A Few New Details on the Blue Ridge Bankshares Capital Raise
Also: a small bank's argument against the Basel Endgame, a community bank venting session and Custodia expert reports
A little over a month ago, Blue Ridge Bankshares, Inc. (BRBS) announced in a quarterly SEC filing that it was “exploring options for raising additional capital.” This blog previously discussed this announcement, and the events leading up to it, here.
On Friday morning, BRBS announced that it has a deal. The company intends to raise $150 million through a private placement “led by Kenneth R. Lehman, a private investor with many years of experience investing in banks, with participation from Castle Creek Capital Partners VIII L.P.”
Following the completion of the private placement, on a pro forma basis Lehman is expected to own approximately 25% of BRBS and Castle Creek is expected to own approximately 12.5%. No new investors other than Lehman and Castle Creek will own more than 9.9% of the company.
Later in the day on Friday, BRBS filed an 8-K with the securities purchase agreement for the private placement. This post looks at a few of the regulatory-related provisions in the SPA and the associated disclosure schedules which, somewhat atypically, were also filed publicly along with the SPA.
MAE Definition - Exclusions for Certain Regulatory Actions
The definition of material adverse effect is often an area of focus in M&A negotiations. This is especially the case where, as here, the target company is already struggling at the time the agreement is signed.
Consistent with the typical approach, the MAE definition starts out by defining MAE broadly, and then provides a long list of exceptions qualifying that broad definition. In this transaction, the “effects disclosed in Schedule 1.1” of the disclosure schedules are among the exceptions referenced in the MAE definition.
The general principle of Schedule 1.1 is that additional regulatory enforcement actions against BRBS or Blue Ridge Bank will be deemed to be an MAE only if those enforcement actions impose restrictions on the business of the company or the bank that are “materially more restrictive and/or adverse” than those currently in effect. Schedule 1.1 goes as far as to list specific future actions a regulatory agency might take (“Specific Restrictions”) that would not be an MAE, unless those future actions have such materially more restrictive and/or adverse effects.
Schedule 1.1 then, however, also lists examples of future regulatory actions that would be deemed an MAE:
provisions ordering the Bank to take specific actions with respect to its lending activities (other than limiting new loans to fintech partners), loans, or asset quality;
provisions requiring the Bank to terminate any existing fintech or BaaS partnerships prior to the expiration of any contractual arrangements related to any such partnership;
additional capital requirements that are more restrictive than those set forth in the IMCR; or
additional restrictions on the business of the Bank not currently addressed in the existing formal agreement between the OCC and the Bank and the IMCR other than the Specific Restrictions.
Schedule 1.1 concludes by adding that, notwithstanding anything to the contrary in the SPA, the following events will be deemed an MAE: (i) any legal judgment or settlement (or enforcement action or notice of charges or other action seeking penalties) in excess of $10 million, individually or in the aggregate or (ii) BRBS being required to use purchase accounting treatment with respect to the transactions.
Regulatory Approvals; Efforts
The SPA defines the required regulatory approvals generically as all permits, consents, orders, non-objections, etc. as required from the Federal Reserve Board, the Virginia state banking regulator, or other governmental authorities.1
To obtain these approvals, no purchaser will be required to accept a Materially Burdensome Regulatory Condition, defined here as a condition that, in a purchaser’s reasonable good faith judgment, “would be materially financially burdensome on the Company’s business following the Closing or would reduce the economic benefits of the transactions contemplated by this Agreement to the Purchaser to such a degree that the Purchaser would not have entered into this Agreement had such condition or restriction been known to it at the date hereof.”
Closing Condition Tied to Regulatory Capital
One of the regulatory developments spurring BRBS to pursue this capital raising transaction in the first place is that Blue Ridge Bank is now subject to Individual Minimum Capital Requirements (IMCR) imposed by the OCC - i.e., capital requirements that are higher than those that otherwise generally apply to national banks under the current capital rules.
Under Section 5.1 of the SPA, the purchasers are not required to close the transaction unless Blue Ridge Bank’s regulatory capital (as adjusted to account for the anticipated effects of the transactions2) would be equal or greater to Required Regulatory Capital. The definition of Required Regulatory Capital takes into account, among other things, the IMCR.3
Possible Future Undertakings Tied to Regulatory Capital
In addition to the above closing condition tied to Blue Ridge Bank’s capital, the SPA also requires BRBS and Blue Ridge Bank to be well-capitalized and, if applicable, in compliance with any heightened regulatory capital requirements imposed by their regulators, for a defined period following closing.
Specifically, in the event that either BRBS or Blue Ridge Bank does not have regulatory capital in an amount equal to the Required Regulatory Capital, BRBS agrees to use commercially reasonable efforts to ensure that BRBS and/or Blue Ridge Bank come back into compliance as soon as practicable, “either promptly through commencing a capital raise or other means that are reasonably anticipated to restore compliance.”
This provision of the SPA applies for the next three years, “or any such shorter periods as specified in any regulatory enforcement action or otherwise required by the applicable regulatory authority.”
Other Details From the Disclosure Schedules
Two separate small details here:
Schedule 3.1(m) confirms that Blue Ridge Bank “has one or more pillar failures in its BSA program, which are violations of law under Section 8(s) of the Federal Deposit Insurance Act. The Bank continues to take actions to remediate its BSA program, including corrections of pillar failures.”
Schedule 3.1(j), disclosing against the absence of certain changes rep, says that BRBS is “undertaking efforts to increase brokered deposits and other wholesale funding by up to $100 million late in the fourth quarter of 2023 or early in the first quarter of 2024 to enhance its liquidity position.”
Outside Date
The SPA sets an outside date of 120 days from the December 21, 2023 date of the agreement. The 8-K filed by BRBS yesterday afternoon says that closing of the investment is expected by March 2024.
An Unusual Meeting About the Basel Endgame Proposal
For political and other reasons, if adopted as proposed the Basel Endgame revisions to the U.S. capital rules would apply, as a general rule,4 only to banking organizations with $100 billion or more in total assets.
Because certain aspects of the internationally-agreed Basel standard, if implemented in the United States, would result in a reduction in risk weights for certain exposures compared to the risk weight assigned to those exposures under the current rules, this left the U.S. banking regulators with what they saw as a problem.
That is: if (1) not all banks are going to be subject to new the rules and (2) the new rules are, for some exposures and holding all else equal, going to result in a reduction in the amount of capital required to be held against those exposures, then for these exposures the adoption of revised capital rules for large banks could put small banks at a disadvantage relative to their larger competitors compared to the status quo.
To address this concern, the agencies decided to propose deviations from the internationally-agreed standard by making an upward adjustment to the Basel risk weights for residential real estate and retail credit exposures. They explained:
Without the adjustment relative to Basel III risk weights in this proposal, marginal funding costs on residential real estate and retail credit exposures for many large banking organizations could have been substantially lower than for smaller organizations not subject to the proposal. Though the larger organizations would have still been subject to higher overall capital requirements, the lower marginal funding costs could have created a competitive disadvantage for smaller firms.
This argument has been met with some skepticism, but I was interested to see the Federal Reserve this week release a readout of a meeting that suggests the agencies’ concerns about competitive equity resonated, though perhaps in slightly garbled fashion, with executives of at least one smaller bank. The meeting readout says:
Representatives of Axos Financial, Inc. expressed concerns regarding unintended competitive consequences from the Basel III endgame proposal for banks with less than $100 billion in assets and requested that potential competitive consequences to smaller banks be analyzed as part of the rulemaking.
In particular, representatives expressed concern that the risk weighting of regulatory residential real estate exposures based on loan-to-value (LTV) in the Basel III endgame proposal would harm the smaller banks by providing a competitive advantage to large banks making low LTV loans.
For context, Axos as of the end of the most recent quarter had just under $21 billion in total assets.
We only have these two paragraphs, so the exact points Axos made during this meeting are not entirely clear.5 As discussed above, the agencies already have adjusted the risk weights for residential real estate exposures upwards compared to the Basel standard. Is Axos arguing that the agencies should go even further? Or is their suggestion instead, as some have floated,6 that smaller banks, too, should be able to apply the more sensitive internationally-agreed risk weights for residential real estate exposures? I suppose other alternatives are also possible.7
A Venting Session for Community Banks and Credit Unions
Since 2010 the Federal Reserve Board has maintained a Community Depository Institutions Advisory Council made up of representatives of community banks, thrifts and credit unions. Twice a year this group travels to DC to share perspectives with the Federal Reserve Board.
Yesterday, the Board made available a summary of the most recent CDIAC meeting, held in mid-November. Obviously there are thousands of community banks and credit unions in the United States, so without making any claims that these views are perfectly representative, and certainly without endorsing some of the claims made about various regulatory developments and their likely effects, I’ll highlight below some of the commentary I thought was most interesting.
Bank Exams
CDIAC members say that, “overall, examinations have been running smoothly” and that communications with examiners have improved.
Nonetheless, members continue to have both process-based and substantive concerns about the exams to which they are subject:8
“[A]fter providing significant information prior to an examination as requested, once on-site, examiners often request additional information or shift their focus.”
Members believe exams are now “taking more time to complete, and examination reports are being delayed, seemingly because of more internal reviews at agencies.”
There is a heightened focus on liquidity and safety and soundness, leading examiners to make what members see as “unnecessary” demands to maintain higher levels of liquidity.
“The impression being given is that examiners prefer additional cushion at CDIs even if the management is strong and risks are little changed.”
There is a more intense focus on fair lending, with increased referrals to the DOJ. Some members assert that banks have received MRAs “directing [them] to take corrective action to establish new branches and expand financial literacy programs.”
Safety and soundness exams are growing in length (and thus in associated costs), and members are concerned about this, “especially given that, ultimately, few issues are detected and few MRAs issued.”
Slow FedNow Takeup
Members offered various reasons why FedNow adoption has generally been slow, including:
limitations based on their core processors’ ability to make system changes;
a “high five figures” cost to make necessary system modifications, which cannot be justified in light of “negligible customer demand”; and
a need to prioritize other system changes, either to meet new or revised regulatory requirements (e.g., the new CRA rule, Section 1071 reporting), or to improve cybersecurity.
Deposits
CDIAC members “raised concerns regarding the ability of smaller institutions to attract and retain deposits.” They noted that “[l]arger banks are now outpricing smaller institutions on deposit products, creating apprehension about rising funding costs.”
Also of concern to “at least one” representative was the current deposit insurance framework. This representative believes that it would be helpful for the Transaction Account Guarantee Program to be reinstated, to better enable small banks to compete with larger banks: “Operating deposits from businesses are a critical source of funding for CDIs, and banks are concerned about continued outflow of these deposits to larger banks.”
Merger Activity
CDIAC members see the current M&A environment as relatively dormant, “primarily due to mark-to-market valuation challenges.” Members did note, however, that “[l]arger credit unions are receiving an increase in inquiries from banks seeking to sell, primarily because other banks are unable to make acquisitions in the current environment.”
There is also a passing reference in this section to “regulatory orders to bolster capital” which have been issued to smaller banks with large AOCI losses. Members believe banks “might face challenges in 2024” if they are unable to comply with those regulatory orders “unless they opt for mergers.”
Bank Term Funding Program
The BTFP is currently scheduled to end on March 11, 2024. The meeting summary observes, without providing any hints at what the Federal Reserve intends to do, that CDIAC members “were interested in understanding if the BTFP would be extended beyond March 2024, at least until the negative impact from AOCI has been resolved by falling bond rates.”
Changes to the Federal Home Loan Bank System
CDIAC members worry about “planned regulatory changes to the FHLB system—many of which will occur through the supervisory process instead of via formal rulemaking.” Members believe that it is “highly likely” that these changes will result in FHLBs raising costs, tightening collateral conditions, and reducing banks’ ability to access FHLB funding.
There is also a concern I had not heard before and am not sure what to make of about the effects of the SEC’s climate disclosure rules, if and when finalized:
Council members expressed concern that, once finalized, the FHLBs may have disclosure obligations related to the collateral they hold. Should that be the case, the burden could fall on CDIs and other banks, consequently raising the effective cost of FHLB advances or disincentivizing borrowing from FHLBs.
Durbin Amendment
Durbin Amendment limits on interchange fees apply to issuers with $10 billion or more in total consolidated assets, and CDIAC members believe this had led to a “misperception” that the Durbin Amendment exempts community banks.
Council members are interested in correcting the misperception that the Durbin Amendment “exempts” community banks, including as it relates to the current price cap that the Federal Reserve proposes to amend. […] Per-transaction fee revenue is difficult to track because of core processor limitations, but the general impression is that it has been dropping. Even for those CDIs not subject to Regulation II, competitive pressures from larger banks mean that fee limitations affect CDIs.
There is also a sentence in this section saying that community banks and credit unions are “concerned and somewhat puzzled by the Federal Reserve’s statement that it is not seeking comments on the cost implications” of its recent Durbin proposal.9
Custodia Expert Reports
The focus of this blog has probably been a little too litigation-heavy recently, but even so I think it’s worth mentioning that Custodia yesterday publicly filed a brief in its ongoing case against the Federal Reserve Board and the Federal Reserve Bank of Kansas City. The brief argues, based on the administrative record and other materials obtained through discovery, that Custodia is entitled to judgment as a matter of law on its claims.
I mention this here because a whole bunch of interesting exhibits are attached to the brief, including three expert reports that had not yet been made public. The expert reports are from Peter Conti-Brown (for Custodia), Katie S. Cox (for Custodia)10 and Morgan Ricks (for the FRBKC).
Thanks for reading! Thoughts on this post are welcome at bankregblog@gmail.com
I assume that at a minimum CIBC Act filings will be required here from both Lehman and Castle Creek.
For purposes of determining whether this closing condition has been satisfied, Blue Ridge Bank’s regulatory capital will be adjusted “(i) on a pro forma basis after taking into account the Subscription Amounts hereunder for which all conditions precedent under Section 5.2 have been satisfied (and assuming that 100% of the net proceeds are contributed to the Bank) and (ii) to accrue for all expenses and one-time charges reasonably expected to occur in connection with the transactions contemplated by this Agreement to the extent not already reflected in the Company’s or the Bank’s financial statements.”
The full definition of this term is in Section 4.17:
an amount equal or greater to, (a) if neither the Company nor the Bank is subject to a regulatory capital requirement pursuant to an enforcement action issued by a bank regulatory authority, the amount necessary for the Company (if applicable) or the Bank to be deemed to be “well capitalized,” as such term is defined in the applicable state and federal rules and regulations, or, (b) if either the Company or the Bank is subject to a regulatory capital requirement pursuant to an enforcement action issued by a bank regulatory authority, the amount necessary for the Company and/or the Bank to be in compliance with any capital requirements imposed by any bank regulatory authority, as applicable, pursuant to such enforcement action (including, without limitation, the existing formal agreement between the Office of the Comptroller of the Currency (the “OCC”) and the Bank and the previously-disclosed individual minimum capital ratios (“IMCR”)) (the greater of the amount in either (a) or (b), the “Required Regulatory Capital”)
As an exception to the general $100 billion rule of applicability, the market risk provisions of the proposal would also apply to any banking organization with $5 billion or more in trading assets and liabilities or for which trading assets and trading liabilities are 10% or more of total assets.
It is also not clear that Axos was necessarily meeting with the right people to get this point across: according to the readout the meeting was attended only by FRBSF staff, without anyone from the staff of the Federal Reserve Board. This makes me think, though obviously I do not know for sure, that there were other, more ordinary-course matters also discussed at this meeting, but because the Basel Endgame proposal also came up, the FRBSF staff felt they needed to produce a publicly available summary of the meeting.
From FDIC Director McKernan’s dissenting statement on the proposal:
[T]he entire discussion offering any modicum of rationale for this significant—and even controversial—decision is a sparse three sentences buried in the impact analysis. The purported rationale is to avoid putting smaller banks, which would not be subject to the proposal, at a competitive disadvantage to large banks. That is certainly a critically important policy objective. But to achieve both competitive parity and risk sensitivity, one alternative worth exploring is to extend the modernized set of Basel III credit-risk-capital requirements for residential real estate exposures to all banks, both large and small, while perhaps affording each smaller bank an option to keep its current, generally larger, capital requirements for those exposures.
For instance, I doubt the agencies go this way, but I guess in theory they could choose to make no changes at all, for any bank, relative to the treatment of residential real estate under the current U.S. implementation of the Basel rules.
I already included this caveat above, but in this section in particular its worth stressing that my quoting these complaints should not be understood as a claim that all of them necessarily make sense, at least as characterized in the summary.
I have to admit I am not sure which statement from the Board the CDIs are talking about here, but as always when I find myself in this position, this is likely a due to a gap in my own understanding, not something that someone else got wrong.
This is unrelated to Custodia, but I cannot resist noting one fun thing to speculate about in the Katie S. Cox export report.
A portion of the report talks about how on the same day the Board denied Custodia’s membership application, the White House released a statement on cryptocurrency risks. The Cox expert report opines that this timing was not coincidental. Cox also says:
During my career with the Federal Reserve, I do not recall the White House issuing a policy statement or an Executive Order related to a Board matter coincident with the Board’s action on a proposal. I am aware of the White House intervening on at least two proposals for which I was the principal Board analyst. However, on both occasions, the White House directly contacted a Governor of the Board to orally convey the White House’s preferred action on a proposal.
Earlier in the report, Cox states that she worked in the M&A section at the Board from 1999 until 2020. So, which two proposals during that period do we think the White House went so far as to call up a Board member to express a view on?