarp obligations. For banks with Tarp funding, this may be part of a capital-raising solution.
What can our bank do to create a defensible position with respect to its level of loan loss reserves?
Calculating allowances for loan-loss reserves is not easy, and banks are allowed to use not only current appraisals, but an element of judgment as to reserve levels. Our experience with clients is that regulators are reluctant to bless the levels of reserves suggested by bank personnel. So we often recommend that a consultant be retained to give an independent view of the expected performance of the bank’s loan portfolio. A credible independent analysis will enhance a bank’s position in negotiations with its regulator about the appropriate level of reserves. Select a consultant with the capacity to provide credible econometric support for projected loan performance, not just a typical file review. Not all consultants have the capability to provide econometric support.
What are the consequences for our bank if we have relied on brokered deposits and our capital rating falls below the “well capitalized” level?
One cause of bank failure is a lack of liquidity, and this presents a special risk for banks that rely on brokered deposits. For such banks, if their portfolios are under stress, there is a risk that their capital rating will be downgraded to less than “well capitalized.” Such a downgrade could have severe consequences; once a bank loses its well-capitalized rating, Section 29 of the FDI Act requires that the bank not roll over or renew its brokered deposits when they mature unless the FDIC grants a waiver. Banks finding themselves in this position should work with their counsel to secure waivers from the FDIC to get time to reduce their reliance on brokered deposits. While the FDIC can be expected to resistant granting waivers where a bank is likely to fail, a strong case can be made that, as long as the bank is “adequately capitalized” and otherwise sound, it should be granted time to deal with issues involving brokered deposits.
How should our bank expect regulators to approach a compliance examination in the current economic environment?
Bank regulatory agencies have intensified their focus on consumer compliance issues over the last two years, and this area will become even more important in the years ahead. Fair lending challenges and CRA challenges are on the rise, and we find that Respa, HMDA, Flood insurance and other consumer protection statutes are driving increased regulatory scrutiny. It is becoming more common for regulators to impose formal cease-and-desist orders, with the attendant reputational consequences for the bank. Counsel can help a bank determine whether violations cited by an examiner have merit. Examiners do sometimes misinterpret the consumer protection laws.
What is the likelihood that officers and directors of our bank will face personal liability and what can they do to reduce their exposure?
At those banks experiencing economic stress, officers and directors face a heightened risk of personal liability. While the bank remains open, regulatory agencies may seek to impose civil money penalties if they determine that the actions of an officer or director violated the law. In the event that a bank or its officers and directors are threatened with a CMP, counsel should be consulted. Counsel will work through the published regulatory criteria for assessing a CMP and argue against imposing any monetary penalty or lessen any penalty that is assessed. When a bank is closed, officers and directors risk personal liability from potential claims by the FDIC in its role as receiver. If the FDIC concludes that an officer’s or director’s conduct constituted a violation of his or her responsibility to the bank it will consider bringing an action. It is important that officers and directors of a potentially failing bank take steps before failure to protect themselves from liability and prepare for their defense. Retaining counsel (other than the bank's regular outside counsel), before the bank's failure, to advise about record retention and to prepare officers and directors for post closure interviews is a prudent course that can help avoid or mitigate serious risk for the individuals involved. One or more of the five questions discussed above will ahead present serious tests for many banks in the months ahead. Understanding these risks and coping with them will be vital to survival for some. It is crucial to recognize that bank examinations are no longer routine regulatory reviews, but can bring existential challenges to a bank and potential exposure for officers and directors as well. In this regulatory environment, if things go wrong in an examination, the situation can quickly deteriorate. Being well prepared for an examination and ready to demonstrate that the bank can anticipate problems and promptly address them is a skill that today’s banker must hone.