PUB. 12 2023 ISSUE 2 CommunityBanker The WORLDWIDE DEMAND BUYERS OF U.S. DEBT COME IN MANY SHAPES AND SIZES
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© 2023 Virginia Association of Community Banks | The newsLINK Group, LLC. All rights reserved. The Community Banker is published four times each year by The newsLINK Group, LLC for the Virginia Association of Community Banks and is the official publication for this association. The information contained in this publication is intended to provide general information for review and consideration. 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 specific circumstances. The statements and opinions expressed in this publication are those of the individual authors and do not necessarily represent the views of the Virginia Association of Community Banks, 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 Community Banker is a collective work, and as such, some articles are submitted by authors who are independent of the Virginia Association of Community Banks. While The Community Banker 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. CONTENTS 12 14 VACB Board of Directors CHAIR Jay A. Stafford Benchmark Community Bank Kenbridge CHAIR-ELECT Tara Y. Harrison Virginia National Bank Charlottesville VICE CHAIR Joseph R. Witt, CPA The Old Point National Bank Hampton IMMEDIATE PAST CHAIRMAN Dennis A. Dysart First Bank Strasburg PRESIDENT & CEO Steven C. Yeakel, CAE VACB Richmond VACB STAFF Katharine C. Garner, CMP Vice President Education & Communications Kelli C. Mallinger Member Services Administrator VACB DIRECTORS CLASS OF 2023 J. Steven Grist CornerStone Bank Lexington James E. Hendricks Village Bank Midlothian Lisa E. Kilgour MainStreet Bank Fairfax Paul M. Mylum National Bank Roanoke Thomas L. Rasey, Jr. The Farmers Bank of Appomattox Appomattox CLASS OF 2024 Chris Snodgrass The Bank of Marion Marion Blake M. Edwards, Jr. Skyline National Bank Independence CLASS OF 2025 Dabney T.P. Gilliam, Jr. The Bank of Charlotte County Phoenix 4 PRESIDENT’S COLUMN VACB Banker Synergy Contributes to Another Successful ICBA Capital Summit 5 CHAIRMAN’S MESSAGE Community Banks and the Culture of Mahalo! 7 MULTIFACTOR AUTHENTICATION How Having a Layered Defense for Your Bank Can Help to Combat Cyber Threats 10 WORLDWIDE DEMAND Buyers of U.S. Debt Come in Many Shapes and Sizes 12 VACB — WILLIAMS MULLEN 23RD ANNUAL BANKERS’ GOLF CUP TOURNAMENT 14 HOW DOES RECENT BANK DRAMA IMPACT THE VALUE OF COMMUNITY BANKS? 16 NAVIGATING THE POTENTIAL IMPACT OF RECENT REGULATORY GUIDANCE 19 SECTION 1071 FINAL RULE What You Need to Know 22 SAVE THE DATE VACB 46th Annual Convention & Trade Show 3 The CommunityBanker
President’s Column Steven C. Yeakel, CAE VACB President and CEO VACB BANKER SYNERGY CONTRIBUTES TO ANOTHER SUCCESSFUL ICBA CAPITAL SUMMIT Just before Christmas last year, the ICBA announced that a change in the calendar of the U.S. House of Representatives had compelled a change in date for its 2023 Capital Summit. The Summit, held each spring in the nation’s capital, is the advocacy event of the year for the voice of community bankers in Virginia and across the nation. It was not a small change. In fact, the change of date had moved this important event directly into the middle of shareholder meeting season in Virginia, causing numerous longtime VACB participants to cancel their plans to attend. But when the dust had settled in mid-May on another successful ICBA Capital Summit, VACB bankers had told the Virginia community banking story in 12 of Virginia’s 13 Congressional offices (both of our senators and 10 of 11 representatives), meeting personally with both senators and five representatives, and with senior banking aides for five other representatives. The stories were easy to tell, but they had to be told in order to protect the community bank brand. We defended the prized community bank business model against the painfully obvious shortcomings of the speculative lending/explosive growth model that doomed Silicon Valley Bank on one coast and Signature Bank on another. We urged our delegation to keep community banks safe from any corrective action, financial or regulatory, to be levied against much larger banks with much riskier profiles, just as the FDIC had done in early May by exempting community banks from the assessment to replenish the DIF. Our elected representatives listened and were supportive. We also spoke of the burdens being imposed by coming rules to mandate disclosure of small business lending data when Section 1071 of the Dodd-Frank Act is finally implemented. We shared concerns over the bureaucratic momentum behind the development of a central bank digital currency and concerns about inadequate regulation of stablecoin (cryptocurrencies, et al.), which, in actuality, are neither “stable” nor “coin.” We advocated ways to level the playing field with credit unions and others and, when we had the chance, spoke to even more issues of concern. It was encouraging to see the great mixture of new participants with “long-timers,” and I’d like to thank each of them individually. • William Bauder — National Capital Bank • John Brough — Chain Bridge Bank • Debra Cope — MainStreet Bank • Dennis Dysart — First Bank • Anthony Edwards — Skyline National Bank • Aaron Green — Pendleton Community Bank • Mark Hanna — ICBA Virginia Delegate • James Hendricks — Village Bank • Abdul Hersiburane — MainStreet Bank • Claire O’Connor — National Capital Bank • Phillip Quintana — Summit Community Bank • Jay Stafford — Benchmark Community Bank It would be great to have even more bankers joining us in future advocacy efforts. Please be ready when the calls come. The work is important and rewarding, and it’s the most important way to promote and defend this highly valued and widely supported industry. 4 The CommunityBanker
Chairman’s Message Jay Stafford, VACB Chairman Benchmark Community Bank COMMUNITY BANKS AND THE CULTURE OF MAHALO! Do you remember writing term papers in college? Anybody who did a four-year tour of duty in an institution of higher learning is bound to recall being driven more by desperation than knowledge as you pulled an all-nighter to finish that paper due the next day. Knowing I needed to write this update for our publication after returning from the recent ICBA convention in our 50th state, I even surprised myself by letting inspiration guide the thoughts I couldn’t wait to share with you. Hawaii is every bit as beautiful as I’ve always heard and our ICBA outdid themselves in putting together a truly memorable event. It was most welcomed after spending an eternity in TSA lines before getting on an airplane with 350 of our closest friends and sitting one row behind first class for what felt like three days. Never mind that I really am that cheap. That is a mistake my wife will never allow me to make again. The Hilton Hawaiian Village Resort on Waikiki Beach was fabulous. Everyone there treated us as though ours was the only visit that mattered. We were in Hawaii for a meeting, yet the island experience was the icing on a cake we’d waited most of a lifetime to taste. There is so much to learn. From Pearl Harbor and the Arizona Memorial to the fact you can order a Spam Breakfast Platter at the local McDonald’s, Hawaii overflows with sights and sounds we thought we would never have the opportunity to experience. Everywhere we went, Hawaiians ended with the local word for thank you: Mahalo. The ICBA Convention lived up to its billing as a shining example of leadership in community banking. Early in the week, we heard from our now-Past Chairman, Brad Bolton, from Alabama. He gave a passionate speech about his year as Chairman as he inspired us all to go back home and advocate for community banking. Not to be outdone was incoming Chairman Derek Williams of Century Bank & Trust, Milledgeville, Georgia. His state was especially hit hard during the Great Recession with Georgia having lost 90+ banks to failure. Despite that, Williams’ faith in community banking never wavered. One only needs to look at the leadership of ICBA President/ CEO Rebeca Romero Rainey to understand the origination of their inspiration. Rebeca is the epitome of leadership as witnessed by her response to breaking news during the convention. Two large bank failures — California’s Silicon Valley Bank and New York’s Signature Bank — threatened the banking industry’s stability in the public eye. Unfazed, Rebeca immediately went before the press and bank examiners, defending the fact that community banks should not be characterized by these two bank failures. During a situation that could easily have put a damper on the convention and derailed all efforts to reinforce the standing of community banks in the United States, she deftly juggled both the annual convention and this big news story. It was impressive to watch her work. You should feel proud to be a member of the ICBA. They fight hard for us every day. You can be proud that the community bank culture is authentic from its core to the very top of our association. With over 900 attendees at the convention, you could still feel the warmth and community banker mindset of those I got to meet. Despite their busy convention schedules and the people needing their attention, Rebeca, Brad and Derek made time to speak with me. Derek Williams’ acceptance speech was particularly inspirational. I remember one comment he made during his acceptance speech, and it went something like this: “We understand our customers and communities in ways few do, so when rules and regulations harm those we serve — we must speak up and make our individual community banker voices heard.” He encouraged us, as community bankers, to stand with our customers to stimulate local economies and support our communities with compassion, 5 The CommunityBanker
courage and commitment. In short, he challenged us: “The future of our industry is in our hands.” It was a great convention. I’ll cherish the trip and the fun we had, from the Hawaiian music to the picturesque beaches, oceanfront restaurants and shops, and even Brad and Derek doing the Hula. The ICBA is a great organization, serving as a champion for our industry. I encourage each of you to put a future ICBA Convention on your Before-I-Retire Bucket List. Closer to home, the VACB annual convention will be in Roanoke the weekend of October 1-3. Your board continues to work diligently on the Strategic Plan developed last August. Watch for updates in the weeks and months ahead. I’m inspired by the knowledge that our nation’s community banks play a critical role in our communities each and every day. As state banking leaders, your support and advocacy for community banking is invaluable and I am grateful for all you do to support our industry. Believe me, without us, life would look very different in the communities we serve. Mahalo, Jay Stafford 6 The CommunityBanker
MULTIFACTOR AUTHENTICATION: HOW HAVING A LAYERED DEFENSE FOR YOUR BANK CAN HELP TO COMBAT CYBER THREATS By Mike Gilmore, Chief Compliance Officer, RESULTS Technology As a leader and decision-maker at your bank, you know that technology is a double-edged sword. It helps you work effectively, learn more about your customers, and make better decisions. But the online world also has the potential to destroy a business you’ve worked so hard to build. We live in a digital world — there’s no way to run a business without technology. So, the only option is to protect yourself as best as you can. One of the most effective ways to do this is with multifactor authentication (MFA). You’ve probably heard about it before, and if you’re tired of hearing about it, don’t leave just yet! We’re going to debunk the common complaints about MFA and explain why it’s the single most important thing you could do for your bank’s security today. “But It Adds an Extra Step to All My Applications” The biggest complaint with multifactor authentication is that it bogs people down. You open up your email; you have to put in a code. If you want to access a document in Google Drive; you have to open an app and request a “token” (a number) to key in. While it may add a few seconds to your day, not implementing MFA could get you in legal trouble. The Federal Trade Commission recently updated the Safeguards Rule, which “requires financial institutions under FTC jurisdiction to have measures in place to keep customer information secure.” MFA is one of those measures. In addition, the Federal Deposit Insurance Corporation (FDIC) strongly recommends MFA as well as a Managed Service Provider (MSP) that is experienced with banks and the special security needs that they require. And if that wasn’t enough to convince you, most cyber insurance requires the use of MFA. Luckily, a good MSP knows how to properly implement MFA to make it fast, easy, and secure. To get the security benefits of MFA without excessive inconvenience, there are strategies you can use. At RESULTS Technology, we recommend using push notifications. This way, you won’t have to wait or search for a code; it simply pops up on your screen with the option of remembering your device for 90-180 days. This takes away the constant code inputting and time drag. 7 The CommunityBanker
Is It Really That Effective? Yes, But Nothing Is Foolproof! When MFA was first gaining steam, Microsoft claimed it could stop 99.99% of data breaches. But like most things, especially when it’s concerning cybersecurity for banks, cybercriminals quickly got to work finding ways around it. So while you can’t have a near-perfect guarantee, MFA is still highly effective. Many bank employees may think that the biggest cybersecurity risk comes from a customer’s account being hacked or from someone accessing the bank’s main data frame. But hackers aren’t interested in those hard-to-reach targets. Instead, they might find an employee’s email login information and, without MFA, make it into their account. But that’s not their target — your employee’s compromised account is just the Trojan horse. With the credibility of an employee’s account, they’ll send emails to coworkers and customers. Once they have an email address and password, the attacker can eavesdrop on your email accounts. With the credibility of your employee’s account, they can quietly collect private data from your customers or internal staff for months without detection. Through this process, they can request private information, rewire payments to go into their own account or infect thousands of more computers with a phishing email. The possibilities are endless when it comes to social engineering. If they’re successful, your bank will risk everything from lost income due to reputational damage — in the age of information, mistakes are amplified, which could put your company at an extreme disadvantage. But with multifactor authentication as a layer of your cyber defense, you could stop the criminal before they have a chance to wreak havoc. Do I Need a Paid Service, or Can I Get the Same Security for Free? If you’re feeling the strain of cyber threats but don’t have the resources to have a cybersecurity provider, most apps and tools have an MFA feature. To improve your security today, you should go through each of your vendors — VPN, Gmail, Outlook, Dropbox, DocuSign — anything you access online, and implement MFA. You won’t have to spend any money, and your cyber posture will have straightened up immediately. The downside to these free options is that there’s no guarantee of how secure the authentication process is. You won’t be able to track what devices are being used or who has access. Another downside is that they will all vary in how they’re implemented and used, so you’ll need to remember to audit Financial institutions should understand how these changes could affect their operating model and strategy. 8 The CommunityBanker
your MFA security often to ensure it’s always in use. You’ll also have to log in and do the authentication for each app separately, which can be frustrating. Free options work in a cinch but shouldn’t be the extent of your MFA strategy. This is especially the case since not all systems provide a free option. Instead, try to collaborate with an IT provider that specializes in cybersecurity for banks. They’ll set up a paid version of MFA that coordinates between all your applications and gives you insight into the following: • What devices are connected to your accounts? • Who is accessing the system? • Is there unauthorized access? • Where are people logging in? A paid service will also allow you to remember devices for a few months at a time and set up an automated authentication process, so you don’t have to do any extra steps. Multifactor Authentication Is a Worthy Investment — Make the Most of It When it comes to cybersecurity for banks, there’s no silver bullet. You need multiple layers of defense, and MFA should be one of them. It only takes a few seconds to do this extra step — and it could save you from a world of hurt. These days, you need MFA to protect yourself against rising cybercrime. If you neglect this essential security measure, you’re opening yourself up to the full brunt of reputational damage in the age of social media. In addition, the time you spend verifying your identity is nothing compared to the cost and hassle associated with recovering from a data breach. Please reach out if you have any questions or need help at (913) 347-6497 or visit www.resultstechnology.com. Mike Gilmore is the Chief Compliance Officer of RESULTS Technology and a Certified Information Systems Auditor (CISA) with more than 30 years of experience in the banking industry. RESULTS Technology provides IT services to community banks across the Midwest. In his role as CCO, Mike provides compliance and risk assessments, audit and exam support, and policy documentation. He can be reached at mgilmore@resultstechnology.com Contact us today to place your announcement ad Call 801-676-9722 Or scan the qr code to fill out the form. Who to congratulate , who to acknowledge , and who to thank for a job well done. Employees are motivated when they are recognized and feel valued. The Community Banker magazine is a great platform to celebrate your team's accomplishments!
I think we can all agree that there has been plenty to be concerned about in the last, say, five years. Some are environmental issues, some are social and, for community bankers, plenty are economical. What gets a lot of play in the business, and even mainstream media, is our growing national debt. There’s no doubt that the mountain of borrowings that keeps our federal government liquid and solvent is greater than ever before. It’s not surprising to me that there’s spirited debate about debt limits, or if Congress will ever in our lifetimes find a way to slow our dependence on deficit spending. Related to this conversation is the concern that, to paraphrase Blanche DuBois, we have always depended on the kindness of strangers. It seems self-evident that foreign central banks have propped up our debt market for decades, buying dollar-denominated securities by the trillions, thereby keeping our borrowing costs manageable, and potentially even encouraging our bad behavior by going ever deeper in debt. But is any of this true? Walked, Then Ran First, let’s try to get our minds around the situation. The Federal government first borrowed money before there was a Federal government, when the Dutch and the French loaned money to the Continental Congress to help finance the Revolutionary War. Treasury borrowings, as we know them today, sort of date back to World War I, with the issuance of “Liberty Bonds,” which was just after WORLDWIDE DEMAND BUYERS OF U.S. DEBT COME IN MANY SHAPES AND SIZES By Jim Reber, President and CEO, ICBA Securities 10 The CommunityBanker
the creation of the Federal Reserve Bank. As we have seen, the Treasury and the Fed have a long history of collaboration. Even at the start of the 21st century, total Treasury debt was “only” $3 trillion at a very manageable 30% of GDP. Just four years ago, our borrowings were about $17 trillion at 77% of GDP. Today? We’re over $24 trillion, nearly 100% of GDP. While it would be tempting to blame a lot of the more recent growth on COVID and the fiscal response to that, the reality is each administration of the last quarter century has contributed to the current debt stockpile. And, now that rates are at a 15-year high, our interest payments alone are now over $900 billion per quarter. As Craig Dismuke, Market Strategist for Stifel, is fond of saying, “Interest is an expenditure that doesn’t create jobs.” Bedrock Option Now, for some hopeful commentary. The owners of our Treasuries are a diverse lot, with diverse objectives. Investors include the savings bond/retail buyers, institutional money managers who run mutual funds, depositories, our central bank, and yes, other sovereign central banks. What’s interesting to note is that the percentage of our debt owned by China, Japan, Germany and the rest of the foreign investors has declined substantially in the last decade, from about 42% to less than 30%. The Federal Reserve, meanwhile, has picked up the pace and has essentially absorbed the pro-rata share of the pie in the last decade. So it would be wrong to conclude we’re hostage to foreign governments’ largesse. Still, that leaves around half of our total debt in the hands of private investors. Who are these people? Most are names you’ve heard of, and maybe even invested your personal or retirement money with. Large mutual fund families, state-sponsored retirement funds and life insurance companies are examples. In aggregate, they have owned nearly half of the total debt pie for most of this century, so their collective appetite for full faith and credit investments has mirrored Uncle Sam’s appetite for more borrowing. A lot of this can be attributed to the aging of the population and the advent of “targeted date” funds. Keeps the Wheels Turning If you’re of a certain vintage, you may already be invested in these vehicles. Targeted date funds are built for individuals who have an eye on a retirement date, whether it’s five or 15 years from now. Each fund will gradually reallocate its assets out of riskier sectors (e.g., equities) and into debt securities (including Treasuries) as the target date approaches. Collectively, retirement funds (and individuals acting on their own) that gradually, systematically, add more Treasuries to their portfolios may continue to keep up demand to absorb the everincreasing supply. So how does this rubber hit the road for Main Street? For starters, demand for U.S. debt helps keep a lid on our Federal deficit by subsidizing interest costs. It probably also keeps community banks’ net interest margins a bit lower than otherwise, even if most banks’ portfolios contain no Treasuries at all. Still, the global need for Treasury bills, notes and bonds may just possibly sync up with our growing deficit, and ultimately be supportive, long-term, of commerce as we know it. Unlike DuBois, the U.S. Treasury doesn’t depend on the kindness of strangers; rather, the global need for safe, liquid debt securities. 828 Main St, 15th Floor Lynchburg VA 24504 www.countsauction.com Call us for your Auction & Appraisal needs. 434-525-2991 Jim Reber (jreber@icbasecurities.com) is President and CEO of ICBA Securities, ICBA’s institutional, fixed-income brokerdealer for community banks. 11 The CommunityBanker
VACB — WILLIAMS MULLEN 23RD ANNUAL BANKERS’ GOLF CUP TOURNAMENT VACB held its 23rd Annual Bankers’ Cup Golf Tournament on May 22 at Spring Creek Golf Club in Gordonsville. Over 70 bankers and associate members gathered for a day of fun and fellowship on the green. The mood was electric and jovial as golfers were glad to be together on a day that featured textbook outing weather and a fast round of golf. This year’s tournament was again co-sponsored by Williams Mullen, and 19 teams wasted no time getting to their spots for the shotgun start. To get the morning and the tournament started, this year’s tournament again featured the tune-up, warmup beverage station sponsored by KlariVis. Out on the fairway, players were well fed and hydrated thanks to our supporting sponsors. Stifel, an endorsed provider of ICBA, and the Federal Home Loan Bank of Atlanta graciously sponsored the beverage carts during the tournament, and Sentry Management provided boxed lunches. Many thanks also to S&P Global & Atlas who provided golf balls for all the players! Our Captain’s Club sponsor, Banc Card, held a meet and greet at their designated hole and gave players a quick break during their day on the green. First Place Team (Team The Bank of Charlotte County) Jimmy Clay Robbie Elliott Scott Martin Derek Mason (With Bank President Dexter Gilliam) Second Place Team (Team Touchstone Bank) Mark Debes Sean Link Joseph Pennington As the Spring Creek golf pro tallied up tournament results to determine the winners, golfers enjoyed food and networking at the posttournament reception and meal. VACB Chairman Jay Stafford from Benchmark Community Bank and VACB’s Steve Yeakel awarded team and contest prizes. The 23rd Annual Bankers’ Cup tournament was a tremendous success once again, and we thank all our members for their support, both on and off the green! We could not do what we do without your continued help and support! 12 The CommunityBanker
Third Place Team (Team The Farmers Bank of Appomattox) Bruce Drinkard Cody Drinkard Todd Moore (not pictured) McNeill Wells with Stifel VACB Longest Drive Winner Mark NeSmith, Blueswipe VACB Closest to the Pin Winner Allen Barber, Virginia Partners Bank 13 The CommunityBanker
I don’t know about you, but recent developments in banking have me flashing back to 2007 — when we saw large banks reap the consequences of some risky activities — and community banks were pulled into the fallout. The recent downfall of certain large banks (you know the ones I mean!) has made a big splash in public bank stock prices, the overall economy, and public sentiment toward banking. So, how has this impacted the value of privately owned community banks? Several bankers have called to ask exactly this. How does the current banking environment play out in a bank valuation? Let’s explore. The first thing to consider is the valuation date. During the first part of this year, most of our firm’s bank valuations were as of a date late in 2022 (for gifting, ESOPs, buy/sell agreements, etc.). Since appraisal standards require that a valuation be performed on the basis of what was “known or knowable” as of the valuation date, a late 2022 value does not show the effect of recent developments. But as we pull ahead to more recent dates, the effects creep in. Public banking stock prices are down, no question. However, many community banks are insufficiently comparable to public banks, and no weighting is placed on a Guideline Public Company Method. Uncertainty, however, IS a factor that has a valuation effect. Most notably, this shows up in the Discounted Cash Flows Method — a forward-looking method based on a bank’s forecast. Uncertainty is synonymous with risk in the valuation world. But, for what it’s worth, uncertainty has been a bigger player in bank valuations since 2020 for other reasons: a worldwide pandemic, rising interest rates, and economic concerns (the list is longer, but these are the top three). So, a different reason, but more of the same. Recent banking transactions also are an indicator of value, but it is hard not to notice that far fewer banks are changing hands. The recent bank drama may have a slight bearing here, but the big driver is those unrealized bond losses. While unrealized losses are sitting on a bank’s balance sheet, value is unaffected (a valuation measures the value of operations, not investments). But most owners are not interested in selling a bank in this environment and realizing those losses. I will leave you with this: the recent large bank drama is viewed as transitory. This too will pass, but the standard of fair market value takes a longer look. The value of larger banks is likely to be somewhat suppressed because of higher comparability to public banks, while community banks are less affected (this seems fair, doesn’t it?). If you are a community bank, the value of your bank is still most associated with the cash flows you will achieve in the future. Your value ties to your profitability, asset strength and growth. For more information, please reach out to Lindy at lindy@bccadvisers.com or visit www.bccadvisers.com. HOW DOES RECENT BANK DRAMA IMPACT THE VALUE OF COMMUNITY BANKS? By Lindy Ireland, Vice President & Shareholder, BCC Advisers Your value ties to your profitability, asset strength, and growth. 14 The CommunityBanker
IS YOUR COMMUNITY BANK INNOVATIVE? Meet Charles. Charles keeps ICBA members informed about emerging solutions that help solve specific community bank challenges. He listens to bankers concerns and plans programs that help get to the core of what our members need most. Even when he’s biking through the streets of Atlanta, he’s thinking about how we can help community bankers level up their fintech game. As an ICBA member, you’ve got Charles in your corner. Learn more at icba.org/innovation
NAVIGATING THE POTENTIAL IMPACT OF RECENT REGULATORY GUIDANCE Banks are facing unprecedented risk management challenges amid rapid technological and competitive changes. Federal and state authorities have recently issued guidance to address paradigm-altering shifts such as climate change, artificial intelligence (AI), cryptocurrency, digital and mobile banking, credit models, data security, and more. Financial institutions should understand how these changes could affect their operating model and strategy. Below are highlights of recent select regulatory guidance: Climate Risk Large financial institutions are impacted first. The Federal Reserve Board will conduct a pilot to analyze climate-related financial risk involving the six largest U.S. banks in early 2023. Financial institutions should understand how these changes could affect their operating model and strategy. By Gale Simons-Poole, Chief Regulatory Relations Officer, BHG Financial 16 The CommunityBanker
Small Business Lending Data Collection Most U.S. financial institutions will be impacted when implemented in 2023. Lenders will be required to annually report small business credit application data, including credit purpose, loan amount, business info and location, gross annual revenue, NAICS code and more. Expansion of UDAAP Standards The expansion broadens the scope of consumer activities subject to UDAAP beyond lending to include advertising, pricing, servicing, reporting, payments, and collections. However, a lawsuit by several banking trade associations seeks to prevent the expansion of CFPB’s UDAAP role beyond its Dodd-Frank Act statutory authority. Reporting Credit Decisions Using Complex Models/Algorithms Lenders using AI, machine learning, and/or complex credit models must disclose the precise reason(s) for Adverse Action Notices as required by the Equal Credit Opportunity Act. Enhanced Consumer Privacy Laws Five states have already enacted enhanced regulations: CA, CO, CT, VA and UT. CA has already placed them into effect; CO, CT, VA and UT state requirements became effective in 2023. Six other states have active legislation pending: MA, MI, NJ, NC, OH and PA. Oversight of Bank Third-Party Risk Management (TPRM) Vendor/third-party relationships are generating renewed regulatory scrutiny, especially fintech partnerships. Ineffective TPRM could be cited as unsafe or unsound practice. Banks must demonstrate TPRM through documentation of third-party relationships, conduct audit and performance reviews, and require third parties to provide data that confirms the quality and sustainability of controls to meet service agreements. What’s an Appropriate Change Management Strategy for Community Banks? Each regulatory scenario described above warrants a course of action specific to that issue. For example, regarding the enhanced consumer privacy laws, banks should revisit privacy disclosures, notices, and policies within the states they operate. More holistically, banks can manage all the impending regulatory changes following these three steps: 1. Monitor regulatory proposals and changes through industry groups and trade associations. Seek clarification and/or assistance from trusted partners outside of your organization. In addition, involve your operations, technology, and compliance staff to gain a comprehensive view of any potential changes. It is also prudent to communicate with your board and senior staff and to document your regulatory discussions in board minutes. 2. Designate an internal stakeholder to implement/ monitor regulatory changes. This stakeholder can also conduct testing after implementation to ensure the process and related controls are operated as intended and document your bank’s change management efforts for subsequent review by external parties. 3. Partner with an external regulatory expert. Staying current with newly implemented and/or potential regulations requires time, expertise, and deep industry knowledge. An external overseer can advise on necessary regulation and compliance issues, giving banks the freedom to focus on serving their communities. Scan the QR Code for more information about compliance and regulatory solutions. https://lp.bhgandbanks.com/banknetwork/?bhgid=21983 As Chief Regulatory Relations Officer (SBA), Gale Simons-Poole expertly navigates regulatory and compliance matters for BHG lending programs and supports BHG’s risk management and reporting. Gale’s three decades in bank supervision include 23 years with the FDIC, most recently as Deputy Regional Director, Risk Management Supervision. Before joining BHG, she spent seven years as Director for Promontory Financial Group, advising clients from large insured national banks to community banks. 17 The CommunityBanker
For more information, please contact Katharine at Virginia Association of Community Banks at (804) 673-8250. Advertise in this magazine and market to who matters. 801.676.9722 | 855.747.4003 thenewslinkgroup.org | sales@thenewslinkgroup.com Get more exposure. 18 The CommunityBanker
SECTION 1071 FINAL RULE WHAT YOU NEED TO KNOW By Victoria E. Stephen Tier Annual originations in 2022 & 2023 Data collection start date Data reporting start date Tier 1 2,500 or more covered credit transactions Oct. 1, 2024 June 1, 2025 Tier 2 500-2,499 covered credit transactions April 1, 2025 June 1, 2026 Tier 3 100-499 covered credit transactions Jan. 1, 2026 June 1, 2027 Whether you were counting down the minutes until its release or hoping it would be put off as long as possible, it’s finally here — the Section 1071 Final Rule. The Final Rule caps a more than 10-year wait from the enactment of the original statute that prescribed these requirements in the 2010 Dodd-Frank Act, and it was released a mere day before the CFPB’s publication deadline. Surprisingly, perhaps, there were several changes from the Proposed Rule to the Final Rule that should provide some much-needed relief to community banks. However, the majority of the rules were finalized as proposed, so for those institutions who fall within the rules’ scope, it will still be quite the mountain to climb until compliance day. What Changed from Proposed to Final? Many were happy to see that the final rule contained some key changes from the proposal issued in September 2021. According to the CFPB, the changes reflect the consideration of more than 2,100 public comments on the Proposed Rule, as well as extensive public input predating the proposal. Threshold Increase Undoubtedly, the biggest and most welcome change from the proposal is the threshold increase. Whereas the Proposed Rule called for institutions to be covered when making as few as 25 covered loans per year, the Final Rule increases this all the way to 100 per year. To be clear, this still covers a large majority of bank small business lending, and those under the threshold should note that the CFPB made clear that “Lenders originating less than 100 loans per year will still be required to adhere to fair lending laws.” Of course, we always knew that banks are subject to fair lending laws regardless of the number of loans originated, but the question will be how the CFPB and/or other regulators may interpret this assertion in this new Section 1071 world. Phased Implementation Probably the second most welcome change is the phased implementation, which means that even for those institutions that are covered, some do not have to collect and report until 2026 and 2027, respectively. Specifically, the Final Rule includes compliance date “tiers” for when a covered financial institution must begin collecting and reporting data: Note that even if your institution originated fewer than 100 covered originations in 2022 or 2023, if you originate at least 100 covered originations in 2024 and 2025, you still must collect and otherwise comply with the rule starting on Jan. 1, 2026. Additionally, the bank must have a method to determine how many covered credit transactions it originated in order to determine its appropriate compliance tier. If the bank happens to not have readily available information needed to make this determination, the Final Rule says that it can use “any reasonable method to estimate its covered originations” for 2022 and 2023 and provides several examples of this. Visual Observation Requirement A third important change from the Proposed Rule is that the bank will no longer be required (or allowed) to collect a business owners’ demographic information by way of visual observation or surname. This made many breathe a huge sigh of relief as the idea of trying to collect ethnicity and race through these means raised a variety of concerns during the time of the Proposed Rule. So, under the Final Rule, this information will only be able to be collected directly from the applicant(s) and not through any other means. What Data Points Does This Cover? It is interesting that the original 2010 Dodd-Frank statute that enacted the 1071 rule required 13 data points, which have now ballooned in the Final Rule to be reportable through 19 The CommunityBanker
81 data fields. One notable change in the data points for the final rule is the addition of “LGBTQI+” business status. Whereas in the Proposed Rule there were two separate data points for business status — one for womenowned and one for minority-owned— the Final Rule just includes one data point for business status which encompasses all three of these: 1. … The Bureau notes that proposed § 1002.107(a)(19), “women-owned business status,” has been combined with proposed § 1002.107(a) (18), “minority-owned business status,” and the final § 1002.107(a)(18) 274 data point now addresses “minorityowned, women-owned, and LGBTQI+-owned business statuses.” As a result, the data points in proposed § 1002.107(20) and (21) have been renumbered as final § 1002.107(19) and (20). … 2. p. 274: https://files.consumerfinance.gov/ f/documents/cfpb_1071-final- rule.pdf While we can’t reasonably cover them all here, the remaining data points were similar to the Proposed Rule and may be reviewed in the CFPB’s Data Points Chart. What Transactions Are Covered? Covered Credit Transactions Very generally, a covered credit transaction is an extension of business credit under Regulation B, but with certain exclusions, some specifically for purposes of Section 1071, such as: • Trade credit; • HMDA-reportable transactions; • Insurance premium financing; • Public utilities credit; • Securities credit; • Certain incidental credit; • Factoring; • Leases; • Consumer-designated credit used for business or agricultural purposes; • Purchases of a credit transaction; • Purchases of an interest in a pool of credit transactions; and • Purchases of a partial interest in a credit transaction (such as a loan participation agreement). Despite the length of this list of exclusions, the definition is still extremely broad and covers a wide variety of transactions, including closed-end loans, open-end lines of credit, credit cards, merchant cash advances and various credit products used for agricultural purposes. Covered Originations A very important thing to note in this area is that “covered originations” for purposes of determining institutional coverage and compliance dates is narrower than the above. A common question we have been getting on the hotline is whether extensions and renewals should be counted. For this purpose, extensions, renewals, and certain other loan amendments are not considered covered originations, even if they increase the credit line or credit amount of the existing transaction. What Else Should I Be Thinking About? Firewall A very unique aspect of this rule is the so-called “firewall” provision, which bears mentioning here. In general, employees and officers should be prohibited from accessing the following responses if that employee or officer is involved in making any determination about the application: • The applicant’s minority-owned, women-owned, and LGBTQI+- owned business statuses; and • Its principal owners’ ethnicity, race and sex. There are limited exceptions to this firewall requirement, including a notice allowance, and the Final Rule also prohibits the bank from disclosing this demographic information to other parties, again, with limited exceptions. Safe Harbors Interestingly, the Final Rule has a safe harbor for certain incorrect census tracts, NAICS codes, and application dates. It also has a safe harbor regarding incorrect determinations of small business status, covered credit transactions and covered applications. For example, if the bank initially determines that an applicant is a small business, but then later concludes the applicant is not a small business, the bank would not be in violation if, at the time the bank collected the demographic data, it had a “reasonable basis for believing that the application was from a small business.” Action Plan Now that the Final Rule has arrived, there are a variety of questions and action steps our members should be considering, such as: • Is my bank covered under the new Final Rule? If so, what is the bank’s mandatory compliance date? • How will this affect the bank’s Compliance Management System? What policies, procedures, and other governance documents or materials may need to be amended? • Is everyone well informed of the changes and their effects, including the Board, senior management, business lines, and other stakeholders? • What type of training is planned and for whom? • What do the bank’s business lending processes look like 20 The CommunityBanker
currently and what change management will be required to implement these changes correctly and in a timely manner? • Has the bank established relationships with any vendors? Do the modules or other software offered need to be tailored to meet the bank’s needs? • What will the institution be employing for data integrity purposes? • What does a tailored project implementation plan look like for my institution? Other Resources In addition to the Final Rule itself, the CFPB published a bevy of other accompanying materials. One is a Fact Sheet, which outlines the history of the Section 1071 rulemaking and the various policy objectives driving it. Another is a Policy Statement which indicates “… that the CFPB intends to focus its supervisory and enforcement activities … on ensuring that covered lenders do not discourage small business loan applicants from providing responsive data, including … ECOA-mandated demographic data requests…” The CFPB also published a Filing Instructions Guide, which provides an overview of the filing process, instructions for what to enter in each data field, validation requirements that must be met before the register can be filed and additional resources to assist with inquiries. A Data Points Chart provides a visual guide to the various data point fields and their respective regulatory references, along with a brief description and filing instructions for each. An Executive Summary lays out an overview of the main facets of the Final Rule. Compliance Alliance will be publishing its own summary of the Final Rule very soon. Finally, a Key Dates chart provides a visual representation of the three compliance tiers and their respective mandatory compliance collection and reporting dates. Note that there are some additional tools on the CFPB’s resources page, and more may be added in the future. We’re Here to Help! It goes without saying that this is just an extremely brief overview of all the Final Rule entails. As you approach your compliance date, or just work to determine whether your institution may be covered at all, we’re here to help! Feel free to reach out to our Compliance Hotline by chat, email, or phone and one of our advisors will be happy to walk through your questions with you. www.bccadvisers.com WE VALUE BANKS. Business valuation for... ▪ Gifting and stock transfers ▪ Buy/sell agreements ▪ ESOP administration ▪ Estate settlement ▪ Stock offerings ▪ SBA 7(a) loans Lindy Ireland lindy@bccadvisers.com 434.333.6814 Now in Central Virginia! 21 The CommunityBanker
SAVE THE DATE VACB 46th ANNUAL CONVENTION & TRADE SHOW October 1-3, 2023 Hotel Roanoke & Conference Center Visit VACB.org for more information.
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