Comments to FDIC on De Novo Application Process

Dear Sir:

The American Bankers Association(ABA) appreciates the opportunity to respond to the FDIC’sRequest for Information on its Deposit Insurance Application Process (RFI). Recognizing theconstraints of the Federal Deposit Insurance Actand other statutes, this RFI is seeking feedbackon any “unnecessary burdens that have become a part of the [deposit insurance application]process.” To inform this RFI, ABA drew on feedback from the ABA de novo bank task forceconvened last year, led by then ABA Chairman Ken Burgess. This task force was largelycomprised of banks that were formed around the financial crisis, yet proved successful andresilient during that difficult time. ABA also received important perspective from banks formedafter Dodd-Frank was enacted, helpful input from bankers across the country, and thoughtfulviews from the state bank association leaders within the ABA State Association Alliance.

ABA shares FDIC Chairman McWilliams’ concern that “de novo activity is not where it shouldbe.” As Chairman McWilliams rightly noted, only 11 banks opened their doors betweenJanuary 2010 and December 2018. So few de novos does little to abate the precipitous decline ofchartered banks in the United States. At the start of 2010, there were over 8,000 chartered banks,but recent data show that number has fallen to just under 5,450. More important, the charteringof new banks helps to meet the needs of more customers and communities, brings new energyinto the ranks of bankers, and demonstrates the vitality of the banking industry while being ameasure of investor confidence in its future.

ABA appreciates the FDIC’s current and past efforts to encourage de novo formation. Oneparticularly significant development stems from April 2016, when the FDIC eliminated theseven-year period of enhanced supervisory review for de novos, which to a significant degreeacted as a post-crisis moratorium on new bank formation. Without debating whether the seven-year period of enhanced supervisory scrutiny was necessary at the outset, there is littledisagreement that reverting back to a three-year period moved in the direction of encouragingmore de novo formation.

The FDIC’s Handbook for Organizers of De Novo Institutions (Handbook) breaks down thethree major phases of de novo bank formation as follows: (1) pre-filing activities, (2) theapplication process, and (3) pre-opening activities. However, the Handbook’s clean layout ofthese three phases belie how difficult it is for organizing groups to open a de novo. Just some ofthe first responsibilities of a bank organizing group include recruiting a team of experienced andextensively vetted executive officers, board members, and staff. Organizing groups must alsosatisfy state and federal regulators that a market opportunity exists, create a detailed businessplan complete with modeled projections (including alternative scenarios), provide drafts ofoperating policies, employment agreements, equity incentive plans, offering materials, create adetailed marketing plan, and describe the product lines their projected market will need.

To finance the effort, an organizing group must raise funds for start-up expenses and ultimatelycapitalize the bank. Before opening, an organizing group must also negotiate and execute leasesfor their physical locations in addition to agreements with the third party vendors that they usefor IT, core banking services, and other services. Pre-opening also requires extensive stafftraining and systems testing. Only after extensive work and considerable expense do de novoseven begin the journey to recover their start-up costs and strive toward profitability.

Aside from the de novo application and approval process itself, investor appetite to form a newbank will always start with an assessment of whether creating a new bank is a sufficientlyattractive investment opportunity relative to alternative uses of capital. The challenges andregulatory burdens facing banks currently in existence are the same challenges and regulatoryburdens that newly formed banks must assume. The relatively low interest in new bankformation could be viewed as a troubling bellwether that the current regulatory burdens facingAmerica’s banks are simply too much. These current regulatory burdens are compounded by thechallenges these banks face in being both taxed and regulated more than many of their marketcompetitors.

These challenges notwithstanding, ABA appreciates the FDIC’s embrace of new entrantsinterested in assuming the benefits and responsibilities afforded to those in possession of a bank charter. New entrants to the banking system bring fresh ideas and help spur innovations in anindustry with a long track record of developing new ways to benefit bank customers and theircommunities.

Within this letter, ABA is not addressing every challenge with the application process, which hasgrown to be lengthy and cumbersome, nor every factor that encourages or discourages bankformation. However, with this context in mind, ABA offers the following response to theFDIC’s RFI seeking feedback on and recommendations for the deposit application process itself.

INCREASE DE NOVO TIMELINE AND APPROVAL TRANSPARENCY

Recently, the FDIC created a page on its website listing pending new deposit insuranceapplications and the date such applications were received, which can be helpful information topotential bank organizers. Before this page was created, information on pending de novoapplicants was sparse. Monitoring new deposit insurance applications required a detailedunderstanding of the de novo process combined with regular searches on the FDIC’s website fornew bank applications subject to the public comment window required by the CommunityReinvestment Act. ABA appreciates and supports the FDIC’s effort to share more informationon pending de novo applications.

ABA recommends expanding upon the current information shared to include when de novoapplicants complete other key phases of the de novo process, provided that the organizers haveno objection to sharing such information. This would help give future prospective organizers amuch better sense of how long it takes to form a new bank and how long it has taken previousorganizers to move from one application phase to another. Moving forward, some of the de novoapplicant dates that might be shared include: Submission of Interagency Charter and DepositInsurance Application, Receipt of Application, Accepted as Substantially Complete, GrantedCharter, Granted Deposit Insurance, First Day Bank Opens for Business.

Providing a clearer timeline of prior de novo applications offers relevant information on whetheror not the FDIC acts promptly at each stage of the application process, which would beconsistent with the FDIC’s recent “Trust Through Transparency” initiative.

On a related note, ABA recommends publicizing the criteria the FDIC uses for determining whatconstitutes a de novo while also noting which granted deposit insurance orders have led to suchde novos. In testimony before the Senate Banking Committee, FDIC Chairman McWilliamsobserved that only 11 new banks had been approved and opened between January 2010 and hertestimony on October 2, 2018. The testimony stated that this number of new banks did not include shelf charters, conversions, or new subsidiaries by organizations that already have anaffiliated bank. However, the FDIC lists anyone that receives a decision on an application fordeposit insurance in the same place and does not distinguish which of these are de novoinstitutions as the FDIC understands them. From January 2010 until October 1, 2018, theFDIC website lists 35 decisions on bank applications for deposit insurance, withoutdistinguishing which of those 35 decisions led to the 11 approved and opened de novos found inthe Chairman’s testimony.

ABA believes that having greater transparency around which orders granting deposit insuranceresult in approved and opened de novos would be helpful. Without distinguishing de novos fromdeposit insurance application approvals that are sought for different purposes, the FDICincreases the risk that the public will not accurately contextualize the conditions and capitalrequirements found in these very different filings. Having considerably more deposit insuranceapplication approvals than true de novos listed also paints an inaccurate picture that de novoactivity has been more fulsome than it actually was for the last ten years. A more accurateaccounting of de novo activity on the FDIC’s website is also consistent with the FDIC’s “TrustThrough Transparency” initiative.

REDUCE FDIC WASHINGTON OFFICE DELAYS

The Handbook states that, “[d]epending on the application characteristics and the findings withregard to the statutory factors, the application may be acted on at the regional level, at thedivisional level (at the FDIC’s Washington Office), or by the FDIC Board of Directors.”It further states that “[r]egardless of the nature or circumstances of the proposal, field and regionalstaff will communicate with organizers throughout the application process and keep themapprised of our status in considering the application.”

However, ABA understands there to be instances where organizers are not adequately apprisedof the status of their applications. Bank organizers have expressed consistent frustration thatapplications (or portions of applications) needing input from the FDIC’s Washington Officelanguish with no explanation as to who or what is holding back their application. From theperspective of organizers, decision makers in the FDIC’s Washington Office are hidden fromview and cannot be reached, even when assigned local case managers seem receptive tofacilitating such direct communication. This lack of transparency and accountability has enabledwhat multiple organizers have described, at times, as a lack of urgency on the part of the FDIC’sWashington Office.

Depending on how far along the applicants are in the de novo process, the expenses thatorganizing groups must bear to accommodate such delays can be significant and may require raising additional seed money during the application process. ABA has learned that it is notunusual for organizing groups to spend $100,000 a month toward the tail end of their approval,which includes significant occupancy expenses and payroll expenses for day one employees,with no revenue to offset those costs. At the later stages of organization, a 2-week delay by theFDIC is better interpreted by these groups as an unnecessary $50,000 spent.

ABA recognizes that there may be legitimate reasons for carefully reviewing applications, andthat certain concerns cannot be communicated in the interest of transparency (e.g. the status ofcriminal background checks for key personnel). Still, there may be opportunities to resolve whatmany perceive to be an unacceptable delay structure. More efficient and direct communicationchannels would allow organizers to assess issues raised by the FDIC and resolve them in aquicker manner.

ABA recommends giving bank organizers a clear sense of who, beyond their case manager, has adecision making role in their application, particularly in Washington. In addition to being goodagency practice, ABA believes that this recommendation is also consistent with the FDIC’s“Trust Through Transparency” initiative.

EMPOWER (OR ENCOURAGE) REGIONAL OFFICES

Bank organizers typically express positive feedback about their interactions with the FDIC’sRegional Offices and the case managers they work with. ABA believes that the FDIC’sWashington Office should empower Regional Offices by delegating the vast majority of their denovo decision making authority to the FDIC Regional Offices whenever those offices and theircase managers are prepared to act on de novo applicants. However, ABA also believes that theFDIC’s Washington Office should stay alert to instances where these Regional Offices arelethargic or unduly cautious. Though bank organizers typically view their Regional Officeinteractions favorably, such positive experiences are not universal. In the limited instanceswhere Regional Offices or case managers prove unduly cautious, the FDIC’s Washington Officeshould intervene and serve as a necessary catalyst for bank formation.

To that point, quality case managers are critical to the de novo formation process. To create aconsistent, positive climate that encourages new de novo creation (and more applications), it isimportant that every case manager assigned to a de novo application be highly competent andembrace the value of new bank formation. Whenever helpful, case managers should besupported in their review by others at the FDIC to increase the speed of application review andprevent unnecessary delays.

SIMPLIFY APPROVALS FOR BUSINESS PLAN DEVIATIONS

Section 6 of the Federal Deposit Insurance Act requires the FDIC to consider seven statutoryfactors in connection with an application for deposit insurance. Among those factors, the FDICmust assess the future earnings prospects of a depository institution and the risk the institutionwould pose to the FDIC’s Deposit Insurance Fund.

Requiring de novo applicants to submit a business plan is one way to assist the FDIC inevaluating the statutory factors, though the business plan itself is not statutorily required. Asnoted in the Interagency Charter and Federal Deposit Insurance Application, the business planis an in-depth, comprehensive analysis and set of projections for how an institution intends toorganize itself and become a sustainable banking franchise. The efforts undertaken to develop asatisfactory business plan can be valuable to both the FDIC and organizing groups to be sure thatimportant considerations are taken into account when opening a new bank.

Still, from the perspective of a new bank, having business decisions scrutinized by the FDIC forthe first 36 months of operation is taxing. When a de novo contemplates a material deviationfrom its business plan, the institution must first obtain prior approval from the FDIC. In April2016, the FDIC offered clarity on the myriad of banking decisions that constitute a materialbusiness plan deviation for de novos. Among others, the list of material deviations include growth, a change in asset mix, a change in liability mix, a change in revenue mix, a change inproduct or service offerings, a change in target markets, a change in off-balance sheet activities,and capital-raising activities.

The FDIC appears to view with skepticism de novos that outperform their business plan, treatingsuch performance as evidence that the de novo’s initial projections were not sufficiently accurate.In the absence of strong evidence that such performance is based on the assumption of imprudentlevels of risk, ABA believes that the FDIC should instead champion strong de novo performanceas evidence that new franchises can be even more successful and profitable than planned.

The FDIC’s careful supervision of a de novo comes at a time when the new bank franchise isreplete with capital and operating with a management team and board that has already met theFDIC’s approval. De novos already have powerful incentives to succeed. Investors, managers,employees, customers, and local communities have the same desire for de novos to be successfuland sustainable. These powerful incentives for newly chartered institutions to operatesuccessfully make the agency’s detailed prescriptions in the business plan less necessary from asupervisory perspective.

ABA recognizes that the FDIC has an interest in providing a reasonable level of supervision tonewly chartered institutions and can offer valuable perspectives. However, the FDIC’s detailedprescriptions and prior approval process for business plan changes can risk placing too manybusiness decisions and opportunities in the hands of agency staff when bankers are better suitedand more prompt to make these banking judgments. The long list of material deviations from thebusiness plan serve as a signal to de novos to eschew dynamism or unanticipated opportunities,expressing instead an agency preference to conform to regulatory expectations that new banksshould begin their journey with three years of predictable “plain-vanilla” banking.

The FDIC’s prior approval requirement for material deviations from the business plan alsocreates a presumption that certain legal and normal banking activities are unacceptable until theyare permitted. This puts de novos in the position of asking the FDIC for permission to conductbanking activities with no clear timeline for when or if they will receive an FDIC response.Without prompt action, business opportunities subjected to FDIC for prior permission mayquickly go elsewhere. To be responsive to customers and market opportunities, de novos need tohave a clear and prompt timeline on when they will receive a decision on their requests.

ABA recommends changing the prior approval requirement for business plan deviations. TheFDIC should move to a system where de novos provide the FDIC a notice of intent to deviatefrom their business plan. This notice of intent would trigger a short window wherein the FDICmay object, in writing, to the proposed deviation. This short window could be as little as 30days. Absent an objection within that window, the deviation should be deemed approved by theFDIC. This would remove the presumption that certain legal and normal banking activities areoff limits, placing the burden on the FDIC to articulate promptly why proposed business planchanges are objectionable. It would also give de novos the encouragement necessary to fillunanticipated local market needs that often come with a short window of opportunity.

COMMUNICATE CAPITAL EXPECTATIONS AND APPROVE APPLICANTS

When the FDIC released a draft of its Handbook in December 2016, the draft contained languagestating that for de novos, “the FDIC does not prescribe a minimum dollar level of capital.” Indraft, final, and revised forms, the Handbook has remained unchanged on this point. TheHandbook’s latest iteration from October 2018 says that “the FDIC does not prescribe aminimum dollar level of capital for any given proposal.” Rather, the Handbook states that the FDIC expects initial capital to be sufficient to maintain a tier 1 capital to assets leverage ratio ofnot less than 8 percent for the first three years of operation. This language is consistent withthe FDIC’s long standing Statement of Policy on Applications for Deposit Insurance (SOP).

However, current and prospective bankers have consistently expressed their belief to ABA thatthe FDIC expects formation groups to raise a set minimum amount of capital (i.e. $20-$25million) to start a new bank, regardless of the written statements found in the FDIC’s Handbookor SOP.

High capital expectations, whether in perception or practice, clearly have the potential todiscourage prospective applicants from starting a de novo. When institutions are asked to holdmore capital than is necessary to open their doors and begin a sustainable banking franchise,these banks feel investor pressure to deploy their capital as quickly as possible. ABArecommends, instead, the exercise of appropriate flexibility on the part of the FDIC to permitbinding additional capital commitments that can be drawn upon by a de novo as needed and ascan be effectively deployed, lessening the inefficiency of an excessively high initial capital raise.

This could help banks attract prospective investors who might be persuaded of the value oftaking a long-term view of a bank investment that generates low short-term returns.

Unnecessarily high capital expectations can increase the likelihood that de novos will have togather capital beyond their local market, sometimes driving de novos toward investors that doexpect a quicker return on their capital, which could encourage assuming more risk. Whencapital requirements are too high and lead to growth pressure at the new bank, the FDIC risksdriving bank management to deviate from their own assessment of the optimal balance of riskand return.

Furthermore, a high initial capital expectation may have the effect of “pricing out” de novo banksfrom rural communities or other places where a smaller bank would be suitable but where therewould not be enough readily available business for a more highly capitalized new bank tosucceed. Chairman McWilliams recently noted how many counties in the United Statescurrently have no resident bank at all. Excessively high initial capital requirements can make itdifficult to address that problem.

ABA recommends that the FDIC continue publicizing that there is no minimum level of capitalrequired for de novo formation. The FDIC should also highlight any de novos that open theirdoors with under $20 million in capital. When communicating the FDIC’s position that there isno minimum capital requirement for de novos, a statement on the FDIC’s “Applications forDeposit Insurance” page would be helpful, as would continuing to communicate this positionregularly at public hearings and speaking engagements by agency principals and staff.

ABA also recommends more prominently displaying the initial capital requirements found in theorders granting applications for deposit insurance. The FDIC’s webpage on “Decisions on BankApplications for Deposit Insurance” currently has a table that has columns listing the following:Bank Name, City, State, Date of Agency Action. Simply adding a column that shows the requiredinitial paid-in capital funds that the FDIC requires as a condition of approval would helphighlight an important data point in demonstrating that the FDIC, as a practical matter, hasembraced de novo applicants with varied initial capital levels. ABA believes that prominentlydisplaying this useful information for the public would also be consistent with FDIC’s “TrustThrough Transparency” initiative.

Ultimately, clear communication around the FDIC’s position that they hold no minimumexpectations on capital will be most effective when augmented by approved applications fordeposit insurance to organizing groups that have business plans that need less than $20 million ininitial capital.

REVISE SOP TO ENSURE REASONABLE COMPENSATION TO BANK ORGANIZERS

ABA recommends modernizing the FDIC’s Statement of Policy on Applications for DepositInsurance (SOP) to permit more flexibility in setting reasonable compensation arrangements forthose interested in funding bank organization costs. A strict reading of the SOP’s restrictions oncompensation, sometimes in combination with different state laws, can unnecessarily restrictreasonable compensation arrangements for such individuals.

Organizers that substantially contribute to the organization of a new depository institution butwho do not intend to serve as an active officer or director after the bank opens for business(inactive organizers) are discussed in Section 4(b) of the SOP. These inactive organizers risklosing some or all of the “seed money” they provide to the formation group if the new bank doesnot ultimately get approval to open. However, there are instances where the SOP prevents theseinactive organizers from deriving reasonable and timely consideration for bearing that risk.When this occurs, inactive bank organizers lose the economic incentive to provide seed money toorganizing banks.

ABA believes that this is a problem within the FDIC’s power to resolve. Section 4(b) of theSOP reads, in pertinent part—

"The FDIC recognizes that there will be limited instances where individuals who substantiallycontribute to the organization of a new depository institution do not intend to serve as an activeofficer or director after the institution opens for business. The FDIC generally will not object toawarding warrants or options to incorporators who agree to accept shares of stock in lieu ofcash payment for funds placed at risk or for professional services rendered. In such instances, theFDIC defines funds placed at risk to include “seed money” actually paid into the organizational fundand the value of professional services rendered as the market value of legal, accounting and otherprofessional services rendered. Generally, warrants or options for organizers who will notparticipate in the management of the institution will be considered excessive if the amount ofoptions or warrants to be granted exceeds the number of shares of stock received in repaymentfor funds placed at risk and/or for professional services rendered." (emphasis added)

The FDIC’s current reading of their SOP does not appear to contemplate the granting of warrantsor options to inactive organizers that also receive cash reimbursement. However, in California,receiving shares of stock as compensation for services rendered in organizing a bank appears tobe prohibited, which means organizers must be reimbursed in cash.This required reimbursement system does not compensate inactive organizers for placing funds at risk.Instead, this reimbursement merely lets inactive organizers recover the funds they placed at riskafter the bank finally opens.

Such inactive organizers would normally expect to recover their funds placed at risk, but also begranted a reasonable amount of stock options for the uncertainty of financing a new bank.However, the SOP tethers the amount of warrants or options permissible for inactive organizersto “the number of shares of stock received in repayment for funds placed at risk.” Consequently,any amount of warrants or options granted to inactive organizers can be treated as “excessive,”since any amount of options will exceed the number of shares received in repayment (i.e. zeroshares). This unacceptable arrangement brought about by the SOP deters bank formation, sinceit removes the underlying economic incentive for inactive organizers to support bank formation.

Recognizing that organizer compensation should be reasonable and proportionate to the risksassumed, there does not appear to be any compelling public policy justification for limiting theform such reasonable compensation takes. ABA recommends taking steps necessary to conformthe SOP to permit reasonable compensation arrangements for bank organizers, inactive or otherwise. An important starting point for consideration is to revise the FDIC’s SOP to lookmore like the OCC’s Licensing Manual on Charters, which provides greater flexibility. TheOCC Licensing Manual states, in pertinent part—

"… the bank can repay organizers or founders in cash. Alternatively, the organizing group mayrequest prior OCC approval so that an organizer or founder can receive stock, or a combination ofstock and cash."

ABA believes that this important revision will support the vitality of the dual banking systemand permit arrangements that provide reasonable compensation to those that provide significantsupport to bank formation.

Conclusion

ABA appreciates the FDIC’s interest in increasing transparency and removing unnecessaryregulatory requirements and agency processes that impede new bank formation. We lookforward to working with the FDIC to identify ways, within the FDIC’s statutory framework, toencourage de novo formation and a dynamic banking industry. Should you have any questionsabout these suggestions, please do not hesitate to contact the undersigned at [email protected] or(202) 663-5253.

Sincerely,

Shaun Kern
Senior Counsel
Office of Regulatory Policy