Assessing Strategic Options: Charter Change, Merger, Acquisition, Expansion October 29, 2014

New York Bankers Association 2014 Financial Services Forum

Robert C. Azarow Partner Arnold & Porter LLP

Charter Change: If the Shoe Fits ….

 Bank v. Thrift; Federal v. State; Fed member v. nonmember; SLHC v. BHC  Charter decision depends primarily on bank’s overall strategic business plan – what’s your model? – Consider what activities are currently being conducted and what activities are expected/proposed to be conducted in the future – Federal thrifts are subject to more stringent investment and lending limits compared to national banks and state banks and must satisfy QTL test – Overall market perception of a commercial bank is significantly better than market perception of a thrift 2

Key Regulatory Factors to be Considered  Certain advantages to national bank and federal thrift charters have been eliminated or reduced as a result of the Dodd-Frank Act  National banks and federal thrifts no longer have interstate branching advantage over state banks  Benefits of federal preemption significantly watered down 

Conversion to state charter will require full compliance with state consumer compliance laws

 Preemption intact for licensing/supervision – only benefits multistate activities

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Key Regulatory Factors to be Considered (cont.)  Regulatory climate at state level: – State regulators perceived to be more friendly and sensitive to needs of state banks due to proximity and familiarity with the banking area and local economic conditions • State bankers viewed as having more opportunities to affect banking policy at state level than at federal level

– New York Department of Financial Services (“DFS”) staff generally considered more approachable at high levels compared to OCC senior staff – DFS Superintendent more politically motivated than prior Superintendents and focused on consumer and BSA compliance issues – NY Attorney General actively enforcing laws against financial industry players PRIVILEGED AND CONFIDENTIAL

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Key Regulatory Factors to be Considered (cont.)  Regulatory supervision considerations: – Size may matter - OCC has significant resources and experience supervising larger institutions – OCC exam staff tend to be more invasive into a bank’s strategic decision making compared to FRB and DFS • FRB/DFS exam staff tend to not second guess bank business decisions; focus on risk management processes and procedures and extent to which they are followed in implementing such decisions

– Regulatory assessments significantly higher for OCC supervised institutions than for NY state chartered institutions – OCC is generally viewed as being more hostile to the thrift model; FRB is generally viewed as being more hostile to thrift holding companies 5

Key Regulatory Factors to be Considered (cont.)  Regulatory framework: – National banks and federal thrifts regulated by OCC; holding company regulated by FRB – NY banks regulated by DFS and by FDIC (for non-member banks) or FRB (for member banks); holding company regulated by FRB and DFS – Regardless of charter type, banks with more than $10 in assets are subject to CFPB jurisdiction with respect to consumer financial protection laws

 Regulatory status: – Approval of OCC required for conversion to national bank or federal thrift charter; approval of DFS/notice to OCC required for conversion to NY state charter • However, OCC approval will be required for conversion to a state charter if bank has a 3 composite rating or an outstanding enforcement action

– Conversion unlikely to be approved for a 3 rated institution 6

Effect of Compliance Issues on Potential Sellers  The increasing costs of regulatory compliance are becoming prohibitive for many smaller institutions – Compliance program expenses – Capital requirements

 There is future uncertainty regarding the continued expansion of compliance regulation and enforcement, especially by the CFPB  Selling may become an increasingly attractive alternative to the burdens and uncertainties of regulatory compliance 7

Effect of Compliance Issues on Potential Sellers (cont.)

 Institutions with compliance issues may face M&A consequences as a seller: – Regulators may pressure the institution to sell, especially when concerns with management exist – Seller may be limited in its ability to obtain true value for the sale of the institution – Seller may be forced to commit to more extensive representations and warranties in order to consummate a sale – Private sellers may face ongoing indemnification obligations for compliance issues 8

Effect of Compliance Issues on Potential Buyers  M&A may allow a buyer to use economies of scale to absorb increasing regulatory compliance costs  Buyers must consider the regulatory risk profile of a target institution, and whether that target’s compliance systems can effectively integrate with the buyer’s systems – Representations and warranties should be used to protect against a seller’s legacy compliance issues, as well as indemnification where possible to address potential compliance exposure

 Buyer must also address its own compliance issues (e.g. ERM function, stress testing) prior to a proposed M&A transaction to limit the likelihood of a regulatory denial/suspension, or a regulatory approval with potentially burdensome conditions 9

Effect of Compliance Issues on Potential Buyers (cont.)  Buyers should specifically identify a target institution’s compliance problems, including in any of the following high risk areas: – Residential loan compliance, including • Foreclosures and loan modifications • New requirements under the Dodd Frank Act including qualified mortgage and ability to repay • Flood insurance • Fair lending; HMDA; RESPA • Community Reinvestment Act

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Overdrafts Relationships with payday lenders Privacy and security Transactions with affiliates (for more complex sellers) Insider transactions BSA/AML 10

Regulatory Factors in an M&A Application  Regulatory factors in determining an approval: – Financial and managerial resources and future prospects of the combining and resulting institutions – Effectiveness in combating money-laundering activities – Convenience and needs of the community to be served – Risk to the stability of the United States banking or financial system (applicants must address irrespective of the size of the institutions involved) 11

Financial and Managerial Resources and Future Prospects 

Regulators review supervisory information of institutions involved in the transaction, including reports of examination, and also review proposed plans for the operation of the resulting bank – Regulators may also conduct a pre-merger examination

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Regulators weigh safety and soundness factors, and may deny an M&A transaction that would result in a bank with inadequate capital, poor management or unsatisfactory earnings prospects

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Interstate mergers may only be approved if each bank involved in the transaction is “adequately capitalized” as of the date the merger application is filed, and the responsible agency determines that the resulting bank will be “well capitalized” and “well managed” upon the consummation of the transaction

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Existence of compliance issues could impact each of these determinations

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Bank Secrecy/Anti-Money Laundering (BSA/AML)  Regulators consider the effectiveness of each institution involved to combat money-laundering activities, even in overseas branches  Regulators conduct a review of the following BSA/AML areas: – Adequacy of each institution’s programs, policies, and procedures – Supervisory history of each participating institution – Effectiveness of corrective program outstanding 13

Community Reinvestment Act (CRA)  All M&A transactions are subject to review for compliance with the CRA – Regulators consider the CRA records of performance for all participating institutions – Although recently CRA has received less attention in light of other regulatory issues, an application can still be significantly delayed by a CRA protest – New York Metropolitan area deals are routinely protested by community activists, similar to 1990s

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Results of Compliance Issues in an M&A Application  A regulatory review of an M&A transaction application may result in any of the following regulatory responses: – Application denial or suspension due to significantly adverse findings – Required correction of identified problems before approval is granted – Application approval, subject to standard and/or nonstandard conditions

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Robert Azarow is a Partner in the New York office where he concentrates his practice in securities, corporate, and banking law. His experience includes serving as corporate and regulatory counsel on mergers and acquisitions; public and private offerings of equity, debt and hybrid securities both as issuer's counsel and underwriters' counsel; and conversions of thrift institutions from mutual to stock form. Mr. Azarow also assists public companies in preparing their periodic securities law filings; proxy statements and related shareholder meeting materials; insider trading; and other securities law compliance materials and related disclosure matters.

Robert C. Azarow Partner [email protected]

Mr. Azarow has extensive experience advising banks, mortgage companies, insurance companies, investment banks, and other financial institutions on capital markets transactions. He also advises on acquisitions of public and private companies, asset acquisitions, branch purchases, reorganizations into holding company form, and acquisitions of failed financial institutions and distressed assets from the Federal Deposit Insurance Corporation (FDIC). Further, he has assisted financial institutions with their regulatory compliance matters, including response to examination issues and transaction-related matters, as well as regulatory capital compliance; stock repurchase programs; capital distributions; permissible investments and activities, regulatory agreements for troubled institutions and periodic reporting; regulatory reporting; and Internet banking. Mr. Azarow counsels public companies and financial institutions on a wide variety of corporate governance matters. These include Sarbanes-Oxley compliance; stock exchange listing requirements; shareholder activism; and preparation of hostile takeover defenses.

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