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The Good, the Bad and the Uncertain of Dodd-Frank

If you read only the headlines or talk only with big-bank CEOs, you might think that the Dodd-Frank act signals Armageddon for banks. Words like overregulation, high-capital requirements and lower profitability were being used even before the legislation was passed.

The sweeping Dodd-Frank Wall Street Reform and Consumer Protection Act includes some 400 rules that were supposed to be in place by this summer. But regulators are far behind on their deadline. (Less than half those rules have been finalized.) No statutory penalties exist for unmet deadlines and even Rep. Barney Frank (D-Mass.), an architect of the legislation, understands that governing agencies are working as hard as they can on the rules.

With so much of the implementation of the act still up in the air, the future rules stemming from the act give some community bankers reasons for worry. The feeling among many community bankers is that they are guilty by association.

That is, the act's provisions cover all banks as if they were part of the problems that led to the financial crisis. "I don't think [the legislation] was necessary for community banks," says Cynthia Blankenship, vice chairman and COO of the Bank of the West, a closely held bank in Grapevine, Texas. Well versed in community bank issues, she was a former chairman of the Independent Community Bankers Association and is now chairman of ICBA Services Network. She also has met with President Obama and former President Bush about bank regulation.

"There were some of the problems created by the systemically important financial institutions that, frankly, community banks don't engage in—the problems that led us all to the financial debacle involved the big banks. We aren't going overseas and selling SIVs [structured investment vehicles] or derivatives or packaging mortgage products to sell in the international market like the big banks do. We collect deposits and make loans," she says.

To be sure, the news from Dodd-Frank isn't all bad. Community banks are finding that it represents a mixed bag with some definite wins, some losses and a lot of unanswered questions.

Here is a rundown of the good, the bad and the uncertain on how the legislation affects community banks.

The Good

Deposit Insurance Assessment Rates: Under the law, the deposit insurance rates for community banks have been lowered by between 30% and 50%. The FDIC will receive the same rate of payment from banks as it did pre-Dodd-Frank, but big banks are now required to pay a larger share than they used to. "A community bank that may have been paying $300,000 a year has seen their rates go down to $200,000 or $150,000," explained Chris Cole, SVP and senior regulatory counsel at ICBA.

Community banks are expected to save a total of roughly $5.3 billion in deposit insurance assessment rates over the next three years, according to the ICBA.

Federal Deposit Insurance Coverage: The FDIC increased a bank's insurance coverage per account from $100,000 to $250,000 and Dodd-Frank made the change permanent. Community bankers widely applauded this move. And Blankenship even said there's room for improvement. "That's good, but it needs to continue to be increased." When a hard limit is set, she says, the time value of money inevitably erodes the insurance protection in real terms.

Unlimited Insurance Coverage for DDA (demand deposit accounts): Many small businesses keep large amounts of deposits (over $250,000) with community banks in their DDA accounts which they use as their main operating account. If these accounts were not fully insured, some of these businesses would hesitate maintaining such large balances. A few small businesses might even switch banks to a larger bank that they may view as being "too big to fail."

Assessment Savings: Dodd-Frank will save community banks about $4.5 billion over a three-year period in assessments. The premiums that banks pay to the FDIC for their deposit insurance would be one example.

The new law has changed how the assessments are calculated, which is more favorable for community banks and less favorable to the very large banks, according to ICBA's Cole.

Internal controls exemptions: In addition, the act will help publicly held community banks with small market caps (under $75 million), because it exempts them from the internal control requirements of Section 404(b) of the Sarbanes-Oxley Act, he explains. The ICBA estimates that a typical publicly held community bank would save around $75,000 per year in auditing fees because of the exemption.

The Bad

Repeal of Regulation Q: This is a Depression-era rule that limits the amount of interest banks can pay on savings deposits. Dodd-Frank repealed Reg Q, which means banks will be allowed to pay interest on demand deposit commercial checking accounts.

The repeal may spell trouble for community banks because the FDIC will guarantee only the first $250,000 on an interest-bearing account, says Blankenship. So community banks could find themselves facing pressure to privately insure their customers deposits that exceed the $250,000 limit, which would increases their costs, says Blankenship.

If a commercial customer, such as a hospital, for instance, has $1 million to put in an account, the administrators may opt for a bigger bank instead of a community bank because they believe their funds will be safer, she adds.

Durbin Amendment: This hotly debated amendment to Dodd-Frank limits the interchange transaction fees that banks can charge merchants for debit card use. Interchange fees are those the bank collects from merchants each time a customer swipes his debit card.

Banks, in general, are opposed to this change, naturally, because it cuts into their profits. Although banks with less than $10 billion in assets are exempt from these changes, big banks with much more volume, income and resources will be better equipped to beat out community banks by offering better deals to debit card holders.

Even though banks roundly are against the amendment and some legislators are calling for repeal, it's naturally very popular with merchants. The ICBA's Cole thinks a repeal is unlikely.

Mortgage Area Risk Retention Rule: Under Dodd-Frank, the risk retention rule requires that securitizers of mortgage-backed securities maintain a 5% risk retention when they securitize those securities. "If community banks are forced to pay that five percent, that is going to be a problem for mortgage lenders, like community banks," says Cole.

Ability-to-Repay Rule: In light of the housing crisis and the abuses and predatory lending practices of the past few years, this rule mandates that creditors assess a consumer's ability to repay a mortgage before making a loan and maintain minimum mortgage underwriting standards. The community banking industry wants to expand this rule to make it as broad as possible so that lenders can exercise more discretion.

Compliance Costs: While Dodd-Frank doesn't mandate that each bank have a dedicated compliance officer or officers, its new rules may force smaller banks to beef up their staff just to make sure they are current on requirements. And that could add extra salaries to the bank's expenses that don't generate income.

The Uncertain

Consumer Financial Protection Bureau: It may be too early to worry about the bureau, which lost its architect, Harvard professor Elizabeth Warren, in July. But this is definitely one area rife with uncertainty.

In general, virtually all things related to the CFPB seem mired in political infighting. This summer President Obama appointed former Ohio attorney general Richard Cordray to run the bureau in what was widely perceived as an acknowledgement that the controversial Warren couldn't win Senate confirmation. (See our Outlook story for more coverage on the CFPB.)

To be sure, Cordray, who aggressively went after abusive mortgage practices while attorney general, has his foes, too. So he may not be a shoo-in either. The bureau, a centerpiece of Dodd-Frank, will serve as a government watchdog for consumers over mortgages, credit cards and other forms of lending.

However, it is the structure of the new agency that troubles many. Unlike the Fed, for example, which is run by a board, the CFPB's decision-making will be made by the head only, who is accountable only to the President and whose budget isn't subject to Congressional approval.

The Fallout

With the increased regulation and the cost of compliance rising for banks, the community banking industry looks primed to undergo more and more consolidation in the next 12 to 24 months, says Bill Hickey, co-head of investment banking at the firm Sandler O'Neill.

Hickey says the increased compliance costs are going to be felt almost immediately by small banks, which, he says, has gone unnoticed by lawmakers. "No one who wrote the legislation has any idea of what the costs are to community banks," he says. "If you're a $500 million bank with a one percent ROA, you are going to make $5 million. If you have to hire six people as compliance officers who don't talk to customers, say at $60,000 per employee a year, that's $360,000, or $216,000 after taxes. That means your income has gone down five percent."

Hickey predicts that when a "crescendo" of community bank consolidations starts it will result, naturally, in fewer lending options for customers and layoffs for bank employees. "The local businessman may lose his local bank and the relationships he has forged," he added. "People go to community banks not because they have better fees, but for the relationships they have there."

Indeed, Rusty Cloutier, president of MidSouth, says bank consolidations across the country are already under way. "I see small banks very nervous about the costs," says Cloutier. Dodd-Frank is "going to lead to super-consolidation, and I'm worried about it. I don't think it's good to have all your eggs in one basket. I don't think it's good for the country. A lot of community banks are concerned about what the future holds," Cloutier says.

Even with that angst, advisors at Lafayette, La.-based MidSouth Bank are focusing their efforts on their clients, not Dodd-Frank, Cloutier says. MidSouth serves southern Louisiana and eastern Texas and has $1.3 billion in assets.

Blankenship shares the general concern about the fallout on community banks, as well as the communities they serve. She notes that by the very nature of being part of the life of rural and small town America, those bankers have earned a trust and developed business relationships through honest dealings with their customers.

They see their customers at church or school functions or at Little League games, she noted. "I think the financial system would be a debacle without community banks," she added. "If you were a well-run bank and doing what you were supposed to do [before the financial crisis], you weren't a bad player. You can't get greedy and break the rules and survive," she says.

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