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Welcome Back, Old Friend – Section 8 of RESPA is a Hot Topic Again

The below article is the Special Focus section of the September 2019 Compliance Journal. The full issue may be viewed by clicking here.

Section 8 of the Real Estate Settlement Procedures Act (RESPA)1 – the prohibition against kickbacks and unearned fees – is back and compliance officers are taking note. In the last year, we have seen a significant increase in RESPA section 8 questions, many of which involve a determination as to whether certain marketing activities are permissible. This is due, in part, to evolving technology which provides a platform to facilitate marketing relationships between settlement service providers, along with recent regulatory and case law developments. Some of these arrangements are simple, while others extraordinarily complex. Either way, I sense bit of panic from compliance officers any time there’s a new opportunity to market the institution’s mortgage area that may implicate RESPA (and for good reasons – penalties and reputation to name a couple!). Not all these arrangements are problematic, especially in light of the recent PHH decision and developments out of the Consumer Financial Protection Bureau (CFPB), but some arrangements should still make your ears perk up. 

So, how do we analyze whether a marketing opportunity presents a RESPA Section 8 issue? Let’s discuss.

When we consider marketing activities under RESPA, there are two primary provisions of RESPA Section 8 that are relevant to our analysis: (1) Section 8(a) which delineates prohibited activity,2 and (2) Section 8(c) which prescribes permissible activities.

Sections 8(a)– Prohibited Activity

The first is Section 8(a) of RESPA which prohibits illegal kickbacks – the giving or receiving of a “thing of value” for referrals made between settlement service providers. Specifically, Section 8(a) prohibits any person from giving or accepting any fee, kickback, or thing of value pursuant to an agreement or understanding for the referral of a settlement service involving a federally related mortgage loan (a.k.a. consumer mortgage loans).3 There are three elements to an illegal kickback under Section 8(a): 

  1. A “thing of value” – for example, money, defrayed costs, special contract terms, a promise to provide future referrals, and things (such as sporting event tickets or office supplies); 
  2. An “agreement or understanding”, whether oral, written, or established by practice; and 
  3. A “referral”, which is defined in two ways: (a) oral or written action that has the effect of affirmatively influencing selection of a settlement service provider, or (b) when a person is required to use a particular settlement service provider.  

All of these components must be present to be considered a prohibited activity under RESPA. Thus, when a potential RESPA-implicating opportunity presents itself, each of these components must be analyzed in detail. 

Section 8(c) of RESPA – Permissible Activity

Notwithstanding the prohibitions in Sections 8(a), the second relevant provision, contained in Section 8(c) of RESPA, sets forth permissible activity. Relevant here, RESPA specifically permits the following:

  • “normal promotional or educational activities that are not conditioned on the referral of business and that do not involve the defraying of expenses that otherwise would be incurred…”;4 and 
  • “payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed.”5   

These permissible activity exceptions are generally relied upon in order to create relationships between settlement services providers (e.g. the institution and a realtor). 

Importantly, there are some general principles that have developed over time, via administrative interpretations, case law, and enforcement actions that must be true in order for the marketing activity to be permissible pursuant to one of these exceptions:

  • Services must actually be performed or goods must actually be provided. For example, advertising must actually be provided. Any payment for advertising that does not actually occur will be considered an unlawful kickback.
  • The payment for such services or goods must be bona fide. That is, payment must be reasonable market value. Any excess payment above reasonable market value will be seen as an illegal kickback.6

Now, assuming the marketing activity meets the parameters of one of the Section 8(c) exceptions, the activity receives a “safe harbor” from a RESPA Section 8 violation. Note, however, that the “safe harbor” rule was not the prevailing opinion of the CFPB under the reign of Director Richard Cordray, which was a significant departure from previous, longstanding interpretations of RESPA under the Department of Housing and Urban Development (HUD). However, in perhaps one of the most contentions of RESPA cases in recent history, PHH Corporation v. Consumer Financial Protection Bureau,7 the Court of Appeals for the D.C. Circuit confirmed that Section 8(c) of RESPA provides a safe harbor so long as the activity meets the parameters of the Section 8(c) exceptions. 

Analysis When Considering Marketing Opportunities

With that RESPA background in mind, if your institution is considering a marketing opportunity involving federally related mortgage loans, I suggest engaging in the following analysis:

  • Might this be deemed a prohibited activity under RESPA Section 8(a) or 8(b)?
    • That is, could this be considered an illegal kickback under Section 8(a) in that all three elements are present, as described above and restated here:
      • A “thing of value”; 
      • An “agreement or understanding”; and
      • A “referral”
    • Or, is this impermissible fee splitting under 8(b)?
      • Though not often arising in the marketing context and, consequently, not thoroughly discussed herein, the institution should consider applicability

If NO, that’s the end of your analysis – no Section 8 concern
If MAYBE or YES, continue to (2) and (3).

  • Is the activity “saved” by the Section 8(c) educational and marketing exception; or
  • Is the activity “saved” by the Section 8(c) “bona fide payment for services actually performed” exception?

Let’s take a couple of common marketing opportunities and run through the analysis:

Hosting a Complementary Educational Seminar for Settlement Service Providers

If an institution chooses to host a complementary educational seminar for real estate professionals, such an event may be considered to violate Section 8(a) of RESPA because it’s certainly the provision of a “thing of value” provided in hopes of generating business (or, in other words, referrals from those settlement service providers). In fact, previous HUD Guidance states that such educational events implicitly positions settlement service providers to refer business to the institution. We can question whether there is an “agreement or understanding”, but let’s just assume that the conduct is indicative of such. The question then becomes whether this can be redeemed by the “normal promotional and marketing” exception under 8(c).

Whether an educational seminar meets the safe harbor exception is very much dependent upon the facts and circumstances at hand. Consider the following:

  • Is the event in any way conditioned on past, present, or future referrals of business? For example, does the institution provide an incentive for attendees to refer business back to the institution? Or, does the institution only invite settlement service providers that have previously referred business to the institution? If so, the safe harbor is unlikely to be met.
    • Note that who is invited can make a difference here. The more “open” the attendance list (e.g. not just settlement services providers located near your branches or those who have previously referred business your way), the more likely the seminar is to pass muster.
  • Does the seminar defray costs of the attendees? For example, if the seminar provides a course required to receive or maintain licensure, that would be defraying a cost ordinarily incurred and would be, consequently, unlawful.

The most challenging aspect here is to remain referral-neutral. Pay careful to this component in your analysis.

Advertising with a Realtor

Recently, a number of institutions have been given the opportunity to advertise their services on a realtor’s website or jointly advertise with a realtor on a separate platform (e.g. Zillow). I think we could all agree that this is prohibited activity under Section 8(a). Thus, we turn to whether it can be saved under either of the relevant Section 8(c) exceptions delineated above.

Of course, facts matter here. The following should be considered:

  • Is the advertising conditioned on past, present, or future referrals of business? For example, if the institution and the realtor enter into a contractual arrangement for direct advertising, does the agreement discuss future business or incentives for referrals? Pay close attention to contract language, if a contract exists, and remain referral-neutral in order to meet the exception. 
  • Is the institution paying for the advertising? If the advertising is free, this will not meet the exception as the institution’s costs will be defrayed. 
  • Is the institution paying reasonable market value for the advertising? Assuming the institution is paying for the advertising, is the institution paying reasonable market value? Remember, any payment above reasonable market value will be seen as an illegal kickback. 

One of the challenges with meeting these relevant Section 8(c) exceptions is to get the fee structure exactly right. If the institution is obtaining free advertising or is receiving “below market rate” advertising, you run the risk of receiving “defrayed costs” or not making a bona fide payment for the advertising. In contrast, if you pay above market rate, the portion of the payment above market rate kicks you back into prohibited activity under Section 8(a). To this end, we always suggest drafting a business justification to demonstrate that the fee paid is fair market value and maintaining it in your files. To determine market value, we suggest considering the following:

  1. Look internally for evidence of similar transactions (e.g. is the price similar to the institution’s other advertising costs for the type of media, duration, etc.);
  2. Look externally to determine if the price is consistent with the price third parties would incur for similar services (e.g. other financial institutions in the area); and
  3. Management should exercise its best judgment based on the internal and external evidence. 

Furthermore, you should be especially careful when navigating joint marketing arrangements when a third party is involved. For example, Zillow offers lenders and real estate agents the opportunity to jointly advertise via the Zillow online platform. In this program, Agent invites up to five lenders to jointly market with Agent. Lender then pays Zillow for the opportunity to advertise with Agent. The advertising fees paid by lender, in turn, reduce the amount the Agent pays Zillow for Agent’s advertising. The more the lender spends, the more often the lender is featured (versus other lenders with whom the Agent advertises). Though this program was being investigated by CFPB for violations of RESPA Section 8 and UDAAP, the investigation quietly concluded and Zillow announced in a June 2018 SEC filing that the company had received a letter from the Bureau indicating that it would not be pursuing enforcement action. 

The Zillow case is comforting to institutions insomuch as the CFPB validated that these types of marketing arrangements can lawfully exist. However, they do not come without scrutiny. In these types of arrangements, institutions should pay considerable attention to how the fee structure flows through the parties, in addition to the considerations above. In my experience, these arrangements can be incredibly complex and always invite risk. It’s prudent to get legal counsel involved before agreeing to participate in this kind of arrangement.

To conclude, RESPA Section 8 questions can be complex, rife with competing interpretations from HUD, CFPB and the courts, and require wading through unchartered waters with ever-changing leadership at the CFPB. Given that penalties are steep, as permitted by statute – recent RESPA CFPB enforcement actions have imposed penalties ranging from $35,000 to $265,000 and the amount at issue in the PHH case was $109 million – these questions deserve attention, thorough analysis, and often times, involvement of counsel. 

WBA wishes to thank Atty. Lauren C. Capitini, Boardman & Clark, llp for providing this article. 

  1. 12 U.S.C. § 2607.  Implementing Regulation X is codified at 12 C.F.R. § 1024.14.
  2. Note that section 8(b) prohibits the giving or accepting of a “portion, split, or percentage of any charge made or received” for rendering settlement services other than for services actually performed.  In other words, institutions cannot share a portion of or split fees with other settlement service providers when rendering settlement services unless the payment given/received is for “services actually performed”.  Though a very important component of RESPA to understand, this provision is not often relevant in the marketing context.
  3. 12 U.S.C. § 2607(a) and 12 C.F.R. § 1024.14(b).
  4. 12 C.F.R. § 1024.14(g)(1)(vi).
  5. 12 C.F.R. § 1024.14(g)(1)(iv).
  6. See PHH Corporation v. Consumer Financial Protection Bureau, 839 F.3d 1 at 41 (D.C. Cir. 2016).
  7. 839 F.3d 1 (D.C. Cir. 2016).  The court’s interpretation of RESPA was upheld by a petition for rehearing en banc by the D.C. Circuit Court of Appeals.  PHH, No. 15-1177 (Jan. 31, 2018).

By, Ally Bates

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Regulation CC Dollar Amount Adjustment Rule Finalized

The below article is the Special Focus section of the July 2019 Compliance Journal. The full issue may be viewed by clicking here.

On July 3, 2019, the Board of Governors of the Federal Reserve System (FRB) and the Bureau of Consumer Financial Protection (CFPB) published a jointly issued final rule (rule) amending Regulation CC that implements a requirement to periodically adjust dollar amounts under the Expedited Funds Availability Act (EFA Act). This requirement stems from a Dodd-Frank Act amendment to the EFA Act a number of years ago. 

The rule also extends Regulation CC’s coverage to American Samoa, the Commonwealth of the Northern Mariana Islands, and Guam, and makes certain other technical amendments. This article will only focus on the dollar amount adjustment provisions of the rule.

Specified Dollar Amounts Subject to Adjustment

Subpart B of Regulation CC implements the requirements set forth in the EFA Act regarding the availability schedules within which institutions must make funds available for withdrawal, exceptions to those schedules, disclosure of funds availability policies, and payment of interest. 

The EFA Act and subpart B of Regulation CC contain the following specified dollar amounts concerning funds availability which are subject to adjustment: (1) The minimum amount of deposited funds that institutions must make available for withdrawal by opening of business on the next day for certain check deposits (“minimum amount’’) under 229.10(c)(1)(vii); (2) the amount an institution must make available when using the EFA Act’s permissive adjustment to the funds availability rules for withdrawals by cash or other means (‘‘cash withdrawal amount’’) under 229.12(d); (3) the amount of funds deposited by certain checks in a new account that are subject to next-day availability (‘‘new account amount’’) under 229.13(a); (4) the threshold for using an exception to the funds availability schedules if the aggregate amount of checks on any one banking day exceed the threshold amount (‘‘large deposit threshold’’) under 229.13(b); (5) the threshold for determining whether an account has been repeatedly overdrawn (‘‘repeatedly overdrawn threshold’’) under 229.13(d); and (6) the civil liability amounts for failing to comply with the EFA Act’s requirements under 229.21(a).

Frequency of Adjustments; Initial and Subsequent Adjustment Dates

The rule specifies that amounts for the six enumerated categories listed above must be adjusted every five years in accordance with a calculation set forth in the rule, with the first adjustment taking effect on July 1, 2020. Thus, each subsequent adjustment following July 1, 2020 will take effect every fifth July 1, (e.g. July 1, 2025; July 1, 2030, etc.).

Calculation Methodology of the Adjustment Amount

The adjustment amount will be calculated across an “inflation measurement period” (defined in the regulation) by the aggregate percentage change in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), rounded to one decimal, and then multiplied by the applicable existing dollar amount, the result of which being rounded to the nearest multiple of $25. However, no dollar amount adjustment will be made if the aggregate percentage change is zero or is negative, or when the aggregate percentage change multiplied by the applicable existing dollar amount and rounded to the nearest multiple of $25 results in no change.

When there is an aggregate negative percentage change over an inflation measurement period, or when an aggregate positive percentage change over an inflation measurement period multiplied by the applicable existing dollar amount and rounded to the nearest multiple of $25 results in no change, the aggregate percentage change over the inflation measurement period will be included in the calculation to determine the percentage change at the end of the subsequent inflation measurement period. That is, the cumulative change in the CPI–W over the two (or more) inflation measurement periods will be used in the calculation until the cumulative change results in publication of an adjusted dollar amount in the regulation. 

Adjustments will likely be published in the Federal Register at least one year in advance of their effective date. The Agencies stated they anticipate publishing in the first half of 2024 the adjustment amounts that will take effect on July 1, 2025.

Initial Adjustment Amounts

The following is a list of current dollar amounts that apply prior to July 1, 2020, and the set of first adjustment amounts that will take effect on July 1, 2020.

  1. For purposes of the minimum amount under § 229.10(c)(1)(vii), the dollar amount in effect prior to July 1, 2020 is $200; effective July 1, 2020, the amount will be $225;
  2. For purposes of the cash withdrawal amount under § 229.12(d), the dollar amount in effect prior to July 1, 2020, the amount is $400; effective July 1, 2020, the amount will be $450;
  3. For purposes of the new account amount, large deposit threshold, and the repeatedly overdrawn threshold under §S 229.13(a), (b), and (d) respectively, the dollar amount in effect prior to July 1, 2020, the amount is $5,000; effective July 1, 2020, the amount will be $5,525; and
  4. For purposes of the civil liability amounts under § 229.21(a), the dollar amounts in effect prior to July 1, 2020, are $100, $1,000, and $500,000 respectively; effective July 1, 2020, the amounts will be $100, $1,100, and $552,500 respectively.

Updating Disclosures & Notices

Institutions will need to update funds availability policies, disclosures, and notices (including change-in-terms notices for existing accounts) that will be provided on and after the applicable effective date to reflect the appropriate adjusted amount(s). It should be noted that rule has not changed the timing or content requirements for such policies, disclosures, and notices.

Revised and New Commentary Examples in the Regulation

The rule has revised and added certain examples in the commentary to reflect the July 1, 2020 adjustment amounts, and to address the new adjustment amount calculation methodology. However, the rule neither addresses nor modifies model hold notice verbiage or format, as a separate rulemaking is underway for that purpose.

Conclusion

Fortunately, the rule provides a substantial period of time before the first set of adjusted amounts is effective on July 1, 2020. Institutions should read the rule and begin reviewing their funds availability policies, disclosures, and notices to identify needed changes, and devise an implementation strategy for accounts opened prior to July 1, 2020, and those opened on or after that date. In addition, the plan should address procedures for future adjustments. The final rule may be viewed at: https://www.govinfo.gov/content/pkg/FR-2019-07-03/pdf/2019-13668.pdf 

By, Ally Bates

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What Are Brokered Deposits and What Is the Significance of FDIC Reform?

The below article is the Special Focus section of the April 2019 Compliance Journal. The full issue may be viewed by clicking here.

Brokered deposits are relatively simple in concept but subject to complex regulatory restrictions. By concept, “brokered deposit” is a term used to describe a source of funding for financial institutions. That is, funds managed by a deposit broker, being an individual who accepts and places funds in investment instruments at financial institutions, on behalf of others. This concept has evolved over the years, grown controversial, and subjected to regulatory restriction. To that extent, the question is: what deposits are considered brokered for purposes of regulatory coverage? 

According to section 29 of the Federal Deposit Insurance Act (FDI Act) and Section 227 of the Federal Deposit Insurance Corporation’s (FDIC) rules and regulations, brokered deposit means any deposit that is obtained, directly or indirectly, from or through the mediation or assistance of a deposit broker.1 A deposit broker is:

  1. Any person engaged in the business of placing deposits, or facilitating the placement of deposits, of third parties with insured depository institutions, or the business of placing deposits with insured depository institutions for the purpose of selling interests in those deposits to third parties; and
  2. An agent or trustee who establishes a deposit account to facilitate a business arrangement with an insured depository institution to use the proceeds of the account to fund a prearranged loan.

This broad language gives FDIC significant discretion to determine whether a deposit is brokered, making the above question difficult to answer. 

Emerging technologies continue to create innovative deposit opportunities. For example, internet and mobile banking did not exist when the rules were written. Brokered deposits were born from new technologies, but those technologies continue to evolve, and with them, the concept of what a brokered deposit is. 

Background 

The inception of brokered deposits came with the ability to transfer funds electronically. These technologies made it quick, easy, and cheap to access before un-reached markets, which enabled greater bank liquidity and growth. Controversy exists as to whether such growth contributed to the 1980 financial crisis, an examination of which is outside the scope of this article. However, the 1980 financial crisis did result in FDIC launching a study into brokered deposits which led the agency to write rules in 1989 and amend them in 1991. 

The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 added Section 29 of the FDI Act, titled “Brokered Deposits” (Section 29). Section 29 places certain restrictions on “troubled” institutions. Specifically, Section 29 provides:

  1. Acceptance of brokered deposits is restricted to well-capitalized insured depository institutions.
  2. Less than well-capitalized institutions may only offer brokered deposits under certain circumstances, and with restricted rates.

In 1991 Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). The FDICIA resulted in threshold adjustments to the brokered deposit restrictions under Section 29 and gave FDIC the ability to waive those restrictions under certain circumstances. 

More recently, the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) amended Section 29 which excepted certain reciprocal deposits from treatment as brokered deposits. As seen above, Section 29 does not define the term “brokered deposit.” Rather, it defines the term “deposit broker.” Following EGRRCPA, on February 6, 2019, FDIC published an advance notice of proposed rulemaking and request for comment on unsafe and unsound banking practices: brokered deposits and interest rate restrictions (ANPR). The ANPR announces FDIC’s comprehensive review of its regulatory approach to brokered deposits and their interest rate caps. As part of its re-evaluation FDIC seeks comment on how it should revamp its definition of brokered deposits and interest rate restrictions. 

While the EGRRCPA implementation is specific to reciprocal deposits, FDIC’s ANPR is broader in scope, and presents an opportunity to re-examine the definition and treatment of brokered deposits as a whole. 

Impact 

How Brokered Deposits are Used 

Brokered deposits are a relatively new mechanism to the financial service industry. They provide:

  1. A quick, cheap, alternative sources of funding from national markets.
  2. An additional tool for institutions to maintain liquidity and interest rate risk analysis for balance sheet management.
  3. A potential tool for community banks to expand their deposits and maintain funds that do not move away when the local market shifts.
  4. Flexibility in availability of funds to institutions with varying demands in regional markets for deposits vs. loans.
  5. Greater opportunities to match deposit terms to loan funding.
  6. Alternative, competitive rates for investors.
  7. An additional tool for investing institutions to manage funds.

Significance of Regulation under Current Rules 

As discussed above, Section 29 restricts acceptance of brokered deposits and limits deposit interest rates. A well-capitalized institution is, generally, unrestricted. However, an undercapitalized institution may not accept, renew, or roll over any brokered deposit. An adequately capitalized institution may not accept, renew, or roll over any brokered deposit unless FDIC grants a waiver. Even though a well-capitalized institution is unrestricted, examiners consider the presence of core2 and brokered deposits when evaluating liquidity management programs and assigning liquidity ratings.

Furthermore, brokered deposits are a significant source of assets for some institutions. Institutions also seek to meet their customers deposit needs in an age of constantly evolving technologies. This creates uncertainty as to whether a particular deposit qualifies as a brokered deposit. The answer to that question is complex, as it lies not only in statute, but FDIC issued studies, interpretations, advisory opinions, regulations, and an FAQ on identifying, accepting, and reporting brokered deposits. 

Brokered deposit determinations are fact-specific and influenced by a number of factors. FDIC has broad discretion in application of its rules, which involves complex methodologies for determining and adjusting rates, and considers brokered deposit determinations on a case-by-case basis. For example, the term deposit broker has been applied to social media platforms, fintech, homeowners associations, and employee benefits providers. How FDIC views brokered deposits is also up to interpretation. Fortunately, FDIC states its view of brokered deposits in its 2016 FAQ:3 

“Brokered deposits can be a suitable funding source when properly managed as part of an overall, prudent funding strategy. However, some banks have used brokered deposits to fund unsound or rapid expansion of loan and investment portfolios, which has contributed to weakened financial and liquidity positions over successive economic cycles. The overuse of brokered deposits and the improper management of brokered deposits by problem institutions have contributed to bank failures and losses to the Deposit Insurance Fund.”

FDIC still appears to view brokered deposits as volatile and scrutinizes them accordingly. One direct result is rate cap limitations. By rule, rate caps only apply to less-than well capitalized banks. However, regulators have looked to the limits during exams, regardless of capital levels, pointing to potential volatility. Furthermore, under its 2009 calculation method, current rate caps are artificially low and hardly reflect what a customer can get from other sources. For example, as of April 22, 2019, a 12-month CD had a national average rate of 0.66% and a cap at 1.141%.4 On April 22, 2019, the Treasury yield was at 2.46%.5  

So, the current rules require financial institutions to identify deposits that are brokered, mind the rate cap limitations, and consider liquidity rating implications, in anticipation of regulatory examination. As technologies continue to evolve, and the financial industry follows those trends, the brokered deposit regulations designed before the age of online banking are outdated. For example, such broad coverage means banks seeking deposits through the internet could be subject to rate caps.

Significance of FDIC’s ANPR

The ANPR is an opportunity to comment and guide FDIC’s future approach to brokered deposits. Issues to comment on include:

  1. Clarify the definition of brokered deposit and deposit broker for the modern era of technology.
  2. Create a methodology to calculate a rate cap that appropriately reflects the cost of deposits.
  3. Provide examples of what brokered deposits mean to your institution with today’s modern technologies (ex: internet deposits such as online, mobile banking, and social media).
  4. Refocus of policy goals: original intent was to restrict large volumes of volatile funds. Brokered deposits were suspect of this category of deposit, but did not, and do not, necessarily continue to merit fierce restrictions.
  5. Reconsider limitations on brokered deposit offerings for well-capitalized institutions.

FDIC’s ANPR means a potential to modernize and even narrow the designation of a deposit as brokered, given the current wide scope of interpretation, stigmatization, limitation, and regulatory burden over a broad categorization of deposits. An update to Section 29 could mean new opportunities for banks to seek funding from new sources and explore new technological applications to deposits.

Conclusion

In 2019, many consumers bank from their phone. Various internet technologies give access to funds quickly, and new technologies are surely on the horizon. As businesses, banks need to accommodate these technologies in order to stay competitive. The ANPR is an opportunity to explore how brokered deposits are treated and can be better utilized. Comments can direct FDIC’s regulatory framework to enhance the functionality of brokered deposits as another deposit tool. 

Comments on the ANPR are due May 7, 2019. After the ANPR, FDIC will issue a proposed rule, with another opportunity for comment prior to a final rule. The ANPR can be found here: https://www.fdic.gov/news/board/2018/2018-12-18-notice-sum-i-fr.pdf 

1. 2 C.F.R. § 337.6(a)(2)

2. Core deposits are distinct from brokered deposits in that they are considered “stable,” including checking, savings, and CD accounts made by individuals rather than a deposit broker.

3. FIL-42-2016, Identifying, Accepting and Reporting Brokered Deposits: Frequently Asked Questions (Updated June 30, 2016; Revised July 14, 2016).

4. https://www.fdic.gov/regulations/resources/rates/

5. https://www.macrotrends.net/2492/1-year-treasury-rate-yield-chart

By, Ally Bates

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Private Flood Insurance

The below article is the Special Focus section of the March 2019 Compliance Journal. The full issue may be viewed by clicking here.

On February 12, 2019 the Federal Financial Institutions Examination Council published a final rule on loans in areas having special flood hazards (2019 final rule). The 2019 final rule amends the flood regulations for the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Farm Credit Administration, and the National Credit Union Administration (Agencies). The Agencies issued the 2019 final rule to implement the private flood insurance provisions of the Biggert-Waters Flood Insurance Reform Act of 2012 (Biggert-Waters Act). The 2019 final rule was published in the Federal Register on February 20, 2019 and compliance is manditory on July 1, 2019; however, lenders may begin following the rule now.

Background

The Biggert-Waters Act includes a statutory definition of private flood insurance and directs the Agencies to implement acceptance through rulemaking. In 2013 the Agencies proposed a rule requiring the acceptance of private flood insurance pursuant to the statutory definition. The proposed rule generated interpretive uncertainties that ultimately resulted in the Agencies issuing a revised proposed rule in 2016. The 2019 final rule is an attempt to clarify the definition of private flood insurance under the Biggert-Waters Act.

2019 Final Rule

In addition to attempting to clarify the statutory definition of private flood insurance, the 2019 final rule includes a compliance aid to enable institutions to identify acceptable private policies. Additionally, subject to certain restrictions, it permits institutions to exercise discretionary acceptance of flood insurance policies that do not meet the definition of private flood insurance. Finally, the rule specifies how lenders may accept policies issued by “mutual aid societies” such as certain Amish Aid Plans.

Definition of Private Flood Insurance

The statutory definition of private flood insurance under the Biggert-Waters Act incorporated factors from the Federal Emergency Management Agency’s Mandatory Purchase of Flood Insurance Guidelines. The 2019 final rule attempts to clarify this statutory definition. As such, institutions familiar with the statutory definition will notice slight variations when compared to the 2019 final rule’s definition. For purposes of this article, the analysis will focus on the 2019 final rule’s definition and not make a comparison.

Under the 2019 final rule, private flood insurance means an insurance policy that: 

  1. Is issued by an insurance company that is: 
    • Licensed, admitted, or otherwise approved to engage in the business of insurance by the insurance regulator of the State or jurisdiction in which the property to be insured is located; or 
    • Recognized, or not disapproved, as a surplus lines insurer by the insurance regulator of the State or jurisdiction in which the property to be insured is located in the case of a policy of difference in conditions, multiple peril, all risk, or other blanket coverage insuring nonresidential commercial property; 
  2. Provides flood insurance coverage that is at least as broad as the coverage provided under a Standard Flood Insurance Policy (SFIP) for the same type of property, including when considering deductibles, exclusions, and conditions offered by the insurer. To be at least as broad as the coverage provided under an SFIP, the policy must, at a minimum: 
    • Define the term “flood” to include the events defined as a “flood” in an SFIP; 
    • Contain the coverage specified in an SFIP, including that relating to building property coverage; personal property coverage, if purchased by the insured mortgagor(s); other coverages; and increased cost of compliance coverage; 
    • Contain deductibles no higher than the specified maximum, and include similar nonapplicability provisions, as under an SFIP, for any total policy coverage amount up to the maximum available under the National Flood Insurance Program (NFIP) at the time the policy is provided to the lender; 
    • Provide coverage for direct physical loss caused by a flood and may only exclude other causes of loss that are excluded in an SFIP. Any exclusions other than those in an SFIP may pertain only to coverage that is in addition to the amount and type of coverage that could be provided by an SFIP or have the effect of providing broader coverage to the policyholder; and 
    • Not contain conditions that narrow the coverage provided in an SFIP; 
  3. Includes all of the following:
    • A requirement for the insurer to give written notice 45 days before cancellation or non-renewal of flood insurance coverage to:  
      • The insured; and 
      • The lending institution that made the designated loan secured by the property covered by the flood insurance, or the servicer acting on its behalf; 
    • Information about the availability of flood insurance coverage under the NFIP; 
    • A mortgage interest clause similar to the clause contained in an SFIP; and 
    • A provision requiring an insured to file suit not later than one year after the date of a written denial of all or part of a claim under the policy; and
  4. Contains cancellation provisions that are as restrictive as the provisions contained in an SFIP.

Compliance Aid

Pursuant to the above definition, a national bank or Federal savings association must accept private flood insurance in satisfaction of the flood insurance purchase requirements. Thus, a financial institution is required to accept private flood insurance and must also ensure it meets the above definition. However, the 2019 final rule provides a compliance aid to assist in that mandatory acceptance. Pursuant to the compliance aid, a financial institution may determine that a policy meets the definition of private flood insurance without reviewing the policy, if the following statement is included within the policy or as an endorsement to the policy:

“This policy meets the definition of private flood insurance contained in 42 U.S.C. 4012a(b)(7) and the corresponding regulation.”

While the compliance aid provides a safe harbor to financial institutions that accept policies containing the above language, there is no requirement for insurers to include the compliance aid language. Furthermore, because the 2019 final rule prescribes mandatory acceptance of private flood insurance that meets the above definition, financial institutions must accept policies that meet the above definition whether it includes the compliance aid or not. Meaning, a financial institution cannot reject a policy for the sole reason that it does not contain the compliance aid language.

Discretionary Acceptance

The 2019 final rule provides financial institutions the discretionary ability to accept or reject policies that do not meet the above definition of private flood insurance. Lenders may accept such policies, at their own discretion, if the policy:

  1. Provides coverage in the amount required by the NFIP; 
  2. Is issued by an insurer that is licensed, admitted, or otherwise approved to engage in the business of insurance by the insurance regulator of the State or jurisdiction in which the property to be insured is located; or in the case of a policy of difference in conditions, multiple peril, all risk, or other blanket coverage insuring nonresidential commercial property, is issued by a surplus lines insurer recognized, or not disapproved, by the insurance regulator of the State or jurisdiction where the property to be insured is located; 
  3. Covers both the mortgagor(s) and the mortgagee(s) as loss payees, except in the case of a policy that is provided by a condominium association, cooperative, homeowners association, or other applicable group and for which the premium is paid by the condominium association, cooperative, homeowners association, or other applicable group as a common expense; and 
  4. Provides sufficient protection of the designated loan, consistent with general safety and soundness principles, and the national bank or Federal savings association documents its conclusion regarding sufficiency of the protection of the loan in writing.

Mutual Aid Societies

In order to meet the mandatory acceptance provisions for private flood insurance, the 2019 final rule permits lenders to accept policies written by mutual aid societies if:

  1. The applicable supervisory agency has determined that such plans qualify as flood insurance for purposes of the Act; 
  2. The plan provides coverage in the amount required by the NFIP; 
  3. The plan covers both the mortgagor(s) and the mortgagee(s) as loss payees; and
  4. The plan provides sufficient protection of the designated loan, consistent with general safety and soundness principles, and the national bank or Federal savings association documents its conclusion regarding sufficiency of the protection of the loan in writing.

In addition, the rule defines mutual aid society to mean an organization:

  1. Whose members share a common religious, charitable, educational, or fraternal bond; 
  2. That covers losses caused by damage to members’ property pursuant to an agreement, including damage caused by flooding, in accordance with this common bond; and
  3. That has a demonstrated history of fulfilling the terms of agreements to cover losses to members’ property caused by flooding.

Conclusion

With the 2019 final rule becoming effective July 1, 2019, and optional compliance available under the 2019 final rule now, WBA recommends financial institutions review their policies on acceptance of private flood insurance. Financial institutions will need to understand the definition of private flood insurance policies pursuant to the rule, even if they had previously adhered to the statutory definition, as the 2019 final rule implements slight changes. Furthermore, institutions should be prepared to understand the relation of the compliance aid to the mandatory acceptance requirements.

The 2019 final rule may be found here: https://www.govinfo.gov/content/pkg/FR-2019-02-20/pdf/2019-02650.pdf ■

By, Ally Bates

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It’s Still a Good Time to Become Financially Fit

The Wisconsin Bankers Association offers for your use the following consumer education column. Your bank is free to use this as a community column in your local newspaper, a letter to the editor, a press release or in any other way you see fit. The purpose is to give our members an easy-to-use tool for promoting the banking industry to Wisconsin’s communities.

New Year, New Me, right? We’re a few weeks into the new year and you may have dropped your New Year’s Resolution to become financially fit. Don’t despair. It’s still early in the new year and a great time to clean up your financials, adopt better spending habits, and start saving more. Here are a few tips to keep in mind:

Make a budget and stick with it
This almost cliché financial advice is repeated so often for one important reason: it works. Start by tracking your spending, once you’ve tracked how much money you spend over the course of a few weeks, you can look for trends in what you’re spending. These trends help you start planning on how much income goes towards necessities (like rent/mortgage, utilities, groceries), and see areas where you can cut back (rarely-used subscription services, eating out less) and start putting away a portion of your income towards a savings goal. The most important part of a budget is sticking with it, once you start tracking your spending you should make sure to take time every day or every few days to log your spending and compare that to your planned spending.

Deal with any debt
Debt is an extremely stressful thing to deal with but the new year is a time to get a handle on any debt that may have piled up around the holidays. Debt should be something factored into your budget like your electric bill and tracked. Although it may be daunting, contact your creditors to discuss your situation, they may be willing to work with you to put together a repayment plan. If you're carrying debt on multiple credit cards, talk to your local bank about the possibility of consolidating that debt into a single payment so you can close the extra card accounts. No matter what you do, addressing debt instead of ignoring it will help you get a handle on it and make positive progress.

Shop around
Many times people will stick with whatever they find first, be it their internet provider, car insurance, or brand of soup, but that may not be the best deal, especially a few years down the line. There’s nothing wrong with being loyal to a company but just because they’ve been your cable provider for a few years isn’t necessarily a good reason to stay with them and doesn’t ensure that you are getting the best value for what you are paying. Look around to see what other companies are charging for similar services, you may find that your current company is priced competitively or you may find that you can get a better deal elsewhere. One thing to beware of is a cheaper product or service that is cheaper for a reason, make sure you are still getting a similar quality or ask yourself if you are ok with a downgrade.
Making a commitment to financial health and wellness can be a great way to start the New Year on good footing that can last throughout the year and your life.   

An archive of Consumer Columns is available online at www.wisbank.com/ConsumerColumns. 

By, Eric Skrum

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Personalized Strategic Plans

Personalized Strategic Plans
To manage board and shareholder expectations, design a strategy that fits the unique composition of your institution

Balance sheets are healthier than they've been since pre-recession years, yet earnings remain stubbornly elusive for most financial institutions. In some cases, the challenge of achieving high-performance in a banking landscape that features persistently low rates, extreme regulatory burden, and intense competition on multiple fronts creates friction in the board room. If bank management, directors and shareholders don't share expectations for the bank's performance, time and energy will be wasted on efforts that don't drive the institution toward that unified goal. The bank's strategic plan is more important than ever as it serves as the bedrock and written understanding of that shared vision and the steps to achieve it. In order to maintain buy-in with the strategic plan over the course of its three- to five-year life, the plan must reflect the unique perspectives and priorities of the bank's shareholders, directors and management.

Start with a Shared Strategy

The best – and perhaps only – way to keep management, directors and shareholders on the same page as the institution moves into the future is for all three stakeholders to start with the same goals, risk tolerance and vision for the bank. The strategic plan can be a powerful tool in clearly defining those elements, especially when all parties do not have the exact same vision. "You don't need 100 percent agreement, but you do need 100 percent buy-in," said Thom Back, senior manager at Wipfli. Ken Johnson, principal of Ken Johnson Consulting, recommends all bank directors participate in an anonymous questionnaire prior to the strategic planning process; not only does this demonstrate how the board as a whole feels about the bank's current situation, but it also allows for discussion of any items where there is a large discrepancy. "It's helpful to have everyone grounded to what others' perspectives are," Johnson explained. "That starts you off in the same place and helps you set realistic goals."

In drafting the specifics of the strategic plan, management must balance the board's performance goals with the institution's clearly defined risk tolerance. "You have to ensure that there's a balance between growth desires, capital levels, and dividend targets and understand which of those goals is the highest priority," said David Koch, president/CEO of Farin & Associates. On a more granular level, Cass Bettinger, president of Cass Bettinger and Associates, explained that strategic planning should involve the board setting a target return on equity range and capital ratio based on the bank's risk management strategy, which then enables management to calculate what the bank's target return on assets must be. It is essential for management to have a crystal clear understanding of the board's risk tolerance in order to successfully balance that equation. "If the board and management work together on that basis, at the end of the day you'll have a strategic plan that is very clear about what it's designed to produce for shareholders and what all the objectives and strategies are," Bettinger said. 

Ultimately, both the goals and risk tolerance of the bank are guided by the directors' shared understanding of the institution's mission, which should be defined with input from directors, management and shareholders. "Good strategic plans are about a lot more than just the numbers," said Elliot Berman, principal of Bowtie Advisors. "There needs to be a strategic planning process, not just a budgeting process," Berman continued. "The board should get involved at the front end of that process. At the outset, they need to provide a high-level sense of direction for management, and at the end need to approve the plan."

Understand Your Key Stakeholder Groups

While each bank has a unique composition of key stakeholders, most have three main groups: directors, executive management and shareholders. All three contribute different perspectives and skillsets to the creation of the bank's mission and the strategic plan built on that mission. Directors connect shareholder interests with management's tactics by guiding the institution at a high level. "It requires business acumen and understanding to lead the organization toward a vision that will improve the financial performance of the bank," Johnson explained. The board's role is also to use their business acumen and leadership abilities to represent the shareholder's interests. "The board's responsibility to shareholders for strategic planning is the single most important responsibility the board has," Bettinger pointed out. Paying attention to increasing shareholder value can help mitigate investor dissatisfaction with the bank's performance as well as provide management with actionable guidance. "Management gets the most out of the board when they spend 70 percent of the time looking forward," said Berman. 

Management's role is to convert the board's vision for the institution with the specific tactics bank staff will need in order to accomplish that mission, as well as to ensure that the board is properly equipped to guide the bank. "Understand the strengths, skills and relationships that each director brings to the table," said Koch. "Strengths-based management is key to a successful, engaged board." The CEO needs to be the driver in aligning the expectations of directors and shareholders to the bank's performance. "The strategic planning process has to engage the board and management, working together to fulfill the mission of the bank," said Bettinger. The best way to accomplish that, according to Johnson, is for the CEO to ensure that the bank's strategic planning process includes the right people and the right information. "It's not easy, but the CEO is the one who is charged with organizing it," he said. 

Part of ensuring the right people are included is cultivating a thorough understanding of the bank's shareholder base. "The board and management need to have an understanding of what their shareholder base is looking for, because that will influence the strategic plan," said Mark Koehl, CPA, partner at Wipfli. "Knowing the shareholder group is key to helping the bank's plan be successful." It's unwise to generalize with shareholders, and each bank will have a unique mix of investors depending on its size and ownership structure. However, there are a few categories of shareholder that many banks share: 1) mature shareholders who may be nearing retirement, and therefore are looking for dividend growth and liquidity, but also community involvement; 2) second- or third-generation shareholders, who may no longer be based in the community and therefore are primarily interested in earnings per share growth and return on equity; 3) mid-life investors who may feel disillusioned with community banking due to current political and economic headwinds, and therefore wish to maximize the bank's sale price and look for a partner. 

In addition, from each of these groups (or others that exist at your institution), sometimes activist investors arise. Between 2012 and 2014, only 8 percent of SEC filings showing at least 5 percent ownership and "activist intent" came from financial institutions. However, in 2015, that jumped to more than 17 percent. "Activist investors see the value of the bank differently than the board and management," Back said. "It doesn't translate to 'wrong,' they just have a different vision for the bank." The best way to prevent this dissonance is through consistent and clear communication between all stakeholder groups. "Activist investors make noise either because they see a financial opportunity being missed or because they care about the bank but feel like they aren't being heard," Koch explained. "Shareholders need to feel that the strategic plan reflects their needs and their input and their priorities, and the only way to do that is to engage them in the process," Bettinger agreed.

Keeping In Step

Communication and transparent monitoring are the two essential drumbeats that management should use to keep all stakeholders in step for the duration of the strategic plan. "Transparency is a very key aspect," said Back. "Not transmitting exactly what your intentions are can sometimes paint you into a corner worse than laying out the plan. It also maintains trust, which is critical." Koch also said transparency on the key goals and objectives of the plan should be a top priority. "Senior management's role comes down to consistent positive messaging with the board and staff," he said. "There's no magic there, just understanding the audience and being honest, and if the message isn't positive speak to what can be done to turn things around." Another part of management's role in open stakeholder communication is to solicit input from large shareholders on a consistent basis, especially as it pertains to the strategic plan. "CEOs and directors aren't performing their job properly if shareholders are not involved in the strategic planning process," said Johnson. This doesn't need to occur monthly, or even quarterly, but the lines of communication should never be closed. "You're not necessarily seeking out input from shareholders who aren't on the board on a frequent basis, but you have to always be open to answering questions," said Koehl. 

While responding to shareholder questions and expectations for bank performance is a complicated interaction that involves a lot of different factors, not just the strategic plan, Berman suggests using the strategic plan as a framework when communicating with shareholders. "You don't have to get into details, but use the plan and what you're doing with it as the outline," he advised. The most important feature of stakeholder communication, especially to shareholders, is the effort you put into it. "If you focus on your communication with your shareholders in the same way you focus on communication with major customers or prospective customers, you'll see results," said Berman. 

The other vital aspect of transparency is how stakeholders monitor the bank's progress in accordance with the strategic plan. This requires clear communication timing, specific numerical goals and metrics for measurement. "It's really important that management and the board discuss the timeframe," said Bettinger. "For community banks in particular, it's not about short-term profits but long-term value." Specific numerical goals can help avoid rewarding a focus on short-term gains by providing specific long-term targets. "Once you define the mission or vision, the CFO needs to put it down on paper as a pro forma balance sheet and income statement. Then you know what's supposed to be happening," Johnson advised. "While the numbers are not the plan, there do need to be specific, measurable goals," Back agreed. 

Measuring the institution's performance against those goals requires metrics and testing, because no institution will ever be in total alignment with their strategic plan at all times. "Every plan is wrong in some way," said Koch. "If it's not, your plan either isn't specific enough or you're very lucky." One popular way to quantify the alignment between the plan and performance is found by examining the key assumptions that may not be right via stress testing. "It's not about sticking one number out there as your plan. It's also about knowing the three or four most important factors in getting there," Koch explained. "In the risk management process we tend to focus mainly on what might go wrong, but it is only useful to the extent that it helps you identify what needs to go right in order for you to hit your goals." Those benchmarks and milestones are crucial signs on the roadmap of your strategic plan, so all stakeholders should be able to identify them. 

Clear communication of the bank's strategic objectives and how to track them is also how the bank leadership determines when it's time to reassess the strategic plan as a whole. "The strategic planning process isn't an annual event," said Bettinger. "It's ongoing. You always have new opportunities and new threats emerging." As those new opportunities and threats arise, it is inevitable that the strategic plan will adapt accordingly. With the joint efforts of shareholders, directors and bank management, the bank will also rise to meet them.

By, Amber Seitz

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Responsive by Design: Strategic Plans Must Allow for Detours on the Road to Success

Responsive by Design
Strategic Plans Must Allow for Detours on the Road to Success

You're on a road trip, and the GPS on your dashboard (or smartphone) assures you that you're following the right path. Then, you hit road construction. You can't follow the path you originally mapped out. What happens? "Recalculating…" Your GPS guides you down a different road that leads you to your intended destination. Your bank's strategic plan should follow the same philosophy: create a plan, but allow for detours. "High-level, when you're looking at the strategic plan and where you're going, you have to be open to modification," said Marc Gall, vice president at BOK Financial Institutional Advisors. "The strategic plan is a roadmap, but you need to react to the environment, too."

Plan for Spontaneity 

The key to designing flexibility into your strategic plan is to avoid pouring time and effort into creating one, only to have it collect dust on a shelf somewhere. "Get away from thinking of the strategic plan as a standalone item," advised Ed Depenbrok, principal at dbrok group, LLC and a director at Ridgestone Bank, Brookfield. "It is a part of how you run the organization." In other words, there must be a connection between the strategic plan and day-to-day activities at the bank. To forge that connection, clearly lay out the specific tactics of how each larger strategic goal will be achieved. "It's a top-down, bottom-up process," said Nate Zastrow, executive vice president – chief financial officer at First Bank Financial Center, Oconomowoc. "You have a macro strategy and the micro-strategies beneath it. It keeps us fluid and flexible." Identifying the specifics beneath the overarching goals links the strategic plan to operational items like short-term budgets.

Executing your strategic plan in this manner may require a shift in both thinking and culture at your institution. "When you're trying to work from a place of being nimble, responsive and efficient, your team has to internalize those characteristics," said Jim Perry, senior strategist at Marketing Insights. "You can't just pick those attributes off the shelf. They have to be supported in your culture." However, making the change to a responsive plan often has a positive impact on bank staff. For example, if the original plan called for an increase in agricultural business lending, but the current market doesn't allow for that, adjusting the plan prevents your lenders from feeling pressured to do the impossible. "Don't make loans just because your strategic plan calls for it," Gall advised. "The worst thing you can do for morale in an institution is stick to goals that have become unachievable regardless of what's possible in the current market."

Identify Bellwether Metrics

So how do you determine when to call an audible? The metrics laid out in your strategic plan are the road signs that tell you which way to go and when to turn. "Without fundamental information about where your market is headed, you really can't make the right strategic choices," said Perry. "Making knee-jerk reactive decisions rather than basing those decisions on timely, accurate information makes it much harder to achieve your strategic goals." Monitor the economic and demographic shifts happening in your market and compare them to your original plan. This provides the perspective you need to make the determination of when to adhere to the strategic plan and when to take a detour. "You can't just put in your strategic plan that you're going to grow loans by six percent over the next three years," said Depenbrok. "You need to know if that's possible in your market, and whether you need additional talent or products."

That perspective is why identifying key metrics and monitoring them frequently is critical to having a successful, responsive strategic plan. For example, according to Zastrow, FBFC's process involves a monthly meeting to highlight areas where benchmarks were not met, identify why, and then adjust accordingly. An investment in business intelligence technology facilitates that process. "We leverage that technology from a management standpoint so that we're not driving blind," Zastrow explained. "We have a very robust business intelligence program with analysts who can generate reports that allow us to compare and contrast where we're at with where we want to be." That analysis will also help management and the board find the right balance between following the original plan and pursuing new opportunities. "There's a balance between striking while the iron is hot if opportunities are identified, and following the strategic plan and your risk tolerance," said Gall.

Watch the Road Ahead

In today's rapidly changing banking environment, a responsive strategic plan is essential for institutions to adapt quickly and reduce overall risk, particularly with regards to technology and compliance. "You have to assess technology and regulation in your strategic plan because they're part of the world we operate in," said Depenbrok. "There are so many more fixed costs today to operate a bank, and if you don't plan for them, it's going to be even worse." A responsive strategic plan will outline when the bank needs to invest in certain areas, and allow for allocation adjustments as customer and staff needs change. "Industry-wide, if you look at the high-performing community banks, they're investing in order to grow their business and build scale," said Perry. "They know that by expending capital to bring in new technologies that will reduce expenses long-term, they're positioning themselves for growth."

Bank staff can help identify areas where operational changes can be made to increase the institution's overall productivity, according to Gall. "Many times staff haven't been given the incentive or charge to think about how they can do their daily work differently to help the bank reduce expenses and operate more efficiently," he said. In addition, a responsive plan should allow for new ways of executing the same strategy, i.e. adjusting internal processes. "When looking at what you have to shift moving forward, look first at areas where either people or processes need to be adjusted in order to improve results," said Perry. "The people and processes are the things you can immediately control, rather than external market conditions."

Finally, a responsive strategic plan should accommodate increased spending in areas banks can't control, such as regulation. "Once the rules are made, you can fight to try to change them, but that takes a lot of time and energy that could be reallocated to being the best at playing by the new rules," said Zastrow. With all of the recent change in the industry, an investment in third-party advice can be a competitive advantage, according to Depenbrok. "Change is happening so quickly in our industry from a technological point of view and a regulatory point of view, figuring it out on our own is very difficult," he said.

By, Amber Seitz

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Making More from Less: Five ways banks can enhance the value of their branch network

Making More from Less
Five ways banks can enhance the value of their branch network

Between products like mobile and online banking, ATMs, fintech solutions and digital wallets like PayPal, it's no wonder some people are questioning whether brick-and-mortar bank branches are still relevant. However, consumers still crave the trust and assurance that comes with human interaction, especially when it comes to their finances. Bank branches aren't on the brink of extinction; they're evolving. Here are five key actions banks can take to transform their branch networks and enhance their value: 

1. Focus on Customer Needs and Behaviors

Consumer demands will drive nearly every aspect of branch transformation in the future, so identifying exactly what your customers want and need is critical. "Branch transformation is not up to us, it is up to the customers," explained Darren Dewing, senior vice president, director of retail distribution at Associated Bank, Milwaukee. "Their behavior will determine the future of the branch network." Dewing noted that while direct customer feedback is important, it's also essential to measure their actions. With the current upheaval in the financial services industry, bank branches will need to transform in order to survive; it will be the customers, not the banks, who ultimately define what they turn into. "It comes down to what customers demand of us and adapting accordingly," said Jeff McCarthy, vice president – marketing director at First Bank Financial Centre, Oconomowoc and a member of the 2016-2017 WBA Marketing Committee.

2. Re-Think Technology 

Many bank executives still consider technology to be a threat to the banking business model, either because of its potential for security gaps or because it eliminates many traditional customer touchpoints. However, customers who utilize digital banking products typically develop a deeper relationship with the bank, and technology can also greatly reduce a branch's cost per transaction. "Transactions are cheaper without employees handling them," explained Jennie Sobecki, owner of Focused Results, LLC and a speaker at the recent WBA Branch Manager series. "In order to leverage your investment in your branches, you need to also invest in technology to make those branches more efficient." When reconsidering how your branch network leverages technology, keep the customer (and customer service) front-and-center. "We view technology as another way of serving the customer," said McCarthy. "We want them to be able to bank with us when and where they want to." 

However, while technology allows banks to expand their markets well beyond their branches, most institutions will find they cannot bolster one at the expense of the other. "Customers don't want either technology or branches," said Sobecki. "They want both." The best way to ensure that your branch network gets the most value possible out of any technology investments is to constantly encourage customer adoption. "Make sure your customers are using the technology!" said Dewing. "You've spent the money, so make sure you're optimizing your investment by showing the customers the value you've created for them." That can be as simple as training front-line staff to demonstrate online or mobile transactions for customers when they come into the branch, or as complex as remodeling the branch to include tech stations and teller pods. 

3. Leverage the Value of Physical Space

One of the most valuable elements of any branch network is the physical branch buildings. Even with today's real estate market, that is a tangible value that banks can enhance in a variety of ways. Some banks choose to purchase their branch spaces, rather than lease them. "Our philosophy is to find great real estate and own it if we can," said Dewing. "That is not always possible or practical, but it's preferred." Whether you own or lease, many of today's bank branches are larger than they need to be to support current foot traffic. Sobecki suggests "right sizing" existing branches by walling off unused space and either leasing it out or converting it into a community room for the bank's commercial customers to use as meeting space. Make sure your branch buildings do a good job of promoting your brand, as well. Signage and décor both make a difference. "Potential customers don't walk in the front door if they don't know you're there," Dewing pointed out. Seeing the branch also keeps the bank top-of-mind for customers. "There's a real sense of strength and security for customers when they see a physical branch," said McCarthy. "There's still a sense of reassurance when you drive by the branch and know, that's where my money is." 

4. Update your Metrics

Before making any changes to your branch network, it is important for bank management to update the metrics that will be used to measure the success of those changed branches. Some of the traditional measures are not as valuable as they once were. "Sometimes we spend too much time on lagging indicators, like transactions and/or net income, and not enough time on leading indicators of future value," said Dewing, specifying that branches that add or deepen quality household relationships will provide that future value. Sobecki recommends measuring wallet share, product penetration by branch – that is, identifying which branches are the top sellers for the most profitable products – and revenue per square foot. "Retail bankers need to think of themselves as retailers," she said. "Revenue per square foot is how retailers evaluate their space." She also recommended measuring your mobile banking platform as a branch in addition to physical locations.

5. Recognize Each Branch is Unique

When planning changes to your branch network, it is crucial to recognize that every branch is as unique as the community and clientele it serves. "There isn't one silver bullet to make this work," Sobecki said. "Each individual bank needs to find out what works for them and their culture." Market research is an essential tool here, but so is individual involvement. "You have to understand the needs of the community if you're working there every day," said McCarthy. "We encourage our branch staff to be involved in the community, so we make sure that we have the right people in the right place." Ultimately, each branch within the network will operate according to the needs of its community and customers. Some will focus on wealth management and host community events, while another will primarily serve commercial customers and drive online usage. "The most important thing a community bank can do is make sure they have the right type of branch in the right market," Sobecki explained. 

No matter what you may have read on the internet, rumors of the Bank Branch's death have been greatly exaggerated. "When people are going through major life changes, whether it's buying a house, getting married, or retiring, they still want to come in and talk to an expert face-to-face," said McCarthy. "Branches are still alive and well, and still serve a purpose for customers."

By, Amber Seitz

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Structural Integrity: Make compliance part of your institution’s DNA

Structural Integrity
Make compliance part of your institution’s DNA

Compliance is top-of-mind for every bank executive today – it might even keep you up at night – but do all of your employees feel the same level of responsibility? They should.

There’s a difference between following prescribed protocols from regulators and having a truly effective and efficient compliance system. In the struggle to keep ahead of new and changing regulations and complex expectations from examiners, some banks have fallen into the rut of using their compliance department as the last line of defense. However, a holistic approach to compliance, where key elements are knit into an integrated whole and every employee feels personal ownership of their role within the compliance system, tends to be more effective (and more efficient) than viewing the compliance department as a safety net.

Key Features

The foundation of a holistic compliance system is the distribution of ownership across all departments and the bank’s strategic plan. “Compliance is the responsibility of the organization as a whole, so it needs to be distributed,” explained Elliot Berman, Principal at Bowtie Advisors. According to Berman, distributed compliance systems are one of the most effective responses by financial institutions to the continuing challenge of meeting the resource needs of today’s regulatory expectations about compliance. A distributed system is not just an idea; it must be put down on paper as part of the bank’s plans and processes to create accountability. “It is critical that each area of the bank examine its compliance risks and articulate in their operating plans how they will manage them,” said Joe Fikejs, COO of Bank Mutual, Milwaukee. “Then, they need to be held accountable to the goals and plans that are set. This best practice also reiterates the message that compliance is not just the responsibility of the compliance department.”

Another key feature of a holistic compliance system is compliance personnel that are seen as collaborative partners to be consulted in the early stages of every project rather than gatekeepers or the final step in a process. “I prefer the ‘compliance first’ approach,” said Ami Dregne, compliance officer at Citizens First Bank, Viroqua. “I don’t like being the last stop before something goes out.” Berman also prefers this model of spreading responsibility because it allows the compliance team to be subject matter experts. “That’s a more effective use of their expertise,” he said. “I’ve seen organizations where compliance is viewed as the ‘department of no’ and that’s not conducive to success.” Dregne also advocated for a collaborative relationship between compliance and the rest of bank staff. “You don’t want staff to feel like the compliance officer is ‘Bad Cop,’” she said.

Implementation

When implementing a distributed compliance system, first lay the groundwork with communication and support from upper management. “Having management involved is key so that the employees know and trust the compliance team will tell them how things need to be done in order to stay compliant, rather than just make their jobs harder for no reason," Dregne explained. A hands-on management approach is also essential to foster a sense of ownership for all staff. “You won’t have a strong risk-conscious culture until all employees feel they have key roles that they take ownership of,” said Fikejs. “It is as simple as connecting the dots between regulation and key processes.” Drawing those connections for staff doesn’t require that management be subject matter experts, either. “It’s not a compliance issue, really,” said Berman. “It’s a communication and operations issue.”

Another facet of this holistic approach to compliance that cannot be overlooked is the need for ongoing training. “Weaving compliance and risk management across all key areas of a financial institution’s strategic plan is the start, but it cannot stop there,” said Fikejs. “It needs to be reinforced on a regular basis at key meetings, training and in communications.” Compliance training doesn’t have to be torturous, either. “Compliance is not as exciting as other functions in banking, so try to have fun with it,” Fikejs suggested. “Use gamification at meetings to reinforce key messages.” It’s also important not to let your compliance training schedule slip into “peaks and valleys,” according to Berman. Even though changes to regulations and procedures require mandatory training to update employees, it is also important to provide ongoing refresher training. “Find a balance between the ‘big training’ and the reminders,” he advised.

Finally, equip your compliance personnel for success by ensuring they have access to all the tools and resources they need to coordinate your compliance program. One of the most powerful resources out there is a wide network of peers. “It’s important to have a peer network you can rely on for perspective,” said Dregne. “Many compliance officers wear many hats and some are stronger in certain areas, so we lean on each other a lot.” Regular contact with industry thought leaders and other compliance experts will help your team guide the institution to consistent success.

As with many business functions, the bank’s compliance system should also undergo a continuous improvement process. “Review processes and workflows frequently to ensure unnecessary complexities and controls are removed,” Fikejs recommended. “The more simplistic the process, typically the better.” The ultimate goal is to empower everyone in the bank to work in tandem with the compliance team and take ownership of their individual compliance role. With that approach in place, the whole institution will benefit from a more efficient and effective compliance system.

By, Amber Seitz

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What if Your Employees Owned The Bank?

What if Your Employees Owned The Bank?
A crowdsourced succession solution

Ownership succession is a critical concern for closely held financial institutions. As majority shareholders age and start to look for liquidity from their investment, bank management can find themselves facing a sale if there is no obvious successor. An Employee Stock Ownership Plan (ESOP) is a lesser-used solution that may work well at some banks. An ESOP is a federally regulated retirement plan that invests in the stock of an employer on behalf of its employees. When the employees leave or retire, they either sell their stock on the market or back to the company. As such, ESOPs are often thought of as simply a tax-advantaged employee benefit. While true, they can also be a powerful piece in a bank's ownership succession plan.

Nationally, nearly 800 banks offer ESOPs, but most control relatively small blocks of stock. Very few bank ESOPs own more than a quarter of their institutions, though there is a tiny fraction with 100 percent employee ownership. In order to determine if this strategy is a good fit for your institution, you must first understand why forming an ESOP can be beneficial and the process for implementing one.

Reasons to form an ESOP

Companies choose to form ESOPs for a variety of reasons, but the four most common motivations are to supplement an existing employee benefit plan, to promote growth, to create shareholder liquidity, and/or for its tax advantages. "The benefit is if you sell 100 percent of the company to an S-corp ESOP, you pay no federal and state income tax post-closing," explained Kevin Hanson, director at Business Transition Advisors, a consulting firm that specializes in succession planning at closely held businesses. BTA consults with ESOPs frequently because ownership succession is another very common motivation for forming an ESOP. Nearly two-thirds of ESOPs nationally were created to provide a market for the shares of a departing owner of a profitable, closely held company. "It's sort of a 'have your cake and eat it, too' situation with ESOPs and staying independent," said Horicon Bank President Fred Schwertfeger.

Promoting growth is another common reason for implementing an ESOP. "Studies have shown that there is improved performance when you compare whole or partial ESOPs to non-ESOPs," said Community First Bank President Dan Klahn. ESOPs can also increase employee engagement and retention when staff are educated on the benefits they're receiving. "It helps us attract and retain talent," said Horicon Bank Executive Vice President Jay Vanden Boogart. "When they have meaningful skin in the game through the ESOP, they value that." That value is enhanced when the ESOP is added on to an existing benefit structure. Over half of ESOP companies nationally have at least one additional employee retirement plan. For example, the ESOP at Community First Bank, Boscobel is set up as a complement to their 401k plan. "From the employees' perspective, it's another added benefit," said HR Officer Tammy Nelson.

How to set up an ESOP

The process of implementing an ESOP is a complex one with many variations depending on the specific institution. However, every company – banks and non-banks – must start with being profitable enough to support the debt service of the ESOP. "Profitability is key," Hanson explained. "This isn't something you can do if the company is struggling financially." Scott Huedepohl, president/CEO of Community State Bank, Union Grove, advises starting out with a thorough understanding of what the bank will need in order to support the ESOP from an administrative side, as well. "It's critical to turn over every rock and make sure you really know what you're getting into," he said. "Make sure you have the support structure in place because you're moving from multiple ownership to employee ownership. The trustee will carry a lot of power and a lot of liability risk."

After verifying the institution's financial capability and conducting research, bank management's next step should be to hire outside assistance. "Find a firm that can help with the ESOP implementation," Hanson recommended. That firm can help the bank conduct a preliminary analysis, which will look at the bank's ownership structure, number of employees, and most importantly the value of the company. "If you don't have the value, an ESOP can't happen," Hanson stressed. The bank's ownership structure will also impact its ability to take full advantage of the ESOP's tax treatment. "Having an S-Corp in place is helpful," said Schwertfeger. "Getting your structure to the right place is important."

If bank management determines that an ESOP is still a good fit for all stakeholders, the next step is an in-depth feasibility study. "The feasibility study defines what the structure of the end company will look like from an ESOP trust perspective, a corporate perspective, et cetera," Hanson explained. It will also define the timing and cost of the ESOP implementation. The results of the feasibility study create the groundwork for the purchase price negotiations for the transaction. Once the transaction is finalized, the ESOP must be implemented and rolled out to the bank's employees. "It can be quite complex for the employees to understand, so we focus on education so they understand all the components," said Nelson. "We've also created an Employee Ownership Council who serve as ESOP ambassadors to other staff." This council has members from each of Community First Bank's five branches, with positions ranging from CSR to the manager of the mortgage banking group.

Is it right for your bank?

ESOPs look different at different companies, depending on their intended purpose, maturity and a host of other factors. When deliberating whether to form an ESOP, management must determine early on if this strategy fits well with the bank's overarching strategic plan. For example, the average Wisconsin ESOP has been in place for 19 years, and many have been around for much longer. This longevity requires that bank management be forward-thinking and anticipate potential challenges that may arise for their successors. "Where your ESOP is at in the maturity cycle will impact the kind of challenges you have," Huedepohl explained. "There's a huge difference between an ESOP that's mature and one that's new." Schwertfeger advised the same prudence: "Consider the long-term nature of the decision," he said. A related question to consider is the bank's ability to weather potential cash liquidity issues. Community State Bank's ESOP is 30 years old, and with that maturity comes the challenge of ensuring that all departing employees' shares can be bought back. "One of our major challenges is managing our liquidity," Huedepohl explained. "We're privately traded, so we have to make sure we have plenty of liquidity to buy those shares back."

Another consideration is if the bank has the expertise and time to administer the ESOP in-house, or if they will need to hire a third party. "It's fairly complex and highly regulated from an administration standpoint," Klahn cautioned. "With that complexity and regulation comes higher cost." However, some of that cost is offset via the ESOP's tax advantages. Management must also weigh the intangible benefits, in addition to crunching the numbers. For example, Community First Bank's ESOP is just over two years old, but Nelson says she's already seen a change in employee culture. "We've seen higher employee engagement over the past year or so," said Nelson. The ESOP has also helped as a recruitment and marketing tool. "Our community understands that the bank staff who help them every day are employee-owners, and they view that very positively," said Klahn.

Ultimately, the most important element for management to consider when examining the idea of forming an ESOP is whether their primary motivation for doing so fits within the bank's strategy and culture. "The motivation behind it will impact the structure of the ESOP," Klahn explained. The bank's shareholder base is the crux of both structure and motivation; to form an ESOP bank management must have an accurate assessment of shareholder needs. "You need to have shareholders who are interested in liquidity," Schwertfeger said. For some shareholders the ESOP's tax treatment may be the most lucrative option for the sale of their stock. "Shares sold to an ESOP can qualify for a capital gains deferral, which may save shareholders significant amounts of money as they exit their ownership of the bank," Nelson explained. No matter what the ESOP's purpose is, the concept of employee ownership suits the community banking model. "It's consistent with the community bank culture and mindset," Huedepohl said.

 

Questions about forming or administering an ESOP? The experts interviewed for this article recommended these resources: 

By, Amber Seitz

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