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Evaluating the sponsor bank relationship is critical for ATM deployers: Part 2
March 1, 2010
When banks agree to register and sponsor service providers, such as independent sales organizations, a significant amount of due diligence must be completed by the bank. (See the first installment, which during the ATM Industry Association's conference last month.) This week, we review the warning signs that all ISOs and ATM deployers should be on the lookout for (Part 2) as well as some simple steps you can take to understand and know more about your sponsoring financial institution (Part 3).
Understanding the contractual commitment between you and your sponsor bank is critical. It is equally important to ensure that your sponsor bank can appropriately provide the ongoing services defined in the contract and meet its financial requirements. To do this, you must be aware of your sponsor bank's financial condition and have a contingency plan in place to prevent or at least reduce expenses if a move is required. Consider it a part of good contingency planning.
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Warning Indicators of a Bank Failure:
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With bank failures expected to continue through 2010, the time to start this kind of planning is now. You should begin by understanding and regularly monitoring the key financial indicators of your sponsor bank. This simple step could prevent the disruption caused by an unexpected loss of sponsorship and/or an unwelcomed change in your sponsor bank because of acquisition.
Although there are many warnings signs that indicate your sponsor bank may not be able to meet contractual commitments, you don't need a CPA to track the most important information. The list below highlights risk indicators that you can obtain from public sources and use to easily monitor your bank.
Negative return on assets or return on equity
A bank that cannot operationally make a profit will eventually fail or seek new investors.
- Bank financial reports listing these ratios are available to the public here.
- Bank analysis information, including ratings on capital adequacy, asset quality, profitability and liquidity are performed by a variety of companies. One example is the star rating found at BankRate.com.
Decrease in Tier 1 risk-based capital ratio
This ratio is core capital as a percent of risk-weighted assets, or capital divided by assets. As a bank continues to lose money without new investors, the ratio of capital to assets decreases; if this ratio becomes too low, regulators will assume control of the bank.
- Look up the bank's financial reports on the FDIC Web site. Line 103 of "Summary Information." Tier 1 capital should be at least 10 percent.
- Some networks have minimum capital requirements for service provider sponsorship. For example, Plus (Visa) requires a member to have $25 million in capital to sponsor ATM ISOs.
Large loan losses, small reserves for loan losses and increased real-estate owned
In a declining real estate market, banks usually have increased repossessions. A house with a loan for $500,000 may be repossessed and sold for $250,000, creating a loss to the bank of $250,000. This decline in the real estate market is the cause of most bank failures in 2009.
- Look up the bank's financial reports on the FDIC site. If line 91 of "Summary Information" is 100 percent, that indicates earnings cover charge-offs; but an amount les than 100 percent indicates charge-offs are coming from capital, a definite warning sign.
- In the same summary, if Line 89, which is charge-offs as a percentage of loans, is less than 1 percent, that is very good.
Make no mistake, if the warning signs above apply to your sponsor bank, the bank is fighting for survival and is already under close scrutiny by the regulators and the FDIC.
Decreased ratios on a sponsor bank's books set regulators into action. Regulators will intercede with an "Enforcement Action" in the form of either a "written agreement" or a "prompt corrective action directive" that mandates that specific actions be taken by the bank. Such actions may include restricting or preventing lines of business that carry more risk, restricting the payment of dividends or bonuses, implementing new procedures, and changes in senior management. An Enforcement Action can and often does place additional limits on service providers, and these days such actions are more likely.
According to the Federal Reserve, 32 Enforcement Actions have been issued since the beginning of 2010, compared to 16 in 2009, and six in 2008 over the same time period.
See Part 3, which includes simple steps you can follow to protect your business, later this week.
Marilyn Kilcrease is the president of Creative Card Solutions, a managing partner of ATM ISO CashWorks and the president of CloudCover, a card-processing company. Susan Kohl, CEO of ThoughtKey, contributed to this article. ThoughtKey is a payment-industry consulting firm that focuses on PCI management, regulatory compliance, risk management and expert testimony.
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