PUB 20 ISSUE 1 NEW MEXICO PUBLISHED BY NEW MEXICO BANKERS ASSOCIATION, FOUNDED IN 1906 PHOTO BY: JIM RENFROW President’s Message — David Hockmuth Page 6 H. Rodgin Cohen Weighs in on Digital Assets, M&A, and �Too Big to Manage” — Rob Blackwell Page 14 Keep It Long Enough, It will Come Back in Fashion — Elizabeth Madlem Page 18
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OVER A CENTURY: BUILDING BETTER BANKS — HELPING NEW MEXICO REALIZE DREAMS The mission of the New Mexico Bankers Association (NMBA) is to serve member bank needs by acting as New Mexico banking’s representative to government, the public, and the industry; providing resources, education and information to enhance the opportunities for success in banking; promoting unity within the industry on common issues; and seeking to improve the regulatory climate to the end that banks can profitably compete in the providing of financial and related products and services. ©2023 The New Mexico Bankers Association (NMBA) | The newsLINK Group, LLC. All rights reserved. The New Mexico Bankers Digest is published four times each year by The newsLINK Group, LLC for NMBA and is the official publication for this association. The information contained in this publication is intended to provide general information for review, consideration and education. The contents do not constitute legal advice and should not be relied on as such. If you need legal advice or assistance, it is strongly recommended that you contact an attorney as to your circumstances. The statements and opinions expressed in this publication are those of the individual authors and do not necessarily represent the views of the NMBA, its board of directors, or the publisher. Likewise, the appearance of advertisements within this publication does not constitute an endorsement or recommendation of any product or service advertised. The New Mexico Bankers Digest is a collective work, and as such, some articles are submitted by authors who are independent of NMBA. While the New Mexico Bankers Digest encourages a first-print policy, in cases where this is not possible, every effort has been made to comply with any known reprint guidelines or restrictions. Content may not be reproduced or reprinted without prior written permission. For further information, please contact the publisher at 855.747.4003. PRESIDENT’S MESSAGE 6 OUR BANKING SYSTEM IS SOUND AND RESILIENT David Hockmuth, President, New Mexico Bankers Association EXECUTIVE VICE PRESIDENT’S MESSAGE 7 2023 LEGISLATIVE WRAP UP John W. Anderson, Executive Vice President, New Mexico Bankers Association WASHINGTON UPDATE 10 MEETING IN THE MIDDLE(WARE) By Rob Nichols, President and CEO, American Bankers Association 12 RISING INTEREST RATES MAY SHUT SOME COMMUNITY BANKS OUT OF FHLB FUNDING By Jay Kenney, SVP & Southwest Regional Manager, PCBB 14 H. RODGIN COHEN WEIGHS IN ON DIGITAL ASSETS, M&A, AND “TOO BIG TO MANAGE” By Rob Blackwell, Chief Content Officer, IntraFi 18 KEEP IT LONG ENOUGH, IT WILL COME BACK IN FASHION: BUYDOWN PROGRAM CONSIDERATIONS By Elizabeth Madlem, Bankers Alliance 22 THE EAST PALESTINE DERAILMENT: A STORY OF GOVERNMENT CORRUPTION AND INACTION By Mark Anderson, NMBA Legal and Legislative Assistant BANK NEWS 24 DEEPLY GRATEFUL: IT HAS BEEN AN HONOR TO SERVE Our Mission Contents President David Hockmuth Wells Fargo Bank, NA 200 Lomas, NW Albuquerque, NM 87102 President-Elect Mark Horn Pinnacle Bank 107 E. Aztec Ave. Gallup, NM 87301 Secretary Treasurer Michael Lowrimore Bank of the West 303 Roma Ave., NW Albuquerque, NM 87102 Immediate Past President Jason Wyatt Western Commerce Bank 212 North Canal St. Carlsbad, NM 88220 TERMS EXPIRING 2023 Ken Clayton Western Bank, Artesia 320 W. Texas Artesia, NM 88210 Sheila Mathews Four Corners Community Bank 500 W. Main, Suite 101 Farmington, NM 87401 Jay Jenkins CNB Bank PO Box 1359 Carlsbad, NM 88220 TERMS EXPIRING 2024 Kyle Beasley Bank of Albuquerque 100 Sun Ave., NE, Suite 500 Albuquerque, NM 87109 Paul Mondragon Bank of America, NA 4401 Central Ave., NE Albuquerque, NM 87108 Elizabeth Earls U.S. Bank, NA 7900 Jefferson, NE Albuquerque, NM 87109 TERMS EXPIRING 2025 Scott Czarniak First National 1870 7300 Jefferson St., NE Albuquerque, NM 87109 Aaron Emmert Pioneer Bank 3000 N. Main St. Roswell, NM 88201 Kamal Ali PNC Bank 2494 Louisiana Blvd., NE Albuquerque, NM 87110 2023 NMBA Board of Directors 4
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PRESIDENT’S MESSAGE DAVID HOCKMUTH President New Mexico Bankers Association Prior to March 10, 2023, many of us were not aware of Silicon Valley Bank (SVB) or, for that matter, Signature Bank, New York. But, thanks to high-profile events involving both banks, now we are. Every day since that fateful day, I was inundated with e-mails, texts, news articles, and memos concerning the failures of the two banks. What happened and how serious are these events going forward? On March 10, Silicon Valley Bank, based out of Santa Clara, California, with $209 billion in assets as of year-end 2022, was closed by the California Department of Financial Protection and Innovation, which appointed the FDIC as receiver. Two day after the failure of SVB, Signature Bank, New York, with $110 billion in assets at year-end 2022, was closed by the New York State Department of Financial Services, which also appointed the FDIC as receiver. In an abundance of caution and with concern about an economic spillover from the failures, on March 12, the Secretary of the Treasury, upon unanimous recommendation of the boards of the Federal Reserve and the FDIC, approved systemic risk exceptions for the failures of SVB and Signature. This enabled the FDIC to guarantee all of the deposits of both banks. I should note that shareholders lost their investment and unsecured creditors took losses. The boards and most senior executives were removed. In addition, the Federal Reserve, with Treasury’s approval, created a temporary lending facility, the Bank Term Funding Program, to allow banks to receive additional liquidity to meet unexpected depositor demand. The program allows banks to borrow against Treasury and agency securities at par for one year. Including other sources of liquidity such as discount window lending, the new program will provide ample liquidity for the banking system. It is important to note that any losses to the FDIC’s Deposit Insurance Fund as a result of uninsured deposit insurance coverage will be repaid by a special assessment on banks. The FDIC estimates that the cost to the Deposit Insurance Fund of resolving SVB is $20 billion. The FDIC also estimates the cost of resolving Signature Bank to be $2.5 billion. Importantly, NO taxpayer money has been put at risk. Why did SVB and Signature Bank fail? It appears that the primary cause of these banks’ decline was an unusual combination of narrow customer base, explosive growth, and above average risk management failures. As stated in testimony by Federal Reserve Vice Chairman for Supervision, Michael Barr, before the U.S. Senate Committee on Banking, Housing, and Urban Affairs: “SVB’s failure is a textbook case of mismanagement. The bank had a concentrated business model, serving the technology and venture capital sector. It also grew exceedingly quickly, tripling in asset size between 2019 and 2022. During the early phase of the pandemic, and with the tech sector booming, SVB saw significant deposit growth. The bank invested the proceeds of these deposits in longer-term securities, to boost yield and increase its profits. However, the bank did not effectively manage the interest rate risk of those securities or develop effective interest rate measurement tools, models, and metrics. At the same time, the bank failed to manage the risks of its liabilities. These liabilities were largely composed of deposits from venture capital firms and the tech sector, which were highly concentrated and could be volatile. Because these companies generally do not have operating revenue, they keep large balances in banks in the form of cash deposits, to make payroll and pay operating expenses. These depositors were connected by a network of venture capital firms and other ties, and when stress began, they essentially acted together to generate a bank run.” The FDIC has completed the sale of both banks to acquiring institutions. New York Community Bancorp’s Flagstar Bank is acquiring Signature Bank and First-Citizen Bank and Trust Company is acquiring SVB. What is the plan? As a banker, I am proud to say our banking system is sound and resilient with strong capital and liquidity. In the case of SVB and Signature Bank, the regulators and Treasury took actions to protect our economy and to strengthen public confidence in our industry. The U.S. banking system is the widest and deepest in the world. Our strength is in our numbers and in our diversity of bank size and business model. With nearly 4,700 banks, including more than 3,700 community banks under $1 billion in assets, the U.S. banking system remains strong, and employs more than 2 million professionals, safeguards $19.4 trillion in deposits, and extends $12 trillion in loans. Let’s not throw the baby out with the bath water. Certainly the Executive and Legislative branches of government need to know what happened with SVB and Signature and why. But it is premature to call for legislative and regulative rule changes before all the facts are in. Allowing for a thoughtful and deliberate review of the facts will yield much better results. OUR BANKING SYSTEM IS SOUND AND RESILIENT 6
JOHN W. ANDERSON Executive Vice President New Mexico Bankers Association EXECUTIVE VICE PRESIDENT’S MESSAGE I want to acknowledge the effort that was put forward by our bankers before the 2023 Legislature against the State Bank legislation. 2023 LEGISLATIVE WRAP UP The 2023 Legislature adjourned at noon on Saturday, March 18, having considered 550 House bills, 537 Senate bills, 30 Constitutional amendments, and 178 memorials during the 60-day session. The Legislature passed a total of 246 bills, plus memorials and resolutions — a considerably higher number than in the last 60-day session in 2022, but fewer than in most such sessions over the last decade. The governor had until April 7 to either sign or veto the successful bills. Of the 246 bills enacted in this 60-day session, the Governor signed 211 into law and vetoed 35. This session was all about spending. There was $1.2 billion allotted for the state budget, $1.2 billion for capital outlay projects, $100 billion for a General Appropriations Act Junior, $1.1 billion for tax breaks, and $666 million for income tax rebates. Money Bills • HB 2 (State Budget Bill) funds most of the state government. The final budget bill increases the state budget by $1.2 billion over the current year for a new total of $9.575 billion. It provides for a 6% salary increase for state employees and fully funds the Opportunity Scholarship program that provides free tuition at state colleges and universities. Also, it increases the budget for public education by $226 million and Medicaid is increased by $224 million. This was important as New Mexico has one of the highest Medicaid populations in the U.S. • SB 192 (Junior Appropriation Bill) provides additional appropriations, totaling $100 million (non-recurring), that allow each legislator to designate a certain amount of funding to projects of their choice. • SB 505 (Capital Outlay Projects) appropriates $1.2 billion in nonrecurring expenses to the general fund. We are using general funds in lieu of ST bonds. The surplus of non-recurring general fund reviews related to historically high oil and gas productions presents the opportunity to pay cash for 2023 capital projects rather than relying on bonding. Paying cash generates long-term savings by eliminating the cost of interest. There is also a provision (SB 378) that mandates an annual $92 million transfer from the STPF to GF over 10 years, an amount equal to the long-term debt service avoided by not issuing severance tax bonds for capital outlay in 2023. Issue 1 • 2023 7
Tax Package — HB 547 The Governor, on the last day for her to take action on legislation sent to her by the 2023 Legislature, line-item vetoed the majority of the tax package. She left intact: • An increase in the Child Tax Credit for the lowest three income levels from $175 to $600, $150 to $400, and $125 to $200. The provision also adds language to annually adjust the credit amounts to account for inflation • A temporary personal income tax rebate to be paid to all residents who filed state tax returns for tax year 2021 of $500 for single filers and $1,000 for married individuals filing joint returns. • Expansion of the medical services gross receipts tax deduction to add all receipts from copayments or deductibles paid by a patient to a health care practitioner for commercial contract services provided under health insurance. • Increase the benefits of the film tax credit, including raising the cap for films not shot by New Mexico partners, expanding subsidies for non-residents, and enhancing the benefit of filming in rural locations in the state. Among those tax provisions included in HB 547, which were VETOED, include: • Income tax brackets revised: Single filers with incomes below $66,500 and married filers with incomes below $100,000 will see a tax rate decrease (cost to the general fund is $155 million). VETOED • Gross receipts tax: Reduced by a quarter-percent over four years (cost to general fund when fully implemented is $504 million). VETOED • Corporate Income Tax: The tax bill provides for a single corporate income tax rate of 5.9%. Current law has two income tax rates: 4.8% for corporations making less than $500,000 and 5.9% for corporations making more than $500,000. As corporate income tax is a marginal tax, our corporations will experience an increase (cost is $7.4 million in revenue derived from corporations). VETOED • Armed Forces Retirement Exemption: The bill removes the sunset on the armed forces retirement pay exemption currently in effect through 2026. With this change, the exemption would remain at $30,000 of retirement pay per armed forces retiree, beginning in the taxable year 2024. Surviving spouses of armed forces retirees were added to the exemption (cost to the general fund is $1.2 million). VETOED • Index Social Security Income for Taxes: Currently, social security income is exempt from state income tax for individuals with income of less than $75,000 for married filers filing separately; $150,000 for heads of household, surviving spouses, and married filers filing jointly; and $100,000 for single filers. This bill would annually adjust the income caps by a ratio of the consumer price index, increasing the income levels by the inflation rate except in instances where the inflation rate would result in a downward revision. VETOED • Apportionment of Business Income (Single-Sales Factor): Would replace the three-factor formula with an opt-in single sales factor. This is the ratio of sales in New Mexico divided by total sales in all states. It allows “eligible businesses” the option of retaining the three-factor formula or adopting a sales-only apportionment through the tax year 2028 at which time all businesses will shift to single sales. The assumption in this analysis is that all businesses will adopt an apportionment formula that reduces or maintains taxes, resulting in a negative impact on the general fund through corporate income taxes. After FY28, the fiscal impact is unknown as some businesses will pay more and others less corporate income tax when moved over to single sales. VETOED There are 42 categories of tax issues addressed in the original tax bill. The cost to the general fund when fully implemented is $1.2 billion. However, by removing most of the tax changes from the tax package, the recurring cost will decrease to $150 million as of the 2024 budget year. It will gradually increase to $246 million by 2027 primarily due to the revisions to the film incentives. This does not include the one-time tax rebates which will cost the state $670 million. Bank-Related Legislation The good news was there was NO State Bank legislation introduced this session. However, the Governor did ask the Legislature to consider HB 414, which would create a Housing Department, a non-cabinet department in the executive branch. It would have been tasked with providing housing stabilization, homelessness prevention, transitional housing, standardization of housing services, and increasing the development of housing. It would exercise functions and administer laws pertaining to housing services currently administered by other state agencies and the MFA. The bill would have amended the Housing Trust Fund Act, which governs the NM Housing Trust Fund, to make the fund a non-reverting fund in the State Treasury and change the trustee of the fund from the MFA to the Housing Department. Monies in the fund would be appropriated to the Department. Bottom line, in time, the Department replaced MFA as the state’s Housing Authority. Fortunately, the bill DID NOT PASS. I want to acknowledge the effort that was put forward by our bankers before the 2023 Legislature against the State Bank legislation. We prepared editorials against the state bank, appeared before interim legislative committees to testify against the state bank, and ran ads in major newspapers, pointing out what a bad idea it is. We also traveled in the Fall of 2022 and hosted Legislative/banking dinners and lunches around the state to discuss the NMBA Legislative agenda and the number one priority was NO state bank. 8
Other Relevant Legislation • SB 216 (Homestead and Other Exemptions): The current law for homestead exemptions is $60,000 for a single person and $120,000 for married couples. The bill increases the homestead exemption to $150,000 for a single filer and $300,000 for married couples. However, the homestead exemption does not apply if the homestead property was pledged as credit for a mortgage or if there was a pre-existing lien on the property before the establishment of the homestead. The bill PASSED. • SB 99 (Rent Control): The bill would have repealed the current prohibition placed upon counties and municipalities regarding rent control legislation. New Mexico is among 37 states that prohibit or preempt rent control. However, privately-owned property under contract for funding or benefits from federal, state or local governments may exercise rent control. The bill DID NOT PASS. • Constitutional Amendments: Proposed Constitutional Amendments regarding legislative salaries and longer legislative sessions (60 days every year) were defeated. New Mexico is currently the only state that does not provide for legislators to receive a salary. • SB 11 (Paid Family and Medical Leave): The most controversial bill introduced during the session, Senate Bill 11, would have established a 12-week Paid Family Medical Leave (PFML) benefit for nearly all workers in the state. The 12-week benefit could be taken intermittently and in increments of no less than four hours at a time. The bill would require employee contributions of 0.5% and employer contributions of 0.4% of wages into a PFML fund. The PFML benefit would be paid for with money in the PFML fund, with some of the money in the fund going toward administrative costs. The bill DID NOT PASS. • SB 46 (Wrongful Foreclosure Protection Act): The bill would have enacted the Wrongful Foreclosure Protection Act which would provide new protections and remedies for homeowners facing foreclosure. The bill would require a new list of dates and amounts related to the underlying default. While most of the information is already obtained and reviewed as part of the foreclosure referral, there are requirements that could prove to be problematic for older defaults or files that have undergone multiple service transfers, such as listing “all instances in which the home loan was accelerated or in which the periodic payments owed on the home loan were demanded to be repaid at one” and “all instances in which the home loan was decelerated or in which the borrower or homeowner was allowed to resume periodic payments after a demand for repayment of the full amount of the home loan had been made.” The bill also restricts any “person” from making a misleading statement or omission of fact or law in a complaint for foreclosure of a home loan or in any motion for summary or default judgment filed when seeking foreclosure of a home loan. The bill provides severe civil remedies for each “discreet violation.” The bill DID NOT PASS but is likely to be reintroduced in 2024. • HB 90 (UCC Revisions): The bill addresses emerging technologies, providing updated rules for commercial transactions involving virtual currencies, distributed ledger technologies such as blockchain, artificial intelligence, and other technological developments. The bill adds a new article to the UCC, Article 12, addressing certain types of digital assets defined as controllable electronic records. According to the bill, “controllable electronic record” means a record stored in an electronic medium that can be subjected to control pursuant to Section 55-12-105 NMSA 1978. The term does not include a controllable account, a controllable payment intangible, a deposit account, an electronic copy of a record evidencing chattel paper, an electronic document of title, electronic money, investment property, or a transferable record. The bill PASSED. • HB 118 (Office of Entrepreneurship): The bill provided $500,000 to the Economic Development Department for the purpose of creating a permanent Office of Entrepreneurship. The office’s mission would be to grow entrepreneurship in the state by strengthening business policies, working with organizations supporting entrepreneurship, providing technical support for entrepreneurs, and providing access to public resources for entrepreneurship, including acting as a liaison between industry and state government. The bill was VETOED. • HB 8 (Creative Industries Division in Economic Development Department): The bill establishes the Creative Industries Division within the Economic Development Department to support the full breadth of creative industries in the state, including traditional New Mexico crafts, visual and literary arts, software development and video game design, theater and entertainment, architecture, music, dance, culinary arts, and more. The bill was VETOED. • SB 251 (Metro Development Act Changes): The bill amends the Metropolitan Redevelopment Code to expand on the tax increment financing (TIF) mechanisms for funding metropolitan redevelopment projects. The bill would allow a municipality or county to dedicate up to 75% of each entity’s local option gross receipts tax increment over the current adjusted base to fund directly or to bond for the construction or reconstruction of properties within the dedicated metropolitan redevelopment area. The bill PASSED. • SB 26 (Excess Oil & Gas Funds to Severance Tax Fund): The bill reinvests some of the state’s oil and gas windfall into the Severance Tax Permanent Fund to help lessen any impacts to the general fund from future volatility in the industry. Beginning in Fiscal Year 2025, SB 26 will automatically set aside excess oil and gas revenues and send funds to the Severance Tax Permanent Fund. Doing so will allow those excess revenues to earn a projected average return of 5.7% in the Severance Tax Permanent Fund. The bill PASSED. Issue 1 • 2023 9
ROB NICHOLS President and CEO American Bankers Association WASHINGTON UPDATE For community banks seeking to remain competitive in today’s crowded financial services marketplace, innovation is imperative. A relationship with a core provider can make or break an institution’s innovation goals, and for too many community banks, legacy core technologies are holding them back. This is a critical challenge that ABA set out to solve through its Core Platforms Committee, which was founded in 2018 to engage the top players in core processing and to help break down the barriers that impede banks’ ability to offer customers the products and services they want. Since the committee was founded, we have improved the lines of communication with the core providers, and we remain optimistic about the commitments we’ve received from many of these firms to improve in this area. But for many banks, innovation remains a struggle. In fact, it’s estimated that more than two in five U.S. banks are still running core banking processes on legacy systems that were designed nearly four decades ago. In a recent ABA survey, 42% of bankers expressed dissatisfaction with the service they receive from their core provider, identifying several pain points including a limited ability to customize offerings and subpar integration capabilities with other technologies. However, undergoing a complete core conversion is a massive undertaking that comes with significant costs, complexities and risks, and many banks are understandably hesitant to abandon their longtime core provider. So how can community banks bridge the gap? One possible alternative to a “rip and replace” strategy is to employ the use of middleware — a solution that leaves existing core systems in place, while wrapping the core with a new layer of technology, typically an API architecture. This architecture enables banks to reduce reliance on their legacy core to deliver products faster; collect, maintain and use customer data more effectively; and foster partnerships with fintech companies. It’s a strategy that can considerably reduce the timeline for bringing new products and services to the market while reducing reliance on a legacy core system. Successful innovation is key to the preservation of the broad and diverse community banking sector that makes our nation’s financial services industry the envy of the world. MEETING IN THE MIDDLE(WARE) 10
ABA’s Office of Innovation highlights the case for middleware in a newly released whitepaper, “Exploring Banking Middleware Solutions.” The paper provides an in-depth look at how banks can benefit from incorporating a middleware layer into their core systems and gives a snapshot of the middleware vendor landscape in the U.S., as well as considerations banks should take into account when engaging with a middleware vendor. I urge you to read the whitepaper, which you can access at https://aba.com/middleware, and check out the other resources the Core Platforms Committee has made available at https://aba.com/core. ABA is deeply committed to helping its member banks succeed — regardless of where they are in their innovation journey. Our Office of Innovation works exhaustively to stay on top of the latest trends, connect banks with strategic partners and pave the way for responsible innovation policy in Congress and at the regulatory agencies. Successful innovation is key to the preservation of the broad and diverse community banking sector that makes our nation’s financial services industry the envy of the world. Email Rob at nichols@aba.com. ABA is deeply committed to helping its member banks succeed — regardless of where they are in their innovation journey. Issue 1 • 2023 11
Measuring capital value can sometimes be challenged by the type of scale that is used. Take the tangible capital rule that determines if a bank qualifies for Federal Home Loan Bank (FHLB) advances. Created in 1932, the FHLB system promotes its role as a source of liquidity to banks, particularly during times of economic stress. In order for a bank to qualify for those FHLB funds and liquidity resources that might otherwise be unavailable to community banks, that institution must meet FHLB’s criteria for tangible capital levels. This includes stock assets that may not yield the minimum required amounts under current market rates. That rule is under stress right now as a result of the recent economic conditions, rising interest rates, and low yields that are partly responsible for causing those negative tangible assets. The situation has started to push some community banks below tangible capital requirements, which would then exclude them from FHLB advances. That could have serious consequences for those institutions. Financial Institutions Ask for Rule Modifications While the problem is thought to have an immediate impact on only about 100 community banks, it is serious enough to draw the attention of the entire financial community. In a letter to federal regulators, 77 financial organizations asked for the rule to be modified, substituting Tier 1 Capital (also referred to as regulatory capital) for tangible assets. That should be enough to ease the situation. Among those who signed are the American Bankers Association and the Independent Community Bankers of America. The primary culprit behind the problem is the rapid rise in interest rates, which has hit some community banks hard, undercutting their asset values enough to turn their tangible capital levels negative. When that happens, community banks are cut off from low-cost FHLB advances, which can lead to an immediate liquidity crisis unless they get a RISING INTEREST RATES MAY SHUT SOME COMMUNITY BANKS OUT OF FHLB FUNDING By Jay Kenney, SVP & Southwest Regional Manager, PCBB 12
waiver from regulators. The continuing rise in interest rates could push more banks over the line. Some in the financial world are warning that the issue could lead to a fast-spreading liquidity crisis. Blame It on the Pandemic and the Rise in Deposits As bankers explained in their letter, banks took in a flood of deposits during the pandemic, and much of that was invested in short-term securities such as treasuries. As interest rates rose, however, the value of those treasuries and other securities dropped. Bigger banks were more diversified, but many community banks have been caught in the squeeze, leading some to have to place a negative value on their tangible assets. The banks may be perfectly sound, but the tangible asset calculation makes them look like they are in trouble. Viewed one way, the tangible capital rule is doing what it is supposed to do: ensuring that banks with dodgy financials don’t get access to FHLB financing. But as the current situation makes clear, tangible assets may not be the best way to evaluate banks in the current economic climate. About a decade ago, regulators such as the Fed and the FDIC adopted new rules that used Tier 1 Capital as the primary measure of soundness, but the FHLB continued to use tangible capital. Both methods offer a snapshot of a bank’s condition. But Tier 1 capital casts a wider net and, according to the financial organizations, provides a better reflection of actual conditions. In addition, using Tier 1 would likely alleviate the liquidity crisis for affected banks. How the Federal Housing Finance Agency (FHFA), the FHLB’s regulatory agency, will respond remains to be seen. The FHFA could temporarily waive the rule, change it, or leave things the way they are. Meanwhile, a growing crosssection of community banks wait anxiously to see if they will continue to have access to FHLB financing. Dedicated to serving the needs of community banks, PCBB’s comprehensive and robust set of solutions includes cash management, international services, lending solutions, and risk management advisory services. To continue this discussion, or for more information, please contact Jay Kenney at jkenney@pcbb.com. The banks may be perfectly sound, but the tangible asset calculation makes them look like they are in trouble. Issue 1 • 2023 13
H. RODGIN COHEN WEIGHS IN ON DIGITAL ASSETS, M&A, AND “TOO BIG TO MANAGE” By Rob Blackwell, Chief Content Officer, IntraFi
U.S. banks grappled with a number of challenges last year, from inflation and rapidly rising interest rates to the collapse in crypto to the Russia-Ukraine conflict. Despite these headwinds, most institutions appear wellpositioned to whether the economic downturn many believe is coming. However, regulatory concerns persist — about systemic risks, consumer protections, cybersecurity, financial inclusion, and data governance, among other issues. Bank leaders should keep current on developments in Washington to help ensure their institutions meet compliance obligations and remain well-positioned for the future. Recently, on Banking with Interest, I discussed a number of regulatory issues with legendary bank lawyer and Sullivan & Cromwell Senior Chair H. Rodgin Cohen, including the too-big-to-manage debate, scrutiny of M&A and its impact on dealmaking, the Fed’s plans to boost capital requirements, the need for digital-asset regulations, and much more. What follows is our conversation, edited for length and clarity. Are some banks really too big to manage? It’s a fair question, but keep in mind that banking organizations, particularly the largest, are subject to a complex web of laws, regulations, and guidance — which are often ambiguous and almost always involve subjectivity in their interpretation and application. In addition, regulatory expectations and interpretations can change over time. Large banks also are under virtually continuous examination by their regulators and have more compliance personnel per dollar of revenue than any other type of business organization. With so many people examining for compliance, it’s inevitable more violations will be found. There are real advantages to large banks: they bring credit, the breadth of financial services, and the convenience a modern economy needs. I don’t mean to excuse obvious violations or failures of controls, but before one reaches the conclusion that banks are too big to manage, they should strongly consider these benefits. Issue 1 • 2023 15
Regulators have taken a tougher stance on M&A. You’ve compared it to a line from Casablanca — they wait and they wait and they wait. What does that mean for the industry? There’s a cost to time. In 2021, the two largest bank transactions were approved in about five months. Today, applications from large banks are taking a year or more to approve. When you increase the amount of time, you lose customers and employees. There’s the additional loss of business opportunities and revenue, and expense synergies get further delayed. Something I want to point out is the Fed’s data on processing time, which shows a clear dichotomy between the time it takes to approve a protested application versus a nonprotested application. Agencies should reconsider what constitutes a substantive, credible protest because the differential between protested and nonprotested seems to occur irrespective of the protester’s credibility. Is there a way for banks to satisfy regulatory concerns over M&A other than waiting longer? Or do they just need to understand approval is going to take a year instead of six months? I think your premise is correct; it’s a question of time rather than substance. If you look at the approval orders from the Federal Reserve and OCC on the U.S. Bank/MUFG Union Bank and BMO/Bank of the West transactions — the largest approvals in some time. It’s 16
Bank leaders should keep current on developments in Washington to help ensure their institutions meet compliance obligations and remain well-positioned for the future. not merely that they were approved, it’s that the analyses the agencies used were comparable to analyses used in the past — which should be the case because the statute is the same. Is there an asset threshold where regulators won’t approve a deal? I don’t know if regulators will say there is one, and they should be cautious because Congress has acted twice on this issue — first in the mid-1990s, then with Dodd-Frank. The tests were not in terms of absolute dollars, but in the percentage of nationwide deposits in the first case and nationwide liabilities in the second. I think a percentage test makes more sense. Regulators have signaled more scrutiny of bank-fintech relationships. What are they looking for? It depends on the type of fintech. Several banks have suffered significant losses from their relationships with crypto companies. When you look at the most recent release from the agencies, their attitude seems to be “unsafe at any speed.” So with regard to crypto fintechs, the message is clear: it’s a red light. With the more traditional fintechs, it’s a cautionary yellow light. The concern is that some fintechs are engaging in improper or illegal practices, particularly in the context of consumer protection. Some worry banks are a transmission vehicle for fintechs to get into questionable consumer and small-business products and services. Regulators are telling banks they’re going to hold them responsible under their vendor-management obligations if those products and services violate laws and regulations. Most analysts believe Fed Vice Chair Michael Barr is going to raise capital requirements, but they don’t know the levers he’s going to pull to do it. How do you see this playing out? I do think the Federal Reserve is going to raise the requirements. This Federal Reserve has made it clear it no longer considers capital neutrality a goal, and that suggests it won’t be met. This isn’t because capital requirements are going down, it’s because they’re going up. There are many levers to pull, and more than one will be pulled. For instance, at many large banks, the stress-test process is the most capital-constraining, and it doesn’t take much to change it. You can change the economic assumptions to assume more of a market correction, higher unemployment, or any number of economic factors. Most important are the assumptions on whole categories of loan losses. Take a category of loans that represent, say, 20% of a bank’s loan portfolio, increase the percentage losses by 25% over a time horizon, and capital requirements will increase proportionately. To listen to the full conversation, visit https://www.intrafi.com/press-insights/podcasts/. Issue 1 • 2023 17
KEEP IT LONG ENOUGH, IT WILL COME BACK IN FASHION: BUYDOWN PROGRAM CONSIDERATIONS The early 2000s are reemerging with their crop tops, low-rise jeans, flip phones, and mortgage buydowns. Deja-vu! Pre-crisis teaser rates have been reborn into mortgage buydowns, both temporary and permanent. With the housing markets remaining pricey and rates still higher than they have been in years, many buyers are looking for assistance in any form. And as the refinancing market cools down, mortgage originators are becoming increasingly more creative in finding innovative ways to bring business through the door. And this has led to lender, builder, and seller concessions to help close deals. Buydowns generally are going to refer to when a borrower pays “points” upfront to reduce the mortgage rate to a level that places their monthly payments in a range they can afford. It is thought that the rate has been “bought down” from its original rate for the entirety of the mortgage by paying a lump sum upfront. The more recent trend has been for these to be seller-paid rate buydown concessions, with the seller offering to reduce to buyer’s mortgage interest rate for either the first few years (temporary) or for the duration of the loan (permanent). The seller is either contributing to the buyer’s closing costs or paying for a temporary rate buydown. What the market is seeing now is an influx of temporary buydowns, with the most common ones being a “2-1” and “1-0,” meaning a 2% interest rate reduction in the first year and a 1% interest rate reduction in the second year, or a 1% interest rate reduction in the first year only, respectively. Sellers, builders, lenders, or a combination of all three put-up money to cover the difference in interest rate payments between the original mortgage rate and the reduced mortgage rate. So for a 2-1 example, the mortgage rate is continued on page 20 By Elizabeth Madlem, Bankers Alliance 18
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reduced by 2% for the first year and then will step up by 1% in the second year, and another 1% in the third year to reach the actual mortgage rate at origination. It essentially works as a subsidy for the first two years of the mortgage before reverting to the full monthly payment. And the benefits are there for consumers — it can make purchasing a home more affordable (even if temporarily) and can “buy time” for borrowers to refinance into a lower rate should interest rates fall. With permanent rate buydowns, generally, it will be a seller paying a portion of the buyer’s closing costs that are used towards buying mortgage discount points, with each point reducing the rate on average by about 0.25 percentage points, costing 1% of the loan amount. So if a borrower bought a $500,000 home with a 20% down payment, the mortgage amount would be $400,000, with each point costing $4,000. With permanent buydowns, borrowers are historically slower to refinance, given the cost/benefit decisions taking place with recouping upfront money put down for the loan versus refinancing costs associated with a new loan. But one of the biggest issues with buydowns, either temporary or permanent, is proper disclosure on the Loan Estimate (LE) and Closing Disclosure (CD). For disclosure purposes, there are specific Regulation Z contemplated buydowns: third-party buydowns reflected in a credit contract; third-party buydowns not reflected in a credit contract; consumer buydowns; lender buydowns reflected in a credit contract; lender buydowns not reflected in a credit contract; and split buydowns (see 12 CFR 1026, Supp. I, Paragraph 17[c][1]—3 through 5). Regulation Z provides numerous scenarios that determine whether the terms of the buydown should be reflected in the LE and CD. Generally, the following buydowns are reflected in the disclosures: third-party buydowns reflected in a credit contract; consumer buydowns; lender buydowns reflected in a credit contract; and split buydowns (consumer portion only). Otherwise, a third-party buydown not reflected in a credit contract, a lender buydown not reflected in a credit contract, and a split buydown (not third-party e.g., seller’s portion) are not included. With most of the criteria for determining whether a buydown is reflected on the LE and CD being dependent upon a credit contract, it is important to note that Regulation Z does not define a credit contract. But it is stated as being a contract that forms a legal obligation between the creditor and the consumer, as determined by applicable State law or other law. So whether or not a buydown agreement would be considered a credit contract or legal obligation between the creditor and consumer depends upon what “State law or other law” consider to be a legal obligation. Whether a buydown agreement is actually modifying the terms of a note or contract is going to depend on how it is structured and whether that note or contract ultimately reflects that lowered interest rate. Counsel should be included in any final determinations, as well as investor requirements. So where should the terms of the buydown be reflected in the LE and CD? Unfortunately, the commentary does not provide an “item-by-item” list of what parts of the LE and CD the buydown should be reflected in. The key requirement to remember is that if the buydown is required to be reflected, it must be reflected in the finance charge and all other disclosures affected by it. That includes the “Finance Charge” on page five of the CD (except for seller-paid buydown fees as those are considered seller’s points); the “Annual Percentage Rate” on page three of the LE and page five of the CD; the “Projected Payments” table on the first page of the LE and CD; and the “Product” on the first page of the LE and CD reflecting a step rate. There are different ways proper disclosure can be done, dependent upon the specific loan scenario. Sometimes a buydown is money going to the borrower from the continued from page 18 20
seller, while other times, it is money going to the bank from the seller. These would be disclosed differently. So, the first question to ask: Who is giving money to whom, and for what purpose? A more common scenario for temporary buydowns is where the buydown is seller paid and is not being reflected in the note or credit agreement as it is contracted for between the buyer and the seller. How is this properly disclosed? Well, the most common way to disclose this, since it is not reflected in the note or credit agreement, is to disclose this as a Seller Credit. Since this is not considered discount points that either the buyer or the seller are paying to the bank, the bank would not disclose them in Section A. The bank is not involved in the scenario where a buydown agreement is solely between the borrower and the seller. Rather, the regulation and commentary do not specify that this must be disclosed in any particular way, so it is viewed generally as just a concession from the seller, which has multiple ways of compliant disclosure. Disclosing as a Seller Credit, as noted above, is the more common. This would be found in the Calculating Cash to Close Tables (LE & CD) and also in Section L on the CD, as it is not a credit that is paying any specific fee listed on page two of the disclosure. It could also be disclosed in Section N of the CD as a seller credit due at closing. If it is a situation where the buydown funds are from the seller to the bank, it would be disclosed in Section A in the Seller Paid column, and not Section H because the recipient of Section H fees are third parties, and the bank is the one receiving the fee. In this instance, the money from the seller is specifically being used to buy down the rate, which is a Section A fee, since that is paid to the bank. There are other arrangements in which the seller just gives the borrower some money to make up the difference in what the borrower is paying between Rate A and Rate B with no actual buydown of the rate taking place. This is a Section N disclosure. But in the instance in which the bank will actually be the recipient of the fee, and the fee from the seller is to pay for a specific loan cost, it should be disclosed in Section A. The remix is happening — the early 2000s are repeating themselves. But even more so now with the increased examiner focus and scrutiny on consumer harm, it is important to make sure the bank is aggressively reviewing its buydown loan programs for the risks they can bring: reputational, compliance, legal, credit, and fair lending, and diligently documenting justifiable business decisions, reviewing investor requirements, and examining for proper disclosure and fair lending implications. The Advisors’ Trust Company® Zia Trust, Inc. 505.881.3338 www.ziatrust.com 6301 Indian School Road, Suite 800, Albuquerque, NM 87110 It’s an honor to serve residents of The Land of Enchantment, and clients in 41 other states. We’ll Meet You. even out Here. Our team of Trust Officers and 3 local offices provide fiduciary services across the state. We work alongside your clients’ investment advisor Bisti Badlands, De-Na-Zin Wilderness Area, New Mexico Issue 1 • 2023 21
THE EAST PALESTINE DERAILMENT: A STORY OF GOVERNMENT CORRUPTION AND INACTION On the evening of February 3, 2023, residents situated around the Ohio-Pennsylvania border were settled in for a typical chilly Winter night, completely unaware that their lives and surroundings would be changed permanently in a matter of minutes. On that evening, in the small town of East Palestine, Ohio, only several miles from the Pennsylvania border, a 150-car Norfolk Southern train carrying toxic chemicals derailed in spectacular fashion. Residents of East Palestine who live near the train tracks have described the event as “seeming like a terrorist attack,” filling the skies with enormous fireballs and turning a peaceful February evening into a cacophony of twisted metal and distressing explosions. And just like that, thousands of innocent people became subject to perhaps the greatest environmental disaster within American borders in decades. Families who had settled in one community for 50-plus years were suddenly faced with the decision of evacuating their homes or risk staying and possibly facing prolonged toxic chemical exposure. Then, on February 6, a “controlled chemical burn” was performed on the site of the derailment, allowing Norfolk Southern to clear the tracks and resume scheduled rail operations. However, the controlled burn wildly compounded the problem, releasing massive amounts of the toxic chemical vinyl chloride into the air, where it eventually will come back down and settle into the soil and water, an enormous source of concern for residents in the area. A fairly sizeable region of the country has now been rendered a toxic wasteland, and there doesn’t seem to be any recourse for those affected or any punishment for those responsible. It’s a tale that’s sadly growing painfully familiar in modern America, just substitute out the names, industry, and circumstance. The intensity and frequency of malfeasance by corporate actors only increases every year, but it often feels like these cataclysmic events can only be addressed with a whimper. The government, which in theory exists to put a check on powerful corporate actors, has become so thoroughly co-opted that it now essentially acts as the counsel to corporations, helping them dodge any potentially nasty repercussions. The Norfolk Southern train derailment is so stunning because we see it in such naked terms: the inability to help people even in the slightest whose lives have been ruined through no fault of their own. Norfolk Southern has taken a series of steps in recent years to essentially ensure something like the catastrophic derailment in Ohio would happen in the near future. If one looks at it cynically, it seems like derailments are built into their business plan as they have calculated that dealing with derailments is less expensive than updating its infrastructure. In a 2021 Associated Press article, derailments like the one in East Palestine were foreshadowed. As the article details, “Even as railroads are operating longer and longer freight trains that sometimes stretch for miles, the companies have drastically reduced staffing levels, prompting unions to warn that moves meant to increase profits could endanger safety and even result in disasters. More than 22% of the jobs at railroads Union Pacific, CSX and Norfolk Southern have been eliminated since 2017 when CSX implemented a cost-cutting system called Precision Scheduled Railroading that most other U.S. railroads later copied. BNSF, the largest U.S. railroad and the only one that hasn’t expressly adopted that model, has still made staff cuts to improve efficiency and remain competitive. The railroads acknowledge they have cut staff, lengthened trains, and made other adjustments to reduce spending, but they are adamant none of the changes increase dangers. Regulators at the Federal Railroad Administration say they are tracking the changes and that the data so far does not show the new operating model is unsafe. But unions counter that with the stakes so high any time a train derails, the new system is risky.” By Mark Anderson, NMBA Legal and Legislative Assistant 22
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