This is an expanded version of a roundtable article that appeared in the January 2010 ABA Banking Journal A podcast of the original roundtable will be posted next week.
Carolyn Mroz chooses another natural analogy: “The Dodd-Frank Act is the 800-pound gorilla in the room. Everyone knows that it’s there, but no one knows what the gorilla is going to do. So you’re kind of in limbo.”
Patton is president and CEO at $100 million-assets Sierra Vista Bank, Folsom, Calif., and Mroz, president and CEO of $157 million-assets Bay-Vanguard Federal Savings Bank, Baltimore. The pair were among six bank and savings institution members of the America’s Community Bankers Council who met with ABA BJ in mid-November for a roundtable discussion regarding concerns and early strategies for dealing with the mammoth legislation.
The six leaders met before most of the first wave of Dodd-Frank proposed regulations had come out. Of those that have been published so far, such as the Federal Reserve’s debit interchange proposal, the only “satisfaction” has been confirmation that Dodd-Frank really is turning out to be as bad as community bankers expected.
“In talking to my congressional representatives, they were so excited by it, they were tone deaf,” complains Kevin McCarthy, president and CEO at $450 million-assets Newport Federal Savings Bank, Newport, R.I. McCarthy’s pleas that representatives look at the impact on community banks were ignored. “I’ve looked at community banks as the good guys through this crisis,” says McCarthy. “And yet the reward is they ram this down our throats.”
The bankers’ issues with Dodd-Frank boil down to three broad impacts: 1. in combination with other developments in 2010, a severe impact on community bank revenue at a time when banks need every cent they can make; 2. a sharp and cumulative increase in regulatory burden; and 3. alleged carveouts and considerations for smaller banks that not one member of the roundtable believes are real.
Regarding carveouts, “we’re not immune,” said Sharon Burran, president and COO, $400 million-assets Woodhaven National Bank, Fort Worth. She was referring to community bank exemptions to such Dodd-Frank features as examination by the new Consumer Financial Protection Bureau and the Durbin amendment’s restriction on debit interchange income. “If this new regulator doesn’t like what the Comptroller’s examiners do, then it can send its examiners down to examine us.”
New Hampshire banker James Tibbetts worries that elements of the Dodd-Frank Act intended to apply solely to larger institutions—such as elements of the law pertaining to compensation programs—will become “best practices.” And best practices have a way of becoming expectations, if not de facto requirements.
“It all goes downhill to the community banks,” says Tibbetts, president and CEO at $223 million-assets First Colebrook State Bank, Colebrook, N.H.
Income going, income gone
When delving into Dodd-Frank’s impact on community banks, it’s quickly apparent that while some parts of it hit them in new places, others hit in them in places that already ache.
The Durbin amendment represents one punch that is part of a combination. Several bankers point out that debit interchange income—portrayed by some as mainly having an impact on larger banks—hits community financial institutions hard as well.
When asked what single part of Dodd-Frank he’d remove if given the power to strike it, Richard Hoban of Frandsen Financial Corp., Arden Hills, Minn., has no hesitation: “I would want to remove the Durbin Amendment, for sure, that’d be number one on my list.”
“It’s very worrisome for me, the loss of revenue,” continues Hoban, president and CEO at the $1.3 billion-assets multibank holding company. “Interchange income is the third-largest line item on our income statement, for noninterest income. And it’s been the fastest-growing line item over the past three years.”
“Interchange is one of our largest noninterest income items too, and, like Rich says, it has grown,” says Sharon Burran of Texas. “More people are using debit cards and, of course, the young people, that’s all they pay with.”
Unfortunately, Burran says, there’s another side to the equation—debit card fraud continues to rise—“and we are responsible for the cost of the fraud losses.”
“So, somehow, income has to offset whatever losses we take,” Burran continues. “We really need to keep that balance intact.”
In theory, Dodd-Frank gave community banks a carveout from the Federal Reserve’s pending regulations (comment deadline, Feb. 22).
“There’s really no such thing,” insists Burran. “They say we’ve got a carveout, being under $10 billion in assets. But we have to compete in the market with the larger banks. And if we do not lower our fees and all the big banks do, then no one will come to us. So we have to compete, and do the same thing.”
“We’ll have to adapt to the price leaders,” says Hoban, whose banks chiefly operate in Minnesota, North Dakota, and Wisconsin.
Where will this lead?
But there’s more to the objections than immediate pain.
New Hampshire’s Jim Tibbetts worries about the precedent. “What bothers me is the idea that one of our regulators is going to set price controls on one of our products. That opens the tent door. I’ve got the very uncomfortable feeling that we’re losing our ability to price our products and services.”
Hoban sees the interchange legislation blocking further technological improvements in payments systems, through removal of income incentives. Banks won’t invest capital in activities where it lacks a decent return, he argues. “With the government taking that flow of capital away by decreasing revenue, it’s going to stagnate,” says Hoban.
Greg Patton attacks the premise of this part of Dodd-Frank. “If the objective was to help the consumer, show me where the money is going to wind up in their pockets,” he says. “It won’t. The shift will be from the entities that created the opportunity, who are responsible for fraud costs, business development, and research and development and distribution. So Robin Hood has arrived in Washington—but I don’t think the good people of Nottingham will get the benefit.”
New ventures on hold
Interchange is only the most obvious income effect of Dodd-Frank. There’s more.
Patton, for instance, says that the combination of the SAFE Act, regarding mortgage banking, and pending Dodd-Frank compliance burdens convinced Sierra Vista’s management not to launch a mortgage banking operation. “We decided that the compliance burden was too significant to outweigh the potential noninterest income stream,” Patton explains.
Indeed, the growing compliance burden affects more than the direct costs that hit the bottom line. The costs of management distraction must also be accounted for.
“I find myself getting a little bit more involved with compliance stuff,” says Newport Federal’s Kevin McCarthy. “It kind of bubbles up, and distracts you from thinking about business strategies. Compliance, quite frankly, is just a cost center. You’re not bringing in any revenue through it.”
The coming compliance burden has kept Carolyn Mroz’s Bay-Vanguard from launching new products. “The unknown factors—what will the accounting cost us, what will the legal cost us, what will compliance cost us” holds them back, she says. “We reason, ‘Let’s not go and start anything new, because we don’t know what our budget next year will be, to cover all those costs.”
Final nails in free checking
Likewise, the cumulative impact of federal overdraft protection restrictions, the coming interchange regulations, and more have led bankers to completely rethink the pricing of checking accounts.
Hoban’s organization is introducing a new e-checking account that will use the “green” angle to promote its online elements. Existing customers will be offered the option of converting to this new account or going back to paying for checking.
“It’s more restrictive,” says Hoban, “but it’s a bit of a middle ground between full-service free checking and completely eliminating the product. We wanted to find that middle ground, because we wanted to be able to still offer some form of free checking, because many of the larger banks in our area are exiting completely from free checking.”
Overall, the bankers feel that increased regulation and compliance duties will force them to pass more costs along to consumers. “One of the messages we have to drive home to Congress and congressional staffers,” says Maryland’s Mroz, “is ‘You thought you were doing something good. But here’s the real deal’.”
Perils of regulatory redesign
On multiple levels, the bankers spoke of Dodd-Frank as a tsunami of regulatory burden. McCarthy and Mroz, as federal savings institutions, in one sense have a double tsunami coming. They will not only receive the same regulatory drenching all other community banks get, but will also see their current primary federal regulator disappear in less than a year. The law calls for its absorption by the Comptroller’s Office, the OCC.
“I’m a little nervous about being regulated by OCC,” says Mroz. “I’ve heard many horror stories. But, then, I’ve heard horror stories about the Office of Thrift Supervision too. So I guess it still depends on your bank. But that’s the part about Dodd-Frank that has me the most nervous.”
Elaborating, Mroz notes that many OTS staffers will be moving to the Comptroller’s Office and that there will be retraining of those employees. “But at least they understand our business, residential mortgage lending,” says Mroz.
Newport Federal’s Kevin McCarthy points out that promises that the new Consumer Financial Protection Bureau (CFPB) won’t add to community banks’ travails don’t ring true. He jokes that he’s old enough to recall when the Community Reinvestment Act was brand new.
“When they installed CRA, they said it wasn’t going to be too bad,” says McCarthy. Things turned out otherwise. So McCarthy believes the CFPB “is going to be a semi-nightmare.” Sharon Burran of Texas worries about the new regulator’s power over the traditional federal financial regulators.
Richard Hoban says that one of the few alleged positives of the legislation is its regulation of nonbank entities. The new bureau is intended to have oversight of such businesses, among which are mortgage brokers.
Hoban isn’t so sure, however, that the net effect of Dodd-Frank won’t be more pressure on traditional banks and little effective change on the way the nonbank entities are treated. Plus, he says, referring to the CFPB, “it’s been politicized and that’s a huge worry.”
Kevin McCarthy says the costs of running the bureau and dealing with the nonbanks are what concerns him.
“I wonder whether we’re going to end up getting a setup that we don’t want, and being forced to pay for the thing, too,” says McCarthy.
Dealing with coming compliance burden
The Dodd-Frank legislation represents an overwhelming capstone on the legislative and regulatory reaction to the financial crisis. Compliance officers and departments already struggle to implement the many new and revamped compliance requirements put in place over the last two years or so. The coming hundreds of Dodd-Frank regulations have these community bankers quite worried.
“We are going to be inundated with things that have to be implemented very quickly,” says New Hampshire’s Jim Tibbetts, “in order to be in compliance. And what is our recourse, if any?”
Some of the bankers have already taken measures to deal with the increasing compliance volume. Others are exploring alternatives.
Hoban’s organization added an additional compliance officer in 2009. The hiring was based on the new duties coming along then, and on Hoban’s anticipations “as we saw this tsunami coming towards us.”
Beyond this, Hoban says Frandsen Financial spent 2010 reevaluating its compliance procedures, using a risk-based approach. Given that compliance resources will always be finite, Hoban explained, management felt it critical to determine which areas and activities exposed the bank to the most severe risks and costs, such as civil money penalties.
“I think many banks are going to be doing that,” says Hoban.
Maryland’s Carolyn Mroz, atypically for a CEO, has been the driver for compliance at her institution, orchestrating the effort through a committee.
“But I think I will outsource in 2011,” Mroz explained. “I don’t think I have a choice. Dodd-Frank is going to put things over the edge.”
While some of the participants saw outsourcing as a means to add manpower, Greg Patton wondered if his young bank—and others—might not be well advised to hire outsiders for their expertise as well.
“You are taking the risk that your homespun compliance effort has big holes in it,” says Patton, “holes that you don’t find out about until somebody in a dark suit comes in and writes you up.”
Some state bankers associations are looking into cooperative compliance services, and some bankers find attractive the idea of sharing compliance staff among multiple, nonaffiliated banks. Several say their compliance staffs find local compliance officer networks and peer groups helpful.
Share your thoughts about Dodd-Frank, about the regulatory burden on banks, and today’s community banking challenge in general below. What parts of Dodd-Frank do you hate the most?