Thriving in the Economic Recovery Thriving in the Economic Recovery

Michael G. KeeleyHunton & Williams LLP1445 Ross Avenue, Suite 3700

Dallas, Texas 75202(214) 468-3345

mkeeley@hunton.com

32615891

Community Bankers Association of Illinois36th Annual Convention

Louisville, KentuckyOctober 2, 2010

Charles E. GreefHunton & Williams LLP1445 Ross Avenue, Suite 3700

Dallas, Texas 75202(214) 468-3331

cgreef@hunton.com

TROUBLED BANK ACQUISITIONS TROUBLED BANK ACQUISITIONS

32615891

3

TROUBLED BANK ACQUISITIONS A MAJOR OPPORTUNITY

One bank in ten in the United States (829) is on the FDIC Problem Bank List

These banks are under regulatory pressure to sell or raise capital can be bought at reasonable prices

Many of these banks have NOLs, built-in losses and other tax benefits which can be used by acquirors to make the pricing even more attractive

Structuring tools are available to minimize acquirors exposure to asset quality and contingent liabilities of the target

4

DUE DILIGENCE

Thorough due diligence on target is critical

Talk to targets accountants, attorneys and outside loan review

Review reports of examination, compliance reports under regulatory administrative actions, correspondence with regulators

Review major contracts data processing, facilities leases

Review employee benefit plans- Underfunded plans- Severance policies- Change in control agreements- Impact of troubled bank status

5

IMPORTANT TAX CONSIDERATIONS

Net operating loss carryforwards of C corporation targets

Loss carryforward limitations

Section 382 annual limitations

6

TOOLS TO ADDRESS 382 LIMITATIONS

Purchase bank from leveraged holding company

Increase in Section 382 annual limitation

BHC can use NOL in year of transaction. NOL is then allocated between BHC and bank

Common shareholder approval is required

Review documentation with target BHC creditors

7

TOOLS TO ADDRESS 382 LIMITATIONS (Continued)

Avoid change in control for tax purposes

Change in ownership of more than 50 percent of voting securitiesover a three year period

Acquisition or recapitalization by existing shareholders

Count all less than 5 percent shareholders as a single shareholder

Acquire balance of shares after three years

8

TRIGGERING BUILT IN LOSSES

Definition of a built in loss

Trigger by sale of asset to third party after closing

Trigger by sale of asset to selling shareholders or BHC after closing

If built in losses are less than $10 million or 15 percent of assets of target, losses are not subject to Section 382 limitations

9

ASSET QUALITY PROTECTION ALTERNATIVES

Goal is to pay seller fair value for loans and assets that are collectable while protecting buyer from losses on those that are not

Escrow portion of purchase price Pay portion of purchase price by promissory note containing principal

reduction feature for post-closing losses In stock acquisition, issue convertible security which converts into

acquiror stock at an exchange ratio that adjusts based on post-closing losses at target

Require selling holding company or shareholders to use portion of purchase price to buy ORE and nonperforming loans out of bank

10

ESCROW

Portion of purchase price is escrowed with third party agent for agreed period of time

If excess losses occur in targets loan portfolio, part of escrowed funds are returned to acquiror

Balance remaining in escrow is delivered to seller at end of agreed period of time

11

PROMISSORY NOTE WITH PRINCIPAL REDUCTION FEATURE

Portion of purchase price is paid by delivery of promissory note

If excess losses occur in targets loan portfolio, principal balance of note is reduced

Interest ceases to accrue on amount of reduction, but claw back provisions are rare

12

USE OF CONVERTIBLE SECURITY

Acquiror issues security to target shareholders which is convertible into acquiror common stock after a set period to time

Conversion ratio is adjusted downward if target experiences excess loan losses prior to conversion date

13

REQUIRE TARGET OWNERS TO PURCHASE ASSETS OUT OF TARGET BANK

Definitive agreement can require selling holding company or shareholders to use portion of purchase price to purchase ORE and non performing loans from target immediately after closing

Acquiror sells ORE and collects loans, is reimbursed for collection costs, remits balance of proceeds to selling shareholders or holding company

Seller is paid for assets that are collectable and not for those that are not

Can purchase ORE and loans for cash and a note payable to the bank to increase dollar amount of assets purchased. Note is secured by all assets purchased from bank. Proceeds are applied to cost of collection, then interest on the note and then principal on the note. After the note is paid in full, proceeds are paid to selling shareholders

14

REQUIRE TARGET OWNER TO PURCHASE ASSETS OUT OF TARGET BANK (Continued)

Advantages / Disadvantages

- Risk of loss on purchased ORE and loans remains with target bank shareholders

- Balance sheet of target bank is improved immediately as classified assets are purchased out of bank

- If note is used, acquiror should be certain the amount of leverage is not excessive

.

15

REQUIRE TARGET OWNER TO PURCHASE ASSETS OUT OF TARGET BANK (Continued)

Tax benefit - Built-in tax losses on ORE and investment securities are triggered by sale. Note that book loss has already been taken

- If sale is after change in control occurs and built-in losses do not exceed $10.0 million, losses will not be limited by Section 382 and will be fully available for acquiror

.

16

DEFINITIVE AGREEMENT ISSUES

Definition of loss- Who decides when a loss occurs? Examiners, accountants,

outside loan review, inside loan review, and/or management of acquiror

- Can give target shareholders right of first refusal- Is loss only on an indentified group of loans or is it on any loan in

the target banks portfolio?- When does loss protection terminate?

17

DEFINITIVE AGREEMENT ISSUES (Continued)

Do representations and warranties survive closing?

Acquiror can have offset rights against balance of note

18

ACQUISITION OF OVERLEVERAGED TARGETS

Bank stock loans Subordinated debt Trust preferred securities

- Managed pools- Static pools

TARP Note tax consequences of debt forgiveness income

Purchasing bank from target holding company

Is bankruptcy a viable alternative?

19

CONCLUSIONS

Troubled banks are numerous and can often be acquired at attractive prices

Utilize tax benefits to enhance economics of transaction for buyer

Utilize available structures to protect buyer from asset qualityissues at target

Negotiate with BHC creditors to discount BHC obligations

FAILED BANK ACQUISITIONS FAILED BANK ACQUISITIONS

32615891

21

ACQUISITION OF FAILED BANKS WITHFDIC FINANCIAL ASSISTANCE

Presents acquisition opportunities Terms are favorable

- Financial assistance on loans- Indemnification against liabilities- Options on real estate, contracts and employees

Pricing has been attractive - Average premiums paid for deposits acquired have been very

low by historical standards - Sufficient financial assistance on loans to allow buyers to

record substantial bargain purchase gains at closing Risk of such transactions has been increasing

22

NUMEROUS OPPORTUNITIES FOR BUYERS

9 banks failed from 2003 2007

25 failures in 2008

140 failures in 32 states occurred in 2009

21 in Illinois

Approximately 127 banks have failed through September 24, 2010

15 in Illinois

FDIC expects more failures in 2010 than the 140 which occurred last year

23

OPPORTUNITIES FOR BUYERS(continued)

Number of banks on FDIC problem bank list has soared from 416 at June 30, 2009 to 552 at September 30 and to 775 banks at March 31, 2010 and 829 at June 30, 2010 more than one bank in every ten despite over 250 bank failures

24

IMPORTANT TRANSACTIONS UPDATE

On March 22, 2010, the FDIC changed the bidding structure and loss sharing coverage in assisted transactions. The significantchanges are as follows:

The concept of a Stated Threshold, the point at which loss sharing increases from 80/20 to 95/5, has been eliminated. Lossshare coverage set at a constant 80/20.

The asset premium or discount bid was formerly a fixed dollar bid, then was a percentage of the book value of the assets purchased.

The amount of losses a buyer will absorb before loss sharing begins (the First Loss Tranche) became now a separate element to be bid and will be expressed as a percentage of the book value of assets covered by loss sharing.

25

STRUCTURING OF FAILED BANK ACQUISITION -COMPONENTS OF BID

Deposits premium bid Asset premium (discount) bid SF 1-4 family applicable % for SF Tranche 1 SF 1-4 family applicable % for SF Tranche 3 Commercial applicable bid % for Comml Tranche 1 Commercial applicable bid % for Comml Tranche 3 Optional Value Appreciation Instrument

26

INTRINSIC VALUE

How established Clawback

27

CLAWBACK/WINDFALL PROFIT TAX

On the true-up measurement date (45 days after the end of the 10thanniversary of the bank closing), the assuming bank pays to the FDIC 50% of any windfall.

The measurement of the clawback is equal to 50% of the excess, if any, of the Intrinsic Loss Estimate less (ii) the sum of (A) 25% of the asset premium (discount) plus (B) 25% of the cumulative shared loss payments plus the permissible servicing expenses related to all shared loss assets

28

ACQUISITION OF FAILED BANKS - KEYS TO SUCCESS

Understand the transaction structure Assemble team

- Due diligence - Financial and accounting - Legal and regulatory - Do trial run

Line up financing Advise regulators in interest in process and in specific institutions FDIC supplemental bid list for larger bank targets

Surviving Your Next Exam Surviving Your Next Exam

32615891

30

Current Regulatory Environment

Stricter examiner scrutiny Shift from supervisoryapproach to enforcement approach

Federal regulation is Washington centric limited local discretion and impact

SBR Supervision by Ratio Nonowner occupied CRE ratio 300% ADC loans 100%

CRE trends

31

Congressional Oversight Panel Report CRE Losses and the Risk to Financial Stability, February 10, 2010:

Over the next few years, a wave of commercial real estate loan failures could threaten Americas already-weakened financial system. The Congressional Oversight Panel is deeply concerned that commercial loan losses could jeopardize the stability of many banks, particularly the nations mid-size and smaller banks, and that as the damage spreads beyond individual banks that it will contribute to prolonged weakness throughout the economy.

Late 80s/early 90s playbook

Current Regulatory Environment

32

Preparing for your Next Exam

Think CAMELS and Risk Management asset quality is the key

CRE guidelines are now bright lines Status quo is not a good strategy ALL directional

consistency Growth and earnings are yesterdays objectives

33

Asset Quality/Credit Risk

Commercial Real Estate (CRE) Monitor and document concentrations and

subconcentrations Prepare workout plan on every material nonowner

occupied CRE relationship (as if classified), especially ADC loans

Document active management and aggressive risk reduction strategy

Stratify risks stress tests Test appraisals

34

Asset Quality/Credit Risk continued

ADC Loans Address interest reserves Amortize credits Guarantees

Appraisal Process and Review Review and modify appraisal process/policy Test appraisals Document exceptions

35

Asset Quality/Credit Risk continued

Credit Review Process Review/update loan portfolio management process Test independence/hire outside firm Prepare workout/action plan for classified/problem

assets Workout Officer/Department/Staffing

36

Asset Quality/Credit Risk continued

Loan Policies and Procedures Revise/tighten policies Add concentration limits Reduce loan approval limits Implement other controls Use of interest reserves

Participations Purchased Staffing and Expertise (align with risk and economic

environment)

37

Equal Credit Opportunity Act

Unlawful for any creditor to discriminate against any application, with respect to a credit transaction on the basis of Race, color, religion, national origin, sex, marital

status or age; Because an applicants income is derived from a

public assistance program; or Because an applicant has, in good faith, exercised

any right under the Consumer Credit Protection Act Banks are creditors for purposes of ECOA

All bank regulators have administrative enforcement authority and are exercising it

38

ECOA Penalties and Violations

Less than satisfactory CRA Actual or punitive damages in individual or class action

lawsuits Punitive damages limited to:

$10,000 in individual actions Lesser of $5000,000 or 1% of creditors net worth in

class actions

Attorneys fees to aggrieved applicant ECOA violation may constitute violation of other federal

laws

39

Procedure

1. Pre-Exam Process2. Compliance Examination3. Notice of Preliminary Findings4. Opportunity to Respond5. Follow-up by Agency6. Possible referral to DOJ

40

Long Term Recommendation

Banks should develop internal mechanisms to ensure loan pricing uniformity, including: Creating a loan pricing matrix Ensuring that deviations from the matrix are

explained through legitimate factors Developing internal evaluation procedures

(including periodic internal regression analysis) Ensure bank policies are transparent and uniform Address potential problems prior to examination

41

$30 billion small business lending fund to invest capital into community banks

Treasury to invest senior preferred stock for C Corps or debt securities for Sub S

Amount of Investment::- < $1 billion in assets = 5% of RWA- > $1 billion < $10 billion = 3% of RWA

Small Business Lending Fund

42

Provide regulators with small business lending plan- Small businesses have:

- Equity of less than $10 million- Revenue of $50 million or less

Provide linguistically and culturally appropriate outreach to certain groups

- Minority communities- Women- Veterans

TYPE OF LOANS COVERED:- C&I- Owner occupied non-farm, non-residential real estate- Finance agricultural productive and other loans to farmers- Loans secured by farm land

Requirements

43

Treasury consultation with banking regulators CAMELS 1 or 2 CAMELS 4 or 5 CAMELS 3 ?

Eligibility

44

Starting point- 5% for C corps- Tax adjusted for S Corps

Buy down of Rate- As low as 1%

For every 2.5% increase in small business lending rate will be decreased by 1%

Base line is average amount of small business lending reported by issuing bank for the four full quarters prior to enactment of Act.

Rate

45

Refinance CPP Better story Avoid taint of TARP

Added Bonus

46

Develop small business lending plan

Develop systems to track new organizations

Act early

What to do Now