To help our clients navigate their way through the coronavirus (COVID-19) crisis, Arnold & Porter has established a Coronavirus Task Force. Regularly visit our Task Force webpage for the latest news and developments, and subscribe to our "Coronavirus (COVID-19)" mailing list to receive our latest client Advisories and register for upcoming webinars.
Introduction
With shares trading at severely discounted prices, the federal funds rate at zero percent, and banks being encouraged to use the Federal Reserve discount window, among other actions being taken by the federal government to maintain liquidity in the markets and prevent a meltdown of the US economy, many publicly traded bank holding companies are considering stock buyback programs, or extending the time period for those already planned. Before going down that road, however, bank holding companies should consider the potential regulatory and public relations consequences of doing so.
This Advisory includes various regulatory and public policy considerations for US publicly traded bank holding companies that are considering starting or expanding share buyback programs during the coronavirus pandemic and provides recommendations for bank holding companies that plan to move forward on any share buyback plans during these stressed economic times. Though not specifically covered in this Advisory, state corporate law requirements as well as federal securities law considerations, including insider trading, Regulation M, and periodic and current disclosure obligations, should always be taken into account when adopting or implementing a share buyback program.
Is a Share Buyback Program During an Economic Crisis a Prudent Decision and Consistent with Safe and Sound Practices?
The federal banking regulators are actively encouraging banks to use available capital and liquidity to support the economy. To that end, the Board of Governors of the Federal Reserve System (Federal Reserve) has made a number of monetary policy decisions and created new credit facilities using its emergency powers in hopes of maintaining liquidity in the markets, and the federal banking agencies have issued a statement encouraging banking organizations to use their capital and liquidity buffers to continue lending to and assisting businesses. Additionally, political pressures on corporations, especially banking organizations, to help alleviate the economic stress caused by the coronavirus has pushed the largest US banking organizations to announce their suspension of stock buyback programs until at least June and to use excess capital to service the economy. In the interest of further incentivizing banking organizations to use their capital and liquidity buffers to lend and continue financial intermediary activities, on March 17, 2020, the federal banking agencies adopted an interim final rule to amend the definition of "eligible retained income" to make any automatic limitations on capital distributions that could apply under the agencies' capital rules more gradual.1 The federal banking regulators are also considering other rule changes that would free up bank capital and liquidity, including further delaying the implementation of Current Expected Credit Losses methodology and changing leverage limits.
While encouraging banking organizations to use their capital and liquidity buffers to continue lending and assisting customers, the regulators expect banking organizations to make prudent decisions, including those related to stock repurchases and other capital distributions. Additionally, the federal banking agencies have not made any changes to any other rule or regulation that may limit capital distributions or discretionary bonus payments under the regulatory capital rules. Therefore, the Federal Reserve's rules and regulations, including those related to prior approval or notice requirements under the regulatory capital rules2 and the capital plan rule3 (which feeds into the Federal Reserve's Comprehensive Capital Analysis Review (CCAR) framework) apply to share buybacks by a bank holding company. Bank holding companies that obtained prior approval for a share buyback program from the Federal Reserve prior to the coronavirus outbreak should also consider consulting with the Federal Reserve given current economic conditions.4 Any bank holding company that does not have an existing share buyback program and is considering share repurchases not in the ordinary course should carefully consider what the reaction of its primary federal bank regulator, state bank regulator (for state-chartered banks) and Federal Reserve would be to that course of action.
Keep in mind that the Federal Reserve requires bank holding companies to serve as a source of financial and managerial strength to their subsidiary banks. In addition, banks are restricted in their ability to finance the repurchase of their parent holding companies' shares. Repurchases of debt instruments that form part of a banking organization's capital are subject to additional restrictions.
Any bank holding company that is seeking the approval of the Federal Reserve (and therefore to avoid later regulatory scrutiny) should be prepared to discuss the regulatory risks of pursuing a share buyback program, and how the banking organization would be adequately capitalized after the share buyback program in light of its ongoing operations, lending activities and other financial obligations, notwithstanding the current stressed economic conditions. Banking organizations should also be prepared to address the same types of issues that the New York Department of Financial Services is demanding that its regulated institutions report in writing by April 9:
- Assessment of the credit risk ratings of the customers, counterparties,and business sectors impacted by the coronavirus;
- Assessment of the credit exposure to customers, counterparties, and business sectors impacted by the coronavirus arising from lending, trading, investing, hedging, and other financial transactions, including any credit modifications, extensions, and restructurings (including capitalizations of interest);
- Assessment of the scope and the size of credits adversely impacted by the coronavirus that currently are in, or potentially may move to, non-performing/delinquent status, including consideration of stress testing and/or sensitivity analysis of loan portfolios and the adequacy of loan loss reserves;
- Assessment of the valuation of assets and investments that may be, or have been, impacted by the coronavirus;
- Assessment of the overall impact of the coronavirus on earnings, profits, capital, and liquidity (including impact on loan-to-deposit ratio) of your institutions; and
- Assessment of reasonable and prudent steps to assist those adversely impacted by the coronavirus.
In general, if a bank holding company has not stress tested its portfolio to understand the implications of the coronavirus on its customers, loans, earnings, and capital, the Federal Reserve could view the reduction of capital through a stock buyback as an unsafe and unsound practice by the bank holding company or the bank holding company's disregard of its source of strength obligations to its subsidiary bank.
Is the Share Buyback Program Worth the Potential Regulatory and Political Scrutiny or Criticism?
Banks are under significant political pressure to use excess capital to lend and provide banking services to the stressed economy. Any bank (or its holding company) that takes advantage of the discount window or other government supported liquidity would come under severe criticism for using excess liquidity during the same time period of stress to buy back its own stock, even if the need occurred as a result of unanticipated events or if the stock buyback decisions were made prior to the banking organization being in need of government assistance.
Additionally, a bank holding company should consider whether pursuing a share buyback program at this time would materially impact its ability to continue its lending and financial operations or its ability to assist its customers, including by making accommodations suggested by the regulators (waiving fees, extending due dates, reasonable loan modifications, etc.). Bank holding companies that engage in share buybacks at this time in a manner that negatively impacts the banking organization's ability to lend and serve as a financial intermediary during these stressed times may be exposed to heightened political scrutiny, and even regulatory scrutiny by the Consumer Financial Protection Bureau or state regulators under consumer protection laws. State governors and other state government officials have issued a number of orders over the past few days targeted at consumer protection, including halting evictions and foreclosures.5 The US Department of Housing and Urban Development is instructing mortgage servicers to suspend foreclosures and evictions of homeowners of single family homes with mortgages guaranteed by the Federal Housing Administration for the next 60 days,6 and the Federal Housing Finance Agency has directed the same of the government sponsored enterprises for mortgages backed by the enterprises.7 More efforts are expected from the federal government aimed at protecting businesses and consumers impacted by the coronavirus, including those that will result in additional stress on banking operations and the US economy to prevent further economic decline.
In summary, although stock repurchases may be technically permitted by applicable regulations, safety and soundness considerations will be paramount during these economically uncertain times. Banking organizations should take a moment to step back and consider the potential wider implications of its financial actions, including the impact on the organization's public reputation and the perception of the board and management team by its primary banking regulators.
Footnotes
1. The new definition of "eligible retained income" allows a banking organization to use the greater of (i) a banking organization's net income for the four preceding calendar quarters net of any distributions and associated tax effects not reflected in the net income or (ii) the average of a banking organization's net income over the preceding four quarters. Previously, "eligible retained income" was limited to the first prong, which could result in unanticipated drops in capital ratios of a banking organization due to a sudden and unplanned-for occurrence of economic stress. The federal banking agencies expect that the economic stress caused by the coronavirus may result in banking organizations realizing a sudden, unanticipated drop in capital ratios that could result in banking organizations limiting their lending and other financial intermediation activities to avoid facing abrupt limitations on capital distributions. The definition of "retained eligible income" was amended to incentivize banking organizations to use their capital buffers as intended in adverse conditions and serve as a financial intermediary and source of credit to the economy. The new definition is expected to reduce the likelihood that a banking organization is suddenly subject to abrupt and restrictive distribution limitation in a scenario of lower-than-expected capital levels.
4. See, e.g., Press Release, "Federal Reserve issues guidelines for capital action proposals by large bank holding companies," November 17, 2010 (Federal Reserve's guidelines issued after the 2008 financial crisis setting forth criteria for evaluating proposals to undertake capital actions to ensure that bank holding companies hold adequate capital to maintain ready access to funding, continue operations, and continue to serve as credit intermediaries, even under adverse conditions.). See also, SR 09-4, "Applying Supervisory Guidance and Regulations on the Payment of Dividends, Stock Redemptions, and Stock Repurchases at Bank Holding Companies," February 24, 2009, as revised December 21, 2015.
5. See e.g., Press Release, "Governor Newsom {of California} Issues Executive Order to Protect Renters and Homeowners During COVID-19 Pandemic," (In executive order, Governor requests that financial institutions implement an immediate moratorium on foreclosures arising out of a decrease in income or out-of-pocket medical expenses caused by the coronavirus).
6. See, Press Release, HUD No. 20-042, "HUD Provides Immediate Relief for Homeowners Amid Nationwide Coronavirus Response, Suspends all Foreclosure and Evictions for the Next 60 Days," March 18, 2020.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
