The Community Bank Chairman’s Forum

The Community Bank Chairman’s Forum

Presented by:

Jeffrey C. Gerrish, Chairman Philip K. Smith, President Greyson E. Tuck, Director Gerrish Smith Tuck, Consultants and Attorneys @GST_Memphis

Sponsored byPaul W. Barret, Jr. School of Banking

The Community Bank Chairman’s Forum January 17-18, 2019

The Ritz-Carlton Naples, Florida

GERRISH SMITH TUCK

Consultants and Attorneys

You can view or download the materials for the Community Bank Chairman’s Forum from our website at www.gerrish.com.

Follow us on Twitter: @GST_Memphis

Jeffrey C. Gerrish

Mr. Gerrish is Chairman of the Board of Gerrish Smith Tuck Consultants, LLC and Gerrish Smith Tuck, PC, Attorneys. The two firms have assisted over 2,000 community banks in all 50 states across the nation. Mr. Gerrish's consulting and legal practice places special emphasis on strategic planning for boards of directors and officers, community bank mergers and acquisitions, bank holding company formation and use, acquisition and ownership planning for boards of directors, regulatory matters, including problem banks, memoranda of understanding, cease and desist and consent orders, and compliance issues, defending directors in failed bank situations, capital raising and securities law concerns, ESOPs and other matters of importance to community banks. He formerly served as Regional Counsel for the Memphis Regional Office of the FDIC with responsibility for all legal matters, including all enforcement actions. Before coming to Memphis, Mr. Gerrish was with the FDIC Liquidation Division in Washington, D.C. where he had nationwide responsibility for litigation against directors of failed banks. He has been directly involved in fair lending, equal credit and fair housing matters, in raising capital for problem financial institutions and in numerous bank merger transactions. Mr. Gerrish is an accomplished author, lecturer and participates in various banking-related seminars. In addition to numerous articles, Mr. Gerrish is also the author of the books Commandments for Community Bank Directors and Gerrish’s Glossary for Bank Directors and produces an every two week complimentary newsletter, Gerrish’s Musings. He also is or has been a member of the faculty of the Independent Community Bankers of America Community Bank Ownership and Bank Holding Company Workshop, The Southwestern Graduate School of Banking Foundation, the Wisconsin Graduate School of Banking, the Pacific Coast Banking School, the Colorado Graduate School of Banking and has taught at the FDIC School for Commissioned Examiners and School for Liquidators. He is a member of the Executive Committee and the Board of Regents of the Paul W. Barret, Jr. School of Banking. He is a Phi Beta Kappa graduate of the University of Maryland and received his law degree from George Washington University's National Law Center. He is a member of the Maryland, Tennessee and American Bar Associations, was selected as one of “The Best Lawyers in America” 2005 through 2018 and as the Banking Lawyer of the Year, Best Lawyers Memphis, 2009. Mr. Gerrish can be contacted at [email protected]. GERRISH SMITH TUCK, PC, ATTORNEYS GERRISH SMITH TUCK CONSULTANTS, LLC 700 Colonial Road, Suite 200 700 Colonial Road, Suite 200 Memphis, Tennessee 38117 Memphis, Tennessee 38117 (901) 767-0900 (901) 767-0900 EMAIL: [email protected] EMAIL: [email protected]

Philip K. Smith

Mr. Smith is the President and a member of the Board of Directors of the Memphis-based law firm of Gerrish Smith Tuck, PC, and its affiliated bank consulting firm, Gerrish Smith Tuck Consultants, LLC. Mr. Smith's legal and consulting practice places special emphasis on bank mergers and acquisitions, financial analysis, acquisition and ownership planning for boards of directors, strategic planning for boards of directors, regulatory matters, bank holding company formations and use, securities law concerns, new bank formations, S corporations, going private transactions, and other matters of importance to banks and financial institutions.

Mr. Smith is a frequent speaker to boards of directors and a presenter at numerous banking seminars. He received his undergraduate business degree and Masters of Business Administration degree from the Fogelman School of Business and Economics at The University of Memphis and his law degree from the Cecil C. Humphreys School of Law at The University of Memphis. He is authoring a monthly electronic newsletter, The Chairman’s Forum Newsletter, which discusses key topics impacting financial institutions and, specifically, the role of the Chairman. Mr. Smith is a Summa Cum Laude graduate of the Barret School of Banking where he has been a member of the faculty. He has also served as a member of the faculty of the Pacific Coast Banking School, the Colorado Graduate School of Banking, the Southwestern Graduate School of Banking and the Wisconsin Graduate School of Banking.

GERRISH SMITH TUCK, PC, ATTORNEYS GERRISH SMITH TUCK CONSULTANTS, LLC 700 Colonial Road, Suite 200 700 Colonial Road, Suite 200 Memphis, Tennessee 38117 Memphis, Tennessee 38117 (901) 767-0900 (901) 767-0900 www.gerrish.com www.gerrish.com Email: [email protected] Email: [email protected]

Greyson E. Tuck Mr. Tuck is a member of the Board of Directors of both the Memphis based law firm of Gerrish Smith Tuck, PC, Attorneys and Gerrish Smith Tuck, Consultants, LLC. These two firms have assisted numerous community banks in virtually every state across the nation. Mr. Tuck’s legal and consulting practice places special emphasis on community bank holding company formation and use, community bank mergers and acquisitions, regulatory matters, corporate reorganizations, corporate taxation, general corporate law and community bank strategic planning. Mr. Tuck comes from a community banking family. He is a graduate of the University of Tennessee, where he majored in Accounting and Finance, and received his law degree from the University of Memphis Cecil C. Humphreys School of Law, where he was a Herff Scholar. Mr. Tuck is a graduate of the Paul W. Barret, Jr. School of Banking and currently serves as a faculty member at a number of banking schools across the country. He is a frequent presenter at national and state bank association conferences and has authored a number of articles of interest to financial institutions. Mr. Tuck is a member of the Tennessee Bar Association and an active participant in the Memphis Bar Association. GERRISH SMITH TUCK, PC, ATTORNEYS GERRISH SMITH TUCK CONSULTANTS, LLC 700 Colonial Road, Suite 200 700 Colonial Road, Suite 200 Memphis, Tennessee 38117 Memphis, Tennessee 38117 (901) 767-0900 (901) 767-0900 EMAIL: [email protected] EMAIL: [email protected]

GERRISH SMITH TUCK, CONSULTANTS AND ATTORNEYS

CONSULTING ♦ FINANCIAL ADVISORY ♦ LEGAL

Mergers & Acquisitions Analysis of Business and Financial Issues

Target Identification and Potential Buyer Evaluation Preparation and Negotiation of Definitive Agreements

Preparation of Regulatory Applications Due Diligence Reviews

Tax Analysis Securities Law Compliance

Leveraged Buyouts Anti-Takeover Planning

Financial Modeling and Analysis Transaction Pricing Analysis

Fairness Opinions

Bank and Thrift Holding Company Formations Structure and Formation

Ownership and Control Planning New Product and Service Advice

Preparation of Regulatory Applications Consulting Advice on Best Uses and Practices

New Bank and Thrift Organizations Organizational and Regulatory Advice

Business Plan Creation Preparation of Financial Statement Projections

Preparation of the Interagency Charter and Federal Deposit Insurance Application

Private Placements and Public Stock Offerings Development of Bank Policies

Financial Modeling and Analysis

Mergers and Acquisitions Financial Modeling and Analysis Subchapter S Election Financial Modeling and Analysis

Stock Repurchase Financial Modeling and Analysis Financial Statement Projections

Business and Strategic Plans Ability to Pay Analysis

Net Present Value and Internal Rate of Return Analysis Stock Valuation Analysis

Fairness Opinions

Bank Regulatory Guidance and Examination Preparation

Preparation of Regulatory Applications Examination Planning and Preparation

Regulatory Compliance Matters Charter Conversions

Problem Banks and Thrifts Issues

Examiner Dispute Resolution Negotiation of All Formal and Informal Enforcement Actions

Defense of Directors/Officers in Failed Bank Litigation Failed Institution Acquisitions

New Capital Raising and Capital Plans Appeals of Material Supervisory Determinations Expert Witness and Litigation Support Services

Subchapter S Conversions and Elections Financial and Tax Analysis and Advice

Reorganization Analysis and Restructuring Cash-Out Mergers

Stockholders Agreements Financial Modeling and Analysis

Customized Facilitation of Director

and Officer Retreats Customized Director and Officer Retreats

Long-Term Business Planning Assistance and Advice in Implementing Strategic Plans Business and Strategic Plan Preparation and Analysis

Director Education

Capital Planning and Raising Private Placements and Public Offerings of Securities

Bank Stock Loans and Document Review Financial Analysis, Capital Plans and Policies

Going Public / Private Transactions

Executive Compensation and Employee Benefit Plans Employee Stock Ownership Plans

401(k) Plans Leveraged ESOP Transactions

Incentive Compensation and Stock Option Plans Employment Agreements-Golden Parachutes

Profit Sharing and Pension Plans Compensation Studies and Analysis

General Corporate Matters

Corporate Governance Planning and Advice Recapitalization and Reorganization Analysis and

Implementation Customized Board and Officer Training and Education

Sessions Management Studies, Evaluations and Succession Planning

Corporate Governance Studies Unique Family Bank Planning Issues

Taxation

Tax Planning Tax Controversy Negotiation and Advice

M&A Tax Advice and Planning

Estate Planning for Community Bank Executives Wills, Trusts, and Other Estate Planning Documents

Estate Tax Savings Techniques Probate

Other

Public Speaking Engagements for Banking Industry Groups (i.e., Conventions, Schools, Seminars, and

Workshops) Publisher of Books and Newsletters Regarding Banking and

Financial Services Issues Expert Witness and Litigation Support Services

The Community Bank Chairman’s Forum Table of Contents

PAGE

INTRODUCTION AND CURRENT ENVIRONMENT ................................. Tab A ENHANCING SHAREHOLDER VALUE ......................................................... Tab B

I. Excelling for the Long-Term ........................................................................................... 7

A. Our Primary Goal is to Enhance Shareholder Value ..................................... 7 B. Does Size Matter? ................................................................................................ 8 C. Being Successful: Money-Making Opportunities Over the Long-Term ........................................................................................... 9 D. Manage Risk .......................................................................................................... 11 E. Keeping Your Shareholders Happy .................................................................. 11 F. Taking Advantage of the Merger and Acquisition Environment ........................................................................................................ 13 G. Alternative Investment Opportunities for the Holding Company ............................................................................................................... 15 H. Getting and Keeping the Right People ............................................................. 16 I. Take the Opportunity to “Action Plan” for the Future ................................. 28

II. Operating in the Current Regulatory Environment ..................................................... 31

A. Regulatory Issues - General ................................................................................ 31 B. Bank Examinations – Preliminary Considerations ......................................... 31 C. What if Your Bank Anticipates a Major Regulatory Problem? ..................... 34 D. Regulatory Enforcement Actions ...................................................................... 36 E. 10 Commandments for Dealing with the Regulators ..................................... 44 F. Miscellaneous Enforcement Related Issues ..................................................... 47 G. Dealing with Regulatory Relations .................................................................... 50 CHAIRMAN’S GENERAL DUTIES AND RESPONSIBILITIES .................... Tab C

I. Introduction ......................................................................................................................... 54 II. Chairman’s General Duties and Responsibilities ............................................................. 55 A. Directors’ Meetings ................................................................................................ 55 B. Board Composition ................................................................................................ 58

GERRISH SMITH TUCK Consultants and Attorneys


Table of Contents

PAGE II. Chairman’s General Duties and Responsibilities ................................................... (cont’d) C. Board Evaluation .................................................................................................... 59 D. Committee Appointments, Responsibilities and Functions ............................. 60 E. Corporate Governance .......................................................................................... 60 F. Public Relations ....................................................................................................... 60 G. Confidentiality ......................................................................................................... 61 H. Conflicts of Interest ................................................................................................ 61 III. Chairman’s Obligations in Specific Circumstances ......................................................... 62 A. Mergers and Acquisitions ...................................................................................... 62 B. Problem Banks ........................................................................................................ 63 C. Dealing with a Difficult Director ......................................................................... 64 D. Dealing with Management ..................................................................................... 64 E. Role in Strategic Planning ...................................................................................... 65 F. Role in Board and Management Succession ....................................................... 66 OVERVIEW OF COMMUNITY BANK MERGERS AND ACQUISITIONS ........................................................................................ Tab D I. Introduction .......................................................................................................................... 70 II. Buying Or Selling Secrets: Enhancing Shareholder Value Through Purchase Or Sell ................................................................................................... 71

A. Establish Your Bank’s Strategy Early On ........................................................... 71 B. Creation of the Plan................................................................................................ 73 C. Anti-Takeover Planning and Dealing with Unsolicited Offers ........................ 78 D. Change in Accounting for Acquisitions .............................................................. 82 E. Contact and Negotiation for Community Bank Acquisitions .......................... 83 F. Price, Currency, Structure, and Other Important Issues .................................. 88 G. Directors’ and Officers’ Liability Considerations .............................................. 99



Table of Contents

PAGE 10 COMMANDMENTS FOR COMMUNITY BANK CHAIRMEN AND DIRECTORS Tab E

I. 10 Commandments for Community Bank Chairmen and Directors ......................... 103


__________________________________________________________

Tab A Introduction and Current

Environment __________________________________________________________


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I. INTRODUCTION AND CURRENT ENVIRONMENT

The community banking industry is substantially different than it was ten years ago. The Great Recession and the subsequent (and extended) low interest rate environment, the onslaught of new regulations and legislation, and a new executive administration created a world of change that required community banks to remain flexible and resilient in order to sustain long-term independence, profitability, and safety and soundness. This, of course, while industry “experts” (our firms excluded) constantly blow smoke about how smaller institutions will be unable to survive independently and must seek out a merger or acquisition to achieve economies of scale and compete in the “new normal.” In order to thrive amidst change, many community banks have continued to go back to the basics to increase efficiency, reduce costs, and improve overall profitability. With interest rates slowly continuing to rise, community banks are also having to balance deposit growth and sustainable cost of funds alongside all of the other complexity. In light of all of these issues, community bank Boards of Directors that desire for their bank to remain independent must understand the importance of planning to enhance shareholder value as the bank transitions into and acclimates to this new environment. Despite all of the changes, one constant remains for community banks—the Board of Directors’ and senior management’s primary obligation to appropriately allocate financial and managerial capital to enhance the value for the bank’s or holding company’s shareholders. Neglecting this foundational mandate will result in the shareholders looking for an alternative investment and the bank merging out of existence or engaging in an outright sale transaction. It is incumbent upon the Board and the senior officers to plan to avoid such results. In this regard, it is critical to understand both the short-term and long-term environmental factors. Several factors that are and will continue to impact the environment in 2019 include the following:

Improved earnings and moderate balance sheet growth. In the years following the Great Recession, many community banks bolstered profitability by reducing expenses. Although this trend continues for many community banks, community banks have largely focused on core earnings over the past few years and adopted a “back to basics” approach to lending, which has been primarily evidenced by community banks’ general focus on profitability rather than balance sheet growth. This position is counter to the stance taken by many community banks prior to the Great Recession when most institutions believed that size was the key to profitability. While many institutions have “leveled off” or continue to shrink assets in order to focus on core profitability, this trend has shifted over the past few years, and community banks are now beginning to experience what our firms refer to as moderate asset growth between 3% and 7% per year. As a whole, community banks continue to adopt a “back to basics” mentality, but many banks have become more aggressive in their balance sheet growth strategy. We expect that trend to continue in the near term.

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Increased focus on other lines of business. In addition to focusing on improving core earnings and easing back into asset growth, many community banks are re-assessing other lines of business, such as trust departments or insurance agencies, as a means of increasing non-interest income and taking some of the pressure off of interest income in a compressed margin environment.

Increased focus on share liquidity. Additionally, many community

banks have heightened their resolve to remain private, locally owned institutions. Because the stock of these privately owned institutions is often illiquid, many community bank holding companies have increased their focus on share liquidity by implementing share repurchase programs as a means of making a market for their own stock.

Bankers’ second wind. Since the Great Recession, we have seen significant banker fatigue, which has helped to drive some of the consolidation the industry has experienced. In the current environment, however, many bankers that had all the “fun” they can stand have exited the industry, with many remaining bankers experiencing a renewed enthusiasm for merger and acquisition transactions. For them, there needs to be some relief, and so far the mergers and acquisitions market has provided it.

Kinder/gentler regulators. On the safety and soundness side, the regulators continue to become more amicable and easy to work with, even in their dealings with problem institutions. While enforcement actions are still a reality for many institutions, the regulatory environment as a whole has softened significantly. This has been aided significantly by regulatory relief bills, such as the Economic Growth, Regulatory Relief and Consumer Protection Act (S. 2155). While there are still many questions left unanswered related to this regulatory relief – specifically as it relates to not yet finalized regulatory rulemaking – the change has been largely positive for community banks. With mid-term elections having resulted in a once again split congress, and with new appointed heads of some of the federal banking agencies, it is unclear exactly what regulatory “relief” will look like in the future. This lack of certainty notwithstanding, we do expect the regulators to continue to take a more amicable approach to potential safety and soundness concerns, particularly with otherwise well-run community banks.

Interest rate risk. All community banks have suffered in large part due to the low rates and compressed margins. Interest rates have now begun to rise, and community banks are now focusing (somewhat frantically in some cases) on how to grow core deposits and appropriately plan for continued rising rates. As regulators continue to focus heavily on interest rate oversight and risk management, community bank Boards of Directors across the nation are taking a critical look at interest rate risk when planning for the future. The

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Federal Reserve has continued to advance the ball down the field in the interest of keeping inflation low, but we are beginning to see an easing in this regard. With the increased focus on interest rate oversight and risk management, we must be prepared for that interest rate risk as we plan going forward.

Mergers and acquisitions continue. Community banks continue to focus on their role in the current mergers and acquisitions environment, which has picked up significantly over the past few years. Despite merger and acquisition activity coming in the form of a “steady stream” rather than the “wave” anticipated by many industry experts, activity has, in fact, increased significantly among community banks. Based on recent surveys, as many as half of existing financial institutions are open to considering merger and acquisition transactions. Although many institutions desire to remain independent in the industry, others are seeking economies of scale for compliance purposes, lack appropriate Board or management succession to succeed in the future, or have simply had enough “fun” over the past eight years. With transaction pricing continuing to climb, many organizations are “testing the waters” to see whether any good deals are available that would increase profitability and enhance value for the organizations’ shareholders. It is our firm’s belief that community banks have and will continue to be a prominent, successful component of the banking industry regardless of size (and regardless of what arbitrary thresholds industry pundits claim). With these trends in mind, however, each community bank’s Board of Directors must ultimately make the decision that is in the best interest of the organization’s shareholders.

Compliance. Regulatory compliance and the overall regulatory burden remain one of the greatest areas of concern for community bankers. Whereas the regulatory focus used to be safety and soundness, which has improved drastically, the regulatory shift to compliance since the Great Recession has been reemphasized through the regulator’s focus on fair lending issues, Bank Secrecy Act violations, Consumer Financial Protection Bureau mortgage rulemakings, and unfair, deceptive, and “abusive” acts or core practices. Regulatory scrutiny has also extended to bank overdraft practices, insider lending practices, and other various issues related to loan documentation, which have created a sore spot for many bankers as the regulators have begun to criticize practices and policies that have been in place for decades. Even more troubling, we have also seen instances where the regulators have used the “management” rating within the bank’s overall CAMELS rating as a means to send a message when the regulator is simply not happy with something the bank is doing. In other words, if the regulators are critical of something in the bank but cannot formally require the bank take action or cite the bank with a violation, the regulators have begun to reduce the bank’s management rating as a catch-all of sorts. While this practice has not become widespread, it does

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highlight the fact that even in an improved regulatory environment, the results of the turbulent economic crisis are still in the forefront of some regulators’ minds.

Enterprise Risk Management. In light of the turbulent banking environment, enterprise risk management, or “ERM,” has never been more important to community banks. ERM means your bank pays attention to everything impacting its business, especially risk. Put another way, ERM is a holistic, risk-centered approach to managing your organization. Our firms are encouraging every bank to implement a well-documented ERM program. This program needs to be tailored to your institution’s size and the complexity of its operations. The regulators do not expect smaller community banks to have the same risk management framework as a multi-billion dollar regional, but they do expect a comprehensive program specific to the bank.

Information Technology. Information technology, along with the associated risks, has also received increased regulatory focus, particularly in light of the continued data breaches that have occurred in the past number of years. Empowerments of fintech companies in the industry, same day ACH payments, screenscrape and mobile access, and general cybersecurity have dramtically shaped and heightened expectations for the nation’s small community banks. Although community banks are expected to keep pace with larger organizations when it comes to customer-facing technology, the small banks do not have the robust IT department, expertise, or budget of their larger competitors to ensure all security elements are taken into account and mitigated against. While the regulators have not historically focused on specific technology offerings and elements of a community bank’s operations, they have begun to take particular interest in the current environment, especially if a bank experiences a breach or other fraud impacting the security of the bank’s systems and confidentiality of customer information. In light of the industry’s enhanced focus on information technology issues, long-term information technology planning as a subset of the Board of Directors’ overall strategic planning process is a non-negotiable.

Financial Capital. As of January 1, 2015, the Basel III capital framework went into full effect for community banks, although certain measures, such as the capital conservation buffer, will fully phase in as of this year. As adopted, the Basel III capital rules remain overly burdensome to community banks, even with the community bank “friendly” carevouts within the regulatory framework. One of the most significant aspects of the Economic Growth, Regulatory Relief and Consumer Protection Act was a mandate to the federal banking regulators to adopt a new “community bank leverage ratio” framework that would establish one ratio (tangible equity capital divided by total average consolidated assets), to be set between 8% and 10%, as an alternative, elective capital framework for community banks. In late 2018, the federal banking regulators issued proposed rulemaking that set this community bank

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leverage ratio at 9% in order to be “well-capitalized,” with lower thresholds set for purposes of the other Prompt Corrective Action capitalization categories. As of the date of these materials, the federal regulators have not yet finalized these rulemakings, though the comment period has closed. The industry is waiting eagerly to review the final regulations. Whatever form they take, our firms’ belief is that the framework stands to be a drastic improvement for community banks. While Basel III’s capital rules do not prevent many community banks from safe, sound, and profitable operation, they are overkill and ignorant of the realities of community bank operations.

Human Capital. Succession issues and attracting and retaining quality employees have become critical considerations across the industry. The days of starting as a teller and rising up through the ranks to CEO are the exception. Competition for quality people is just as intense as competition for loans and other business. Like gaining new business, however, attracting and retaining quality people is more than dollars and cents. Corporate culture and bank stability (which is less predictable in a consolidating industry) are some of the primary considerations for potential hires, which means community banks must be willing to invest more than competitive salary and benefits in its employees.

Strategic/Action Planning. Strategic planning has such a bad

connotation that in our firm, we often refer to it as Action Planning. Action Planning is a “process” where the Board gets away from “the process.” It creates an environment where the Board and senior management focus on the issues and determine the actions that are appropriate to send the bank forward in accordance with the strategies established.

With that groundwork, the remainder of these materials discuss the directors’ and officers’ primary responsibility to enhance value for the shareholders, the Chairman’s general responsibilities as the leader of the Board, and the Chairman’s specific role in the mergers and acquisitions context.

__________________________________________________________

Tab B Enhancing Shareholder

Value __________________________________________________________


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I. EXCELLING FOR THE LONG-TERM

Excelling for the long term is the non-negotiable goal for all community bankers desiring to remain a part of an independent organization. This is consistent with the directors’ and officers’ obligation to enhance and/or maintain shareholder value over the long term. Excelling is by definition significantly beyond the survival strategy that many community banks employed during the economic downturn. Over the long term, community banks, to thrive, must refocus their efforts on longer term issues and address critical long-term decisions strategically. These include:

Our primary job is to enhance shareholder value Does size matter? Making money Managing the risk Keeping your shareholders relatively happy Taking advantage of the merger and acquisition environment Contemplating alternative investment opportunities for the holding company Getting and keeping the right people Dealing with long-term regulatory relations and restructuring Planning for the future

The remainder of this section of the materials deals with issues of doing our job and excelling over the long term through enhancing shareholder value, making money, and the like.

A. OUR PRIMARY GOAL IS TO ENHANCE SHAREHOLDER VALUE

As noted above, community bank directors and senior management’s primary job is enhanced value for the organization’s shareholders. A director’s typical response is a declaration that the community bank’s job is to be a good corporate citizen, the employer of choice, the economic engine in the community, and the like. However, the reality is that if we, as directors and officers, do not enhance value for our shareholders, we will not have the opportunities of an independent community bank to be the good corporate citizen, the employer of choice, or the economic engine in the community. If our primary job is to enhance shareholder value – i.e., growing earnings per share 8% to 10% a year, return on equity north of 10% to 12%, liquidity for the shares, an appropriate cash flow off the shares, and safe and sound operations – then the question is, how do we do that job over the long term? The entire issue of enhancing shareholder value requires the Board of Directors and senior management group to make strategic decisions that involve the allocation of financial capital and the allocation of managerial capital. With respect to financial capital, numerous issues are present:

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How do we allocate the capital? Does excess capital exist (a term never heard by the regulators)? Is additional capital necessary? If we have excess capital, how do we use it (e.g., redeem shares, create liquidity, buy

another bank, get in another line of business, absorb losses, or something else)? The questions above address issues related to the allocation of financial capital that the Board must address not only in the context of the current environment, but also in light of its long-term obligation to enhance the value for its shareholders. The allocation of human capital is also significant. Each of our banks has its own component of human capital. We have heard many bankers and consultants say the bank’s real assets walk out the door every day when they go to their homes after work. The Board not only must assure the attraction and retention of the appropriate human capital to implement the bank’s business plan, but it must also, at a 30,000 foot level, determine how to allocate that human capital. Admittedly, the environment is challenging. From a long-term strategic standpoint, what should our bank’s human capital, particularly our senior management team, be focusing on? Should they focus on the core banking business? Should they focus on core deposits? Should they focus on geographic expansion? Should they focus on trying to enter another line of business? It is the Board of Directors’ job to determine, in consultation with senior management, how the bank’s human capital should be allocated in big-picture terms. Again, this allocation must occur in light of the Board and management’s primary job to enhance value for the organization’s shareholders.

B. DOES SIZE MATTER?

As noted previously in this material, numerous fear-mongers, running from investment bankers to accounting firms, are taking the position that in order to survive, a community bank must be at least $x in total assets (the “x”, of course, is typically a number equal to 2 times your bank’s current asset size). Our response: “nonsense.” There will certainly be a place for the smaller community banks. The Board of Directors, however, in consultation with management, needs to address the “size issue” for their specific bank. This should not be out of fear, but an objective assessment. Would it make sense to join forces with another community bank to provide additional revenue to cover the cost of operations? Do the hassle and integration difficulties justify the loss of control, the changed relationship with the community, the possible book value dilution, and the certain ownership dilution that results from a combination with another community bank, at least on a stock-for-stock basis? The issue is, what is the ideal size for your bank, not what does some pundit who is out of town with a briefcase have to say. In our opinion, community banks well under $100 million will survive and thrive in the future. They may not make as much money as they used to. They may continue to have regulatory hassles, particularly in the compliance area regarding “dotting i’s and crossing t’s.” But they will survive just fine. The critical issue for the long-term future is, what is the best position for your bank as it relates to enhancing the value for the shareholders as it relates to size?

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C. BEING SUCCESSFUL: MONEY-MAKING OPPORTUNITIES OVER THE LONG TERM

If we are going to enhance the value for our shareholders, one of the fundamental underpinnings is the bank needs to “make money”. We have discussed this issue often with bankers over the years. The secret formula for making money in community banking is:

Revenues minus Expenses = Profit We have talked to many bankers this year who indicate that their overall after-tax net income is likely to be lower than it was in previous years, notwithstanding some modest growth of the bank. In many cases, this is due to salary and benefits costs, increasing regulatory and compliance expenses, and the like. The good news is margin compression, which has been occurring over the past number of years, has reversed slightly in the current environment. Margin, in this context, is defined as, in its most basic terms, the difference between your average yield on your asset portfolio (primarily loans) versus the cost of the funds (deposits or other sources) that you need to take in to be able to loan the money out. The reality is if we are going to make money, we need to take a big picture focus on the two components of the secret formula, i.e. the revenue side and the expense side.

1. Deconstructing the Income Statement

As noted, the reality is if the bank is going to make money, management needs to focus on the big picture of deconstructing the income statement to determine where additional revenue could be obtained and how expenses can be reduced. The Board’s job is to understand how money is made in the banking business, not to micromanage the bank. It is the Board’s job, at a high level, to analyze the secret formula for profitability (Revenue minus Expenses = Profit) and give direction to management as to profitability levels that are deemed to be acceptable. As an overall note, community banks have made their living on relationship banking. If we put our resources toward building relationships with our customers, then the bank can take advantage of the result, which is that customer loyalty ensures profitability. As the Board considers allocating resources, it must consider allocating resources toward the buildup of banking relationships on both the loan and deposit sides of the balance sheet. Looking at the revenue side, there are a number of obvious areas that stand out. These areas are typically more tactical and operational planning for the officers, rather than long-term strategic planning areas for the Board, and include: yield on the securities portfolio, reduction of fixed assets, and conversion of non-earning assets to investible assets, such as a sale/leaseback. Increasing the yield on assets through loan floors, pricing models, and the like, also make sense. The entire issue of fee income through fees assessed, overdraft programs, and the like, should all be reviewed. There is generally no competitive advantage to a bank from being the least expensive in its marketplace with respect to charges for overdrafts or account

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charges, for example. Also, consider how much is waived in fees every year. There is a lot of money being left on the table. The bottom line on the revenue side is to go back to the fundamentals, the basics, and dissect the revenue side of the equation. New lines of business also make sense to consider if it is an appropriate strategic capital allocation. The question is, can any money be made over the long term even if there are some losses over the short term? Trust is an expensive entry. Insurance and securities usually are accomplished through a third-party vendor. The other side of the equation is expense reduction. Again, many of these issues are generally not strategic issues for the Board, but are operational and tactical issues for management. The loan loss reserve, for example, will continue to be a significant expense for most community banks focusing on growth. Other issues in the current environment, however, will require more strategic involvement from the Board. The most notable example is the bank’s strategy for how to attract and retain core deposits. Particularly in highly competitive markets (the number of which seem to always be increasing), competing for customer deposits will touch on marketing strategy, personnel, growth goals, and profitability goals. In other words, if the Board of Directors is setting a strategic focus of significant asset growth through new loans, then it is going to have to consider the practical implications of funding those loans and what risks or expenses it is willing to take on in order to do so. It is then up to management to figure out how to carry out that strategy. Another significant and related issue is reducing the expense of deposits and other funding costs. The whole issue of deposit costs, brokered deposits, and wholesale versus retail will continue to be a hot button for the foreseeable future. There is also the issue of personnel, which is the second largest expense for most institutions. Despite all of the focus on technology and efficiency, it is important not to cut into the muscle because, as community banks, we primarily make our money through customer relationships. Smaller banks may not be the cheapest, fastest, or the best, but if we can develop a relationship with the customer, it will be much harder for another bank to pull them away or for us to run them off. Achieving this requires quality talent from frontline employees to management. As competition for that talent increases, the Board of Directors must consider the lengths to which it will go in order to have the human capital available to achieve its goals. The whole issue of deposit costs, brokered deposits, wholesale vs. retail, and the like will continue to be a hot button. Many banks around the nation embarked on a wholesale deposit funding strategy because it was cheaper, easier, and faster in the past. Unfortunately, it is not terribly reliable. When the banks get into difficulty, brokered deposits are the first to go or the first to be regulatory prohibited. Clearly, if we can reduce the cost of our deposits or increase our demand deposits, then that will have a fundamental impact on our profitability.

2. Deconstructing the Balance Sheet

By design, reviewing the income statement for areas to improve under the secret profitability formula requires a review of the balance sheet, which often involves

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reviewing issues of risk management. It also involves the issues of core deposits, wholesale funding on the liability side, lending types, volume, investments, fixed assets, and the rest on the asset side. Again, the critical issue for a community bank Board of Directors is to take a big-picture view of the issue: is the balance sheet structure appropriate to allow the bank to make money going into the future? If it is not, then it needs to be strategically redesigned or realigned.

D. MANAGE RISK

Banking is a risky business as we all know. As a new year approaches, many more community banks will begin to focus on managing risk. A number of our firms’ clients have established Board-level risk management committees or retained a risk management officer. Hopefully, this risk assessment process will work better for the community banks than it did for the large banks before the recent economic meltdown. Nevertheless, it is critical that risk be assessed as we begin to look forward to how to achieve success in the future. As noted, a number of Boards are establishing risk oversight committees. It is important that the Board understands that its job is risk “oversight,” not risk “management.” Risk oversight involves making sure that processes, procedures and policies are in place. Risk management is the job of the management team, not the Board of Directors. As part of the planning process, the Board should consider whether to enhance the risk oversight function.

E. KEEPING YOUR SHAREHOLDERS HAPPY

To keep our banks independent, we must keep our shareholders as happy as possible in this continuing difficult environment. As noted, as our banks mature, our shareholder base becomes much more interested in our bank’s or holding company’s stock as a financial investment only, rather than as an emotional or sentimental investment. For example, a number of our client banks have reached their 100th year anniversary in the past few years – a commendable goal for any independent community bank! A commendable goal for any independent community bank! Discussions with some of the CEOs of those clients indicate that when their bank was formed 100 years ago with very little capital, all of it was raised locally. Virtually every person in town who could afford it became a shareholder of the bank. The bank was “their bank.” Everyone had an emotional attachment to the bank and its stock. As the bank grew and matured and those shares began to be passed from generation to generation, not only did most of the shareholders no longer live in town, it was also not “their bank.” Most of the shareholders in a bank of that nature will view the stock solely as a financial investment. Because of that, we have to tangibly enhance the value for those shareholders from a financial point of view, which can include growing earnings per share (by either growing earnings or reducing shares), providing liquidity, and increasing cash flow. Within this context, part of the Board doing its job well is creating liquidity for the shares. For most community banks, that means allocating capital to redeem shares when a shareholder requests it or otherwise establishing a voluntary repurchase plan. The Board’s analysis must address whether the allocation of capital toward the redemption of shares is a good idea. For most community banks that have too much capital and no stock liquidity, it

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is. Many banks struggle with the issue of “how do we provide share liquidity?” In addressing this issue, the natural progression of the discussion is to begin considering the company and bank’s ownership structure. In this regard, the Board basically has three alternatives: a Subchapter S - less than 100 shareholders (six generations with a common ancestor

counting as one shareholder), a private company (not a Sub S and not SEC reporting), or a public company (SEC reporting). Numerous times over the years, our firm has seen many community bank Boards of Directors look to becoming a public SEC-reporting company as their salvation to the issue of liquidity. The reality is that most community bank holding companies that are SEC reporting and listed on an exchange have very little market liquidity for their shares. Even those companies must allocate capital to generate liquidity. In most cases, community bank Boards of Directors strategically determine that becoming a publicly-reporting company is not in the best interest of their shareholders. In most cases, our firm believes this is the appropriate decision, particularly in light of other ownership alternatives. If part of keeping the shareholders happy involves providing them with significant cash flow off their stock, liquidity for their stock, other earnings growth and an excellent return on equity, what could be a better solution for most community banks than Subchapter S? For most community banks, particularly where the growth is average (e.g., less than 5% annually), Subchapter S is the best way to enhance the value for the shareholders and keep them happy. It will often provide excellent cash flow, a good return on equity, fabulous earnings growth, and as a practical matter, more liquidity than the shareholders have as a private company or even a small SEC reporting company. (As a relevant aside, the benefits offered by Subchapter S status remain intact even with the recent tax legislation that changed taxation of income related to pass-through entities, such as Subchapter S corporations. While the rules related to this area of law have not yet been finalized, the shareholders of Subchapter S community banks are, in the vast majority of situations, still better off owning stock of a Subchapter S entity when compared to owning stock of a C corporation. Even with the reduced income tax rate for C corporations, shareholders of Subchapter S community banks still avoid double taxation of corporate income and receive a boost to after-tax cash flow – not to mention other benefits associated with the Subchapter S structure, including liquidity.) Before you assume that we have gone mad, let us consider how a Subchapter S corporation could possibly provide greater share liquidity than other alternatives. Focus on this. As a shareholder of a C corporation, even a small SEC public company, the shareholder’s investment liquidity is, as a practical matter, at the mercy of the current marketplace or the holding company as to whether they will buy the shareholder’s shares at the time the shareholder desires to sell at a fair price. On the contrary, in every Subchapter S transaction (if it is done correctly), each shareholder signs a shareholders’ agreement that, as a practical matter, provides that if a shareholder wants to sell his or her shares, the holding company is obligated to buy them with the pricing provisions determined in the agreement. If the

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shareholder receives a valid offer from a third-party, that shareholder can take the offer to the holding company, which can then agree to buy the shares or not to buy the shares. If the holding company does not buy the shares, the shareholder can sell the shares to the third-party purchaser as long as it does not do anything to inadvertently terminate the Subchapter S election. All things considered, in many cases, a shareholder of an S corporation has greater liquidity than a shareholder of a C corporation. If your bank is interested in converting to Subchapter S structure and do not believe you can do so, then focus on the fact that if 50% (or two-thirds in some states) of your shares will vote in favor of converting your bank and holding company to a Subchapter S corporation, it will be accomplished. A 100% vote of the shares in favor of the reorganization is not required. In any event, our job in these challenging times is to keep our shareholders happy and keep our banks independent as long as we would like to do so. For additional information, please request Gerrish Smith Tuck material entitled “Stock Ownership of Community Banks” and Gerrish Smith Tuck material regarding conversion to Subchapter S.

F. TAKING ADVANTAGE OF THE MERGER AND ACQUISITION ENVIRONMENT

As noted previously in this material, the merger and acquisition wave, i.e. consolidation, has started and will continue through 2019 and beyond. If your community bank is going to be a buyer in the current M&A market, then the Board needs to decide how much capital is available to allocate to a purchaser and whether the holding company has a currency that any other bank or bank holding company shareholder would accept. For most smaller community banks that either do not have a listed or liquid class of stock or that cannot “sell” a seller on the potential of stock that is not yet listed or liquid, the only available currency for a purchase will be cash. From that standpoint, banks and holding companies need to know how much excess capital there is and where they can get other sources of capital. We need to know what financial resources are available to allocate in a merger and acquisition context. In today’s environment, community banks continue to sell for what our firm considers the “traditional” reasons. These include lack of management succession, lack of Board succession, lack of a clear exit strategy for the shareholders, little to no cash flow from the shares, little to no liquidity for the shares, and in some cases heightened burden and costs associated with regulatory compliance. With those factors, many banks are simply turning to the marketplace as a way to enhance shareholder value. Fortunately for those institutions, today’s merger and acquisition marketplace provides plenty of opportunities. Over the past few years since the end of the national financial crisis, between approximately 250 and 300 merger and acquisition transactions have taken place in the industry per year. While this is significantly less activity than was present in the industry 20 years ago (e.g., 504 merger and acquisition transactions were completed in 1998, in which our firm was proudly third in the nation with respect to number of bank merger and acquisition transactions), it still represents significant buying and selling opportunities for community banks. Our firms have had the opportunity to serve as both financial advisors and legal advisors in the community bank mergers and acquisitions arena for over three decades. We understand the merger and acquisition business in this marketplace, and we believe there will continue to be opportunities available for community banks, whether as buyers or sellers.

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Regardless of whether you are on the buying side or selling side of the merger or acquisition, in this particular environment, you need to understand how to appropriately price a transaction. Our merger model, as well as every other appropriate merger firm’s model in the nation, is based upon the fundamental theory that a buyer is not going to make an acquisition that is going to hurt its own shareholders from an earnings per share standpoint or cause the company to be unable to execute its business plan, e.g., dilute its capital. As a result, the M&A model in a stock-for-stock transaction is based on the fundamental formula set forth below:

Target’s Net (After-Tax) Income = Maximum Number

Acquiror’s Projected Earnings Per Share of Acquiror’s Shares

Maximum Number of Acquiror’s Shares X Acquiror’s Market Price Per Share = Maximum Non-Dilutive Acquisition Price

As you will note, this is a dilution analysis dealing with earnings per share for the target. There can be numerous adjustments to this basic model that deal with cost savings that would boost earnings for the target, revenue enhancements that would result from “synergies” with the purchaser and the like to finally result in the purchase price but the fundamental underlying concept is set forth in the above formula. Under ASC 805 (formerly FASB 141(R)), bank acquisitions are required to be accounted for under the acquisition accounting method. According to the method, there are six steps to accounting for bank acquisitions: 1. Determine the acquiror and the target;

2. Determine the acquisition date;

3. Value the target’s assets and liabilities at their “fair value” as of the acquisition date;

4. Determine the target’s equity (which is the difference between the fair value of its assets and liabilities);

5. Value the purchase consideration as of the acquisition date (which includes (1) the fair value of the consideration plus (2) fair value of any non-controlling interest the acquiror may hold in the target).

6. a. If purchase price exceeds equity, determine split between goodwill and core deposit intangible;

b. If equity exceeds purchase price, re-value assets and liabilities and if same result occurs, book difference between purchase price and equity as “bargain purchase” and recognize as income.

The difficult part of accounting for bank acquisitions is determining the “fair value” of the assets as of the acquisition date. This is especially difficult for loans, because the fair value is not necessarily what the target bank paid to acquire the loan or the face value of the ledger balance. Instead, the fair value is based on a number of factors, which the accountants valuing the loans must consider.

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Accounting for bank acquisitions is complicated. Be sure to get professional help. For additional information regarding a more comprehensive discussion of the Acquisition Accounting Method, please request the Gerrish Smith Tuck material “Mergers & Acquisitions.”

G. ALTERNATIVE INVESTMENT OPPORTUNITIES FOR THE HOLDING COMPANY

As banks and holding companies attempt to boost income in this challenging marketplace, and all other avenues of increasing revenues from our core banking business and decreasing costs, e.g. obtaining more core deposits, increasing fees have been exhausted, then often companies will look beyond their core banking business to determine how else they could generate income for the company in this challenging environment.

Many of them view an investment in an alternative line of business as an excellent way to diversify the earnings stream of the company. In theory, this is good. The theory holds up provided that as the bank expands into other lines of business, it understands those other lines of business. As we travel the nation, the lines of business most talked about include insurance agency sales, securities brokerage, and trust, asset management, and financial planning—all matters of interest that relate to the forthcoming wealth transfer in this country (which will be smaller than anticipated), the retirement of the baby boom population (which will be somewhat delayed), and the eventual need for asset management.

We also have a number of clients who have invested excess capital in loans to other bank holding companies and other equity investments. The general rule for equity investments is that the bank holding company can invest in up to 4.99% of the stock of any company without Federal Reserve Board approval. The bank holding company can also invest in anything that is closely related to banking or “proper incident thereto,” as identified by the Federal Reserve under Regulation Y, or, as a financial holding company, the investments can even go beyond that.

The question is what makes sense in order to be successful in the future? Does the acquisition of an insurance agency make sense? It may if you have the talent, the aptitude, and the fortitude to make it successful. Does the acquisition or the creation of a finance company make sense in your market? Does the acquisition of some other related business make sense?

One other issue regarding success in the future is that the Board of Directors needs to consider whether to become a financial holding company. The financial holding company designation was created by the Gramm-Leach-Bliley Act to allow banks that elected financial holding company status to engage in additional financial and non-financial activities and also to be able to move a little quicker in the acquisition arena and provide post-acquisition notice rather than prior approval of the Federal Reserve. A financial holding company is simply a “plain vanilla” holding company that certifies to the Fed that it is well managed, well capitalized and CRA satisfactory.

For a community bank that is not public, there is no downside whatsoever to requesting the financial holding company designation. For a public company, the only downside to requesting financial holding company designation is if the holding company ever loses that

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designation, i.e. it is no longer well capitalized or well managed or CRA satisfactory, then it must “tell the world” through an 8-K or other public filings.

The issue in the current environment, however, is whether the bank and holding company should diversify its business model in order to diversify its income stream and, theoretically, de-risk its income stream in a highly competitive environment by moving away from the loan interest income and towards other sources of income. This is an alternative that every bank should discuss in the current environment.

H. GETTING AND KEEPING THE RIGHT PEOPLE

It is wonderful to discuss our obligation to be successful in the future, enhance shareholder value and allocate financial capital in support of the bank and holding company’s business plan. It is quite another issue to assure that our bank and holding company actually have the human resources to make that a reality. Notwithstanding the financial meltdown, the loss of hundreds of thousands of jobs, and the recession/depression which hopefully is in the rearview mirror, there is continuing pressure on community banks to be able to attract and retain key personnel, particularly those superstars who are revenue generators. If the organization is going to have the opportunity to attract and retain key personnel, then the Board of Directors must make some fundamental decisions: 1. Is employee ownership a good thing? 2. Does the organization have the tools to retain the key people it has now? 3. As the company develops its business plan, what will be required to attract new

people to this organization? For most banks, that means the following:

Paying fair cash compensation. Often, not just at peer levels but above peer levels,

depending on the bank’s performance, overall within the bigger scheme of things. In other words, if the bank is a high performer, then you are going to expect high performance people and you are going to have to pay them accordingly.

Incentive compensation. In order to attract and retain key people, most hard

chargers will want a significant portion of their compensation in non-salary or incentive compensation where they have an excellent upside potential. If you cap that upside potential in incentive compensation, you will be capping the incented employee’s work effort. Our firms had one client that capped the incentive compensation based on a return on equity that was 14%. Never in the history of that bank did the ROE ever exceed 14%, although it came right up to it a number of times. The incentive system also needs to be something other than a discretionary bonus. A discretionary bonus is not an incentive system. It is typically a bonus based on the last five minutes of the employee’s impression on the Board before they grant the bonus.

Equity compensation. As noted above, one of the fundamental issues for the Board

to consider is whether employee ownership is a good thing. If it is, then some type

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of equity system needs to be implemented. Whether this is an ESOP, a KSOP, stock options, restricted stock, stock grants, there are a multitude of choices.

Providing appropriate incentives for officers, directors and employees can often serve as a means whereby shareholder value is enhanced. It creates an incentive for individuals managing and operating the bank to insure that the bank operates profitably. It also gives those individuals a share in the increased profitability and productivity which they have created. Five major ownership incentives are used in a typical community bank and are fairly easy to implement. These include the employee stock ownership plan (ESOP), the incentive stock option plan (ISOP), stock appreciation rights plan (SAR), non-qualified stock option plans and restricted stock plans. Each of these is briefly addressed below. 1. ESOPs. An ESOP is also a means for a community bank to create liquidity as well

as establish an employee benefit for the Bank's officers and employees.

a. Definition of an ESOP. The definitions for Employee Stock Ownership Plans (ESOPs) include:

* qualified retirement plan and trust, * defined contribution plan, * stock bonus plan, * deferred compensation fringe benefit plan, and * a financing vehicle or strategy.

The basic rules of operation of an ESOP are identical to other qualified retirement plans, including stock bonus plans, profit sharing plans, or defined benefit pension plans. The ESOP must be operated for the exclusive benefit of employees and must not discriminate in favor of the highly compensated and others in the prohibited group including officers, directors and shareholders. The ESOP differs from other plans in that the primary investment of the ESOP must be employer stock.

b. Mechanics of an ESOP. As operated under the statutory regulations, the

mechanics of an ESOP can be very similar to a profit sharing plan. The ESOP differs from a profit sharing plan in one respect in that the benefits accruing to the benefit of employee/participants are employer stock. Other aspects related to the operation of an ESOP are listed as follows:

* Contributions to an ESOP by the employer are usually discretionary

and determined by the Board of Directors.

* Employees who meet age and service qualifications participate in the plan.

* Employee accounts in the ESOP grow through:

- Employer Contributions - Appreciation - Earnings

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- Forfeitures - Release of stock as collateral in a leveraged ESOP

* Employee benefits are determined under a vesting schedule based on

the employee's years of service.

* Employees who terminate employment before they are 100% vested forfeit a portion of their account balance that can be reallocated to other participants' accounts.

* ESOP benefits are usually paid at the employee's death, disability or

retirement. * Participants have the right to demand stock when benefits are paid.

However, as a practical matter, employees rarely demand stock since they need liquidity for retirement, etc.

* If stock is distributed and the stock is not readily tradable on an

established market, the distributee must have a put option that allows the distributee to require the employer to repurchase the stock at fair market value within a fixed period of time.

* Stock that is distributed to ESOP participants or beneficiaries can be

made subject to a right of first refusal that gives the employer the right to repurchase the stock before it is transferred to any third party.

The use of ESOPs for Subchapter S holding companies or banks, 401(k) ESOPs or leveraged ESOPs have additional operational requirements and offer additional benefits for employers and employees.

c. A Holding Company vs. an ESOP as the Purchaser in a Stock Repurchase

Plan. An employee stock ownership plan (ESOP) is a specialized type of qualified retirement plan which invests in stock of the employer corporation. As stated above, an ESOP is generally a defined contribution plan which must satisfy the qualification requirements of the Internal Revenue Code and the regulations concerning employee eligibility, participation, vesting and nondiscrimination.

Carefully planned use of an ESOP may yield substantial tax, financial and strategic planning advantages. Tax-deductible contributions may be made to an ESOP in the form of cash to buy existing stock from shareholders, or new stock may be contributed or sold to the plan. Deductible cash contributions may be made to cover principal and interest payments on ESOP debt when an ESOP has borrowed money to purchase employer stock (a "leveraged ESOP"). It is possible to use a holding company, an ESOP or both vehicles in a stock repurchase or ownership restructuring program. Although there are a

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number of differences between the two techniques, most of the major considerations fall into the categories of (a) voting differences, (b) economic advantages and disadvantages, and (c) financing costs.

(1) Voting Differences. The use of a holding company (as opposed to

an ESOP) to repurchase stock creates differences in the relative voting strengths of existing shareholders. Stock repurchased through the holding company becomes nonvoting treasury stock effectively increasing the relative voting strength of each remaining shareholder, friendly or unfriendly. Stock purchased by an ESOP (a "friendly" shareholder), however, continues as voting stock while the other shareholders have unchanged relative voting rights. The exact methods by which ESOP stock is voted are determined by specified rules and may vary depending upon the structure of the ESOP and the employer. Regardless of whether the stock is actually voted by the ESOP trustee(s) or the employees covered by the plan, the general effect will still be to have a "friendly" shareholder.

(2) Economic Advantages and Disadvantages. The major economic

issue to be examined is having the stock purchase by the ESOP, where any increase or decrease in value will accrue to the employees, versus having the stock purchased by the holding company, thus passing the risks and benefits to the BHC's shareholders. Of course, repurchased shares may be divided between a holding company and an ESOP. Many institutions split stock repurchases between a holding company and its ESOP, making it difficult for affected parties to later criticize the transaction, since all parties received some benefits or shared the losses.

(3) Financial Considerations. The cost of financing the transaction is

another major consideration in determining whether to use a BHC or an ESOP in a repurchase transaction. In this category, the advantage normally lies with the ESOP, because of substantial tax advantages including the ability to effectively deduct principal payments, as well as interest payments, on any ESOP loan. Many existing pension and profit-sharing plans may be converted to ESOPs with part or all their funds available for stock repurchases. Such conversions have substantial technical aspects, and experienced counsel must be consulted. For additional information, please request Gerrish Smith Tuck material entitled "Utilization of Employee Stock Ownership Plans."

2. Incentive Stock Option Plan (ISOP)

a. The ISOP is the term used for qualified stock options that do not result in a tax consequence when the option is granted or when it is exercised (other than alternative minimum tax considerations). However, the amount that the fair market value of the stock exceeds the option price is a tax preference item used in the computation of the alternative minimum tax in the year the ISO is exercised. Features of the ISO are:

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(1) An employee will be entitled to capital gains when the stock is sold if he or she holds the stock for 2 years from the date the option is granted and one year after he receives the stock (unless he dies). If the stock is sold before these periods end, the employee has ordinary income. The taxable gain (whether capital gain or ordinary income) is the lesser of: (i) the fair market value of the stock less the basis (cost) in the

stock or (ii) the amount realized on the sale less the basis (cost) of the

stock).

(2) The employer will be entitled to a deduction only if the employee pays ordinary income on his gain.

(3) The employee must have been employed by employer at least 3

months before the exercise of the option (12 months if the employee is disabled).

(4) There are basically nine requirements for an ISOP:

- The written plan must be approved by the shareholders. - The option must be granted within 10 years after the plan is

adopted. - The option must be exercised within 10 years after the grant

of the option. - The option price must not be less than fair market value at

the time it is granted. A good faith attempt to establish value must be shown.

- The option must be non-transferable except by death, and

can be exercised only by the employee. - The employee, at the time the option is granted, must not

own more than 10% of the employer's stock. (This is waived if the option price is 110% of fair market value and requires exercise in 5 years.)

- An option can't be exercised if an earlier ISO granted to the

employee is outstanding. (Earlier options can't be cancelled.) - The value of the stock that can be exercised for the first time

by an employee in any one year cannot exceed $100,000, based on the fair market value of the stock at the date of grant of the option.

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- A special IRS ruling provides that employees may exercise ISO's with other non-qualified stock options of the corporation and not affect that $100,000 limit above. (Of course, the employee will be taxed on the non-qualified stock options.)

b. Under current tax laws, capital gains are preferable to ordinary income for

most taxpayers; therefore ISOPs have become preferable to Non-qualified Stock Option Plans (which can result in ordinary income to the option holder).

c. Incentive stock options are excluded from compliance with IRC Section

409A requirements for defined compensation type plans. 3. The Stock Appreciation Rights Plan (SAR)

a. The following is an example of how a typical Stock Appreciation Rights Plan might work: On January 1, 2013, Bank Holding Co. (BHC) grants to B, a key employee of BHC & Bank, 1000 SAR units. Each SAR unit entitles B to the appreciation in value in one share of BHC stock over a 10 year period beginning January 1, 2013. If not exercised, the SAR units expire December 31, 2022. SAR units granted on January 1, 2013 may be exercised after December 31, 2018 (under a five year vesting schedule). At the time of exercise, B will receive cash based on the fair market value of BHC stock on the SAR exercise date. If on January 1, 2013 the value of BHC stock is $25 per share and on January 1, 2019, when B exercises the SAR, the value of BHC stock is $50 per share, then B will receive $25 per unit for each SAR unit that is exercised. The key factor is the valuation. Fair market value of one share of stock is usually the value relied on but the method of establishing the value could be based on book value or otherwise and should be set forth in the SAR plan. There is no specific Internal Revenue Code provision authorizing the Stock Appreciation Rights Plan. There are a number of IRS private letter rulings and Revenue Rulings regarding SARs.

b. A summary of the steps involved and the key factors that would be included

in a typical SAR plan are:

(1) The Board of Directors approves the initial plan and the annual allocation of units to Bank management employees under the plan.

(2) For ten years, units representing shares of bank holding company

("BHC") common stock are assigned to management employees with a value per share based on common stock value.

(3) Employees receive no vote nor ownership rights with units assigned.

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(4) Employees' units increase in value by (1) appreciation in BHC stock, (2) dividends paid on BHC stock.

(5) Employees receive annual reports on the value of their SAR account. (6) Annual valuations of stock will determine rights to appreciation. (7) Employees can receive cash from BHC in exchange for their SAR

unit value five years or later from the date the units are awarded or when an employee becomes disabled or dies, whichever comes earlier. The plan may provide that the employee has the option to cash-in his or her SAR rights after five years or that the employee is required to cash in after five years. If the employee has the option to cash in the SAR after five years and does not exercise the option, the account will continue to grow.

(8) If an employee's employment with the Bank terminates, either

voluntarily or involuntarily (not for cause), he or she is entitled to cash in his vested units only at death, disability or upon reaching age 65. No appreciation accrues and no dividends shall be posted to his account after such termination. At the Bank's option, the employee may be cashed out at the time he or she leaves.

(9) If employee is terminated for cause (fraud, embezzlement, etc.), or if

an employee competes with the Bank, he or she shall have no rights to receive any of the value assigned to his or her units and his or her interest in the SAR plan shall be revoked and terminated.

(10) If substantially all of the assets of the Bank or controlling stock of

BHC or Bank is acquired by any other owners, the SAR rights previously granted to participants may be exercised immediately regardless of whether they have been held for five years. Also, if that event occurs or is about to occur, the Board of Directors may immediately grant any authorized but unassigned SAR rights that may also be immediately exercised by the participants.

(11) The tax consequences to the employee are:

- The employee recognizes no taxable income at the time a unit

is awarded to his or her account or as his or her account grows, and

- At the time of payment of cash benefits to the employee, he

or she recognizes ordinary income for tax purposes on the amounts received.

c. The tax consequences to Bank are:

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(1) Bank gets no deduction at the time the unit is awarded to the employee, and

(2) At the time cash is paid to the employee, the Bank can deduct these

payments provided the payments under the plan are reasonable enough to be considered ordinary and necessary business expenses.

d. SARs are excepted from the compliance requirements of IRC Section 409A

for deferred compensation type plans if (a) the SAR payment is not greater than the excess of the fair market value of the stock (disregarding any lapse restrictions) on the date of exercise over the fair market value on the date of grant of a fixed number of shares at that time, and (b) the SAR may not include any feature that delays income inclusion beyond the exercise of the SAR.

4. Combination Incentive Stock Option Plan (ISOP) and Stock Appreciation Rights

Plan (SAR)

a. A disadvantage of the ISOP is that in the year the employee exercises the option, he or she must do so with his or her own funds or borrowed funds unless the employer pays a bonus to the employee in that year.

For this reason, ISOPs and SARs are often used as a combination. The SAR is granted and timed so that the employee can cash in his SAR units in the same year that he or she will need cash to fund the purchase of stock pursuant to an ISOP. When this occurs, the employer will have a tax deduction in the amount paid for the SAR and the employee will have taxable ordinary income in this amount. Payment of the funds to the employer for the stock received by the exercise of the ISO will not result in a deduction for the employer or in income to the employee (unless there are alternative minimum tax considerations). From a cash flow standpoint, the employer may have paid out the same amount for the SAR that it will receive for the stock, so the transactions are a wash to the employer. That transaction would also be a wash to the employee from a cash flow standpoint, but the employee will receive new stock (with a basis of the cost of the stock) and will owe tax on the SAR amount.

b. The IRS has ruled that tandem ISOPs and SARs are permitted if:

(1) The SAR expires no later than the ISO. (2) The SAR does not exceed 100% of the difference between the

market price of the stock and exercise price of the ISO. (3) The SAR has the same restrictions on transferability that are on the

ISO. (4) The SAR may be exercised only with the ISO.

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c. The SAR can be exercised only when the market price of the stock exceeds the exercise price of the ISO.

5. Non-Qualified Stock Options

Non-qualified stock options are often granted to community bank directors at the same time ISOP's are established for officers and employees. If the non-qualified stock options have a value at the time they are granted, such options are taxable to the employee or director in the year the option is granted to them, unless the option is non-transferable. If it is non-transferable, no tax is due until the exercise of the option. A non-qualified stock option must have the fair market value of the stock at the time of grant as the exercise price and have no other provisions that delay the recognition of income when the operation is exercised, in order to avoid compliance with IRC Section 409A requirements for deferred compensation type plans. When the option is exercised, the employee or director will have taxable ordinary income on the difference between fair market value of the stock at the time of the exercise and the option exercise price. The employer will have a deduction in the same amount. The non-qualified stock option may contain any of the features required for an incentive stock option plan, but none of those are mandatory. The non-qualified stock option can be used in tandem with the Incentive Stock Option Plan (to exceed the $100,000 annual limit) and with the Stock Appreciation Rights Plan.

6. Restricted Stock

Restricted Stock Plans generally grant stock to executives with certain restrictions. The restrictions may be that certain financial goals must be met before the restrictions lapse or that the executive must continue to be employed for a certain number of years or both. If the conditions associated with the restrictions are not met, the stock is forfeited. The restricted stock may have favorable tax benefits in that the executive is not required to recognize ordinary income for tax purposes when the restricted stock is issued. An example of how a Restricted Stock Plan works is as follows: 1,000 shares of non-transferable stock might be issued to the executive of the bank, subject to the restriction that, if the executive leaves the employment of the bank within five years, he or she will forfeit all the stock. Assuming that this condition constitutes a “substantial risk of forfeiture”, the executive will not be required to recognize income under IRC §83 until the restriction of forfeitability lapses in five years. Another condition could be that the restriction does not lapse until certain levels of earnings or other financial goals are reached. The executive will be taxed on the value of the stock when the restrictions lapse and the conditions are met, however. Thus, if the value of the stock has gone from $30 a share to $50, the executive will have $50,000 of ordinary income in the fifth year. Because the executive might not want to sell the stock at that time, this could impose an extreme cash flow hardship.

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If, instead, the executive makes an "83(b) election" as authorized under the Internal Revenue Code, he would have had to include $30,000 in his income in the year of receipt of the restricted stock, but would have been able to defer recognition of the $20,000, (due to the increase in the stock's value), until the stock was sold, which might be 10 or 15 years later. The $20,000 would be taxed at capital gains rates. The numbers in this example are such that the immediate inclusion of $30,000 in taxable income would normally be very unattractive. However, if the current price of the stock was low, say $15 per share in the above example, and substantial appreciation was anticipated, a Section 83(b) election would probably be advisable, since it would be made at a low present tax cost with a possibility of significant tax deferral. Also, the granting of the restricted stock could be spread over a period of years to lessen the tax effect of the 83(b) elections. Granting of the restricted stock can be linked to bonuses that help to pay the tax obligation imposed if the 83(b) election is made. A modification of the above example would be for the company to sell the restricted stock to the executive for $30 a share (fair market value), so that a §83(b) election could be made at no current tax cost. The bank could loan to the employee part or all of the $30,000 required to purchase the stock, subject to the limitations under Part 215 of the FDIC Regulations entitled "Loans to Executive Officers, Directors, and Principal Shareholders of Member Banks" (Regulation O). The loan could be made repayable immediately, if the executive left the bank's employment. A part of the executive's bonus each year can be designated to retire the loan. It is also worth noting that the Tax Cuts and Jobs Act of 2017 created a new §83(i) election that would permit certain employees to spreadout tax liability associated with restricted stock over a period of five years. This section, however, has certain requirements that make it highly unlikely to be utilized by community bank employees for incentive purposes.

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Restricted Stock v. Stock Options

Restricted Stock ISOs NSOs

Can employees receive capital gains tax

treatment?

Yes, any gain over price at date of grant is taxed as capital gain if an

83(b) election is made.

Yes, any gain on shares received on exercise is taxed as capital gain, provided holding

period rules are met.

Only for gains on shares held after

exercise.

Is employee taxed at grant?

No, unless employee makes 83(b) election; otherwise, ordinary

income tax paid when restrictions lapse.

No. No.

Is employee taxed at vesting?

Yes, unless employee made an 83(b) election at grant.

No. No.

Is employee taxed at exercise?

N/A No. Yes.

Can tax be deferred until sale?

Yes, if 83(b) election made at grant, capital gain can be deferred.

Yes, if requirements met. No.

Can Alternative Minimum Tax apply?

No. Yes, to spread on exercise if

shares not sold in year of exercise.

No.

Does the employer get a deduction?

Yes, for amount recognized as regular income to employee.

Only for disqualifying dispositions for amounts taxed

as ordinary income.


Does the employee get dividends?

Can be attached to restricted shares before restrictions lapse.

Not until shares are actually purchased.

Not until shares are actually purchased.

Are there voting rights for employees?


No. No.

Is there value if the share price goes down

below grant price? Yes. No. No.

Do the awards affect dilution and EPS

calculations?

Yes, but normally fewer restricted shares are issued than options

because of their downside protection.

Yes, even if the awards are underwater.

Yes, even if the awards are

underwater.

Can employees delay exercise after vesting?

No, shares belong to employee when restrictions lapse.

Yes, usually for several years. Yes, usually for several

years. How is value affected by decrease in stock value

below date of grant value?

Value of stock decreases, but not worthless.

Worthless. Worthless.

Does the employer recognize an expense in its income statement?

Yes, in an amount equal to the fair value of the stock at grant.



How is the compensation expense

recognized?

Accrued on the vesting or performance period.

Accrued on the vesting or performance period.

Accrued on the vesting or

performance period. Can the employer

reverse compensation expenses for forfeited

awards?

Yes, for forfeited awards with “service” or “performance

vesting”.

Yes, for forfeited awards with “service” or “performance

vesting”.

Yes, for forfeited awards with “service”

or “performance vesting”.

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Questions and Answers Regarding Restricted Stock Plans

Can employees receive capital gains tax treatment?

Yes, any gain over price at date of grant is taxed as capital gain if an 83(b) election is made.

Is employee taxed at grant? No, unless employee makes 83(b) election; otherwise, ordinary income tax paid when restrictions lapse.

Is employee taxed at vesting? Yes, unless employee makes 83(b) election.

Can tax be deferred until sale? Yes, if 83(b) election made.

Can Alternative Minimum Tax apply?

No.

Does the employer get a deduction?


Does the employee get dividends?


Voting rights for employees Can be attached to restricted shares before restrictions lapse.

Is there value if the share price goes down below grant?

Yes.

Do the awards affect dilution and EPS calculations?

Yes.

Can employees delay exercise after vesting?

No, shares belong to employee when restrictions lapse.

How is value affected by volatility?

Better in less volatile companies.

For additional information on all these compensation issues, please request Gerrish Smith Tuck material entitled “Incentive Executive Compensation” and “Utilization of Employee Stock Ownership Plans”. If we are going to move the process forward and not simply throw up our hands and sell the bank, then the human resource side of the capital allocation equation must be addressed.

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I. TAKE THE OPPORTUNITY TO “ACTION PLAN” FOR THE FUTURE

For the last 20 years, our firms have focused a large portion of our consulting practice on assisting banks in figuring out “what to do with their lives.” We often come in after other consultants or professionals have been in trying to assist the bank in the same vein. We have often found that the banks and their Boards are stumbling along focusing on “process” over “results.” In our firm, we have even gotten away from the term “strategic planning” (although we do give it its deference) and prefer to refer to it as “action planning.” Action planning results in (guess what?) action plans to be implemented over the course of the planning period, which is often two to four or five years. In order for the Board and management to work their way through the current challenging marketplace and environment, long term action planning is a nonnegotiable. Set forth below are 10 Commandments for Action Planning:

I. KNOW THAT STRATEGIC PLANNING IS A BOARD OBLIGATION.

Strategic planning is an obligation of the Board of Directors of your bank and holding company. It cannot be delegated downward to the management nor can it be avoided at the Board level. Tactical and operational planning, which is different from strategic planning, is a management obligation once the Board sets the long-term strategies as part of its 30,000 foot flyover approach. The Board should make conceptual decisions, not micro-manage the institution.

II. UNDERSTAND THE FOUNDATION FOR STRATEGIC PLANNING.

It is critically important for the Board of Directors to understand the foundation for strategic planning. It is the Board’s obligation and part of its fiduciary duty to give direction to management regarding the allocation of capital, both managerial and financial. Managerial capital we can point to, shake hands with and slap on the back. Financial capital we can determine. The Board’s obligation as part of strategic planning is to direct the allocation of capital for the next few years.

III. MEET THE OBLIGATION TO ENHANCE SHAREHOLDER VALUE.

The Board’s obligation to plan involves the allocation of capital to enhance shareholder value. Enhancing shareholder value is a nice “MBA” type term. To put a framework around enhancing value for community banks, it basically means focusing on the four areas noted earlier in these materials:

A. Growing earnings per share – earnings drive the value of the company and

per share earnings drive per share value; B. Targeting a reasonable return on equity – more difficult in the current

economic environment and with increased regulatory capital requirements; C. Creating liquidity for shareholders, i.e., the ability of a shareholder to sell a

share of stock at a fair price at any time;

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D. Providing for reasonable cash flow to your shareholders resulting from a reasonable dividend policy; and

E. Operating in a safe and sound manner, since all of the other metrics will

not enhance value for your shareholders long-term if the bank folds due to poor underwriting, risk management, etc.

IV. PREPARE FOR CHANGE.

In the rapidly changing environment in which our community banks operate, we as directors must, in fact, prepare for change. Change is difficult for many directors, particularly when they have been on the Board a long time. They do not handle change well in their personal lives, and they do not handle change well in the bank they have known so long. Nevertheless, we must realize that planning involves change. We must be willing to change, not for change’s sake, but to do what it takes to move the bank forward.

V. GET OFFSITE AND OFFLINE.

Unless you simply cannot avoid it, do not conduct your strategic planning at the bank and encourage all participants to turn off their cell phones, tablets, and laptops. It just does not work (at least not very well) if everyone is easily accessible to the outside world. Everyone will be interrupted. Get your group offsite and off of their mobile devices and allow them to “bond” (Board bonding may be a scary thought for some of the senior management group). As noted above, the planning process itself should not take much more than six to 10 hours, or one to one and a half days. An afternoon and morning of the following day will usually do it. Feed them and “water” them and you will provide a good climate for discussing the changes involved in planning.

VI. DON’T WASTE YOUR TIME.

One of the biggest mistakes of the strategic planning process is wasting the directors’ time discussing items that are not Board level decisions (micromanaging) or discussing items better left to another time (detailed financial planning). The strategic planning process is not a budgeting process. While some consideration of financial issues is important, any extended discussion or attempts to project performance ratios and the like is not as productive a use of the Board’s time as is the consideration of substantive issues as discussed below.

VII. HAVE AN AGENDA.

Actually, have two agendas. There should be an “open” agenda since the senior management team, or at least the top portion of it, should be at the meeting and there should be an executive session agenda. The executive session is the “Board only” including inside directors as well as outside directors. The open agenda will seek input and direction on matters that relate to the company as a whole. The executive session will deal with Board issues, attracting and retaining key officers and

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employees and corporate governance matters. The easiest way to create an agenda (at least what we do as facilitators) is to send confidential questionnaires to participants in advance of the meeting. Confidential questionnaires will elicit the real issues at the institution.

VIII. ANALYZE SUBSTANTIVE ISSUES.

The agenda needs to address the substantive issues that deal with your bank and holding company. There are a number of substantive issues of importance to nearly all community banks, including capital allocation issues, ownership, growth versus profitability strategy, geographic expansion, technology planning, creating liquidity for the shares, dividend policy, marketing and the like. There also will be unique issues associated with your institution. These unique issues can be derived from confidential questionnaires sent to the participants prior to the planning session.

IX. USE AN OUTSIDE FACILITATOR.

Address the issue of whether you should use an outside facilitator. There is an obvious cost associated with this route. The offsetting benefit, whether you use a facilitator such as an academic who may be able to assist in facilitating the discussion but has no knowledge of the industry or an “expert” facilitator who has knowledge of the industry, is that if the facilitator is doing his or her job, the facilitator should:

A. Keep the discussion moving;

B. Control the meeting;

C. Move through the agenda;

D. Move the group toward consensus on various areas, if possible;

E. Identify long-term strategies, goals and action plans; and

F. Create an outline of an action plan so that there is accountability as a result

of the meeting.

An outside facilitator can also ask the hard questions with no need for political avoidance or often even knowledge that there is a political issue. Our recommendation is to use an outside facilitator when it makes sense for you (we acknowledge the shameless self-promotion involved in this recommendation).

X. HAVE AN ACTION PLAN.

The planning process is useless without some accountability. Each planning meeting should result in a specific action plan indicating the action to be taken, parties responsible and the date due. The action plan should be a line item on the Board agenda on a monthly or quarterly basis.

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II. OPERATING IN THE CURRENT REGULATORY ENVIRONMENT

The current regulatory environment is as challenging today as it has ever been. While things have certainly improved since the height and aftermath of the Great Recession, regulators are typically not ones to forget easily. It has been our experience that many regulators view current operations and risks with an eye toward avoiding a repeat of the issues leading up to the recession. In other words, even if there has been an easing of regulatory pressure compared to 2011, for example, the regulators are still generally quick to clamp down on any identifiable issues. As directors and officers of our community banks, it is imperative that we fully understand how to address the significant regulatory overlay on our industry. If our goal is to continue to serve our shareholders and communities, then long-term independence needs to be assured within the current regulatory context, including regulatory examinations and regulatory enforcement actions.

A. REGULATORY ISSUES – GENERAL

In this environment of change, it is critical for the bank’s Board and management to understand their rights and how to effectively, in a variety of circumstances, deal with and "manage" the regulators and/or an adverse regulatory exam. The commercial banking industry remains one of the most regulated industries operating in the United States. Although structural choices may provide some choice of regulators, the typical community bank is at least regulated to a certain extent by one of the following: the chartering state, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC) and/or the Federal Reserve Bank (FRB). Each of these regulatory agencies has its own methods and its own agenda (which are admittedly difficult to predict in the current political environment, particularly as it relates to changes and appointments coming out of the executive branch). It is imperative to know the bank's and director's rights and how to manage each agency, whether you are seeking to respond to an examination, trying to deal with the regulators in a problem bank environment, or attempting to understand your duties as directors and officers.

B. BANK EXAMINATIONS – PRELIMINARY CONSIDERATIONS

1. Current Trends

The regulatory examination process for safety and soundness examinations has changed. Community bankers are increasingly being criticized at every turn. Nowadays, there are few pats on the back or congratulations for a job well done and even less examiner communication, though the latter continues to improve. Many of our clients have been subjected to examinations where criticism upon criticism is heaped upon the bank for matters that, until recently, were often just passing references in the examination report. Such items such as underfunded loan loss reserve, commercial real estate and other loan concentrations, lack of appropriate policies and

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procedures, failure to timely identify problem credits, poor management oversight and general loan documentation issues have become hot buttons causing more adverse exams. Unfortunately, these exams and this change in regulatory attitude often means examiners are taking CAMELS 1 and 2 banks and bringing them down a notch or two -- or worse. The most pronounced current trend, however, is in the area of compliance. This is “not your father’s compliance.” It is primarily dealing with significant issues of unfair and deceptive practices, “abusive” practices as added by Dodd-Frank, and fair lending. These are big ticket items which every bank should be petrified of. What is an unfair and deceptive or abusive practice? Who knows – primarily what the examiner says it is. The major downside to unfair and deceptive practice cases and fair lending is the cost to the bank that is targeted. Generally, reimbursement is required, a civil money penalty is assessed and contribution by the bank to a not-for-profit financial literacy fund is often required or negotiated as part of the settlement. Be petrified of compliance. It continues to be a hot button. Even as regulators continue to somewhat losen their grip, the hammer continues to fall very hard on banks caught in compliance violations.

2. Causes of Regulatory Criticisms Based on our experience in assisting community banks from coast to coast, we note consistent regulatory criticism in the following areas: Management Oversight Loan Administration and Oversight Legal Compliance Loan File Maintenance Miscellaneous “Hot” Topics (BSA, Corporate Governance, etc.)

Every community banker should plan ahead for their next exam and pre-empt criticism that will undoubtedly occur if any one of these areas are weak in their bank. Some require more effort than others, but all of these areas are of critical importance to examiners and their superiors. If an examiner "perceives" strength in these areas, the bank benefits and focusing attention on these areas ahead of time should produce a better bank for the long term.

a. Management Oversight

Regulatory agencies criticize bank management (including the Board of Directors) as a general criticism to cover a host of alleged sins. One primary criticism we have seen increasingly is the inability of the Board of Directors to act in a capacity independent of day-to-day management personnel. This is often determined to be the case if the Board does not operate with a well-defined committee structure that includes both inside directors and outside directors. Additionally, Boards of Directors that are comprised substantially of management officials and that have limited participation by outside directors

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are a renewed focal point for the regulatory agencies. Several clients have been “asked” to put new members on the Board of Directors to balance the numbers in favor of outside directors. There is a general belief among the regulators that unless there is more independence from management on the Board, all of the other issues such as loan administration, regulatory compliance and the like will go by the way side.

b. Loan Administration and Oversight Obviously, the loan function of the bank is critically important to its success. Too much concentration in one type of loan, too many under performing loans, improper collateral on loans and other problems often signal the first signs that a bank is in trouble. The regulators have been tending toward taking a broad brush approach toward a bank’s loan function by looking at the overall loan administration and oversight function of the bank. This often causes specific criticisms of the senior loan officer or other supervising personnel. More often than not, if the bank has a problem in one area (for example, a concentration of credit) the regulators are likely to criticize the entire loan administration function and use that as a basis for further scrutiny of loan documentation, compliance with loan policies and procedures and other matters. Establishing and maintaining a current "watch list" and monitoring a formalized loan grading and review system is critically important. It is imperative that the bank identify the problem assets before the regulators do. Under a loan grading system, loan officers periodically review each loan for which they are responsible and assign a loan quality rating. That loan quality rating is based on a number of factors, including performance history, collateral and documentation. Quarterly reviews of each loan are frequently a part of a strong loan grading system. It is important to coordinate watch-list reports with loan grading to assure that loans that have some question of collectibility get transferred to the watch list at the earliest time. Once implemented, a good loan grading system can be the basis for bankers to more objectively determine what needs to be provided in the loan loss reserve account. Implementing a loan grading system is yet one more responsibility for already overworked loan officers. However, examiners expect a bank to maintain a fully implemented loan grading system. Loan review, as part of an examination, becomes much smoother and examiners place more confidence in the representations of loan officers with regard to those loans in question when a formal system is in place, adhered to and identifies the credits before the examiners do.

c. Loan File Maintenance

Bank examiners are more inclined to classify a loan "substandard" because of document deficiencies rather than citing it for a "technical exception." As a result, community bankers are finding more and more loans classified as substandard when, in fact, those loans really have no adverse collection risks.

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In all likelihood, it is the content of the file and the lack of file maintenance and organization that give rise to a substandard classification. To avoid such adverse treatment for otherwise high-quality loans, bankers should take advantage of checklists and other file maintenance procedures. This assures that a loan is properly documented and that documents such as appraisals, surveys, evidence of insurance, copies of collateral filings, financial statements and other documents are obtained prior to funds being disbursed. Even small community banks should have in place a process whereby a loan file is not deemed complete for disbursement purposes until certain minimal requirements with regard to the file are met. Cleaning up old loan files can be unduly burdensome, but implementing new procedures for all future loans or renewals is not.

d. Legal Compliance Violations of law, including but not limited to Regulation O (transactions with “insiders” and legal lending limit), are a leading cause for the imposition of civil money penalties against banks, their executive officers and directors. More often than not, legal violations occur because of oversight and not through recklessness or intent on the part of the bank.

3. General Rule: The Board of Directors is in Control

An adverse examination may result in the primary federal regulator presenting an enforcement action or requesting charge-offs or other corrective action. All bankers should keep in mind that a regulator cannot force a bank to do anything without giving the bank substantial due process rights. Unless a bank, through its Board of Directors, voluntarily agrees to a regulator's request, the only way a federal regulator can require a bank to charge-off a loan, enter into an enforcement action, or take any other type of corrective action, is for the bank and the regulator to go through a hearing before an impartial administrative law judge who will then determine whether or not such action is appropriate.

C. WHAT IF YOUR BANK ANTICIPATES A MAJOR REGULATORY PROBLEM?

1. The Basic Question

When the banker is at a stage where he or she knows or anticipates that the bank will have some regulatory (generally asset quality) problems, should the banker go to the regulators with those problems, or should he or she wait and hope the problems can be resolved before the next examination?

2. The General Rule The general rule is that regulators do not like surprises, and the identification of problems by the bank before the examiner arrives tends to instill confidence in the

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examiners that the bankers are not “in denial”. The general rule dictates that if an unusual situation arises of such magnitude that it may impair the bank's capital or is unlikely to see rapid resolution, then it is appropriate to bring it to the attention of the regulators prior to the examination.

3. The Best Approach What is the best method for approaching the regulators? Often the best method for approaching the regulators is to pay a personal visit to the regional office. Most community bankers are familiar with field examination personnel. The banker may also be familiar with field office personnel or managers who supervise examination personnel in the bank's geographic location. Notwithstanding the apparent authority of those individuals when they come into the bank, in reality, in any of the regulatory agencies, none of those individuals has any significant authority. If a significant problem arises at the bank, whether it is a loan problem, a defalcation that may be covered by the blanket bond, management problem, or any other type of significant problem, it is appropriate to take that problem to either the regional office for the FDIC, the regional administrator's office for the Comptroller of the Currency or the appropriate Reserve Bank for the Federal Reserve. As noted above, the regulators do not like surprises. A visit to the regional office of the appropriate regulatory agency will result in a memorandum in that agency's file which will be read by the field examiner prior to the next examination. It is always wise, as a courtesy, to advise the field examiner, oftentimes after the fact, that a visit has been made to the appropriate regional office. If the field examiner is ever concerned that he or she was not contacted first, an appropriate response is to blame it on "the advice of counsel".

4. The Gambler's Approach For those community bankers who are less risk averse or more "gambler-oriented", it may be appropriate, if it is a short-term problem the banker believes can be addressed adequately prior to the next examination, for it not to be brought to the attention of the regional office. If, for example, the bank has a major loan workout problem, but the banker is convinced it will be collected prior to the next examination, then why bother the regulators with something which will not ultimately be a problem. If the banker gambles that an examination will not take place and is correct, then the bank and banker have won. If the banker gambles and does not bring the problem to the attention of the regulators and is incorrect with respect to the timing of the examination, or the timing of the resolution of the matter, and the problem is still apparent at the time of the examination and the banker has not laid the foundation to show that he or she is on top of it from a management standpoint, then the bank and the banker have lost. The approach chosen depends on the banker's (and Board's) appetite for risk.

5. The Truth About Regulators

Regulators are people too! That said, the banking regulators should not be considered a banker's friend or trusted advisor. Keep in mind the regulators have a job to do. An

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individual regulator’s personality may sometimes make him or her likeable (probably only in rare situations!), but don't expect the regulators to be friendly if they believe your bank has severe regulatory issues.

D. REGULATORY ENFORCEMENT ACTIONS

1. Introduction

Contrary to the belief of most bankers, regulators cannot force a bank to do much of anything (except possibly under the prompt corrective action provisions discussed below) without giving the bank substantial due process rights. The only way a federal regulator can require a "well" or "adequately" capitalized bank to charge off a loan or take any other affirmative action is either the bank, through its Board of Directors, voluntarily agrees to take that action, or the bank is required to take action after exercising its due process rights. Because of the limited tools available to both the state and federal regulators, a substantial degree of regulatory enforcement is accomplished through "jawboning" or intimidation. This is completely understandable since, if the regulator can jawbone or intimidate a bank into consenting to an action, then the regulator does not need to go through its own very cumbersome and lengthy procedures to require a bank to take a certain action, or to give a bank its day in court. Although the power of the federal regulators was enhanced significantly by the enactment of sweeping legislation in the late 80s and early 90s, the requirements of due process were not totally abandoned.

One of the most important reforms as a result of some of that legislation was the requirement that all written agreements, final orders issued in connection with enforcement proceedings and any modifications or terminations of either of the above be available as a public document. Additionally, the legislation required that all enforcement hearings be made open to the public unless closed by the regulatory agency upon motion of the bank.

2. Regulatory Enforcement Options

In order to understand its rights, a bank must understand the agencies regulatory enforcement alternatives. Although each of the regulatory agencies has certain lesser alternatives that they may designate by different names, the basic alternatives fall into the following categories:

a. Informal: Board Resolution or Commitment Letter. The least stringent

regulatory alternative is to request that the Board of Directors pass a resolution committing to take certain corrective actions or take certain affirmative steps to solve the bank’s problem. Of all the alternatives, this is the least risky to the bank and its directors. Since a "resolution" is simply an informal moral commitment by the Board, it is not enforceable in federal court and its breach is not subject to civil money penalties.

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b. Informal: Memorandum of Understanding or Letter Agreement. A Memorandum of Understanding (MOU) or letter agreement is an enforcement tool proposed by bank regulators in a situation where they do not believe that the more formal and more effective Consent Order or Formal Agreement (OCC) is warranted. A Memorandum of Understanding is simply a written agreement between the commissioner of banking, or the regional administrator for national banks, or the regional director for the FDIC region, as appropriate, and the Board of Directors of the bank. The Memorandum of Understanding has no more force or effect than a Board resolution as long as it is not formally designated as a "written agreement with the agency."

c. Formal: Formal Agreement or Written Agreement. A Formal Agreement or

Written Agreement is, as its name implies, a more formal and binding regulatory tool. It is a notch above the MOU and a notch below the Consent Order. A bank bound by a Formal Agreement (a favorite of the OCC) or a Written Agreement (a favorite of the Federal Reserve) may be subject to civil money penalties for breach of the agreement. Violation of the agreement may also be the basis in and of itself for a cease and desist proceeding as discussed below. Both the Formal Agreement and Written Agreement are public documents.

d. A Section 39 Action. This is a regulatory tool that is only occasionally used

(primarily in the mid-west) as an additional regulatory enforcement action. This action is somewhat of a hybrid that is a little more severe than an MOU but yet a little less severe than a Formal Agreement or cease-and-desist order. The primary benefit to the regulators is that it streamlines their process for ultimately converting the action to the more formal cease-and-desist order if there is a need. However, our experience has shown that only a few of the districts are employing this tool and most prefer to simply issue an informal MOU or proceed with a more formal cease and desist action. Although there is some gray area, it appears the Section 39 action is an informal proceeding that is not subject to publication or judicial enforcement and is of questionable constitutionality.

e. Formal: Section 8 – Consent Order and Cease-and-desist Orders (C&D).

Section 8(b) of the Federal Deposit Insurance Act (12 U.S.C. 1818(b)) is the authority for all banking agencies to bring formal enforcement actions. Section 8(b) provides an action to impose an order may be brought by an appropriate federal banking agency, when, in its opinion, "any insured depository institution, bank which has insured deposits or any institution-affiliated party is engaging or has engaged, or the agency has reasonable cause to believe that the bank or any institution-affiliated party is about to engage, in an unsafe or unsound practice in conducting the business of such bank, or is violating or has violated, or the agency has reasonable cause to believe that the bank or any institution-affiliated party is about to violate, a law, rule or regulation, or any condition imposed in writing by the agency in connection with the granting of any application or other request by the bank or any written agreement entered into with the agency . . . ." 12 U.S.C. Section 1818(b).

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During 2009, one major victory that resulted from actions of the Chairman of the Board of Gerrish Smith Tuck Consultants and Attorneys, Jeff Gerrish, and his interaction with FDIC Chairman Bair, was the universal replacement by the FDIC of the Cease-and-desist Order with a Consent Order (affectionately known as the “Gerrish Order”). The Consent Order, although still public, eliminates virtually all the inflammatory (obnoxious) language in the former Cease-and-desist Order. This change would not have occurred without Chairman Bair’s personal involvement.

As a result of the above, beginning in 2009, the FDIC, following the efforts of Gerrish Smith Tuck, changed its policy on Cease-and-desist Orders. If the bank now consents to a formal enforcement action (instead of exercising its right to go to an administrative hearing), then the resulting document will be called a Consent Order (rather than the more ominously named Cease-and-desist Order). Also, the Consent Order will omit most of the inflammatory boilerplate language contained in the Cease-and-desist Order (including language stating that the bank will cease and desist from operating with inadequate management and Board of Directors, engaging in hazardous and lax lending practices, and the like).

Cease-and-desist Orders are still available to the FDIC. Basically, it will use the Cease-and-desist Order when the bank will not consent.

Regulators also have authority to issue a "temporary" cease-and-desist order. The temporary cease-and-desist order, which is effective immediately ("temporary" is a misnomer), may require the bank or party against whom it is directed to cease and desist from any violation or practice and to take affirmative action to prevent insolvency, dissipation, or prejudice pending the completion of the proceedings. The temporary cease-and-desist order may also be imposed whenever the records of an institution are so incomplete and inadequate that the regulatory agency cannot determine the institution's financial condition. The institution or individual subject to the temporary order may challenge the order in federal district court.

Please note, regulators cannot issue a Consent Order or a Cease-and-desist Order, other than a temporary Cease-and-desist Order, unless (1) the bank consents to the order or (2) it is imposed on the bank subsequent to a hearing before an administrative law judge. It is current FDIC policy to (1) issue a Consent Order when the bank consents, and (2) issue a Cease-and-desist Order when it is imposed by an administrative law judge after a hearing.

As a practical matter, each of the regulatory agencies attempts through jawboning or intimidation to obtain consent to desired enforcement action. This consent is from the bank's Board of directors as a result of an informal procedure generally involving a face-to-face Board meeting. This informal procedure usually involves providing the Board of Directors with a draft of the proposed Order or Agreement and meeting with the Board of Directors at the bank or at the regional office. If the regulatory agency can obtain consent to the proposed order through this process, it can avoid going through the lengthy

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and time consuming process of giving the bank its day in court as provided by the federal statute.

Many of the orders and agreements are consented to simply because the Board of Directors does not realize that it has any reasonable alternative. Not only do most members of the Board of Directors not realize that there is an alternative to consenting, they also do not realize that they have substantial room to negotiate over a period of weeks or months as to what, if anything, the Board on behalf of the bank will ultimately consent to. The usual consent meetings, particularly without counsel present, are designed primarily to intimidate the Board into executing the consent agreement. All aspects of a proposed order are negotiable, including the capital provisions.

Unlike any of the informal alternatives, (a Resolution, Memorandum of Understanding, a Letter Agreement) an Order, Formal Agreement or Written Agreement has regulatory teeth. Although a Memorandum of Understanding is a totally unenforceable document, an Order or Written Agreement can be enforced by the appropriate banking agency in the federal district court for the district in which the bank is located. In addition, a violation of an Order can serve as the basis for the assessment of a civil money penalty against an insured depository institution or an institution-affiliated party (including a director) who aided, abetted or allowed the bank to violate the Order. Also, as a practical matter, unlike a Memorandum of Understanding, it is difficult to get the regulatory agencies to terminate an Order. The Order will generally be on the bank for at least two examinations prior to termination.

These considerations, as well as the content and proposed requirements of the Order, must be factored into the decision making process of any Board which is considering consenting to an Order or Agreement.

A Board of Directors should never consent on behalf of the bank to an enforceable Order or Agreement without assurance from the chief executive officer and senior management team that all provisions of the Order or Agreement can be complied with within the allowed time limits.

f. Termination of Deposit Insurance. Although the ultimate sanction for a

problem bank is for the Federal Deposit Insurance Corporation to bring an action to terminate its deposit insurance, such actions, as a practical matter, are no longer necessary now that FDIC has prompt corrective action authority, as discussed below.

A termination of insurance action historically was commenced after an examination by the bank's primary regulator where the regulator determines that the bank is a 4 or 5 rated bank on the CAMELS rating system, and has a capital to assets ratio below 3 percent.

Procedurally, a termination of insurance action is commenced by the notification of the institution's primary regulator of the FDIC's determination that the institution has engaged or is engaging in unsafe or unsound practices in conducting the business of the institution. The notice is required to be given to

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the institution's primary regulator not less than 30 days before the FDIC's notice of intention to terminate insurance is issued. This time period is granted to the primary regulator to attempt to correct the problems detailed by the FDIC.

At the end of the 30 day period, if the problems have not been corrected, the FDIC will issue a notice of intention to terminate insured status. The bank has the opportunity to file an answer to the notice of intention to terminate insured status and present its evidence at a private administrative hearing prior to the FDIC's Board of Directors determining whether insured status should be terminated.

As noted, a termination of deposit insurance proceedings are generally no longer pursued because of the regulators prompt corrective action authority as discussed below.

g. Prompt Corrective Action. In order to resolve the problems of insured

depository institutions at the least possible long-term loss to the insurance fund, the FDIC Improvement Act established a system of prompt corrective action which the regulators are required to follow.

Prompt corrective action orders generally require the bank to raise a significant amount of capital within an unrealistic, e.g. 30 day, period of time. As such, prompt corrective action orders, which are generally referred to as PCAs are known otherwise as “Probably Can’t Achieve.” PCA orders have been virtually useless as a prompt for the industry and for individual banks to increase capital. By the time the bank receives a PCA order, it has usually done everything in its power to raise capital and is headed south fast.

Pursuant to this system, financial institutions are divided into the following categories: (1) Well Capitalized: institutions that significantly exceed required

minimum capital levels. (Total Risk-Based Ratio of 10 percent or above; Tier 1 Risk-Based Ratio of 8 percent or above; Common Equity Tier 1 Risk-Based Ratio of 6.5 percent or above; Tier 1 Leverage Ratio of 5 percent or above)

(2) Adequately Capitalized: institutions that meet required minimum

capital levels. (Total Risk-Based Ratio of 8 percent or above; Tier 1 Risk-Based Ratio of 6 percent or above; Common Equity Tier 1 Risk-Based Ratio of 4.5 percent or above; Tier 1 Leverage Ratio of 4 percent or above)

(3) Undercapitalized: institutions that fail to meet any of the required

minimum capital levels. (Total Risk-Based Ratio of less than 8 percent; Tier 1 Risk-Based Ratio of less than 6 percent; Common Equity Tier 1 Risk-Based Ratio of less than 4.5 percent; Tier 1 Leverage Ratio of less than 4 percent)

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(4) Significantly Undercapitalized: institutions that are significantly below any of the required minimum capital levels. (Total Risk-Based Ratio of less than 6 percent; Tier 1 Risk-Based Ratio of less than 4 percent; Common Equity Tier 1 Risk-Based Ratio of less than 3 percent; Tier 1 Leverage Ratio of less than 3 percent)

(5) Critically Undercapitalized: institutions that fail to meet either the

required leverage limits or risk-based capital requirements (tangible equity to total assets of less than or equal to 2 percent).

Please note that as of the date of these materials, the federal regulators have issued proposed, but not yet finalized, rulemaking related to the “community bank leverage ratio” requirements set forth in the Economic Growth, Regulatory Relief and Consumer Protection Act (S. 2155). As proposed, this new regulatory capital framework would consider a community bank “Well Capitalized” for Prompt Corrective Action purposes if it had greater than or equal to a 9% “community bank leverage ratio.” The proposed rulemaking also contained tiers related to the other Prompt Corrective Action thresholds. Because these rules are not yet finalized, they are not discussed in detail in these materials. For additional information regarding the proposed regulatory capital framework for community banks, please contact Gerrish Smith Tuck. An institution that is not “Well Capitalized” may not solicit, accept, renew or roll over brokered deposits. This prohibition will not apply to an institution that is “Adequately Capitalized” if the institution requests a waiver of the prohibition in writing to the FDIC Board of Directors and such request is granted. The Board of Directors may grant such a request only upon a showing of good cause. The rule allowing only “Well Capitalized” and certain “Adequately Capitalized” institutions to deal in brokered deposits is problematic, as it puts banks in the position of having to raise money locally, often at a higher cost, at a time when they can least afford to do so. Based upon the above-classifications, the regulators are required to take specific actions aimed at protecting the insurance fund. Institutions classified as "Undercapitalized" will be required to submit an acceptable capital restoration plan to the appropriate Federal agency which must specify the steps the institution will take to become adequately capitalized, the levels of capital to be attained and how it will comply with the restrictions imposed by the Act. These restrictions include restricted asset growth and prior approval for all acquisitions, branching and new lines of credit, along with any other discretionary safeguards the regulators may feel are necessary. A "Significantly Undercapitalized" institution, or one that is "Undercapitalized" and has failed to submit or comply with a capital plan, will be subject to one or more of the following regulatory actions:

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(a) required capital raising activities; (b) restrictions on transactions with affiliates, interest rates paid, asset

growth and activities; (c) with limited exceptions, the removal of directors and senior officers;

and (d) a prohibition on accepting deposits from correspondent banks.

Additionally, the regulators may prohibit the bank's holding company from making any distributions without Federal Reserve Board approval, and may require the holding company to divest or liquidate any subsidiary in danger of insolvency or which poses a significant risk to the institution, including the "Significantly Undercapitalized" institution, if the regulators feel divestiture would improve the financial institution's condition and future prospects. The regulators are also given the authority to require any other action necessary to carry out the purposes of the Act. With regard to an institution classified "Critically Undercapitalized," these institutions are required to comply with numerous activity restrictions. At a minimum, these restrictions include prohibiting the institution from doing any of the following activities without prior regulatory approval:

(a) entering into any material transaction outside the course of normal

business; (b) extending credit for a highly leveraged transaction; (c) amending its charter or bylaws; (d) making any material change in accounting methods; (e) engaging in any covered transaction (a transaction with an affiliate); (f) paying excessive compensation or bonuses; and (g) paying interest in excess of certain limits.

The appropriate Federal regulator will have 90 days from the date an institution is classified "Critically Undercapitalized" to appoint a receiver or take whatever action it deems necessary.

h. Interest Rate Restrictions. All banks that are considered to be less than well-

capitalized for purposes of 12 C.F.R. Part 337 are subject to restrictions on the maximum permissible interest rates that may be offered and paid on deposits. Banks that are less than well-capitalized are prohibited from paying deposit interest rates that exceed the national rate caps, which are updated weekly on the FDIC’s website. The national rate is defined as a simple

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average of rates paid by all insured depository institutions and branches for which data are available. The prevailing rate in all market areas is considered to be the national rate. The FDIC then adds 75 basis points to the national rates determined for various types of deposits of comparable size and maturity to establish the national rate caps or maximums that may be paid by banks that are less than well-capitalized. A less than well-capitalized bank that believes it is operating in a high-rate area may use the prevailing rates in its market area only after seeking and receiving a written FDIC determination that the bank is operating in a high-rate area. Until such a determination is received, the bank must comply with the national rate caps. Also, banks receiving a high-rate area determination must continue to use the national rate caps for all deposits outside the designated high-rate market area. The FDIC uses standardized data (i.e. average rates by state, metropolitan statistical area, and micropolitan statistical area) for the market area in which the bank is operating to determine if the bank is operating in a high-rate area. If the standardized rate data for the bank’s market area exceed the national average for a minimum of three of the four deposit products reviewed by at least 10%, the FDIC may determine that the institution is operating in a high-rate area. In performing this analysis, the FDIC uses rate information on money market deposit accounts, 12-month CDs, 24-month CDs, and 36-month CDs that are less than $100,000.

i. Closing the Bank. When a bank gets in trouble, the first question we normally

get from directors is, “Is the bank going to close?” Our standard response is the following: “The bank will not close as long as (a) management can guarantee bank liquidity, i.e. the ability of the bank to meet the demands of its depositors, and (b) capital does not erode below 2%.” The bottom line in most troubled banks, even severely troubled banks, is that the Board will have time to raise capital or correct the problems before either the state or federal regulator closes the bank, neither of which will happen absent a liquidity crisis or a leverage capital ratio below 2%.

j. Civil Money Penalties. Civil money penalty actions may be initiated by the

federal bank regulatory agencies, and several state regulatory agencies as well, under many situations. A civil money penalty action may be brought for the violation of any law or regulation, final or temporary order, written condition imposed by the appropriate regulatory agency or any written agreement between the institution and the regulatory agency. Penalties can be as much as $1,250,000 per day.

The process for the regulatory agencies to initiate a civil money penalty is generally to issue a “15 day letter” to the director, officer or affiliated party who is the target of the proposed penalty. The letter generally indicates the agency has investigated and believes a civil money penalty is warranted based on certain facts as disclosed in the letter. The letter gives the target “15 days” to respond to the agency and indicate why the target thinks the penalty should not be

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issued. The letter also gives the target the opportunity to provide his or her financial statement to the agency. Rarely do we recommend a financial statement be provided at this point in the process (if ever). A civil money penalty, similar to other regulatory enforcement actions, cannot simply be “imposed” on the director, officer or affiliated party. If a penalty is assessed, a Notice of Assessment is formally sent indicating the amount of the penalty. If the target objects to the assessment and files a formal request for a hearing, then the assessment does not become final until the target either consents to it voluntarily or it is imposed as a result of an administrative hearing involving the target and the agency.

k. Removal Action. Many of the worst problem banks or problem asset situations

are attributable to abusive insider transactions, poor management, or both. In appropriate circumstances, the federal bank regulatory agency can bring an action to remove an institution-affiliated party from participating in the affairs of the bank under Section 8(e) of the Federal Deposit Insurance Act. Procedurally, the appropriate federal banking agency may serve the target party written notice of its intention to remove the party from office or prohibit any further participation by that party in the conduct of the affairs of the insured institution. The target party files an answer and the customary administrative procedures follow. A temporary suspension order also may be issued by the appropriate banking agency pending resolution of the removal action if the institution-affiliated party's actions meet the requirements of a removal action and such suspension is necessary for the protection of the institution or its depositors. Like a temporary cease-and-desist order, this action may be challenged in an appropriate United States District Court. Regardless of the outcome of the suspension order, the institution-affiliated party is still entitled to a full administrative hearing as to whether or not the removal action is proper. The law also provides that state criminal indictments and convictions constitute further grounds for suspension or removal of an individual. A similar provision also exists with respect to federal charges under other laws.

E. 10 COMMANDMENTS FOR DEALING WITH THE REGULATORS

As has been mentioned many times in these materials, the industry has and continues to change. Community bank Boards of Directors must remain prepared! As a community bank, it is imperative to understand how to deal with the regulators in this current uncertain environment. I. EDUCATE YOURSELF. The financial services industry is moving rapidly in a number of different directions.

It seems that new regulatory guidance or amendment is issued every week. In such an environment, it is critical, even for the smallest institution, that directors and

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officers be educated about the options and opportunities for the institution. Only then can they make wise choices with respect to its effective long-term strategies. Many state associations and other trade groups are now offering educational programs targeted specifically for directors and senior executives. Your directors and officers should take advantage of these options.

II. SELF-REGULATE. Now, more than ever, it is incumbent upon the Board and management to scrutinize

themselves and their institution before the regulators do. This needs to be done in both the safety and soundness (asset quality primarily) and compliance areas. Enterprise Risk Management has become a regulatory staple, even for smaller community banks. The Board should establish risk identification and monitoring systems to ensure that management manages risk appropriately. Additionally, the use of a strong internal and external audit procedure, a management and Board evaluation process, and similar steps may go a long way. Scrutinizing yourself more harshly may help you find that your regulatory relations improve and examinations run more smoothly.

III. ADMIT YOUR MISTAKES.

Denial by the Board is not a strategy. The Board needs early identification of mistakes, having the Board and management own up to their mistakes, and getting them corrected. Regulators realize that new laws and regulations take time to implement. However, a turning point in how harshly the Board and management are criticized may very well depend on whether they are willing to admit their mistakes and shortcomings, take corrective action, and move on, rather than hoping that the regulators do not notice or that things will simply work out for the better.

IV. STAY OUT OF THE “PENALTY BOX.”

As noted, the current regulatory compliance environment is “not your father’s compliance.” This is unfair and deceptive practices, abusive practices (as added by Dodd-Frank), and fair lending (i.e., race, age, ethnicity, etc.), discrimination, consumer protection, and the like. Your Compliance Officer needs to be on his or her “A game,” and the Board needs to be aware of the issues, particularly in these big picture compliance matters. A compliance “event” with the regulators generally involves reimbursement to the affected consumers (maybe several million dollars), a civil money penalty payable to the U.S. Treasury, and a contribution to a financial not-for-profit literacy fund. Do not ignore it.

V. BE RESPECTFUL, BUT DON’T BE AFRAID TO DISAGREE. When the examiners come in the bank, it is not fruitful to create a hostile

environment. The best rule is to follow the “Golden Rule” and treat the examiners the way you would like to be treated if you were in their shoes. Their goal is not to destroy your institution. It is to assess regulatory compliance, capital adequacy, and quality of management. It is best to be respectful to the examining staff and communicate with them openly. On the other hand, it is important that the Board

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and management stand their ground when necessary. We see far too many banks whose only reaction to any regulatory comment is acquiescence. Address comments or criticisms that are clearly erroneous or patently unfair. Additionally, the bank should understand various legal and business options to any scenario whether it is in contesting an adverse exam, negotiating a possible regulatory enforcement action, or taking other steps.

VI. DOCUMENT EVERYTHING. In today’s environment, if it is not documented, then it did not happen. If the

examiners extend a criticism and it goes un-rebutted, then they assume that you agree with it. If you make a comment and you do not do so in writing, then it becomes lost in the shuffle or “it never occurred.” Any comments, criticisms, or disagreements you have with the examination or the examiners should be noted in writing early on and delivered to the examiner-in-charge. This concept also applies to regulatory communication regarding significant business activities and notices. Keep your own records and formalize all pertinent conversations in writing. Doing so will eliminate any question of fading memories or recollections over the long term.

VII. UNDERSTAND THE REGULATORS’ OPTIONS. As discussed, the regulators have a myriad of options for dealing with institutions

which they believe need a “corrective” program. These options range from a Board resolution to a memorandum of understanding to a Formal Agreement to a Consent Order. Potential civil money penalties for directors, officers, and others are also in the mix. It is important to understand the impact and enforceability of each of the regulators’ options. For example, a resolution or memorandum of understanding, if it is violated, cannot be enforced with civil penalties. A Formal Agreement or a Consent Order can be subject to civil penalties of hundreds of thousands of dollars a day. Under certain of the options, federal court enforcement is also available. It is important to understand what the regulators are proposing and the impact of the alternative.

VIII. UNDERSTAND YOUR OPTIONS. Just as it is necessary to understand the regulators’ options, it is also necessary to

focus on the community bank’s options when dealing with the regulators. Fortunately, we still live in the United States of America where “due process” is available. Simply because the regulators propose an enforcement action does not mean that it becomes effective without the Board’s agreement—the Board can negotiate or litigate! Negotiations generally take place through a professional, but the Board needs to realize that it is not required to agree to whatever piece of paper the regulators put forth. In its most extreme form, this means that the bank is generally entitled to an administrative hearing before an administrative law judge and an impartial third party decision before any corrective action, particularly one enforceable with civil penalties or in federal court, can be imposed. Keep in mind, however, the regulators want to have their own way and will use intimidation of your Board to get it.

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IX. WORK TOWARD A “WIN/WIN.”

Your job is to run a healthy, profitable bank for the benefit of your organization’s shareholders. The regulators job is to protect the insurance fund (and their reputations) and to make sure that banks operate within the rules and guidelines. Although their job is not to necessarily help you or your shareholders, the regulators’ interests are benefited by your institution operating in a safe, sound, and profitable manner. You may not always agree with their methods, but they may have “suggestions” that are beneficial to bank operations and long-term profitability. If your bank finds itself in trouble, focus on reaching common ground. Identify and prioritize your interests, and engage in open discussion. Cooperative efforts and a little give and take can go a long way.

X. KNOW YOUR ROLE.

Your real job is that you work for your shareholders, not the regulators. The Board has a fiduciary duty to shareholders to govern the organization in the best way possible. This duty is not put on hold while you please the regulators, and it sometimes requires standing up to the regulators, where appropriate. Working for your shareholders means enhancing the bank and holding company’s value, or at least maintaining it, in order to grow earnings per share (earnings drive value), have a decent return on equity, have the ability to allocate capital to provide liquidity for the shares if excess capital is available or obtainable, and provide the shareholders with cash flow or something that looks like cash flow. If a bank filters all of its decisions through that lens, then odds are the shareholders and the regulators will be happy.

Following these Ten Commandments for Dealing with the Regulators should assist your bank in a smooth transition through a time of change.

F. MISCELLANEOUS ENFORCEMENT RELATED ISSUES

1. Publication of Enforcement Action.

Agencies are required to publish and make available to the public all final enforcement orders and any modifications or terminations regarding the orders, unless the agency determines in writing to delay publication for a reasonable time to safeguard the safety and soundness of an insured institution. The bottom line is that if your bank or holding company consents to a Formal Agreement or a Consent Order, it will be public. It will be published and disseminated on the regulatory agency’s website. It will be available to any customer, shareholder, or competitor who desires to read it in its entirety. The publicity aspects of a formal enforcement action need to be considered by the Board of Directors. If the Board determines to consent to an enforcement action which will become public, then the Board also needs to have a plan for countering the adverse publicity which will be generated.

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In connection with the FDIC’s change of policy on its Cease-and-desist Orders to move toward the more user-friendly Consent Order in the event the bank desires to consent, it also changed its policy with respect to publicity of administrative proceedings. The administrative proceeding, as noted earlier in this matter, commences with a Notice of Charges, a document similar to a civil complaint. Prior to the summer of 2009, Notices of Charges for banks who declined to consent to the previously available Cease-and-desist Order were not public. Although the administrative hearing was public, as noted later in this material, the Notice of Charges is not. For the first time, in August of 2009, the FDIC began to publish Notice of Charges. This creates another publicity event for the bank.

2. Appealing Supervisory Determinations. Any material supervisory determination, whether it be any one of the component ratings, the CAMELS rating, a request to increase the Allowance for Loan and Lease Losses, a classification or the like, is available for appeal by the bank. The appeals process for each federal and state supervisory agency generally follows the same process. Banks seeking to appeal a material supervisory determination should first seek resolution of the problem with the examiner in charge while he or she is still at the examination site. If the issue cannot be resolved at this stage, the bank should request a meeting with the examiner in charge and his or her supervisor. These meetings usually take place at the supervising agency’s local field office. If the meeting at the local field office does not resolve the dispute, the bank should present its appeal, preferably in writing, to the head of the agency’s regional office. If the head of the regional office is unable to reach a satisfactory conclusion, the bank may appeal the decision to the agency’s Director either in Washington, D.C. or the state’s capital. The heads of an agency’s regional office generally prefer to resolve a dispute at the regional level rather than at the federal or state level. Problems that make it to the top get a fresh look and are many times resolved in favor of the bank. The regulatory leader of a region generally seeks to avoid a bank’s appeal to the Washington, D.C. office because it reflects adversely upon the region when their decisions are overturned by those with the authority to do so. Our clients have generally had good success with the appeals process in the past, though it is certainly not the most user friendly of processes. The FDIC in particular has engaged in discussions about making the appeals process more approachable in this regard, but there has not yet been any definitive guidance on the matter. Unfortunately, any bank subject to a formal enforcement action (or even one proposed) loses its right to participate in the agency appeals process. This is under the theory that the bank has a right to its day in court if it would like and the formal administrative process is the bank’s due process.

3. Agency Approval of Officers and Directors.

Troubled financial institutions, newly chartered institutions and institutions that have undergone a recent change in control are required to give 30 days prior notice to the

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appropriate federal bank regulatory agency before appointing senior executive officers or directors. The agency then has the power to approve or disapprove such appointments within the period. Extensive biographical and financial background information may be required by the regulators prior to approval.

4. Golden Parachute Contracts.

Once a bank is designated as “troubled” or “problem” bank by a federal regulatory agency (even before any enforcement action is proposed), the bank is subject to restrictions on its ability to pay an executive officer what, under the regulations, could be deemed to be a “golden parachute” payment. This often arises in the context of either the sale of a bank that is designated a problem bank when the executives have change in control provisions in their contract which are triggered by the sale, or when the executive who presided over the time period during which the bank got in trouble reaches an agreement with the Board to depart which under the executive’s contract would trigger some type of a departure payment. To the surprise of many of the executives in either of these contexts, the sale or voluntary/involuntary departure, the payment to the executive will likely be deemed a parachute payment under the regulations which will be prohibited without specific regulatory approval. Our experience has been that generally, regulatory approval will not be forthcoming, even in the context of the sale of the entire institution. There have been a couple of executives who have unsuccessfully attempted to litigate this with the federal agencies.

5. Administrative Hearings and Procedures.

A bank that challenges a proposed enforcement action may expect between a four and eight month period between the date of examination and a trial in connection with a cease and desist proceeding and as long as 12 months or more from the examination to the final decision of an administrative law judge or the agency with respect to the imposition of an order. The length of this period is largely dictated by the administrative law judge's calendar and the complexity of the matter. During the time period, various stages will take place. After the Notice of Charges and Hearing is served on the bank, the bank will file an answer, then both sides will exchange documents, proposed witness lists, proposed exhibits, proposed findings of facts and conclusions of law and trial briefs. Each exchange will be at a set interval prior to the trial. Negotiations commence at or before the proposed cease-and-desist order is presented to the bank. Depending on the particular situation, negotiations will generally continue up to trial date. Enforcement proceedings are required to be open to the public, unless the agency, in its discretion, determines that holding a public hearing would be contrary to the public interest. Keep in mind, however, that the administrative law judge presiding over the hearing retains the discretion to close the hearing as needed to protect the interests of the institution's depositors and borrowers. Over the years, our firm has probably tried more bank administrative cases than any other group. Our experience has been that only the parties actually show up for the hearing, even though it is technically open to the public.

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G. DEALING WITH REGULATORY RELATIONS

As noted earlier in this material, bad regulatory relations are no fun. Having had extensive experience working with the regulators over the years – which includes Jeff Gerrish’s former experience with the FDIC suing bank directors and bringing cease and desist and other enforcement actions against banks, our firm understands that there are more fun times for banks. Unfortunately, dealing with the regulators is a reality of banking. Keep in mind that in connection with regulatory relations, capital is and always will be king. Lots of capital solves lots of problems. A healthy capital cushion cannot just keep your bank from failing, which for all of you is probably a remote possibility, but can keep you from having a couple of years of tough regulatory relations. It has been a long time since regulatory enforcement actions have been in the forefront. The regulators are very familiar with their processes and procedures. Most bankers are not. Become familiar with your options and alternatives because the penalties for violation of any type of final enforcement action are draconian at best. Use professional help to protect the bank. Success over the long term must be the goal for community banks. It is a reasonable and achievable one. To be successful in the long-term, however, we must continue to navigate the short-term operating and regulatory environment, whatever changes may come.

__________________________________________________________

Tab C Chairman’s General Duties

and Responsibilities __________________________________________________________


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I. INTRODUCTION

One of the most important positions in community banking is the Chairman of the community bank and bank holding company’s Board of Directors. Often, this position is maintained by the “oldest” director, the “first” director, the bank’s organizer, the originator, or some other such rationale for putting this individual as the leader of the Board of directors. The position is, in fact, one of leadership. Leadership in a variety of areas, which will be addressed by this material. There is no doubt the role of the community bank Chairman is unique. It can be argued that traditionally, this position has been one of honor, i.e., more ceremonial than substantive. While still an honor, as the industry has evolved over the last 15 years, and particularly over the last decade, the Chairman’s role has become significantly more important. It is, in fact, dynamic and loaded with responsibility. The bank and bank holding company desire the best, brightest and those with the most leadership abilities and potential in the Chairman’s role. This material and the materials that follow should assist the Chairmen in further defining and understanding their obligations to their various constituencies, including other Board members, shareholders, management, and the community at large.

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II. CHAIRMAN’S GENERAL DUTIES AND RESPONSIBILITIES

The Chairman of the Board is a director and has the general duties and responsibilities of a director, as noted in other parts of this material. The Chairman also has a unique position which entails responsibilities additional to those of a typical director. These include at least the following: Preparing for and conducting directors’ meetings Maintaining an effective Board of Directors Determining duties, responsibilities and evaluation of Board members Establishing committees and identifying responsibilities and functions Addressing issues of corporate governance Dealing with the public Dealing with the shareholders. While there is no step by step checklist for the position of Chairman of the Board, the information in this material is based on our years of experience in dealing primarily with community bank and bank holding company Chairmen. We have tried to extract the “good” and de-emphasize the “not as good”.

A. DIRECTORS’ MEETINGS

The Chairman is in a leadership position. He or she is the leader of the Board of Directors and, oftentimes, the public face of the bank. That leadership starts with the directors’ meetings. Although management may give notice of meetings, distribute Board reports, and the like, it is the Chairman’s job to be responsible for all aspects of the meeting, whether or not another person provides the ministerial functions associated with the meeting. As a practical matter, the Chairman should set the time, place, and date of the meeting. The Chairman should also set the agenda. The Chairman serves as the mediator/father (mother) figure, disciplinarian, and Board anchor for the Board meetings. The following sets forth a non-exhaustive list of Chairman’s duties with respect to the Board meeting: 1. Create Agenda for Meeting

Many Boards use the same agenda they have used for their Board meetings for the last 20 years or however long they have been open. It is rare that any director or even the Chairman questions why an item is included in or excluded from the agenda. The agenda is often used simply because “that is the way it has always been done around here”. We suggest you take a fresh look at the agenda. One of the responsibilities of the Chairman is to create an effective Board agenda that is appropriate and will move the meeting along toward resolution. The Chairman’s job is to determine which issues need to be discussed and in what order they will be presented. The Chairman must take the time to ensure the Board will address all issues that need to be addressed and that those issues are timely and addressed in a manner that allows the Board to provide direction for the bank.

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Items on the agenda, of course, include financial reports, loan reports, regulatory reports, reports on issues relating to shareholders and many others. It is often good for a Board, from an agenda standpoint, also to provide some time, whether during each monthly Board meeting or quarterly, for some strategic thinking or review of the strategic plan.

2. An Effective Board Book

One of the Chairman’s duties is to make sure the information provided to the Board of Directors to be discussed at the Board meeting is appropriate. The Chairman should ensure the information is neither too much nor too little. It is also important the information be delivered well in advance of the meeting so the Board can review the information and act intelligently on the action items required. It is critical that directors have the time to understand and consider the issues facing the bank. The definition of “well in advance” may be different for each institution, but probably means at least three to five days. The Chairman and Board should also decide whether the information will be available electronically or in hard copy. It is also the obligation of the Chairman to make sure the Board puts appropriate time in prior to the meeting, and if Board members are unprepared, to chastise the Board or Board members for their lack of preparedness. Of course, as part of consensus building, the Chair may solicit input from the Board members as to how and how far in advance they would like the Board packages delivered. The bottom line, however, is that the Board needs to get the information delivered in an efficient manner and take the time to review it prior to the meeting. This should significantly reduce meeting time and allow the Board to focus on the important issues, not “all” issues.

3. Set the Tone of the Meeting

Although it is a significant “intangible”, the primary obligation of the Chairman of the Board is to provide leadership to the Board. This includes setting the tone for the meeting to allow effective decision-making and debate. All Boards are different. Some are passive, some are contentious, some are a mix. The Chairman’s obligation is to determine the most effective means to run the Board meeting. Does the Chairman set the tone by holding tight reins over the Board? Does the Chairman set the tone by providing more flexibility and allowing discussions, subject to being brought back for a vote? This is where the Chairman needs to establish leadership. The Chairman’s obligation is to have an effective operating and decision-making Board. It is the Chairman’s job to set the tone which will achieve this result.

4. Promote Active Board Involvement

An involved Board has the greatest chance to be a successful Board. It is the Chairman’s responsibility to ensure Board members attend and stay active and engaged throughout Board meetings. The Chairman should encourage directors to actively participate in all Board discussions and be proactive rather than reactive in their duties.

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5. Ensure Board Participates in Major Strategic Decisions

The Chairman must provide leadership in not only monthly operational issues, but long-term strategic issues as well, as addressed further in this material. In general terms, however, the Chairman is responsible for guiding the directors with respect to providing strategic decision-making for the bank and holding company. It is often the Chairman’s job, along with management or outside consultants, to identify the strategic issues for the bank, get those issues in front of the Board of Directors with adequate information, and then drive the Board to consensus in decision-making on those strategic issues. It is important that all directors participate in the analysis and decision-making process on strategic issues to provide Board “buy in”.

6. Deal with the Shareholders

One of the Chairman’s leadership roles is oftentimes to be the public face of the bank as it relates to shareholder or investor relations. This is often true whether the bank is publicly held or non-SEC reporting. Because the primary obligation of the Board of Directors is to ensure that actions taken by the Board, strategic or otherwise, serve to enhance the value for the shareholders, the Chairman is often in a position where he or she needs to convey information received directly from shareholders to the Board of Directors. The Chairman may also solicit information from the shareholders other than simply at the annual meeting.

Likewise, the Chairman is the public face of the bank and the holding company at the annual meeting of the shareholders. This is often a time for the Chairman to set forth the bank and holding company’s strategies, goals and visions and report the feedback back to the Board of Directors. Of course, the Board is not bound to follow an individual shareholder’s (or even the collective shareholders) opinions, but the Board should give them due consideration in determining the long-term strategies for enhancing shareholder value.

7. The Chairman is “the Closer”

The Chairman’s job is not simply to run the meetings but to make sure all substantive issues are addressed and decisions made and implemented. The Chairman, in his or her leadership role, must look at ways to accomplish the Board’s intentions and implement the action plans with respect to enhancing shareholder value. The Chairman should also monitor the implementation of the decisions made by the Board of Directors.

8. The Parking Lot Meetings

One of the obligations of the Chairman in his or her leadership role is to make sure that all Board members participate in all decision making. It is very common for community banks and holding companies to hold “parking lot” meetings. It is these parking lot meetings where Board matters are again reviewed, addressed and secondary decisions made. It is the Chairman’s obligation to encourage, if not demand, that all issues get on the table with all directors present at the Board

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meeting. As a practical matter, this may simply drive the “parking lot meetings” further “underground”, but it is worth a try.

9. Executive Sessions

A good corporate governance practice, as addressed in other parts of this material, is for the Chairman to call the Board into executive session on some periodic basis. An executive session is simply a session of the Board of Directors without the chief executive officer or other inside directors. Under Sarbanes-Oxley, for public companies, particularly those that are listed on an exchange, an executive session on a “regular basis” is required. We interpret “regular basis” to be quarterly.

Good corporate governance has legitimized the executive session of the Board. Prior to the corporate governance requirements after Sarbanes-Oxley, executive sessions were only held when the bank was making a change in the management. These were often secret meetings at the Chairman’s house and the like. This is no longer the case. Today the executive session is seen as a legitimate part of effective corporate governance.

Executive sessions done right should eliminate the need for “parking lot” meetings, as noted above. These sessions should give every director the opportunity to discuss any issues on his or her mind without the presence of management. If the Board elects to hold executive sessions it is the Chairman’s responsibility to designate a minute taker. This is on the theory that what is not documented has not occurred for regulatory purposes. After each executive session, the Chairman or the lead director should also discuss with the chief executive officer the general results of the executive session. This is designed to reduce the CEO’s anxiety over the executive sessions.

B. BOARD COMPOSITION

A community bank Board of Directors has traditionally been composed of white males ranging from the ages of 50 to 75. While there is certainly nothing wrong with the traditional community bank Board, it may not fulfill the needs of the modern community bank. Directors with different business and cultural backgrounds may provide the diversity needed for success in today’s competitive environment. The Chairman should consider the composition of his Board and determine whether the Board members allow for optimum Board leadership. With regard to the composition of the Board, the Chairman should:

1. Build an Effective and Competent Board

Competent Board members are a necessary ingredient for success in community banking. Chairmen should seek out and promote directors who understand the business values and competitive environment of a community financial institution. Board members who understand these factors are an asset to the organization. Board members who do not understand these factors are a liability. The Chairman is

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also responsible for ensuring new Board members understand the values, culture and competitive environment of the bank. Only when all Board members understand each factor will the Board be able to perform at its optimum level.

2. Ensure Structure of the Board Promotes Effective Management

The Chairman of the Board is responsible for ensuring all positions on the Board are filled by the Board member who will most effectively function in that position. For example, it would not be wise for a Chairman to appoint as head of the loan committee a director who has no knowledge of community bank lending. The Chairman must ensure each Board member is placed in a position that will optimize his or her contribution to the bank. Ensuring the right people are in the right place will not guarantee success, but will greatly improve one’s chances.

3. Provide Continuing Education for Board Members

Community banking is constantly evolving. The thoughts and strategies of five years ago may not be applicable to today’s banking environment. It is the Chairman’s responsibility to provide opportunities for Board members to increase their knowledge of the community banking industry. Most often this is accomplished through directors attending director’s conferences or workshops. However, director education should not be limited to these special events. An effective Chairman provides Board education through a number of avenues, most notably distribution of current literature about community banking. There are a number of educational opportunities for Board members, and the Chairman should strive to take advantage of each of them.

C. BOARD EVALUATION

One of the Chairman’s leadership roles is in establishing a Board evaluation system and providing for the evaluation of senior management. The Chairman should ensure the Board itself is reviewed at least annually. This may be in the form of a self-evaluation or an outside evaluation. These evaluations promote effective corporate governance by allowing the Board to identify its own strengths and weaknesses. A Board with knowledge of its strengths can capitalize on these for the benefit of shareholders. More importantly, however, is a Board being aware of its weaknesses. A Board with this knowledge can devote time and energy to improve on these for the benefit of shareholders. As noted, Board evaluations can be of the Board as a whole, individual Board members, a peer-to-peer evaluation, an outside evaluation or otherwise. The key is that the Chairman provides leadership in assuring that some evaluation of the Board and individual Board member’s performance is conducted. The Chairman should also take the leadership role in assuring management is evaluated. In many community banks, no CEO evaluation (at least on a formal basis) is ever conducted. Many CEOs indicate they assume they are doing a good job because the Board continues to give them a raise but provides little, if any other, feedback. Often, CEO evaluations are difficult because the Board members are evaluating a friend, protégé, etc. Notwithstanding

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the difficulty, the Chairman’s obligation is, in part, to make sure that management, as well as the Board, is evaluated. In evaluating the Board of Directors, the Chairman should remember the primary focus is on group performance. A focus on individual performance is appropriate, but the main focus should be on the group as a whole. Board evaluations should focus on the Board’s strengths and weaknesses. The evaluation should also consider whether the Board is meeting its goals. If goals are not being met, the evaluation should identify why these goals have not been met and should outline steps the Board will take to improve its chances of meeting them in the future.

D. COMMITTEE APPOINTMENTS, RESPONSIBILITIES, AND FUNCTIONS

As part of the Chairman’s leadership role, it is the Chairman’s obligation to establish committees and populate those committees with appropriate directors. To do this, the Chairman should evaluate the needs of the bank and determine which committees will best fulfill those needs. Once the committees are determined, the Chairman should identify the purpose and goal of each committee and how its success is to be judged. Committee members must understand their expectations and should be given a set of obtainable goals. Further, the Chairman should see to it the committee is comprised of Board members that will most effectively fulfill the role of the committee. Finally, the Chairman should review the committees at least annually to ensure they are functioning as desired and fulfilling the needs of the bank.

E. CORPORATE GOVERNANCE

Whether the Chairman is the Chairman of a company that is reporting to the SEC and subject to Sarbanes-Oxley or the Chairman of a private bank or bank holding company or even a Subchapter S, the Chairman has the duties to make sure appropriate corporate governance is implemented. For chairmen of public companies, the corporate governance roadmap is established by Sarbanes-Oxley. For private companies, the best practices in corporate governance must be weighed against the costs of implementing such best practices. It would be foolish for a private bank holding company that did not have to comply with Sarbanes-Oxley to spend the hundreds of thousands of dollars necessary in corporate governance simply to establish “best practices” that were not required. The Chairman of a non-public community bank holding company must weigh the costs versus the benefit of “best practices” in corporate governance. Corporate governance, from a substantive standpoint, is addressed later in this material, but from a Chairman’s standpoint, the Chairman must understand that it is his or her responsibility to establish appropriate corporate governance for the bank and holding company. This often requires the Chairman to work closely with the bank’s outside counsel or consultant.

F. PUBLIC RELATIONS

The Chairman is often seen as the face of the financial institution. A Chairman’s actions and words are imputed to and reflective upon his bank. As such, it is imperative the Chairman at

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all times represents the bank with dignity. It is important the Chairman promotes the bank’s image to shareholders, employees and the community the bank serves. It is also the Chairman’s responsibility to ensure each Board member acts in a manner that promotes the image of the bank. In addition to representing the bank in a positive manner, the Chairman and other Board members should strive to help to attract new and maintain existing business. Today’s competitive banking environment makes gaining new customers tough and magnifies the importance of keeping existing customers happy. Community banks need to take advantage of every good opportunity presented to them. One such opportunity is to have the leadership of the bank actively promote the bank’s interest. All chairmen should strive to promote the interests of the bank by representing the bank in a positive manner and actively seeking to maintain and increase the bank’s customer base.

G. CONFIDENTIALITY

Ensuring Board confidentiality is an obligation of the Chairman. Most Chairmen have had Board members who, for whatever reason, have deemed it appropriate to discuss bank business (including borrower business) at the country club after a few too many drinks, at the coffee shop, or otherwise in the community. It is the Chairman’s obligation to instruct the Board on confidentiality issues, and to address leaks associated with confidentiality. To use a Nixon-era phrase, “the Chairman is, in fact, the one person ‘plumbers’ operation.” Nothing can ruin the reputation of a bank and holding company faster than confidential information leaking like a sieve out of the Board of Directors. It is imperative that Chairmen oversee the Board in this area, ensuring each Board member is maintaining information provided as confidential.

H. CONFLICTS OF INTEREST

The Chairman, like the directors, owes his or her bank a duty of loyalty. The duty of loyalty requires the Chairman and directors to refrain from placing their personal interests before the interests of the bank. It is the Chairman’s responsibility to make sure the entire Board understands and adheres to the duty of loyalty. Like revealing confidences, a breach of the duty of loyalty will present a number of legal, ethical, and professional problems.

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III. CHAIRMAN’S OBLIGATIONS IN SPECIFIC

CIRCUMSTANCES

A. MERGERS AND ACQUISITIONS

The Chairman’s obligation in the merger and acquisition context is the same as in every other context, i.e., leadership. From a substantive standpoint, issues in mergers and acquisition are addressed in other parts of this material. From the Chairman’s leadership standpoint, however, the Chairman’s primary responsibility is to ensure the Board has a plan in the merger and acquisition area. Whether this plan involves buying another financial institution, remaining independent for the long term without additional acquisitions, or selling the bank or bank holding company, the Chairman must play a leadership role in whatever plan is established. From a substantive standpoint, the Board’s decision-making process must include the question of whether the bank can do a better job for its shareholders than another company when determining independence, and whether the bank’s holding company shareholders will be better off after an acquisition than they would have been without the acquisition. It is the responsibility of the Chairman to make sure the Board considers these options and makes an informed decision regarding the big picture, “30,000 foot flyover” action plan. The Chairman should ensure the Board considers the appropriate factors in determining whether to buy, sell or remain independent. These factors include:

The age of the Board of Directors The age and loyalty of the shareholder base Whether management succession has been adequately planned for Whether the shareholders have liquidity for their shares The cash flow coming off the stock The prices currently being paid in similar acquisitions There are numerous reasons a bank may want to purchase another financial institution. A bank may choose, right or wrong, to purchase another bank because: The purchase will enhance shareholder value The purchase will offer desired geographic and/or product diversity The purchase will allow the bank to obtain good management The bank believes everyone else is doing it so we should, too

When determining whether to buy a bank, a Chairman should ensure the Board properly considers the goals of the acquisition and the ability of the financial institution to successfully run the merged organization. Running a $3 billion bank is different than running a $500 million bank. The Board should consider whether the bank and holding company’s existing capital, management and the Board itself are prepared from a risk and other perspectives to effect an acquisition transaction.

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A bank may make the decision to sell for a number of reasons. The Board may decide it will sell to enhance shareholder value, replace an aging Board, provide liquidity for a stock, take advantage of a window in the market or relieve itself of regulatory concerns. Whatever the case may be, the Chairman should ensure, if the Board makes the decision to sell, the bank and bank holding company are properly positioned to maintain maximum value for the shareholders. This involves consideration of a number of issues.

Short-term contracts Earnings Capital Management contracts Conservative lending Minimize expenses Have what buyers want Regardless of whether a Board has made the decision to buy, sell or remain independent, unsolicited offers may come a Chairman’s way. What are the Chairman’s duties in dealing with an unsolicited offer? A Chairman must always remember the Chairman and each of the directors owe a duty of care and duty of loyalty to the bank and/or holding company shareholders. A Chairman, in particular, complies with his duty of care when he discharges his duties: In good faith; With the care an ordinarily prudent person in a like position would exercise under

similar circumstances; and In a manner he reasonably believes is in the best interests of the corporation.

A Chairman acts in compliance with his duty of loyalty so long as he does not place his own interests above those of the corporation. It is important the Chairman remembers his actions will be viewed with enhanced scrutiny by virtue of his position. The Chairman should ensure an adequate process is followed and reasonable decision reached regarding an unsolicited offer.

B. PROBLEM BANKS

Many banks will continue to see heightened regulatory scrutiny in the asset quality area. While the number of problem banks has decreased significantly, the community bank Chairman still has to deal with regulatory issues he or she may have never meaningfully faced in the past. Fortunately, the Chairman’s role in a troubled bank is no different than the Chairman’s role in a healthy bank – leadership. In the specific context of a bank in “trouble,” the Chairman will probably need to be more involved than usual to make sure regulatory issues are being addressed, and the primary obligation of the Board as a whole will be to resolve fundamental issues that got the bank into trouble in the first place and restore the bank to healthy regulatory relations. This is usually accomplished by working with the regulators and bank management, which is another area requiring the Chairman’s leadership.

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It is important the Chairman makes sure everyone is on the same page. Bank management, the regulators and the Board must all be a part of identifying and understanding the problem and its solution. Only when all three parties understand and agree with each other will a successful conclusion be reached.

C. DEALING WITH A DIFFICULT DIRECTOR

Bank Boards have difficult directors. Some of these directors are old, some are senile, some are young and obnoxious, some are “know it alls”, some think they are management (pick your poison). Bank Boards have difficult directors. It is the Chairman’s obligation to deal effectively with the difficult director. The Chairman’s obligation is to ensure the Board is an efficient and effective group. This does not mean the Chairman is obligated to ensure friendship between each and every director. All directors will not get along or agree all the time. One of the Chairman’s leadership roles is to make sure the Board does not have to continually suffer with a “problem director.” The Chairman’s first duty regarding a problem director is to identify the problem director. A problem director is someone who acts irrationally, obnoxiously, and/or illogically on a regular basis. A problem director is not someone who repeatedly disagrees with the Board or who challenges them by providing an alternative point of view. A problem director is someone who hinders Board effectiveness and inhibits rather than fosters corporate growth. Once a Chairman identifies a problem director, he must determine what course of action to pursue. Normally, the Chairman would engage in some kind of informal counseling with the director. If that is unsuccessful, then Chairman should consider whether the corporate bylaws allow for removal of the director by some specified action, such as a majority vote by the Board. The Chairman should also consider when the director’s term is up and whether there is a mandatory retirement age. The possibility the director could not be re-nominated for a subsequent term must also be explored. Whatever the case, it is important the Chairman identifies and considers all possible courses of action. If the Chairman has made the determination that a problem director must be removed, it is important the Chairman first recognizes removal will not be an easy task. Directors do not appreciate losing their job. Most often, the Chairman must confront the director and speak directly with him or her regarding the issue. The Chairman should be truthful and forthright while striving to maintain courtesy and professionalism in the conversation. The Chairman should inform the director the Board has decided it is in the best interest of the corporation for the director to resign. If a one-on-one conversation does not work, a Chairman should coordinate with outside counsel regarding removal of the problem director.

D. DEALING WITH MANAGEMENT

A Chairman has two basic obligations to company management. First, the Chairman should ensure he and the Board refrain from micro-managing the bank. The Chairman should always be mindful of the fact that his role is to ensure the Board provides long-term strategic guidance for the bank. Neither the Chairman nor the Board should participate in the day-to-

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day management of the bank. This is the function of management and the reason they were hired. Often, Boards feel that they must “micromanage” because they either do not have confidence in management or they do not believe from a liability standpoint they have the right to rely on management. Two major situations generally result in micromanagement. The first is the de novo bank where the Board of Directors has been intimately involved in the formation of the bank. Once the bank opens, oftentimes, the directors have a difficult time stepping back and feel they should continue to be intimately involved in the operations of the bank. It is the Chairman’s obligation to make sure the directors stay back and not micromanage. The other situation is, as noted above, when the bank gets in trouble. When the bank gets in trouble, the trust factor for existing management often dissipates or at least diminishes. If the trust factor with management is not there, then the Chairman needs to discuss with the Board the securing of new management. Generally, the Board has a right to rely on the management of the organization and has no need for micromanagement as long as the Board’s reliance is “reasonable”. Other than that last sentence being a bunch of lawyer weasel words, what it really means is that as long as management is doing its job, the Board has a right to rely on that management. If management is criticized by a professional outside resource, such as the financial statement auditors, the external loan review, external compliance review, bank examiners in their exam reports, or otherwise, then it is incumbent upon the Board, as led by the Chairman, to make sure those criticisms are rectified if the Board wants to continue to be able to profess that it has “reasonably” relied on management. The Chairman’s second obligation to management is to provide support, guidance and evaluation. Chairmen are not placed in their position by chance. They are placed there because they are able to offer knowledge and advice to the corporation’s management. Chairmen should be mindful of this and should make themselves available to corporate management if sought out for advice.

E. ROLE IN STRATEGIC PLANNING

The Chairman of the Board of a community bank is responsible for ensuring the institution is poised for success both currently and in the future. This responsibility necessitates the use of strategic planning. Strategic planning means many things to many people. In the community bank context, what is strategic planning? Strategic planning is not:

Budgeting A set of unattainable goals A document prepared solely for regulators Bonding for the directors Strategic planning is:

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Who and where we are Where do we want to be How are we going to get there Whose responsibility is it to take us there Strategic planning is accomplished through a strategic planning session and the creation of an action plan, which should consider: Current analysis of the bank’s condition Discussion of key issues Consensus of decisions Assignment of responsibility Development of timeline Follow-up

Strategic planning must also address and answer: The long-term strategy regarding independence Business strategy – do we want to be a growth institution, a profitable institution or

both Organizational structure – ownership issues Capital adequacy Stockholder liquidity Board and management succession Employee and director benefits Dividend policy Technology plan Product, services and lines of business Geographic expansion Unsolicited offers Long-term planning Financial issues

F. ROLE IN BOARD AND MANAGEMENT SUCCESSION

It is the responsibility of the Chairman to ensure the Board has adequately considered and planned both Board and management succession. It is imperative this be done early. Planning for management succession only months before implementation does little to help the institution. The Chairman’s obligation to management succession is to make sure the Board, with management’s assistance, has established a plan for a situation where the top executives are here today and gone tomorrow, either due to death, disability, taking another job, winning the lottery, or for whatever reason. The Board also needs to understand the senior officers’ long-term work plans, i.e., when they are going to retire, and the succession plans should be developed from that.

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In planning Board and management succession, the Chairman should ensure the Board considers and determines if the replacement will be temporary or permanent. It is also imperative the Board identifies who will replace certain key executives. Do not limit the management succession discussion to just the CEO. The Board should also regularly review its management succession plan, especially if there is a change in corporate structure.

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Tab D Overview of Community

Bank Mergers and Acquisitions

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I. INTRODUCTION

As is noted throughout these materials, the Chairman’s role is one of leadership. The area of Mergers and Acquisitions is no exception. The Chairman’s role includes educating him or herself with the respect to the alternatives assisting the Board in determining whether its long term strategy is to buy another institution, remain independent over the long term subject to the receipt of an unsolicited offer, or whether the shareholders will be better off receiving the cash for stock of a purchasing bank holding company. None of these decisions are easy, particularly when the acquisition environment is changing. The following materials provide a discussion of various issues related to community bank merger and acquisition transactions that will assist the Chairman and the Board of Directors as a whole in carrying out their responsibilities.

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II. BUYING OR SELLING SECRETS: ENHANCING

SHAREHOLDER VALUE THROUGH PURCHASE OR SALE

In 1980, there were 14,870 independently chartered banks in the United States. At year-end 2018, there were approximately 5,430. While the trend of consolidation is undeniable, any strategy – whether to buy, sell, or remain independent – can be viable in the current environment if appropriate planning occurs. The following material should assist the Chairman and the entire Board in identifying the issues and common concerns in either buying or selling a community bank or implementing a decision to remain independent and simply keep your shareholders happy by enhancing shareholder value.

A. ESTABLISH YOUR BANK’S STRATEGY EARLY ON

It is important that a community bank have an acquisition strategy that it addresses and determines annually. However, before establishing that strategy, whether it is to buy, sell, or simply remain independent and enhance value, the Board must recognize the issues associated with each alternative. In doing so, it must balance the various stakeholders’ interest, including shareholders, directors, management, employees, depositors, and customers, as well as consider the market environment in which it is operating. In addition, the Board must consider the management and capital with which it has to work. If embarking on an acquisition, how much can the institution pay and who will manage? If looking to sell, what does the institution have to offer? 1. Stakeholders’ Interest

It is incumbent upon the directors to consider each of the stakeholders’ interests. Clearly, the shareholders’ interests are of paramount importance. The shareholders’ desire for liquidity and increase in market value, combined with a change in the stage of life and general aging of the shareholder population, may drive the Board’s decision in one direction or the another. In addition to the shareholders, however, the desires of top management, middle management, employees, the customer base and the community must be considered. As a practical matter, it is very difficult to have a successful sale without, at least, the acquiescence of senior management. Even a sale which the shareholders support can be scuttled by senior management’s discussions with the potential purchaser with respect to the condition of the bank and the valuation of contingent liabilities. As a result, senior management and the other parties’ “needs” must be identified and met. In addition, if ownership is fragmented, it is in the best interests of the Seller and Buyer to organize and consolidate the “control group” as early as possible. Any possibility of having factions develop among members of the control group should be eliminated, if feasible.

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2. Market Environment In connection with enhancing shareholder value without sale, the typical community bank is faced with a number of environmental forces, including aging of the shareholder base and lack of management succession, technology considerations, increased competition and regulatory concerns, all of which may drive the bank toward the strategy of buying additional institutions or branches to enhance value or selling their own institution to enhance value. In addition to the regulatory burden currently imposed on banks, the Consumer Financial Protection Bureau has seemed intent on increasing that burden significantly, as well as the costs associated with compliance. Even with a newly appointed director of the Bureau, community banks can expect the focus on consumer protection to continue.

3. Capital

The Board’s determination of its alternatives must include how best to allocate its capital. The Board of Directors must first determine how much capital is available. This includes not only the consolidated equity of the bank and the holding company, but also the leveraging ability of the holding company. Once that number is determined, how the capital pie is “sliced” must be considered. The new reality is that community banks will be required to maintain higher capital levels than they have historically. While such capitalization levels used to qualify a community bank as overcapitalized, 9% Tier 1 and 12% total risk-based capital ratios will become the norm and practical regulatory minimums, particularly when you consider the impact of the Basel III capital rules. Does the Board use a significant portion of its capital to repurchase its own stock or does the bank use the capital to offset losses? Does it use some of that capital to buy another bank or branch? Does it use the capital for natural growth? Does it dividend that capital to its shareholders? Or, does it exchange that capital for an equity interest in another institution through sale? Particularly in light of Basel III, the new reality with regard to minimum capital means that, across the board, community banks may suffer a lower return on equity and possibly lower pricing multiples. While proposed rulemaking with respect to the new “community bank leverage ratio” will hopefully significantly reduce the capital burden on community banks, the Board nonetheless needs to make a conscious decision, particularly in an overcapitalized community bank, as to whether to return some of that capital to its shareholders. The issue is not one of receiving “capital gains” treatment versus “ordinary income” treatment on that “extraordinary dividend” capital. The issue is getting some “value” for that excess capital through a dividend versus limited or no value through a sale, which is priced based on the company’s earnings stream (though that is not to say tax considerations are irrelevant).

4. Management Most transactions will result in existing management being retained by the acquiring institution (at least for some period of time). This is simply due to the combination of facts that (a) most acquiring institutions do not have excess management, and (b) most Sellers will not be acquired if management is not assured of a position after the acquisition or otherwise financially compensated. Non-management owners should

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never forget that there is an inherent conflict of interest in allowing managers to negotiate with a potential purchaser when the management will be staying on after the sale. Obviously, management is then negotiating with its future boss.

5. Consideration of Potential Acquirors If a community bank’s Board of Directors has made the decision to sell the company at some point in the future - no matter how distant - so that the question is not “if” to sell the company but “when,” the Board of Directors must consider which acquirors may be available at the time it finally decides to sell. A community Board should consciously identify its potential acquirors. It should then analyze, as best it can, what may occur with those acquirors. A potential acquiror that is interested in moving into the community where the community bank operates its franchise may do one of several things:

a. It may be acquired itself and thereby be eliminated as a player. b. If it desires entrance in the market, it may use another entry vehicle, i.e. another

institution or a de novo branch and be eliminated as a player. c. It may simply lose interest and allocate its resources to another strategic direction

and eliminate itself as a player.

Unfortunately, if “selling” is in the community bank’s current thought process, i.e. a strategy other than an adamant one for independence, sooner is probably better than later. “Sooner” will provide the maximum number of potential purchasers.

B. CREATION OF THE PLAN

Whether the Board of Directors’ decision is to buy, sell or remain independent and simply enhance value, it must plan for the ultimate outcome it desires. 1. Implementing an Acquisition Strategy

a. Needs of the Buyer

Before finding a bank, bank holding company or thrift to buy, a Buyer must first define the kind of financial institution it desires and is, from a financial and management standpoint, able to buy. The Buyer must develop an acquisition strategy describing an overall plan and identifying acquisition candidates. Buyers must consider, in advance, the advantages that the Buyer wishes to obtain as a result of combining with the selling institution. These benefits generally fit within the following categories:

(1) Financial * Earnings per share appreciation

* Utilization of excess capital and increased return on equity

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* Increased market value and liquidity * Increasing regulatory burden offset by enhanced earning power

and asset upgrades. (2) Managerial or Operational

* Obtain new management expertise * Additional systems and operational expertise * Use of excess competent management

(3) Strategic

* Diversification * New market entrance * Growth potential * Economies of scale and/or scope * Enhanced image and reputation * Elimination of competition * Obtain additional technology expertise

b. Formation of the Acquisition Team and Assignment of Responsibility

(1) The Players

(i) The Buyer and the Seller

The typical Buyer in this environment will probably be a small to mid-sized holding company desiring entry into the market to expand its franchise, or a community bank slightly larger than the target, looking to gain critical mass to cover the cost of doing business. The typical Seller will be a community bank of any size in a good market with acceptable performance, and in all likelihood, with a Board that has “had all the fun it could stand”. From the Seller’s perspective, the decision to sell an institution will generally fall into one of four scenarios:

(a) The controlling stockholders make a decision to sell

after a substantial period of consideration due to the pressures of personal financial factors, estate planning needs, age, technology, competitive factors, regulatory actions, exposure to directors’ liability and so forth.

(b) The institution is in trouble and needs additional capital

and/or new management. (c) The institution has no management succession and an

older management and shareholder base.

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(d) The Board is concerned about missing the upcoming “window.”

(ii) Financial Consultants, Special Counsel and the Accountants

With the status of current regulations and the growing complexity of mergers and acquisitions, few institutions are capable of closing a successful deal without outside assistance. From a technical standpoint, there is a greater need than ever before to secure the services of specialized financial consultants, legal counsel, and experienced auditors. The costs may be high, but it is a misguided chief executive who thinks he or she can economize by doing his or her own legal, accounting or even financial work in an acquisition transaction. The primary goals of any outside advisor should be to close the deal and to protect his client’s interests. To achieve these objectives, the advisor(s) must have a number of attributes and qualifications, some of which differentiate him or her from many other professionals. First and foremost, the advisor must have the requisite knowledge and experience in business combinations and reorganizations. This not only includes a solid understanding of the intricacies of acquisition contracts and regulatory issues, but more importantly, also a high degree of familiarity with the business and financial issues that arise in community bank acquisitions. Second and equally important, it is essential that the advisor understands the tax implications of the acquisition and provides structuring advice early on in the negotiations. Aside from the technical skills, the advisor(s) must seek to find solutions to problems which may arise rather than simply identifying them. Instead of finding reasons for “killing a deal,” which comes quite naturally to some, the talented advisor is oriented to “making the deal,” unless it would result in insufficient protection for his client. The experienced advisor knows what must happen and when it should take place. Along with the principal parties, he must maintain the momentum for the deal. Experienced professionals will prepare and work from a transaction timetable, outlining the various tasks that must be accomplished, the person(s) responsible, and target dates. An early decision which must be made is who will actually handle the negotiations. A general rule to follow when using outside “experts” for negotiations is as follows. If representing

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the Buyer, the experts should become involved early, but stay behind the scenes to avoid intimidating an unsophisticated Seller. If the experts are representing the Seller, they should become involved early in the negotiations and be visible to avoid a sophisticated Buyer trying to negotiate an unrealistic or unfair deal with an inexperienced Seller.

(iii) Assignment of Responsibilities

Once the bank’s team and advisors are in place, it is critical to specifically assign responsibilities to each member of the team. It is helpful to have one coordinator for these tasks. That coordinator is often the outside counsel or financial consultant who has experience with transactions of this type. The assignments of responsibilities should be formalized and documented so that significant matters are not overlooked in the excitement of the acquisition process.

(iv) Preparation of Candidate List

Typically, Buyers find that the most difficult, frustrating and time-consuming step in buying another institution is finding an institution to buy - one that “fits”. This is especially true for the first-time Buyer who frequently underestimates the time and effort necessary to plan and locate viable acquisition candidates. Unfortunately, many such Buyers start a search for acquisition candidates without being fully prepared. The result is early disappointment with the whole idea. Following a well-constructed plan will assist a Buyer in pinpointing “buyable” Sellers and reduce unproductive time. The Buyer needs to be aware that there is an inherent inclination toward acquisition. Well thought out and well planned acquisitions create value and minimize risks. Unplanned acquisitions maximize risks and limit future flexibility. Certain studies suggest that bank mergers do not guarantee major cost savings benefits. With planned acquisitions, many of the anticipated benefits will result. With unplanned or poorly planned acquisitions, they rarely do. In any event, as a Buyer, be careful valuing synergies.

2. Implementation of the Sale Strategy

Some institutions will simply decide it is the time to sell. This may be due to an aging shareholder base, lack of management succession, failure to keep up with technology or related issues, lingering compliance troubles, or a combination of several of those issues. Once the institution makes the decision to sell, the Board of Directors needs

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to be certain that it has in place a “process” designed to obtain the highest and best price for the bank shareholders in the best currency. Some institutions attempt to do this by having an appraisal conducted of their bank before they engage in negotiations. Unfortunately, an appraisal will not tell the Board what the bank is worth on the market. It will only indicate what other banks have sold for and what the bank may possibly be worth. The only way for a Board of Directors to assure itself that it is obtaining the highest and best price in the best currency for its bank is to put the bank on the market on either a limited or extensive basis. Over the past several years, our firm has marketed and sold a number of community banks on a turnkey basis. The process involves:

a. The identification of prospective purchasers. b. The preparation of confidential evaluation material describing

in detail the condition of the bank. c. The distribution of that material, subject to a confidentiality

agreement, to a list of potential acquirors as approved by the Board of Directors.

d. The submission by those potential acquirors of expressions of

interest based on the material submitted to them and subject to due diligence indicating the price they would pay for the bank, the currency, i.e. stock, cash or a combination, the structure, i.e. branch or separate bank and any other relevant issues.

e. A review by the Board of Directors of the offers and a

determination as to which, if any, of the bidders receive an opportunity to conduct on-site due diligence.

f. The negotiation of the transaction and legal services in

connection with closing the transaction. Once an offer or offers are selected by the Board, only then do the potential acquirors conduct a due diligence of the bank in order to reconfirm or increase their offer and eliminate the due diligence contingency. Once the decision to sell has been made, the best way for the Board of Directors to assure itself that it has met its fiduciary duty and obtained the highest and best price for the bank is to market the institution. The second line of defense for the Board of Directors is the fact that the consummation of the acquisition will also be conditioned upon receipt of a fairness opinion shortly prior to the closing of the acquisition.

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C. ANTI-TAKEOVER PLANNING AND DEALING WITH UNSOLICITED OFFERS

1. Avoiding Unwanted Attempts to Change Control

It is not unheard of for a larger holding company or another community bank to present a community bank target with an unsolicited offer. Our firm has actually seen a handful of these over the past couple of years. In our experience, the offers do not generally take the route of an “unsolicited tender offer” or “hostile offer”, but nevertheless, cause the target bank or bank holding company a certain degree of trepidation. The implementation of a well thought out and strategically minded anti-takeover plan will give the community bank holding company greater mastery over its own destiny when presented with a potential unsolicited or hostile offer. The anti-takeover plan will not prevent the bank holding company from being sold if its Board of Directors believes it is in the best interest of the shareholders for such a transaction to take place. An appropriate anti-takeover plan, however, will present the Board with the luxury of time to consider an offer or to shop the institution or the ability to reject the offer or make it difficult to obtain approval for an unwanted acquiring company. For an existing bank holding company, qualified counsel should review the holding company’s charter and bylaws to determine what, if any, anti-takeover provisions already exist. Additional anti-takeover provisions should be added in connection with charter and bylaw amendments at the next regular annual shareholders meeting after full disclosure to shareholders. Banks desiring to form holding companies, because of the exemption in the federal securities laws, which eliminates the need to file a formal SEC registration in connection with the formation of the holding company if the bank charter and the holding company charter are substantially similar, are best advised to form the bank holding company, and as a second step, sometime six months to a year down the road, implement an anti-takeover plan. Once the holding company has been formed, the anti-takeover plan can be implemented with the assistance of counsel at the next regular annual meeting of the shareholders after full disclosure to the shareholders. The primary benefits of adopting a comprehensive anti-takeover plan are fourfold: * The existence of the plan may deter unwanted investors from initially seeking a

control or ownership position in the institution. * The plan may be a valuable negotiation tool when the Board is approached by

an investor. * The plan provides specific defenses if a tender offer or other similar maneuver

is commenced. * The existence of the plan will likely drive any potential acquiror into the

boardroom instead of out to the individual shareholders directly.

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Obviously, strategies for handling a takeover attempt should be considered before the situation is confronted. Numerous courts have rendered significant opinions on anti-takeover and defensive strategies. One of the main reasons for favorable decisions upholding anti-takeover defenses is the timing of the implementation of such defenses. Corporations amending their charters and bylaws to include such protective provisions as part of advance planning have generally had the defenses upheld in court. In many cases, firms with strategies implemented in response to a specific bid have had such provisions invalidated on the basis they were put in place only to protect existing management and were not in the best interests of shareholders. Last minute, reactionary planning is usually ineffective. Implementing a comprehensive anti-takeover plan if a financial institution does not have a holding company may be extremely difficult and ultimately ineffective. Amendments to a financial institution’s charter (“articles of incorporation”) as opposed to a holding company’s charter, often must be approved by the institution’s primary regulator. Many standard corporate provisions, such as the elimination of cumulative voting or preemptive rights and staggered election of directors for multiple year terms are expressly prohibited in archaic state and federal banking laws. Regulators are conservative even regarding what charter amendments may be used if legally permissible. In addition, if the regulatory agency ultimately allows the defenses to be placed in the charter, there is little or no legal precedent to determine whether the defenses will be upheld in court. A bank holding company is not limited by such considerations. For corporate purposes, a holding company is a general state-chartered corporation and is limited only by the law of the state in which it is incorporated. Certain types of “structural” anti-takeover techniques may be used with a bank holding company as follows:

Anti-takeover Defenses

* Stagger election of directors * Limit shareholder written consent to approve certain actions

* Limit the size of Board * Permit special Board meetings on “best efforts” notice basis

* Deny shareholders cumulative voting rights

* Require “supermajority” shareholder vote approval of certain takeover or acquisition transactions

* Allow director removal only “for cause”

* Provide authorized but unissued shares of institution stock

* Limit shareholder ability to replace directors

* Deny shareholder preemptive rights

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* Implement director qualification requirements

* Enumerate factors directors can consider in approving or disapproving a potential takeover

* Limit director affiliations with other institutions

* Require fair price provisions in potential takeover offers

* Require non-management director nominations to meet certain requirements

* Amend shareholder voting rights under certain circumstances

* Limit shareholder called special meetings

In addition to the previously noted structural anti-takeover techniques, there are certain general defensive strategies or “black book” procedures that should be followed, including the following:

* Prepare a limited “black book” containing a list of key personnel, including

special legal counsel, financial and public relations personnel and their office and home phone numbers.

* Prepare information about how to locate all directors and key personnel on

short notice.

* Identify a senior management team of three or four directors and three to four senior managers to deal with an unsolicited offer on a daily basis. * Review shareholder list in order to ascertain shareholders’ geographic location

and identify key shareholders that might assist in solicitation efforts and be able to gauge shareholder loyalty.

* If the bank holding company is a publicly reporting company, the company

should implement a consistent “stock watch” program to monitor the daily trading of its stock.

* Implement a shareholder and investment relations program. * Implement safe keeping practices for your shareholder list. * Instruct all directors and personnel to decline comment to the press with

respect to offers. * Establish a line of credit with a correspondent bank for a defensive stock

repurchase program.

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Employment contracts containing “Golden Parachute,” “Golden Handcuff” or “Retention Bonus” provisions may also be entered into with key officers at the holding company level. Although such contracts must comply with IRS Code Section 409A, these contracts provide substantial monetary benefits to such officers if control changes involuntarily. The contracts may serve as a deterrent to “raiders” because of the cost they add to an acquisition. Most importantly, if structured properly, the contracts will help guarantee objective advice by management during a takeover attempt. Without such arrangements, management’s objectivity may be influenced by negotiating with a raider who could be their future boss. A valid anti-takeover plan and a mission statement certifying that the bank desires to remain independent do not always prevent the institution from receiving an unsolicited acquisition offer. In order to understand how to deal with an unsolicited offer, a banker must understand the difference between an unsolicited offer and an “inquiry”. An inquiry is simply an overture by another institution asking whether the institution is for sale or would sell out for something in the neighborhood of X times book value or X times earnings. An unsolicited offer is more formal. It generally involves the receipt of a written offer by another institution for a merger or acquisition of the stock of the selling institution. An inquiry is informal and can generally be dealt with informally. An unsolicited offer, however, should be dealt with in a formal manner in order to protect the Board of Directors.

2. Dealing with Unsolicited Offers

Upon the receipt of an unsolicited offer from another institution, the first step that the banker should take is to consult with specialized merger and acquisition professionals and the bank’s Board of Directors. Many unsolicited offers contain very short fuses. It is generally not necessary to strictly comply with the deadline set forth in the offer, but it is advisable to have counsel consult with the offeror and let them know that the Board is currently considering its options. The Board of Directors has four basic options when faced with an unsolicited offer. Each of these options must be considered in view of the Board’s extensive fiduciary duties to shareholders in this situation. Numerous issues which are beyond the scope of this brief outline are present. For further specific information, please contact us.

- Reject the offer. - Accept the offer. - Negotiate the offer. - Shop around to see if there is a better offer.

Rejecting the offer out of hand is dangerous for both the individual who has actually received the offer and the Board of Directors. The offer may ultimately be rejected but the rejection should be based upon a detailed financial and legal analysis of the inadequacy of the offer in view of the criteria considered by the Board of Directors.

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This would include relying on charter and bylaw provisions dealing with the analysis of offers as discussed above. A Board of Directors’ acceptance of an “unsolicited first offer” constitutes a breach of fiduciary duty on its face. Many acquirors will generally make unsolicited offers based on public information regarding anticipated earnings-per-share impact on the larger holding company. If the holding company is interested in the franchise and interested in the bank, it will generally increase its offer through negotiation. The third alternative is to negotiate the offer. Once a community bank begins to negotiate or consider the offer, the bank is clearly in play. It will be sold. Many Boards of Directors of banks desiring to remain independent have found that independence disappears once they decide to try and “negotiate” an unsolicited offer. The fourth alternative is to see what other offers are available. In any event, when an unsolicited offer is received, the general advice is to test the waters once the bank is put into play and see what other offers are available. It is only through this mechanism that the Board can determine that it has received the highest and best price.

D. CHANGE IN ACCOUNTING FOR ACQUISITIONS

As noted earlier in these materials, ASC 805 currently governs acquisition accounting, and it is a departure from the previously preferred method of “pooling of interest accounting” for acquisitions. If the acquisition qualified for the pooling of interests method, the acquiror accounted for the target’s assets, liabilities, and net worth at the same book value those items had on the target’s financial instruments without regard to the fair market value of the target’s assets or liabilities or the fair market value of the consideration the acquiror issued in exchange for the assets. Therefore, under the pooling of interests method, no new “goodwill” was created. To qualify for the pooling method, an acquisition was required to meet a number of complex requirements, including that: (1) acquiror voting stock must be the principal consideration, (2) acquiror and target must not be subsidiaries or divisions of another company, (3) consideration paid by the acquiror could not include an earn-out or other contingencies, and (4) the acquiror could not intend to dispose of any significant portion of the target’s or its own assets. If an acquiring bank could not meet the requirements of the pooling method, the acquisition would be accounted for under the purchase accounting rules. In 2001, the pooling of interest method was completely replaced by the purchase accounting rules. From 2001 to 2008, acquisition transactions were accounted under the purchase accounting regime. In that situation, the target’s old accounting book values are not relevant. The target’s asset book values are generally stepped up or down for their current fair market value. This results in higher (or lower) post acquisition depreciation and amortization. To the extent the acquiror’s purchase price for target exceeds the fair market value of target’s assets; goodwill is created and treated as a new asset on the balance sheet of the acquiror. The bad news then, was that the buyer had to record goodwill on its books. The good news was that the goodwill was no longer amortized

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against future consolidated income of the buyer, unless it was deemed to be impaired after being tested. The purchase accounting rules were changed once again effective December 15, 2008. Financial Accounting Standards Board Pronouncement 141(R), which was codified as ASC 805, made a number of changes to the methods of accounting for an acquisition. The most significant impact of this new pronouncement is that a target’s assets and liabilities are now transferred to an acquiror at their “fair value”. This value can be difficult to ascertain when evaluating a potential transaction, which adds more uncertainty to the transaction. Also important is the new requirement that all costs incurred in connection with an acquisition transaction must be expensed in the period in which they are incurred. This changes the rule that acquisition expenses could be capitalized. Other changes include the requirement that contractual contingencies and non-contractual contingencies must be recorded at their fair value at the time of the acquisition and bargain purchases (a transaction where the purchase price is less than the difference between the fair value of the assets and liabilities acquired) must be booked as a gain on the acquiring company’s income statement.

E. CONTACT AND NEGOTIATION FOR COMMUNITY BANK ACQUISITIONS

1. The Approach

An acquisition by a regional holding company or another community bank may be one in a series of acquisitions for that institution. It is likely, however, that the sale by the Seller will be a sale by an inexperienced Seller and will be that Seller’s first and often last sale.

a. Preliminary Approach through the CEO or Principal Shareholder

Many different approaches are used by potential acquirors, be they bank holding companies or other community banks, toward target community institutions. In virtually every case, however, the approach will be to the chief executive officer of the Selling Bank or its principal shareholder. Often, the CEO or other high ranking officer of the acquiror will simply call the CEO of the target and ask if he would be willing to discuss the possibility of “affiliating” or associating with it. Inevitably, the potential acquiror’s representative will avoid the use of terms such as “acquisition”, “sale”, or “being acquired” and use the euphemisms of “affiliation,” “association” and “marriage” when talking about the acquisition.

b. Getting Serious

Although potential acquirors have made various approaches in the past with respect to acquisition of community institutions in particular, virtually all potential Buyers have now learned that in order to have any serious discussions with the community bank, the chief executive or chairman of the Board of the Buyer needs to engage directly in discussions with the chief executive of the

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Selling Bank or its principal shareholder. To be effective, this needs to happen very early in the exploratory stages. Experience has shown that the Buyers that have tried to acquire banks by sending officers other than the CEO or chairman to conduct any serious discussions have generally not been as successful as those represented directly by one of them. Most community bankers understandably take the position that when they are about to make the most important decision that they will ever make for their bank, they want to directly “eyeball” the CEO of the Buyer. Many understandably resent it if the bank holding company chairman or CEO does not give them at least some reasonable amount of attention.

c. The Sales Pitch

Buyers and Sellers have varying interests and reasons for wanting to engage in a transaction. Usually the acquiring institution, although it is technically a “Buyer,” must “sell” itself to the target. This is particularly true where stock of the Buyer is to be used as the currency for the transaction. The sales pitch varies with the perceived “needs” of the community bank which the Buyer intends to meet as a result of the acquisition. Many times, the needs of the Selling Bank will depend primarily upon the financial condition of the Seller. If the Selling Bank needs additional capital for growth or otherwise, the approach by the Buyer usually emphasizes that an affiliation with the Buyer will provide a source of additional capital so that the bank may continue to grow and serve its community. If the Selling Bank is already well capitalized and satisfactorily performing, the approach usually involves an appeal to the stockholders of the community bank with respect to the liquidity of the stock of the Buyer and the lack of marketability and illiquidity of the selling community bank’s stock. The Buyer will also always emphasize the tax free nature of most transactions and the existing market for its stock. In banks in which the chief executive officer is near retirement age and does not have a capable successor on board, the Buyer generally emphasizes its management depth and its ability to attract successor management who will have a career opportunity with a larger organization. In summary, the Buyer will generally emphasize that it can bring to the table capital, management, liquidity for the investment, future earnings potential, appreciation, and career opportunities for employees. The specific needs of the Seller will determine which of these particular benefits will be emphasized.

2. General Negotiation Considerations

In all bank acquisitions, there are some advantages that inherently go to those who are selling and others that accrue to the Buyer. No matter which side you are on, two primary goals should be recognized: first, improve your bargaining position, and, second, understand the other side’s position.

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a. Stages of Negotiations:

(1) Preliminary negotiations leading up to determination of price and other social issues - usually represented by a letter of intent or term sheet.

(2) Negotiations leading up to execution of definitive documentation. (3) Additional negotiations at or immediately before closing regarding last

minute price adjustments and/or potential problems. Acquisition negotiations can take a long time. It is important that both parties be patient. Although the Buyer may have made several acquisitions, it is likely that the Seller is taking the most important step in its history.

b. General Negotiation Suggestions for Both Parties:

(1) No premature negotiations - ignore deadlines. Make concessions late

and always get something in return. The opposite is also true - take concessions and attempt to move on without giving up anything.

(2) Plan and attempt to control all aspects of negotiations including place, time and mood. The Buyer usually has an advantage in this regard.

(3) Throughout negotiations, be courteous but firm and attempt to lead the negotiations. Within the general rule that the “Buyer gets to draft”, try to have your professionals retain control over drafting and revisions of definitive documentation.

(4) Use the “foot in the door” negotiating approach to get to higher levels

of commitment. As the costs and expenses mount, a party will be more reluctant to terminate the deal since his institution will have to bear the expenses. (These expenses are usually a larger share of the Seller’s operating income.)

(5) Consider using letters of intent or term sheets because they:

- clear up any ambiguity or confusion over the terms of the deal,

- cause a psychological “commitment,”

- take the institution off the market and discourage other bidders, include confidentiality provisions, and

- set forth the timing of the deal.

(6) Keep communications open with shareholders. Make sure all parties in

interest understand the delays associated with a bank acquisition.

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(7) Always be careful of unreasonable time demands. Is the acquisition so unique that the risk of speeding up the process is justified? Are there other bidders or alternatives for the other party? Where is the pressure coming from to expedite the transaction? How will the faster pace affect the acquisition? Are there “hidden agendas” existing with advisors? Is the potential reward commensurate with the risks?

(8) Be absolutely certain that you receive competent legal advice on exactly

what public disclosures should be made regarding negotiations and the timing of such disclosures. Substantial liability can occur for misleading or late disclosures.

(9) Throughout negotiations, be certain everyone understands the

importance of the “due diligence” examination since so often these examinations identify major problems. Try to make certain that by the time you get to the closing documents there are no more surprises.

(10) Always attempt to use a win/win strategy. It is almost impossible to

make a totally unfair and overpowering deal “stick.” Regardless of the legal consequences, most people will not honor a contract if they realize they have been “taken.”

c. Specific Seller Negotiation Considerations

(1) The Seller should not reveal the reasons his group is interested in

selling. (2) A Seller should always show a limited desire to sell. This will have the

effect of forcing the Buyer to sell itself rather than requiring the Seller to “sell” his institution.

(3) Consider using a representative for negotiations so that the

representative can use the strategy of saying, “I can only make recommendations to my client. I cannot commit for him.”

(4) Due diligence examinations are integral parts of any acquisition. The

Seller should usually try to force “due diligence” examinations before any definitive document is signed or as early as possible. This avoids premature press releases which can be embarrassing later. Also it removes the major contingency early. Termination of an acquisition, regardless of the reasons given in a press release, will nearly always damage the reputation of the Seller more than the Buyer. It will be automatically assumed that there is something wrong with the institution being sold.

(5) Remember the “foot in the door” negotiating approach used by many

purchasers. A Seller should always realize that negotiations are never over until the cash or stock is received.

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(6) Bring up integration issues early in the negotiations if the post-acquisition operation of the bank is important to the Seller’s management and directors.

(7) Don’t forget the social issues.

d. Specific Buyer’s Negotiation Considerations

(1) Avoid discussion of price in the initial meetings. It is too sensitive a

subject to raise until some personal rapport has been developed. In determining the pricing, always consider what incentive plans must be given to management.

(2) Consider the “social issues” early on.

(3) Make no proposal until you have arrived at a clear understanding of the

Seller’s desires and expectations. (4) With a “cash” transaction, determine in the beginning the “financing”

of the deal. Keep in mind that often a Buyer, a lender and the regulators must approve the deal from a cash flow and financial point of view.

(5) If the Seller is unsophisticated enough to allow its existing senior management to negotiate, the Buyer should take advantage of the

natural reluctance of management to negotiate “too hard” with its future boss.

(6) It is always important that there is no uncertainty about who is speaking

for the Buyer. Also, always make certain the person speaking for the Seller controls the Seller or has authority from the Seller.

(7) Meetings of more than five or six people are less likely to be fruitful. (8) Be careful of valuing synergies. They rarely exist. (9) Identify all of the true costs of the acquisition, including the

termination/deconversion fees associated with the target’s data processing contract, change-in-control payments to the target senior executives, etc. Such payments can be high, to say the least, and can have a significant impact on pricing. Identify them sooner rather than later.

Fair, honest, and straightforward negotiations will produce productive agreements. Any transaction that is “too good” for either side will generate ill will and run the risk of an aborted closing. In order for a transaction to work, it must be viewed as fair to both parties.

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F. PRICE, CURRENCY, STRUCTURE, AND OTHER IMPORTANT ISSUES

1. Pricing and Currency Issues

If pricing of an acquisition transaction is not the most important issue, then it runs a very close second to whatever is. Granted, although “social issues” play a large role in acquisition transactions and have derailed many through the years, pricing and an understanding of pricing are critical.

a. Stock or Cash as the Currency

(1) When considering an acquisition transaction as either Buyer or Seller, it

is imperative to make a decision up front as to whether stock or cash will be the currency. The currency will generally be dictated by the desires of the selling company. If the Seller wants a tax free stock transaction, then a cash transaction will only be acceptable generally if it is “grossed up” for tax purposes which will often make it prohibitively expensive. Particularly with the post-election “bump” many larger, regional banks’ stocks experienced, stock as currency has increased in attractiveness for many institutions. This “bump” has normalized more recently, but it still reintroduced the viability of stock as an alternative to cash consideration. With that said, numerous questions arise which should be considered in connection with taking the stock of a holding company or other Buyer. Primary concerns should be as follows:

(i) The number of shares selling stockholders will receive in

relation to the perceived value of the community bank’s stock. Is the price acceptable based on the market value of the holding company stock being received?

(ii) The investment quality of the holding company stock at that

price. Is the holding company stock a good investment at that price and is it likely to increase in value or is it already overpriced and is more likely to drop?

(iii) The liquidity in the holding company stock to be received. Is

the market thin or is there a ready market available for the stock? Although a number of holding company stocks are listed on an exchange and often there are many “market makers” through regional brokerage houses in these stocks, the true market for the stock may be extremely thin.

(iv) Who bears the market risk during the length of time that will

transpire between the time an agreement in principle is reached and the time the stock is actually issued to the community bank stockholder so it can be sold?

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(v) The taxable nature of the transaction. Will the stock be received in a tax free transaction so there will be no taxable event unless and until the community bank shareholders sell their new holding company stock?

(2) Determining Relative Value of Illiquid Shares

When two community banks are combining for stock and neither bank has a “liquid” currency, then the acquiror and the target must determine the relative value of the two banks and their contribution to the resulting entity. In other words, the banks must determine how large a stake in the new combined company the target represents, which will dictate the value of a share of target stock in terms of stock of the acquiror. This determination is generally based on a “Contribution Analysis”. To arrive at a relative value of the two institutions and their resulting share in the resulting institution, each bank’s relative contribution of earnings, assets, and equity to the combined resulting holding company should be considered. Because the contribution of a large earnings stream is generally more valuable than the contribution of equity, which is, in turn, more valuable than the contribution of assets, these three criteria should be weighted accordingly. By considering the relative value of each bank’s contribution to the combined entity, and by understanding which category, earnings, equity, assets, contributes more to the long-term value of the combined organization, the two combining banks can determine the relative values of the stock to each other.

(3) Pricing

(i) Current Environment of Reduced Price

Once upon a time, in the middle part of this decade, banks were consistently selling for two times book value. As it was not that long ago, it is logical that a potential target bank, whose business has not materially changed, could claim that the value of his bank has not changed either. The fact of the matter, however, is that community banks are operating in a vastly different economic environment, and are selling for significantly lower multiples of book value. Prices continue to rise, but they are still not up to pre-recession levels. Simply put, healthy banks are selling for less than what they did before the recession.

(ii) Historical Pricing

“Historical Pricing” is a method of pricing a bank deal by reference to similar deals. A bank will determine its own value

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by looking at prices paid for banks of similar size and profitability that serve similar markets. The fallacy of this reasoning is that a bank is “worth” only what a willing buyer will pay for it. Valuing a bank by reference to others is rarely, if ever, an effective way at arriving at an accurate value. That is why historical pricing is not considered to be an accurate indicator of a bank’s potential selling price. Historical pricing can be used to see if an offer is in the correct ballpark, but that is near the extent of its value.

(iii) Price Based on Earnings Stream

As noted, although pricing in bank acquisition transactions is often reported as a multiple of book value, bank acquisition transactions are always priced based on the target’s potential earnings stream and whether it will be accretive or dilutive after the acquisition to the potential acquiror. Whether or not the acquisition will be accretive or dilutive to the acquiror from an earnings per share standpoint is going to depend on the earnings stream that can be generated from the target post-acquisition. This means that cost savings obtained by the acquiror as a result of the acquisition, i.e. general personnel cuts, and revenue enhancements which will be obtained as a result of the target being part of the acquiror’s organization must be considered. Generally, when considering the resulting pro forma reflecting the post-acquisition earnings stream for purposes of pricing the acquisition, the target should be given a significant credit on the purchase price calculation toward cost savings to be obtained by the acquiror. The target generally gets no credit for revenue enhancements, which are items that the acquiror brings to the table, i.e. the ability to push more product that the acquiror already has through the distribution network of the target.

Because most transactions are initially “priced” before obtaining detailed nonpublic information about the target, the potential acquiror generally needs to determine an estimate of cost savings for purposes of running its own model. The general rule of thumb with respect to savings of noninterest expense of the target is as follows:

Out of Market Acquisition 15 to 20% Adjacent Market Acquisition 20 to 30% In Market Acquisition 25 to 40%

Once the pro forma earnings stream for the target after the acquisition by the acquiror has been determined, it is fairly easy to determine how many shares or dollars the acquiror could

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give to the target shareholders without diluting the earnings of its own shareholders. Most acquirors of community banks will not engage in transactions that are earnings per share dilutive, at least that are earnings per share dilutive for very long.

(4) Critical Contract Considerations With Respect to Pricing a Stock-for-Stock Transaction

(i) The single most important provision in the acquisition

agreement relates to how the price is determined, i.e. at what time will the number of shares to be received by the community bank shareholders actually be determined. This is important since the value of the stock, particularly if a larger, public holding company is involved, typically fluctuates day to day in the market.

(a) Competing interests between the Selling Bank and the

Buyer are clearly present. The community bank’s interest is to structure the price so that the dollar value of the transaction is determined in the contract, but that the number of shares to be received by the community bank increases proportionately as the market value of the holding company stock decreases up to the date of closing.

Conversely, the Buyer’s interest is to structure the transaction so that the value is fixed in the agreement and the number of shares or value of the transaction decreases as the price of the holding company stock increases in the market. These competing desires are usually resolved in one of several ways.

- A fixed exchange ratio that does not change no

matter what the stock price is, i.e., a fixed number of shares to the Seller’s shareholders.

- An exchange ratio that fluctuates both up and down but has a collar and a cuff on it so that

the amount of fluctuation in the exchange ratio

is fixed. If there is a variation in the stock price that goes beyond the collar or cuff, the number of shares does not adjust any further.

(b) Bank stock indices are also often being used as part of

the pricing mechanism.

(ii) It is also important to obtain a “walk” provision which is utilized in the event the value of the Buyer’s stock drops below

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a specified dollar amount at a specified time or times. In that event, the Seller’s Board has the right to terminate the agreement without any obligation to proceed further.

(a) As a practical matter, the “walk” provision is generally

extremely effective from the Seller’s standpoint. In the unanticipated event that the stock of the Buyer falls below the “walk” price, the community bank always has the opportunity to renegotiate the exchange ratio and thereby retain its flexibility.

(b) The key to the “walk” provision is to determine in

advance at what date the holding company stock will be valued. Many acquisition agreements provide for an average value for a twenty-day trading period which ends five days prior to the effective date of the merger. Such a provision, however, may create unnecessary problems in implementation.

(c) It is preferable to have a “walk” provision that has a

twenty day period run both from the date of approval by the shareholders of the Selling Bank and from the date of approval of the Buyer’s application by the Federal Reserve Board or other agency. Using these dates gives the community bank two shots at the “walk” provision. This also gives the advantage to the community bank so that if the federal regulatory approval, i.e. the “first walk date,” is obtained prior to the shareholders’ meeting, and the community bank determines to terminate the transaction, a proxy and prospectus need not be delivered and shareholder vote may never need to be taken.

2. Social Issues

Although pricing and pricing considerations are of paramount importance, many transactions stand or fall on social issues. As a result, oftentimes, particularly for a Seller, the negotiation of social issues first makes sense. If the social issues cannot be adequately addressed, then there is generally no need to move on to price discussions. Social issues include the following:

a. Who is going to run the bank or company post acquisition? b. What will the company’s or bank’s name be? c. Who will sit on the Board of Directors? d. What will be the compensation of the directors and/or officers remaining?

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e. What will be the severance provisions for officers and employees who are terminated?

f. Will the institution be turned into a branch or remain as an independent

charter? g. Will employee benefits change? h. How much autonomy will the Board or advisory board and management have

post acquisition? i. How much bureaucracy will be involved post acquisition?

Even an adequately priced acquisition may never close if the social issues cannot be addressed to the satisfaction of principal players. Address social issues early on.

3. Merger of Equals

It is not uncommon for community banks to consider a “merger of equals”. In other words, neither bank considers itself the target. In such situations, banks should be aware that under purchase accounting rules one bank must be designated as the acquiror when accounting for the transaction. Numerous issues are presented in what are purported to be mergers of equals. Often these are referred to as “unequal mergers of equals” not only because one institution must technically be the acquiror for accounting purposes, but generally one institution deems itself to be the acquiror. As many issues as can possibly be resolved ahead of time should be. Mergers of equals are difficult to consummate and integrate.

4. Intangible Considerations Associated with the Price and Autonomy

a. When a Selling Bank considers selling, major concerns on the chief executive’s mind are generally related to price of the acquisition and autonomy after the acquisition. It is generally possible to satisfactorily quantify the price provisions and build in certain protections from market value fluctuations of the holding company stock. It is not as easy, however, to get a grasp on the issue of autonomy.

b. The community bank executive must understand, however, that while the

acquiring holding company stresses the substantial autonomy that will be given to its subsidiaries, in reality, the autonomy dissolves rather quickly as more and more authority is assumed by the acquiring holding company’s main office.

c. It is generally true that within two or three years after the acquisition by a larger

holding company, the chief executive officer of the community bank leaves and is replaced with someone chosen by the holding company. Although there are many reasons for this, the major one is that a CEO, accustomed to operating his or her own bank subject only to his Board of Directors, is simply unable or unwilling to adjust to having to respond to directions from so many people in so many areas in a larger holding company setting. For this reason, the CEO

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who is ready, willing and able to retire within a few years of the acquisition is in the best possible position to negotiate a good deal for his shareholders. He does not have to be so concerned about his own future at the holding company and can aggressively negotiate against the people who will be his future bosses if he stays with the bank after its acquisition.

d. In general, however, there is an inherent conflict between the desire for

autonomy by the CEO and the best interest of the shareholders. In the usual case, the shareholders’ sole concern is getting the best price in the best currency. If it is not cash, it should be in a stock that is readily marketable and is expected to at least retain its value. The CEO must be careful that there is not a trade-off on price to obtain a better deal or more autonomy for the local

Board and management at the expense of the consideration received by shareholders. Usually the shareholders are not concerned about autonomy - particularly if it is at their expense.

5. Dividends/Subchapter S Distributions

The payment of dividends or Subchapter S distributions must be considered in any acquisition transaction. Often, the community bank’s dividend payment history may provide significantly less cash flow than the dividends that will be received by the community bank shareholders after application of the exchange ratio in a stock-for-stock transaction. If this is the case, then acceleration of the closing of the transaction to ensure that the community bank shareholders are shareholders of record at the time of the dividend declaration by the acquiring company should be a priority. The worst possible case is that the community bank does not pay its dividend and misses the acquiring company’s dividend. This is generally avoided by providing that the community bank can continue to pay its regular dividend up until the date of closing and that the community bank will be entitled to its pro rata portion of its regular dividend shortly prior to closing if the community bank shareholders will have missed the record date of the acquiring company as a result of the timing of the closing. In other words, the community bank would get its own dividend or the acquiring company’s dividend, but not both. The acquisition of Subchapter S institutions provides an additional consideration. Subchapter S organizations make (or at least should make) “tax equivalent” distributions to their shareholders for the purpose of covering the shareholders’ increased tax liability as a result of pass-through income. If a Subchapter S institution is acquired prior to making any tax equivalent distributions for the current tax year, then the target shareholders could be left with a tax liability from partial year income without any corresponding distribution.

Related, the potential for an extraordinary dividend must be considered. Since the replacement of the pooling of interest method of accounting, there are no adverse consequences to the payment of an extraordinary dividend. Indeed, in today’s environment, many community banks use the extraordinary dividend to reduce their capital account to approximately 8% immediately prior to closing. The payment of an extraordinary dividend in a cash transaction will often have no adverse impact as a

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result of the purchase price often being tied to “core” capital, rather than including excess capital in the calculation.

6. Due Diligence Review

No matter how large the Buyer or whether it is an SEC reporting company, before a Seller’s shareholders accept stock in an acquiring bank or holding company, a due diligence review of that bank or holding company should take place. This is similar to the due diligence review which the Buyer will conduct of the Seller prior to executing the definitive agreement. It is generally best to have disinterested and objective personnel conduct the due diligence review of the acquiror. Several difficulties are generally encountered in connection with this review, not the least of which often times is simply the sheer size of the Buyer whose condition is being evaluated and whose stock is being issued. An additional and recurrent difficulty involved in the due diligence review is obtaining access to the Buyer’s regulatory examination reports. Although these reports are intended for the use of the Buyer’s company and bank only, it is virtually impossible to justify recommending to the Seller’s Board of Directors and its stockholders that they sell to the Buyer in a stock-for-stock transaction if the due diligence team is denied the right to review the regulatory reports to determine if there are any material considerations that would affect the decision to sell.

It is generally most efficient for the Selling Bank to retain outside experts to either completely conduct the due diligence examination or at least assist and direct the examination with the assistance of key people from the Seller. Individuals who are experienced in doing this type of work will quickly know the areas to focus on, the information necessary to obtain, and can generally facilitate a rapid due diligence review that is of minimum disruption to the Buyer and maximum benefit to the Seller. Most of the experienced and sophisticated Buyers are used to having these reviews performed in their offices and generally they will be cooperative with respect to the process. Even in a cash deal, prudent Sellers will conduct due diligence on the acquiror to verify that the company has or has access to the cash to execute the deal, and can obtain regulatory approval. In addition, conducting due diligence on a Seller can uncover problems at the front end that would later derail the deal. Spending valuable time and untold thousands of dollars pursuing a deal with no chance of success is an immense waste of time and resources. Due diligence can uncover a host of “under the radar” issues that are imminently important, even to a Seller in a cash deal.

7. Fairness Opinion

Another issue that is extremely important to the Selling Bank is that the definitive agreement contain, as a condition to closing, the rendering of a fairness opinion. The fairness opinion is an opinion from a financial advisor that the transaction, as structured, is fair to the shareholders of the Seller from a financial point of view. The fairness opinion will help to protect the directors from later shareholder complaints with respect to the fairness of the transaction or that the directors did not do their job.

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The fairness opinion should be updated and delivered to the Seller bank as a condition of the Seller bank’s obligation to close the transaction. Conditioning the closing on the receipt of an updated fairness opinion will also protect the Seller further by permitting it to terminate the transaction in the event of material adverse changes between the time the contract is signed and the closing, which precludes the delivery of the fairness opinion.

8. Structuring

A good number of acquisitions, whether large or small, are structured as tax free exchanges of stock. It is imperative that the Seller, its Board of Directors, and shareholders understand the tax ramifications of the transaction as well as the Buyer’s tax considerations in order to fully understand the Buyer’s position in the negotiations. Any acquisition transaction will be a taxable transaction to the Seller’s shareholders unless it qualifies as a tax free transaction pursuant to the Internal Revenue Code. Although a detailed discussion of the structuring of the transaction and tax considerations is beyond the scope of this outline, it should be noted that often community banks are offered a tax free exchange of stock in the acquiring institution. This will be the result of either a phantom merger transaction or an exchange of shares under state “Plan of Exchange” laws. Under certain circumstance, a transaction can still be tax free for shareholders receiving stock of the Buyer, even though up to 50 percent of the consideration of the transaction is cash. It is critical that the Seller use a firm that has counsel qualified to review the structure of the transaction. If a transaction is improperly structured, the result may be double taxation to selling shareholders. It is anticipated that cash transactions will become much more frequent in the near future. From the Seller’s perspective, the obvious advantage to a cash deal involves a “bird in the hand”. Sellers who accept cash are subject to none of the risk associated with taking an equity position in an acquiring bank and have received consideration for their shares that is totally liquid – a big advantage. On the other hand, Sellers for cash are not afforded the upside potential of holding an equity interest. They will not be entitled to dividends or any subsequent appreciation in the value of the acquiror. For better or for worse, Sellers in a cash deal are frequently totally divorced from the bank following the acquisition. In addition, the sale of a bank for cash will be a taxable transaction. The shareholders will be subject to income tax at capital gains rates to the extent their shares had appreciated in their hands. There is also a unique structuring consideration when the target organization is a Subchapter S corporation. Acquisition transactions can either be structured as a sale of the target’s equity (stock) or a sale of the target’s assets. For tax purposes, a sale of the target’s equity results in a “carry over” basis. In other words, the target company’s assets have the same depreciable tax basis as they had pre-acquisition. A sale of assets, on the other hand, results in the acquired assets having a tax basis equal to each asset’s fair market value. This is called a “step up” in basis, meaning that the acquirer is able to

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re-depreciate the assets. While this represents a significant benefit to the acquiror, a sale of assets often results in an increased tax liability for the seller.

In transactions involving the sale of an S corporation, Internal Revenue Code Section 338(h)(10) allows the acquiror to treat the acquisition of S corporation equity as a purchase of S corporation assets, thus gaining the tax benefits noted above. Because this results in increased tax liability for the sellers, however, the shareholders of the seller have to consent to the 338(h)(10) election. Selling shareholders are unlikely to bestow a benefit on the acquiror while increasing their own taxes without being compensated in some way. Thus, this structural element is ripe for negotiation.

9. Documentation and Conditions to Closing

Every Buyer or Seller needs to be aware of the basic documentation in acquisition transactions as well as conditions to closing. The basic documentation often used includes:

a. Term Sheet b. Definitive Agreement c. Proxy Statement and Prospectus d. Tax and Accounting Opinions e. Due Diligence Report on Buyer f. Fairness Opinion g. Miscellaneous Closing Documents It is advisable to use some kind of term sheet in a merger or acquisition. A term sheet not only provides a moral commitment, but more importantly, it evidences that there has been a meeting of the minds with respect to the basic terms of the transaction. The definitive agreement is the “big agreement”. The definitive agreement generally runs from 40 to 60 pages and is full of legalese, including significant representations and warranties as well as pricing provisions, covenants that must be obeyed by the selling institution from the time of the signing of the agreement until the closing, and conditions to closing. The conditions to closing generally include financing in a cash transaction, regulatory and shareholder approval in all transactions (since they are generally structured as mergers), the receipt of a fairness opinion and the fact that there has been no material adverse change from the date of the agreement to the date of closing in the target (in a cash transaction) or in either company (in a stock-for-stock transaction).

10. Dissenting Stockholders

Since virtually all transactions will be structured as mergers to enable the acquiror to acquire 100% of the target’s stock, the target’s shareholders will generally have dissenters’ rights. In a transaction structured as a merger, the vote of the target shareholders of either two-thirds or 50%, depending on the applicable law, will require 100% of the shareholders of the target to tender their stock to the acquiror in exchange for either the cash or stock being offered unless such shareholders perfect their dissenters’ rights. The perfection of dissenters’ rights by a shareholder does not permit the shareholder to stop the transaction or keep his stock. It only entitles the

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shareholder to the fair value of his or her shares in cash. In very few transactions are dissenters rights actually exercised for the simple fact that in a stock-for-stock transaction with a listed security, the dissenters can generally sell the stock received and obtain their cash very quickly. In a cash transaction or a stock transaction for a less liquid security, most dissenters do not have a large enough position to make it economically feasible to exercise their rights and pursue the appraisal and other remedies available. Historically, most transactions were conditioned upon no dissent in excess of 10%. This was due to some requirements for pooling of interest accounting. Even with the disappearance of pooling of interests accounting, it is likely that most transactions will retain a 10% or less dissent limitation in order to give the Buyer some certainty as to the price that will be paid and the support of the shareholder base for the transaction.

It should be noted that by exercising its dissenters’ rights, a shareholder is committing to accepting the value of the shares as determined by a Court. This can be a gamble. If the Court determines that the stock is worth less than what is being offered by the acquiring bank, the shareholder receives less.

11. Aspects of Securities Law Issues

Although a thorough discussion of securities law issues is beyond the scope of this outline, virtually any acquisition, including a stock exchange by Selling Bank shareholders for a Buyer’s security, will need to be approved by the Selling Bank shareholders. This will require the preparation of a prospectus (for the issuance of the stock) and a proxy statement (to obtain the vote of the shareholders). There is often a temptation from the Selling Bank to allow the Buyer, particularly if it is a larger holding company, to totally handle the disclosure process for the prospectus-proxy statement. The Seller must remember that to the extent the document is a proxy statement for a special meeting of the Seller’s shareholders, it is also a securities disclosure statement of the Selling Bank and must contain all material and proper disclosures about the Selling Bank. As a result, it is imperative that counsel, accountants, and management of the Selling Bank be actively involved in the disclosure process. Of more practical importance than the reparation of the disclosure material to the Board of Directors and shareholders of a target company in a stock-for-stock acquisition is whether their stock will be restricted from immediate sale once received. As a practical matter, in most stock-for-stock acquisitions with larger holding companies that are listed on an Exchange, a condition of the transaction is that the stock be registered by appropriate filings with the Securities and Exchange Commission. Registered stock, once received by shareholders of the target company who are not “affiliates” (insiders) of the target, can be sold immediately. Affiliates of the target, defined as directors, executive officers or shareholders holding in excess of 5% of the target’s stock, are restricted from sale under the Securities and Exchange Commission Rules 144 and 145. Although these Rules are lengthy and complicated, as a practical matter, an affiliate receiving restricted shares in connection with an acquisition only can dispose of those shares under the following basic conditions:

a. The sale must occur through a broker.

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b. The affiliate cannot sell more than 1% of the stock of the acquiring company in any three-month period (this is usually not a problem since typically, no shareholder in a community bank receives more than 1% of the acquiring company’s stock as part of the transaction).

c. An affiliate is subject to a holding period of six months, during which, sale of

the securities is disallowed.

G. DIRECTORS’ AND OFFICERS’ LIABILITY CONSIDERATIONS

Directors of a corporation (a bank and/or its holding company) are elected by shareholders and owe those shareholders the fiduciary responsibility to look out for the shareholders’ best interest. Directors fulfill this fiduciary responsibility by exercising to the best of their ability their duties of loyalty and care. A director’s duty of loyalty is fulfilled when that director makes a decision that is not in his or her own self-interest but rather in the best interest of all shareholders. A director’s duty of care is fulfilled by making sure that decisions reached are reasonably sound and that the director is well-informed in reaching those decisions. In traditional settings, courts will rarely second-guess a Board of Directors’ decision unless a complaining shareholder can clearly prove self-dealing on the part of the Board of Directors or that the Board of Directors behaved recklessly or in a willfully or grossly negligent manner. The burden is on a complaining shareholder to show that the Board did not act properly in fulfilling its fiduciary duties. In sale transactions (sale of business, merger, combination, etc.), Boards of Directors are subject to “enhanced scrutiny” in reaching important decisions regarding the sale of the business. Boards of Directors must be able to demonstrate (1) the adequacy of their decision-making process, including documenting the information on which the Board relied on reaching its decision, and (2) the reasonableness of the decision reached by the directors in light of the circumstances surrounding the decision. In a sale of business setting, the burden shifts to the directors to prove that they reasonably fulfilled their fiduciary duties. The following is a partial list of actions that would be appropriate for a Board of Directors to take in reviewing or in making a decision whether to merge and/or be acquired or accept a tender offer in most situations: 1. The Board should inquire as to how the transaction will be structured and how the

price of the transaction has been determined. 2. The Board should be informed of all terms within the merger agreement, acquisition

agreement or tender offer. 3. The Board should be given written documentation regarding the combination,

including the merger agreement and its terms. 4. The Board should request and receive advice regarding the value of the company which

is to be bought and/or sold. 5. The Board should obtain a fairness opinion in regard to the merger.

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6. The Board should obtain and review all documents prepared in connection with the proposed merger, acquisition or tender offer.

7. The Board should seek out information about national, regional and local trends on

pricing a merger or acquisition. 8. Finally, the Board members should be careful not to put their own interests above the

interests of the shareholders. If directors’ deferred compensation or other agreements exist between the corporation, they must be negotiated but not serve as a block to a transaction that would otherwise be in the best interests of shareholders.

The whole concept of “enhanced scrutiny” has arisen from (and, for that matter, is still being developed) by a number of Delaware Supreme Court decisions relating to hostile and/or competitive acquisition transactions. A great amount of material has been written attempting to explain the impact of these Delaware Supreme Court decisions. Not everyone agrees on exactly what these decisions mean, and lawyers and Boards of Directors continue to grapple with exactly what Boards must do to survive the “enhanced scrutiny” that courts will place on Boards of Directors in a sale of business transaction. Despite the lack of absolutely clear guidance on what Boards must do to survive the test of enhanced scrutiny, a number of general rules are becoming apparent. These include the following: 1. In a sale of business transaction, the Board of Directors must assure itself that it has

obtained the highest price reasonably available for the shareholders, but this does not necessarily mean that the Board of Directors must conduct an “auction” to obtain that price.

2. The Board of Directors is obligated to “auction” the business if there is a “change in

control.” For example, if the selling shareholders will trade their shares of stock for shares of the acquiror and the acquiror has a dominant, control shareholder, then an auction is required to assure that the selling shareholders receive the highest price and the best type of consideration.

3. In the absence of a large control shareholder, an auction is not necessarily required if

the selling shareholders receive stock of the acquiror and that stock is freely tradable on an established market.

4. If the shareholders are to receive cash in exchange for their shares, an auction may be

required. At a minimum, the directors must determine that they have agreed to the best available transaction for shareholders. Directors may be able to rely on publicly available pricing data for comparable transactions in reaching this conclusion.

5. In any case, directors should obtain a fairness opinion from a qualified valuation expert

as to the fairness of the transaction to shareholders from a financial point of view. Directors can use this fairness opinion as a major component in satisfying their duty of care to the shareholders and surviving the “enhanced scrutiny” that the courts will impose.

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Boards of Directors involved in any type of sale process or sale evaluation must take extra steps to assure that they are fulfilling their enhanced fiduciary responsibilities to the shareholders. Using board committees, specialized counsel and consultants to help the Board structure the “process” of evaluating a sale is absolutely critical to fulfilling the Board’s responsibilities.

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Tab E 10 Commandments for

Community Bank Chairmen and Directors

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10 COMMANDMENTS FOR COMMUNITY BANK

CHAIRMEN AND DIRECTORS

Below you will find the “10 Commandments for Community Bank Chairmen and Directors” that our firm has drafted to serve as the foundational principles of the Chairman’s and director’s role in the community bank organization.

I. THINK PROSPECTIVELY: PAY ATTENTION TO EVERYTHING

(ESPECIALLY RISK).

Things are moving far too rapidly in the community banking segment of the industry not to pay attention. Risk needs to be monitored by the Board of Directors. Although enterprise risk management did not produce great results for the big banks, that is no reason for the community banks to ignore it. The Board should establish risk identification and monitoring systems to ensure that management manages risk appropriately.

II. DON’T FORGET YOUR REAL JOB: ENHANCE VALUE FOR THE

SHAREHOLDERS.

Your real job is to work for your shareholders by enhancing the bank and holding company’s value, or at least maintain it. Even in the midst of change, that still means growing earnings per share (earnings drive value), having a decent return on equity, allocating capital to provide liquidity for the shares if excess capital is available or obtainable, providing the shareholders with cash flow or something that looks like cash flow, and operating the bank in a safe and sound manner. If the Board does not focus on enhancing or maintaining shareholder value, there may not be a bank in the future to serve your community.

III. REGULATORS WILL BE REGULATORS: LEARN TO DEAL WITH

THEM.

The regulators were present prior to the nationwide financial crisis. The regulators were present during the financial crisis. The regulators are still present today amidst all of the changes going on in the industry. No matter what the external circumstances, the Board of Directors has to learn how to deal with the regulators in an appropriate manner. Understand the bank’s rights, and understand the regulators’ options. At that point, it is incumbent upon the Board of Directors to educate itself, self-regulate, admit its mistakes along the way, and do its best to stay out of the compliance “penalty box.” Document everything and be respectful, but never be afraid to disagree and stand your ground when appropriate. Remember that your real job is to work for your shareholders, and not the regulators. Do your best to work toward “win/win” sitautions with the regulators when it is possible, but always focus on your primary job of enhancing shareholder value. If you do that, the odds are that both your shareholders and the regulators will remain happy.

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IV. YOUR COMPLIANCE OFFICER NEEDS TO BE ON HIS OR HER “A”

GAME. As the industry continues in the “compliance” era, it is important for the Board

of Directors to be aware of the issues involved, particularly as it relates to unfair and deceptive practices, abusive practices, and fair lending (that is discrimination based on the race, age, ethnicity, and the like). Your Compliance Officer needs to be on his or her “A game.” A compliance “event” with the regulators generally involves reimbursement to the affected consumers (maybe several million dollars), a civil money penalty payable to the U.S. Treasury, and a contribution to a financial not-for-profit literacy fund. Do not ignore it.

V. CAPITAL IS STILL KING: DON’T BE AFRAID OF IT AND

UNDERSTAND HOW TO GET IT.

Even with the new “community bank leverage ratio” on the horizon, capital remains the king and will be for the foreseeable future. For now, under the current rules, the de facto capital ratios for community banks remain a 9% Tier 1 risk-based and 12% total risk-based capital ratio. This will be the case for even healthy banks with modest risk profiles. Understand how you get capital. If you are under $3 billion in consolidated assets, you can still borrow it. If you are over $3 billion in consolidated assets, understand issues of ownership and book value dilution as you sell common, preferred, or a hybrid stock. Also consider creative alternatives such as preferred, convertible preferred, and the like.

VI. UNDERSTAND MERGERS AND ACQUISITIONS: DOES SIZE

MATTER?

The industry continues in a period of consolidation, and it appears that the “wave” will continue into the future. It will be up to the Board to decide whether the bank and holding company should be a “consolidator” or a seller. Do not take your eye off your real job, which is to do what is right for your shareholders. Also, do not be scared or intimidated into a sale by those “fear mongers” who are pounding the table indicating you have to be a certain size to survive as a community bank. You do not.

VII. VOTE NO: UNDERSTAND LIABILITY ISSUES.

Often, at Board meetings, the pressure is to “go along to get along.” If you have a doubt in your innermost being, a twinge in your gut, a check in your spirit, vote “no” and make sure that “no” vote is recorded in the minutes. Will you be viewed as a rebel? Sure, in the short term. Will you be viewed as a brilliant and wealthy person in the long term? Absolutely! A “no” vote protects the director from liability on that particular transaction.

VIII. ADDRESS SUCCESSION ISSUES: BOTH BOARD AND MANAGEMENT.

Community banks have historically done a poor job in the area of Board and management succession planning. Make sure your Board has some way to

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change out your Board members. Have a management succession plan on paper that can be implemented, not just if the CEO dies, but if the CEO, for whatever reason, decides to take another job or wins the lottery. These things do happen. Assess the need for a Board succession plan. Who is going to retire and when? What criteria are important in looking for new Board members? Does the Board have an appropriate Corporate Governance Committee? Plan for it.

IX. DEAL WITH YOUR SHAREHOLDER BASE: MAKE A

DETERMINATION ABOUT OWNERSHIP AND LIQUIDITY.

It is the Board’s job to determine what the ownership of the company should look like and to provide for liquidity if the holding company does not have market liquidity (most of us as community banks do not). It is the Board’s job to determine whether the company should be public, should go private (get rid of SEC reporting) or move to Subchapter S. In most states, if you can muster 50% of the vote of the shares, you can change your ownership structure. There are political and financial issues associated with any ownership change, but it is the Board’s job to assess that. It is also the Board’s job to make sure the shares have some liquidity, i.e. the ability of a shareholder to sell a share of stock at a fair price at the time they want to. This normally, for a typical community bank holding company, involves the allocation of capital toward the redemption of shares. The Board should make a conscious decision as to whether that type allocation of capital is appropriate.

X. PLAN FOR THE FUTURE: IT WILL BE DIFFERENT THAN YOU THINK.

The one predictable thing about change is that it will always look different than you think. It is critical that the Board plan strategically for the future of the bank as change occurs in the industry around it. The playing field has largely leveled out since the “Great Recession,” and the Board of Directors needs to ensure the bank has the financial and human capital it needs to remain independent and profitable for the long-term. Planning for the future includes planning for ownership, capital, management, earnings, mergers and acquisitions, geographic expansion, and the like.

Jeffrey C. Gerrish

Mr. Gerrish is Chairman of the Board of Gerrish Smith Tuck Consultants, LLC and Gerrish Smith Tuck, PC, Attorneys. The two firms have assisted over 2,000 community banks in all 50 states across the nation. Mr. Gerrish's consulting and legal practice places special emphasis on strategic planning for boards of directors and officers, community bank mergers and acquisitions, bank holding company formation and use, acquisition and ownership planning for boards of directors, regulatory matters, including problem banks, memoranda of understanding, cease and desist and consent orders, and compliance issues, defending directors in failed bank situations, capital raising and securities law concerns, ESOPs and other matters of importance to community banks. He formerly served as Regional Counsel for the Memphis Regional Office of the FDIC with responsibility for all legal matters, including all enforcement actions. Before coming to Memphis, Mr. Gerrish was with the FDIC Liquidation Division in Washington, D.C. where he had nationwide responsibility for litigation against directors of failed banks. He has been directly involved in fair lending, equal credit and fair housing matters, in raising capital for problem financial institutions and in numerous bank merger transactions. Mr. Gerrish is an accomplished author, lecturer and participates in various banking-related seminars. In addition to numerous articles, Mr. Gerrish is also the author of the books Commandments for Community Bank Directors and Gerrish’s Glossary for Bank Directors and produces an every two week complimentary newsletter, Gerrish’s Musings. He also is or has been a member of the faculty of the Independent Community Bankers of America Community Bank Ownership and Bank Holding Company Workshop, The Southwestern Graduate School of Banking Foundation, the Wisconsin Graduate School of Banking, the Pacific Coast Banking School, the Colorado Graduate School of Banking and has taught at the FDIC School for Commissioned Examiners and School for Liquidators. He is a member of the Executive Committee and the Board of Regents of the Paul W. Barret, Jr. School of Banking. He is a Phi Beta Kappa graduate of the University of Maryland and received his law degree from George Washington University's National Law Center. He is a member of the Maryland, Tennessee and American Bar Associations, was selected as one of “The Best Lawyers in America” 2005 through 2018 and as the Banking Lawyer of the Year, Best Lawyers Memphis, 2009. Mr. Gerrish can be contacted at [email protected]. GERRISH SMITH TUCK, PC, ATTORNEYS GERRISH SMITH TUCK CONSULTANTS, LLC 700 Colonial Road, Suite 200 700 Colonial Road, Suite 200 Memphis, Tennessee 38117 Memphis, Tennessee 38117 (901) 767-0900 (901) 767-0900 EMAIL: [email protected] EMAIL: [email protected]

Philip K. Smith Mr. Smith is the President and a member of the Board of Directors of the Memphis-based law firm of Gerrish Smith Tuck, PC, and its affiliated bank consulting firm, Gerrish Smith Tuck Consultants, LLC. Mr. Smith's legal and consulting practice places special emphasis on bank mergers and acquisitions, financial analysis, acquisition and ownership planning for boards of directors, strategic planning for boards of directors, regulatory matters, bank holding company formations and use, securities law concerns, new bank formations, S corporations, going private transactions, and other matters of importance to banks and financial institutions.

Mr. Smith is a frequent speaker to boards of directors and a presenter at numerous banking seminars. He received his undergraduate business degree and Masters of Business Administration degree from the Fogelman School of Business and Economics at The University of Memphis and his law degree from the Cecil C. Humphreys School of Law at The University of Memphis. He is authoring a monthly electronic newsletter, The Chairman’s Forum Newsletter, which discusses key topics impacting financial institutions and, specifically, the role of the Chairman. Mr. Smith is a Summa Cum Laude graduate of the Barret School of Banking where he has been a member of the faculty. He has also served as a member of the faculty of the Pacific Coast Banking School, the Colorado Graduate School of Banking, the Southwestern Graduate School of Banking and the Wisconsin Graduate School of Banking.

GERRISH SMITH TUCK, PC, ATTORNEYS GERRISH SMITH TUCK CONSULTANTS, LLC 700 Colonial Road, Suite 200 700 Colonial Road, Suite 200 Memphis, Tennessee 38117 Memphis, Tennessee 38117 (901) 767-0900 (901) 767-0900 www.gerrish.com www.gerrish.com Email: [email protected] Email: [email protected]

Greyson E. Tuck Mr. Tuck is a member of the Board of Directors of both the Memphis based law firm of Gerrish Smith Tuck, PC, Attorneys and Gerrish Smith Tuck, Consultants, LLC. These two firms have assisted numerous community banks in virtually every state across the nation. Mr. Tuck’s legal and consulting practice places special emphasis on community bank holding company formation and use, community bank mergers and acquisitions, regulatory matters, corporate reorganizations, corporate taxation, general corporate law and community bank strategic planning. Mr. Tuck comes from a community banking family. He is a graduate of the University of Tennessee, where he majored in Accounting and Finance, and received his law degree from the University of Memphis Cecil C. Humphreys School of Law, where he was a Herff Scholar. Mr. Tuck is a graduate of the Paul W. Barret, Jr. School of Banking and currently serves as a faculty member at a number of banking schools across the country. He is a frequent presenter at national and state bank association conferences and has authored a number of articles of interest to financial institutions. Mr. Tuck is a member of the Tennessee Bar Association and an active participant in the Memphis Bar Association. GERRISH SMITH TUCK, PC, ATTORNEYS GERRISH SMITH TUCK CONSULTANTS, LLC 700 Colonial Road, Suite 200 700 Colonial Road, Suite 200 Memphis, Tennessee 38117 Memphis, Tennessee 38117 (901) 767-0900 (901) 767-0900 EMAIL: [email protected] EMAIL: [email protected]

POWERPOINT PRESENTATION


Gerrish Smith TuckConsultants and Attorneys

1

Jeffrey C. Gerrish, ChairmanPhilip K. Smith, PresidentGreyson E. Tuck, DirectorGerrish Smith Tuck, Consultants & Attorneys


January 17-18, 2019The Ritz-CarltonNaples, Florida

• Lecture / Peer Discussion

• Interactive

• Breaks

• Lunch

• Private Consultations

• Who is Here?


2

• Industry Environment

• Why So Positive?

• Major Changes Requiring Re-evaluation

• What Do We Do Now – Strategic Initiatives

• Your Real Job

• Community bank net income of $6.8B in 3rd quarter 2018− Increase of $1.2B (21.6%) compared to 3rd quarter 2017

− ROA of 1.17%

• Net interest margin of 3.74% in 3rd quarter 2018 − Increased from 3.66% from 1st quarter 2017

• Loan balances increased $98.9B (6.6%) in LTM− Compared to 4% growth at non-community banks

• Noncurrent loans rate of 0.80% in 3rd quarter 2018− 26 bps lower than non-community bank rate


3

• Improving Overall Financial Performance

• Most Banks Are Still Focusing on Profitability

• Regulators Are Still Focusing on Compliance

• Legislative Change Brought Regulatory Relief

• Continued Consolidation

• Other Lines of Business

• How Do We Define Growth?

• Aging Population (Shareholders, Management, and Board)

• Technology Innovation


4

• Directors’ and Officers’ Real Job– Allocate managerial (human) capital and financial

capital to enhance shareholder value

• Fundamental Question: What Do We Have to Work With?

• What Does It Mean to Enhance Shareholder Value?

• Growing Earnings Per Share

• Respectable Return on Equity– 10% to 12% ROE

– 1% ROA

• Share Liquidity

• Cash Flow

• Safe and Sound Operations


5

• Technology Changes– A competitive reality, not a luxury

• Operational Changes– You are not the same bank you used to be

• Board and Managerial Changes

• Succession Planning– Not just the CEO


6

• De-Risk Earnings Stream– Stick to what you know

• Deconstructing the Financial Statements

• Pricing Loans and Deposits

• Source of Non-Interest Income

• Old Metrics May Be Old– Earnings drive value

• Incent What You Want – Earnings, Safety, Capital, etc.

• Long-Term View of Success, but Short-Term Results– Value to shareholders


7

• Bank Holding Company

• Subchapter S

• Public Versus Private

• Branch Structure

• Opportunities Abound

• Smart Use of Capital

• Buying Branches

• A Merger of Equals?


8

• Compliance, compliance, compliance

• New areas of focus

• Concentrations, liquidity

• Round of enforcement actions

• Managing the process as Chairman

• Director Education– Do you “know” enough

• Director Involvement and Engagement– Customer referrals

– Visibility within organization and community

– Activity rather than Passivity

• Improve Board Meetings


9

• Have a Consent Agenda

• Don’t Look Only Backwards

• Make Appropriate Use of Committees

• Ask for Trending Data, Not Minutiae

• Ask for What You Want

• Utilize Technology– Board Portals

• Terms of Service

• Staggered Terms

• Mandatory Retirement

• Evaluation of Directors

• Director Emeritus

• Diversity


10

• Knowledge and Informed

• Independent

• Integrity

• Vision-Strategic Planning

• Confidentiality

• Avoids Regulatory Problems

• Fulfills Role to Stockholders

• One Who Can Change and Adapt


11

• Leads the Board by example

• Ensures each director is involved and effective

• Understands the Bank’s business and industry

• The “face” of the Board to the Shareholders

• Does not shy away from the regulators

• Spearheads strategic initiatives, including succession


12

• Think Prospectively: Pay Attention to Everything (Especially Risk)

• Don’t Forget Your Real Job: Enhance Value for the Shareholders

• Regulators will be Regulators: Learn to Deal with Them

• Your Compliance Officer Needs to be on His or Her “A” Game

• Capital is Still King: Don’t Be Afraid of It and Understand How to Get It

• Understand Mergers and Acquisitions: Does Size Matter?


13

• Vote No: Understand Liability Issues

• Address Succession Issues: Both Board and Management

• Deal with your Shareholder Base: Make a Determination About Ownership and Liquidity

• Plan for the Future: It Will Be Different Than You Think

• Growth or Profitability?

• Mergers and Acquisitions

• Ownership Issues– Liquidity

• Long-Term Planning – Led by the Chairman


14

• Deconstruct the Financial Statements– Back to the basics lending

• Asset Quality

• Product & Service Offerings

• Risk Assessment/Management

• Technology Planning

• No specific regulatory requirement (except for national banks)

• General regulatory expectation

• Formal and informal regulatory order requirements


15

• General regulatory expectation

– Documents management’s course over next 2 to 3 years / 5 years

– Encompasses all areas and operations

– Sets broad, achievable goals

• Resistance to change

• Change for change sake

• Open mind / willing ear

• Establishment of “company policy”


16

• Types of planning

– Visioning – where will we be 10 years from now?

– Long-term planning – timeframe?

– Tactical and operational planning – management’s job

• There is buy-in from the directors and officers– Who should attend

– Decision making process

• It is enjoyable for the participants– Get offsite

– Bond

– The Caribbean/Ritz-Carlton is always nice


17

• The group does not focus too much on the process itself– Focus on substantive areas – discuss/decide/move on

– Too touchy/feely

• You do not spend the entire time on the SWOT analysis– SWOT as a “cottage industry”

– Rules for SWOT

– An ice breaker

• The participants are honest with themselves and others– The four “C’s” of planning –

communication/candor/consensus/confidentiality

• No one person dominates the meeting– Patriarch

– Chairman or CEO

– Shareholder

– Facilitator


18

• It never turns into a budgeting session– Drives budget

– Establish big picture financial targets

• You do not focus too much on the mission, vision, and value statements– What do you use these for?

– Regulatory expectation

• You focus on substantive issues– Identify issues

– Create agenda

• There is accountability and follow up

• You use an outside facilitator– Shameless self-promotion

– Asks hard questions without political ramifications

– Industry expert versus academic


19

• Time Horizon Focus

• Profitability Focus

• Compliance Focus

• Risk Analysis Focus


20

• Continued M&A deals– Appreciable Activity Among Smaller Banks

– Does size matter?

• Increased Unsolicited Expressions of Interest

• Transaction/Structure Creativity– Cost Focus/Purchase and Assumption Transactions

• Political, Economic and Regulatory Uncertainty Affecting Stock as Transaction Consideration

• Very Few Failed Bank Deals

• M&A Activity Drivers

– Acquirers Looking for Size

– Acquirers Looking for Liquidity (Cash to Lend)

– Asset Quality and Compliance/Regulatory Burden

– Shareholder, Director and Management Succession

• Stronger Pricing

• Goal: Enhance Shareholder Value


21

020406080

100120140160180200220240

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Average Price / Book (%) Average Price / Earnings (%)

* Through January 3, 2019 (no transactions yet announced in 2019)** Source: S&P Global

* Through January 3, 2019 (no transactions yet announced in 2019)** Source: S&P Global

2015 2016 2017 2018

Number of Deals 293 251 267 262

Average Price/Book (%) 134.7 130.9 155.7 164.5

Average Price/Tangible Book (%) 138.5 136.9 162.9 173.3

Median Price/Earnings (x) 24.3 21.7 23.0 25.0

Average Price/Assets (%) 14.3 14.6 16.4 17.2

Average Price/Deposits (%) 16.9 16.7 19.6 20.2

Median Premium/Core Deposits (%) 5.5 4.8 9.1 9.9


22

• I want to buy another bank

• I want to position my bank to sell

• I want to remain independent

• I want to do something

• I don’t want to do anything

• I have no idea what I want to do

• Can I? Will I have to sell?

• As a buyer, can I be opportunistic?

• How do I maximize value?

• How do I stay independent?


23

• Be a leader

• Understand the general context of M&A

• Obtain professional help

• Put the interest of shareholders first

• Duty of care – Reasonably prudent bank or holding company director

• Duty of loyalty– Avoid conflict of interest

– Avoid misappropriation of corporate opportunities

• Enhanced scrutiny– Adequate process

– Reasonable decision


24

• Can we enhance shareholder value?

• Can we do a better job in the future? – Is there are future for community banking?

• Can we grow effectively?

• Can we maintain efficiency?

• Can we compete?– With banks?

– With non-banks?

• Can we survive?


25

Develop a Framework (a Strategic Plan) andKnow Where You Are Going!

• Can you remain independent and profitable?

• Should you buy another bank? Another branch?

• Age of the Board of Directors

• Aging shareholder base / less loyalty

• Lack of management succession

• Lack of shareholder liquidity

• Had all the fun you can stand?

• Market window


26

• Capital is King– Stock Offerings

– Holding Company Leverage

– Must Find Most Productive Uses

• Internal Growth– Greater Volume

– New Products and Services

– New Locations

• External Growth (Geographic Expansion)– Proactive or Reactive?

– What should the footprint look like?

– Buy another Bank?

– Buy a Branch?

– Buy a Non-Bank Company?

• Controlling your own destiny– Strategy for addressing unsolicited offers

– Creative Options


27

• Reject Offer– Based on Detailed Financial and Legal Analysis

• Accept Offer– Breach of Fiduciary Duty

• Negotiate Offer– Puts Bank in Play

• Shop Around– Only Way to Determine Best Price

• Enhancing shareholder value – EPS and ROE Accretion; Appropriate return on investment

• Geographic diversity

• Product diversity

• Obtain good management

• CEO ego driven


28

• Consider a branch or LPO!

• Structure – Purchase and assumption

• Differences from a merger

• Valuation: same process as a cash acquisition –EPS accretion

• Cash

• Stock– Number of Shares

– Investment Quality

– Liquidity

– Tax Treatment

• Cash and Stock Mix


29

• Earnings Driven (Acquiror’s Dilution)

• Book Value Reliance

• Due Diligence

• Dividends

– Extraordinary?

– Timing of Payment

• Target’s After Tax Earnings

• + or - the After Tax Benefit or Acquisition Cost

• Lost Opportunity Income

• Loan Interest, if any

• Goodwill Amortization, if any

• Cost Savings

• Revenue Enhancements

• Net After Tax Post-Acquisition Earnings Accretion


30

• Difficult to Determine Value of Lightly Traded Stocks

• Question of Relative Value

• Determined by Contribution Analysis

– Income

– Assets

– Equity

• Getting the board ahead of the numbers

• Not conducting adequate due diligence

• Not considering social issues

• Failure to lock up key individuals

• Why buy it if you can steal it?

• Consider branching or LPO


31

• Pricing expectations beyond what the market will bear

• Not understanding how banks are valued

• Structuring a merger of equals

• Trying to do it yourself

• Take your eye off the shareholders

• Allowing politics to be played on the board

• Setting price expectations unrealistically as a means to turn down a deal

• Directors spending the money before they get it


32

Please contact us if we can be of service to you or your organization, or if yousimply have further questions where we may be of assistance.

Jeffrey C. Gerrish Philip K. Smith Greyon E. [email protected] [email protected] [email protected]


700 Colonial Road, Suite 200Memphis, Tennessee 38117Telephone: (901)-767-0900Facsimile: (901)-684-2339

Please visit our website at www.gerrish.com.Follow us on Twitter! @GST_Memphis

Jeffrey C. Gerrish, ChairmanPhilip K. Smith, PresidentGreyson E. Tuck, DirectorGerrish Smith Tuck, Consultants & Attorneys


January 17-18, 2019The Ritz-CarltonNaples, Florida

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The Bank Directors’ Bible: Commandments for Community Bank

Directors Now in its third edition, this 221 page book represents a compilation of the noted “Ten Commandments” articles published by Gerrish Smith Tuck over the years. Topics include Commandments for Bank Directors, Commandments for Enhancing Shareholder Value, Commandments for Strategic Planning, Commandments for Dealing with Regulators and other topics.

Gerrish’s Glossary for Bank Directors Now in its second edition, this is a 203-page dictionary of key words, acronyms and terms (and, in some cases, a slightly irreverent look at some of the terms) typically used by bank directors and executives. Examples of defined terms include: accrual, ALCO, dependency ratio, financial holding company, kiting, liquidity risk, OAEM, private placement and many others.

Gerrish’s Musings Gerrish’s Musings is designed for CEOs and board members of community banks. Gerrish’s Musings reflects our firm’s insights and experiences as we travel weekly visiting with community bank clients from coast to coast. The newsletter is delivered by e-mail twice a month to subscribers.

The Chairman’s Forum Newsletter The Chairman’s Forum Newsletter is designed specifically for Chairmen of the Board. The newsletter is the response to the overwhelming success of the Chairman’s Forum Conference hosted by Jeff Gerrish and Philip Smith twice yearly. The newsletter is published electronically each month governing topics unique to the changing role of the Chairman of the Board.

Price: $99.00 for first book $49.00 for each additional (plus applicable shipping and handling) $295.00 for “searchable PDF” for Board portals

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Please feel free to contact us at (901) 767-0900 if you require any further information or assistance. This form may be faxed to Gerrish Smith Tuck at (901) 684-2339, e-mailed to [email protected] or mailed to the mailing address

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_________ To ensure compliance with the requirements imposed by the U.S. Internal Revenue Service, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding tax-related penalties under the U.S. Internal Revenue Code or (2) promoting, marketing or recommending to another party any transaction or tax related matters addressed herein.

GERRISH'S MUSINGS

Jeffrey C. Gerrish Philip K. Smith

Greyson E. Tuck Gerrish Smith Tuck

Attorneys/Consultants 700 Colonial Road, Suite 200, Memphis, TN 38117 Phone: (901) 767-0900 Fax: (901) 684-2339

Email: [email protected] [email protected] [email protected] Website: www.gerrish.com

December 28, 2018, Volume 383

Dear Subscriber:

Greetings from Alabama, Georgia, Florida, Tennessee, Iowa, Minnesota, and Missouri!

GROWING PUBLIC

Musings readers may have noticed the title of this article and thought it was perhaps a

“misspeak.” The fact is, it really involves growing public, not going public. We have been involved

with several banks recently that have grown out of the Small Bank Holding Company Policy

Statement, notwithstanding the fact that the threshold was raised to $3 billion in assets as a result of the

recent regulatory relief legislation to $3 billion in assets. Once your consolidated organization is above

that $3 billion level, then your bank and holding company are consolidated for capital purposes, and

the Federal Reserve expects to see something in the consolidated capital ratio range between 5% and

6%. You can still leverage a large bank holding company to about 30% debt to equity and maintain an

appropriate consolidated capital ratio, but you cannot go much beyond that.

Several of the banks we have been with lately have grown or are about to grow through the

Small Bank Holding Company Policy Statement level. They have been nicely leveraging capital into

their banks to support balance sheet growth, do acquisitions, and the like, but that is going to be

changed up a little bit in the future. A couple of them are simply going to do Initial Public Offerings

and become very public all at once. Some of them are simply going to grow through the $3 billion

asset level and conduct private placements as a way to generate equity for the holding company and

cash for the subsidiary banks to support capital.

As most Musings readers know, we are not much in favor of community banks becoming

public, SEC-reporting bank holding companies unless they get some benefits out of it. These couple of

December 28, 2018 Copyright © 2018 Jeffrey C. Gerrish. All rights reserved. Page 2

clients we have been with recently will get the benefits of real access to the public capital markets and

real market liquidity for their shares (both will end up at more than 3,000 shareholders in their

companies). Those are good reasons to go public. If you can get the benefits of going public, then the

expense of doing so is likely worth it, particularly once you exceed that $3 billion level.

LONG-TERM PLANNING

As most Musings readers know (many of you met us this way), we facilitate a sizeable number

of community bank long-term planning sessions each year. We are glad to be able to have the

knowledge and national viewpoint to assist the boards and senior management of our community bank

client base around the country in setting the direction for their institution. We enjoy dealing with

opportunities that long-term planning involves.

We are being contacted and booked for planning sessions in 2019. If your board plans to use

one of us in 2019, we would be delighted to get you on the calendar. We do not want you to miss an

opportunity for us to facilitate your planning session, particularly if you have a fixed date.

Let us know.

THE MERGER AND ACQUISITION MARKET

As we approach the end of 2018, we thought it would be appropriate to take a backward look at

the community bank merger and acquisition market. The year started off very strong the first six

months or so, which was due in large part to the roaring economy and roaring stock market,

particularly as it related to bank stocks. This has not been the case the second half of the year. An

interesting dynamic has resulted. The large banks have become somewhat reluctant to pay for the

targets with their stock because prices are depressed. They are also, of course, reluctant to do cash

transactions if generating the cash requires a public offering at their depressed stock price. There are

still a number of smaller banks ($200 million and under) that are looking for purchasers. Virtually all

of those are cash deals. That cash has not really dried up at that deal level because most of the buyers

are community banks that are leveraging their holding company $10 million or $20 million and

generating the cash necessary to purchase the target. So the odd dynamic is that larger community

banks, between $400 million and $1 billion, that may be looking for cash transactions are sitting on the

sidelines because the larger banks that would pay them cash in a part-stock/part-cash deal are reluctant

to part with either the cash or the stock at what they view is a depressed price of their own stock. The

optimists in us suggest that this may reverse itself. We do not think it can come any time too soon.


We also anticipate the merger market for 2019, notwithstanding some of these downdrafts in

the economy and the stock market, will remain strong, particularly at the smaller community bank

level where there appear to still be lots of sellers and a good number of buyers as well.

2019 DE NOVO BANK PROGNOSTICATIONS

We recently received a call from a reporter for a daily banking publication asking for our

thoughts on de novo bank activity in 2019. If you remember back in the summer, we were getting

calls on an almost weekly basis from various groups interested in de novo bank charters. That interest

has cooled significantly. There are still some groups that are in pursuit of de novo charters, but the

level of interest has fallen off sharply.

We believe the cooling of the de novo market will likely continue through 2019 for a couple

reasons. First, the Democrats’ takeover of the House has decreased the chances of additional

significant regulatory relief in the near term. We do not believe a divided Congress is going to

produce a bank regulatory relief bill that provides some type of significant change in the regulatory

environment. Second, the recent volatility in the stock market, which has created a pretty big

downturn in bank stock pricing, has cooled interest.

Overall, we think 2019 will be much like 2018 in terms of de novo bank activity. We think we

will see some new banks open and some new charter applications filed, but we do not expect to see a

significant increase compared to the approximately 20 charter applications filed this year.

UNREALIZED SECURITIES LOSSES IN ACQUISITION PRICING

We recently received a question from a client regarding the treatment of unrealized losses on a

potential target bank’s Available-for-Sale Securities in an acquisition transaction. In this particular

instance the banker asking the question had received a marketing package for a bank that had decided

to solicit expressions of interest. The marketing package essentially provided that in pricing the

transaction the acquiring bank could not take into account the target bank’s unrealized losses on

Available-for-Sale Securities. In other words, those would be added back to equity for purposes of

determining transaction pricing and the like. The question was whether this was a standard approach

to transaction pricing.

In short, the answer to the question is no, this is not a standard approach to transaction pricing.

However, it is one that we are seeing with more frequency due to the rising interest rate environment.

As we have said in Musings a number of times previously, a target bank’s value is driven by

the earnings it provides to an acquirer, not its book value. However, many transactions are priced off


of book value. Whether the transaction includes or excludes the target bank’s loss on Available-for-

Sale Securities is really of little importance. If the losses are excluded such that equity is artificially

inflated, the offered purchase price premium simply comes down by some amount to offset that loss.

That is expressed either as a lower percentage of book value or in a lower absolute transaction

premium. Either way, the purchaser gets purchase price protection from the losses associated with that

group of assets.

ANNOUNCING ACQUISITION TRANSACTIONS

Several times recently the question has come up as to when it is appropriate to publicly

announce acquisition transactions, either to the target bank employees or the public at large. Over the

past several months, we have had several situations where we represent the community bank buyer

who has signed an indication of interest for the purchase of another community bank. In these cases,

the target community bank wanted to tell the bank employees about the transaction at the time of the

signing of the indication of interest. Our advice to our client could pretty succinctly be described as

“no.”

Acquisition transactions should not be publicly announced until the acquisition agreement for

the transaction is fully signed. This is the first point in the transaction where both parties are legally

committed to the deal. The transaction should not be publicly announced prior to this time because the

chances of the deal falling apart are higher prior to signing the actual agreement. A publicly

announced transaction that does not ultimately come together is not good for anyone involved,

particularly the selling institution.

If you are thinking of engaging in an acquisition transaction as either a buyer or seller, do not

jump the gun on the public announcement. There is simply too much risk for all involved in publicly

announcing it prior to the signing of the actual acquisition agreement.

A REAL HEAD SCRATCHER

We recently assisted a community bank in evaluating a potential acquisition transaction. The

potential target was a very small community bank in a very rural part of the country. It was also

significantly overcapitalized. We evaluated the transaction based on the target bank’s earnings and

“normalized” capital positions and assisted the client in drafting and submitting an indication of

interest for the transaction. Shortly after submitting the indication of interest, we spoke with the

advisor that was assisting the bank through the marketing process. The advisor told us we would not

be invited to perform due diligence because our bid was not high enough. We asked where we needed


to be to get to a point where we would be invited to do due diligence, and the advisor told us that we

needed to essentially be at two times book value. We were extremely surprised (to put it politely) at

this level of pricing. The target’s advisor indicated to us that he too was surprised at where the bids

ended up.

We see the level of pricing in this transaction as impossible to justify based on our experience.

The good thing is that our client was very willing to walk away from the deal. We had the discipline to

price the deal at a level that made sense for our community bank client. When we found out that was

not going to chin the bar, they did not make a bad decision and raise the price. Instead, they simply

walked away and decided to keep their powder dry for other acquisition opportunities. It was a great

decision for them.

CHAIRMAN’S FORUM

As most Musings readers know, we facilitate an annual (often twice-a-year) Chairman’s Forum

for community bank Chairmen, lead directors, CEOs, and other outside director types. The next

Chairman’s Forum will be in Naples, Florida (sunny and warm) on January 17-18, 2019. For

additional information you may visit the following link:

https://barret.ws/landing/chairman/

The Forum is being sponsored by Barret School of Banking and the ICBA. There are still a

couple of slots left for participants in the Forum.

CONCLUSION

We all hope all Musings readers and your families had a wonderful Christmas and are looking

forward to a great New Year. We wish all of you the best. As we noted, Musings is being published

today because “Musings never sleeps.” Thank you for your interest and your business this year. We

wish all of you a happy and safe New Year!

See you in two weeks.

Jeff Gerrish Philip Smith Greyson Tuck

Copyright © 2018 – Philip K Smith Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, Gerrish Smith Tuck would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.

Opening the door to new ideas Gerrish Smith Tuck, Consultants and Attorneys

December 2018

We hope this newsletter finds you in a condition of having survived

Christmas and in anticipation of closing out 2018 and looking forward to a positive

2019! During this sometimes “interesting” week between Christmas and New

Year’s, there often is either a huge rush to get things done by year-end, a lot of

pressure to close out things or to finally finish things you had started or sometimes

it’s a bit of a casual week to get the body, mind and spirit ready for the coming

new year. We trust that you find a comfortable balance between those two

extremes.

As we reflect on 2018, we hit a couple of key issues that have developed

throughout the year to reemphasize those and point toward some new ideas and

initiatives for 2019. It is our honor to have you read our materials and for many of

you we appreciate your business this past year and look forward to seeing many

others of you at the upcoming Chairman’s Forum in Naples, Florida. Let’s all

make 2019 a wonderful year!

Happy Reading!

Gerrish Smith Tuck 700 Colonial Road, Suite 200

Memphis, TN 38117 Phone (901) 767-0900

www.gerrish.com

The

Newsletter

Jeffrey C. Gerrish Philip K. Smith Greyson E. Tuck

Gerrish Smith Tuck Page 1

Opening the door to new ideas Gerrish Smith Tuck, Consultants and Attorneys

December 2018

Chairman’s Summary

♦ Are you going “far enough” on M&A?

♦ Should we add a __________ to the Board?

♦ Be aware of forward-looking supervision.

♦ Do you separate the role of Chairman of the Board from CEO?

Are You Going “Far Enough” on M&A? At a recent strategic planning session, a Chairman of the Board

somewhat wondered out loud “Are we going far enough on M&A?” When I

asked him to explain a little bit of his thoughts on that comment, he

referenced the fact that throughout 2018 and really even in the prior year his

organization had been well positioned to pursue growth through

acquisitions. The Chairman indicated that, not only had they been well

positioned, but they had let it be known that they wanted to be a buyer, they

had received contact from a few banks and some individuals marketing

banks for sale, and had even taken some of the preliminary steps to review

marketing packages of a selling bank and conduct some due diligence.

When we suggested that it seemed as though they were on the right

track and heading in the right direction, his comment was that they did not

think so because they were highly disappointed that they never seemed

The

Newsletter


to get past those preliminary stages. Even though they had submitted Letters

of Intent on a couple of potential transactions, they never got a call back,

were never invited to conduct extensive due diligence and no one ever

pursued serious negotiations with them. So, the Chairman’s concern in

asking if they had gone “far enough” was to ask if, in terms of structure and

pricing, they were not doing enough. In essence, were they trying to price

the deals too modestly, were they not willing to give the sellers key things

the sellers might need or desire (such as retaining certain employees,

keeping the charter, etc.)? Now, without knowing more, you cannot really

say in the abstract that the organization, the board or the Chairman in

particular were not going “far enough”. But it was our opinion that the

Chairman’s comment pointed out a flaw in their M&A process that we often

see among community banks. That flaw is not adhering to the principle that

we often espouse which is to be willing to pay for value added.

For example, if we can demonstrate that paying a certain price for a

target bank will improve your earnings per share and return on equity over

the next five to seven years beyond what you can produce without doing the

transaction, does it matter that the proposed acquisition price is something

that “sounds” excessive such as two times book value? We often hear

Chairmen and other board members make comments to the effect that “we

are not going to pay anybody two times book value”. Why? If it is going to

produce more positive economic benefits for your organization than not

doing the deal, what difference does it really make? Our guess is that it is

the fear that you are overpaying and that no one else is paying that great of a

price. However, like this organization, if you find you are always coming up


short and never getting the invite to actually be the purchaser, then realize

that these other organizations are willing to price up deals in a way that truly

gives the seller great economic value, but also produces positive returns for

the buyer. So, make sure you are “going far enough” in your financial

analysis and your willingness to pay what the market will bear.

Should We Add a __________ to the Board? Go ahead, fill in the blank above. Our guess is that at some point

during the past year, there may have been discussions around this topic. We

have had boards of all different sizes in all parts of the country ask us this

question in one form or another and the answer to fill in the blank varies

from bank to bank. Historically, we have been asked questions such as

whether the board needs to add a female to the board, or add a minority to

the board, or add another insider or outsider to the board. The list could go

on and on. Most recently, we were asked by a Chairman whether the

organization should consider adding a millennial to the board.

So, you can see that it is a bit of a universal struggle on finding the

right composition for your Board of Directors. Interestingly, in many of

those circumstances, our answer when asked the question is “No”. What we

mean is that you should not put someone on the board just because they

check a box related to gender, race, age, occupation, stock ownership, etc.

Rather, what you need to do is add board members who meet whatever

needs you have for the organization and find the best person that

accomplishes that regardless of what label they may wear. So, for example,

if you are needing someone with more financial background, a CPA or


someone like that to serve on your board, find the best possible candidate

regardless of labels. If you do the search and that turns out to be a female

minority in your market who could also serve as a great source of referrals to

your organization, then great! If you truly want to begin a new push toward

technology that you have never done and begin a marketing process to

attract millennials to your bank, then certainly it might make sense to add a

person of the millennial age group to your board. While our Boards of

Directors are becoming more diverse in terms of age, gender, race, and other

elements that promote diversity, that is happening by necessity because our

boards are becoming more reflective of our communities and our customers.

Take that approach toward populating your boards, not merely trying to

meet some preconceived quota. But if you look around the room and you

meet the old adage that your entire board is male, stale, pale and frail, it is

probably time to consider a change for 2019.

Be Aware of Forward-Looking Supervision Many of you may be aware of what we would describe as a “shift” in

regulatory emphasis. Historically, our boards have been trained to the

regulatory focus of examining your bank as a “snapshot in time” as of a

particular date. So, for example, a group of examiners might walk into your

bank today and review your bank as of December 1, 2018 using financial

data as of September 30, 2018. On that basis, it becomes a “snapshot in

time” of how you looked on those relevant dates and to then give the board

and management constructive criticism (ha ha) on concerns for the

organization.


But, as Chairmen, you should be aware of a significant shift in how

examiners conduct their examinations. What we are beginning to see is

more of a movement away from the “snapshot in time” theory and a focus

on “forward-looking” supervision. By this, we are hearing the regulatory

agencies tell boards to stop merely focusing on the “rearview mirror” and

rather begin to look “over the dashboard” to begin anticipating the next

issues coming for the board and organization. In doing so, we are beginning

to see regulators criticize banks not for how they are operating in the current

environment, but for perceived weaknesses that the regulators think may

happen if a certain set of circumstances perhaps could unfold sometime in

the future given some things that may or may not happen economically,

regulatory-wise, interest rate-wise, etc. So, yes, you are now not only

charged with governing the organization, but you must be a bit of a fortune

teller as well and anticipate what is coming down the road and start

preparing for it now.

So, make sure your board is aware that their primary job is no longer

historically reviewing what just happened the past quarter, but it needs to

begin to be more forward focused on the coming quarter and what is likely

to happen. Take this simple example, is your board more concerned about

loans that are 30 days past due or are they more concerned about what loans

might go on the watchlist in the future if economic circumstances change?

In today’s environment, they must be focused equally on both scenarios.


Do You Separate the Role of Chairman of the Board From the CEO?

We have hit on this topic a number of times by questioning whether

the roles of the Chairman of the Board and the CEO ought to be separated.

The reason this keeps coming up is because in various forms around the

country you are beginning to see organizations take adamant stands that the

role of the Chairman of the Board and the CEO should be split. Then, you

will read a follow-up article from two other companies that say under no

circumstances should those roles be separate and rather they should be

combined. Recently, this issue has raised its head again.

It was reported that Regions Financial, a large regional financial

holding company, had separated the roles of the Chairman of the Board and

Chief Executive Officer for the first time in five years. With the roles of

Chairman of the Board and CEO combined, the organization had properly

selected an individual to serve as the “lead independent director” which is a

structure we recommend if the roles are combined. In this circumstance,

that individual who was the lead independent director (apart from the

Chairman/CEO) has now been elected as Chairman of the Board separate

from a recently elected CEO. Somewhat interestingly, these moves were

made under the heading of “succession planning” and it seems that this

particular organization has a history of sometimes having combined roles

and sometimes having separate roles. In fact, the organization went out of

its way to explain that splitting the roles of the Chairman from the CEO was

not the result of a shareholder proposal, meaning that there was not some

type of corporate governance push to accomplish this. Rather, the


company’s statement indicated that the decisions regarding the board

leadership structure were “the responsibility of the Nominating and

Governance Committee of the Board”.

So, different organizations continue to take different approaches and

some organizations, like this one, may alternate between having the roles

combined or separated depending on the individuals to serve succession

planning needs, etc. There is no one correct answer. Do what is best for

your organization, but if the roles are combined, a lead independent director

should be appointed in most circumstances.

Meeting Adjourned We are happy to report that the Chairman’s Forum in Naples, Florida

in January is practically a sell-out. We believe there may still be a few spots

available for registration, but we were recently advised that the hotel room

block had been filled. However, at the time of preparing this newsletter, we

received notification of a couple of rooms coming open, so if you still have

an interest in attending you may follow this link and you may be able to find

a few last minute rooms and registration. Otherwise, we can put you on a

waiting list. If you would like to attend, but are having trouble with hotel

information, please contact us directly and we can provide you some

alternative locations or try to help you in other ways.


For those of you unable to attend, we will post an update on some of

the discussions in an upcoming newsletter.


Copyright © 2018 – Philip K Smith Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, Gerrish Smith Tuck would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.


We thank you for subscribing to this newsletter and we appreciate the

many comments we receive throughout the year regarding its form and

content. We hope it is useful to you in creating value for your organization

and we wish all of you a happy and prosperous new year.

Until next time,

Gerrish Smith Tuck 700 Colonial Road, Suite 200

Memphis, TN 38117 Phone (901) 767-0900

www.gerrish.com

HOW TO CONTACT US: If you have questions or comments about the newsletter or would like to ask a follow-up question,

please email Philip Smith at [email protected].

Jeffrey C. Gerrish Philip K. Smith Greyson E. Tuck

mailto:[email protected]

GERRISH SMITH TUCK

[email protected] Consultants & Attorneys to Community Banks Nationwide www.gerrish.com

Succession Planning for the Future

GERRISH SMITH TUCKTHE CLIENT’S NEEDS COME FIRST

Consultants and Attorneys

if you want to keep your bank an independentcommunity bank, you must proactively addressmanagement succession, particularly as it relates to thebank’s Chief Executive Officer.Planning For SuccessionUnfortunately, succession planning is not somethingthat simply falls into place. It generally requires planningover a period of years. Given its importance, how doyou plan for succession? The reality is most boards ofdirectors do not have experience in finding a new CEOto lead the organization. That being the case, thisarticle offers a few practical tips.At the CEO level, succession planning generally occursin two scenarios. The first scenario is the short-term,immediate—“What happens if the CEO cannot comeinto work the next day for a prolonged period of time?”The second scenario is the long-term, typicallyretirement—“Who is going to run the bank when theCEO retires?” Under each scenario, the process shouldstart with identifying the CEO’s current expectedtimeframe for retirement. Ideally, the board will haveat least 24 months’ notice of when the CEO intends tostep down; otherwise, the “short-term” and “long-term”scenarios noted above are practically the same.The more difficult step in the process is identifying whowill replace the CEO. For banks that have been able to

(cont’d on pg. 2)

There is a saying that “lessons in life will be repeateduntil they are learned.” Regardless of the underpinningsor original context of the thought, our firm believesthis saying holds true for the current community bankingenvironment. Over the past decade, the bankingindustry has been through a number of phases—stagesof adaptation and change—and each phase has been areminder of one thing: management succession isabsolutely critical to the long-term viability of everycommunity bank. Regardless of external environmentor internal operations, a failure to plan for managementsuccession is guaranteed to result in the eventual saleof an independent community bank.This fact is evident if you consider the various phasesof the community banking industry over the past tenor so years. In the economic recession, many communitybanks were looking for individuals to right the ship.Otherwise, the sharp decline in the economy, assetquality, and regulatory relations were going to lead tofailure. Once merger and acquisition activity pickedback up, it was (and still is) all too common to seecommunity banks resolving to sell simply because thereis no one to lead the bank in the future as an independentorganization. Those institutions that weathered thestorm and remained independent are now looking tofine-tune operations and improve efficiency in order tokeep the bank viable over the long term. Even for thoseinstitutions, the “What happens if…” questions areinevitable in good planning. The bottom line is this:

Volume 2018 No. 1 - 2 - Gerrish Smith Tuck

groom a successor internally, the transition will likelybe much smoother. Looking outside for a successorhas pros and cons, but it is almost universally lessstreamlined than having a good in-house candidate. Youwill almost certainly need adequate notice, as notedabove. Which option is best for your bank depends onnumerous factors. In either case, the board needs toidentify what specific traits it is looking for in thesuccessor. Most boards with quality CEOs have anideal of finding an individual with the exact samepersonality, skill set, etc. as the current CEO. In reality,that is impossible, which means the board needs tobegin having new conversations. The process will notbe identical for every community bank, but there are afew universal guidelines.First, look for individuals that have experience running(or nearly running, such as Chief Operating Officer orsomething similar) a similar-sized or larger communitybank. The CEO position is not one that should be atraining ground for incoming personnel, regardless ofwhether they are internal or external. The CEO is theindividual who is going to run the bank for theforeseeable future. Because of that, whoever comes into take over the existing CEO slot needs to havesomething similar to CEO experience, either at anotherbank or in your own community bank.Second, look for an individual with a personabledemeanor and that is capable of having good boardrelations. Whether the CEO is also going to beChairman is a separate issue, but assuming for purposesof discussion that the CEO is not going to be theChairman, then the new CEO is going to have to liaisonwith the Chairman and the rest of the board andmaintain good board relations in the process. A

combative CEO (of which our firm has seen many)only causes long-term harm.Third, the incoming CEO needs to be capable of lead-ing the organization. Oftentimes a Chief Lender orChief Financial Officer who may have been numbertwo or three in the bank will be promoted into the CEOposition even though they have failed to exhibit appro-priate leadership in their current position. While lead-ership can be taught to a certain extent, it is, in manyways, an inherent trait that causes individuals to will-ingly follow the direction of the leader, as opposed tobeing intimidated into following him or her. This canbe difficult to identify in a vacuum, which is why it isimportant to look to the individual’s prior experience.Fourth, consider the candidate’s business developmentpotential. In most circumstances, the CEO should bethe primary cheerleader for the bank and be the primarybusiness developer or “face” of the bank in thecommunity. Some banks have an individual other thanthe CEO who fills that role. If you bring in an outsidethird party as CEO, however, part of the job descriptionneeds to be to get plugged into the community. It isimportant for boards of directors to realize that thismay take a period of years. It will not happen overnight.Regardless, you need to make sure that the potential isthere before you commit.Fifth and finally, consider whether the incoming CEOshould also be Chairman. There has been a lot of inkspent on whether the CEO and the Chairman positionsshould be filled by the same person. For the majorityof community banks in the country, the CEO and theChairman are the same person. That often changes,however, when the existing CEO retires into anExecutive Chairman position. There is nothing wrongwith that except you need to make sure the incomingCEO has sufficient latitude and authority to serve asCEO, notwithstanding the fact the former CEO is stillon the Board and involved in the bank as Executive

(cont’d on pg. 3)

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ProposedSubchapter S Legislation

Chairman. A separation of duties and a detaileddescription of duties needs to occur to make sure thishappens. It can work, but it requires planning and cleardelineation of roles.Ideally, every community bank would have both writtenlong-term and short-term management succession plansthat identify successors, set forth the search andtransition process, and provide for regular evaluationand adjustments. In reality, most boards of directorshave not taken the time to plan to such an extent. Thatlack of planning does not, however, mitigate theseriousness of the issue. As noted above, CEOsuccession is critical to remaining an independentcommunity bank. If your bank made it through therecession and has survived the wave of industryconsolidation, then your leadership deserves accolades.Be aware, however, that the time will come when yourcommunity bank will be in need of new leadership. Itis not a matter of “if.” It is a matter of “when.” Theboard and the existing CEO of the community bankneed to approach the matter seriously and methodically.We have assisted numerous banks in working throughCEO succession planning as well as succession planningissues for other members of management and the boardof directors. Let us know if we can help.

Since the early 2000s, approximately one-third of thecommunity banks and holding companies in the countryhave operated as Subchapter S companies. Theelimination of double taxation and the increase in basisin the company’s shares associated with the SubchapterS election have benefitted tens of thousands of bankshareholders since the Subchapter S rules were relaxedin 2004. The benefits of the Subchapter S election,however, have recently been called into question bynew tax legislation, which decreased the top corporatefederal income tax rate to 21 percent and the topindividual federal income tax rate to 37 percent. Whilethe legislation is by no means simple or clear as it relatesto taxation of Subchapter S shareholders, it is our firm’scontinued position that Subchapter S status is the mostefficient means of getting company earnings into thehands of shareholders notwithstanding the newcorporate and individual federal rates.The Benefits of Subchapter SBefore discussing the impact of the new tax law onSubchapter S community banks, it is important tounderstand why Subchapter S has been a preferredorganizational structure for community banks. Asreferenced above, the main attraction of S corporationstatus is the income tax savings received by thecorporation and its shareholders. C corporations payincome tax at the corporate level on their earnings, and,if the corporation pays dividends to its shareholders,the shareholders pay tax on those dividends, resultingin “double taxation.” S corporations, on the other hand,generally are not subject to federal income tax at thecorporate level; rather, it is only the shareholders whopay tax on the earnings of the corporation. Corporate

(cont’d on pg. 4)

The Future of Subchapter S forCommunity Banks

GERRISH SMITH TUCKDIRECTOR TRAINING MATERIALS

Philip Smith of Gerrish Smith Tuck, in coordina-tion with the Independent Community Bankers ofAmerica (ICBA) Community Banker University,has written and produced a three-DVD series fordirector training that discusses relevant issues suchas strategic planning, mergers and acquisitions, andcompliance. To order your copy of the DVD se-ries, please contact Carolyn Martin [email protected].


income, loss, deductions and credits are passed throughthe corporation directly to the shareholders, who reporta pro-rata share of income (or loss) on their personaltax returns and pay taxes on this income at theirindividual income tax rate. The shareholders’ basis inthe company’s stock is then increased by the amountof earnings on which the shareholders paid taxes butwhich were not distributed to the shareholders.To alleviate the additional tax liability shouldered byshareholders as a result of the Subchapter S election,the S corporation typically pays “tax equivalent”distributions to the shareholders. The “tax equivalent”distributions are intended to provide the shareholderswith cash to cover their individual tax liabilities as aresult of the organization’s income passing through tothe shareholders. Usually, the organization assumeseach shareholder is taxed at the highest federal taxbracket, which results in substantial cash flow to thoseshareholders in the lower tax brackets.In addition to the “tax equivalent” distribution, most Scorporations also pay a “dividend equivalent”distribution, which is simply the amount that would havebeen paid to the shareholders as a dividend from theholding company had it never elected Subchapter Sstatus. This amount, like a C corporation dividend, is areturn of corporate profits and provides after-tax cashflow on the investment. As a result of thesedistributions, the shareholder receives more than enoughfunds to pay his or her tax liability plus the amount heor she would have received as a C corporationshareholder, with no further tax. Because all earningsare taxed, any distribution of retained earnings by thecompany in the future is not subject to additionaltaxation at the shareholder level.In addition, the shareholders’ basis in the company’sstock increases as earnings are taxed but not distributed.Accordingly, if the company sells or if a shareholdersells his or her stock, the shareholder receives apotentially significant tax benefit related to the sale.

With these benefits in mind, in order for the new taxlegislation to make C corporation status more attractiveto community banks, it would have to reduce Ccorporation taxes to such an extent that being subjectto double taxation with respect to dividends (andultimately all retained earnings) is less costly toshareholders than paying taxes on S corporationearnings at their individual federal income tax rates.The New Tax LawAs of late December 2017, Congress passed andPresident Trump signed into law the Tax Cuts and Jobs

EDITORIAL STAFFEDITORS IN CHIEF: Jeffrey C. Gerrish

Philip K. SmithEDITORS: Jennifer J. Chase

Valerie G. WiltCONTRIBUTING EDITORS: Greyson E. Tuck

Jason G. McCuistion

This publication is distributed with theunderstanding that the author, publisher,distributor, and editors are not rendering legal,consulting, accounting, or other professionaladvice or opinions on specific facts or mattersand, accordingly, assume no liability whatsoeverin connection with its use.Please address comments or questions regardingthe newsletter to Jeffrey C. Gerrish, GerrishSmith Tuck, PC, 700 Colonial Road, Suite 200,Memphis, TN 38117, (901) 767-0900, or to theemail address: [email protected].

Gerrish Smith Tuck NewsletterVolume 2018 No. 1

Copyright @ 2018 Gerrish Smith Tuck, PC


Act of 2017. This legislation made significant changesto individual and business taxes. For purposes of thisarticle, the most significant of these changes were thereduction of the marginal individual federal income taxrates, the reduction of the top marginal federal incometax rate applicable to C corporations from 35 percentto 21 percent, and the introduction of a 20 percentdeduction to certain income paid by shareholders ofpass-through entities, such as Subchapter Scorporations. The reduction in individual marginal ratesis straightforward. In addition to reducing some of themid-tier tax rates, the top marginal rate was decreasedfrom 39.6 percent to 37 percent, exclusive of the 3.8percent Medicare surtax.The reduction in the C corporation tax rate is alsostraightforward. Whereas a C corporation would havepaid up to 35 cents in federal income taxes on everydollar of income in tax year 2017, that same Ccorporation will only pay up to 21 cents in federal incometaxes on every dollar of income in tax year 2018.

Unfortunately, the Tax Cuts and Jobs Act has createdsome confusion as it relates to taxation of Scorporations. Under the new tax legislation, theshareholders of Subchapter S corporations will be ableto deduct 20 percent of the Subchapter S corporation’sbusiness income before applying their individual tax ratefor federal purposes. This deduction, however, issubject to certain limitations. One such limitation existsif 20 percent of the S corporation’s net income exceeds50 percent of the S corporation’s W-2 wages. If that isthe case, then the ability to deduct 20 percent of the Scorporation’s net income would be phased out past acertain income tax threshold.Fortunately, the reality of community bankingoperations makes this limitation inapplicable to mostcommunity banks. Community banks thrive on theirrelationship model of banking. It is a high-touchindustry that lives and dies by the individual employeesthat provide products and services to customers acrossthe nation. As a result, salaries and benefits are oftenone of the highest expenses (other than interest ondeposits) on most community banks’ incomestatements. In many cases, salary and benefits expensesexceed bottom line net income. Accordingly, in mostcases, 50 percent of a community bank’s W-2 wageswill exceed 20 percent of its net income. Under suchcircumstances, the risk of phase-out of the 20 percentas a result of the W-2 wages limitation is low for mostcommunity banks.A second limitation exists if the income is attributableto a “specified service or trade or business,” which isdefined by Code Section 1202(e)(3)(A) as “any tradeor business involving the performance of services inthe fields of health, law, accounting, actuarial science,performing arts, consulting, athletics, financial services,brokerage services or any trade or business where theprincipal asset of such trade or business is the reputationor skill of one or more of its employees.” Thus, if abank is found to be in any of these categories—notably

(cont’d on pg. 6)

On March 1, 2018, Gerrish Smith Tuck celebratedits 30th Anniversary. During those years, ourconsulting and law firms have worked with over2,000 community banks in every state in thenation. Thank you to all our clients for trustingus to assist your institutions with everything frommergers and acquisitions and financial advisoryservices to strategic planning and regulatory issues.Community banks are the reason our firms exist,and we will strive to continue to serve you wellinto the future. Here’s to another 30 years!


tax regime under the Tax Cuts and Jobs Act to eliminatethe benefits of Subchapter S status for communitybanks. Under the new tax regime, Subchapter S statusremains the best vehicle for virtually every communitybank to enhance value for its shareholders.Notwithstanding the drop in the corporate tax rate from35 percent to 21 percent, C corporation net incomeremains subject to double taxation. The first level oftax will continue to be on the corporation itself, simplyat a lower rate of 21 percent. The second level of taxwill continue to be charged to the shareholders whencorporate earnings are actually distributed to theshareholders through dividends.A Subchapter S election will continue to eliminate thefirst level of federal taxation on corporate earnings, andit will also alleviate some of the tax burden associatedwith a sale of stock in the future. While the reductionin the top marginal C corporation tax rate is significant,it is not significant enough to offset the benefits of

(cont’d pg. 7)

the financial services category—then the 20 percentdeduction would be phased out based on the individualshareholders’ respective levels of income.Based on the language of applicable statutes, it doesnot appear that banks should fall within the definitionof a “specified service or trade or business.” The TaxCuts and Jobs Act indicates a “specified service or tradeor business” only to mean those activities specificallydescribed in Code Section 1202(e)(3)(A). Importantly,whereas Code Section 1202(e)(3)(A) specifically lists“financial services,” Code Section 1202(e)(3)(B)specifically references the business of banking. In otherwords, the statutory provisions identify the bankingbusiness as distinct from the “financial services”business. Since banking is not listed in Code Section1202(e)(3)(A), but is instead referenced in Section1202(e)(3)(B), our firm does not interpret the applicablesections of the new tax legislation to include bankingas a “specified service trade or business.”This distinction, though nuanced, is important becausethe new legislation’s phase-out provisions appear to onlybe applicable to income created from a specified serviceor trade or business. If banking is considered to be atype of financial services, then the 20 percentdeduction would be phased out for shareholders withincome above a certain amount. As it stands, however,Subchapter S community banks should be able to takeadvantage of the full deduction, which is consistentwith the position of both national trade associations.As noted above, this is a complex issue that our firm expectswill continue to evolve as the rule-making process for the newtax regime moves forward. Given the complexity of this issue,our firm recommends you discuss the issue with your accountantto determine the exact effects of the Tax Cuts and Jobs Act onyour organization.The Takeaway on Subchapter S Community BanksAs noted above, our firm does not anticipate the new

GERRISH SMITH TUCKAFFILIATED RESOURCESOver the last 30 years of exclusively helpingcommunity banks across the nation, we havedeveloped relationships with various serviceproviders who we believe provide the bestservices in their particular niche. This includesbank branch location specialists, IPO managers,securities transfer agents, loan review specialists,auditors, bank technology specialists, executiveplacement firms, and the like.If you need any of these services, or others, andare not sure who to call, please let me know andwe will provide some recommendations.

Jeff Gerrish [email protected]


tax liability of the C corporation and $150,000 capitalgains tax liability of the C corporation shareholders, itis important to remember that all $5 million ofSubchapter S earnings have now been taxed. Thus, theSubchapter S company can now distribute any or all ofits earnings to its shareholders without any additionaltax liability. If the C corporation were to dividend its$3,200,000 in retained earnings, the total capital gainstax liability of the C corporation shareholder wouldincrease by $640,000—effectively an aggregateeffective tax rate of 36.8 percent on the C corporation’s$5 million in earnings, compared to an effective tax rateof 29.6 percent on the S corporation’s $5 million inearnings (exclusive of any Medicare surtax). This doesnot even take into account any increase in basis in theS corporation shareholders’ stock, which reduces thetax liability if a shareholder sells its shares or if thecorporation sells to another entity in the future.Since passage of the Tax Cuts and Jobs Act, our firmhas assisted a number of community banks in analyzingwhether to continue as a Subchapter S corporationunder the new law. Without exception, the analyseshave shown that Subchapter S status remains favorable,not only in regard to current tax liability, but also inregard to the impact on the shareholders’ basis in thestock. While it may appear that the “lower” tax rate onC corporation earnings is preferable, Subchapter S statusremains the preferred means of getting corporateearnings ultimately into the hands of the shareholders.

Subchapter S status for community banks able to takeadvantage of the new law’s 20 percent deduction.As an example, assume a C corporation with net incomebefore taxes of $5 million would pay up to $1,050,000in federal corporate income tax. If the C corporationthen declares dividends of $750,000, the shareholderswould pay capital gains tax of up to $150,000 on thatamount (assuming a capital gains rate of 20 percent).The remaining $3,200,000 in corporate retained earningswill also be taxed if it is ever distributed to shareholders.If a shareholder decides to sell its shares of the Ccorporation stock in the future, or if the corporation isacquired by another entity, the shareholder will be taxedon the difference between the sale price and theshareholder’s basis in the stock at the capital gains rate.On the other hand, shareholders of an S corporationwith $5 million in earnings would have federal incometax liability of up to $1,480,000 ($5 million, less the 20percent deduction, times 37 percent), assuming that allshareholders are taxed at the highest marginal federalrate of 37 percent. While this exceeds the $1,050,000

RESOURCE MATERIALS

Several members of Gerrish Smith Tuck,Consultants and Attorneys, facilitate strategicplanning sessions for community banks all overthe nation. Now is the perfect time to scheduleyour 2018 planning session. If you would likeGerrish Smith Tuck to facilitate your next strate-gic planning retreat, please contact Jeff Gerrishat (901) 767-0900 or [email protected].

SCHEDULE YOURSTRATEGIC PLANNING NOW

The Chairman’s Forum Newsletter and Gerrish’sMusings are complimentary email newslettersprepared and distributed by Gerrish Smith Tuck.The Chairman’s Forum Newsletter, distributedmonthly, is exclusively designed for communitybank Chairmen, Vice Chairmen, and senior di-rectors. Gerrish’s Musings, distributed twice permonth, contains practical commentary for com-munity bank directors and officers based on JeffGerrish’s and Greyson Tuck’s experiences withcommunity banks around the nation.If you would like to receive either of these com-plimentary newsletters, please contact ValerieWilt at (901) 684-2310 or [email protected].

THE CHAIRMAN’S FORUMNEWSLETTER AND

GERRISH’S MUSINGS


Gerrish Smith Tuck has created numerous Memos toClients and Friends on various topics (available freeof charge). Set forth below are sample Memos toClients and Friends:Acquisitions

· Responding to Unsolicited Offers· Treatment of Transaction Expenses

Employee Benefit Issues· Incentive Compensation Plans· Taking a Fresh Look at ESOPs· Key Employment Contract Provisions Utilized

by Community BanksRaising and Allocating Capital

· Raising Capital Without Registering with theSEC

· Stock Repurchase Plans· The Continuing Benefits of a Community Bank

Holding CompanyRegulatory

· Qualified Mortgage Rule· Civil Money Penalty Process· Basel III’s Capital Conservation Buffer

Subchapter S· Subchapter S Taxation Under the New Tax Bill· Use of S Corporations by Financial Institutions· Eligible Subchapter S Shareholders

Miscellaneous· Loan Production Offices· Efficient Conduct of Board Meetings· Enterprise Risk Management· Legal Entity Identifiers· Growth Over $500 Million / $1 Billion

Gerrish Smith Tuck, in connection with variousspeaking engagements around the country, hascreated high quality “handout” booklets. Thepublications below are available for a nominal charge:

Asking the Right M&A QuestionsLooking Beyond the Past: A New Direction for

Community BanksDirector Duties: Creating Value for the OrganizationCorporate GovernanceDirectors’ Responsibilities in Mergers & Acquisitions:

Responding to the Unsolicited OfferHow to Improve the Value of Your BankWhat’s Next – Back to Basics and Back to the FutureEnhancing Shareholder Value – With or Without SaleCommon Mistakes in the New M&A MarketCommunity Bank Survival Guide – Strategies for a

Changing EnvironmentThe Community Bank’s Guide to Mergers and Acqui-

sitionsIs a Holding Company in Your Bank’s Future?New Truths About Directors, Shareholders and

Regulators (Including Compliance)The Community Bank Survival Guide: How to Sur-

vive and ThriveThe Pros and Cons of Converting to Subchapter SStrategic Planning: Don’t Make Me Do It!Understanding the Director’s Role

If you are interested in any of these memos or publications, please call or email ValerieWilt at (901) 684-2310 or [email protected].

Please visit our website at: www.gerrish.com

RESOURCE MATERIALS


AREAS OF SERVICEGerrish Smith Tuck, LLC, Consultants and Gerrish SmithTuck, PC, Attorneys are committed to thedelivery of the highest quality, timely and most effectiveconsulting and legal services exclusively to communityfinancial institutions in the following areas:

FINANCIAL ADVISORY/ CONSULTING SERVICESAcquisition Financial Analysis

Fairness OpinionsTransaction Pricing Analysis

Capital PlanningSubchapter S Financial Modeling

Directors’ LiabilityMergers and AcquisitionsExecutive Compensation

Acquisition PricingEmployee Benefits

Bank/Stock Valuation AnalysisEstate Planning

Strategic PlanningNew Bank Formations

Tax PlanningGoing Private

Subchapter S CorporationsExpert Witness

LEGAL SERVICES

CUSTOM DIRECTORPROGRAMS & PRESENTATIONSIn addition to facilitating numerous strategic planningretreats and proprietary director and officer trainingsessions, Gerrish Smith Tuck also has recently pro-vided speakers for the following tradeassociations on a wide variety of topics:

• Alabama Bankers Association• American Bankers Association• Arkansas Community Bankers• Arizona Bankers Association• Bank Holding Company Association• California Bankers Association• Community Bankers Association of Georgia• Community Bankers Association of Illinois• Community Bankers of Iowa• Community Bankers of West Virginia• Independent Bankers of Colorado• Independent Community Bankers of America• Independent Community Banks of North Dakota• Independent Community Banks of South Dakota• Indiana Bankers Association• Iowa Independent Bankers• Maine Bankers Association• Michigan Association of Community Bankers• Montana Independent Bankers• Nebraska Independent Community Bankers• Pennsylvania Association of Community

Bankers• Pennsylvania Bankers Association• South Carolina Bankers Directors College• Tennessee Bankers Association• Virginia Association of Community Banks• Washington Bankers Association• Western Independent Bankers

Please email us or visit our website atwww.gerrish.com for a complete listing of upcomingconferences and seminars at which we will be speak-ing. Gerrish Smith Tuck is also available to facilitatestrategic planning retreats and proprietary training de-signed for your Board of Directors.

Mergers and AcquisitionsESOPs

Dealing with the RegulatorsSecurities Offerings

Going PrivateDirector and Officer LiabilityPrivate Securities Placements

Fair LendingSubchapter S FormationsExecutive Compensation

Holding Company FormationsFederal and State Taxation

New Bank FormationsGeneral Corporate & Securities

Regulatory Enforcement ActionsProbate

Employee BenefitsEstate Planning for Executives


Commercial Bancgroup, Inc.Bank Holding Company for

Harrogate, Tennessee

has acquired

Citizens Bancorp, Inc.Bank Holding Company for

New Tazewell, Tennessee

Gerrish Smith Tuck, Consultants andAttorneys, served as financial and legaladvisors to Citizens Bancorp, Inc. andCitizens Bank.

First Holding Company ofCavalier, Inc.Bank Holding Company for

Cavalier, North Dakotahas acquired

Mahnomen Bancshares, Inc.Bank Holding Company for

Mahnomen, MinnesotaGerrish Smith Tuck, Consultants andAttorneys, served as financial and legaladvisors to Mahnomen Bancshares, Inc. andFirst National Bank of Mahnomen.

Recent Transactions

To discuss your institution’s strategic transaction opportunities, please contact Jeff Gerrish [email protected], Philip Smith at [email protected], or Greyson Tuck at [email protected].

Mineral Point, Missouri

has acquired three branch offices from

Creve Coeur, Missouri

Gerrish Smith Tuck, Consultants andAttorneys, served as financial and legaladvisors to UNICO Bank.

Charlotte, Michiganhas announced its intention to acquire

Stockbridge Bancorporation, Inc.Bank Holding Company for

Stockbridge, MichiganGerrish Smith Tuck, Consultants andAttorneys, served as financial and legaladvisors to Stockbridge Bancorporation, Inc.and SSBBank.

Eagle Bancorp Montana, Inc.Bank Holding Company for

Helena, Montanahas acquired

TwinCo, Inc.Bank Holding Company for

Twin Bridges, MontanaGerrish Smith Tuck, Consultants andAttorneys, served as financial and legaladvisors to TwinCo, Inc. and Ruby Valley

Bank

East Tawas, Michigan

has acquired a branch office from

Alpena, Michigan

Gerrish Smith Tuck, Consultants andAttorneys, served as financial and legaladvisors to Huron Community Bank.


Recent Transactions


Abby Bancorp, Inc.Bank Holding Company for

Abbotsford, Wisconsinhas acquired

Fidelity Bancorp, Inc.Bank Holding Company for

Medford, WisconsinGerrish McCreary Smith, Consultants andAttorneys, served as financial and legaladvisors to AbbyBank.

Amboy Bancorp, Inc.Bank Holding Company for

Amboy, Illinois

has acquired

Franklin Grove, Illinois

Gerrish McCreary Smith, Consultants andAttorneys, served as financial and legal advisorsto Amboy Bancorp, Inc. and The First NationalBank in Amboy.

Sullivan BancShares, Inc.Bank Holding Company for

Sullivan, Illinoishas acquired

Moultrie Bancorp, Inc.Bank Holding Company for

Lovington, IllinoisGerrish McCreary Smith, Consultants andAttorneys, served as financial and legaladvisors to Sullivan BancShares, Inc., FirstNational Bank of Sullivan, Moultrie Bancorp,

Inc. and Hardware State Bank.

Blackhawk Bancorporation, Inc.Bank Holding Company for

Milan, Illinoishas acquired

First Port Byron Bancorp, Inc.Bank Holding Company for

Port Byron, IllinoisGerrish McCreary Smith, Consultants andAttorneys, served as financial and legal advisorsto Port Byron Bancorp, Inc. and Port Byron State

Bank.

TCB Mutual Holding CompanyMutual Holding Company for

Tomahawk, Wisconsinhas acquired

Merrill, WisconsinGerrish McCreary Smith, Consultants andAttorneys, served as financial and legal advisors toTCB Mutual Holding Company and Tomahawk

Community Bank.

Hillsboro, Illinois

has acquired a branch office from

Terre Haute, Indiana

Gerrish McCreary Smith, Consultants andAttorneys, served as financial and legal advisors toFirst Community Bank of Hillsboro.


Recent Transactions


Community Financial Corp.Bank Holding Company for

Edgewood, Iowahas acquired

Garnavillo Bank CorporationBank Holding Company for

Garnavillo, IowaGerrish McCreary Smith, Consultants andAttorneys, served as financial and legaladvisors to Garnavillo Bank Corporation and

Olympic Bancorp, Inc.Bank Holding Company for

Port Orchard, Washingtonhas acquired

Puget Sound Financial Services,Inc.Bank Holding Company for

Fife, WashingtonGerrish McCreary Smith, Consultants andAttorneys, served as financial and legaladvisors to Puget Sound Financial Services,

First State Bancshares ofDekalb County, Inc.Bank Holding Company for

Fort Payne, Alabamahas acquired

First Rainsville Bancshares,Inc.Bank Holding Company for

Rainsville, AlabamaGerrish McCreary Smith, Attorneys,served as financial and legal advisors toFirst Rainsville Bancshares, Inc. and

First Bank of the South.

Planters Holding Company

Indianola, Mississippihas acquired

Covenant FinancialCorporation

Clarksdale, MississippiGerrish McCreary Smith, Consultants andAttorneys, served as financial and legaladvisors to Covenant Financial

Corporation and Covenant Bank.

Docking Bancshares, Inc.Bank Holding Company for

Arkansas City, Kansashas acquired

Relianz Bancshares, Inc.Bank Holding Company for

Wichita, KansasGerrish McCreary Smith, Consultants andAttorneys, served as financial and legaladvisors to Docking Bancshares, Inc. and

Canton, Illinoishas acquired

Henry State Bancorp, Inc.Bank Holding Company for

Henry, IllinoisGerrish Smith Tuck, Consultants andAttorneys, served as financial and legaladvisors to Henry State Bancorp, Inc. and

Henry State Bank


Recent Transactions


WSFS Financial CorporationBank Holding Company for

Wilmington, Delawarehas acquired

First Wyoming FinancialCorporation

Bank Holding Company for

Wyoming, DelawareGerrish McCreary Smith, Consultants andAttorneys, served as financial and legaladvisors to First Wyoming FinancialCorporation and The First National Bank ofWyoming.

Security Financial ServicesCorporation

Bank Holding Company for

Durand, Wisconsinhas acquired

Bloomer Bancshares, Inc.Bank Holding Company for

Bloomer, WisconsinGerrish McCreary Smith, Consultants andAttorneys, served as financial and legaladvisors to Bloomer Bancshares, Inc. andPeoples State Bank of Bloomer.

TS Contrarian Bancshares, Inc.Bank Holding Company for

Treynor, Iowahas acquired

Tioga Bank Holding CompanyBank Holding Company for

Tioga, North DakotaGerrish McCreary Smith, Consultants andAttorneys, served as financial and legaladvisors to Tioga Bank Holding Company and

The Bank of Tioga.

Fairfield, Iowa

has acquired

Keota, Iowa

Gerrish McCreary Smith, Consultants andAttorneys, served as financial and legaladvisors to Farmers Savings Bank.

Effingham, Illinoishas acquired

First Federal MHCMutual Holding Company for

Mattoon, IllinoisGerrish McCreary Smith, Consultants andAttorneys, served as financial and legaladvisors to Washington Savings Bank.

Sargent Bankshares, Inc.Bank Holding Company for

Forman, North Dakotahas acquired

FNB Bankshares, Inc.Bank Holding Company for

Milnor, North DakotaGerrish McCreary Smith, Consultants andAttorneys, served as financial and legaladvisors to FNB Bankshares, Inc. and First

National Bank of Milnor.


Consultants and Attorneys700 Colonial Road, Suite 200

Memphis, TN 38117P.O. Box 242120

Memphis, TN [email protected]

THE CLIENT’S NEEDS COME FIRST

GERRISH SMITH TUCK