On November 20, 2014, the Federal Deposit Insurance Corporation (FDIC) issued additional guidance* on its 1998 Statement of Policy on Applications for Deposit Insurance, in an effort to clarify the requirements for de novo banks and to encourage more applications. Since the financial crisis, there has been stagnant or declining growth in bank charters, with only one new bank formation since the fourth quarter of 2010. The FDIC requirements for de novo banks are often cited as a reason for the drop in applications, as potential incorporators view the requirements as onerous and sometimes impossible to meet in today’s economic and regulatory climate. The FDIC’s Q&A publication appears to be an attempt by the agency to counteract this impression and to prompt a resurgence of applications.
Whether the FDIC really means what it says will be demonstrated in the months and years ahead. Hopefully, with the economy strengthening, qualified new bank groups will get an opportunity to start their again and fill some of the voids created by mergers.
The 1998 Policy Statement
In 1998, the FDIC issued a Statement of Policy on Applications for Deposit Insurance, which detailed certain requirements for de novo bank applications. Among other things, the requirements looked to the proposed bank’s business model, the financial prospects of the bank, and the strength of its management team.
Specifically, an applicant had to demonstrate the following seven statutory factors:
- Financial History and Condition. Since a new institution would have no financial history, the FDIC looked to the ability of the proponents of the bank to provide financial support for the new institution, whether the institution limited its investment in fixed assets, and whether any insider transactions were properly structured and documented.
- Adequacy of the Capital Structure. The initial capital of a proposed depository institution had to be sufficient to provide Tier 1 capital to assets leverage ratio of not less than 8.0% for the first three years of operation. Further, if the new institution was to be a wholly owned subsidiary of a holding company, the FDIC looked to the capital structure of the holding company as well.
- Future Earnings Prospect. The applicant had to demonstrate that it could be operated profitably within three-years, which was usually accomplished through the submission of a three-year business plan.
- General Character and Fitness of the Management. The new institution had to support a management rating of a “2.” Since management likely did not have any operating history, the FDIC looked to the management’s financial and other business experience, their duties and responsibilities at the new institution, professional and personal financial responsibility, reputation for honesty and integrity, and familiarity with the economy, financial needs, and general character of the community that the new institution will serve. The new institution also had to have at least a five-member board and provide financial and biographical information for all proposed directors, officers, and 10% shareholders.
- Risk Presented to the Bank Insurance Fund. The FDIC interpreted this factor broadly and relied on any information available to it, including the new institution’s business plan. Any changes to the business plan within the first three years had to be reported to the FDIC.
- Convenience and Needs of the Community to be Served. The services of the proposed institution needed to match the needs of the community in which it is located.
- Consistency of Corporate Powers with the Purposes of the Act. The proposed activities of the bank had to fall within the activities allowed for national banks or state-chartered banks, respectively.
- The original de novo period for new institutions lasted approximately three years, during which time the FDIC took a stronger stance for new banks with respect to the risk-profile of their activities.
The 2009 Expansion to Seven Years
In the wake of the financial crisis and the high volume of bank failures, the FDIC expanded its supervisory powers pursuant to a Financial Institution Letter, issued on August 28, 2009,** and, effectively, extended the de novo period from three years to seven years. The FDIC announced it was extending its de novo period procedures, including higher capital ratios and more frequent examinations, to last for the first seven years of a bank’s operations. Further, any material change to an institution’s business plan must receive prior approval from the FDIC and the institution must submit an additional business plan for years four through seven. This resulted in almost all changes requiring Washington, D.C. approval, which at a minimum delayed activities, including capital raises.
The 2014 Q&A Clarification
The November 2014 Q&A publication issued by the FDIC provided additional guidance and clarity with respect to the de novo period requirements, as well as further information about the application process, support available to applicants, and application approval timing.
Most importantly, the Q&A publication clarified the following two issues:
- The initial capitalization of a new institution is not required to be sufficient to provide a Tier 1 capital to assets leverage ratio of at least 8.0% for the first seven years. The initial capitalization need only be sufficient for the first three years of operation, although the institution may need to maintain its capital ratio above the 8.0% threshold for the entire seven year de novo period. For institutions that have a non-traditional risk profile, the required ratio threshold may be higher.
- The initial business plan need only cover the first three years of operation. However, a supplemental plan for years four through seven will likely be required.
There are still questions that remain unanswered and new questions raised by the Q&A publication. However, there seems to be a conscious effort on the part of the FDIC to encourage new applications. In fact, in a November 25, 2014 American Banker article, “Industry Groups Hail Move on De Novos,” by Ian McKendry, James Watkins, a senior official at the FDIC, is quoted as stating: “We very much are looking forward to getting more . . . applications.”
Graham & Dunn PC assisted in 25 bank formations during the peak of the 1990s and early 2000s in Washington, Oregon, Alaska, Arizona and Nevada. We have also been involved in assisting clients in successfully navigating regulatory hurdles during the expanded seven year de novo period. If you have any questions or wish to discuss issues specific to your institution or the formation of a new financial institution, please contact Stephen M. Klein (206.340.9648 or firstname.lastname@example.org) or Katherine A. Robinson (206.340.8770 or email@example.com).