On December 11, 2018 Kathleen Kraninger, the new Director of the Bureau of Consumer Financial Protection, held a media conference. She introduced herself and answered media questions. Subsequent headlines have focused on among other things: (a) whether she would simply follow the recent course set by her predecessor Acting Director Mick Mulvaney, and (b) whether the Bureau’s recent name change would stick. Director Kraninger’s comments appeared to signal accountability, independence and curiosity. The impact on regulated institutions in 2019 and beyond remains to unfold. Here are some developments to watch in 2019.

Listening Tour 2019. Kraninger will be engaging in a listening tour to get to know the 1500 employees in the Bureau. For example, she plans to visit to San Francisco, Chicago, New York regional offices. She also indicated that she intends to connect with other regulators and constituencies including, state regulators, other related federal agencies, consumer advocates and regulated institutions.   She also indicated she will work to have a productive relationship with House Financial Services Committee and its incoming chair Maxine Waters. Earlier this month, Waters released a statement requesting Kraninger undertake specific initiatives “to put consumers first by rolling back the anti-consumer actions taken by her predecessor and allowing the Consumer Bureau to resume its work of protecting hardworking Americans from unfair, deceptive or abusive practices.”   New staffing alignments and other strategic changes may be borne form this listening tour.

Believes Regulated Industry Wants to Comply. In a nod to industry, Kraninger noted that institutions want to comply with consumer protection laws. The Bureau needs to give institutions clear rules in her view. However, she also signaled strong action for outliers, indicating that enforcement is a critical function and tool of the Bureau “fundamental to the agency’s mission.”  She also noted that “bad actors” should expect repercussions under her watch.

The holidays are a time for deals — rebates, discounts and special financing offers. Especially prevalent are automobile advertisements with images of big red bows atop shiny new cars and exhilarated families dashing out into the snow to unpack presents out of the back. Well, the regulators are watching those advertisements too. For the fourth time in a month, the CFPB is warning consumers, especially servicemembers, about the potential pitfalls of the car buying process and understanding exactly what they are buying and what they are financing. The FTC is joining in to help, with its own resources as well.

Add-On Products are an area of special concern and focus for the CFPB. The CFPB recommends that buyers “be prepared to say ‘No, thank you’ if [they’re] offered add-ons [they] don’t want or need.” But the CFPB also adds a warning that customers should be sure to review their contracts carefully to make sure the items declined are not included. Dealer sales practices vary on these types of products, and the CFPB appears to be suggesting not so subtly that buyer had better beware.

Value & Actual Costs/ Financing. Products and services the regulators highlight include: (a) guaranteed auto protection (GAP), (b) tire, dent, paint and fabric protection packages, (c) extended warranties, and (d) service contracts. These additional products and services can be valuable to consumers depending on how long they intend to keep the car, how they want to maintain it, and their own economic circumstances and budget cashflow. The CFPB and FTC focus signals that in marketing these products and services, institutions and their business partners must be direct and forthright about the product, its features, its limitations, and the price. High pressure sales tactics or aggressive marketing may result in customer complaints, regulatory inquiries, and litigation and reputation risk.

On November 21, 2018, the Federal Reserve, Office of Comptroller of the Currency and the FDIC jointly published a notice of proposed rulemaking (the “NPR”) to provide an alternative capital system for qualifying banking organizations.  Specifically, the regulators have proposed a new, alternative, simplified capital regime for qualifying institutions that will deem an institution to be well-capitalized so long as it maintains a leverage ratio of at least 9% and adequately capitalized so long as it maintains a leverage ratio of at least 7.5%.

The NPR seeks to implement the community bank leverage ratio (CBLR) mandated by Section 201 of the Economic Growth, Regulatory Relief and Consumer Protection Act (“EGRRCPA”).  EGRRCPA requires the regulatory agencies to develop a CBLR of not less than 8 percent and not more than 10 percent for qualifying community banking organizations, and provides that organizations that meet such CBLR will deemed well capitalized for all purposes.  EGRRCPA further provides that a qualifying community banking organization to be a depository institution or depository institution holding company with total consolidated assets of less than $10 billion.

Summary of the NPR

The NPR establishes five criteria for an depository institution or holding company to be deemed a Qualifying Community Banking Organization:

• Total consolidated assets of less than $10 billion;
• Total off-balance sheet exposures of 25% or less of total consolidated assets;
• Total trading assets and trading liabilities of 5% or less of total consolidated assets;
• MSAs of 25% or less of CBLR tangible equity; and
• Temporary difference DTAs of 25% or less of CBLR tangible equity.

Under the NPR, the numerator of the CBLR would be CBLR tangible equity.  CBLR tangible equity would be equal to total equity capital, determined in accordance with Call Report or Form Y-9C instructions, prior to including any minority interests, less (i) accumulated other comprehensive income (AOCI), (ii) all intangible assets (other than MSAs) including goodwill and core deposit intangibles, and (iii) DTA’s arising from net operating loss and tax credit carryforwards.

The CBLR denominator would be average total consolidated assets, calculated in accordance with Call Report or Form Y-9C instructions, less the items deducted from the CBLR numerator, except AOCI.  The NPR notes that the calculation is similar to the one used in determining the denominator of the tier 1 leverage ratio.

Under the NPR, a Qualifying Community Banking Organization may elect to use the CBLR framework at any time, so long as it has a CBLR greater than 9% at the time of the election.  Under the CBLR framework, the Qualifying Community Banking Organization will be considered well capitalized so long as it has a CBLR greater than 9%. A qualifying depository institution that previously elected to use the CBLR framework but has fallen below 9% will not be required to convert back to the regular capital system.  Instead, the following CBLR leves will serve as proxies for the PCA categories:

• Adequately Capitalized – CBLR of 7.5% or greater;
• Undercapitalized – CBLR of less than 7.5%; and
• Significantly Undercapitalized – CBLR of less than 6%.

The framework for Critically Undercapitalized would remain unchanged at a ratio of tangible equity to total assets of 2% or below.  Any institution that would be deemed Significantly Undercapitalized under the CBLR framework would be required to promptly provide its appropriate regulators sufficient information to calculate the PCA tangible equity ratio.

A little over 10 years ago, at the wise encouragement of Walt Moeling, we launched this blog.  From day one, the response from clients, referral sources, regulators and competitors has been amazing.

All in, we’ve published over 1,000 blog posts, authored by almost 100 different attorneys with the firm.  From BankPogo.com to BankBryanCave.com to BankBCLP.com, the site has evolved with the evolution of the firm, but has always been focused on providing usable advice to financial institutions across the country.

I’m thrilled with what we were able to build, but also refuse to just rest on our past accomplishments.  We are always on the lookout for areas of interest to our client, where we can partner with the financial institution industry to create value for all.  I think we all hope that such assistance will never again involve assistance with government investments in our depository institutions, but if it does, we look forward to building upon the expertise gained in the great recession.

Ten years ago, on October 13, 2008, the U.S. Treasury Secretary Henry Paulson effectively locked the CEO’s of the nine largest banks in the United States in a conference room and demanded that they accept an investment from the U.S. Government. Although we had front row seats for much of the activity over the ensuing years, reading the New York Times summary of that meeting from the following day still provides a sense of just how shocking all of this was.

While the U.S. Treasury simultaneously announced its intention to also provide the possibility of investments in other banks, it was a long wait for details, particularly for privately held and Subchapter S Banks.  Ultimately, over the course of the next 15 months, the U.S. Treasury invested $199 billion in 707 financial institutions across 48 states.  As of October 1, 2018, the Treasury has received over $226 billion back in dividends, repayments, auction proceeds, and warrant repurchases.

Of the $199 billion in investments in 707 institutions, as of October 1, 2018, only three investments, reflecting $24 million in original investments, remain in Treasury’s portfolio.  264 institutions repaid in full and another 165 refinanced into other government programs.  (The SBLF and CDFI funds were similar to the TARP CPP program, but were ultimately done under different congressional mandates.  While not necessarily representative of an ultimate cash return on the Treasury’s investment, each of these funds has also provided a strong return to the Treasury.)

The Eleventh Circuit recently rejected a defense to foreclosure based on a federal statute governing insurance of reverse mortgages by the Department of Housing and Urban Development (“HUD”).

HUD administers a mortgage-insurance program designed to induce lenders to offer reverse mortgage loans to elderly homeowners.  If the loan meets certain conditions, HUD insures against any outstanding balance owed on the loan.  One condition, contained in 12 U.S.C. § 1715z-20(j), provides:

The Secretary may not insure a home equity conversion mortgage under this section unless such mortgage provides that the homeowner’s obligation to satisfy the loan obligation is deferred until the homeowner’s death, the sale of the home, or the occurrence of other events specified in regulations of the Secretary. For purposes of this subsection, the term “homeowner” includes the spouse of a homeowner.

Borrowers and their estates have argued the statute prevents lenders from seeking repayment of a loan subject to a reverse mortgage until either the sale of the home, or the death of both the borrower and his or her non-borrowing spouse – even if the loan documents provide to the contrary.   The Court in Estate of Caldwell Jones, Jr. v. Live Well Financial, Inc., No. 1:17-cv-03105-TWT (decided Sept. 5, 2018) rejected this argument.

In Estate of Caldwell Jones, Jr., former NBA star, Caldwell Jones, Jr., obtained a reverse mortgage secured by his home.  Jones lived in the home with his wife and his minor daughter, until he passed away in 2014.  Jones’s wife was not a co-borrower.

10 Years ago today, on October 3, 2008, President George W. Bush signed the Emergency Economic Stabilization Act of 2008, creating the Troubled Asset Relief Program (TARP) and authorizing the expenditure of up to $700 billion.  Pursuant to its obligations under TARP, the Treasury still publishes regular reports on its investments and activities thereunder.  The Treasury has also published a TARP Tracker that provides an interactive and chronological history of TARP.

The various components of TARP were not developed (and then further streamlined) over the next year or so, but the 10-year anniversary of the overall program seems like an appropriate time to look at the overall results of the program.  (In fact, the very thought that TARP would become primarily a program of investments in banks 10 years ago would probably have been laughed at… everyone felt it was going to focus on purchasing toxic assets.)  Over the next several months, we’ll periodically look back on the developments (with the benefit of hindsight), including looking at the launch of this blog.

While $700 billion was initially authorized, the authorization was subsequently reduced to $450 billion.  Based on the latest Monthly Update published by Treasury, just over $440 billion was disbursed and only $70 million remains outstanding today.  Overall, the U.S. Treasury has received just over $443 billion in cash back as a result of its expenditures under TARP.

While overall TARP was actually profitable for the U.S. Treasury, when you break down TARP into categories of programs, one can see that the bank investment component (which is generally thought to be the most controversial aspect) was actually the most profitable.

Looking specifically at the various bank investment programs, the government invested a total of $245.1 billion.  Of that investment, it did recognize write-offs and realized losses of over $5.2 billion.  However, it also recognized over $35.7 billion in income (primarily dividends and profits on sold investments), resulting in a total cash return of $275.5 billion on its $245.1 billion investment.

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On September 28th, Jonathan and I recorded a brief podcast on the impact of regulatory reform on community banks in 2018.  Before turning to substance, I first congratulated Jonathan on his ability to combine two of our shared passions: college football and mergers & acquisitions.  Jonathan’s post on a Football Fan’s Guide to M&A Transactions is an excellent application of college football coaching strategies that can be applied in any strategic planning discussions by boards of directors of any organization.  His further exploration of some of the principles that other SEC teams bring to bear on M&A thinking on Twitter is also something I encourage everyone to read.

On substantive issues, we primarily focused on reforms enacted under The Economic Growth, Regulatory Relief, and Consumer Protection Act, or EGRRCPA, but also touched on the modernization of the Georgia banking code. Specific topics discussed include:

• the expansion of the Small Bank Holding Company Policy Statement;
• the relaxation of the reciprocal brokered deposit rules;
• Volcker Rule relief;
• the upcoming regulatory off-ramp (or at least rest stop, if not fully an off-ramp); and
• the increased threshold for the 18-month examination cycle and short-form call reports.

Twenty venture capitalists gathered in Silicon Valley last week to discuss the impact of blockchain technology, including digital currency, on financial services and venture capital. The 20 VCs represent an equal number of funds, which invest–or are looking for investment opportunities–all over the world, including the third world. They represented a diverse group of perspectives, with some having regulatory experience, some having experience with conventional payment mechanisms and some with innovative mechanisms such as PayPal. Even their disagreements were instructive of the uncertain future of blockchain technology and its various potential applications.

The consensus is that digital currency is entering a nuclear winter. A majority of Initial Coin Offerings made in 2017–perhaps as much as 75%–turned out to be fraudulent and have no value today. Not coincidentally, the vast majority of Initial Coin Offerings originated in Eastern European countries that are home to spam and bot farms…and where there is little, if any, regulatory oversight.

To the extent bitcoins may become a viable, commercial technology for B2B transactions, it is likely to occur in a technology hub in the U.S. or Europe. Those hubs have the talent, the infrastructure and the robust regulatory structures that can be adapted to ICOs and create the trust necessary to make digital currency a positive, viable alternative to government currencies. In fact, the centralization of technology talent in the U.S. is depriving the rest of the world of talent.

The attempts of island states, like Bermuda, Malta, Cyprus, the Isle of Mann, and even Singapore to draft regulations that facilitate the creation of bitcoin issuers on their soil is unlikely to have a significant impact. Nobody who is experienced and seriously intends to build a global digital technology company and change the financial services industry on a global scale will think one can create the necessary large organization on these islands. These islands do not have an ecosystem of sophisticated VCs and do not have a critical mass of talented engineers. The island states are going for broke because they have so little to lose. When and if the technology matures, U.S. companies will step in and crush competitors based in these islands.

With both college and professional (not to mention fantasy) football in full swing, we find many conversations with clients drifting to topics from the
gridiron at this time of year.  Given that many of us are devoting a significant amount of our personal time to following our favorite teams, many times business points are best illustrated at this time of year by using football analogies.

Certain sports agents have posited that the highest achieving football coaches could easily run Fortune 500 companies but instead chose to coach football for a living.  While that point is debatable, we can certainly draw from the talking points of today’s best coaches in setting a framework for approaching a merger transaction.  While we can’t deliver Nick Saban, Bill Belichick, or Kirby Smart to your boardroom, use these sound bites to your advantage in setting the tone for how your board addresses an M&A transaction.

1. 1. Trust the process. “The Process” has become a hallmark of the University of Alabama’s championship dynasty.  Coach Saban focuses on the individual elements that yield the best results by the end of the season.  Similarly, a well-planned process can be trusted to yield the best long-term results.  This simple point is among the easiest for boards to miss.  We are often concerned when clients engage in “opportunistic” M&A activity.  Instead, we prefer to see a carefully planned process that includes the following fundamental elements:
      * Parameters around the profile that potential partners should have, including market presence, lines of business, and size;
      * Clearly defined financial goals and walkaway points; i.e., those metrics beyond which no deal can be justified;
      * For sellers, the forms of consideration that will be acceptable (i.e., publicly-traded stock, privately-held stock, or cash); and
      * Selection of qualified advisors.
   2. Self-scout. Great football teams have an honest self-awareness of their strengths and weaknesses and grasp them on a deeper level than their opponents.  Buyers and sellers should also have a frank assessment of their shortcomings.  In planning for the M&A process, those weaknesses should be addressed in advance to the extent possible.  To the extent they cannot be fixed in advance of embarking on an M&A process, parties should provide a transparent assessment of their weaknesses to potential partners.  Doing so enhances credibility and builds trust in the other facets of due diligence.
   3. Know the tendencies of your opponent. On the other side of self-scouting is a great team’s ability to understand and address the weaknesses of its opponents.  While we never advise clients to think of M&A partners as adversaries, advance due diligence of a potential partner to identify their needs can certainly help lead to a successful transaction.  At its core, a good M&A transaction is about giving a potential partner something it does not have and cannot build for itself.  To the extent that parties can identify the needs of potential partners in advance of their initial conversations, they can speak directly to those needs at the outset, thus positioning themselves as an optimal partner in a crowded M&A field.