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Senate-passed Regulatory Reform Offers Real Benefits to Depository Institutions under $10 Billion in Assets

On March 14, 2018, the Senate passed, 67-31, the Economic Growth, Regulatory Relief and Consumer Protection Act, or S. 2155.  While it may lack a catchy name, its substance is of potentially great importance to community banks.

The following summary focuses on the impact of the bill for depository institutions with less than $10 billion in consolidated assets.  The bill would also have some significant impacts on larger institutions, which could, in turn, affect smaller banks… either as a result of competition or, perhaps more likely, through a re-ignition of larger bank merger and acquisition activity.  However, we thought it was useful to focus on the over 5,000 banks in the United States that have less than $10 billion in assets.

Community Bank Leverage Ratio

Section 201 of the bill requires the federal banking regulators to promulgate new regulations which would provide a “community bank leverage ratio” for depository institutions with consolidated assets of less than $10 billion.

The bill calls for the regulators to adopt a threshold for the community bank leverage ratio of between 8% and 10%.  Institutions under $10 billion in assets that meet such community bank leverage ratio will automatically be deemed to be well-capitalized.  However, the bill does provide that the regulators will retain the flexibility to determine that a depository institution (or class of depository institutions) may not qualify for the “community bank leverage ratio” test based on the institution’s risk profile.

The bill provides that the community bank leverage ratio will be calculated based on the ratio of the institution’s tangible equity capital divided by the average total consolidated assets.  For institutions meeting this community bank leverage ratio, risk-weighting analysis and compliance would become irrelevant from a capital compliance perspective.

Volcker Rule Relief

Section 203 of the bill provides an exemption from the Volcker Rule for institutions that are less than $10 billion and whose total trading assets and liabilities are not more than 5% of total consolidated assets.  The exemption provides complete relief from the Volcker Rule by exempting such depository institutions from the definition of “banking entity” for purposes of the Volcker Rule.

Accordingly, depository institutions with less than $10 billion in assets (unless they have significant trading assets and liabilities) will not be subject to either the proprietary trading or covered fund prohibitions of the Volcker Rule.

While few such institutions historically undertook proprietary trading, the relief from the compliance burdens is still a welcome one.  It will also re-open the ability depository institutions (and their holding companies) to invest in private equity funds, including fintech funds.  While such investments would still need to be confirmed to be permissible investments under the chartering authority of the institution (or done at a holding company level), these types of investments can be financially and strategically attractive.

Expansion of Small Bank Holding Company Policy Statement

Section 207 of the bill calls upon the federal banking regulators to, within 180 days of passage, raise the asset threshold under the Small Bank Holding Company Policy Statement from $1 billion to $3 billion.

Institutions qualifying for treatment under the Policy Statement are not subject to consolidated capital requirements at the holding company level; instead, regulatory capital ratios only apply at the subsidiary bank level. This rule allows small bank holding companies to use non-equity funding, such as holding company loans or subordinated debt, to finance growth.

Small bank holding companies can also consider the use of leverage to fund share repurchases and otherwise provide liquidity to shareholders to satisfy shareholder needs and remain independent. One of the biggest drivers of sales of our clients is a lack of liquidity to offer shareholders who may want to make a different investment choice. Through an increased ability to add leverage, affected companies can consider passing this increased liquidity to shareholders through share repurchases or increased dividends.

Of course, each board should consider its practical ability to deploy the additional funding generated from taking on leverage, as interest costs can drain profitability if the proceeds from the debt are not deployed in a profitable manner. However, the ability to generate the same income at the bank level with a lower capital base at the holding company level should prove favorable even without additional growth.  This expansion of the small bank holding company policy statement would significantly increase the ability of community banks to obtain significant efficiencies of scale while still providing enhanced returns to its equity holders.

Institutions engaged in significant nonbanking activities, that conduct significant off-balance sheet activities, or have a material amount of debt or equity securities outstanding that are registered with the SEC would remain ineligible for treatment under the Policy Statement, and the regulators would be able to exclude any institution for supervisory purposes.

HVCRE Modifications

Section 214 of the bill would specify that federal banking regulators may not impose higher capital standards on High Volatility Commercial Real Estate (HVCRE) exposures unless they are for acquisition, development or construction (ADC), and it clarifies what constitutes ADC status. The HVCRE ADC treatment would not apply to one-to-four-family residences, agricultural land, community development investments or existing income-producing real estate secured by a mortgage, or to any loans made prior to Jan. 1, 2015.

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Constitutional Challenge to Garnishment Statute

This update is provided to our earlier post regarding the passage of HB 683 in 2012 permitting banks to answer garnishments without the need for an attorney.   As you may recall, we advised you then that there may subsequently be a challenge to the statute of on the grounds that the statute allegedly violates the separation of power principle set forth in the Constitution of Georgia.  As we predicted, Georgia Legal Services Program (“GLSP”) has recently challenged HB 683 on precisely this ground.

GLSP is challenging this law on the grounds that the General Assembly cannot define the practice of law and that defining the practice of law is instead reserved for the Supreme Court of Georgia.  Specifically, GLSP is seeking an advisory opinion from the Standing Committee on the Unlicensed Practice of Law of the State Bar of Georgia finding that only lawyers should be permitted to file answers in garnishment cases.

In its brief, GLSP states that “the Act is bad policy for all involved in garnishment proceedings because of the indispensable role that lawyers play in the administration of justice.”  GLSP further provides:  “[T]he Act, if unchecked, will establish precedent permitting the Georgia General Assembly to determine what constitutes the authorized practice of law – a power vested solely with the judiciary.”

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New Georgia Garnishment Reform Bill Allows Bank Employees to Answer Garnishments Directly

Georgia Governor Nathan Deal recently signed into law HB 683, a bill that reforms the way in which banks and other corporations may respond to a garnishment summons.  Under the new law, banks may now use their own employees to respond to a garnishment summons and are no longer required to hire an attorney for this task.

This statute seeks to overrule a 2011 Georgia Supreme Court decision which held that corporations must use a Georgia-licensed attorney to answer garnishments, and that non-lawyer employees who responded to garnishments on behalf of their employers were engaging in the unauthorized practice of law.

If you decide to utilize non-attorney personnel to answer garnishments, as permitted by the new statute, you should keep in mind the following issues:

  • The new law only permits non-lawyers to file answers to garnishment summons.  If a traverse is filed in response to the answer, an attorney is then required to represent the bank.  A traverse is a statement filed by a plaintiff in response to the answer, claiming that the answer is untrue or insufficient.  Once a traverse is filed, the bank then must then hire an attorney to represent it further in the case.
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Senate Defeats Bill to Delay Interchange Fee Caps

After a long and divisive lobbying fight, retailers defeated the banking industry Wednesday as the Senate narrowly defeated legislation to delay new caps on debit-card swipe fees.

The legislation was offered by Sens. Jon Tester (D-Mont.) and Bob Corker (R-Tenn.) and failed on a 54-45 vote, falling just six votes shy of the 60 needed for passage and clearing the way for a provision in last year’s Dodd-Frank Wall Street reform law to take effect July 21.

The provision, often referred to as the “Durbin Interchange Amendment” required the Federal Reserve to establish fair and reasonable interchange fees for many debt and prepaid card transactions.  Last Fall, the Federal Reserve proposed new rules which (among other things) would limit to 12 cents per transaction the fee that large banks (with more than $10 billion in assets) can charge merchants every time a consumer uses a debit card or a prepaid gift card.  These proposed rules garnered significant critcism and final rules, which are now overdue from the Federal Reserve, are expected shortly.

Senators Tester and Corker initially proposed delaying the Durbin amendment from taking effect for 24 months. The final version of the Tester-Corker plan was to cut the delay in half to 12 months and called for a six-month study of the costs associated with debit transactions and their impact on consumers and small, community banks.

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Senate Adopts Corporate Finance and Executive Compensation Reforms

In addition to significant reforms specific to the financial services industry, the Financial Reform Bill is likely to contain a number of significant provisions that would affect corporate governance and executive compensation at public companies, as well as Regulation D private placements, whistleblowers and beneficial ownership reporting.

We address the reforms contained in the Senate-adopted “Restoring American Financial Stability Act of 2010” and compare to the House-adopted “Wall Street Reform and Consumer Protection Act of 2009.”  As the Senate and House are now proceeding to the reconciliation phase, it is difficult to predict what changes, if any, will be made to the final legislation.

You can also obtain a Printer-Friendly Version of this Client Alert.

Some of the more important provisions of the Act are the following:

Corporate Governance Requirements

Majority Voting for Directors. Within one year of enactment, stock exchanges would adopt rules prohibiting the listing of companies that fail to comply with the following voting standards:

  • election of directors by a majority of votes cast, in uncontested elections, and by a plurality of shares represented and entitled to vote, in contested elections
  • if a director receives less than a majority of votes cast in an uncontested election, the director would tender his or her resignation, and the board would either:
    • accept the resignation, determine when it will take effect and publicly disclose the date, generally within a reasonable period of time, as established by the SEC, or
    • upon a unanimous vote, decline to accept the resignation and, within 30 days (or such shorter period as the SEC may establish), publicly disclose its reasons for the decision and why it was in the best interests of the company and its shareholders.

The SEC would be permitted to exempt companies from these requirements, based on their size, market capitalization, number of record holders or other factors. The House Bill does not contain a comparable provision.

Authorization of Proxy Access Rules. The Act would authorize the SEC to adopt rules that would (1) require proxy or consent solicitations to include a director nominee submitted by a shareholder, and (2) require companies to follow certain procedures relating to such a solicitation. Like the House Bill, the Act authorizes, but does not require, the SEC to adopt such rules.

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Will Trust Preferred Retain Tier 1 Capital Status?

The Senate-approved version of the Restoring American Financial Stability Act of 2010 raises many issues for community banks.  Provisions added to it by the amendment of Senator Susan Collins (R-Maine), however, are drawing special attention.  The full text of the amendment can be found as Section 171 of the Senate-approved legislation.  The Senate unanimously consented to Senator Collins’ amendment by voice vote on May 13, 2010.

The amendment requires the various federal banking regulators to establish minimum leverage and risk-based consolidated capital requirements for all banks, all bank holding companies, and those non-bank financial firms subject to regulation by the Federal Reserve, regardless of size, that are no less than the capital requirements currently in effect for banks.  While unstated in the legislation, this amendment has two primary effects on community banks.  First, it eliminates the current regulatory exemption from consolidated capital requirements available to bank holding companies having less than $500 million in assets. Second, it would exclude trust preferred securities and bank holding company TARP CPP Preferred Stock from the consolidated Tier 1 treatment of bank holding companies.

The elimination of the small bank holding company exemption puts additional pressure on community bank holding companies to raise capital through the sale of common stock, as such holding companies will no longer merely need to assure that cash is down-streamed into the bank as Tier 1 capital.  However, for purposes of complying with regulator-mandated higher capital requirements at the bank level (whether by memorandum of understanding, IMCR, formal agreement or consent order), the treatment of the capital at the holding company level will continue to be of less importance than the treatment at the bank level.

Under the current regulations, subject to certain limitations, both trust preferred securities and TARP CPP cumulative preferred stock are treated as Tier 1 capital for bank holding companies.  However, neither are treated as Tier 1 capital if issued by a depository institution directly.  (The TARP CPP securities issued directly to banks without holding companies were originally issued in the form of non-cumulative preferred stock to preserve the Tier 1 treatment for such institutions.)  Current estimates are that there is approximately $129 billion in Tier 1 capital that would be eliminated by the disqualification of trust preferred securities as Tier 1 capital, which could force a corresponding $1.3 trillion deleveraging of bank balance sheets, and would cause an average decline of over 200 basis points in the capital ratios of publicly owned bank holding companies. (As background, the FDIC has always objected to the Federal Reserve’s determination, starting in 1996, that trust preferred securities should be included as Tier 1 capital.)

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Senate Publishes Text of Regulation Reform Bill

On May 26, 2010, the Senate released the official copy of the Senate-passed “Restoring American Financial Stability Act of 2010.”  Before becoming law, the senate-approved bill will need to be reconciled with the previously House-passed “Wall Street Reform and Consumer Protection Act of 2009.”  We understand the White House is pushing for reconciliation of the two bills before the Fourth of July congressional recess.

The reconciliation process can lead to dramatic changes in the final legislation, including changes and additions that are not currently reflected in the house or senate versions.  For example, in 1980, the increase in FDIC insurance to $100,000 was introduced for the first time in the reconciliation process.

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Enhanced Deposit Insurance Extended Through 2013

On May 20, 2009, President Obama signed the Helping Families Save Their Homes Act of 2009 (Senate Bill 896).  Among other things, the Act:

  • extended the $250,000 deposit insurance limit through December 31, 2013;
  • extended the length of time the FDIC has to restore the Deposit Insurance Fund from five to eight years;
  • increased the FDIC’s borrowing authority with the Treasury Department from $30 billion to $100 billion;
  • increased the SIGTARP’s authority vis-a-vis public-private investment funds under PPIP (including the implementation of conflict of interest requirements, quarterly reporting obligations, coordination with the TALF program); and
  • removed the requirement, implemented by the American Recovery and Reinvestment Act of 2009, for the Treasury to liquidate warrants of companies that redeemed TARP Capital Purchase Program preferred investments.  The Treasury is now permitted to liquidate such warrants at current market values, but is not required to do so.

This extension does not affect the Transaction Account Guarantee provided by the FDIC’s Temporary Liquidity Guarantee.  The Transaction  Account Guarantee, which provides an unlimited guarantee of funds held in noninterest bearing transaction accounts, is still scheduled to expire on December 31, 2009.

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Frank Introduces TARP Reform and Accountability Act of 2009

On January 9, 2009, Barney Frank introduced H.R. 384, the TARP Reform and Accountability Act, to amend the TARP provisions of the Emergency Economic Stabilization Act of 2008.

As introduced, the Reform Act would: require quarterly reporting on the use of TARP funds, limit the ability to use TARP funds to acquire healthy institutions, require additional compensation limitations, and require Treasury to make TARP Capital available to smaller depository institutions, including Subchapter S corporations and mutuals.

It is important to remember that this is the initial legislation as proposed by Congressman Frank, and it may never become the law, or undergo significant revisions before it becomes the law.  At this point, the proposed legislation raises as many questions as it does propose changes.

A brief summary of the provisions of TARP Reform and Accountability Act follows.  Note: Some of the provisions contained in the Reform Act would apply to all institutions that have received assistance under TARP, while others are structured to only apply to those receiving assistance following the effectiveness of the Reform Act.  We have attempted to distinguish between these provisions below.  We believe it is also important to distinguish between modifications that are requirements versus merely where the Reform Act provides for additional authority for Treasury to act.  Finally, Section 105, as noted below, may effectively permit the TARP Capital program to be largely unchanged for all institutions.

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