Monthly Archives:' June 2015

Name Check Process for Applications

On June 25, 2015, a supervisory letter was provided dictating some important changes to the “name check” process for banking applications. Under the previous process, name checks generally were conducted on all proposed officers and directors and/or new principal shareholders of a supervised financial institution involved in an application under consideration by the Federal Reserve.  Exceptions were made for individuals considered “known to banking” and proposed outside directors with limited or no ownership interests (that is, less than five percent) in the supervised financial institution. Generally, a banker was considered “known to banking” if they had five years of relevent banking or thrift experience.  Where the specific facts and circumstances warrant, name checks were conducted on an entire board or ownership group.  For example, in proposals which involved numerous organizers (each with limited or no ownership in the relevant supervised financial institution) and no clear top policymakers, name checks generally were conducted for the entire group of organizers.

New Name Check Process

The Federal Reserve is now implementing several changes to the name check process.  The Federal Reserve generally will conduct name checks only on an individual that, upon consummation of an application, will become a principal shareholder or one of the top two policymakers of the supervised financial institution.  In addition, the Federal Reserve will no longer take into consideration whether an individual is “known to banking” when determining whether a name check must be conducted.  Rather, unless the facts and circumstances suggest otherwise, a completed name check will remain current for a period of five years, and individuals and companies with current name checks will generally not be rechecked, unless circumstances indicate to the Reserve Bank or Board staff that a name check is appropriate. In addition to the above changes, the Federal Reserve will obtain credit bureau reports in certain limited situations to supplement and corroborate financial information provided in application filings or from other sources.  The use of such “credit checks” will align their practice with that of other federal banking agencies.  These credit checks will be conducted on an ad hoc basis when the facts and circumstance indicate that the information provided in the credit report could be helpful to the Federal Reserve in its comprehensive assessment of individuals under review.

CFPB Expands Consumer Complaint Database

Each week the CFPB sends thousands of consumers’ complaints about financial products and services to companies for response. Those complaints are published in a complaint database after the company responds or after 15 days, whichever comes first.

On June 25, 2015, the Consumer Financial Protection Bureau’s (CFPB’s) Consumer Complaint Database went public providing increased access to consumer complaints. Since 2012, the CFPB has shared anonymous individual-level complaint data on their website to educate the public and improve the functioning of the marketplace. the public complaint included the date of complaint, the type of consumer product at issue, the issue classification, the sub-issue classification, the company criticized in the complaint, and the state and zip code of the complainant’s residence.

In March 2015, individuals were given the option to openly air their grievances by publicizing searchable, narrative descriptions of their complaints in the CFPB database. According to the CFPB, 59% of the consumers lodging complaints have elected to publicize their complaints. Included in the new database is information regarding the timeliness of the company’s response to the complaint, the company’s public response, and whether the complainant disputed the company’s response.

The CFPB believes the new database will: (i) provide context for customer complaints, (ii) allow users to spot trends, (iii) permit consumers to make informed decisions, and (iv) encourage companies to improve their own processes and systems.

View the Complaints in the new database.

Agencies Issue Flood Rule

The Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board), Federal Deposit Insurance Corporation (FDIC), the Farm Credit Administration (FCA), and the National Credit Union Administration (NCUA) (collectively, the Agencies) are amending their regulations regarding loans in areas having special flood hazards to implement certain provisions of the Homeowner Flood Insurance Affordability Act of 2014 (HFIAA), which amends some of the changes to the Flood Disaster Protection Act of 1973 mandated by the Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters). Specifically, the final rule requires the escrow of flood insurance payments on residential improved real estate securing a loan, consistent with the changes set forth in HFIAA. The final rule also incorporates an exemption in HFIAA for certain detached structures from the mandatory flood insurance purchase requirement. Furthermore, the final rule implements the provisions of Biggert-Waters related to the force placement of flood insurance. Finally, the final rule integrates the OCC’s flood insurance regulations for national banks and Federal savings associations. The Agencies plan to address the private flood insurance provisions in BiggertWaters in a separate rulemaking.

Read the OCC’s relase

Shareholder Succession Planning

As counselors and advisors to community banks and bank holding companies, we often engage with our clients in strategic discussions and planning sessions about senior management succession, new products and services, the acquire or be acquired question, and capital planning. However, oftentimes when we try to engage the board in a substantive discussion about shareholder planning and the need to explore what liquidity options are, or should be, available, we are met with a look of confusion or complete reticence to engage in the discussion. For community banks to survive, even those that are very closely held, it is critical to begin a discussion about how aging shareholders or the next generation who may not be interested in the banking business are going to be cashed out and new shareholders are going to be brought in.

For community banks that are “family owned,” meaning one or several families are the largest shareholders and act in some form of board or management capacity with the next generation expected to step up to manage the bank, the board of directors may not see a need to engage in shareholder succession planning. And while keeping the bank largely family owned and operated sounds appealing (after all, Granddaddy said that we better not ever sell a share of bank stock), according to the Family Business Institute, only 30% of these businesses last into a second generation, 12% make it into the third generation, and a mere 3% operate into the fourth generation or beyond. So rather than leaving the legacy of the bank to chance, wouldn’t it make more sense to deploy those well-earned risk management skills in the practice of shareholder succession planning?

This article provides a brief overview of the benefits of an employee stock ownership plan (ESOP) and how they work. The second article in this series will discuss the use of subordinated debt as a tool for shareholder succession planning and the expanded limit of the small bank holding company policy statement to bank holding companies with assets <$1B.

Questions to ask:

  •  If there are particular individual family members who are interested in and capable of leading the bank for the next decade or two, should the BHC look for a way to allow them to buy out existing shareholders who don’t have an interest in remaining active?
  • While not a fun conversation to have, are there shareholders that need to be taken out because they are not going to provide any long term value to the BHC while other potential shareholders with the ability to create value sit on the sideline
  • Are there aging shareholders who are going to devise their shares to children or grandchildren with no real ties or interest in the BHC?
  • Does the BHC have the ability (retained capitalat the BHC level, subordinated debt, BHC stock loan, etc.) to buy-out large shareholders as they get older and look for liquidity?
  • Does the BHC need to explore the idea of an employee stock ownership plan as a succession planning measure to create shareholder liquidity, motivate employees, and remain locally owned?

As BHCs look for ways to manage their shareholder base and their future, the above questions need to be asked and discussed in a candid and productive way to ensure
the long-term viability of the bank and BHC. Below is a discussion about employee stock ownership plans (ESOPs) and its ability to facilitate the necessary shareholder
succession planning moves that might need to occur.

What is an ESOP?
An ESOP is “tax qualfied” defined contribution retirement plan which is designed to invest primarily in the bank’s stock. ESOPs are regulated by the Internal Revenue Service (Internal Revenue Code) and the Department of Labor (Employee Retirement Income Security Act) just like pension and 401(k) plans. Congress’ purpose in authorizing ESOPs was to encourage employee ownership and the opportunity to build equity and wealth among a broader base of individuals than would normally be possible.

Simply put: an ESOP is a way to provide employees the ability to invest in a BHC’s stock at no cost. ESOPs are also an incredible retirement plan option, as discussed
below under the [E&Y S corp ESOP Study] section.
ESOP Benefits:

Build employee engagement

  • Attract top talent
  • Establish a business succession plan or create shareholder liquidity
  • Manage capital in a tax-advantaged manner
  • Protect employees and the community
  • Transfer wealth in a way no other retirement plan can do
  • Encourage an employee ownership culture

ESOP Benefit as a Retirement Plan
Study Finds S ESOPs Total Return Beats S&P 500 by 62%, Employee-Owned S Corporations of America (Mar. 31, 2015), http://www.esca.us/news-room/
newsroom/2548?task=view
.

Study by EY
WASHINGTON, D.C. (March 31, 2015) – New data compiled by EY’s Quantitative Economics and Statistics (QUEST) practice, shows that private employee stock ownership retirement plans (S corporation ESOPs) outperformed the S&P 500 Total Returns Index in terms of total return per participant by 62%, while net assets increased over 300%, and distributions to participants totaled nearly $30 billion from 2002 to 2012.

The EY study found that the total return for S ESOP participants from 2002 through 2012 was $99,000 for an 11.5% compound annual growth rate, 62% percent higher than the S&P 500 Total Returns Index’s 7.1% growth rate over the same period. Distributions to plan participants totaled nearly $30 billion in the same ten-year period, and paid significantly more benefits per participant than 401(k)s. 

“This striking new study confirms what our members know from direct experience,” commented ESCA Chairman Steve Smith, Vice President-General Counsel of Amsted Industries. “They know first-hand that S ESOPs are providing secure retirements for their workers and economic benefits to their communities. These compelling findings—showing strong and continuing growth in net assets, distributions, average account balances, and number of participants with accounts—make that even more apparent. S ESOPs are a model for how to make retirement security a reality for the broad American middle class.”

“The report finds that S ESOPs are providing an increasingly important role in supporting the retirement security of their participants,” said Robert Carroll, National Director of QUEST and one of the study’s authors.

Prior reports have shown that S ESOP companies have lower default rates and weather economic storms better than their non-ESOP counterparts. In 2014, the National
Center for Employee Ownership compiled new data showing that private employee-owned businesses default on their loans far less than other businesses. In 2010 by economists Phillip Swagel and Bob Carroll, both former senior Treasury Department officials, found that, during the most recent economic recession, S ESOP firms they
surveyed increased employment by nearly 2%, at the same time that overall, employment in the private sector fell by nearly 3%. In his 2013 study, Macroeconomic
Impact of S ESOPs on the U.S. Economy, economist Alex Brill of Matrix Global Advisors wrote, “Beyond the immediate benefit they provide to employees and customers, S ESOPs’ positive outcomes yield benefits to the U.S. economy broadly.” Brill’s analysis found that total direct and indirect output from these companies accounts for nearly 2% of gross domestic product.

How Does an ESOP Work?

An ESOP, like other tax qualified retirement plans, has a tax-exempt trust which holds the ESOP’s assets. There are two types of ESOP structures that may be utilized to acquire BHC stock: non-leveraged and leveraged.

Non-leveraged ESOPSs
A non-leveraged ESOP is funded through annual deductible contributions of cash or stock from the BHC to the ESOP which are allocated to each employee account according to the ESOP’s terms. A BHC can also give participants a special one-time opportunity to transfer 401(k) assets to the ESOP to purchase shares of stock through the ESOP. The later type of non-leveraged transaction is a special type of securities offering which is typically exempt from state and federal securities laws.

Leveraged ESOPs
ESOPs are the only retirement plan which can borrow money. A leveraged ESOP allows the ESOP to borrow funds from the BHC to purchase the stock which serve
as collateral for the loan until they are distributed to participants’ accounts in accordance with the plan document upon loan payments by the ESOP. The discussion and diagram below describe a typical leveraged ESOP where the BHC borrows funds from a third-party lender and then makes a loan to the ESOP.

When the BHC issues a distribution to its shareholders, the ESOP receives the pro rata income for the shares it purchased and can use that income to make a loan payment ot the BHC, pay plan expenses, pay benefits or save the distribution to acquire additional shares at a future date. If the distribution is used to make a loan payment, the BHC can use the loan repayment from the ESOP to make payments on its loan from the third-party lender.

Through an ESOP employees are able to acquire BHC stock without paying income tax on the stock at the time it is allocated to their ESOP account. The BHC receives the benefit of using pre-tax dollars to provide liquidity for shareholders who want or need liquidity while optimizing its shareholder base, and it provides a tool to finance future growth.

Some additional points about ESOPs:

  1. Under Section 1042 of the Internal Revenue Code, if the ESOP acquires 30% or more of the outstanding stock of a privately-held company, any capital gains tax on the transaction is deferred indefinitely, provided that the seller reinvests the proceeds in “qualified replacement property” within 12 months of the date of sale. This is only available to C Corp ESOPs, though legislation has recently been introduced in Congress to extend this treatment to S Corp ESOPs as well.
  2. Unlike a sale or merger, the ESOP enables the seller to sell any portion of his or her stock. A sale or merger usually requires the seller to sell 100% control.
  3. The ESOP enables the company to repay principal on a third-party loan with tax-deductible dollars.
  4. In a C Corp ESOP, dividends paid on stock held by an ESOP are fully tax-deductible, provided that such dividends are either passed through to participants or are used to make principal or interest payments on an ESOP loan. S Corp ESOPs are not subject to federal income tax on earnings or dividends.
  5. In the case of an S corporation, the ESOP’s share of S corporation earnings is not subject to federal or state corporate taxation or to taxed as “unrelated business taxable income,” unless the ESOP runs afoul of certain “anti-abuse” provisions. Thus, in the case of a BHC that is 100% owned by its ESOP, the BHC’s earnings will be entirely tax-exempt.
  6. An ESOP enables controlling shareholder employees to keep control until they are ready to fully retire. When the owner does retire, the ESOP enables the owner to pass control to management.
  7. An ESOP enables an owner to provide for business continuity for the bank he or she has grown and nurtured over many years. Unlike a sale or merger, an ESOP enables a company to retain its separate identity rather than become a branch or division of a larger company.
  8. An ESOP enables a bank to attract, retain and motivate key employees through offering employees the ability to beneficially own stock.
  9. Studies have shown that ESOP-owned companies become more productive and profitable than comparable firms in the same industry that are not ESOP-owned.

As briefly demonstrated above, ESOPs are a powerful tool at the disposal of S corporations willing to devote the time and resources required to effectively implement an ESOP strategy. An S corporation ESOP can generate liquidity for shareholders and aid in succession planning, provide employees with an incredibly taxefficient
retirement savings plan, and ensure the overall health of an organization by creating owners out of the stakeholders (shareholders and employees alike) that are vital to the long-term success of the company.

If you have any questions regarding if an ESOP is right for your financial institution please contact William “Dub” Sutherland.

Congressman Marchant's Remarks on HR 2789

U.S. Congressman Kenny Marchant (TX-24) has introduced H.R. 2789, the Capital Access for Small Business Banks Act. The legislation seeks to provide small banks – specifically those classified under Subchapter S of the U.S. tax code – with greater freedom to attract capital investment so they can better serve the families and businesses of their communities.

Marchant released the following statement after introducing H.R. 2789:

“Small banks are vital to a healthy and growing American economy. Subchapter S banks in particular make up roughly one-third of all U.S. banks and 90 percent of them are located in rural communities. These local banks provide invaluable support to working families and have helped countless American entrepreneurs put their ideas in motion. Yet, when small banks seek to raise capital so they can better serve their communities, our tax code restricts their access to new investment. I have introduced the Capital Access for Small Business Banks Act to fix this problem.

“At a time when many small banks are struggling just to stay in business, H.R. 2789 would offer these trusted financial institutions greater freedom to take on new investors and raise capital. In doing so, the bill would bring renewed strength to Subchapter S banks, the communities they serve and the American economy as a whole – without added risk to the broader U.S. financial system. Most importantly, the Capital Access for Small Business Banks Act would bring us one step closer to a tax code that better supports American families and job creators. That’s what small banks and our local communities deserve.”

Capital Access for Small Business Banks Act

Representative Kenny Marchant today introduced the Capital Access for Small Business Banks Act (H.R. 2789). The Capital Access for Small Business Banks Act (H.R. 2789) would invigorate local economies by freeing up typically-small financial institutions, namely Subchapter S banks, to raise needed capital in the face of an increasing regulatory regime so that they can keep serving their communities.

At approximately 2,300 strong, Subchapter S banks account for about one-third of all banks in the US. 90% of these are rural, primarily serving the needs of their local families and businesses, and over 90% are small in size with assets under $1 billion. These institutions are a key part of our national economic engine.

Unfortunately, the climate of increasing regulation after the financial crisis of 2008 has put added burden on these smaller institutions—a burden that is disproportionate to the risk they pose to the banking system. Unlike other S corporations, S corp. banks need to meet these capital requirements while abiding by limits on the number and type of allowable shareholders that constrain their ability to raise capital. These banks are also prohibited from organizing as other, more flexible pass-through entities such as limited liability companies, which would create greater opportunities to raise capital.

S corp. banks require an opportunity to raise capital in new ways, without introducing new risks into the financial system, in order to thrive in the current climate and continue to provide everyday Americans with important financial services.

Legislative Solution

The Capital Access for Small Business Banks Act would help provide opportunities for S corp. banks, as well as thrifts and their holding companies, to raise needed capital by:
1) Raising the limit of shareholders for S corp. banks from 100 to 500.
2) Allowing S corp. banks to issue preferred stock without a cap. 3) Preserving sound tax treatment of S corp. banks by allowing preferred stock dividends to be deductible by the bank and ordinary income for the holder.

Over the years, the limit on the number of shareholders allowed for S corps has steadily grown to meet the needs of a growing small-business economy. In the current regulatory environment, and without the freedom to organize in alternative forms (without being subject to the double-taxation of a C corp.), it is time to give S corp. banks the necessary freedom to meet their capital requirements, grow their businesses, and better serve their communities.

CDFI Fund Announces New Market Tax Credit Winners

The U.S. Treasury Department’s Community Development Financial Institutions Fund (CDFI Fund) today announced more than $3.5 billion in New Markets Tax Credit awards aimed at stimulating investment and economic growth in low-income urban neighborhoods and rural communities nationwide. A total of 76 organizations (Allocatees) across the country will receive tax credit allocation authority under the 2014 round of the New Markets Tax Credit Program.

“Every community deserves a chance to succeed, and the New Markets Tax Credit Program is an economic development tool that spurs growth and breathes new life into neglected, underserved low-income communities,” said U.S. Treasury Secretary Jacob J. Lew. “The tax credit allocation authorities announced today will go to community development organizations that will make much needed private sector investments in businesses and real estate projects located in the nation’s distressed urban and rural communities. Along with these investments come jobs, vital services, and opportunities where they are needed the most.”

“Over its fifteen year history, the New Markets Tax Credit program has successfully fostered competition for private sector investment into low-income communities that lack access to the capital needed to support and grow businesses, create jobs, and sustain healthy local economies,” said Annie Donovan, Director of the CDFI Fund. “The investments made possible by today’s awards will have significant impact nationwide.”

View the 2014 Winners

Need Information on .Bank Registration?

.BANK will be open to all eligible organizations in 19 days. The fTLD has recently launched a new website, www.register.bank, so banks can find all of the information they need to prepare for the .BANK registration process.

On the new website banks can see frequently asked questions, see policies, learn about the enhanced security requirements needed for .BANK domains, find out who is eligible to purchase them and identify which domains are reserved from registration.

Although General Availability opens in June, banks should be visiting this site now to research the different approved registrars and learn how to pre-verify with one that best fits their needs.

For more information on .bank see our post from March 3rd.

BACKGROUND

fTLD Registry Services, LLC’s (fTLD) mission is to secure generic Top-Level Domains (gTLDs) to enable verified members of the banking and insurance communities to meet the security, technology and business needs arising from the Internet Corporation for Assigned Names and Numbers’ (ICANN) introduction of new gTLDs.

Members of the banking and insurance communities and their respective stakeholders should have a voice in the future developments of gTLDs to meet institutional and consumer needs and ensure that new gTLDs are both trusted and secure.

fTLD is committed to operating gTLDs fairly, transparently, without undue preference and in the best interest of the communities and the consumers they serve.

fTLD submitted community-based applications for .BANK and .INSURANCE in 2012. fTLD was granted the right to operate .BANK on September 25, 2014, and .INSURANCE on February 19, 2015.

CDFI Fund Releases New Markets Tax Credits Data for 2003-2013

The Community Development Financial Institutions Fund (CDFI Fund) has released data collected on New Markets Tax Credit (NMTC) investments across the nation through fiscal year (FY) 2013. The CDFI Fund requires all Community Development Entities (CDEs) that have been awarded NMTC allocations to submit an annual report detailing how they invested Qualified Equity Investment (QEI) proceeds in low-income communities. These reports must be submitted to the CDFI Fund by the CDEs, along with their audited financial statements, within six months after the end of their fiscal year.

Through the first 11 application rounds of the NMTC Program, the CDFI Fund has made 836 awards, allocating a total of $40 billion in tax credit authority to CDEs through a competitive application process. This $40 billion includes $3 billion in Recovery Act allocations and $1 billion of special allocation authority to be used for the recovery and redevelopment of the Gulf Opportunity Zone.

CDEs are required to report their NMTC investments in the CDFI Fund’s Community Investment Impact System (CIIS) for a period of seven years. Due to a time lag in reporting, NMTC investments reported in CIIS are less than the total amount allocated for the NMTC Program.

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