On the latest episode of The Bank Account, Jonathan and I were joined by our Chicago partner, Jena Valdetero, to discuss snow, cybersecurity and data breaches. While Jena would normally be the one dealing with winter weather, it was Jonathan and myself watching the snow fall in Atlanta while Jena enjoyed a relatively warm, sunny day in Chicago.
Jena is part of Bryan Cave’s Data Privacy and Security Team, and joined us to discuss some of the current threats in cybersecurity and some of the steps that banks (and bank customers) should be taking, as well as offering some thoughts on how banks can assist their customers in minimizing the ever present cybersecurity risk.
Courts across the country continue to weigh in on the issue of website accessibility. Earlier this month, the U.S. District Court for the District of New Hampshire denied a Motion to Dismiss filed by online food delivery servicer Blue Apron. In denying the motion, the court found that Blue Apron’s website is a place of public accommodation – despite the fact that Blue Apron operates only online and has no traditional brick and mortar locations. Access Now, Inc. v. Blue Apron, LLC, Case No. 17-cv-00116, Dkt. No. 46 (D. N.H. Nov. 8, 2017). In so finding, the court relied on binding precedent in the First Circuit, and noted that other Courts of Appeals, namely the Third, Fifth, Sixth and Ninth Circuits, have held that in order to be considered a “public accommodation,” an online business must have a nexus to an actual, physical space. Id. at pp. 9-10. This decision highlights that the issue of website accessibility, especially as it applies to online only businesses, remains a contested issue.
The New Hampshire federal court also found that despite the lack of regulations from the Department of Justice (“DOJ”), “Blue Apron must still comply with Title III’s more general prohibition on disability-based discrimination….” Id. at pp. 14-15. The court noted that there might have been a due process violation if plaintiffs had “attempt[ed] to hold Blue Apron liable for failure to comply with independent accessibility standards not promulgated by the DOJ, such as the WCAG 2.0 AA standards….” Id. at p. 20. This was not a concern, however, because plaintiffs relied on Title III of the ADA as governing potential liability and only invoked compliance with WCAG 2.0 AA standards as a “sufficient” but not “necessary” condition. Id. at p. 21.
The Court also took up the issue of primary jurisdiction and held that because “the potential for delay” was “great,” it would not invoke the primary jurisdiction doctrine and dismiss or stay the matter until DOJ issues regulations concerning website accessibility. This holding is in direct contrast to the holding in Robles v. Dominos Pizza, LLC, where the United States District Court for the Northern District of California held that it would violate Domino’s due process rights to find that its website violates the ADA because the DOJ still has not promulgated regulations defining website accessibility. See Robles v. Dominos Pizza LLC, No. 16-cv-06599, Dkt. No. 42 (N.D. Cal. Mar. 20, 2017). Further analysis regarding the Robles case can be found in this blog post.
Arthur C. Clarke famously observed: “Any sufficiently advanced technology is indistinguishable from magic.” Our regulatory, legislative, and judicial systems illustrate this principle whenever new technology exceeds the limits of our existing legal framework and collective legal imagination. Cryptocurrency, such as bitcoin, has proven particularly “magical” in the existing framework of bankruptcy law, which has not yet determined quite what bitcoin is—a currency, an intangible asset, a commodity contract, or something else entirely.
The answer to that question matters, because capturing the value of highly-volatile cryptocurrency often determines winners and losers in bankruptcy cases where cryptocurrency is a significant asset. The recently-publicized revelation that the bankruptcy trustee of failed bitcoin exchange Mt. Gox is holding more than $1.9 billion worth of previously lost or stolen bitcoins highlights the issue.
The Mt. Gox Case: Timing is Everything
In 2013, Mt. Gox[1] was the world’s largest bitcoin exchange. By some estimates, it accounted for more than 80% of all bitcoin exchange activity. By February 2014, Mt. Gox had shut down its website, frozen customer accounts, and ceased trading. A leaked internal document indicated that hackers had gained access to Mt. Gox’s online wallets and stolen nearly 850,000 bitcoins, each then worth approximately $550. That same month, Mt. Gox commenced insolvency proceedings in Japan, and thereafter filed a corresponding chapter 15 bankruptcy in the United States. Mt. Gox eventually “found” approximately 200,000 bitcoins previously believed to be among those lost or stolen.
When it became clear that Mt. Gox could not reorganize and would proceed with liquidation, the Japanese court appointed a trustee over Mt. Gox’s assets. A former Mt. Gox exchange customer then filed a lawsuit against the trustee seeking the return of the customer’s purchased bitcoins. The Japanese court, however, ruled that the bitcoins at issue were not capable of ownership under Japanese law and dismissed the lawsuit. Article 85 of the Civil Code of Japan provides that an object of ownership must be a tangible “thing,” in contrast to intangible rights (like contract or tort claims) or natural forces (like sunlight or electricity). Bitcoin, the court ruled, does not meet the definition of a “thing” under the statute and, therefore, does not qualify for private ownership.
The Senate Banking Committee has released the text of proposed legislation providing real regulatory relief to community banks. With ten Republican co-sponsors and nine Democratic co-sponsors, the measure would appear to have better odds than prior regulatory reform actions. That said, no action is expected until sometime in 2018, and we’re still a long way away from adopted legislation. The proposed legislation provides for significant regulatory relief for community banks, including:
a regulatory “express lane” for community banks with sufficient leverage capital ratios;
a limited exemption from the brokered deposit restrictions for CDARS and other reciprocal deposits;
Volcker Rule relief for traditional banks will less than $10 billion in assets;
an increase in the Small Bank Holding Company Policy Statement threshold from $1 billion to $3 billion; and
an increase in the threshold for an 18-month exam cycle for healthy institutions from $1 billion to $3 billion.
Without attempting to predict how the tax reform legislation will ultimately end up, we also look at a few key provisions of the proposed house and senate versions of the Tax Cuts and Reforms Act. One item discussed is the potential impact on deferred tax assets, including the likely hit to existing deferred tax asset valuations and the elimination of net operating loss carry-forwards going forward. We also spend a fair amount of time addressing the need for all Subchapter S banks to begin the process of exploring the impact of the prospective reforms, particularly as it relates to the tax treatment for shareholders that are active in the bank’s management. As Sub S elections have to be withdrawn by March 15th to be effective for the whole year, the time to start planning is now!
Before getting to those topics, we have a brief foray into me trying to avoid talking about college football, as well as updates on the proposed tax reform act and the announcement of the appointment of Jerome Powell to serve as Chair of the Federal Reserve Board.
Among the alternatives discussed:
A sale to a credit union;
A sale to a non-bank buyer;
A merger of equals, strategic merger, or stepping stone transaction; and
Longer term planning to set up the bank for a future sale.
On the latest episode of The Bank Account, Jonathan and I discuss a veritable hodgepodge of new regulatory pronouncements, including the CFPB’s small dollar loan rule and the OCC’s guidance on CRA ratings. But before we got to the bank regulatory issues, Jonathan first had to seek my opinion on the new Florida Gator jerseys (pictured). I’m actually fairly proud in my restraint. For the handful of listeners who enjoy this banter, I encourage you to view these rejected Florida Gator uniforms. For those that wish we’d stick with banking, I assure you my interest in discussing college football has reached another low after this weekend.
We also encourage our listeners to check out the American Bankers Association’s new podcast, the ABA Newsbytes Podcast. While we’re happy for you to listen to our podcast over and over again, we recognize that it has diminished value starting with the third listen, and encourage you to explore other podcasts as well.
In April of this year, Bank of the Ozarks, a $20 Billion, NASDAQ-listed, bank holding company, announced its plan to eliminate its holding company, which was completed in June. In July, BancorpSouth, a $15 billion, NYSE-listed, bank holding company, announced its plan to eliminate its holding company. With the inclusion of BancorpSouth Bank, only four of the 115 banks with more than $10 billion in assets don’t have a holding company; but that number has doubled in the last six months.
Eliminating a holding company can often be done without limiting the permissible activities of the organization, with the potential for reduced regulatory oversight, simplified financial reporting, and consolidated governance. However, the holding company structure can also offer significant capital flexibility, particularly for institutions under $15 billion with trust preferred securities or institutions under $1 billion that can take advantage of the Small Bank Holding Company Policy Statement. Depending on the status of the applicable banking statutes, a holding company structure can also provide significant corporate governance benefits, including facilitating stock repurchases and avoiding super-majority voting thresholds for certain transactions.
We have heard, read and seen (and internally had) some confusion regarding the joint proposed rulemaking regarding the potential simplification of the capital rules as they relate to Mortgage Servicing Assets (MSAs) and certain Deferred Tax Assets (DTAs).
In addition to simply being complicated regulations, the regulators also have two proposed rulemakings outstanding related to these items. In August 2017, the banking regulators jointly sought public comment on proposed rules (the “Transition NPR“) that proposed to extend the treatment of MSAs and certain DTAs based on the 2017 transition period. Then, in September 2017, the banking regulators jointly sought comment on proposed rules (the “Simplification NPR“) that proposed to alter the limitations on treatment of MSAs and certain DTAs (and also addressed High Volatility Commercial Real Estate or HVCRE loans).
The Simplification NPR also addressed the interplay of the Simplification NPR and the Transition NPR. The Simplification NPR provided that the Transition NPR, if finalized, would only remain effective until such time as the Simplification NPR became effective. Accordingly, the Simplification NPR, if adopted, will ultimately control, with no transition periods for MSAs and certain DTAs following January 1, 2018.
Net Operating Loss DTAs
Importantly, neither the Transition NPR nor the Simplification NPR have any affect on the Basel III capital treatment net operating loss (NOL) DTAs. DTAs that arise from NOL and tax credit carryforwards net of any related valuation allowances and net of deferred tax liabilities must be deducted from common equity tier 1 capital. Through the end of 2017, the deduction for NOL DTAs are apportioned between common equity tier 1 capital and tier 1 capital. In 2017, 80% of the NOL DTA is deducted directly from common equity tier 1 capital, while the remaining 20% is separately deducted from additional tier 1 capital. Starting in 2018, 100% of the NOL DTA will be deducted from common equity tier 1 capital.
The end of the transition period will have the effect of lowering the common equity tier 1 capital ratio of all institutions with NOL DTAs, although the tier 1 capital and leverage ratios should remain unchanged. This impact is entirely unaffected by the adoption (or non-adoption) of the Transition NPR and/or Simplification NPR.
Similarly, other aspects of NOL DTAs are unaffected by the proposed rules. Specifically, (i) GAAP still controls the appropriateness of valuation allowances in connection with the DTA, (ii) tax laws still control the length of time over which DTAs can be carried forward, and (iii) Section 382 of the Internal Revenue Code still controls the limitation (and potential loss) of DTAs upon a change in control of the taxpayer.
Temporary Difference DTAs
Unlike Net Operating Loss DTAs, DTAs arising from temporary differences between GAAP and tax accounting, such as those associated with an allowance for loan losses and other real estate write-downs, can be included in common equity tier 1 capital, subject to certain restrictions. To the extent that such DTAs could be realized through NOL carryback if all those temporary differences were deemed to have been reversed, such DTAs are includable in their entirety in common equity tier 1 capital. Essentially, to the extent the temporary difference DTAs could be realized by carrying back against taxes already paid, then such DTAs are fully includable in capital. Carryback rules vary by jurisdiction; while federal law generally permits a bank to carry back NOLs two years, many states do not allow carrybacks.
As Jonathan and I mentioned on our podcast on succession planning a few weeks ago, our patriarch and founding father, Walt Moeling, formally retired at the end of 2016. However, his knowledge and influence continue to permeate almost everything we do (and he still has the same office down the hall). One of the ways that influence can be seen continues to be in our use of stories originally told to us by Walt. Of course, his storytelling ability has been noticed, including by the press. Several years ago, as part of our succession planning, we began chronicling some of those stories. What follows is what I wrote two years ago…
In early 2010, our clients were dropping like flies, with one or two clients failing every Friday. Even as one client entered receivership, we were each likely working with three or four others that were on the same path. (Each was a horror movie, and we knew exactly how it would play out, even if our clients held out optimism each time that, for whatever reason, their story would play out differently.)
Walt and I were on the phone with one such client who had just passed the 2% leverage ratio threshold, and was in discussions on next steps. The executives were worried about how their employees would handle the receivership. Walt, as usual, slipped into a story about another (former) client that had been a client for years. Whenever Walt called, the president’s administrative assistant, Nancy, would answer the phone and chat with Walt before tracking down the bank’s president. Walt shared how he had listened as Nancy became increasingly depressed as the bank’s condition had deteriorated.
In his best Southern belle, falsetto, voice, Walt would demonstrate the decreasing pep in Nancy’s voice. From an upbeat “Good Morning, Walt!” to more and more depressing “Oh, Walt, things are hard, but we’re trying.” In the weeks leading up to that client’s receivership, Walt himself became increasingly saddened by Nancy’s stress. Calls now usually started “Oh, Walter, things are rough.”
As discussed yesterday, the new HVADC rule would likely expand the scope of loans that require elevated risk-weighting, but reduce the risk-weighting from 150% to 130%. In addition, the new rules would eliminate the need (or risk-weighting benefit) to require borrower contributed capital (and to retain any internally generated profits from the project for the life of the loan).
The proposed rule for MSAs and DTAs would require 250% risk-weighting for such assets (as contemplated in the original BASEL III rules as of January 1, 2018 and proposed to be delayed in August), but would also allow financial institutions to include MSAs and DTAs as capital, each up to 25% of Tier 1 Capital (with no separate aggregate cap amongst them).
As discussed yesterday, the new HVADC rule would likely expand the scope of loans that require elevated risk-weighting, but reduce the risk-weighting from 150% to 130%. In addition, the new rules would eliminate the need (or risk-weighting benefit) to require borrower contributed capital (and to retain any internally generated profits from the project for the life of the loan).
The proposed rule for MSAs and DTAs would require 250% risk-weighting for such assets (as contemplated in the original BASEL III rules as of January 1, 2018 and proposed to be delayed in August), but would also allow financial institutions to include MSAs and DTAs as capital, each up to 25% of Tier 1 Capital (with no separate aggregate cap amongst them).
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On the latest episode of The Bank Account, Jonathan and I were joined by our Chicago partner, Jena Valdetero, to discuss snow, cybersecurity and data breaches. While Jena would normally be the one dealing with winter weather, it was Jonathan and myself watching the snow fall in Atlanta while Jena enjoyed a relatively warm, sunny day in Chicago.
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