United States: FDIC Expands De Novo Period: Guidance for State, Nonmember Banks That Are Fewer Than Seven Years Old

On August 28, 2009, the FDIC issued new supervisory guidance advising the banking industry that the agency is extending the de novo period from three (3) to seven (7) years. Nationwide, the FDIC asserts that "newly formed insured institutions pose an elevated risk to the FDIC Deposit Insurance Fund," prompting the FDIC to unilaterally revise the Orders issued to new banks over the last few years that set out capital and allowance for loan and lease losses requirements, as well as other opening restrictions. At this time, we do not have definitive information about what, if anything, the state regulators, the Federal Reserve, or the Comptroller of the Currency may do to complement or contradict the FDIC's new supervisory position. We suspect that financial and personnel resources will be key to other agencies' decisions. When that information is available, we will notify our clients accordingly.

Capital

Under existing policy, newly insured FDIC-supervised banks are subject to higher capital requirements during the first three years of operation. The new supervisory guidance expands that period from three to seven years, which the FDIC says is consistent with the deposit insurance assessment rules. In Tennessee, the FDIC and the Commissioner of Financial Institutions have required that a new bank operate with not less than 8% Tier 1 Leverage capital for the first three years of operations. We are currently assuming that a bank that is five years old, for example, would be placed back under the 8% requirement even if its capital had dropped to under 8% in the years since its third anniversary. Nothing in the guidance suggests otherwise.

Examinations

The FDIC is also revising its visitation and examination schedules for risk management, compliance examinations, and CRA evaluations for newly insured nonmember banks. New FDIC-supervised banks will undergo a limited-scope examination for risk management within the first six months of operation and a full-scope examination within the first twelve months. Subsequent to the first full examination and through the seventh year of operation, the bank will remain on a 12-month examination cycle. No 18- month interval examinations will be applied during the first seven years of operation. We do not yet know how this will affect joint examinations conducted by state regulators and the FDIC.

All new banks will undergo a full-scope compliance examination and a CRA evaluation within the first 12 months of operation. A visitation will be performed in Year 2; a compliance examination only in Year 3; a visitation in Year 4; and a compliance examination and CRA evaluation in Year 5. Thereafter, the bank "may" be subject to the regular examination schedule. We think it is interesting that the guidance uses the word "may" rather than "will" with respect to subsequent examinations during the remainder of the de novo period.

Business Plans

For the first seven years of operation, any material changes to a new bank's business plan must receive the prior approval of the FDIC because troubled or failed de novo institutions have demonstrated several common elements during the first seven years of operation:

• rapid growth
• over-reliance on brokered deposits
• concentrations without adequate risk management
• significant deviations from approved business plans
• non-compliance with conditions in the deposit insurance orders
• weak risk management practices
• unseasoned loan portfolios which masked potential deterioration during an economic downturn
• weak compliance management systems leading to consumer protection problems
• involvement in certain types of third-party relationship with inadequate oversight.

Going forward, for the first seven years of a FDIC-supervised bank's operation, any material change to the bank's business plan must be submitted to the FDIC for approval, together with adequate support for the business reason for the proposed change. The FDIC will evaluate the proposed change to determine if the bank has sufficient capital; management expertise; and internal controls in place to manage the risks associated with the changed plan. If the bank implements a material change to its business plan during the new de novo period without first obtaining FDIC approval, the FDIC is permitted to consider assessing civil money penalties or other types of enforcement actions.

Revised Projections and Business Plans

Before the end of Year 3 of operation, newly insured FDIC-supervised banks will be required to submit:

• business plans for Years 4 through 7 that include:

• pro forma financial statements for Years 4 through 7.

Newly insured state nonmember banks that have not yet reached the end of the third year of operation will be required to submit financial projections and updated business plans for Years 4 through 7. According to the American Banker's September 1, 2009, report on the new supervisory guidance, banks that have passed the three-year mark will not be required to submit new business plans, but it is unclear whether material changes in the business plans of banks that are between three and seven years old will have to get the prior approval of the FDIC before deviating from their original plans.

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