Bank Responses to Government Stress Tests – Dealing with Regulators For Toxic Assets

The Treasury Department announced that the results of its comprehensive bank stress tests will be made available soon. The comprehensive stress tests and other traditional methods of evaluating bank performance are yielding results that some banks will find of critical importance in dealing with regulators, their customers and their shareholders. The public disclosure of this information by Treasury complicates matters. During this critical time, financial institutions in crisis need to focus on four key areas among the many challenges they face.

First, capital management and balance sheet restructuring are of critical importance in surviving a stress test. Although options for new capital are limited, there are strategies available for enhancing capital, including private equity, and government programs that could make the difference between survival and government intervention. Further, balance sheet restructuring, including a model for shrinking the institution’s balance sheet while maintaining consistent capital levels, results in enhanced capital ratios. This is an important strategy for achieving targeted capital levels.

In addition, effective and timely regulatory communications and negotiations are essential for the survival of many institutions. Institutions should focus on accurate and timely reporting of facts balanced against advocacy of the institution’s position on key management and business issues. Management needs to focus on the common ground it can find with regulatory agencies for purposes of improving the institution’s prospects of remaining viable.

A third area of significant importance is an active engaged senior management team and board of directors. Management focus on business and strategic plan implementation is closely observed by regulators. In addition, involvement of the institution’s board of directors through supervision of management and implementation of strategic plan is also closely observed. Institutions that demonstrate the ability to manage through the crisis stand a greater chance of survival.

Finally, documentation of the bank’s good faith efforts to comply, including transparent and robust regulatory communications and active involvement of management and the board of directors, will be key in demonstrating that management and the board of directors have met their duties in managing the institution through the crisis. This is of importance when defending claims by third parties, including shareholders, other stakeholders or regulatory agencies that may in the future maintain that management or the board breached its duties.

Troutman Sanders works with financial institutions of all sizes in addressing these challenges and implementing solutions. Our team is ready to assist with regulatory negotiations, capital and strategic planning, strategic plan implementation, documentation of efforts, and other challenges facing financial institutions.

Contact:

Jake Lutz
Practice Group Leader
804.697.1490

Tom Powell
404.885.3294

Jerome Walker
212.704.6286