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Regulations continue to be both burdensome, costly

Rochester Business Journal
February 14, 2014

The regulatory paperwork at community banks continues to increase as 2014 dawns, and it will increase even more as the rest of the new playbook is implemented, bankers say.

Asked if he sees the end of the tunnel that is the Dodd-Frank Wall Street Reform and Consumer Protection Act, Frank Hamlin III, president and CEO of Canandaigua National Bank & Trust Co., says he cannot.

“They’re only about a third of the way through creating the legislations that spring from that,” he says of the reforms. “And this is three years into it. That’s where the real burden is from.

“And once we get through Dodd-Frank there will be another something or other that people will start rattling their sabers over, and we’ll deal with that.”

Executives and representatives of community banks here and nationwide have been pounding on the doors of regulators and legislators since Dodd-Frank was signed into law by President Barack Obama in July 2010.

Dodd-Frank, they say, unfairly and disproportionately penalizes small banks that had nothing to do with the subprime mortgage crisis and global fiscal calamity that began in 2008 and triggered the reforms and the creation of the Consumer Financial Protection Bureau.

“Our auditor has gone from 100 percent of her time on audits to probably spending 10 percent of her time on audits and 90 percent of her time getting us prepared for the regulatory world we’re living in,” says Dana Gavenda, president and CEO of Fairport Savings Bank.

“The cost is ungodly. It’s coming at the cost of being able to do the normal things that we should do, like internal audits.”

Some of the adverse impacts of Dodd-Frank on smaller banks have been mitigated.

Several were related to the Volcker Rule, which originally would have required banks to sell their holdings in collateralized debt obligations backed by trust preferred securities and recognize the losses in their accounting.

In December, prior to congressional legislation that rectified the Volcker Rule provision, Community Bank N.A. sold $418 million in trust-preferred collateralized debt obligations and other securities because of uncertainties related to the rule.

The bank, which is based in DeWitt, Onondaga County, took a pretax loss of $6.9 million, or 12 cents a share, because of the sale and its repayment of $226 million in advanced Federal Home Loan fees.

Proceeds of some $246 million were reinvested in Treasury securities to mitigate the potentially negative effects of the Volcker Rule, said Scott Kingsley, Community Bank’s chief financial officer, during a conference call last month with investors.

The bank made the transactions with the knowledge that the provision might be tweaked, Kingsley said.

“We still believe it was in the best long-term interest of the community and our shareholders to proceed as we did,” he told investors.

Named for former Fed chairman Paul Volcker, the rule was designed to prevent banks from making risky investments with their capital and to reduce investments in private equity or hedge funds.

The Volcker Rule, issued Dec. 10 and amended Jan. 14 to allow smaller banks to retain collateralized debt obligations, becomes effective April 1.

“The Volcker Rule created quite a bit of activity, particularly in the community banking space, because some rules were put into place that were not in the original proposals,” says Lawrence Heilbronner, executive vice president and chief financial officer at CNB.

“That threw a lot of community bankers off guard—and, frankly, the regulators after they issued it. That has died down. There will be community banks that are still impacted by the Volcker Rule, based on their activities. For us, we think it should be fairly minimal.”

The revised provision applies to banks that invested in collateralized debt obligations backed by trust-preferred securities issued by banks with less than $15 billion in assets. The CDOs also must have been established before May 19, 2010, with the bank acquiring them before the Dec. 10 completion of the Volcker Rule.

“We’re adjusting just fine,” Hamlin says. “Because of our size, a lot of the regulations that maybe had been originally proposed are not necessarily being applied to us, because we’re under $10 billion.”

Municipal securities, which had been within the scope of the original rule, were eliminated from the final version.

“We do a lot of business with municipalities, but the nature of our business is deposit taking and investment purchases,” Heilbronner says. “Because of the nature of that business, we’re not impacted by the municipal adviser rule. Had we been impacted by that, it would have required registration by our employees with the SEC and the numerous onerous rules that follow.”

CNB will be affected by a mortgage servicing stipulation that, as of Jan. 14, requires banks to mail periodic statements to consumers, specifying payments due and the application of past payments.

“In this digital age, for any loan that we service and any mortgage loan that we service, we have to send out paper statements, at least once a month,” Hamlin says. “We’re expecting that those statements will cost us an additional $50,000 a year. When you consider that that’s approximately 10,000 customers, it is really quite onerous.”

Consumers are already complaining, Hamlin says.

“It’s already started to kick up our call volume with people complaining about not wanting that garbage, essentially,” he says. “I’m not aware that we have the opportunity to do anything electronically yet to satisfy that requirement. We are suggesting that our customers just call their legislators directly.”

The Consumer Financial Protection Bureau’s qualified mortgage provision came into play Jan. 10. The rule is designed to limit or prohibit high-risk loans by requiring applicants to prove their ability to repay the loan.

If a lender is judged not to have made a reasonable effort to verify ability to pay on a defaulted loan, the lender can be forced to refund fees and interest charges to the borrower and be unable to foreclose on the mortgaged property.

Lenders of non-qualified mortgages are required to hold 5 percent of the mortgage’s risk.

“We believe we’re going to be one of the primary non-qualified mortgage lenders left in our market,” Fairport Savings Bank’s Gavenda says. “Some of the big banks just won’t do non-qualified mortgages.

“We can do them because we know our borrowers,” he says. “We know the unique circumstances our borrowers have, and we’re willing to put loans on our balance sheet. We don’t have to sell everything into the secondary market. We think there’s an opportunity for us there, but it means we’re taking a greater risk. It means internally there are some things we need to do to prepare for that type of loan.”

Fairport Savings Bank made those types of loans before they were classified as non-qualified.

“It’s not a loan that you wouldn’t make anyway,” Gavenda says. “It’s someone who has a lot of assets but doesn’t have tremendous cash flow. So you look at their assets and say, ‘I know your cash flow doesn’t meet the payment requirements, but your assets are substantial.’ And you make the loan anyway.”

Martin Birmingham has faced regulatory hurdles at banks big and small. He is president and CEO of Five Star Bank and previously was regional president in Rochester for Bank of America Corp.

“The regulatory environment is something we’re very sensitive to and focused in on,” he says of Five Star Bank and its holding company, Financial Institutions Inc. of Warsaw, Wyoming County. “In some ways, it gets as much attention as many of our business initiatives.

“Compliance is a major activity for the industry and certainly for our bank. One of the concerns is that the cost of compliance is increasing and the complexity of compliance is increasing. We’re fortunate at our company that we have the size and scale, the right talent and enough personnel, to absorb these costs and be able to comply.”

The cost of compliance has surprised Gavenda.

“The expense is so much more than we anticipated it being,” he says. “Now, when everything is implemented and we get a year down the road, maybe it won’t be as bad. But I see this Consumer Financial Protection Bureau as being constantly on the lookout for ways to protect consumers.

“I’m not objecting to that,” Gavenda adds. “We figure out ways to manage the regulatory environment we live in. But the downside of it is, in order to meet their criteria, even as a community bank, there’s expense and time associated with it.”

Hamlin, who became Canandaigua National’s president in January 2011 and its CEO in March 2013, appreciates the need for regulations but not the process that led to Dodd-Frank.

“It’s just poorly thought-out regulations, from people not really concentrating on what the end game is,” he says. “This, too, will pass.

“As I look at this situation, and as I’ve calmed down a little bit over my brief tenure here, I’m realizing that this environment has been the environment for decades. People get upset, and they act in a reactionary fashion.

“They come up with a bunch of rules to correct something that likely won’t happen again, or if it does happen, it’ll happen in a different manner and the protections they put in place will be ineffectual. And time marches on.”

2/14/14 (c) 2014 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email service@rbj.net.



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