Banks as Federal Contractors, A Brief History

By: Mike Lehr, HR Consultant

Unless legal counsel says otherwise, if FDIC covers a bank’s deposits, it’s best to assume it’s a federal contractor. That not only means the bank likely needs an affirmative action plan if it issues fifty or more different W2s in a year, but the federal government holds the bank to higher employment standards.

Still, as human resources professionals know, bank CEOs, presidents, and other senior executives often want to know, “What law says so?” After all, when we think of a “federal contractor,” we often think huge employers with thousands of employees.

For banks with only a few hundred (if that) employees, this all seems very unnecessary. Yet, the short answer is that a reinterpretation of existing law after the 2008 financial crisis made most banks federal contractors if they obtained federal deposit insurance.

Reviewing the way our government works and the history of banks as federal contractors can clarify this answer. After all, the law is not clear. It hasn’t changed much in over twenty years.

This review begins by reminding others that federal laws change in three main ways:

    1. Congress passes or revises laws.
    2. Executive branch reinterprets existing laws.
    3. Courts rule on and clarify regulations causing disagreements among parties.

While Congress neither passed nor revised any law specifically stating banks are federal contractors, the Department of Labor (DOL) reinterpreted the law. Until the 2008 financial crisis, the Office of Federal Contract Compliance Programs (OFCCP), an agency of the DOL, mainly interpreted the law to say FDIC made banks contractors. The DOL, its boss so to speak, never accepted this however.

So, until 2008, unless a bank clearly acted as “an issuing and paying agent for U.S. savings bonds and notes” or “a federal fund depository,” in a substantial manner, the DOL likely didn’t consider it a federal contractor.

Until 2008, FDIC payouts to banks were rare, almost non-existent. This crisis though saw many sizeable payouts. As a result, the DOL accepted OFCCP’s interpretation of the law. The crisis forced the DOL to see FDIC coverage as doing business with the federal government. So now, by its “boss” agreeing, the OFCCP has more authority to enforce its regulations such as affirmative action plans on banks.

Again, a reinterpretation of existing law after the 2008 financial crisis increased dramatically the likelihood that a bank is a federal contractor. This brief history has helped human resources professionals answer questions related to “what law says so?”

For more guidance and support on complying as a federal contractor, you can reach Mike Lehr at mlehr@younginc.com. Mike Lehr is not an attorney. As such, the content in this article should not be construed as providing legal advice. For specific decisions on compliance with OFCCP regulations, readers should consult with their legal counsel.

HMDA Data for 2018 Released

By: William J. Showalter, CRCM, CRP, Senior Consultant

The Federal Financial Institutions Examination Council (FFIEC) recently announced the availability of data for the year 2018 regarding mortgage lending transactions at 5,683 financial institutions covered by the Home Mortgage Disclosure Act (HMDA) in metropolitan statistical areas (MSA) throughout the nation.

The newly available HMDA data include disclosure statements for each covered financial institution, aggregate data for each MSA, nationwide summary statistics regarding lending patterns, and the Loan Application Register (LAR) submitted by each institution to its supervisory agency by March 1, 2019, modified for borrower privacy. This release includes loan-level HMDA data covering 2018 lending activity that were submitted on or before August 7, 2019.

The FFIEC prepares and distributes these data products on behalf of its member agencies – the Federal Deposit Insurance Corporation (FDIC), Federal Reserve Board (FRB), National Credit Union Administration (NCUA), Office of the Comptroller of the Currency (OCC), and Consumer Financial Protection Bureau (CFPB) – and the Department of Housing and Urban Development (HUD).

The HMDA loan-level data available to the public will be updated, on an ongoing basis, to reflect late submissions and resubmissions. Accordingly, loan-level data downloaded from https://ffiec.cfpb.gov/ at a later date will include any such updated data. An August 7, 2019 static dataset used to develop the observations in this statement about the 2018 HMDA data is available at https://ffiec.cfpb.gov/data-publication/. In addition, beginning in late March 2019, Loan/Application Registers (LARs) for each HMDA filer of 2018 data, modified to protect borrower privacy, became available at https://ffiec.cfpb.gov/data-publication/.

Data Overview
The 2018 HMDA data use the census tract delineations, population, and housing characteristic data from the 2011-2015 American Community Surveys. In addition, the data reflect metropolitan statistical area (MSA) definitions released by the Office of Management and Budget in 2017 that became effective for HMDA purposes in 2018.

For 2018, the number of reporting institutions declined by about 2.9 percent from the previous year to 5,683, continuing a downward trend since 2006, when HMDA coverage included just over 8,900 lenders. The decline reflects mergers, acquisitions, and the failure of some institutions.

The 2018 data include information on 12.9 million home loan applications. Among them, 10.3 million were closed-end, 2.3 million were open-end, and, for another 378,000 records, pursuant to partial exemptions in the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA), financial institutions did not indicate whether the records were closed-end or open-end.

A total of 7.7 million applications resulted in loan originations. Among them, 6.3 million were closed-end mortgage originations, 1.1 million were open-end line of credit originations, and, pursuant to the EGRRCPA’s partial exemptions, 283,000 were originations for which financial institutions did not indicate whether they were closed-end or open-end. The 2018 data include 2.0 million purchased loans, for a total of 15.1 million records. The data also include information on approximately 177,000 requests for preapprovals for home purchase loans.

The total number of originated loans decreased by about 924,000 between 2017 and 2018, or 12.6 percent. Refinance originations decreased by 23.1 percent from 2.5 million, and home purchase lending increased by 0.3 percent from 4.3 million.

A total of 2,251 reporters made use of the EGRRCPA’s partial exemptions for at least one of the 26 data points eligible for the exemptions. In all, they account for about 425,000 records and 298,000 originations.

Demographic Data
From 2017 to 2018, the share of home purchase loans for first lien, one- to four-family, site-built, owner-occupied properties (one- to four-family, owner-occupied properties) made to low- and moderate-income borrowers (those with income of less than 80 percent of area median income) rose slightly from 26.3 percent to 28.1 percent, and the share of refinance loans to low- and moderate-income borrowers for one- to four-family, owner-occupied properties increased from 22.9 percent to 30.0 percent.

In terms of borrower race and ethnicity, the share of home purchase loans for one- to four-family, owner-occupied properties made to Black borrowers rose from 6.4 percent in 2017 to 6.7 percent in 2018, the share made to Hispanic-White borrowers increased slightly from 8.8 percent to 8.9 percent, and those made to Asian borrowers rose from 5.8 percent to 5.9 percent. From 2017 to 2018, the share of refinance loans for one- to four-family, owner-occupied properties made to Black borrowers increased from 5.9 percent to 6.2 percent, the share made to Hispanic-White borrowers remained unchanged at 6.8 percent, and the share made to Asian borrowers fell from 4.0 percent to 3.7 percent.

In 2018, Black and Hispanic-White applicants experienced higher denial rates for one- to four-family, owner-occupied conventional home purchase loans than non-Hispanic-White applicants. The denial rate for Asian applicants is more comparable to the denial rate for non-Hispanic-White applicants. These relationships are similar to those found in earlier years and, due to the limitations of the HMDA data, cannot take into account all legitimate credit risk considerations for loan approval and loan pricing.

Government-backed Lending
The Federal Housing Administration (FHA)-insured share of first-lien home purchase loans for one- to four-family, owner-occupied properties declined from 22.0 percent in 2017 to 19.3 percent in 2018. The Department of Veterans Affairs (VA)-guaranteed share of such loans remained at approximately 10 percent in 2018. The overall government-backed share of such purchase loans, including FHA, VA, Rural Housing Service, and Farm Service Agency loans, was 32.0 percent in 2018, down slightly from 35.4 percent in 2017.

The FHA-insured share of refinance mortgages for one- to four-family, owner-occupied properties decreased slightly to 12.8 percent in 2018 from 13.0 percent in 2017, while the VA-guaranteed share of such refinance loans decreased from 11.3 percent in 2017 to 10.2 percent in 2018.

New Data
The 2018 HMDA data contains a variety of information reported for the first time. For example, the data indicated that approximately 424,000 applications were for commercial purpose loans and approximately 57,000 applications were for reverse mortgages.

In addition, among the 12.9 million applications reported, 1.3 million included at least one disaggregate racial or ethnic category. For approximately 6.3 percent of applications, race and ethnicity of the applicant were collected on the basis of visual observation or surname. The percentage was slightly higher for sex at 6.5 percent.

For the newly-reported age data point, the two most commonly reported age groups for applicants were 35-44 and 45-54, with 22.7 and 22.4 percent of total applications, respectively. Just under 3.0 percent of applicants were under 25 and just under 4.0 percent of applicants were over 74.

Credit score information was reported for 73.1 percent of all applications. Equifax Beacon 5.0, Experian Fair Isaac, and FICO Risk Score Classic 04 were the three most commonly reported credit scoring models at 22.8 percent, 18.8 percent, and 18.2 percent of total applications, respectively. For originated loans, the median primary applicant scores for these three models were between 738 and 746. This compares to medians ranging from 682 to 686 for denied applications.

Debt-to-income ratio (DTI) was reported for 75.3 percent of total applications. Approximately 45.1 percent of applications had DTIs between 36.0 percent and 50 percent, with 7.0 percent of applications with less than 20 percent, and 7.1 percent with greater than 60 percent.

Loan Pricing Data
The 2018 HMDA also contains additional pricing information. For example, the median total loan costs for originated closed-end loans was $3,949. For about 42.5 percent of originated closed-end loans, borrowers paid no discount points and received no lender credits. The median interest rate for these originated loans was 4.8 percent. The median interest rate for originated open-end lines of credit excluding reverse mortgages was 5.0 percent.

The HMDA data also identify loans that are covered by the Home Ownership and Equity Protection Act (HOEPA). Under HOEPA, certain types of mortgage loans that have interest rates or total points and fees above specified levels are subject to certain requirements, such as additional disclosures to consumers, and also are subject to various restrictions on loan terms. For 2018, 6,681 loan originations covered by HOEPA were reported: 3,654 home purchase loans for one- to four-family properties; 448 home improvement loans for one- to four-family properties; and 2,579 refinance loans for one- to four-family properties.

Using the Data
The FFIEC states that HMDA data can facilitate the fair lending examination and enforcement process and promote market transparency. When federal banking agency examiners evaluate an institution’s fair lending risk, they analyze HMDA data in conjunction with other information and risk factors, in accordance with the Interagency Fair Lending Examination Procedures. Risk factors for pricing discrimination include, but are not limited to, the relationship between loan pricing and compensation of loan officers or mortgage brokers, the presence of broad pricing discretion, and consumer complaints.

The HMDA data alone, according to the FFIEC, cannot be used to determine whether a lender is complying with fair lending laws. While they now include many potential determinants of creditworthiness and loan pricing, such as the borrower’s credit history, debt-to-income ratio, and the loan-to-value ratio, the HMDA data may not account for all factors considered in underwriting.

Therefore, when the federal banking agencies conduct fair lending examinations, including ones involving loan pricing, they analyze additional information before reaching a determination regarding institutions’ compliance with fair lending laws.

Obtaining and Disclosing HMDA Data
In the past, HMDA-covered lenders had to make the HMDA disclosure statements available at their home and certain branch offices after receiving the statements. Now, lenders have only to post at their home offices, and other offices in MSAs a written notice that clearly informs those interested that the lender’s HMDA disclosure statement may be obtained on the Consumer Financial Protection Bureau’s website at www.consumerfinance.gov/hmda.

In addition, financial institution disclosure statements, MSA and nationwide aggregate reports for 2018 HMDA data, and tools to search and analyze the HMDA data are available at https://ffiec.cfpb.gov/data-publication/. More information about HMDA data reporting requirements is also available at https://ffiec.cfpb.gov/.

More information about HMDA data reporting requirements is available in the Frequently Asked Questions on the FFIEC website at www.ffiec.gov/hmda/faq.htm. Questions about a HMDA report for a specific lender should be directed to the lender’s supervisory agency.

Agencies Amend Real Estate Appraisal Regulations (September 27, 2019)

By: Kyle Curtis, Director of Lending Services

The OCC, Board, and FDIC adopted a final rule to amend the regulations requiring appraisals of real estate for residential real estate transactions. The rule increases the threshold level at or below which appraisals are not required for residential real estate transactions from $250,000 to $400,000.

The rule defines a residential real estate transaction as a real estate-related financial transaction that is secured by a single 1-to-4 family residential property. For residential real estate transactions exempted from the appraisal requirement as a result of the revised threshold, regulated institutions must obtain an evaluation of the real property collateral that is consistent with safe and sound banking practices.

The requirements for an evaluation are set forth in the 2010 Appraisal Guidelines, and are more extensive than what many smaller institutions do for evaluations. Readers may wish to review the requirements in that document and determine whether changes need to be made regarding your evaluation practices.

The rule also amends the agencies’ appraisal regulations to require regulated institutions to subject appraisals for federally related transactions to appropriate review for compliance with the Uniform Standards of Professional Appraisal Practice.

Effective Dates
The provisions of much of this final rule will be effective by the time you read this; however, the evaluation requirement for transactions exempted by the rural residential appraisal exemption and the requirement to review appraisals for compliance with the Uniform Standards of Professional Appraisal Practice are effective on January 1, 2020.

Incorporation of the Rural Residential Appraisal Exemption
Congress amended Title XI to add a rural residential appraisal exemption. Under this exemption, a financial institution need not obtain a Title XI appraisal if the property is located in a rural area; the transaction value is less than $400,000; the financial institution retains the loan in portfolio, subject to exceptions; and not later than three days after the Closing Disclosure Form is given to the consumer, the financial institution or its agent has contacted not fewer than three state-certified or state-licensed appraisers, as applicable, and has documented that no such appraiser was available within five business days beyond customary and reasonable fee and timeliness standards for comparable appraisal assignments.

Given the general rule increase to $400,000, essentially these requirements become moot.

Addition of the Appraisal Review Requirement
The Dodd-Frank Act amended Title XI to require that the agencies’ appraisal regulations include a requirement that Title XI appraisals be subject to appropriate review for compliance with USPAP.

Appraisal review is consistent with safe and sound banking practices, and should be employed as part of the credit approval process to ensure that appraisals comply with USPAP, the appraisal regulations, and a financial institution’s internal policies. Appraisal reviews help ensure that an appraisal contains sufficient information and analysis to support the decision to engage in the transaction. We recently had a discussion with a banker who did not review an appraisal. When they “got around to it” they discovered that the appraisal was “not even close,” and ordered a new appraisal. Based on the new appraisal, their LTV was over 130%.

Many financial institutions may already have review processes in place for these purposes. Evaluations need not comply with USPAP. While financial institutions should continue to conduct safety and soundness reviews of evaluations to ensure that an evaluation contains sufficient information and analysis to support the decision to engage in the transaction, the USPAP review requirement in Title XI does not apply to such a review.

The agencies decided to implement the requirement that financial institutions review appraisals for federally related transactions for compliance with USPAP. The agencies encourage regulated institutions to review their existing appraisal review policies and incorporate additional procedures for subjecting appraisals for federally related transactions to appropriate review for compliance with USPAP, as needed.

Conclusion
Readers who wish to read the entire 80-page document as prepared by the regulators can find it at:
https://www.fdic.gov/news/board/2019/2019-08-20-notice-sum-b-fr.pdf?source=govdelivery&utm_medium=email&utm_source=govdelivery

Young & Associates, Inc. can offer assistance with appraisal review, and any other compliance topics. Please feel free to contact me for information regarding these services at kcurtis@younginc.com or (330) 422.3445.

Interest Rate Risk Reporting

By: Bryan Fetty, Senior Consultant

There are a few common findings that we note when conducting Interest Rate Risk Reviews for clients that are easily remedied and require very little work on the part of the financial institution. One supervisory requirement is to provide a sufficiently detailed reporting process to inform senior management and the board of the level of IRR exposure. Financial institutions are providing the reports to the board, but in the world of regulators, if it isn’t documented in the minutes, you didn’t do it.
Financial institutions should ensure that their committee and board minutes are detailed enough to show the level of discussion about their reports that takes place at the meeting. There doesn’t need to be extensive narrative on the issues, but the minutes should reflect:

      Whether or not the board reviewed the quarterly IRR reports
      Whether or not the monitored risk measures were in compliance with the policy limits
      If any measurements fell outside of the policy limits or the reports show presence of warning indicators, include a short explanation and management’s recommendations/action items (if applicable)
      If there were any material changes in the risk measurement results compared with the previous period, include a short explanation (for example, changes made to the assumptions used in the model, material changes in the mix of assets or liabilities, any unique circumstances)
      On an annual basis, note when the board reviewed the policy, any independent review reports, the key model assumptions, and any stress or assumption tests
      Whether or not any other ALCO-related topics were discussed during the meeting.

For more information on how Young &Associates, Inc. can assist your financial institution with the annual IRR review and model back-testing process, please email Bryan Fetty at bfetty@younginc.com or give him a call at 330.422.3452.

Capital Market Commentary

By: Stephen Clinton, President, Capital Market Securities

Mid-November Market Update
The U.S. is undergoing its longest economic expansion on record, breaking the record of 120 months of economic growth recorded from March 1991 to March 2001. Starting in June of 2009, this record-setting run saw GDP recording growth, albeit at a slower growth rate than previous expansions. The unemployment rate is at 3.6% and job growth continues with employers adding an average of 167,000 jobs this year. The current expansion also includes the longest stretch of job creation on record. The current U.S. economic growth is being driven by consumer spending as businesses have slowed business investment due to the uncertainties surrounding tariffs and global growth concerns.

In late October, the Fed lowered short-term interest rates for the third time this year. These moves follow last year’s four interest rate increases designed to guard against concerns about inflation and financial bubbles. The move to a more accommodative stance is designed to cushion the economy against a slowdown in business investment and in recognition of the uncertainties surrounding the U.S.-China trade conflict. U.S. inflation remains low and below the 2% Fed target which has reduced the Fed’s concern about rising prices and higher labor costs.

While the U.S. economy continues to chug along, things are not as optimistic for our trading partners. China’s economy is slowing dramatically; Japan’s economy grew at the slowest pace in a year in October; and Germany barely skirted a recession in the third quarter. These countries represent the world’s second, third, and fourth largest economies in the world. The global economic slowdown may make it difficult for the U.S. to continue to record GNP growth.
The home mortgage market has benefited from lower interest rates. The average 30-year home mortgage rate has fallen to near 4% from a recent high of 5.2% last November. Lenders made $700 billion in home loans in the July-to-September quarter, the most in 14 years. Mortgage origination activity is on pace to hit the highest level since 2006, the peak of the last housing boom. Refinancing activity is in part responsible for this renewed lending activity with refinancings jumping 75% from last year.

The U.S. government spent nearly $1 trillion more in fiscal year 2019 than it took in, which resulted in the highest deficit in seven years. The deficit has now increased for the last four years, the longest stretch of U.S. deficit growth since the early 1980’s, a period that included two recessions and an unemployment rate near 11%. The deficit has increased 68% since 2016 during a time when there is historically low unemployment and a growing economy. The loss of tax revenues from tax cuts, along with a bipartisan budget deal that increased government spending, are responsible for the growing deficits. Long-term costs associated with an aging population, including Social Security and Medicare, are expected to continue to put pressures on balancing the budget in the future.

U.S. corporate earnings remain strong. With most of the third quarter earnings announcements in the books, 75% have posted results above analysts’ expectations. While overall profits are lower than last year by approximately 2.7%, analysts are projecting improved earnings next year. One growing concern about nonfinancial companies being discussed is the high level of debt corporations hold. The level of corporate debt is at the highest level ever. Low interest rates have made the choice of debt preferable to equity for corporations. This has caused a leveraging of balance sheets.

Short-term interest rates have fallen 35% this year as of November 15. The 3-month T-Bill ended at 1.57%, principally due to the three Fed interest rate cuts. The 10-year T-Note was at 1.84% at November 15, down 85 basis points from the end of last year. After spending some time with a partially inverted yield curve, the shape of the yield curve has moved to its more traditional upward slope. The spread between the 3-month T-Bill and the 10-year T-Note was a narrow 27 basis points.

The stock market reached new highs as of November 15. The Dow Jones Industrial Index was up 20.05% for the year. The broader Nasdaq Index closed up 28.72%. The Nasdaq Bank index was up 16.73%, but the KBW Bank Index was up 26.44%. The stronger upward movement of the KBW Bank Index reflects the strong price increases recorded by larger banks this year.
The market has experienced a high level of market volatility this year. The ups and downs of the U.S.-China trade talks has caused wide market swings. Brexit has been a concern for the market. Protests in Hong Kong have captured attention. The U.S. impeachment inquiry presents market risk. We expect the market to continue to be volatile due to these concerns as well as other issues that may surface and capture the market’s attention.

Interesting Tid Bits

      Tariffs – The U.S. collected a record $7 billion in import tariffs in September. This was up 50% from last year as new duties kicked in on Chinese imports.
      Taxation – For the first time on record, the 400 wealthiest Americans last year paid a lower total tax rate (federal, state, and local taxes) than any other income group. The overall tax rate on the richest 400 households was 23% last year compared to 70% in 1950 and 47% in 1980.
      Manufacturing – Manufacturing makes up approximately 11% of the U.S. GNP, which is down from 16% twenty years ago. Factory workers now make up 8.5% of the overall workforce which is down from 13% two decades ago. There are now more local government employees than factory workers.

Merger and Acquisition Activity
Through November 15 this year, there were 229 bank and thrift announced merger transactions. This compares to 231 deals in the same period last year. The median price to tangible book for transactions involving bank sellers was 158%.

Capital Market Services
Capital Market Securities, Inc. has assisted clients in a variety of capital market transactions. For more information on our capital market services, please contact Stephen Clinton at 1.800.376.8662 or sclinton@younginc.com.

Corporate Change to Foster Growth

By: Jerry Sutherin, President and CEO

I am pleased to announce some changes to the structure of Young & Associates, Inc. that took place in September. The following individuals have received promotions to help our organization continue to grow and guide our organization into 2020 and beyond.

      1. Bill Elliott – Director of Compliance Education
      2. Karen Clower – Director of Compliance
      3. Bob Viering – Director of Lending
      4. Aaron Lewis – Director of Lending Education
      5. Kyle Curtis – Director of Lending Services
      6. Mike Detrow – Director of Information Technology Audit/Information Technology
      7. Martina Dowidchuk – Director of Management Services
      8. Dave Reno – Director of Lending and Business Development
      9. Jeanette McKeever – Director of Internal Audit

Each of these individuals possesses a vast amount of experience, knowledge, and contacts in the financial services industry, and have, time after time, been called upon to utilize this experience and knowledge for the betterment of our clients and, in turn, for the betterment of Young & Associates, Inc. While much of the day-to-day, primary duties and responsibilities of these recognized individuals will remain unchanged, the new role will involve them to a higher degree in the business strategy and implementation needed to grow our business in 2020 and beyond.

The functional areas of Human Resources (Sharon Jeffries), Marketing (Anne Coyne), and Education Coordination (Sally Scudiere) will continue to be valuable advisors/resources to our corporate strategy and senior management team and will be fully utilized through the ongoing process of business growth in conjunction with maximizing employee potential.

Congratulations to all of these individuals on these important promotions. We look forward to working together to serve our current and potential clients in 2020!

When a Stock Valuation Can Add Value

By: Martina Dowidchuk, Senior Consultant

The stock market continues to remind us of its inefficiencies. Most banks saw their stock values decline last year despite the industry’s record levels of earnings, continuing growth, and strong asset quality levels. In fact, the month of December 2018 recorded the greatest monthly stock decline since 1931. The broad market index, the Nasdaq Composite Index, was down 9.5% for the month of December and the banks were impacted even more than the overall market with the Nasdaq Bank Index falling 14.1%. For the year 2018, bank prices declined by 17.9% as measured by the Nasdaq Bank Index. This market correction was caused by a combination of economic and political factors, as well as the market’s perception of their impact on the industry. The Nasdaq Bank Index has showed a considerable improvement since the end of 2018, but as of July 30, 2019, it continues to be more than 9% below the level it reached 12 months ago.

While there will always be external factors outside of any bank’s control affecting the market pricing, the intuitive fundamental relationships tend to remain true among broadly-traded stocks. Regardless of the overall market’s ups and downs, the market values of banks with a higher profitability, stronger growth prospects, and other positive fundamentals are typically higher when compared to banks with weaker performance. However, this is not always true for banks with a limited stock trading activity. To ensure that the improvements in the bank’s performance translate into the shareholder value, the earnings prospects and financial strength need to be proactively communicated to the proper audience so that investors realize the value of a community bank stock and the bank gets a proper credit for its performance.

One of the easiest and fastest proactive measures available is to obtain an independent third-party valuation of the bank’s stock. Professional appraisers use multiple valuation techniques that encompass both sound financial theory and the latest market realities. Different considerations are made depending on the type and purpose of the valuation. Some valuations may require a minority interest value (i.e., a trading value), while others may call for a controlling interest value (i.e., change of control value). A valuation report evaluates the bank’s performance from different perspectives and provides an immediate stock value estimate that can then be communicated to shareholders and potential investors, providing a base point for future trades, stock repurchases, employee stock ownership programs, etc. Furthermore, if the bank has not previously had a valuation of its stock completed, the result in many cases could be a significant, immediate increase in shareholder value as the bank and its shareholders realize the true value and potential of the stock.

For community banks, understanding and proactively managing the shareholder value can be vital for many reasons. Young & Associates, Inc. has been providing valuation services and advice encompassing a variety of transactions and valuation purposes for over 40 years. Our experience in merger and acquisition activities, bank formations, and other capital market transactions gives us the expertise to help our clients understand their market value and make informed decisions as they implement their strategic initiatives. For more information on how Young & Associates, Inc. can assist your bank in this area, give me a call at 330.422.3449 or send an email to mdowidchuk@younginc.com.

Succession Planning – The Key to Remaining Independent

By: Bob Viering, Senior Consultant and Manager of Lending Services

For many community banks today, remaining independent is the number one strategic priority. There are many reasons boards believe remaining independent is important: the board believes that the shareholders’ investment will be maximized over a longer time horizon; that the bank as an independent local bank can best serve the needs of the community; that the employees as a whole will be far better served (and have jobs) by remaining independent. These are all reasonable and sincere reasons.

So, if staying independent is important, why are an increasing number of banks selling today? One of the biggest reasons that banks sell is that the board is not confident that there is anyone ready to take over management of the bank. Developing a successor internally is a multi-year process to groom a talented individual to learn enough about the day-to-day responsibilities and skills needed to manage a bank successfully. Hiring a new CEO externally sounds easy, but to find that right person that not only has the skills and background to succeed and also can fit in the community and, most importantly, the bank’s culture can be a very challenging process, especially if you are in a rural community. If something happens that the CEO role is suddenly open, or the CEO decides to retire in a year or less, all too often there is not enough time to find that right person, and the easier decision is to sell while the bank is still running smoothly.

It sounds like having a plan on how the CEO position will be filled is the answer. We’ve seen very simple plans that are a few short paragraphs that basically say, “Joe and Mary can run the bank in the interim. If one of them is not the right person, we’ll just hire someone.” Even for a very small bank, it’s almost never this easy. Even if you believe one of the top managers has the “right stuff” to be the next leader, have you thought about what skills they may need to develop to be ready? Have they had any real experience leading a group or an important project that gives you confidence they can run the place? Can you picture that person standing up in front of your shareholders? Or representing your bank to regulators? Or allowing your other key employees to operate successfully? Can they run the bank when times get tough (and they always do)? If you answered positively to these questions, do you have a plan, with timeframes, to provide the types of training and experience so that they will be ready to take over?

Even if you are confident you have the right person to take over, or you start early enough to recruit your next leader, what about the next level of management? Are they ready to step up when Joe or Mary ascends to the top spot? Do you have a plan to develop that next level of management? As you step through the layers of your organization, it often becomes clear that there are other key employees that would impact your ability to run the bank smoothly if they leave. What do you do if your head of IT leaves? Is there a replacement? Can the functions be outsourced? Every organization has those key people; they may not even be mangers that are critical to the operation. What’s your plan if they are gone one day?

If you may be facing the expected change at the CEO level and you have other key people that are in sight of retirement, selling can seem like a simple, expedient solution. The key to not being backed into a corner when retirements occur, or when a key person leaving is a threat to the successful operation of the organization, is having a well thought out succession plan. A successful plan has the following elements: it identifies those key individuals in the bank needed to run the organization successfully; it identifies the skills and training needs for those individuals that have the ability to be promoted to more responsible positons, even the CEO role; it has a written plan with timelines for preparing the individual for that next step; and it is updated at least annually to verify that the plan is still the best plan for the bank and that the individuals are progressing as expected.

If you truly want to remain independent, then you must take the time, and it will take time, to develop a meaningful succession plan. Well done, it will take months to develop and time to groom and coach that next level of talent, to review and update your plan as required.

At Young & Associates, Inc. we are committed to the idea that we are all best served by having strong, well-run community banks. If you would like help in developing your succession plan or would like a critical eye to review your existing plan, reach out to us: we’ve got community banking’s back. To contact me, give me a call at 330.422.3476 or send an email to bviering@younginc.com.

Private Flood Insurance Update

By: Bill Elliott, CRCM, Senior Consultant and Manager of Compliance

As you are no doubt aware, the issue of flood insurance has been unsettled for the last 18 months, and the formal FEMA flood program is only approved until the fall. But, after a long wait, the regulators have published additional regulation for private flood insurance – which does not rely on Congress to do anything, and makes the presence or absence of the FEMA program less problematic for lenders.

Background

The Biggert-Waters Act (2012) amended federal flood insurance legislation to require the agencies to issue a rule directing regulated lending institutions to accept “private flood insurance,” as defined by the act. In response to subsequent legislation and comments received regarding the private flood insurance provisions of the first proposed rule (2013), and the second proposed rule (November 2016), all prudential regulatory agencies finally issued the rule, effective July 1, 2019.

It remains to be seen how effective and efficient this will be, as it is a “work in process.” But some have told me that some of their customers have found lower flood insurance rates privately (meaning these policies may become more popular). Others have told me that they have had customers declined for private flood insurance based on the riskiness of the property location.

Summary of the Rule

The rule requires regulated lending institutions to accept “private flood insurance” defined in accordance with the Biggert-Waters Act. There are essentially three categories of private flood insurance.

Category One – Private Flood Insurance with “Compliance Aid” Language

If the following language appears on the flood policy, the lender may accept the policy without any further review:
“This policy meets the definition of private flood insurance contained in 42 U.S.C. 4012a(b)(7) and the corresponding regulation.”

Although it remains to be seen how well this will work, we hope that most insurance companies will include this language, which will make it quite easy for lenders, as no additional effort will be required.

Category Two – Private Flood Insurance without “Compliance Aid” Language

The rule permits regulated lending institutions to exercise discretion to accept flood insurance policies issued by private insurers that do not meet the statutory and regulatory definition of private flood insurance. The conditions for acceptance include a requirement that the policy must provide sufficient protection of a designated loan, consistent with general safety and soundness principles, and the regulated lending institution must document its conclusion regarding sufficiency of the protection of the loan in writing.

The difficulty for lenders will be to determine whether these policies really meet these (and other) requirements. And although the regulation says “discretionary,” it does not appear that the regulators will just allow lenders to summarily reject these policies.

Category Three – Mutual Aid Societies

The agencies will now allow the acceptance of plans providing flood coverage issued by mutual aid societies. The rule defines “mutual aid society” as 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.

A regulated lending institution may accept a plan issued by a mutual aid society, as defined above, if the regulated lending institution’s primary federal supervisory agency has determined that such plans qualify as flood insurance for purposes of the act.

Requirement to Purchase Flood Insurance

There is nothing in the rule that changes the amounts of insurance required, or anything else. This simply allows more options and hopefully, over time, will make everyone’s life – lenders and borrowers – easier.

If you need any assistance in this area, especially private flood policies without the “compliance aid” language, please give us a call at 330.422.3450 or send an email to bille@younginc.com. We are always happy to help.

Capital Market Commentary

By: Stephen Clinton, President, Capital Market Securities, Inc.

July Market Update

July marks the beginning of the 11th year of the U.S. economic recovery that began in June 2009. Back then was the end of the Great Recession that followed the 2007-2008 global financial crisis. The current expansion has continued, uninterrupted, ever since. While the annual economic growth has not been remarkable, it has been stable. GDP growth has been around 2% for each of the years of the recovery. However, the recovery has led to a near 50-year low unemployment rate of 3.7% while holding inflation below 2%. Highlights on the economic front include:

  • On July 31, the Fed lowered its short-term benchmark interest rate by a quarter of a percentage point, the first rate cut since 2008. Previously, the Fed had conducted several rounds of raising rates as it expected inflation to surface due to the “full employment” conditions. Surprisingly, inflation has remained in check and concerns about the global outlook clouded by trade policy uncertainties allowed the Fed to concede that interest rates were too high.
  • The June quarter, for the second quarter in a row, saw industrial production decline at an annual rate of 1.2%. Capacity utilization for the industrial sector decreased 0.2 percentage point in June to 77.9%, a rate that is 1.9 percentage points below its long-run (1972–2018) average.
  • The trend in wage growth has slowed from late last year when wages were rising at their fastest rate in a decade. Average hourly earnings in June rose six cents, or 0.2 %. That kept the annual increase in wages at 3.1% for a second straight month.
  • Strong consumer spending in the second quarter helped bring the GNP growth to 2.1% in the second quarter. The growth in personal consumption expenditures were reported at 4.3%, compared to 1.1% in the first quarter.
  • Home price increases are cooling off after recording strong growth since the recovery began. The Case-Shiller National Home Price Index rose an annual 3.4% in May.
  • Big fluctuations in oil prices have occurred in 2019. First, prices surged 48.2% by April 25, due in part to rising tensions between America and Iran. Then prices plunged 20%, with headlines blaming slower global oil demand growth and weak manufacturing data.
  • The federal deficit is expected to top $1 trillion for the second year in a row. The principal factors leading to the deficits are the 2017 tax cuts while the federal budget exceeded the spending caps enacted by Congress in 2011 by $300 billion.
  • American farmers are hurting. Unusually heavy spring rains have delayed or completely prevented planting across many areas of the Midwest while trade disputes drag down agricultural exports and crop prices. The pain is spreading from farmers to businesses related to farming.
  • The stock market has been strong in 2019. The Dow increased 15.16% in the first seven months while the broader Nasdaq market increased 23.21%. Banks followed the upward trend, rising 15.06% as measured by the Nasdaq Bank Index. Banks are reporting strong financial results. Based upon the March FDIC Quarterly Banking Profile, banks increased their net interest income by 6% from the prior year leading to an improvement of profitability by 8.7%. Noncurrent loans are below 1% while banks increased their reserves for future loan losses. Capital ratios continue to climb. The Fed recently announced the results of its annual capital stress tests (CCAR) for large banks and reported no objections to any of their capital plans. This will allow for increased dividends and continued stock buyback activity for these banks.
  • Short-term interest rates have declined in 2019 with the 3-month T-Bill moving down from 2.45% at the end of 2018 to 2.08% at the end of July. The 10-year T-Note also declined from 2.69% to 2.02%. The yield curve is partially inverted, with the 3 and 5-year T-Notes trading below 2%.

Merger and Acquisition Activity

As of the end of July, bank and thrift merger activity was down approximately 10% from last year at the same time. The median price to tangible book for transactions involving bank sellers was 168%.

Capital Market Services

Capital Market Securities, Inc., has assisted clients in a variety of capital market transactions. For more information on our capital market services, please contact Stephen Clinton at 1.800.376.8662 or sclinton@younginc.com.