Issue 3 2022-2023 Banker Regulatory Scrutiny of NSF and Overdraft Fees OVER A CENTURY: BUILDING BETTER BANKS — Helping Coloradans Realize Dreams
©2022 The Colorado Bankers Association is proud to present Colorado Banker as a benefit of membership in the association. No member dues were used in the publishing of this news magazine. All publishing costs were borne by advertising sales. Purchase of any products or services from paid advertisements within this magazine are the sole responsibility of the consumer. The statements and opinions expressed herein are those of the individual authors and do not necessarily represent the views of Colorado Banker or its publisher, The newsLINK Group, LLC. Any legal advice should be regarded as general information. It is strongly recommended that one contact an attorney for counsel regarding specific circumstances. Likewise, the appearance of advertisers does not constitute an endorsement of the products or services featured by The newsLINK Group, LLC. Jenifer Waller President & CEO Alison Morgan Director of State Government Relations Brandon Knudtson Director of Membership Lindsay Muniz Director of Education Rita Fish Communications & Office Manager Margie Mellenbruch Bookkeeper* Craig A. Umbaugh Counsel* Jim Cole Lobbyist* Melanie Layton Lobbyist* Garin Vorthmann Lobbyist* Andrew Wood Lobbyist* * Outsourced 140 East 19th Avenue, Suite 400 Denver, Colorado 80203 Office: 303.825.1575 Websites: coloradobankers.org smallbizlending.org financialinfo.org colorado-banker.thenewslinkgroup.org Over a Century BUILDING BETTER BANKS— Helping Coloradans RealizeDreams 16 7 27 Colorado Bankers Association The 2 Message from the CEO 3 In Memoriam, Dennis King 4 NOT JUST NONPROFITS CDFI Banks, in Partnership, Leverage Private and Public Funds to Enhance the Communities We Serve 6 Education and Trust Matter When Dealing with Digital Assets 7 HSAs, an Opportunity for Mutual Benefit 12 For Community Banks, The Sun Also Rises Solar Tax Credit Investments Now More Accessible 14 Equity Cure Provisions in Middle-Market, Sponsor- Backed Credit Agreements 16 How to Know if Your Bank Must Report a Cybersecurity Incident 19 Regulatory Scrutiny of NSF and Overdraft Fees 22 Four Tips for Community Banks to Retain Talent 24 The Society of Bank Executives 26 Cash Flow Management 27 Why Banks are Embracing Loan Marketplaces as a Solution to Liquidity Contents September • October 2022 1
Message from the CEO On September 12-13, Colorado bankers visited Washington, D.C. It was a successful and productive week in our nation’s capital, and it was good to be back to in-person meetings after the restrictions and machinations of COVID protocols. Bankers from Arizona, Montana, Utah, and Wyoming joined our Colorado bankers in D.C. The partnership made the event all the richer. We met with representatives of the CFPB and OCC, and we received a briefing from FDIC Acting Chairman Martin Gruenberg. These meetings allowed us to engage in a positive conversation regarding CRA, CBDC, and our concerns regarding interpretations of overreach regarding overdrafts. While representatives did not provide assurances or commitments, we did provide valuable information regarding the need to be judicious in the transition period for CRA and the need to update assessment areas. We also met with staffers from both Colorado Senator’s offices and five of the seven Colorado Representative’s Offices. The topic we primarily focused on is the Senate version of the interchange for credit card bill [SB 4674 sponsored by Sens. Dick Durbin (D-Ill.) and Roger Marshall (R-Kan)]. The bill expands the Durbin Interchange Bill to apply to credit cards. A companion House bill [(HB 8874 by Reps. Peter Welch (D-Vt.) and Lance Gooden (R-Texas)] was recently introduced. If the bill becomes law, it would force credit unions and banks to contract with multiple credit card routing companies. The safety and convenience of credit cards today benefits consumers and businesses. The bills put that at risk by mandating that merchants can choose how card transactions can be routed. Instead of using the safest and most secure networks, they may select cheaper payment rails that could put data at risk and reduce revenue that financial institutions use to fund technology improvements, fraud prevention, and popular rewards programs. Far from increasing competition in the credit card marketplace, this legislation will reduce the number of credit card issuers competing for consumers’ business, wring out the competitive differences among card products, decimate card rewards programs (e.g. airline miles) valued by American families and our tourism sector, and put the nation’s private-sector payments system under the micromanagement of the Federal Reserve Board. The bill does all this by using legislation to award private-sector contracts to a small handful of favored payment networks in order to pad the profits of the largest internet and national merchants who are raising prices on American families far more than the real rate of inflation. Senators Richard Durbin and Roger Marshall filed an amendment that would add SB 4674 to the National Defense Authorization Act, scheduled for consideration in late October. We urge you to take grassroots action opposing DurbinMarshall and its companion bill in the House. Take action now: https://secureamericanopportunity.com/take-action/ oppose-credit-card-routing-mandates. By Jenifer Waller, CEO Colorado Bankers Association www.coloradobankers.org 2
The banking community lost a true ally, an advocate, and mentor. Dennis King, with Home Loan State Bank, passed away on August 31, 2022. Anyone who had the pleasure of visiting with Dennis knew his passion for the community and banking. He cared deeply about people and serving the community. His political prowess benefited the industry. Dennis had a remarkable career in banking in Western Colorado, and over the course of his career helped many people and their businesses. His career began in Delta, Colorado, with United Banks. From this beginning, he went on to work for Norwest, Wells Fargo, and First National Bank of the Rockies. From there, he helped start two new banks: Timberline and Home Loan State Bank. Dennis had an infectious sense of humor that is well remembered by everyone he worked with. He advocated strong relationships with regulators that earned him a reputation as someone who could be trusted. He was very serious about the role the Colorado Banker’s Association played in advocating for community banks. “Dennis was a dear friend; someone I could always call for advice or simply to have someone to commiserate about politics. He had the sweetest sense of humor. If there was a candy dish nearby, Dennis would dump its contents into my purse. Sometimes I would see him do it with a mischievous grin, but often I would find it later, a little joke between us. I miss him greatly,” said Jenifer Waller. Dennis always knew what was going on under the gold dome in Denver and the Capitol in D.C. and which candidates would be supportive. He had a keen understanding of politicians and how to garner support for a cause. Dennis served on the Colorado Bankers Association Board from 2017 to 2021, and he also served on the Government Affairs Committee. He gave selflessly of his time – always willing to help or do what was needed for the right cause. He will be greatly missed by everyone who knew him. Memoriam In September • October 2022 3
Not CDFI BANKS, IN PARTNERSHIP, LEVERAGE PRIVATE AND PUBLIC FUNDS TO ENHANCE THE COMMUNITIES WE SERVE By Kent Curtis, CEO & President, First Southwest Bank The August edition of Colorado Banker shined a light on the power of Community Development Financial Institutions (CDFI) to make big impacts in partnership with the people in the communities they serve. It explained the origins of CDFIs and what has become a social and economic justice movement within the community development finance field. The article described the mission of CDFIs as entities that invest local, state and federal resources, in combination with private sector capital, to finance people and projects in communities historically unable to access it. The Riegle Community Development Banking and Financial Institutions Act of 1994 received bi-partisan and broad support from both houses of Congress, and President Bill Clinton signed it into law Sept. 24, 1994. The Act established CDFIs to promote economic revitalization and community development in both urban and rural communities. CDFIs were also a response to historical injustices like red-lining and were created to help industrious people, both urban and rural, including farmers and ranchers, women-, veteran-, and immigrant-owned, start-up and established business owners, qualify for financing to pursue their dreams and aspirations. We at First Southwest Bank (FSWB), serving rural Colorado, are proud to be one of two CDFI banks in Colorado; the other is Native American Bank in Denver. FSWB earned this designation from the U.S. Treasury in 2014. Initially excited to see a spotlight shown on CDFIs, we would like to correct an assertion that CDFIs are exclusively nonprofit entities. It is true that the majority of today’s ~1,300 CDFIs – made up of banks, credit unions, nonprofit loan funds, and venture capital funds – are nonprofit entities. There exists, however, a small and mighty group of 135 community development banks, nationally represented by the Community Development Bankers Association, which are public and private enterprises doing things a bit differently than most banks. As with other CDFIs, partnership is central to our work since we know we can do more to fulfill our community development missions together than apart. One of our most unique partnerships is with our affiliated nonprofit revolving loan fund, First Southwest Community Fund, established in 2015 to provide riskmitigating gap funding to rural Colorado communities. In partnership, we work to address community needs, Just Nonprofits www.coloradobankers.org 4
First Southwest Bank (FSWB) is a locally owned, independent community bank and one of two Community Development Financial Institution (CDFI) banks in Colorado, offering personal and business banking, agricultural and small business loans. We put customer dollars to work to improve the social and economic landscape of Southern and rural Colorado. With our non-profit partner, the First Southwest Community Fund, we ensure our region’s entrepreneurs, small businesses, and not-for-profit organizations have access to the inclusive and equitable capital they need to grow and enrich our communities. More information can be found at fswb.bank. Or you can contact Kent Curtis at kent.curtis@fswb.com or 970-422-5054. support entrepreneurs, small businesses, rural livelihoods, and thriving communities, and improve the social and economic landscape of rural Colorado. Together, we have access to public, private and philanthropic resources other banks do not. And we can lend those funds through participation with other banks that may have policy limitations. Combining our varied funding sources with bank funding creates the greatest leverage to produce the highest impact possible across our Colorado communities. As a result, in partnership with CDFIs banks and other nonprofits, traditional community banks can be more inclusive and fair in the banking products and services they offer within their markets. We regularly do business with and invest in schools, healthcare organizations, local governments, libraries, early childhood education centers, environmental causes, and varied nonprofit organizations. Recognizing a need for novel approaches and innovative funding mechanisms, in the past few years, we have stepped into the affordable housing space and the roots of our movement. This year, in partnership with Impact Development Fund, another Colorado CDFI loan fund, we served as the lead lender on the Westside and Triangle Mobile Home Park acquisitions in Durango, helping to secure affordable housing for ~90 Hispanic families who had lived there for generations and would otherwise have faced exorbitant rent increases or been displaced. First Southwest Bank also served as a participating lender offering non-qualified mortgage loans in a pilot workforce/ teacher housing program in Norwood and plans to expand to other rural Colorado communities. Since 2016, we have partnered with our local utility, La Plata Electric Association (LPEA), to offer LPEA customers low-cost fixed-rate loans on energy efficiency and solar enhancements, reducing home energy costs and overall living expenses. We invite our fellow CBA member banks to reach out to discuss how together we might fulfill the CDFI mission, the new Community Reinvestment Act rules, and collaborate to expand access to credit, investment, and basic banking services in rural Colorado. Alejandra Chavez, Vice President, Westside Mobile Home Park Cooperative September • October 2022 5
By Larry Pruss, Managing Director of Digital Assets Advisory at Strategic Resource Management (SRM) Education & Trust Matter When Dealing with Digital Assets The Biden Administration’s March executive order seeking information on digital asset usage and security set a flurry of activity into motion. This included a mandate for the Treasury Department to deliver a report on the future of money and payments systems. The agency issued a public request for comment in July, and SRM quickly responded, drawing from our detailed and ongoing coverage of cryptocurrency and other digital assets. The condensed version below highlights the key points we believe banks should consider as policies toward digital assets take shape. Empowerment Through Education Despite the widespread hype surrounding digital assets, a broad cross-section of the population remains woefully underinformed. A lack of a shared vocabulary is part of the problem; few people can distinguish between altcoins, stablecoins, and Central Bank Digital Currencies (CBDCs) and sometimes use these terms interchangeably. Similarly, there’s little understanding of the consumer protections – or lack thereof – backstopping balances held at various crypto exchanges. SRM believes the best way to empower the industry is through education. This is the motivation behind our Crypto University forum, a free resource for financial institutions. Digital assets are a rare instance where banks may choose to encourage greater regulation since they will inevitably become part of mainstream financial services. Basic rules of the road and established definitions (is Bitcoin a commodity or security?) will likely increase adoption in a more organized manner. This will limit the financial pain endured by consumers dealing with unsupervised players. Trust Matters in Times of Change Multiple surveys confirm that financial institutions continue to enjoy market-leading levels of trust from consumers. Studies also show that most consumers prefer to trade and pay with cryptocurrencies through their financial institution if given a chance. A growing number of banks have begun to offer these services through third-party partnerships. Financial institutions have documented significant deposit outflows to crypto exchanges over recent years. Establishing an infrastructure that lets regulated institutions support digital assets can help them defend their deposit bases, benefiting everyone involved. It would also allow them to gain experience with the distributed ledger technologies destined to become the backbone of a future financial system, offering cheaper, faster, and more-secure settlements. Additional distributed ledger use cases continue to emerge for corporate banking, treasury management, and capital markets. Government agencies will undoubtedly want to position licensed, regulated entities to operate the smart infrastructure required to support them, reinforcing confidence in the system. Digital assets hold promise for greater financial inclusion among the underbanked, given the lower clearing and “know your customer” costs. It will take time for the complete evolution of digital assets, but the overall trajectory is clear – particularly for the underlying technologies that will serve as the foundation for our future financial infrastructure. SRM continues to keep a close watch on this space, and we can expect plenty of activity this fall as more reports tied to the executive order are delivered. About the Author Larry Pruss is Managing Director of the Digital Assets Advisory at Strategic Resource Management (SRM). He brings more than 25 years of experience in payments and financial services technology to the table. Larry helps financial institutions develop strategies for the next phase of the digital revolution. www.coloradobankers.org 6
an Opportunity for Mutual Benefit HSAs, By Steve Christenson, CHSP, CIP, CISP, Executive Vice President, Ascensus As summer comes to a close, employers are in the midst of selecting next year’s benefit options for both themselves and their employees. They’re deciding whether to offer retirement plans, health insurance plans, and other benefits, such as flexible savings accounts and health savings accounts (HSAs). It is the HSA part of this equation that we need to take a closer look at. HSAs can be a critical element of an individual’s entire financial plan. Very few savings arrangements offer the same advantages as HSAs – tax-deductible contributions, tax-deferred earnings, and tax-free distributions if used properly. This HSA triple tax advantage is extremely attractive, one reason financial organizations offer HSA programs. Even so, many financial organizations continue to ask the question: “Should we offer this to our clients – and if so, what are the service and education considerations?” Why do individuals open HSAs? To answer this question, it’s important to understand that many individuals open their first HSA through their employer as part of open enrollment. Employers will generally select a health insurance provider and use the suggested HSA provider paired with the insurance plan. This may make it easier for employees to open an HSA and for the employer to make contributions. And knowing that they can receive an HSA contribution from their employer may further encourage employees to open an HSA. Can an individual have multiple HSAs? It’s common for employers to periodically change health insurance and HSA providers. This may require an employee to open an HSA with the new HSA provider. When this occurs, the employee holding the original HSA may wonder what will happen next. The answer – possibly nothing. Because the employee is the HSA owner, he can keep the HSA open even if he’s not contributing to it. And all prior HSA contributions belong to the HSA owner – regardless of the source. Although the employee may keep the original HSA open, the employer will likely stop covering any fees associated with the original HSA. This may subject the employee to minimum balance requirements and fees. The employee may choose to: • Continue using the original HSA in combination with the new HSA, but be subject to potential fees; • Roll over or transfer the assets from the original HSA to the new HSA or another HSA he owns elsewhere (similar to rolling over IRA assets); • Pay for outstanding qualified medical expenses or reimburse himself for past qualified medical expenses paid out of pocket; or • Distribute assets in the original HSA to pay for nonqualified expenses (these distributions would be subject to tax and a possible penalty tax). Continued on page 8 September • October 2022 7
the best way to save for their current and future medical expenses and retirement in general, take some time to educate them about the benefits of having an HSA. Providing objective, accurate information is one of the best ways to build a trusting, long-term relationship with your clients. Second – don’t underestimate the HSA market. Many financial organizations have questioned whether they should enter the HSA market. As in previous years, HSAs continue to enjoy enormous growth. According to the 2021 Devenir and HSA Council Demographic Survey, there were over 32 million HSAs covering 67 million people at the end of 2021. The survey also reported that one in five millennials had an HSA as of Dec. 31, 2021. This demographic is quickly replacing baby boomers in the labor force, which provides the perfect opportunity for your organization to help these individuals transition to an HSA. There’s a common misconception that HSAs benefit only wealthy individuals. But HSAs are used by individuals in every income range. For example, the following chart shows that 78% of HSA owners have a household income of less than $100,000, and 45% have income between $50,000 and $80,000. HSAs can also help these individuals create future wealth and financial stability during retirement. Continued from page 7 To help individuals determine their best option, financial organizations should consider whether the average consumer will know about these options or know where to find the answers. While information can be found either through an HSA provider or other websites, it’s hard to know if individuals will seek this information, interpret it correctly, and make a decision in their best interest. This scenario continues to compound every time an employer changes to a new benefits provider. What else should financial organizations consider? Financial organizations should consider the following key takeaways: First – it’s ok if clients have multiple HSAs. If your organization has a relationship with area businesses, you can work with local employers to provide an HSA solution that allows employers and employees to maintain an HSA with your organization, regardless of which health insurance provider the employer uses. Your organization could coordinate with employers and their employees to establish a long-term HSA relationship either by establishing a new HSA or by consolidating other HSAs that employees may have with other HSA providers. Your organization is already a trusted and known resource in the community, so when your clients are looking for www.coloradobankers.org 8
Third – it’s still important to focus on baby boomers and Gen Xers. According to the previously mentioned survey, HSA owners aged 50 and older hold almost $53 billion in HSA assets. Many individuals believe they can no longer have an HSA once they retire and enroll in Medicare. This is not true, even though individuals can’t contribute to an HSA once they enroll in Medicare, they can still benefit from having an HSA by: • Reimbursing themselves for qualified medical expenses previously paid out of pocket; • Paying for certain Medicare premiums; and • Continuing to pay for qualified medical expenses. How can HSAs help retired individuals? HSAs should be considered part of the overall asset portfolio for long-term retirement planning. According to a 2019 CNBC study, a healthy 65-year-old couple retiring in 2019 will need approximately $390,000 to cover Employers will generally select a health insurance provider and use the suggested HSA provider paired with the insurance plan. This may make it easier for employees to open an HSA and for the employer to make contributions. healthcare expenses. HSAs can play an integral role in paying for these expenses. And it’s not just healthcare expenses retirees need to worry about. Individuals still need to pay for everyday expenses (e.g., food, utilities) after retirement. Luckily, once HSA owners turn 65, they can take taxable but penalty-free HSA distributions to pay for nonqualified expenses. Summary Reviewing these points, consider how your organization can help the community by building new relationships and strengthening existing relationships with local businesses. HSAs can provide an affordable solution to your organization and your clients. And while starting a new HSA program can seem daunting, especially if you have limited staff, you don’t have to do it alone. Ascensus offers multiple services – including document, administration, and consulting services. Contact your Ascensus sales representative today to learn more about this amazing opportunity. September • October 2022 9
» Call Rick Gerber or Ryan Gerber at 1-866-282-3501 or email rickg@chippewavalleybank.com ryang@chippewavalleybank.com 1. Calling us is the first step. 2. You email us the appropriate documents of information. 3. CVB preparing the loan documents generally within 5 to10 days. 4. Meeting the customer. We will come to you to sign loan documents. 5. CVB wires the funds. 6. Wow that was easy. IS YOUR BANK SUFFERING UNREALIZED SECURITY PORTFOLIO LOSSES? ARE YOU IN NEED OF A CAPITAL INJECTION? Bank Stock and Bank Holding Company Stock Loans up to $50 Million Done the Simple Way
FOR COMMUNITY BANKS, THE SUN ALSO RISES Solar Tax Credit Investments Now More Accessible By Josh Miller, CEO, KeyState Renewables For more than a decade, large financial institutions nationwide, joined by Fortune 500 giants like Apple and Google, have been the dominant players in solar investment tax credits (ITCs). Driven by federal incentives, these companies have provided funding for the largest solar projects in the country, collecting healthy returns while raising their corporate profiles as environmental/social/governance (ESG) leaders. The benefits of solar ITCs are hard to ignore. Tax credit investors funding renewable energy projects can significantly offset their federal tax liability and recognize a meaningful annual GAAP earnings benefit. From 2005 to 2020, renewable energy tax credits have fueled the explosive growth of solar and wind power production nearly 18-fold. Large corporate investors continue to focus on major, utility-scale renewable energy projects in an effort to deploy their capital at scale. However, the landscape is beginning to shift, catalyzed by higher natural gas prices and stark geopolitical realities that make the call for sustainable energy more urgent. State legislatures across the U.S. have passed renewable energy generation targets and mandates, creating a growing pipeline of midsize solar projects that must be built and financed. Community banks are a logical source of financing for these mid-size renewable projects. Solar ITCs have a notably better return profile than other tax credit investments commonly made by banks. Solar ITCs and the accelerated depreciation associated with a solar power project are fully recognized once it is built and begins producing power. This is quite different from other tax credit investments, such as new markets tax credits (NMTCs), low-income housing tax credits (LIHTCs) and historic rehabilitation tax credits (HTCs), where credits are recognized over the holding period of the investment (5, 7, 10, or 15 years). Like other tax equity investments, solar tax equity investments require complex deal structures, specialized project diligence and underwriting, and active ongoing monitoring. Specialty investment management firms like KeyState support community banks hoping to make solar tax credit (i.e., “solar tax equity”) investments by syndicating the investments across small groups of community banks. Without support, community banks may struggle to consistently identify suitable solar project investment opportunities built by qualified solar development partners. Not all solar projects are created equally, and it is critical for a community bank to properly evaluate all aspects of a solar tax equity investment. Investment in particular types of solar projects, including utility, C&I, municipal, and community solar projects, can provide stable and predictable returns. However, a community bank investor should perform considerable due diligence or partner with a firm to assist with the diligence. There are typically three stages of diligence: 1. The bank should review the return profile and GAAP model with their tax and audit firms to validate the benefits illustrated by the solar developer and the anticipated impact of the investment on the bank’s earnings profile and capital. 2. The bank should work with regulatory counsel to identify the path to approval for the investment. Solar tax equity investments are permissible for national www.coloradobankers.org 12
www.bell.bank Member FDIC 35344 Partner with Bell for: Participation loans Bank stock and ownership loans Holding company loans and lines of credit Reg. O loans to bank employees, insiders or directors Equipment financing Find the terms and flexibility you need on large or small loans at Bell, with faster turnaround from an experienced team dedicated to correspondent lending. Whatever Loan Amount You’re Looking For, We Can Help. Tracy Peterson Call me at 480.259.8280 – Based in Phoenix, Ariz. Serving Arizona, Colorado and Kansas 35344 AD Colorado Bankers Association 2022_Tracy.indd 1 3/31/22 4:41 PM Josh Miller is CEO of The KeyState Companies, which manages taxadvantaged investment and insurance structures for over 130 community banks across the country. KeyState Renewables launched its solar tax equity fund platform, SOLCAP, in 2019, which to date, has financed over $120 million across 35 mid-size U.S. solar projects in seven states. (lower case “n”) banks under April 1, 2021, OCC Rule (12 CFR 7.1025). Banks have been making solar tax equity investments based on OCC published guidance for over a decade. In 2021, this new OCC rule codified that guidance. It provides a straightforward roadmap and goes so far as to encourage community banks to consider solar tax equity investments. Alternatively, under Section 4(c)(6) of the Bank Holding Company Act, holding companies under $10 billion in assets may also invest in a properly structured solar tax equity fund managed by a professional asset manager. 3. The bank must underwrite the solar developer and each individual solar project. Community banks should partner with a firm that has experience evaluating and underwriting solar projects, and the bank’s diligence should ensure that there are structural mitigants in place to fully address the unique risks associated with solar tax equity financings. Beyond the compelling return profile and stable and predictable cash flows offered by conservative, investment-grade solar projects, achieving energy independence and reducing carbon emissions are critical goals in and of themselves. Solar tax credit investments can be a key component of a bank’s broader ESG strategy. The bank can monitor and report the amount of clean energy generation being produced by the projects it has financed and include this information in an annual renewable energy finance impact report or a broader annual sustainability report. Like other tax equity investments, solar tax equity investments require complex deal structures, specialized project diligence and underwriting, and active ongoing monitoring. September • October 2022 13
Equity Cure Provisions in Middle-Market, Sponsor-Backed Credit Agreements By Taylor Smith, Partner, Davis Graham & Stubbs, LLP An “equity cure” is a type of legal provision often found in credit agreements governing loans that finance acquisitions by private equity sponsors. In an alignment of interests between lenders, private equity sponsors, and their portfolio company borrowers, these provisions allow sponsors to retroactively cure their portfolio companies’ financial covenant defaults by making a cash equity contribution typically treated as a dollar-for-dollar increase to the company’s adjusted EBITDA in the amount necessary to cause compliance with the company’s financial covenants for the applicable measurement period. Equity cure provisions benefit all parties involved by providing a clear protocol for navigating economic downturns or other periods of financial difficulty in a manner that prioritizes de-risking the lender’s credit exposure while protecting the company’s viability and sustaining the sponsor’s commitment to the success of the business. This article summarizes common market practice for equity cure provisions in middle-market, sponsor-backed credit agreements. The vast majority of secured credit agreements with sponsor-backed borrowers will contain one or more financial ratio covenants. For example, a leverage ratio covenant requires that, as of the end of each calendar quarter, the ratio of the borrower’s funded debt to the borrower’s adjusted EBITDA for the trailing four-quarter period must not exceed a specified level. If the borrower’s adjusted EBITDA for the measurement period is insufficient to keep the leverage ratio under the specified maximum level, an automatic event of default will result, entitling the lender to exercise all legal remedies available to a secured creditor, including accelerating the loans and foreclosing on the borrower’s assets. A fixed charge coverage ratio is another common financial ratio covenant that uses adjusted EBITDA in the numerator of the ratio and is, therefore, susceptible to cure through a retroactive deemed increase to adjusted EBITDA. A typical equity cure provision will provide that, concurrently with the delivery of the borrower’s quarterly financial statements and compliance certificate demonstrating the applicable financial covenant breach under the credit agreement, the sponsor may deliver to www.coloradobankers.org 14
the lender a written notice indicating the intent to exercise an equity cure. The notice would need to calculate the applicable cure amount – i.e., the amount that, when retroactively added to the borrower’s adjusted EBITDA for the default quarter, would result in pro forma compliance with the applicable breached financial covenant(s). The cure amount would then be due from the sponsor within a short period of time (e.g., 10 business days) after the delivery of the notice. Especially in middle-market deals, once the borrower receives the cure amount, it is often required to be immediately applied to repay the outstanding loans under the credit agreement, thereby reducing the lender’s credit exposure. Borrowers and sponsors want to ensure that such amounts are exempted from prepayment penalties that may otherwise apply to early principal payments. In certain contexts, borrowers and sponsors may be able to negotiate for the ability to retain the cure amount as cash on the borrower’s balance sheet in lieu of a paydown or for a hybrid approach that, e.g., delays the first mandatory prepayment from cure proceeds until the second exercise of an equity cure during the loan term. The credit agreement will typically specify that the cure amount is treated as a dollar-for-dollar increase to the borrower’s adjusted EBITDA for the default quarter, not only for purposes of the initial quarter-end measurement date associated with the applicable financial covenant breach, but also for purposes of each of the ensuing three-quarter end measurement dates that also include the default quarter in their respective trailing four-quarter measurements of adjusted EBITDA. On the lender-friendly end of the spectrum of market practice, some equity cure provisions will provide that the debt reduction resulting from the application of cure proceeds to the repayment of the outstanding loans is disregarded for so long as the cure proceeds are treated as an artificial increase to adjusted EBITDA, although this formulation is not very common in the market. From the lender’s perspective, an equity cure provision should include language specifying that the cure amount is only deemed to constitute adjusted EBITDA for curing the applicable breached financial ratio covenant(s). It should not, for example, for purposes of any leveragebased pricing grid, leverage-based incurrence test in a negative covenant basket, or other credit agreement provision (beyond the applicable breached financial ratio covenant) that may separately involve a measurement of adjusted EBITDA. This limitation could also conceivably benefit the borrower – for example, in a credit agreement that does not require a mandatory paydown from equity cure proceeds but otherwise contains an excess cash flow sweep that starts its excess cash flow measurement from adjusted EBITDA. Virtually all equity cure provisions limit the frequency with which they can be exercised and the total number of times they can be exercised. The details of these limits vary considerably from deal to deal. A fairly typical formulation might prohibit the exercise of more than two consecutive cures or more than two cures in any period of four consecutive quarters and contain an overall limit of four total cures in the span of a five-year loan term. While most credit agreement provisions are designed to benefit the lender and to protect the likelihood of the loans being repaid (subject to limited carve-outs and exceptions designed to provide the borrower with the flexibility to operate its business), equity cure provisions are fairly unique in that they provide significant benefits to all three of the major parties involved (the lender, the borrower, and the sponsor). When a typical equity cure is exercised, the lender benefits from an immediate paydown of a portion of the outstanding loans in the amount necessary to bring the borrower’s financial ratios within the range that the lender had deemed appropriate during its underwriting process. Needless to say, the lender also benefits from the preservation of future interest payments from the surviving borrower on the remaining loan amount. The borrower avoids enforcement and benefits from a reduced debt burden. Finally, the sponsor benefits from the opportunity to keep its portfolio company in business (and thus capable of yielding future profits) at the price of only a partial paydown of the loans, avoiding the need to hastily arrange a refinancing of the entire loan amount or otherwise engage in costly forbearance negotiations. Having the equity cure protocol hardwired into the credit agreement at closing, in advance of any distress, makes it easier for the parties to capture the aforementioned benefits more efficiently and with less risk of a breakdown in a constructive lending relationship. Taylor Smith is a partner at Davis Graham & Stubbs, LLP, specializing in Finance & Acquisitions, Corporate Finance and Private Equity. He can be reached at 303-892-7435. September • October 2022 15
How to Know if Your Bank Must Report a By Alyssa Pugh, GRC Content Manager, CoNetrix Since the effective date for the incident notification rule for banks, we have received several questions asking about whether an incident would be classified as a “notification incident” or not. For example: • Would a one-hour core system outage be considered a “notification incident?” • Would a bomb threat/robbery be considered a “notification incident?” • Would a third-party breach from 10 years ago be considered a “notification incident?” • Would an incident affecting 10% of our customers be considered a “notification incident?” • Would malware be considered a “notification incident?” Each of these is a very valid question. If you work for a bank, how exactly would you determine which of these incidents must be reported to your federal regulator, per the legal definition? Let’s take a look. The Legal Definition To determine if an incident must be reported to a federal regulator, an incident must meet two qualifiers: 1. It must be a “computersecurity incident.” This is “an occurrence that results in actual harm to the confidentiality, integrity, or availability of an information system or the information that the system processes, stores, or transmits.” 2. It must be a “notification incident.” This is “a computersecurity incident that has materially disrupted or degraded, or is reasonably likely to materially disrupt or degrade” a bank’s operations, including those which would: a) “Disrupt or degrade” the bank’s ability to “carry out banking operations Cybersecurity Incident [or deliver] products and services to a material portion of its customer base.” b) “Result in a material loss of revenue, profit, or franchise value.” c) “Pose a threat to the financial stability of the United States.” (For the full definition, see the final rule: https://www.federalregister.gov/d/202125510/p-331.) The word “material” shows up four times in this definition. While there is no exact definition of the term, context clues and the word’s use in other legal contexts tell us that we are dealing with something serious or extreme. This is evidenced by the terminology used in the examples provided by the agencies, including words like largescale, extended, widespread, failed, unrecoverable, etc. These terms communicate an idea that the types of incidents considered “notification incidents” are very serious and possibly even systemic in nature. What Does This Mean? It is not as simple as “these incidents are notification incidents, and those incidents are not.” This decision will need to be made on an incident-byincident basis. Consider some of these examples: • An incident that affects 10% of the bank’s customers. Does “10%” meet the definition of “material” for you? What exactly is affecting them? How serious is it? How soon will it be resolved? Which 10% of your customers are affected? Is it a random 10%? Is it your top 10%? • An incident that causes a one-hour core system outage. Does this meet www.coloradobankers.org 16
the implications of being a “material” incident if it was only out for one hour? On the surface, this isn’t “extended” or “unrecoverable,” but what does the root analysis show? What caused the one-hour core outage? Is it likely to happen again? Are there any trickle-down effects from this? • An incident involving a bomb threat/robbery. Where did the bomb threat/robbery occur? Was it one-time at one branch or a simultaneous attack on your data centers? What are the chances that the malicious actor gained access to bank systems or data as part of this event? Obviously, none of these scenarios is something you want to have happen. Anytime something goes wrong, that’s a problem. The question is: Is it serious enough to consider a “notification incident?” When in Doubt, Report It If we pay attention to reporting a “notification incident” over the compliance aspect, we can focus on the fact that the agencies are using this information as an “early alert” of emerging threats in the industry. Something that may not seem like a big deal to you could be one piece of an obvious large-scale attack when looking across the industry. If several banks report the same incident, the regulators can act more quickly and help with the response process. Keeping open lines of communication with your federal regulator is beneficial for both you and them, so if you ever have a question about whether to report an incident, go ahead and report it. Notification Incident Decision Tree Due to the nature of “notification incidents,” I cannot give you a silver COMPUTER-SECURITY Notification Incident Decision Tree bullet solution to answer the “is it or is it not” question. Each incident will need to be analyzed to determine if it qualifies. That said, I can give you a tool to help guide you through the thought process. Follow the decision tree chart to help you figure out if your situation would be best classified as a “notification incident.” To take your incident response practices to the next level, check out Tandem Incident Management. This product has been designed to help you create your incident response plan and put it into action with the incident tracking component. To see how Tandem can help you, visit our website at Tandem.App/IncidentManagement-Software. As a millennial, Alyssa Pugh grew up with technology at her fingertips. She has more than 10 years of professional technical and information security experience. She earned a B.A. in Technical Communications and has achieved the CISM and Security+ certifications. Alyssa currently serves as the GRC Content Manager for Tandem, an information security and compliance application. Alyssa has presented multiple conference sessions on topics including risk assessments, business continuity, third-party oversight, and cybersecurity. September • October 2022 17
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CFPB also is generally referring to certain kinds of fees in the consumer financial market as “junk” fees. The FDIC also recently issued guidance specific to NSF fees. The FDIC found that many financial institutions charge NSF fees on each attempt by a merchant or other payee to obtain payment pursuant to authorization from the payor. In the guidance, the FDIC warned financial institutions that charging such fees raises consumer compliance risk, third-party risk, and litigation risk. The FDIC suggested various risk mitigation practices, including changes to disclosures and substantive policies regarding such fees, and stated that financial institutions may face regulatory penalties for failure to “fully correct” such practices. The FDIC’s guidance was issued with respect to both consumer and business depositors. Building on the FDIC’s approach, at least one state regulator has issued guidance that such fees on representments should be phased out entirely.4 Previous Federal Regulatory Guidance on Overdraft and NSF Fees In the early 2000s, the federal banking regulatory agencies released the “Joint Guidance on Overdraft Protection Programs.”5 This guidance outlined a number of regulatory concerns and best practices. For example, the guidance noted that institutions should consider concerns relating to unfair or deceptive acts or practices (UDAP) when advertising and implementing overdraft protection services and also reminded financial institutions of the need to comply with the requirements of the Truth in Savings Act and the Electronic Funds Transfer Act regarding overdraft and NSF fees. Continued on page 20 Regulatory Scrutiny of NSF and Overdraft Fees By Tom Witherspoon, Michelle Fox, Jordan Ortmeier, Stinson LLP On Sept. 8, 2022, the Consumer Financial Protection Bureau (CFPB) issued a consent order requiring one financial institution to pay a $50 million penalty and to refund at least $141 million to consumers allegedly harmed by the bank’s overdraft practices.1 The bank’s overdraft fees, referred to by the CFPB as “authorizedpositive” fees, were charged on transactions that were authorized with a positive balance in the account but settled without sufficient funds to cover the transaction, resulting in an overdraft. The CFPB’s action follows the market trend of increased regulatory scrutiny of overdraft and non-sufficient fund (NSF) fees charged by financial institutions to their deposit customers. The CFPB’s order follows both the CFPB’s running series of blogs and studies of banks’ overdraft and NSF fee practices2 and the Federal Deposit Insurance Corporation’s (FDIC) recent guidance regarding multiple NSF charges on re-presentment transactions.3 The CFPB reports that revenue from such fees remains an important element of overall bank revenue for both small and large banks and that there is a concentration of charging such fees to a low percentage of bank customers. The blogs have highlighted the fact that small banks, to a greater extent than midsized to large banks, are recovering such fee revenue to pre-pandemic levels after a decline during the pandemic. The CFPB stated that its bank examination priorities are impacted by the extent to which financial institutions charge such fees. The CFPB indicates it will review settlement and funds availability procedures, the amount of such fees in comparison to costs incurred in overdraft and NSF scenarios, and whether the financial institution is implementing policies to limit such fees. In sum, the CFPB is reviewing both disclosure practices and substantive policies on such fees. In other recent publications, the September • October 2022 19
Continued from page 19 In 2010, the FDIC issued further guidance on risks associated with overdraft payment programs and compliance with consumer protection laws.6 For the assessment of multiple fees, this guidance focused on implementing limitations on such fees on particular transactions over daily time periods and annually. Specifically, the FDIC recommended that financial institutions undertake meaningful follow-up communication if a customer overdraws on his or her account on more than six occasions in a rolling 12-month period. Both issuances of guidance showed the heightened attention of regulators at the time to protect depositors regarding overdraft and NSF fee practices and disclosures. What Constitutes Unfair and Deceptive Practices? The banking regulators are analyzing such fees under their UDAP/UDAAP authority. Section 5 of the Federal Trade Commission (FTC) Act, which is enforceable by the FDIC, the Office of the Comptroller of the Currency and the Federal Reserve System as a regulator of member banks, generally prohibits unfair or deceptive acts or practices (UDAP). The Dodd-Frank Act also gave the CFPB authority to take action against unfair, deceptive or abusive acts or practices (UDAAP). Regarding multiple NSF charges, recent guidance from the FDIC indicates that the issue of a deceptive practice often turns on related deposit account disclosures. If a financial institution charges multiple NSF fees but fails to clearly and conspicuously disclose the scenario in which such fees will be charged to customers, the omission of this information may be considered a deceptive practice under Section 5. In addition to adequate disclosures, the FDIC will also measure the fairness of the transaction by examining whether customers are given transparent notice of the multiple fees. This appears to also include an opportunity for customers to ensure their accounts can cover subsequent attempts by merchants to obtain payment on the transaction prior to being charged additional fees. The regulators also appear poised to attempt to take action against certain fees as being substantively unfair, regardless of being disclosed. Financial institutions may need to self-identify and correct certain practices before their next examination. This may include looking back at payment- and fee-related data and deciding the best course of action. www.coloradobankers.org 20
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