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THE INDUSTRY MAGAZINE FOR FINANCIAL EXECUTIVES & PROFESSIONALS

FALL 2011

•  VOLUME 19

INSIDE

DEFENDING AGAINST ATM FEE LAWSUITS SIX KEY INGREDIENTS FOR EFFECTIVE COMPLIANCE OF ANTS AND ALLOWANCES

LAUNDERING

MONEY

IN NYC


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BANKING NEW YORK Volume 19 | FALL 2011

EVERYTHING OLD IS NEW AGAIN

LAUNDERING MONEY IN NYC

PAGE 16

PAGE 10

4 LETTER FROM THE PUBLISHER 6 LEGAL

Defending Against

ATM Fee Lawsuits

8 GUARDING THE GATE Have We Really Seen

These Attacks Before?

10 MANAGEMENT The Business Judgment

Rule is the Director’s

Best Friend

12 BANK PROFILE Empire National Bank

PAGE 12

PAGE 26

PAGE 28

20 NEWS First Niagara’s HSBC

Branch Buy

22 COMPLIANCE Six Key Ingredients

for Effective Compliance

with the Bank Secrecy Act

©2011 The Warren Group Inc. All rights reserved. The Warren Group is a trademark of The Warren Group Inc. No part of this publication may be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without written permission from the publisher. Advertising, editorial and production inquiries should be directed to: The Warren Group, 280 Summer Street, Boston, MA 02210 www.thewarrengroup.com

24 RISK MANAGEMENT

TWG STAFF

Programs More Necessary

CHAIRMAN

than Ever

26 COMPLIANCE Evaluating ALLL 28 TECHNOLOGY Making Sense of Mobile

Vincent Michael Valvo Timothy M. Warren CEO & PUBLISHER Timothy M. Warren Jr. PRESIDENT David B. Lovins CONTROLLER DIR. OF OPERATIONS Jeffrey E. Lewis GROUP PUBLISHER & EDITOR IN CHIEF

SALES Sarah Warren George Chateauneuf ADVERTISING, MARKETING & EVENTS COORDINATOR Emily Torres ADVERTISING ACCOUNT MANAGER Cara Inocencio ADVERTISING ACCOUNT MANAGER Richard Ofsthun DIRECTOR OF EVENTS

PUBLISHING GROUP SALES MANAGER

EDITORIAL ASSOCIATE EDITOR

14 MANAGEMENT ALCO: Act Like a Crisis

is Obvious

30 SMALL CHANGE

Christina P. O’Neill Cassidy Norton Murphy

CUSTOM PUBLICATIONS EDITOR

ART CREATIVE DIRECTOR John

Bottini Scott Ellison Ellie Aliabadi

SENIOR GRAPHIC DESIGNER GRAPHIC DESIGNER


Letter from the Publisher | By Vincent Valvo

How’re We Doin’?

W

hen a publication undergoes a redesign, as we have with this issue, it’s also an opportunity to undergo a reorientation. We’re looking to make Banking New York more newsy. To do this in a quarterly publication demands news with "legs" – issues that have staying power beyond a daily email blast. The New York banking market, which is like no other bank market in the country, provides these in abundance. In this issue, we examine the fallout of the IRISL money-laundering case, which has affected Manhattan, but we also include a look at investors’ reaction to the expansion plans of that ambitious upstate bank, First Niagara Financial. We have brought back the Bank Profile, where

we showcase Empire National Bank, a de novo bank whose management team is on its second go-round of opening a new bank in difficult times (note: Their previous effort, opened in 1987, survived to be sold in 2005). In future issues, we’ll showcase key people and issues in New York’s banking industry. We’ll continue to offer our big-picture assessments of the trends and forces that affect this bank market. We hope you like our new look and we invite your comments and contributions. ■

VINCENT MICHAEL VALVO Group Publisher & Editor-in-Chief

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We admit, it’s a trick question. Of course you can’t. ATM security breaches can come from many sources these days: viruses, hackers, card skimming – and occasionally, even a thief. How can you stop what you can’t spot? Evolving to a multi-layered approach to ATM security is the best defense. One that protects the physical environment, your hardware and your software against every kind of threat. And that’s what you get with Diebold. Comprehensive, integrated solutions delivered by a team dedicated to security. diebold.com/moreinfo


Legal | By Frank Simon

Defending Against ATM Fee Lawsuits

T

he 10-year-old Electronic Fund Transfer Act (EFTA) requires that banks display an on-screen notice and a separate notice in a visible area outside of an automatic teller machine, advising that a fee will be charged for using the ATM. The act also states that no fee will be charged if an electronic or posted notice is not visible, unless the consumer agrees to continue with a transaction. Notice posted on the screen alone is not enough and may expose ATM operators to civil liability for violation of the EFTA. Monetary liability to an ATM operator can be significant. If an operator is found by a court to have failed to comply with the EFTA’s notice requirements, in the case of an individual consumer, the ATM operator may be liable for actual damages sustained, plus a statutory penalty of $100 to $1,000. In the case of a class action lawsuit, the ATM operator may be held liable for payment of the lesser of $500,000 or 1 percent of the ATM operator’s net worth. The EFTA also requires the ATM operator to pay the court costs associated with the lawsuit against it, along with the plaintiff’s “reasonable” attorneys’ fees for the lawsuit as determined by the court. It is the exterior notice that is of interest to class plaintiffs. A cottage industry has sprouted up in many states whereby predatory plaintiffs troll for ATMs that lack the exterior notice posting. Once such an ATM is found, they will perform a transaction, snap a picture, and troll for the

next machine. They may also return to a known, violative machine several times to establish the length of time, or window of non-compliance. After one or more representative plaintiffs are in place, a suit can be filed, normally seeking discovery focusing on identification of additional plaintiffs for their class and the window of non-compliance. Basically, they use the ATM operator’s records against the operator to expand and build their class, and to support or even establish the merits of their case. The ease with which an ATM missing the exterior notice can be discovered, coupled with operator risk management and aversion, appears to be the driving force behind the increasing number of these manufactured cases. Unless a solid defense is available to the ATM operator, risk aversion leads to quick settlements so as to avoid a long, litigious case, potentially resulting in an excessive damages award and payment of the class plaintiffs’ associated litigation costs and attorneys’ fees. Further, smaller operators may simply offer 1 percent of their net worth at the outset of a case representing a nuisance value settlement, regardless of the merit in the underlying claim. Although the EFTA essentially imposes a strict liability standard on ATM operators, there are defenses that may be available under certain circumstances. They include: compliance with continued on page 25 

Frank Simon is a partner at Simon, Galasso & Frantz, PLC, a multi-state law firm specializing in the representation of financial institutions and corporations. 6 | Banking New York


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Guarding the Gate | By Matt Lidestri

Have We Really Seen These Attacks Before?

H

ackers seem to be everywhere these days – most recently the Epsilon breach, and then the Sony PlayStation network. Millions of records have been exposed. The impacted organizations are notifying consumers and apologizing as fast as they can. Hasn't the banking community seen all this before? Generally speaking, we haven’t. The Sony PlayStation and online network break-ins represent a higher level of cybercrime that could result in greater losses than we have seen before. Here’s why: The handful of large breaches of the last few years – TJX, Hannaford and Heartland Payment Systems, to name a few -- had less impact on the businesses and consumers from an identity standpoint. Even the notable Epsilon breach is limited in immediate impact, although the

8 | Banking New York

exposed data could be used for future attacks (Epsilon maintains customer records for Best Buy and JP Morgan Chase, among others). The PlayStation network attack is different because the stolen personal records were more complete, meaning they could be used more easily for identity theft. The attacks were also executed in two days, rather than weeks and years, so the information is both fresh and usable. The criminals now know where 77 million PlayStation network users reside, how to impersonate these users, apply for credit, and collect a bigger payday. According to an attorney leading a class action suit against Sony, hackers involved in the breach are already offering 2.2 million credit cards, the corresponding three-digit security verification codes and other personal information for sale on underground Internet sites. Sony may not have paid enough attention to security and risk while developing its PlayStation and Sony online networks. Nonbanks do not face safety and soundness examinations conducted by regulators onsite. Many have accumulated astounding amounts of customer information, and put us all at risk. Apple and Google recently admitted to The Wall Street Journal that they keep records of smartphone calling data, messaging activity, search requests and online activities. Add data collected by iPhone and Android smartphones, which can detect location, movement, direction and proximity to other phones. Put that information into immense commercial databases that also contain names, addresses, etc., and you begin to see the compounding danger. The promise of providing customer data to retailers who can direct advertising while those customers walk by their stores is too sweet to pass continued on page 21 


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Management | By Clifford S. Weber

The Business Judgment Rule is the Director’s Best Friend

D

odd-Frank Act compliance concerns, the uncertain financial environment, perceived economies of scale and institutionspecific factors have spurred the consolidation of New York’s community banks. Since the summer of 2010, at least seven mergers have been announced or completed (see sidebar). Five of them have been interrupted by class action “investigations” or actual commenced litigation. Most of those litigations settled to avoid deal disruption. One of them ended in complete victory for the defendant banks and their directors. This is the story of that victory and its meaning for New York institutions.

Mergers*of New York State-Based Banks Bridgehampton National Bank and Hamptons State Bank Community Bank and Wilber National Bank Chemung Canal Trust Company and Capital Bank and Trust Berkshire Bank and Rome Savings Bank First Niagara Bank and New Alliance Bank Modern Capital Holdings LLC Madison National Bank *Completed or proposed since 2010

BACKGROUND Wilber National Bank was an Oneonta-based commercial bank with nearly $1 billion in assets that began serving its central New York market in 1874. In October 2010, The Wilber Corporation, a New York corporation and Wilber National Bank’s parent bank holding company, entered into a merger agreement with Community Bank System, Inc., the DeWitt, New York parent of Community Bank, a strong, profitable commercial bank. Each company’s board of directors approved the transaction unanimously. The deal, valued at $101.8 million, was structured so that Wilber shareholders received as aggregate consideration for their stock, 20 percent in cash and 80 percent in Community common stock, subject to adjustment based upon Community’s share price and Wilber’s asset quality. The Wilber Corporation was, and Community Bank System Inc. is, a public, exchange listed company. THE CLASS ACTION Some law firms earn their living by representing shareholders in class action litigation. Typically, these self-described “shareholder rights” firms post on their websites “investigations” of the fairness of mergers and other deals shortly after they are announced and actively solicit shareholders to

Clifford Weber is a partner in the White Plains office of Hinman, Howard & Kattell, LLP. He represents community banks in regulatory, securities, corporate and transactional matters and represented The Wilber Corporation in the transaction discussed in this article. 10 | Banking New York


act as nominal plaintiffs. The “investigations” are often bereft of facts or evidence, but the threat of an injunction and delay of the deal frequently persuades companies to settle and pay attorneys’ fees (arguably the real purpose of the litigation). Just days after Wilber and Community announced the signing of their merger agreement, and months before filing documents with the SEC, several law firms proclaimed the launch of investigations into possible breaches of fiduciary duty by the Wilber directors, and other unspecified violations of law. Two firms claiming to represent Wilber shareholders contacted Wilber and Community and tried to extract a settlement. The boards of directors of both companies refused to negotiate. On Nov. 3, 2010, Wilber shareholders filed lawsuits in the New York Supreme Court in Otsego County. Both complaints sought class certification, named Wilber, Wilber’s directors, and Community Bank System as defendants and alleged that the director defendants breached their fiduciary duties by failing to maximize shareholder value in connection with the merger and that Community Bank System aided and abetted those alleged breaches of fiduciary duty. Specifically, the complaints alleged that the directors improperly favored Community Bank System and discouraged alternative bids by agreeing to the merger agreement’s non-solicitation provision and termination fee provision. Plaintiffs further alleged that pursuant to the merger agreement, Community Bank agreed to appoint two of Wilber’s directors to the boards of Community Bank System and to establish an advisory board of Community Bank, made up of the current directors of Wilber. The complaints also alleged that the directors and officers of Wilber entered into voting agreements to vote their shares of Wilber common stock in favor of the merger. In addition, the complaints alleged that the consideration to be received by Wilber’s common shareholders was inadequate and unfair. Plaintiffs sought an injunction stopping the merger and an award of attorneys’ fees. THE BUSINESS JUDGMENT RULE New York law vests a corporation’s board of directors with responsibility for direction of the corporate business. Directors may delegate day to day management to officers, but they cannot shed accountability for governance or their fiduciary duties of care, good faith and loyalty. The business judgment rule is a judge-made rule that protects directors’ decisions from attack when the directors act consistently with their fiduciary duties. As the New York courts have stated: “That doctrine bars judicial inquiry into actions of corporate directors taken in good faith and

in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes. ‘Questions of policy, of management, expediency of contracts or action, adequacy of consideration, lawful appropriation of corporate funds to advance corporate interests, are left solely to their honest and unselfish decision, for their powers therein are without limitation and free from restraint, and the exercise of them for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient.’” The Delaware courts have said that under the business judgment rule, there is a “presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action was in the best interest of the company.” In other words, courts “will not invalidate a board’s decision or question its reasonableness so long as its decision can be attributed to a rational business purpose.” Under this rule, the directors’ decision is protected unless plaintiff can show that the board breached its duty of care or loyalty. Most recently, the Delaware Supreme Court noted that “[d]irectors’ decisions must be reasonable, not perfect.” THE DECISION Community, Wilber and the Wilber directors answered the complaint and promptly moved for summary judgment. On March 28, 2011, the court granted the motion and dismissed both complaints. The merger closed as planned on April 8, 2011. The court based its decision on the following factors, all of which were described in the proxy statement/prospectus delivered to Wilber’s shareholders: • The court gave substantial weight to the process the Wilber board followed once it decided to sell the company. This included many meetings with its financial and legal advisers, solicitation of bids from nine potential acquirers, detailed analysis and comparison of the three bids it received, and comprehensive instruction on directors’ fiduciary duties when considering business combinations. • Wilber received a fairness opinion from a firm that was independent from the financial advisor that marketed the company and whose compensation was contingent on completion of the merger. • The Wilber directors discharged their fiduciary duty by acting with disinterested independence. Plaintiffs furnished no evidence of bad faith. continued on page 19  FALL 2011 | 11


Bank Profile | By Linda Goodspeed

Pictured are Douglas C. Manditch, Empire National Bank's chairman and CEO, and Thomas M. Buonaiuto, president and COO.

Empire National Bank Good Loans in Bad Times

W

hen Sayville Ford, Long Island’s largest Ford dealer and one of the top 100 Ford dealers in the country, needed a cash infusion in 2008 to get through the recession, it naturally turned to its long-time community banker, who handled Sayville’s other business interests. “We always dealt with the big banks regarding the dealership,” says Melanie Spare-Oswalt, vice chairwoman and third generation in the dealership, founded in 1957 by her grandfather. “But they wouldn’t help us at all.” Fortunately, for Sayville Ford and its 68 employees, Empire National Bank had just opened six months earlier. “Empire listened to us,” Spare-Oswalt says. “They met our management team, reviewed our business plan. We closed on a loan in less than a month.” Last year, Sayville Ford was once again the highest-volume Ford dealer on the island. Opening a bank in February 2008, near the bottom of the worst economic recession since the 1930s, might strike some as poor timing. Douglas C. Manditch, chairman, CEO and founder of Empire National Bank, says it was actually a good time to open a bank. “We had no bad loans on our books,” Manditch

12 | Banking 12 New | Banking York New York

says. “We were an experienced group of managers. We saw the market was overheated so we were cautious. Our guard was up.” As other banks stopped lending, Empire was one of the few – as Sayville Ford can attest – that kept lending during the recession. “Our loan portfolio was largely constructed in 2009,” Manditch says. “we put on about $140 million in loans that year.” Today, Empire has $340 million in assets, 50 employees and branches in Shirley and Port Jefferson Station. Its headquarters in Islandia occupies 20,000 square feet in an old building rehabbed with a reflecting pool and waterfall in the atrium. “We operate on a model of service, and personal attention,” Manditch says. Empire’s market includes small and mid-size privately-owned businesses, not-for-profits and professionals, including lawyers, doctors and CPAs. Since 2009, Manditch says, the bank’s lending has slowed because of less demand and increased competition from other banks. “In 2009, not many banks were lending,” he notes. “We had the pick of the litter.” Empire’s loan portfolio reflects that caution. Nonaccruals - loans not accruing interest - account


for about 1 percent of the bank’s total loan portfolio. “We’ve had issues with customers with financial problems,” Manditch says. “We’re not exempt from that.” “Anyone can offer loans in good times,” adds Thomas Buonaiuto, Empire’s president. “When you go through rough times, you need a bank who will not just give you money, you need an advisor who will give you feedback, work with you. We learn a company’s business, talk and listen. We do with small and mid-sized companies what the big banks do with corporate giants and international concerns, although they do not take the time to do the same with smaller companies.” Empire is the second bank Manditch has started in a recession. In 1987, he helped found Long Island Commercial Bank, and served as president and CEO until its purchase in 2005. Buonaiuto was also part of that management team. “Again, while most think 1987 was not a good time to open a bank, it was,” Manditch says. “We weren’t putting on any of the loans that were causing problems. It was a slow recovery then, probably five years. I would guess this recovery is going to take longer than that. Both were difficult times.” A lifelong banker who started as a teller out of high school, Manditch is known for his conservative underwriting and outspoken criticism of the federal government’s Troubled Asset Relief Program (TARP) and other government bailouts and intervention. “Capitalism provides for great rewards,” he said. “It has to provide for failure. If a company is not run properly, it should fail.” What is the proper role of banks in this assessment? Manditch points to the example of Sayville Ford. “There was an owner [who was] very fiscally conservative, very opposed to debt,” he said. “He had assets available to use. We felt it was important to the community to sustain that business. Some other banks

Empire National Bank's headquarters in Islandia occupies 20,000 square feet.

wouldn’t do anything for him. We were able to work with him, and get him out of a hole and running a profitable business again.” Manditch “has always been a conservative lender,” Buonaiuto says. “We always stress cash flow and debt service.” Looking ahead, Manditch says the country’s economic future is bleak. “Any recovery will take a long time,” he said. But for Empire, the future is bright for a “well-run community bank.”

“We’re here for the long run,” he says. “We expect to be around, and continue to provide the service we’re known for.” “Clearly, this is a very challenging time for all businesses,” Buonaiuto says. “Our story over the first three and a half years – our profitability, our underwriting track record, our reputation and following – is very positive. I think there will continue to be opportunities for us to grow. It will be more challenging to find those opportunities, But I’m confident we will.” ■

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Management | By Megan L. Desso

ALCO: Act Like a Crisis is Obvious

J

uly 21, 2011, marked the effective date of the repeal of Section 19(i) of the Federal Reserve Act (FRA), also known as Regulation Q, thereby allowing banks to pay interest on demand deposit balances. Buried on page 715 of 2,319 pages, Section 627(a)(i) of the Dodd-Frank Act (DFA), with only the word “[Repealed],” Section 19(i) of the Federal Reserve Act and the implementing regulations are forever repealed. Regulation Q is a 75-year-old regulation that is a basic tenet of banking as we know it. The prohibition on paying interest is at the heart of every bank’s business plan and is integral to their pricing process. A LITTLE HISTORY ON REGULATION Q Regulation Q was passed in 1933. Lawmakers sought to improve economic growth by prohibiting the payment of interest on demand deposits, thereby incentivizing businesses and high net worth individuals to seek investment opportunities that would more directly benefit economic growth. In 1979, at the beginning of the savings and loan crisis, the industry was challenged by high interest rates, regulatory restrictions on the payment of interest, inflation and the doubling of oil prices, all of which threatened the viability of community banks. Lawmakers responded first with the Monetary Control Act (MCA) of 1980, which established the Depository Institution Deregulation Committee (DIDC), whose primary charge was to phase out Regulation Q. By 1986, the phase-out of interest rate ceilings was complete. Congress then passed the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). Among other things, the act included the creation of the Office of Thrift Supervision (OTS), and gave both Fannie Mae and Freddie Mac additional authorities to support mortgages for low- and moderate-income families. This latest recession saw the demise of the quasi-governmental facilities, Freddie Mac and Fannie Mae, and the removal of the OTS. In 2001, the legislature introduced the Small Business Interest Checking 14 | Banking New York

Act of 2001 (SBICA), which included an element to repeal the last remaining piece of Regulation Q and Section 19(i) of the Federal Reserve Act. The SBICA also intended to allow the Federal Reserve Board (FRB) to pay interest on reserve balances and clearing balances, but not excess balances. Although SBICA did not become law, many of its elements have been incorporated into other regulatory changes over the years. In 2008 and 2009 amendments were made to Regulation D to allow the FRB to pay interest on reserve and excess balances, and even to establish a program whereby correspondent banks could act as aggregators in the placement of client funds into an excess balance account. These programs have been extremely successful as community banks flee to the safe harbor of government offered, risk-free, overnight investment options that pay on average 20-basis points higher than the open market. Most recently, the repeal of Section 19(i) was reintroduced in the DFA, lawmakers maintained that the measure was designed to help community banks compete more effectively against the largest banks for deposits. However, businesses, and highly liquid households, long ago fled the traditional banking system for “smarter” non-bank investments, which paid better rates of return than traditional banking products. The huge reduction in deposits has also impacted the Federal Reserve System, by reducing the reserves held at the Fed. The Fed is clearly in competition with the private sector as it desperately attempts to raise reserves and increase its balance sheet. THE EFFECTS: PAST, PRESENT AND FUTURE Currently, as short-term investments are earning 25 basis points or less, permitting banks to pay interest on demand deposit balances may seem like a nominal overall effect. We need to look forward to the effect in a rising rate environment (as we are, or should be, preparing for now). Banks would typically look to lock in low-


er funding rates rather than collect deposits with floating rates that will increase their costs of funds quickly when rates begin to rise. The true impact of this change cannot be understood in this historically low-rate environment. The Fed Funds rate rose almost 400 basis points following the last recession. ALCO committees need to consider what the impact will be when rates go up 200, 300, or 400 basis points. Regulators are now requiring banks to perform stress testing for 400 and 500 basis point shock scenarios. This change will squeeze already tight margins, and negatively impact net interest income for community banks, while sending customers to the highest bidder. It will have damaging effects on community banks’ costs of funds and take a toll on the cost of credit for customers. The historically low rates banks we are now experiencing have played havoc with asset yields, although the decline in the cost of funds has, in part, compensated for this situation. Repeal threatens to tear away the last thread of hope for community banks to have any positive net interest margin, as it will certainly increase their cost of funds as they fight for deposits against the too-big-to-fail banks. Furthermore, the repeal will raise interest rate risk – especially in a rising rate environment. Community banks across the nation are liquidity flush with nowhere good to place their excess funds. They don’t want to build their balance sheets further. Taking in more deposits without a plan to redeploy the funds is both an ALCO nightmare and a hugely negative impact on capital ratios (which the regulators are expecting financial institutions to increase in line with DFA requirements). When interest rates move up, the elimination of Reg Q combined with the FDIC’s transaction account guarantee program, the new FDIC assessment base, and the increased cost of funds may cause unintended effects to the flow of capital and the risk profile of the banks. This spells A-L-C-O

in my book. ALCO committees across the nation will be hard at work anticipating the effect of this legislative change and the overall impact the collective changes will have on deposits, interest spreads, cost of funds, and capital ratios. Community banks will need to make ALCO pricing decisions without truly knowing the effects of this repeal, and will again be forced to follow suit with what the too-big-to-fail institutions do. THE SOLUTION THAT CREATES MORE PROBLEMS The FRB needs ample balances, which are obtained through reserve requirements, clearing balances, excess balances, and so forth, since it is this liquidity that’s necessary to maintain, and not compromise, the float that the FRB uses to clear checks, process wires and perform other functions. As the industry moves to a more fully electronic and image based clearing environment, additional

downward pressure is placed on the FRB because the traditional float gap recognized in the paper-based check clearing system is all but gone. The Fed needs more liquidity, and, subsequently, more monetary tools to attract liquidity in a climbing rate environment. It’s worthy of noting that the FRB is the very entity driving the industry to become fully image-based. Again, another case of being careful what you wish for – does anyone think for a minute that when Check 21 was passed the FRB fully understood the impact to its bottom line? The government’s actions have only drawn more liquidity out of the public banking sector as banks react conservatively to the poor economic state and flee to place their excess liquidity in the government sponsored risk-free overnight investments. And of course, it is also the government that is encouraging banks to lend. continued on page 21 

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FALL 2011 | 15


EVERYTHING OLD IS NEW AGAIN

LAUNDERING MONEY IN NYC

When it comes to money laundering, the bad guys suddenly have the upper hand: Several foreign companies have come under intense scrutiny for their banking habits, as they are apparently able to move tens of millions of dollars through New York’s biggest banks undetected.


By Scott Van Voorhis

F

ederal prosecutors recently leveled a money laundering case against an Iranian government-owned shipping line for allegedly funneling $60 million through accounts at JPMorgan Chase, Bank of America and Citibank. Under federal sanctions passed in 2008, the Islamic Republic of Iran Shipping Lines has been effectively barred from the global banking system. Known as IRISL, its ships have been used by the Iranian regime to illegally ship weapons around the world. And with some skillful use of shell corporations, the Iranian shipping line was able to evade controls at some of the world’s most sophisticated banks and get access to badly needed American currency, according to the case recently unveiled by prosecutors in New York. The U.S. banks in question have been held blameless, with gaps in federal regulations likely providing a big loophole for the Iranian company to exploit, industry experts say. The ugly headlines generated by the IRISL case and others like it, while painful, could be just the push needed to swing the pendulum back in favor of the banks in this cat-and-mouse game, replete with shadowy front organizations seeking to move cash around the globe for all sorts of nefarious purposes. Faced with big federal fines and the threat of toxic, reputation-damaging publicity, banks are now scrambling to beef up their efforts to clamp down on money laundering activity. “It is an uneasy situation for the banks,” said Harry Clark, co-head of Dewey & LeBoeuf’s International Trade Practice Group. “It is no doubt disconcerting for them to see this. They are always going to be looking over their shoulder, making sure no one will be pointing fingers at them.” The massive money laundering scheme by Iran’s official shipping company got its start two years ago, in September of 2008. The U.S. Department of the Treasury’s Office of Foreign Assets Control earmarked IRISL and 18 affiliated entities for helping import chemicals and other materials for use in Iran’s burgeoning missile and nuclear bomb programs. The designation effectively banned Iran’s shipping line from access to the U.S. financial system, a potential death blow

since the world’s shipping industry runs on the American dollar. As European banks continued to process transactions involving Iran’s shipping company, U.S. banks began blocking them. So IRISL responded with a tactic that, for a time anyway, proved surprisingly effective – creating a new generation of front companies and falsifying records to hide the interests and individuals behind them. The scheme finally unraveled in June, when Manhattan District Attorney Cyrus Vance Jr. released a 317-count indictment of 11 corporations and five individuals. The indictment paints a picture of brazen illegality, in which the names of ships and new front companies were invented on a whim by the Iranian shipping firm in a bid to evade sophisticated screening programs now used by the major banks. “We have changed the names of all our ships into English names,” an IRISL manager wrote on February 23, 2009, according to the indictment. “We will be able to lease containers instead of [IRISL] containers for this traffic. So no trace of IRISL at all in documentation. Nonetheless our present agents will be doing the work.” Tellingly, none of the banks which unwittingly processed the tens of millions in transactions for the front companies spawned by IRISL were charged in the indictments. In fact, the indictment goes out of its way to exonerate the banks involved, noting U.S. banks use monitoring systems designed to vet all incoming and outgoing international wire transactions and “recognize suspicious or prohibited transactions.” Still, it raises the question of how the world’s most sophisticated financial institutions could have been misled by the Iranians’ brazen techniques. Julie Conroy McNelley, a senior analyst within Aite Group’s Retail Banking practice, believes one possible explanation may be found in a loophole in current federal banking regulations. The now four-decade-old Bank Secrecy Act (see related article, page 22) bars banks from sharing customer data such as international wire transfers of funds. The rule stems from regulations designed to continued on page 18 


LAUNDERING MONEY 

continued from page 17

protect the privacy of consumers. These consumer protection rules, however, put banks at a disadvantage when it comes to stopping the bad guys, whether it’s front companies for nations like Iran or, for that matter, the Mafia. If banks were able to pool their data, it would be easier to spot suspicious activity, McNelley notes. For example, the innocuous shipping outfit out of Singapore might look different if records showed a flurry of wire transactions taking place not just at one bank, but at several. While banks continue to battle for

cious transactions to law enforced and supervisory authorities.” The Fed and the Office of the Comptroller of the Currency issued a similar edict last year to HSBC. Meanwhile, other banks, after facing similar probes by federal regulators, are now coughing up hundreds of millions in fines. London-based Barclays is on the hook for nearly $300 million in fines after it acknowledged processing payments to the U.S. from clients in Sudan, Cuba and other countries from which banking transactions are severely scru-

fee income, there’s a natural temptation to look the other way when it comes to millions flowing through various accounts. And while it was not an issue in the IRISL case, other recent money laundering cases have raised the question of negligence at some European banks, McNelley said. The Federal Reserve recently issued a cease and desist order against the Royal Bank of Scotland, ordering the bank to beef up its anti-money laundering systems. RBS is required to submit a plan to the Fed on how it will strengthen top management oversight of its U.S. operations while demonstrating it will report in a timely manner “all know or suspected violations or suspi-

tinized and limited. Lloyds Banking Group and Credit Suisse have anted up nearly $900 million more to the feds in separate settlements. If the feds are hoping to scare the banking industry into compliance, then the crackdown and the mounting fines appear to be doing the trick, McNelley said. She notes there has been a flood of proposals by the big banks looking to hire consultants to beef up their antimoney laundering systems. The market for anti-money laundering software is expected to balloon from $515 million this year to $690 million by the end of 2015, or 9 percent growth a year, Aite estimated in a recent study.

18 | Banking New York

“Anti-money laundering technology has enjoyed a fresh wave of demand across the globe over the last few years, driven by the convergence of increased regulation, high-profile regulatory enforcement actions, and next-generation technologies,” the Aite Group reports. In fact, while money laundering can be difficult to stop when it involves determined and nefarious front organizations, there are steps banks can take to reduce their risks, McNelley says. Given the propensity for front organizations and shell companies to constantly morph to avoid detection, banks have to make sure they are keeping up as well. Taking a look every two or three years is not going to cut it, she notes. Banks need to periodically review their anti-money laundering filters to make sure they are up to date and catching the right activity. Sophisticated data mining of a bank’s internal records and transactions can also help to uncover patterns that might not be apparent to the naked eye. The latest anti-money laundering detection systems can analyze data along the lines of a social network, grouping companies and individuals that, to the naked eye, may appear to have not link, McNelley said. Using “link analysis,” a bank might discover, for example, that 40 obscure small businesses all have a common tie with a single suspicious individual. It might not even be a name, but rather an address or a phone number that provides the link. “It uses data patterns to create social networks among your customers,” she says. Given the twin threats of massive federal enforcement actions and toxic publicity, the banking sector has decided it needs to spend whatever it takes to get ahead of the bad guys. After all, the risk of winding up in the headlines tangled up with front organizations for unsavory regimes – or getting whacked with a half billion dollar fine – can be a powerful motivator. “No corporation wants to have their name in the headlines facilitating money laundering,” McNelley said. ■


JUDGMENT RULE

continued from page 11

• Wilber’s certificate of incorporation authorized the board to consider the factors enumerated in Business Corporation Law Section 717(b), including the long and short term interests of the company and its shareholders and the effects that the transaction may have on the growth, development, productivity and profitability of the company, its employees, customers, creditors and community. • New York caselaw upholds deal protection provisions such as voting (“lockup”) agreements, breakup fees and other contractual terms the plaintiffs alleged to be wrongful.

when considering offers. • Evaluate the prepared marketing materials and expressions of interest from potential counterparties carefully and thoroughly. Ask questions and make certain that you understand the legal, accounting, financial and regulatory aspects of any proposed transaction. Educate yourselves to get the best-informed sense of market value. • Engage and utilize your retained experts, including lawyers, accountants and financial advisors. • Identify and disclose any conflicts of interest posed by a potential transaction. For example, if you lease property to a potential acquirer or own its securities, make certain that you disclose same and seek advice as to whether you should abstain from any vote on the deal. • Careful consideration of competing offers consumes time, which busy

GUIDANCE FOR DIRECTORS The Internet enables aggressive lawyers to pounce on deal announcements, make flimsy allegations, troll cyberspace for potential plaintiffs and commence litigation to extract a settlement and attorneys’ fees. In this environment, the business judgment rule is a company’s and its directors’ best defense to any Monday morning attack on the board’s decision to enter into a change of control or other transaction with material economic consequences. The defense boils down to this: if they properly discharge their duties, the business judgment rule protects from liability directors who are sued by shareholders alleging that they sold the company for an inadequate price (the typical claim) or that they benefited personally (another typical claim). To support invocation of the rule, evidence must exist that the directors upheld their duties. The evidence must show that the directors’ conduct was consistent with due care and loyalty. Documentation of the board’s deliberative process is the evidence that will support a successful business judgment defense in litigation seeking to second guess the board’s transactional decisions. Practical tips for boards considering business combinations include: • Consider including provisions in the company’s certificate of incorporation that give the board flexibility

directors may not be able to devote. Consider appointing a special committee of the board to handle ongoing tasks, including narrowing the field of bidders to consider, filtering different kinds of offers and getting answers to routine questions from the company’s advisors. • Document the process in the minutes and through the adoption of appropriate resolutions at key junctures. Record dissenting votes. Mergers and other major transactions place enormous stress on directors, officers and employees. Aggressors count on that and the fear of delay-by-injunction when they start hollow litigation. But as the WilberCommunity case shows, companies don’t have to cave in to a shakedown. The story can end well for boards that build a solid evidentiary record for the business judgment defense. ■

FALL 2011 | 19


News | By Christina P. O’Neill

First Niagara’s HSBC Branch Buy

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irst Niagara Financial Group’s John Koelmel has been on the acquisition trail for the past two years. First, there was the NewAlliance acquisition announced early this year. Then, in early August, First Niagara announced its intent to purchase 195 branches that HSBC is divesting in upstate new York. And in mid-September, Koelmel indicated to American Banker that he was expecting Bank of America to sell branches as part of an initiative by BoA to cut $5 billion in costs by 2014. BoA’s 40 branches in the Albany, New York area are in part of First Niagara’s expanding geographic footprint. Koelmel’s comment that banks such as his would have “an opportunity to play off” the rightsizing initiatives of larger banks is consistent with his prior remarks on the opportunities presented by today’s banking scene. Back on August 1, Koelmel and his team were fully prepared for the questions they fielded from a group of investors about the purchase of 195 branches that HSBC is divesting. Investors asked: Is this too much, too soon? The acquisition, subject to regulatory approval, is First Niagara’s fourth major buy in three years, a result of many large banks re-assessing their branch structure. The series of buying opportunities, said Koelmel, “come to us faster than we would have expected two or three years ago.” The transaction is expected to close in the first half of 2012. The bank will pay a deposit premium of 6.67 percent of HSBC’s acquired deposits – about $1 billion based on May 31, 2011, balances. When the sale is done, First Niagara anticipates it will have about $38 billion in assets, $30 billion in deposits and 450 branches across upstate New York, Connecticut, Massachusetts and Pennsylvania. It will also employ more than 4,000 people in New York state, compared to 2,600 before the acquisition.

20 | Banking New York

First Niagara expects to sell 25 percent of the total 195 branches in the HSBC package, and consolidate other branches, either because selected locations are outside its strategic focus, or because of antitrust concerns. However, investors on the call were more interested in how First Niagara will absorb acquisition costs. The bank expects to retain $11 billion of the $15 billion in deposits and $1 billion of the $2.8 billion in loans coming with the transaction. Investors also pressed for details as to the bank’s plans for raising capital prior to the closing. Plans are to raise common equity of $750 million to $800 million by then, with debt issuance of $350 million to $400 million. The transaction is expected to result in a tangible book value per share dilution of 17 to 18 percent at the close, with a four to five-year earn-back period, and to be 10 to 11 percent accretive to 2011 operating earnings per share. Restructuring expense of $150 million to $175 million would be taken in 2012. The 10 to 11 percent accretion rate for 2012 is achievable and compatible with a four to five year earnback, said First Niagara CFO Gregory Norwood, and accretion is expected to accelerate in 2013 and 2014. As for the timing on raising capital in the markets, “the idea is to do it at the right time,” Koelmel said. “We will be patient to pick our spot. There are multiple opportunities in the weeks and months ahead. Right now, markets aren’t ideally where we would like to see [them].” The bank’s estimates on internal rate of return of 20 to 22 percent – which one questioner commented seemed high – were based on “a modeling perspective we’re comfortable with,” said Norwood. Koelmel noted the low risk of the balance sheet, and said the bank will continue to assess the amount of risk as it rotates assets more into a loan book, requiring it to hold more capital. Expressing comfort with the earnings stream, he said, “we’ll continue to manage capital the way we always have.” ■


ALCO 

GUARDING THE GATE  continued from page

continued from page 15

Bankers should be asking: What will this do to my cost of funds? What will it do to my service fee income? What will be the impact on my interest yield curve? What services will I have to charge for that I don’t now, to recover costs? How will I compete with the largest banks or will this even be an issue? Will I have to change my account analysis system and, if so, how costly will it be? What will the impact be on wire fee income if the sweep function is no longer needed? And then there’s this: Until December 31, 2012, non-interest bearing transaction accounts will receive 100 percent FDIC coverage on balances. How will this play into the decision for banks? It’s highly questionable to believe

that this repeal will be “good” for community banks and, for that matter, anyone else. Aside from the obvious, such as the increased cost of funds, the additional competition this will cause with the largest institutions, and the possible loss of market share with small businesses, community banks will be forced to charge additional and new fees to recoup the increased cost of funds and other expenses once this change is effective. Speaking both as a bank employee and as an average consumer, I can thank the government for, once again, increasing my cost of banking. Gone will be the days of free checking and rebated ATM surcharges. Yes, gone will be the days of “cheap banking.”  ■

Megan L. Desso is enterprise risk manager at Bankers’ Bank Northeast, Glastonbury, Conn., which provides correspondent banking services to more than 200 community banks in the Northeast. She can be reached at mld@ bankersbanknortheast.com.

8

up – especially when smartphones and other mobile devices become our wallets in another 12-18 months. Criminals are busily engineering their next round of attacks. Will the pain and mistakes of the Sony PlayStation network breach be enough to inspire non-bank holders of customer information to harden their sites and services and be more responsible about what type of data is collected, how it is stored, and restrict access to sensitive data? Those questions are answered every day when we see the news. Meanwhile, many financial institutions are keeping our data safer. They should promote that fact every chance they get, and continue to learn and adapt as events unfold.  ■ Matt Lidestri, CISSP, manages internet security and products for Avon, Conn.-based COCC, Inc.

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FALL 2011 | 21


Compliance | By Vivek Agarwal

Six Key Ingredients for Effective Compliance with the Bank Secrecy Act

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he Bank Secrecy Act (BSA) was originally passed by Congress in 1970 and is intended to safeguard U.S. financial institutions from the abuses of financial crime, including money laundering, terrorist financing, and other illicit financial transactions. It has been amended several times since then, including provisions in title III of the USA PATRIOT Act (collectively referred to as Bank Secrecy Act/Anti-Money Laundering Act or as BSA/AML). There are severe penalties for non-compliance, as banks and individuals may incur criminal and civil liability for violating BSA laws. This may include criminal fines, imprisonment and forfeiture actions. In addition, banks risk losing their charters and bank employees are also in danger of being barred from banking. So what makes for an effective BSA/AML compliance program? Let’s take a look at the six key ingredients. INGREDIENT # 1: COMPETENT BSA COMPLIANCE OFFICER The bank’s board of directors must designate a qualified individual to serve as the BSA compliance officer. Although the BSA compliance officer is charged with managing all aspects of the BSA/AML compliance program, the board is ultimately responsible for the bank’s compliance. It is paramount that the BSA compliance officer has sufficient authority and resources (monetary, physical and personnel) to administer an effective BSA/AML compliance program based on the bank’s risk profile. While the title of the individual is not important, his or her level of authority and responsibility within the bank is critical. He or she should be fully knowledgeable of relevant regulations as well as understand the bank’s products, services and customers, the potential risks associated with those activities, and should be able to regularly apprise the board of directors

and senior management of ongoing compliance with the BSA. INGREDIENT # 2: WRITTEN COMPLIANCE PROGRAM The BSA/AML compliance program must be written, approved by the board of directors and noted in the board minutes. A bank must have a BSA/AML compliance program commensurate with its respective BSA/AML risk profile and must be fully implemented. Policy statements alone are not sufficient – practices must coincide with the bank’s written policies, procedures, and processes. INGREDIENT # 3: INVOLVED BOARD OF DIRECTORS An active, involved and knowledgeable board of directors is critical for successful implementation of the BSA/ AML compliance program. The board should be trained on the various legal and regulatory requirements, penalties for non-compliance and the institution’s risk concerning money laundering and terrorist activity. Without a general understanding of the BSA, the board of directors cannot adequately provide BSA/AML oversight; approve BSA/AML policies, procedures, and processes; or allocate sufficient BSA/AML resources. INGREDIENT # 4: CONTINUOUS TRAINING Banks must ensure that appropriate personnel are trained in applicable aspects of the BSA. Training should include regulatory requirements and the bank’s internal BSA/AML policies, procedures, and processes. Holding training annually may not be enough. Training should be ongoing and incorporate current developments and changes. Training and testing materials, the dates of training sessions, and attendance records should be maintained by the bank.

Vivek Agarwal, CPA, CFE, CISA, specializes in governance, risk and compliance services for Withum, Smith+Brown. 22 | Banking New York


INGREDIENT # 5: SYSTEM OF INTERNAL CONTROLS Internal controls are the bank’s policies, procedures, and processes designed to limit and control risks and to achieve compliance with the BSA. The level of sophistication of the internal controls should be commensurate with the size, structure, risks, and complexity of the bank. Some key elements the internal controls should cover are as follows: • Identification of high risk business operations • Program continuity despite changes in management • Meet regulatory record keeping and reporting requirements • Filing of reports such as suspicious activity reports (SARs) and currency transaction reports (CTRs) • Segregation of duties • Customer identification program and customer due diligence • Information sharing with regulators and board of directors

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INGREDIENT # 6: PERIODIC INDEPENDENT TESTING Independent testing should be conducted by the internal audit department, outside auditors, consultants or other qualified independent parties. A sound practice is for the bank to conduct independent testing generally every 12 to 18 months, commensurate with the BSA/AML risk profile of the bank. The most important factor here is that the review or audit be performed by an independent and objective third party. The persons conducting the BSA/AML testing should report directly to the board of directors. The audit should be risk based and evaluate the effectiveness of the BSA compliance program. ■

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FALL 2011 | 23


Compliance | By Stephen R. King

Risk Management Programs More Necessary than Ever

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ommunity financial institutions are feeling as much pressure as their larger counterparts to comply with the Dodd-Frank bill's more than 10,000 pages of new regulations. This and the sheer number of major regulatory changes (more than 10 each year) are increasing the need to have in place an efficient and nimble risk management programs and a strong risk manager. Today, community financial institutions must focus on putting in place the most effective risk management program possible, and to support their risk officer, in order to attain their business goals, successfully introduce new products, and remain compliant with a growing number of regulations. Risk assessment is a relatively new science that is growing, changing and becoming more important every day. But some institutions are still stuck in older, less efficient models of risk assessment. Some of the pitfalls that exist in poorly executed risk management programs are: • Lack of support for the program and risk officer from the C-suite. • An approach that is too complex and is inconsistent across the institution • A cumbersome program that identifies too many risks and threats. • A silo approach to risk management that is not integrated throughout the institution. Your risk management program should serve your institution by keeping you in compliance while allowing you to stick to your business goals. There are four factors that should be part of any plan: CONSISTENCY – This is vital to a well-oiled risk management program. To counter confusion and inefficiency, an institution should define an assessment methodology with consistent measures that everyone performs. This methodology should start from the business line and then be applied across the institution for the best performance.

24 | Banking New York

FROM THE BOTTOM – The most sensitive receptors for assessing risk at your institution exist at the business line, where the products and services are. Building your risk management program from the bottom up – from the business line to the board level – will ensure that all potential threats and risks are considered and covered. It will also provide a consistent set of measures needed for your risk management program. KEEP IT SIMPLE – It’s important that the entire institution operates in line with your risk management program, and clear communication is key to making this happen. Your risk management program should be explainable to the board down to the most junior associates within your organization so it is embraced and implemented at all levels. CURRENCY – The regulatory and business climate is changing faster than ever before. To ensure that your risk management program is always providing security and maximizing profitability, it is essential that your institution and risk officer are always current on the latest regulations and that the risk assessment is constantly evaluated based on these changes. A good risk officer is one that is always proactive in implementation and maintenance of the program so that it never grows out of date, which increases risk and the potential for losses. Equally important to having a solid risk management plan in place is giving your risk officer more power to effectively and efficiently manage your institution’s program. In the last five years, the risk officer has emerged as a powerful asset in successful financial institutions. And there is good reason for that. The risk officer is there to understand the regulations and their impact on the bottom line and to find solutions that will allow the institution to pursue its business goals while remaining in compliance. A strong risk officer also serves an important role as a liaison between the board, the C-suite and the business lines. When the board has an idea that makes the business line nervous and vice versa, the risk officer is the one that finds the best solutions. Overall, if allowed to flourish, the


ATM FEE LAWSUITS 

risk officer can serve the institution in many ways as an analyst, leader, facilitator, communicator and visionary. Although the regulatory environment is the toughest it’s ever been and risks have increased, community institutions should not shy away from setting high goals for providing the best products available for their customers or increasing profitability. With an effective and nimble risk management plan in place and a strong risk officer at the helm, your institution can survive the current regulatory environment and plan for success in the future. ■

the act and regulations and/or good faith effort; and “act of God;” technical malfunction; and vandalism. Standard litigation defenses are also normally raised, including contract, consent, acquiescence, ratification, notice, laches, a one-year statute of limitations, waiver and estoppel. The ultimate success of any one or more of the defenses identified is case and fact specific. Having an EFTA compliance program in place is essential to helping an ATM operator avoid the act’s pitfalls. Regular inspections of ATMs, and keeping a log of those inspections, drastically closes the possible window of non-compliance and, in fact, assists the ATM operator with its compliance/ good faith effort defense. Many financial institution branches have compli-

Stephen R. King, JD, AMLP, is director of Wolf & Company’s regulatory compliance service group. He can be reached at (617) 428-5448 or sking@wolfandco.com.

continued from page 6 ance programs in place whereby they inspect the machines outside of their branches daily or weekly, and stockpile exterior notice stickers that they can easily apply to a non-compliant machine once discovered. Simply rolling over when presented with a claim is unnecessary where an effective compliance program is in place. EFTA cases are normally lost where a compliance program is not in place, is not regularly followed, or is missing an essential element such as logging the inspections performed. Under those circumstances, the ATM operator may consider looking to its errors and omissions insurance carrier for coverage, especially if a compliance program was in place, but not consistently followed. ■

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FALL 2011 | 25


Compliance | By James Adams

Of Ants and Allowances

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he fables of Aesop have been relayed to countless schoolchildren over the millennia since the Greek storyteller first told them in the sixth century BCE. Whether human, animal or elemental, Aesop’s characters never fail to impart a profound moral lesson. The Boy Who Cried Wolf relates the consequences of lost credibility; The Tortoise and the Hare teaches the importance of managing for the long run instead of the short; The North Wind and the Sun depicts the efficacy of persuasion over force. Aesop poignantly illustrates another principle in the fable of the ant and the grasshopper. The former insect, who is laying up food for winter on a summer day, is challenged by the latter. “Why bother about winter?” says the grasshopper. “We have plenty of food right now.” The wise ant ignores him and resumes his labors. The winter finds the grasshopper dying of hunger as he observes the ant colony feasting on stores it had previously collected. (A 1934 Walt Disney cartoon presents a happy epilogue in which the ants revive the starving grasshopper, who displays his gratitude for their charity by entertaining them with a fiddle concert.) Whether we’re considering the original, sober ending or the cheerier Disney version, the moral of the story remains the same: if one expects to survive adverse weather, appropriate provisioning is essential. However, Aesop fails to address a very important question: How did the ant colony know how much food it would need to sustain itself through the winter? Notwithstanding their work ethic and general foresight, if the ants had miscalculated the required amount of food storage, they might have met the same fate as the 26 | Banking New York

grasshopper (albeit later in the season). Like the ant colony enduring the winter snow, a bank’s ability to successfully weather a storm of loan losses depends on making adequate provisions beforehand. Clearly, the ants’ calculation is much more straightforward: knowing the size of the colony, the daily food consumption per ant, and the expected duration of winter would enable the queen to make a fairly precise estimate. For bankers, the provisioning process for loan losses is decidedly more intricate – and infinitely more regulated. In December 2006, the four national bank regulatory agencies – the Office of the Comptroller of the Currency, the board of governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision, in conjunction with the National Credit Union Administration, issued an updated interagency policy statement on the Allowance for Loan and Lease Losses (ALLL) “to ensure consistency with generally accepted accounting principles (GAAP) and more recent supervisory guidance.” Originally referred to as “the reserve for bad debts,” the ALLL is a bank’s cumulative estimate of uncollectible amounts on its entire loan portfolio, excepting any loans carried at fair value or held for sale, and off-balance sheet exposures. Effectively, the ALLL serves as a buffer to absorb loan charge-offs as they subsequently materialize. At the end of each quarter (or more frequently if warranted), each institution evaluates the collectability of its loans. To the extent that the previous ALLL falls short of the current loan loss es-


timate, additional loss provisioning is made through the income statement. Regulatory guidelines dictate that each loan should be evaluated for impairment either on an individual basis (per FAS 114) or on a group basis (per FAS 5). To reliably assess the need for individual (FAS 114) loan impairments, banks should employ consistent – and dependable – monitoring and risk rating tools which flag underperforming, delinquent, or otherwise at-risk loans using contemporary data. Flagged loans can then be impaired using one of three methodologies. The process can be tedious, but it is fairly straightforward. Unfortunately, appraising potential impairments on pooled loans under FAS 5 jurisdiction is markedly more complicated. All loans not evaluated under FAS 114, as well as those loans determined not to be impaired by FAS 114 standards, should be grouped into pools of loans with similar risk characteristics and collectively assessed for impairment under FAS 5 guidelines. These homogeneous pools can be determined by loan purpose, collateral type, borrower type, or other criteria. Loss estimates are then typically derived by using historical charge-off rates as a baseline and making qualitative adjustments to reflect changes in lending policies and procedures, credit concentrations, credit quality, broad economic trends, and other factors. While granting bank managers considerable discretion in the relative weighting and magnitude of these qualitative adjustments, regulators have been unequivocal about the need for banks to develop, maintain and document “a comprehensive, systematic, and consistently applied process” for determining their loss allowance. Written policies and procedures, annually reviewed by bank boards, are to be implemented for both individual

and pooled impairment calculations. Grading individual loans, appropriately pooling others, and making intelligent qualitative adjustments are time-consuming endeavors. Currently, inefficient data gathering processes force many bank personnel to devote the majority of their ALLL assessment hours to assimilating data, rather than analyzing it. Providing sufficient documentation of the myriad assumptions employed in arriving at the ALLL estimate further complicates the procedure. Anecdotal evidence from the banking community confirms that the heat is on: Regulators are no longer satisfied by the same processes and methodolo-

gies which they deemed sufficient two years ago. Bankers need technological solutions that enable them to readily access contemporary data and document the analysis thereof in determining their allowances. Regrettably, none of Aesop’s original writings remain, leaving historians unsure whether or not he was the true author of his eponymous fables. But while Aesop’s existence is uncertain, the profundity of the fables attributed to him is unquestionable. After 2,400 years, the truism holds: provision wisely now, or pay later. Whether the consequence is hunger or regulatory reprimand, it’s unpleasant in either case. ■

James Adams is a senior analyst at Sageworks, a leading provider of credit risk Magner_4Prod_WarPubs_NY/MA/CenPt/CU:Layout 1 3/8/10 10:30 AM Page 1 management, loan loss reserve, and stress testing software to financial institutions.

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FALL 2011 | 27


Technology | By Kevin Travis

Making Sense of Mobile

W

ill the rapid adoption of smart phone technology assure the success of mobile banking? Is mobile banking just an extension of the Internet, or does it offer entirely new venues to interact with banking customers and generate revenues? These are critical questions at a time when many banks are gearing up to enter the mobile space. Amid the buzz about features and functionality, it is important to keep sight of potential revenueenhancing offerings and the customers who might actually use them. Banks face a critical balancing act. On the one hand, if they fail to invest adequately, they risk being left behind as the mobile device joins the Internet as a central conduit for the consumer banking relationship. On the other hand, scarce resources could be wasted on features and functionality that ultimately do not improve customer acquisition, retention or relationship profitability. In the second scenario, mobile would join a long list of “transformative technologies” (automated teller machines, interactive voice response, online banking) that, while significantly improving customers’ access and banking experience, produced little discernable uptake in banking revenues. Many banks seem resigned to that fate. While it is too early to declare that mobile will be a definite source of new opportunities for fee 28 | Banking New York

income, a recent Novantas consumer survey does provide some positive indications. Within the growing ranks of mobile aficionados, for example, we identified a select group of “ultra-connected” customers who defy the Generation Y stereotype. Having a more affluent profile and spanning the age brackets, the “ultra connected” customers are adept with all forms of consumer communications technology and are far more willing to undertake complex financial services transactions through remote channels. It puts a fresh slant on what an iPad could do, given the right banking apps and set of hands. There is a significant risk of undermining this opportunity by over-focusing on the Gen Y crowd. A marketing and configuration scheme that strictly appeals to the transient tastes of the young could be a turn-off for a more experienced, mature audience who potentially could make more extensive and financially meaningful use of mobile banking. One example is with financial advice. The Gen Y segment may be quite happy to seek guidance from “the cloud,” based on ratings, user comments and feedback from friends. But in providing and promoting this arrangement, for example through a social network link, the bank could be turning off the ultra-connected, a group that is hungry for more expert advice and that would be much more trusting of a personal advisor at the bank.


The upshot is that banks need to do far more homework on customers before rushing to market with mobile applications and innovations, particularly products that are expensive to build and complex to manage. In some cases, there is more ground to be gained with a generic, transaction-based offering that also appeals to people with the greatest potential to use mobile for high-value transactions. Once banks go beyond basic transaction capabilities and start looking at more complex mobile initiatives – such as partnering with third parties for social media-based offerings – there is a heightened risk of colliding with customer expectations if initiatives are not guided by accurate customer segmentation and targeting. Finding the right customers requires the bank to consider several different factors. Along with analyzing the current composition of the mobile customer base, the bank will want to anticipate future waves of customers drawn from different segments, most notably the broad group of people who currently remain wedded to branch/online banking but who could embrace mobile at some point. Then there are questions of brand positioning, competitive differentiation and a tailored marketing outreach. Such customer-informed navigation will only grow in importance as banks venture further into the new world of mobile banking and payments. Even for the bank that prides itself on innovation, that kind of stand-alone pull is only part of the equation. As more customer transactions flood through electronic channels, banks increasingly will be collaborating with merchants and other financial services providers, as well as new players, such as social networks and online affinity groups. In turn, success again will be heavily influenced by an ability to configure and position offerings in line with the needs of prime customer segments. To be sure, customer analytics may seem like overkill at a time when mobile banking seems to cost more than it earns for everyone except smart phone manufacturers (and they definitely have

their ups and downs as well). Steadily, however, more high-value transactions are migrating online, as underscored by Novantas research showing that nowadays, more than a third of consumers first seek financial advice via remote channels. From this perspective, it is not too

early to begin preparing for the day when the volume of high-value remote banking transactions goes from a trickle to a flood. For the many banks just now getting into the game, this calls for building a customer-informed mobile foundation that looks beyond features and functions du jour. ■

Kevin Travis is a partner in the New York office of Novantas LLC, a management consultancy.

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FALL 2011 | 29


Small Change

Front row, left to right: Peter M. Boger, trustee, president and COO; Rudolph J. Stutzmann, trustee emeriti; Lydon Sleeper, chief of staff for Councilperson Elizabeth Crowley; William C. McGarry, trustee, chairman and CEO; Melva Miller, director of economic development, Office of the Queens Borough President; Mary A. Ledermann, trustee; Donald E. Henn, trustee emeriti; and Donald Sullivan, trustee emeriti. Bank row, left to right: Henry A. Braun, trustee; Robert W. Donohue, trustee; Margaret Mary Fitzpatrick, trustee; James J. Dixon, trustee; and Michael A. Agnes, trustee.

RIDGEWOOD SAVINGS BANK CELEBRATES 90TH ANNIVERSARY Ridgewood Savings Bank celebrated its 90th anniversary with a reception held at its main office at 71-02 Forest Ave. in Ridgewood on June 28. In honor of the anniversary, a proclamation from the Office of Queens Borough President Helen Marshall officially declared June 28 as Ridgewood Savings Bank Day in Queens. In addition, Lydon Sleeper, chief of staff of the Office of City Councilperson Elizabeth Crowley, awarded Ridgewood Savings Bank with a citation. David Renz, community liaison for the Office of State Assemblyperson Catherine Nolan, as well as Tom Weisfeld, assistant deputy superintendent of banks for the New York State Banking Department, were also in attendance. Since its inception, Ridgewood Savings Bank has grown to become the largest mutual savings bank in New York state, with 35 branches serving customers throughout the five boroughs, Long Island and Westchester County.

30 | Banking New York

STERLING NATIONAL APPOINTS TWO BRANCH MANAGERS Sterling National Bank announced that Jorge LaCourt and Shepherd Baum have joined the Sterling team as vice president branch managers. LaCourt will oversee the productivity of the Long Island City branch, while Baum will oversee the productivity of the Jamaica branch. Prior to joining Sterling, LaCourt spent over five years in a leadership role at a major national bank where he was responsible for a sales team and customer service personnel. His experience includes business development and sales coaching. LaCourt earned his bachelor’s degree from Vanderbilt University. Prior to joining Sterling, Baum worked at two major national banks, one for whom he served as the assistant branch manager where he was responsible for achieving branch sales goals and helping to increase the bank’s core deposits. In addition, his duties were to train and track the performance of a 30-person team. Baum earned his bachelor’s degree from University of Maryland.


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Banking New York Fall 2011