Banks throughout the country are putting new practices in place to comply with an onset of new federal regulations prompted by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act and other post-meltdown rule changes. Those expensive efforts are sparking major changes and concerns for some of the Capital Region’s smaller lenders.
“It’s really a refocus from top to bottom,” says Rick Smith, president & CEO of TriCounties Bank. “For a small company, it’s very overwhelming.”
Smith isn’t alone. Nearly half of the community bank executives surveyed in one report released by consulting and tax advisory firm KPMG last year identified “regulatory and legislative pressures” as a top culprit for slowing growth. Low interest rates, which also squeeze profits for small banks that rely heavily on residential and commercial lending, are compounding concerns about the financial impact of increased regulation.
“The cost of regulation disproportionately impacts community banks, and that’s because they just don’t have the staff to deal with any sort of heavy regulatory burden. The big banks do,” says Chris Cole, senior vice president and senior regulatory counsel for the Independent Community Bankers of America. “It’s funny. Sometimes when we talk to regulators, they say, ‘Just have their bank talk to their general counsel.’ And I say, ‘Well, that bank doesn’t have a general counsel.’”
It’s not yet clear what the total price tag of the regulatory overhaul will be for small banks. Some financial measures suggest the proportion of overhead costs related to regulatory compliance have actually dropped for community banks in the greater Sacramento region recently. Additionally, consumer advocates say regulatory bodies have taken significant steps to lessen the burden for smaller institutions.
Paul Leonard, California director for the Center for Responsible Lending, says the Consumer Finance Protection Board (CFPB), which was created as part of the regulatory overhaul, has been “going out of the way to try to minimize any unnecessary burdens on those smaller institutions, while upholding its fundamental mission” of ensuring consumer protections.
“Obviously, it’s a bit of a balancing act, but especially the CFPB has been very mindful that one size may not fit all,” he says.
Still, bank executives in the region argue regulations are already proving onerous, with costs expected to grow as more aspects of the new rules are finalized and implemented.
Tom Meuser, chairman and CEO of El Dorado Savings Bank, estimates the work that goes into complying with the regulations — everything from reading draft language to meetings about the new requirements — now consumes about 40 percent of his workforce’s time. One major change was moving his senior loan officer, a 30-year veteran, into a new position created to oversee regulatory compliance.
“She’s doing a great job of compliance, but we don’t make any money doing compliance,” he says. “We make money making real estate loans.”
Such concerns have led smaller banks, including some in the Sacramento area, to press federal regulators for added exemptions and changes to the new rules. It’s also fueled speculation that more banks will look to grow through mergers and acquisitions in order to cope with escalating costs.
“It’s just going to make it uneconomical for some of these smaller institutions to stay in business,” says James A. Wilcox, who studies the banking industry as a professor at the University of California Berkeley’s Haas School of Business. “Some of these guys have been very good at what they do … but with these new costs that are landing differently and more on the smaller guys, it’s going to make (growth through mergers and acquisition) a pretty sensible approach.”
Fifty-seven percent of executives surveyed in KPMG’s 2012 report said they expected their bank to be involved in a merger or acquisition in the next two years, with a bulk of those looking to use strong cash stockpiles to buy their way bigger. The Sacramento Business Review’s 2013 Sacramento Banking Industry Forecast has again predicted an uptick in merger and acquisition activity in the Northern California region, arguing that such moves are “inevitable considering the industry’s structural growth obstacles.”
Despite the predictions, merger and acquisition activity has been slow so far in the Sacramento region. Visalia Community Bank shareholders approved a proposed merger with Central Valley Community Bancorp in June, a deal that brings together 21 branches and more than $1 billion in assets. American River Bancshares, has also reportedly faced pressure from an investor who wants it to cut its losses by selling.
Analysts and industry representatives say banks on both sides of prospective consolidations are waiting for the right price.
“There’s still a big gap between what selling banks want to get and buying banks want to buy,” Cole says.
That dynamic was reflected in the KPMG survey, with more than a third of the respondents identifying price differences as a key impediment to deals. Cole and others predict that even a slight improvement in the economy could lead to a flurry of merger and acquisition activity across the country.
“The economy’s really got to pick up some, I think, before you see this merger activity pick up,” Cole says. “Once that happens though, then you’ll see numerous deals. I think you may see 20 deals going on at one time.”
That could be soon. Smith is hearing more talk locally that “buyers and sellers are getting closer together in terms of expectations.” In the meantime, area banks continue to lobby for tweaks to some of the rules heading for the books.
One recent sticking point between small banks, regulators and proponents of strengthened borrower protections was new standards related to income-to-debt ratios borrowers must meet in order to receive a qualified mortgage. It’s a designation that can protect the bank from lawsuits or regulatory penalties if a borrower defaults.
The so-called Ability-to-Repay rule doesn’t prevent banks from offering loans to borrowers whose financials don’t meet the new standards. But some smaller banks say the legal risk will force them to change longstanding loan practices that previously allowed them to go beyond a formula when deciding whether to approve an application. The Consumer Finance Protection Board settled on language that includes an exemption for banks that have less than $2 billion in assets and make fewer than 500 loans a year, a threshold that falls below what some banks in the area had sought.
“Our business is to do things that others can’t do. That’s what makes us valuable to a community and also gives people some options, rather than going to a lender that is just selling all their loans on the secondary market and always has to meet those standards,” says Meuser, who estimates that 25 to 30 percent of the loans his bank makes would not count as qualified mortgages under the new rule.
“If they come to us, and we can’t make the loan … I don’t know of other lenders who will make that loan,” he adds.
Those arguments don’t get much sympathy from consumer advocates, who say the rules simply make sure banks are extending loans borrowers will be able to repay.
“At some level, it feels like you need some baseline to ensure that consumers are protected,” Leonard says. “The idea of adjusting some of the core provisions of some of these qualified mortgage terms to make exemptions for certain lenders in the marketplace doesn’t seem like it is a particularly prudent idea.”
A 2010 Federal Reserve rule requires banks to ask customers if they want to sign up for overdraft protection programs, which often come with steep penalties for making purchases that exceed the account balance. A Consumer Finance Protection Board report released in June suggests the change may not be enough to protect consumers.
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