Today’s Conversations for a Better Tomorrow: 5 Key Areas ... · •Costs (for highest rated...

Today’s Conversations for a Better Tomorrow:5 Key Areas the Board and Directors Should Be Discussing

Chris Loyd, CPA, CISA, CGMAShareholderJune 5, 2017

This material was used by Elliott Davis Decosimo during an oralpresentation; it is not a complete record of the discussion. Thispresentation is for informational purposes and does not contain or conveyspecific advice. It should not be used or relied upon in regard to anyparticular situation or circumstances without first consulting theappropriate advisor. No part of the presentation may be circulated,quoted, or reproduced for distribution without prior written approvalfrom Elliott Davis Decosimo.

Today’s Speaker

Chris Loyd, CPA, CISA, CGMAShareholderNashville, TN

Professional OverviewChris has more than 15 years of public accounting experience andworks exclusively with financial institutions. He provides external andinternal audits, Sarbanes-Oxley control audits, Loan Review and ITaudits to community banks ranging from $50 million in assets to multi-billion dollar financial institutions. Prior to joining Elliott DavisDecosimo, Chris worked with various industries and service areasincluding financial institutions, healthcare, manufacturing anddistribution and benefit plans.

Agenda

• Capital: - Do we have the necessary capital for growth and in light of new

accounting and regulatory standards?

• Regulations:- How do you keep up and manage costs?

• Succession:- Do we have our next tier of leadership?

• Technology:- Are we prepared for the cybersecurity challenges & the new

generation?

• Independence:- Can we remain independent in light of the above and other

challenges?4

Planning for the future, what should Boards be discussing?

•Planning for the future:- New BASEL III Capital Requirements- Impact of new accounting standards

• Current Expected Credit Losses (CECL)• Lease Standard

- Organic Growth

1.) Capital

6© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC

BASEL III Phase in Arrangements(All dates are as of January 1)

*Including amounts exceeding the limit for deferred tax assets (DTAs), mortgage servicing rights (MSRs) and financials.

Source: Bank for International Settlements

1.) Capital

Phase 2013 2014 2015 2016 2017 2018 2019

Minimum common equity capital ratio 3.5% 4.0% 4.5%

Capital conservation buffer 0.625% 1.25% 1.875% 2.5%Minimum common equity plus capital conservation buffer 3.5% 4.0% 4.5% 5.125% 5.75% 6.375% 7.0%

Phase-in of deductions from CET1* 20% 40% 60% 80% 100% 100%

Minimum Tier 1 capital 4.5% 5.5% 6.0%

Minimum total capital 8.0%Minimum total capital plus conservation buffer 8.625% 9.25% 9.875% 10.5%

• Current Expected Credit Loss Model (CECL)• Final standard issued in June 2016• When is it applicable (calendar year)?

• SEC filers – January 1, 2020• Non-SEC filing public business entities – January 1, 2021• Non-public and non-profits – January 1, 2022 • Early adoption is allowable – January 1, 2019

New Accounting Standards -

1.) Capital

• Impact of CECL- Begin evaluating in 2017- Reminder: On date of adoption:

• Initial adjustment to beginning Retained Earnings (as Cumulative Adjustment)

- Various view points on amount of impact- Current ALLL impact on capital

• Deduction from Tier 1 (limit to 1.25% of RWA); no guidance from regulators if this will change

1.) Capital

• Leases• Issued by the FASB in February 2016• Under the old guidance (currently used in practice):

• Operating leases and capital leases• Operating leases – not included on the balance sheet and

lease expense is charged to operating expense.• Capital lease – recognized as both an asset and a liability.

Interest expense and depreciation are both recognized over the term of the lease.

New Accounting Standards -

1.) Capital

Leases• Under the new guidance:

- Type A (finance lease) and Type B (operating lease)• Type A – most existing capital leases• Type B – most existing operating leases

- Balance Sheet (MAJOR IMPACT) – all leases 12 months or greater, including renewals will result in recognition of an asset and a liability on the balance sheet

- Income Statement (minor impact)• Type A – costs presented as lease expense and recognized on a

straight-line basis• Type B – will recognize amortization of right of use asset

separately from interest10

1.) Capital

•Effective dates (calendar year)- Public and public business entities – 2019 - Private – 2020 - Early adoption is permitted

Leases

1.) Capital

• In Summary, Management and Board should:- Evaluate the “Known” impact

• (BASEL III, Leases)

- Plan now for the “Unknowns”• CECL• Growth

1.) Capital

• Community banks attempt to keep up- Dodd Frank (22,000 pages)- Bank Secrecy Act- Other

• Impediment to Growth?• Managing the costs

- Overhead- Qualified staff

2.) Regulations

How do you keep up and manage costs?

• Impediment to Growth- M & A

• BSA/AML issues- M&T & Hudson City – 3 year delay- Bancorp South – 2 mergers

• CRA• Fair Lending• CRE concentration

2.) Regulations

• Costs (for highest rated banks)- Commercial banks $1 billion to $10 billion (average

compliance costs – 2.9% of noninterest expenses*)- Commercial banks $500 million to $1 billion (average

compliance costs – 4.5% of noninterest expenses*)- Commercial banks $100 million to $500 million

(average compliance costs – 5.5% of noninterest expenses*)

- Commercial banks less than $100 million (average compliance costs – 6.8% of noninterest expense*)

- 60 percent of compliance costs – personnel expense*

2.) Regulations

*The Regional Economist/July 2016

• Costs/Qualified Staff- Size of bank- Passing to the consumer- Qualified staff- Training Staff

• Potential Relief?- Financial CHOICE Act – for small banks some relief on

Dodd Frank and BASEL III if they meet 10% leverage ratio

2.) Regulations

• In Summary, Management and Board should:- Evaluate staffing and qualifications of staff- Consider the costs of staff and outside third

parties to meet regulatory requirements

2.) Regulations

•Focus of Examiners•Evaluate as part of Annual Strategic Planning

•Plan for next five years•Managing overhead

3.) Succession

Do we have our next tier of leadership?

•Evaluation should include:- Board- Senior Management, including Key Lenders- High Risk Areas (IT, Audit, Loan Review)

3.) Succession

•Challenges- “Double Costs” during transition- Qualified candidates (few training programs any longer)

- Rural markets

3.) Succession

• In summary, Management and Board should:- Assess retirements over next 6-8 years- Evaluate unplanned/unexpected departures- Develop training plans

3.) Succession

•Issues- Cybersecurity- IT Staffing- Preparing for Millennials

4.) Technology

Are we prepared for Cybersecurity challenges and millennials?

•Cybersecurity & data breaches- Hacking- Malware- Physical attacks- Social engineering- Privilege abuse

•IT Staffing

4.) Technology

•Millennials- Fastest growing segment for banks- Online banking products (mobile check deposit, peer to peer payment, fingerprint recognition)

- Generation will inherit unprecedented wealth

4.) Technology

• In Summary, Management and Board Should:- Ensure the Bank has competent, qualified leader

of IT team- Evaluate whether the IT team/management have

assessed overall IT/cybersecurity risks- Plan now to attract millennials through the

necessary technological methods

4.) Technology

•If so, how do we deal with:- Capital requirements- Regulatory burdens increasing- Succession issues- Technology challenges

5.) Independence

Do we want to remain an Independent Bank?

• What does the Board & Management really want to do?

• Have candid, open discussion in strategic planning

• The sky is NOT falling!• Size/scale matters but, MANY factors affect

earnings

Strategic Planning – Assess the Board’s intentions

5.) Independence

•In evaluating consider:-Location(s) of markets and branches-Competition-Ability to price products/services-Customer loyalty

Strategic Planning5.) Independence

•Bank of South Carolina Corporation-Charleston, South Carolina-4 branches-Total assets $430 million-30 years old-Public

Consider Two Examples -5.) Independence

•Bank of Clarendon-Manning, South Carolina-5 branches-Total assets $265 million-85 years old-Private

Consider Two Examples -5.) Independence

Note: All information above obtained from SNL

(in thousands) 12/31/2013 12/31/2014 12/31/2015 12/31/2016

Total assets $340,773 $367,138 $399,165 $414,322

Net income $4,247 $4,586 $5,079 $5,424

ALLL/Loans 1.48 1.38 1.38 1.45

ROAA 1.29 1.29 1.35 1.33

ROAE 12.44 12.94 13.40 13.36

Tier 1 Risk Based Ratio 13.32 13.63 14.17 14.10

Risk Based Capital Ratio 14.57 14.88 15.42 15.36

Bank of South Carolina5.) Independence

(in thousands) 12/31/2013 12/31/2014 12/31/2015 12/31/2016

Total assets $217,863 $222,495 $245,470 $262,015

Net income $2,087 $2,158 $2,245 $2,358

ALLL/Loans 1.21 1.20 1.20 1.22

ROAA 1.00 0.98 0.97 0.94

ROAE 7.00 6.98 6.86 6.86

Tier 1 Risk Based Ratio 22.71 22.93 22.22 22.81

Risk Based Capital Ratio 23.91 24.11 23.35 23.94

Note: All information above obtained from SNL

Bank of Clarendon5.) Independence

•Bank of Clarendon- Locations- Competition- Customer loyalty

•Bank of South Carolina- Customer loyalty- Locations- Culture

Why are these banks successful?

5.) Independence

•If not at level desired:- Focus on improvements first- Net interest margin- Noninterest income- Noninterest expenses (efficiency ratio)- Evaluate products/services- Tax planning/strategies

Being Profitable -

5.) Independence

•Evaluate being Private vs. Public- Do you have capital to grow?- If plans for growth, does your stock provide necessary value?

- Is there sufficient liquidity in stock to absorb periodic requests by other shareholders to sell?

Once Desired Level of Profitability Obtained

5.) Independence

•Enhancing Shareholder Value- Cash dividends- Share repurchases- Stock splits/dividends- Incentive Comp/Equity-Based Plans- ESOP/KSOP

Staying Private

5.) Independence

•In conclusion:- Achieve desired level of profitability- Have a PLAN which shareholders understand- Stick to your plan!- Keep the regulators updated on your plan

Staying Independent

5.) Independence

• Take Aways –- Capital – remains king- Regulations – increasing but can be managed- Succession – banking remains a highly respected

profession and talent does exist- Technology – a factor that may set you apart- Remaining Independent is a valid option and can be

very rewarding for shareholders

In Conclusion

Chris LoydEmail: chris.loyd@elliottdavis.comPhone: 615.790.0542Website: www.elliottdavis.com

Elliott Davis Decosimo ranks among the top 30 CPA firms in the U.S. With nine offices across four states, thefirm provides clients across a wide range of industries with smart, customized solutions. Elliott DavisDecosimo is an independent firm associated with Moore Stephens International Limited, one of the world'slargest CPA firm associations with resources in every major market around the globe. For more information,please visit elliottdavis.com.

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