Bank Owned Life Insurance

MAY 13, 2016

David Payne/Arnie Winick

BFS Group

presented:

Draft

How Does BOLI Work?

• A single premium purchase of a life insurance policy on the lives of “highly compensated” employees* (top 35% highest paid).

• Bank is the owner and beneficiary of the life insurance policies.

• The policy’s initial cash value is 100% of the initial premium.

• Principal does not fluctuate (not a mark-to-market asset).

• Inside build-up of the policy’s cash value is non taxable income to the bank. Death benefit proceeds are received tax-free.

• Institutionally priced products that result in higher yields.

• Total policy value is available upon request, with no surrender charge.

• Growth in cash value is recorded as “Other Non-Interest Income” on the Bank’s financial statements.

• Regulatory guidance permits BOLI to be purchased to offset employee benefit costs.

PAGE 2

How Much BOLI Can a Bank Buy?

• In accordance with OCC 2004-56 and SR 04-19, the bank should not exceed 25% of their Tier 1 Capital plus ALL. (FDIC is Tier 1 Capital only)

• When considering a BOLI transaction the regulators require a Bank to insure that the transaction complies with its legal lending limit and concentration of credit limit.

3

BOLI Product Types

PAGE 4

GENERAL ACCOUNT SEPARATE ACCOUNT HYBRID ACCOUNT

• Underlying policy values are

owned and invested by the life

insurance company and are

part of the carrier’s general

assets.

• Product pricing and

description follow the general

rules governing life insurance.

• Historically, the vast majority

of BOLI held by community

banks is general account

• Underlying policy assets are

held for the benefit of the

policy owner in a bankruptcy

remote trust.

• Managed by professional

managers retained by the

insurance company (Creates a

regulated security and is

required to comply with

securities laws).

• Not book value guaranteed.

• Underlying policy assets are

held for the benefit of the

policy owner in a bankruptcy

remote trust.

• Managed by professional

managers hired and guided by

the insurance company. (Not a

regulated security).

• The carrier has more flexibility

with investment options.

5

Options for Investing $10,000,000

Considerations Loan Bond Muni BOLI

Current Average Yield 3.95% 1.60% 1.73% 3.50%

Income Earned $395,000 $160,000 $173,000 $350,000

Income Taxes Due (at 37.96%) ($149,942) ($60,736) N\A N\A

Loan Loss Provision XP (at 1.25% Pre-Tax) * ($38,775) N\A N\A N\A

Lost TEFRA Interest Expense Deduction N\A N\A (36,442) N\A

Net Income Earned $206,283 $99,264 $136,558 $350,000

Held to Maturity "Bonus" No No NoYes (averages another 30% to 40% of the

accumulated CSV)

Duration Typically short Typically five years or less Typically five to ten years Long, but with quarterly rate resets

Credit Risk Varies Typically low Moderate but very concentrated Very low

Call\Redemption Risk Yes (early payoff or loss of customer) Yes Yes No

Collateral Real estate, inventory, equipment, etc.Promise to pay from a single government or

corporate entityPromise to pay from a single municipality Cash Value

Mark-to-Market Risk No Yes Yes No

Personnel Costs Yes Yes Yes No

Basel III Capital Effect Yes No No No

Historical Rates

PAGE 6

Tax Rate: 40%

BOLI historical rates are an average of first year net crediting rates from a sample of general account products. Treasury rates are based on the

average of the past year’s rates. These returns do not reflect the payment of any death benefits. Past returns are not indica tive of future results.

**The minimum maturity for the bonds in this index is 20 years, with an average of 30 years. The bonds have maturities as close as possible to 30

years; they are dropped from the list if their remaining life falls below 20 years, if they are susceptible to redemption, or if their ratings change.

Source: Based on the following highly rated carriers- Great-West Life, Guardian Life, MassMutual, Midland National, Ohio National, New York Life,

Northwestern Mutual, & Savings Bank Life Insurance

(Average Rates)

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

10.00

11.00

% R

ate

Year

BOLI

Historical Rates*

BOLI

Tax-Equivalent

Moodys 30yr AAA Corporate

Bond Index **

5 Year Treasury 10 Year Treasury

Regulators Guidance to Banks

PAGE 7

At the conclusion of 2014, there were over 500 institutions nationwide reporting Cash Surrender Value (CSV) greater than 25% of the sum of Tier 1 Capital and ALL.

This measure is used by the Federal Reserve to gauge concentrations. Over 40 of those institutions reported CSV greater than 50% of Tier 1 & ALL.

This is a great example of how comfortable the regulators are with bank’s investing in BOLI.

Regulatory guidance states a bank should not purchase greater then 25% of Capital in BOLI,

all banks originally follow this guidance.

However, during the recession when many bank’s capital deteriorated because of credit

quality their BOLI CSV continued to grow tax-free, resulting in the allowed percentage to

increase above the guidance.

Currently there are seven banks with over 100% of Capital in BOLI because of prior losses, yet

the regulators, knowing the high quality of BOLI and the ability to grow tax free, rarely request

the institutions to redeem in order to be under the 25% guidance.

Regulators know that BOLI is immediately liquid and therefore remain comfortable with the

asset even above the guidance.

BOLI Market Place Today

PAGE 8

Unprecedented low rates and an ultra-competitive lending environment have led bankers to seek quality assets with reasonable yields. Particularly assets that don’t add undue Interest Rate Risk or other comprehensive income mark-to-market to their balance sheet:

In comparison to alternative earning assets, BOLI is the only asset a bank can

purchase to accomplish these goals

No loans of this credit quality can compete with BOLI yields – Thus why the majority of the top US Banks are fully invested in BOLI capacity

When purchasing General Account BOLI:

The bank is a direct creditor to the insurance company assets

It is likely that the highest rated companies such as MassMutual, Northwestern Mutual,

New York Life, etc. would compare favorable to the best credits in the bank’s portfolio

Misperception of the duration of BOLI:

Mirrors the insurance companies fixed income portfolio

Typically a 5yr-6yr duration

While initially performs as a fixed rate instrument, the yield to the bank slowly adjusts

as interest rates move

BOLI Outlook

PAGE 9

Economic analysis does not show a pending turn to higher interest rates in the near future, opportunity for products that continue to outpace other alternatives

Continued increase in acceptance of BOLI as a high quality credit risk that can offset rapidly increasing healthcare and associated employee benefit costs and provide stable increases to non-interest income

Increased use of BOLI to fund recruiting and retention packages as well as provide pure asset yield

General Account Products with more frequent resets will be the product of choice in a rising interest rate environment

Separate Account Products will continue to be out of favor because of “mark to market” risk and lack of “wrap” providers

Hybrid Separate Account Products are an alternative for banks looking for bankruptcy protection

2014 New BOLI Premium Allocation Breakdown

PAGE 10

General Account, 77%

Hybrid, 22%

SeparateAccount/PPVUL, 1%

2014 BOLI Sales Product Segmentation

2014 BOLI Premium Sales

Approximately $3.2 Billion

* Based on 2014 Market Data

2015 New BOLI Premium Allocation Breakdown

General Account, 75%

Hybrid, 12%

SeparateAccount/PPVUL,

13%

2015 BOLI Sales Product Segmentation

2015 BOLI Premium Sales

Approximately $4.04 Billion

* Source: SNL/FDIC call report as of 12/31/15 and 2015 Market Data

12

114

29

79

49

20

9

25%

69%

43%

18%

8%

0 20 40 60 80 100 120

TOTAL BANKS

NO BOLI HOLDINGS

GENERAL ACCOUNT BOLI

HYBRID ACCOUNT BOLI

SEPARATE ACCOUNT BOLI

ALL THREE TYPES

NJ Bank BOLI Holdings

2015 New Jersey BOLI Placement

13131313

BFS70%

All Others30%

2015 New Jersey New BOLI Purchases/$175 Million

BFS All Others

BOLI Myths

PAGE 14

The bank is profiting from the death of its employees

Illiquidity is overstated, surrender is typically accomplished within 2-3 weeks

Large surrender fees associated with BOLI

BOLI can’t keep pace with loan yields

BOLI is subject to mark to-market accounting

Duration Issues

Summary

PAGE 15

Conservative investment

Yields competitive/superior tax deferred returns

Direct improvement to a bank’s bottom line

Simple to implement, no cost to bank

Helps banks offset rising employee benefit costs

The investment choice of over 54% of the banks in the US