335

The Meeting of the Advisory Committee on Community Banking

of the

Federal Deposit Insurance Corporation

Held in the Board Room

Federal Deposit Insurance Corporation Building

Washington, D.C.

Open to Public Observation

July 10,2015 - 9:00 A.M.

The meeting of the FDIC Advisory Committee on Community Banking ("Committee")

was called to order by Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation

("FDIC") Board of Directors.

The members of the Committee present at the meeting were: Cynthia L. Blankenship,

Vice Chairman and Chief Operating Officer, Bank of the West, Grapevine, Texas; Pedro A.

Bryant, President and Chief Executive Officer ("CEO"), Metro Bank, Louisville, Kentucky;

Roger Busse, President and CEO, Pacific Continental Bank, Eugene, Oregon; Leonel Castillo,

President and CEO, American Bank of Commerce, Provo, Utah; Jack Hartings, President and

CEO, The People Bank Corp., Coldwater, Ohio; Jane Haskin, President and CEO, First Bethany

Bancorp.,.Inc., Bethany, Oklahoma; Mark Hesser, President, Pinnacle Bank, Lincoln, Nebraska;

James Lundy, CEO, Western Alliance Bank, Phoenix, Arizona; Arvind Menon, President and

CEO, Meadows Bank, Las Vegas, Nevada; Mary Ann Scully, Chairman, President and CEO,

Howard Bank, Ellicott City, Maryland; David Seleski, President and CEO, Stonegate Bank, Fort

Lauderdale, Florida; John Tolomer, President and CEO, The Westchester Bank, Yonkers, New

York; and Derek Williams, President and CEO, Century Bank and Trust, Milledgeville,

Georgia.

Christopher Emmons, President and CEO, Gorham Savings Bank, Gorham, Maine, and

Gwen Thompson, President and CEO, Clover Community Bank, Clover, South Carolina, were

absent from the meeting.

Corporation staff who attended the meeting included: Willa M. Allen, Ruth R. Amberg,

Steven o. App, Bobby R. Bean, Richard A. Brown, John P. Conneely, Joni Creamean, Carolyn

D. Curran, Christine Davis, Nancy DelCastillo, Kareem T. Dorsey, Doreen R. Eberley, Diane

Ellis, Lisa K. Ennis, Sarah E. Faust, Jeffrey S. Follis, George E. French, Janet R. Gordan,

Shannon N. Greco, Matthew Green, Robert D. Harris, Craig R. Jarvill, Penny B. King, Geneva

B. Kropper, Michael E. McGarvey, Roberta K. McInerney, Rae-Ann Miller, Robert W. Mooney,
336

Mark S. Moylan, Christopher J. Newbury, Richard Osterman, Mark E. Pearce, David W. Riley,

Claude A. Rollin, Barbara A. Ryan, Robert F. Storch, James C. Watkins, and Charles Vi.

William A. Rowe, III, Deputy to the Chief of Staff and Liaison to the FDIC, Office of the

Comptroller of the Currency, was also present at the meeting.

Chairman Gruenberg welcomed the Committee members and participants and provided

an overview of the meeting agenda. He noted that the first panel would provide an update on the

FDIC's Community Bank Initiative and the technical assistance videos that were being prepared

for release, followed by a discussion of the FDIC's research project on closely held banks; and

that the next two panels would provide an overview of the EGRPRA process focused on the

issues of exam frequency and offsite monitoring, and of the work being done by the Federal

Financial Institutions Examination Council ("FFIEC") to streamline the Call Report. After a

recess for lunch, he continued, the first panel of the afternoon session would discuss the FFIEC's

new cybersecurity tool; that the next panel would discuss the treatment of high volatility

commercial real estate for supervisory and capital purposes; and the final afternoon panel would

focus on recent rulemakings, particularly the small bank pricing rule recently proposed by the

FDIC for deposit insurance assessments and a recent joint final rule on flood insurance.

Chairman Gruenberg then introduced Barbara Ryan, Chief of Staff, Deputy to the Chairman and

Chief Operating Officer, moderator for the day's proceedings.

Ms. Ryan introduced Doreen Eberley, Director, Division of Risk Management

Supervision ("RMS"), Diane Ellis, Director, Division of Insurance and Research ("DIR"), and

Richard A. Brown, Associate Director and Chief Economist, DIR, the panelists for the first

panel, "Update on the Community Bank Initiative." Ms. Eberley began with a discussion of

RMS's efforts to provide technical assistance to community banks, noting that RMS has

developed a cybersecurity awareness training program to be presented to bankers in each of the

FDIC's regional offices and, simultaneously, by teleconference or webcast; that a portion of the

cybersecurity awareness training presentation would be developed into a "Cybersecurity 10 1"

technical assistance video, which would discuss topics such as the cybersecurity threat

environment, how to detect and address threats, and risk management controls; that a vendor

management video would be available by the end of the year; and that RMS' s interest rate risk

and corporate governance videos were being updated. Ms. Eberley also discussed the

development of a director's handbook that would be a practical guide for bank directors in

carrying out their duties by providing resources on a variety of topics, including directors' duties

of care and loyalty, corporate governance, risk management, business plan development,

strategic planning, and supervisory examinations.

Next, Ms. Ellis recalled that the FDIC intended to pursue research on four topics related

to community banks: mutual institutions; cost functions or economies of scale within community

banks; structural profitability; and closely held institutions. She noted that the research on

closely held institutions had generated a great deal of interest and input from Committee

members, and that Mr. Brown would report on the preliminary results.

Mr. Brown began by noting that small, closely held banks may face some unique

challenges relating to their size, limitations on their access to capital, succession planning, and

July 10,2015
337

difficulties in recruiting talent; and that, at the same time, these institutions may have some

unique opportunities due to their competitive strength in smaller communities, which may offer

some degree of insulation from the quarter-to-quarter demands of the capital markets. He

explained that the FDIC designed a short examiner survey to gather information on closely held

banks; that the survey covers FDIC-supervised banks in the Kansas City, Chicago, and Dallas

regions that were examined in 2014 and early 2015-representing about one-third of FDICinsured institutions in these regions and more than 20 percent of all FDIC-insured institutions

nationwide; that the survey collected information going back five years on ownership structure,

operational control, and management succession; and that the survey information would be

combined with Call Report data to provide some basic operational and performance comparisons

of closely and widely held banks. He briefly discussed some of the preliminary information

from the survey, noting that about three-fourths of the FDIC-supervised banks examined were

considered closely held-which, overall, may not be a representative sample because the 1,400

banks in these three regions probably have a higher than average prevalence of community or

closely held banks; that the most common organizational structure for both closely and widely

held banks was a single bank holding company, with 73% ofthe closely held banks having this

structure; that ownership and control were tightly aligned at about 61% of closely held

institutions; and that about one-half of closely held banks had identified a successor from within

the organization, while a substantial percentage were considered not to be well positioned to

recruit qualified management talent from the outside. In summary, Mr. Brown noted that the

preliminary survey results demonstrated that management succession was an issue facing a

substantial number of community banks-both closely and widely held.

In response to Member Hartings asking how it was determined that institutions would

have difficulty with succession planning and recruiting management from the outside, Mr.

Brown explained that the examiners asked questions of bank management regarding succession

planning, and used their judgment based on their knowledge of the institutions and the local

areas. Member Hesser asked how much of the inability to recruit successors could be attributed

to geographic factors and the inability to recruit bankers to community banks in rural areas. In

response, Mr. Brown indicated that geography appeared to be a factor, and that additional data

would need to be analyzed to determine if there was a correlation to rural counties. Member

Blankenship agreed that this was most likely a factor, adding that attracting talent to rural areas

has been difficult for institutions in small rural areas.

Mr. Brown continued, advising that the preliminary survey information indicated that

closely held banks were more likely than widely held banks to be agricultural specialists or

nonspecialist lenders; that closely held community banks rely more on retained earnings as a

source of capital; and that closely held banks were relatively frequent raisers of external capital

over the past five years. He noted that the five year period used for the survey may not be a

typical period of time with respect to raising external capital, since there was a need to raise

external capital during this period and federal programs to assist in doing so; and that widely

held banks may have benefitted more from participation in the TARP and SBLF programs than

closely held banks, but closely held banks were still able to raise capital. He briefly discussed

other observations from the survey results, noting that closely held banks appear to have had

stronger earnings performance than widely held banks over the last five years; and that closely

July 10, 2015
338

held banks have slightly lower efficiency ratios than widely held banks, which indicates an

inherent performance advantage.

In the discussion that followed, Committee members offered a number of comments and

suggestions. Member Scully began by asking about the difference between closely held and

widely held banks in terms of growth rates. In response, Mr. Brown explained that there were no

dramatic disparities in this category. Member Seleski asked if there was a trend over a period of

time based on when the institutions were formed or structural changes. Mr. Brown responded by

noting that, unexpectedly, closely held banks have done more acquisitions within the last five

years than widely held banks, although they generally acquired smaller institutions. Member

Hartings suggested that closely held banks may look at earnings differently and tend to be more

conservative; and that they potentially pose less risk to the Deposit Insurance Fund, which

should be taken into account for purposes of their CAMELS ratings. In response, Ms. Eberley

advised that earnings, risk, and management were taken into account, emphasizing that the

CAMELS ratings are based on an individualized analysis of the quality of an institution's

earning stream and the risk profile of its asset base.

Member Lundy suggested that an area for further research may be the risk that closely

held community banks face when expanding into different geographical markets; and that, in the

Phoenix, Arizona, area, where a few large banks dominate the market, new banks entering the

area are forced to go after a very small piece of the market, increasing the likelihood that these

banks would be driven towards riskier investments. Mr. Brown noted that the FDIC has found

that banks changing strategy in the early 2000s from business lines such as agricultural,

diversified nonspecialist lending, and mortgage lending to other niches such as commercial real

estate were more likely to fail than other community banks; and that changes in geography may

be a factor that merits further research. Member Blankenship suggested that merger and

acquisition activity was another area to be considered for further research, specifically to

determine what type of institutions are doing acquisitions and what types of institutions are being

acquired.

Member Busse asked whether the strategic planning part of the examination process takes

into account proper succession planning, since that could force merger and acquisition activity,

as well as a possible change in the institution's market and strategy. In response, Ms. Eberley

said that the evaluation of management and succession planning has been a standing part of

examinations. With respect to the future of community banks and management succession,

Member Bryant observed that there are fewer training programs for smaller community banks;

and that bringing someone into a community bank who has had training from a much larger

institution does not ensure that the person would be prepared to run a community bank. Member

Seleski opined that the bankers association meetings and other educational opportunities were

useful, but that they could not replace a formal commercial banking training program followed

by years of experience working in different areas of a bank.

Chairman Gruenberg commented that this research sheds some light on both the current

state of the industry and the implications for its evolution going forward. He asked if it would be

feasible to look back over the last 10 to 20 years at the absolute numbers among community

banks to gain some understanding of the breakdown between closely and widely held institutions

July 10,2015
339

and how their ownership has changed over time. In response, Mr. Brown explained that staff

was fairly confident in the analysis looking back five years, but that the analysis of closely held

institutions would get more difficult going further back in time.

Ms. Ryan then introduced the next panel, "Examination Frequency and Offsite

Monitoring," with Ms. Eberley and James C. Watkins, Senior Deputy Director, RMS, who

would provide an overview of the history of examination frequency, the evolution of the

examination process, and an overview of how the examination process has been complemented

by the FDIC's offsite monitoring program.

Ms. Eberley began with a brief summary of the FDIC's statutory authorities to conduct

examinations and undertake enforcement actions. She outlined the FDIC's examiner training

and commissioning program, noting that it involved an extensive corporate training program that

included rotations working in each of the FDIC's business divisions, formal training through five

bank examiner schools, and on-the-job-training. She briefly described the history ofthe

examination frequency, noting that, prior to 1976, all institutions were required to have an annual

examination; that, in the late 1970s to early 1980s, the examination cycle was significantly

extended, reflecting a focus on monitoring the risk in the largest institutions and the increased

use of offsite monitoring; and that, beginning in 1991, Congress mandated annual examinations,

with an 18-month cycle for well-rated, well-managed institutions with assets of less than $100

million-that threshold subsequently was increased to $250 million, and then increased again to

the current threshold of $500 million. She continued, noting that the examination process has

evolved from one where examiners would show up for examinations without advance notice to

more risk focused examinations, with the institution being given advance notice to allow time for

pre-examination work prior to the onsite exam; that the CAMELS rating system was updated in

1996 to be more risk-focused; that, beginning in 1997, the FDIC formally adopted a risk-focused

supervision program, began disclosing component ratings to provide the bank an opportunity to

fix potential problems before the next examination, and adopted a continuous examination

program for banks with more than $10 billion in total assets; that, in 2002, the post-examination

banker survey was updated to improve the communication between examiners and bankers about

how the examination process was working; that, in 2010, the FDIC adopted forward looking

supervision; that, in 2013, the FDIC tailored its pre-examination request list in response to

feedback from institutions; and that, currently, the FDIC has been updating the information

technology examination work program to more specifically address cybersecurity threats.

Before turning the discussion over to Mr. Watkins, Ms. Eberley emphasized that the examination

process now consists of a combination of onsite examinations-starting with pre-examination

planning and information requests, followed by a two to three week onsite visit and exit meeting

with management, and, finally, a report of examination-and offsite surveillance.

Mr. Watkins then provided further detail regarding how the FDIC's examination process

incorporates the offsite monitoring program, noting that there are two types of offsite monitoring

activities: (1) those that occur routinely between examinations, and (2) those that occur

immediately prior to, or following, examinations. He explained that offsite monitoring programs

provide early warning signals that an institution's risk profile may be changing; that the FDIC

has developed a number of offsite monitoring tools using data from a bank's Call Reports, which

are analyzed to identify trends; and that one of the fundamental tools used for offsite monitoring

July 10, 2015
340

was the Uniform Bank Performance Report, which contains valuable comparative group

statistics and percentile ratings for banks segregated into peer groups. He noted that these offsite

monitoring tools help guide pre-examination planning and aid examiners in developing the initial

information request list; that, in 2013, the FDIC launched an electronic pre-examination planning

package, which helps to reduce the size of information requested by ensuring that request lists

are tailored to the particular characteristics ofthe institution; and that, typically, one-third ofthe

examination time was spent offsite, either in pre-examination planning or post-examination

activities. Mr. Watkins concluded by emphasizing that the FDIC has several supervisory

initiatives relating to examinations, including: identifying and implementing changes to improve

the efficiency of the examination processes; providing technical assistance and other information

to bank directors, officers, and employees on areas of supervisory focus and regulatory change;

and identifying other opportunities to eliminate unnecessary regulatory requirements or address

burden issues.

Following the panel's presentation, Committee members provided a number of comments

and suggestions. Noting that the examination process experience has become significantly less

disruptive over the years, Member Blankenship asked about the communication between the

FDIC's bank examiners and state bank examiners, since there does not appear to be many

redundancies. In response, Ms. Eberley explained that the FDIC may accept a state examination

report on an alternating basis to meet the 12- or 18-month schedule, and that the FDIC's field

examiners coordinate and work closely with the state examiners. Mr. Watkins added that state

examiners often attend the wrap-up sessions or meetings with the bank's board of directors at the

conclusion of an examination. Member Castillo asked if the offsite monitoring tools and reports

identifying areas of concern could be shared with the banks. In response, Mr. Watkins noted that

the FDIC has not published all of its monitoring tools, emphasizing that many of them are

centered on identifying growth trends and changes; that staff are encouraged to contact a bank

when changes are identified that make it an outlier in one of the FDIC's programs; and that the

tools are a means of identifying trends and do not necessarily affect the CAMELS ratings. Ms.

Eberley noted that, typically, the case manager would call the bank during the quarterly offsite

review process and communicate any concerns raised in one of the offsite reports.

Member Bryant commented that taking a proactive approach of discussing any changes

in the bank's balance sheet with examiners, either immediately before or after submitting the

Call Report, has been very beneficial. Noting the improvements in technology, Member Haskin

asked ifthe FDIC envisioned a time when the entire examination would be done offsite. Ms.

Eberley responded by emphasizing that, while technology would enable the FDIC to do more

offsite monitoring and potentially minimize the time spent onsite, the face-to-face

communication between examiners and management during the onsite exam process was crucial

to the process; and that, for that reason, examinations would never be done completely offsite.

Member Hartings asked whether the $500 million threshold was still appropriate for the

18-month examination schedule, suggesting that the FDIC's resources may be better served by

focusing on the three-, four-, and five-rated banks rather than the one- and two-rated banks. He

also asked how much the bank's risk rating was based on industry risk versus institution risk. In

response, Mr. Watkins agreed that it was important for the FDIC to spend more time at three-,

four-, and five-rated banks, but that it was also important, as a preventative measure, to spend

July 10, 2015
341

time identifying and addressing concerns at the one- and two-rated banks; and that, with regard

to the risk ratings, the examination process was designed to focus on areas of greatest risk,

particularly if a bank's focus has concentrated on a business line that has an elevated risk. Ms.

Eberley added that the lessons from the crisis of the 1980s and early 1990s highlighted the

importance of examining risk from both the macroeconomic and the microeconomic perspective;

and that the FDIC has been both bank-centric and industry-focused in evaluating risk.

Ms. Ryan then announced that the meeting would briefly recess. Accordingly, the

meeting stood in recess at 10:49 a.m.

* * * * * * *

The meeting reconvened at 11:04 a.m. that same day, at which time Ms. Ryan introduced

Robert F. Storch, Chief Accountant, RMS, to present the third panel, "FFIEC Recommendations

re: Call Report Streamlining," which would provide an update on activities underway to reduce

burden associated with the Call Report requirements for community banks.

Mr. Storch began by explaining that the FFIEC had accepted the recommendations

presented by the Task Force on Reports and directed it to launch a formal initiative to identify

potential opportunities to reduce burden associated with Call Report requirements for community

banks; and that the Call Report burden initiative identified five action areas: (l) implementing

burden-reducing revisions to the Call Report; (2) accelerating the start of the next statutorily

required review of the existing Call Report data items; (3) assessing the feasibility of a potential

community bank Call Report; (4) promoting industry dialogue to gain an understanding of the

significant sources of Call Report burden; and (5) providing Call Report training for bankers. He

noted that the Task Force developed a set of guiding principles to serve as the basis for

evaluating potential additions and deletions of data items to and from the Call Report; that the

first principle provides that Call Report data items should serve a long term regulatory or public

policy purpose that assists the FFIEC member entities in fulfilling their missions, which include

ensuring the safety and soundness of financial institutions and the protection of consumer rights,

as well as agency-specific missions that affect all institutions, such as deposit insurance,

financial stability, and monetary policy; that the second principle acknowledges the balance that

must be struck between maximizing the practical utility of the data items collected and

minimizing, to the extent practicable and appropriate, the burden on institutions; and that the last

principle seeks to ensure that the data items equivalent to those in a Call Report are not otherwise

readily available to the FFIEC member entities through other means. He explained that, in

general, any change to the Call Report would need to satisfy all three guiding principles, with the

understanding that there may be situations where there was a legitimate need or statutory or legal

requirement for certain data items.

Turning to the five action areas identified by the Call Report burden initiative, Mr. Storch

explained that, as one action, the Task Force had prepared a Federal Register notice requesting

comment on several burden-reducing changes and certain other proposed Call Report revisions;

and that the notice would be published at a later date for comment following review by the

agencies' senior management. He noted that, as a second action, the agencies have accelerated

the start of the next statutorily-mandated review of existing Call Report data items, which

July 10,2015
342

otherwise would have commenced in 2017 rather than 2015; that users of Call Report data items

in the various functional areas of the FFIEC member entities are participating in a series of

surveys over an 18-month period beginning in July 2015; that the surveys ask the users to

identify each data item that they use and to explain their need for the item, how they use it, how

often it was used, and the population of institutions from which it was needed; that the Call

Report schedules are being surveyed based on the perceived burden, as cited by the banking

industry; and that, based on the survey results, the Task Force would identify data items to be

considered for elimination, less frequent collection, or new or upwardly revised reporting

thresholds. With respect to the third action item, Mr. Storch reported that the Task Force was

assessing the feasibility of creating a less burdensome version of the Call Report for community

banks, which may be defined as institutions with less than $1 billion in total assets, or based on

other indicators such as bank activities; that the Task Force has begun reviewing data items that

could be eliminated or otherwise restructured from the Call Report for community banks without

a loss of information necessary for supervisory or other public policy purposes; that the Task

Force planned to present its findings on the feasibility of introducing a less burdensome Call

Report for community banks to the FFIEC by the end of2015; and that, if approved, the Task

Force would then begin taking the steps necessary to implement this new version of the Call

Report. He continued, noting that, as an initial form of industry outreach action, the Task Force

would conduct onsite visits to a diverse group of nine community banks between July 2015 and

September 2015; that these banks would offer potential dates for a one- to two-day onsite visit,

during which each bank would explain and demonstrate its Call Report preparation process, and

identify the aspects of the process that contribute to reporting burden, including the manual effort

necessary to prepare and file the Call Report; and that, based on the findings from these onsite

visits, future industry outreach activities could include meetings with bankers and data

processors, as well as targeted requests for comment from the industry as a whole. Finally, with

respect to action on Call Report training, Mr. Storch noted that the agencies conducted a banker

teleconference on the revised Call Report regulatory capital schedule in late February 2015; and

that another banker teleconference has tentatively been scheduled for later in 2015 to discuss the

proposed burden-reducing and other Call Report changes.

In the discussion that followed, Member Blankenship commended the Call Report

initiative, noting that any amount of reduction in the burden would be beneficial; and that, while

banks generally wanted the agencies to have the information needed, there was probably some

information that was not being utilized by the agencies that could be eliminated; and that, after

the information categories were reexamined, it would be beneficial to seek bankers' perspectives

on the information gathering process to determine whether it was an automated or manual

process. In response, Mr. Storch explained that the intent of the survey was to challenge the data

users of various portions of the Call Report to identify areas where there was not a strong

justification for the information and to examine those areas for elimination; that the agencies

would consider whether the costs of a scaled-back version of the Call Report for community

banks would offset the benefits; and that the agencies would look to the industry to provide some

guidance on whether a scaled-back version of the Call Report would achieve a meaningful

reduction in burden. Member Williams agreed that requiring a justification of why certain data

was needed would be beneficial. Member Castillo suggested that adding a comments section on

the offsite reporting would be helpful, since it would allow banks an opportunity to reduce the

back-and-forth between the bank and examiners.

July 10, 2015
343

Ms. Ryan then introduced Roberta K. McInerney, Deputy General Counsel, Legal

Division, Ruth R. Amberg, Assistant General Counsel, Legal Division, and Mr. Watkins for the

next panel, "Update on the FDIC's Regulatory Review under the Economic Growth and

Regulatory Paperwork Reduction Act ("EGRPRA")," which would provide an overview of some

of the general themes that have been discussed at the EGRPRA meetings. Ms. McInerney

recalled that EGRPRA requires the banking agencies to review their regulations at least once

every ten years to identify any outdated or otherwise unnecessary regulations; that the FDIC's

last review was completed in 2006; and that the current review process underway would be

completed by 2016. She noted that, as part of the formal outreach process, the FDIC has divided

the regulations into categories and would publish four notices in the Federal Register seeking

public comment on several categories of regulations identified in each notice; that the third and

most recently issued of these notices was published in the Federal Register in June 2015, seeking

comment on three categories of regulations: consumer protection, directors, officers, and

employees, and money laundering; and that the final Federal Register notice would be published

at the end of2015, seeking comment on rules of procedure, safety and soundness, and securities

regulations. She briefly explained that, in response to the first two notices, the FDIC has

received 65 comments, which are currently being reviewed; that after the comments were

reviewed, a report would be prepared on whether certain regulatory elements can be amended or

eliminated; and that, as part of the EGRPRA review, the FDIC was holding six outreach sessions

across the country, seeking direct input from bankers.

Mr. Watkins reported that five recurring themes have emerged from the comments and

outreach sessions of the EGRPRA process: (1) Call Reports; (2) examination frequency; (3)

appraisal thresholds; (4) Bank Secrecy Act ("BSA") requirements; and (5) communication in the

examination process. He explained that bankers expressed a desire for streamlined Call Reports,

particularly for community banks; that many bankers were seeking fewer examinations and an

adjustment of the examination frequency requirements; that many bankers suggested raising the

appraisal threshold to $500,000; that many commenters suggested raising the Bank Secrecy Act

threshold and recordkeeping requirements, as well as allowing more exemptions from reporting;

and that a number of banks suggested improvements to the examination process, such as

maintaining open and regular lines of communication to ensure that supervisory expectations

intended for the largest banks are not applied to community banks.

Member Hartings opened the discussion following the panel's presentation, noting that

the FDIC's participation in the EGRPRA outreach and other initiatives have highlighted that

both the bankers and the FDIC were interested in making the supervisory process as efficient and

effective as possible. Member Lundy suggested that the FDIC consider adopting some of the

continuous examination ideas applied to larger banks to the examination processes for smaller

banks, which could result in more frequent, but less formal and burdensome, examinations.

Member Bryant commented that a 24-month examination schedule would be beneficial because

of the burden of the examination process on smaller banks. Mr. Watkins responded, noting that

the examiner's knowledge and background brings value to an examination that may not be

represented in the CAMELS ratings; and that, as a result, onsite examinations were helpful to

identify issues at an early stage when they may be easier to address.

July 10,2015
344

Member Williams commented that further consideration of the BSA thresholds was

important because institutions often spend a significant amount of time on reporting

requirements, without significant benefit in terms of reducing money laundering. Members

Blankenship and Hesser agreed, expressing their concerns that considerable time was spent

avoiding technical errors on compliance reporting that could lead to compliance issues; and that

it would be very beneficial if the error percentages could be increased. Chairman Gruenberg

responded by noting that BSA emerged as a significant concern during the FDIC's outreach

sessions; and that, because BSA enforcement was a FinCEN responsibility, it may be beneficial

to have FinCEN participate in further discussions. Member Hesser commented that the Home

Mortgage Loan Disclosure Act ("HDMA") reporting also was overly burdensome due to

concerns that technical errors could result in compliance issues. In response, Ms. McInerney

acknowledged these concerns, noting that the FDIC has raised the enforcement thresholds for

HMDA violations within the last year in an attempt to reduce the number of violations for

technical errors.

Ms. Ryan then announced that the meeting would recess for lunch. Accordingly, the

meeting stood in recess at 11:54 a.m.

*******

The meeting reconvened at 1:06 p.m. that same day, at which time Ms. Ryan turned the

discussion over to Ms. Eberley and Mark Moylan, Deputy Director, RMS, for the next panel,

"Introduction of Cybersecurity Assessment Tool," which would focus on the new cybersecurity

assessment tool recently released by the FFIEC.

Ms. Eberley recalled that one of the FFIEC' s priorities for 2015 was the release of a

cybersecurity self-assessment tool to assist institutions in evaluating their inherent cybersecurity

risk and risk management capabilities. She briefly guided the Committee through the use of the

cybersecurity assessment tool, explaining that the tool has two parts: an inherent risk profile and

a cybersecurity maturity model; that the inherent risk profile uses a matrix to help banks

determine the level of inherent risk of the institution in five different areas: technologies and

connection types, delivery channels, online/mobile products and technology services,

organizational characteristics, and external threats; and that the tool then determines the bank's

cybersecurity maturity and level of preparedness, which consists of five levels: baseline,

evolving, intermediate, advanced, and innovative. Ms. Eberley explained that there was no

specific level of preparedness being recommended; that the level would be based on the inherent

risk of the institution and its assessment of how the inherent risk aligns with the institution's

level or preparedness; that there are five dimensions of cybersecurity maturity that are measured:

cybersecurity risk management and oversight, threat intelligence and collaboration, cybersecurity

controls, external dependency management, and cyber incident management and resilience; and

that each of those five domains provides assessment factors. She explained that the inherent risk

profile and the level of maturity of an institution can be changed, noting that, for example, if an

institution finds it has a moderate level of risk and only a baseline level of preparedness, then

either the level of preparedness could be increased, or the level of risk reduced by eliminating

unnecessary internet connections or vendor contracts. She emphasized that the cybersecurity

assessment tool provides a description of what the expectations would be to move to a higher

July 10, 2015
345

level of preparedness, which can serve as a road map for developing a plan to move to the next

level; and that an institution considering the addition of a new delivery channel or

implementation of other actions that would change their profile should use the tool to recalculate

their risk assessment. Before turning the discussion over to Mr. Moylan to outline how the FDIC

would be formally introducing the cybersecurity assessment tool, Ms. Eberley noted that there

were a number of resources available on the FFIEC's website to assist banks in using and

implementing the tool, including a videotaped presentation on how to use the tool and a written

user's guide providing step-by-step instructions.

Mr. Moylan then explained that the FDIC planned to conduct a cybersecurity outreach

program, which would serve as a complement to the cybersecurity assessment tool; that the

FDIC's program would focus on the elements and sources of cybersecurity risk, as well as the

principles within the information security program to identify control and respond to

cybersecurity risks; and that the intent of the program would be to establish a culture of

collaboration between the institution's technical staff and its management. He advised that the

FDIC would begin holding a number of events for bankers in the FDIC's regional offices

beginning in August and early September 2015; and that the basic framework of the outreach

program would be made into a "Cyber 101" video that would be added to the FDIC's technical

assistance video library.

Ms. Eberley concluded the presentation by emphasizing that the cybersecurity assessment

tool was developed by the FFIEC in response to requests from bankers; that it was a voluntary

self-assessment tool that banks are not required to use; that the FDIC would be updating its

information technology ("IT") examination program used by the examiners; and that the FDIC

would begin using a new examination program that more explicitly discusses cybersecurity

preparedness in the examination process.

In the discussion that followed, Member Hartings noted that the tool itself was quite

lengthy and suggested that it may be helpful if the FDIC's outreach sessions focused on

examples for an institution with a moderate risk appetite to provide some indication of what the

expectations would be for that level of preparedness. In response, Ms. Eberley explained that the

agencies were aware of the size of the tool, which was one of the reasons for having a separate

Appendix A to provide current expectations. She also explained that the FDIC anticipates that

many institutions would be operating at the lower end of the risk profile spectrum, which would

allow them to more readily map the baseline statements. Mr. Moylan added that one of the

important aspects of the tool was management involvement in business continuity planning,

including how to respond to a problem and plan for restoration of business.

Member Hesser asked what examiners would be looking for in future. In response, Ms.

Eberley emphasized that the tool is voluntary for all FDIC-supervised institutions; and that it was

possible that cybersecurity would become a more explicit part of the FDIC's examination

program in the future. Member Castillo asked whether the cybersecurity assessment tool

included a component to assess the cybersecurity risk inherent in the institution's own personnel.

Ms. Eberley responded by noting that this issue was addressed in the training and culture

assessment factor of the tool. Mr. Moylan added that another element emphasized within the

cybersecurity assessment tool was threat intelligence-what that means and how to gather it; and

July 10,2015
346

that the FDIC's outreach program would discuss these elements from the perspective of the

management teams collaborating with IT staff to discuss potential risks and continuity planning.

Ms. Ryan then announced that the meeting would briefly recess. Accordingly, the

meeting stood in recess at 1:38 p.m.

* * * * * * *

The meeting reconvened at 1:47 p.m. that same day, at which time Ms. Ryan introduced

Bobby R. Bean, Associate Director, RMS, and David W. Riley, Senior Capital Markets

Specialist, RMS, to present the next panel, "High Volatility Commercial Real Estate

("HCVRE"). Mr. Riley began by explaining that HVCRE exposure refers to the fact that

commercial real estate values can change substantially over the economic cycle; and that the

agencies have assigned a higher risk weight of 150 percent to HVCRE exposures because, over

the years, HVCRE has had a higher loss rate and has been associated with the failures of

community banks. He noted that there are four categories within acquisition, development, and

construction loans excluded from HVCRE: one-to-four family residential projects, agricultural

loans, community development exposures, and development loans which meet certain criteriadevelopment loans are excluded if they have 15 percent cash equity from the borrower, the

equity contributions (including internally-generated capital) stay in the project, the loans must

meet the supervisory loan to value guidelines, and the hard equity should be cash or the cash

value paid for the land contributed to the project. Additionally, he noted that permanent loans

are not considered HVCRE. Noting that, in April of2015, the agencies released a list of

frequently asked questions on the HVCRE rule, Mr. Riley briefly described some of the most

commonly asked questions. He explained that a majority of the questions are related to the 15

percent equity contribution, particularly as it relates to appraised values; that the rule indicates

that the equity contribution should be hard cash or readily marketable assets, or the cash paid for

the land contributed to the project; and that the agencies have been reluctant to accept appraised

values for this purpose, because appraised values have been unreliable over the years as an

accurate measure of value. Next, he noted that questions frequently arise regarding who would

be considered the "borrower" for purposes of the rule; that the borrower would be the obligor on

the note; that the borrower could be a limited liability company or an individual, with the key

being that the borrower should have 15 percent hard equity in the project, or "skin in the game;"

and that the rule does not prevent an investor from having a loan. He also noted that banks have

requested more guidance regarding how to measure the 15 percent, especially in cases with a

revolving line of credit or where the project has several phases, and how to measure internally

generated capital; and that the agencies are currently trying to answer these questions. In terms

of how to determine whether a loan would be considered a permanent loan, he explained that this

was a qualification based on the bank's standards for underwriting long term mortgage loans,

which can vary from bank to bank; and that the agencies generally require that the loan meet the

bank's standards for a permanent long term mortgage.

In the discussion that followed, Committee members offered a number of comments and

suggestions. Member Haskin asked for clarification that a separate property taken as collateral

would not count as the 15 percent equity contribution. Mr. Riley answered affirmatively,

explaining that the agencies have determined that that would not count, unless the property was

July 10,2015
347

part of the same project. Member Haskin then asked if it would still be insufficient under the

rule where collateral was taken that resulted in a 50 percent loan-to-value ratio on the project.

Mr. Riley responded that the agencies have not accepted the collateral in that situation,

emphasizing that they want to ensure that the hard equity was there. Member Haskin

commented that he did not understand why the rule would assign a higher risk weight in that

situation, since real estate developers may not have cash but do have other pieces of free and

clear land that they want to use as collateral.

Member Tolomer suggested that a developer could obtain a loan against the land they

intended to use as collateral, and then put that down to meet the 15 percent cash requirement,

essentially resulting in the same end result but with added steps and additional risk. Mr. Riley

explained that the agencies were attempting to address these challenges, noting that they do not

want to create a situation that imposes extra burden to accomplish the same result, but that there

had to be a balance between creating extra burden and ensuring that the 15 percent hard equity is

there. Noting that the idea was to avoid the risk of overestimated appraisals, Member Williams

commented that the rule should be reconsidered because borrowers using additional collateral in

lieu of a cash down payment clearly have "skin in the game," since it involves property they

own. Member Lundy noted that a much more disciplined appraisal process has been in place

since the 1980s crisis; and that, while the appraisal process could be improved, the regulatory

community was doing itself a disservice by discounting appraisals. Member Seleski asked why

one-to-four family residential projects were considered lower risk, and what were considered

"community development loans." In response, Mr. Riley explained that the exception for one-tofour family residential projects was not made for risk considerations, but for broader economic

considerations; and that, for purposes of the rule, "community development loans" were loans to

provide affordable housing or used in the provision of community services for low to moderateincome individuals, or they revitalize or stabilize low- to moderate-income geographic areas.

Member Hartings explained that one of the most difficult parts of this rule for a

community banker was the discounting of appraisals, such as a scenario where a 50 percent loanto-value ratio on a loan for an addition technically falls under the HVCRE rule if it uses an ascompleted appraisal, even if the borrower has owned the building for ten years. In response, Mr.

Riley agreed that this scenario would be a low-risk loan, but would indeed be considered

HVCRE and assigned a higher risk rate under the rule, noting that the agencies were trying to

find a uniform way to avoid capturing these types of low-risk loans. Acknowledging that the

rule was intended to capture excessively appraised loans, Member Hartings suggested revisiting

the rule because it results in capturing a lot of other loans that are low risk loans. Member

Blankenship commented that the rule could have the unintended consequence of driving

customers to other funding sources, particularly in smaller communities where customers may

not have a lot of choice, which could impede economic development in those areas. Mr. Bean

responded, noting that the regulators were aware that this was an important issue, and that the

agencies wanted to get it right and implement it in a way that does not result in competitive

inequities between the different institution charters.

For the final panel of the meeting, "Recent Rulemakings," Ms. Ryan introduced Ms.

Ellis, Matthew Green, Associate Director, DIR, and Jonathan N. Miller, Deputy Director,

July 10,2015
348

Division of Consumer Protection, who would discuss the small bank pricing rule and recent joint

rulemaking on flood insurance.

Ms. Ellis began by briefly summarizing the small bank pricing proposal recently issued

by the FDIC, noting that it was a proposal to update the manner in which the FDIC charges

deposit insurance premiums for banks with total assets of less than $10 billion. She explained

that, under the current system, each small bank would be assigned to one of four risk categories

based upon their regulatory capital ratio and CAMELS composite rating; that one assessment

rate would be applied to all banks in the three worst categories; that, for the majority of banks,

which are one- or two-rated and well capitalized, there was a range of rates that would be applied

based on each institution's financial ratios and CAMELS rating; and that the underlying

approach for that model was a CAMELS downgrade prediction, which estimates the probability

of a one- or two-rated institution getting downgraded to a three-, four-, or five-rated institutionwhich was intended to be a proxy for bank failure. She noted that, when the current approach

was being developed in 2006, the FDIC had not had a significant number of bank failures for

quite some time and the CAMELS downgrade prediction appeared to be the best approach to

differentiate banks in the one- and two-rated categories as opposed to a failure prediction model;

that the new approach better captures risk with an underlying failure prediction model,

incorporating the failures from the most recent banking crisis, as well as the failures that

occurred in the late 1980s and early 1990s; that the new approach estimates failure over a threeyear period, as opposed to the current system which only looks at a one-year period; andthat one

measure added to the new system was the extent to which a bank's total assets include higher

risk categories of loans, which are defined as those loans that tended to fare poorly during

downturns, such as construction development loans. She explained that the other major change

to the approach used in the proposal was to eliminate risk categories; that, instead of assigning

all banks with less than $10 billion in assets to one of the four risk categories, financial measures

would be used for all banks; and that there was a proposal to put a ceiling on the rates paid by

one- and two-rated institutions, as well as a floor for the rates paid by three-, four-, and five-rated

institutions.

Ms. Ellis advised that the proposal would become effective when the deposit insurance

fund reserve ratio reaches 1.15 percent; that the FDIC had already built in an assessment rate

reduction to the current system where the assessment rates would drop by roughly two basis

points for most institutions; and that this new system would preserve that assessment rate

reduction and be revenue neutral in the aggregate. Regarding the proposal's effect on individual

institutions, she emphasized that the FDIC has estimated that, after the assessment rates decline,

92 percent of institutions would pay a lower rate, while eight percent would pay a higher rate

based on year-end 2014 data. She noted that the FDIC believes that the proposed system would

be a better, more accurate way of charging deposit insurance premiums, resulting in less crosssubsidization ofthe well rated institutions for the high risk institutions; and that the FDIC's back

testing has shown that the proposed system overall would be better than the current system,

particularly when things change and conditions are deteriorating. Ms. Ellis concluded by

advising that no changes would be required to the Call Reports because the proposed system

would rely on Call Report data currently being collected; and that the FDIC has made a

calculator available on its website to allow individual institutions to evaluate this proposal and

assess its effect on them.

July 10,2015
349

Committee members offered a number of comments and suggestions in the discussion

that followed. Member Tolomer began by commenting that the new approach would better

reward good behavior. Member Lundy observed that this approach could have broader

application, particularly with regard to how the FDIC looks at risk and the examination process.

Member Scully asked whether the FDIC was focused on the business model of the bank

rather its ability to execute that business model, suggesting that banks with a certain business

model would be penalized under the new approach, regardless of how well they executed that

business model. In response, Ms. Ellis noted that the FDIC did not take advantage of the

opportunity to incorporate something similar to a loan mix index when it put the current

assessment system in place; that, based on the experience of two significant waves of bank

failures, there are certain business models, funding models, and lending concentrations that result

in high levels of failure, as well as significant losses; that the new approach attempted to take

execution of the business plan into account whenever feasible, but doing so was limited by the

available data-which was a reason for the continued emphasis on the CAMELS ratings.

Member Scully responded by suggesting that this approach was inconsistent with other safety

and soundness measures since it was the only instance, from a safety and soundness perspective,

that banks with a particular business model would have to increase their levels of capital in order

to avoid paying a higher assessment. In response, Mr. Green noted that the rates would be based

on the combined effect of all of the measures; and that, under the set of overall rates currently

proposed, 80 percent of institutions would experience a decrease in their rates or pay the same

rates. Ms. Ellis also responded, emphasizing that there were multiple factors that all work

together in a balanced approach to affect assessment rates; that the bank could increase capital,

maintain a higher level of core deposits, or make other changes to affect their assessment rate;

and that the new approach charges higher rates for certain business models that create higher

risks. Chairman Gruenberg noted that this new approach was issued as a Notice of Proposed

Rulemaking, and that bankers are encouraged to comment on the proposal.

Next, Mr. Miller briefly discussed the joint final rule recently issued by the FDIC and

other agencies as part of recently enacted flood insurance laws. Noting that the joint final rule

would become effective in 2016, he explained that the new rule has three primary elements: (1)

escrow requirement; (2) detached structures; and (3) forced placement. Regarding the escrow

requirement, he advised that the new rule requires escrow of premiums and fees for flood

insurance for residential improved real estate or mobile homes originated, increased, extended,

refinanced or renewed on or after January 1, 2016; that the new rule was no longer retroactive

with regard to loans outstanding prior to January 1,2016; that there would continue to be a small

lender exception for institutions with assets of less than $1 billion; and that there would be other

exemptions for types of loans that would not need flood insurance, including, HELOCs,

condominium or co-op loans for individual units where the whole building has a flood insurance

policy; and subordinate loans. With respect to detached structures, he advised that there was a

new flood insurance exemption for structures that are part of a residential property but detached

from the primary structure and do not serve as a residence, such as a detached garage or other

structure. Finally, with regard to forced placement, Mr. Miller advised that the new rule (1)

clarifies that the lender or the servicer has the authority to charge a borrower for flood insurance

coverage once their coverage lapses or becomes insufficient, and (2) specifies when borrowers

July to, 2015
350

must receive notice, how long they have to reply, and when the lender or servicer must terminate

forced placement flood insurance and refund any outstanding payments.

In the brief discussion that followed, Member Hesser asked whether there was a time

period for borrowers to respond to forced placement of insurance. Mr. Miller responded,

indicating that he believed the consumer had 45 days to respond with evidence of insurance

coverage. Noting that the detached structures could be a significant issue in rural areas, asked

whether the detached structure exemption would be available in a situation where land was being

purchased for hunting and it had an old unused barn standing on the property. In response, Mr.

Miller indicated that it most likely would qualify for the detached structures exemption because

it was not a residence. Member Bryant commented that the clarifications on the technical

assistance videos were very helpful in understanding flood insurance.

Chairman Gruenberg thanked the attendees for their participation, noting that the

comments from the meeting were genuinely helpful. He emphasized that the new cybersecurity

assessment tool was an important initiative, and suggested that the Committee members may

want to provide some feedback at a future meeting on how the new tool was working.

There being no further business, the meeting was adjourned at 2:52 p.m.

~

Robert E. Feldman

Executive Secretary

Federal Deposit Insurance Corporation

And Committee Management Officer

FDIC Advisory Committee on Community Banking

July 10,2015
Minutes

of the

Meeting of the FDIC Advisory Committee on Community Banking

of the

Federal Deposit Insurance Corporation

Held in the Board Room

Federal Deposit Insurance Corporation Building

Washington, D.C.

Open to Public Observation

JulIO, 2015 - 9:00 A.M.

I hereby certify that, to the best of my knowledge, the attached minutes are accurate and

complete.

~.

Martin J. Gruenber

Chairman

Board of Directors

Federal Deposit Insurance Corporation