WASHINGTON—Credit unions in search of higher returns are loosening lending standards and piling into longer-term assets, exposing the firms to potentially significant losses if interest rates rise and worrying regulators in the process.
Such moves are raising concerns at the National Credit Union Administration, the sector’s regulator, which said a rise in interest rates could make loans and investments unprofitable. Some analysts also said credit unions likely are unaware of the risk they are taking on because they largely avoided the housing downturn. That has raised worries that lax underwriting standards could fuel another bubble.
“I am concerned that the message [about rates] is either not getting through, or it’s getting through and they are just choosing not to do anything about it,” said Debbie Matz, chairman of the NCUA, who has long sounded the alarm about the industry’s exposure to interest-rate risk.
Credit unions, which have been expanding steadily for years and now serve more than 97 million members nationwide, collectively held $1.098 trillion in assets at the end of the first quarter of 2014.
For the lenders, taking on more risk can help boost returns in a low-rate environment. A firm that offers a low-rate, long-term loan might win business over a competitor, and a credit union that invests in a mortgage bond with a relatively longer term can often demand a higher return.
But if interest rates rise, the money in those loans or investments will be locked in, generating relatively less revenue than a new loan or investment made in the higher-rate environment. Meanwhile, those banks and credit unions will have to pay depositors higher interest rates, otherwise those customers could move elsewhere.
“It’s a double-edged sword,” said Federal Deposit Insurance Corp. Chairman Martin Gruenberg at a news conference last week.
Credit unions’ net holdings of long-term assets, a measure of exposure to rising interest rates, rose to an all-time high at the end of 2013 to 35.85% of total assets, according to the NCUA. The increase comes as some credit unions are adopting lax standards for mortgage and home-equity loans and lines of credit reminiscent of those leading up to the financial crisis, according to interviews. Credit unions also are extending the duration on investments like mortgage bonds, regulatory data show.
“In periods of declining mortgage volume, people start loosening underwriting to boost business,” said Guy Cecala, chief executive at Inside Mortgage Finance, an industry newsletter. “They seem to be taking on a lot more risk than in the past.”
WASHINGTON—Small banks may be faring better than their declining numbers suggest, with a new regulatory study finding small U.S. firms are not on the wane despite explosive growth by large banks.
The Federal Deposit Insurance Corp. found there are more banks with assets between $100 million and $1 billion today than there were in 1985, according to a study released Wednesday. That is despite the plummeting total count of U.S. banks, from more than 18,000 in 1985 to less than 7,000 today.
Most of that decline can be attributed to banks under $100 million, suggesting a threshold at which banks have the scale to compete despite their relatively small size.
Smaller institutions still face a raft of challenges, from low interest rates to a less robust mortgage market and new regulatory requirements. But the FDIC offered a more upbeat assessment of those banks’ prospects, finding that community banks are able to cut costs significantly when they pass $100 million in assets—a phenomenon that may explain why institutions of that size haven’t seen a decline in their numbers, the FDIC said.
The decline in overall banking charters suggests “a disaster for small banks, but that’s not what the numbers show if you follow them over time,” said Richard Brown, the FDIC’s chief economist, in an interview.
The study also found that more often than not community lenders giving up their charters have been purchased by other banks with similar business models, suggesting local lenders are growing slightly larger rather than disappearing altogether.
First Oklahoma Bank of Tulsa, Okla., started out when investors acquired the state’s third smallest bank, with about $9 million in assets, in 2009, said Chairman Tom Bennett. Now the bank has $285 million in assets after a strong first quarter of making loans, and Mr. Bennett says he isn’t complaining about regulations. “Somewhere over $100 million you begin to get enough scale that you can absorb the cost,” he said.
The core problems for the smallest firms, he said, are that the slowed-down real-estate market and low interest rates have been squeezing community banks that rely disproportionately on mortgage lending and net interest income for their revenue.
Guilty pleas to criminal charges by BNP Paribas and some other financial firms should put to rest fears that banks are “too big to jail.” Even so, that isn’t necessarily great news for the financial system or investors.
The reason some banks were perceived to be outside the reach of the law’s long arm was that a criminal charge would prove so devastating it could upend a firm and disrupt the functioning of the financial system. BNP Paribas shows why that is no longer the case, but also why that isn’t such a threat to the biggest banks.
True, BNP has had to pay about $9 billion to resolve charges related to violations of U.S. sanctions on doing business with countries such as Iran and Sudan. It also will have to reorganize some of the ways it does business in the U.S. And the bank has suffered a clear hit to its reputation.
Yet prosecutors and regulators worked to cushion the blow a guilty plea would have. Indeed, even a ban on BNP’s dollar-clearing operations was tailored so that it affected only a small part of its business. As well, the bank will have six months to prepare affected clients before the penalty kicks in.
What’s more, while authorities pushed for the bank to remove some staff, no individuals were criminally charged. That echoes other big settlements with U.S. and foreign banks. It also is telling that so far the banks charged are foreign institutions, not U.S. ones, which escaped a comeuppance for behavior that fueled the financial crisis.
The desire to not rock the financial boat, and possibly send markets into debilitating paroxysms, is understandable, especially for regulators. It is easy too to forgive prosecutors, as well, for keeping financial stability in mind.Still, their hesitancy to actually charge individual bankers, force banks to shutter or dispose of units at the heart of wrongdoing or make the buck stop at a CEO’s desk sends the wrong message.
Instead, actions to date let banks, and bankers in particular, think that criminal charges are now like huge financial penalties: a painful and embarrassing, but ultimately manageable, cost of doing business.
In other words, the deterrent effect of such charges is questionable. That already is the case with the seemingly enormous fines being assessed in cases. As big as the numbers involved sound, the banks that are paying out multibillion-dollar penalties are themselves gargantuan. While J.P. Morgan Chase, for example, was forced to cough up $13 billion last fall to resolve issues related to mortgage-backed bonds, it has assets of about $2.4 trillion.
Investors might take short-term relief from this. Indeed, in the wake of settlements, the affected bank’s shares typically rise as there is certainty about the costs involved. The reason: As long as a bank isn’t hit so hard that it is forced to raise new capital and dilute existing shareholders, investors tend to move on pretty quickly from such affairs. In that vein, Credit Suisse shares rose about 1% in the immediate aftermath of that bank pleading guilty in mid-May to a criminal charge of tax evasion.
But investors shouldn’t spend too much time cheering. Without true accountability, a new generation of bankers will be emboldened to take on risks, or engage in behavior, that puts the long-term viability of their firms at risk.The penalty for that will ultimately be borne by shareholders.
Regulatory Cost Calculator
Instructions: This calculator allows users to conduct analysis similar to that presented in the Federal Reserve Bank of Minneapolis Economic Policy Paper (13-3), “Quantifying the Costs of Additional Regulation on Community Banks,” by Ron Feldman, Ken Heinecke and Jason Schmidt. Please review that paper for additional details on the analysis allowed by this calculator.
The underlying data in the calculator come from the quarterly statements of condition and income that commercial banks are required to file with federal regulators (known as “Call Reports”). This calculator contains data on “community” banks, which are defined to have assets less than $1 billion. In the calculator, the user can specify four input parameters:
1. Bank asset size cutoffs. 2. Number of full-time equivalent employees (FTEs). 3. Compensation of FTEs. 4. Year on which the analysis is performed.
This version of the regulatory cost calculator contains updated data through Q4 2013. Note that results for the 2001-2012 period are slightly different due to revisions to the call report data and seasonal adjustment of the CPI.
Download updated calculator (.xlsm, 13MB)
Note: Click the Enable Content or Enable Macros button when the file opens to allow the calculator to appear.
More small banks are selling themselves, and executives say Washington regulations are a big reason why.
At Bank of Commerce, a Charlotte, N.C., lender with $129 million in assets, regulatory costs helped push Chief Executive Wesley Sturges to agree last month to sell to HomeTrust Bancshares Inc. a North Carolina bank group with $1.6 billion in assets. Bank of Commerce, which generated just $441,000 in net income last year, was forced to boost spending on internal personnel and outside audit work to cope with added regulatory hurdles stemming from the financial crisis, on top of the anti-money-laundering laws, credit-reporting rules and many other regulatory issues the bank already was dealing with, Mr. Sturges said. “It’s across the board. When you only have 20 employees, any increase is a lot,” he said.
In a period when low interest rates are squeezing small banks, the costs of adhering to new regulations are taking a toll. Executives from at least a half-dozen small banks that have agreed to be acquired in recent months said the increasing regulatory burden was a factor in their decisions.
The executives said the new rules aren’t scaled for banks of their size. While the Dodd-Frank financial-overhaul law and other new rules were aimed at reducing the problems caused by big banks, small banks must deal with many of them as well, and the costs don’t necessarily get lower as the banks get smaller.
“When they created ‘too big to fail,’ they also created ‘too small to succeed,'” said Dan Baird, chief executive of Capital Funding Group Inc., which last October sold its CFG Community Bank, a Maryland bank with $481 million in assets, to MVB Financial Corp.
In all, there were 6,812 banks in the U.S. at the end of 2013, compared with 8,534 at the end of 2007, according to the Federal Deposit Insurance Corp.
Regulators said they have tried to make it as easy as possible for community banks to adhere to the wave of new regulations. “We are very, very mindful from a community-bank perspective that when you have that type of change, you do have a burden,” said Jennifer Kelly, an Office of the Comptroller of the Currency official who supervises midsize and smaller banks.
Congress has taken note. “If compliance costs increase past the point of economic sustainability, many smaller institutions may merge with larger entities,” House Financial Services Committee staff members said in a memo prepared for a hearing last year on community-bank regulatory burdens.
The moves come as a sluggish economic expansion limits banks’ ability to expand enough to absorb higher costs. That is pushing some bank executives to look to sell. In all, there were 204 bank mergers in 2013 in which the target bank had less than $1 billion in assets, according to financial-research firm SNL Financial.
That is about the same as the 206 in 2012 and up significantly from 102 in 2009, before Dodd-Frank was passed in 2010. As recently as 2011, the number was 130.
To be sure, in most bank sales there are several factors at play. Still, higher regulatory expenses are weighing heavily. A paper last May from officials at the Federal Reserve Bank of Minneapolis said a third of the smallest banks, those under $50 million in assets, could become unprofitable if they had to hire just two additional compliance employees.
Slightly larger banks like Asheville, N.C.-based HomeTrust also are facing a heavier regulatory burden, but are looking to buy other banks in part to absorb the higher expenses more easily. “Our strategy certainly includes growing assets to be able to spread those regulatory costs,” said Dana Stonestreet, HomeTrust’s CEO. That helped prompt him to strike the deal to buy Bank of Commerce for $10.1 million and the redemption of its $3.2 million in preferred stock.
Peter Alworth, chairman of St. Michael, Minn.-based Great Northern Bank, which had $71 million in assets and completed its merger into First American Bank of Hudson, Wis., in February, said Great Northern sold in part because of the need to spread regulatory costs over a larger base of business. “I’ve got the same cost whether I’m running a bank with $75 million [in assets] or $200 million,” he said.
Many bankers think smaller banks now must have at least $1 billion in assets to cope with the increased regulatory burden.
“The $100 million or $200 million bank or credit union doesn’t have the same tools and financial resources that the larger institutions have,” said Richard Garabedian, a banking lawyer with Luse Gorman Pomerenk & Schick in Washington and a former Federal Reserve lawyer.
One issue some small banks say they are having a big problem with is the Consumer Financial Protection Bureau’s new “qualified mortgage” rules, or QM, which require lenders to make sure borrowers can afford the mortgages they take out. Some banks say following the rules, which took effect in January, has been complicated and time-consuming.
“Our people are spending more time trying to figure out QM and CFPB issues than they are making loans,” said Robert Rupel, CEO of Team Capital Bank, a Bethlehem, Pa., bank with $944 million in assets. Team Capital agreed in December to be acquired by Jersey City, N.J.-based Provident Financial Services Inc., and Mr. Rupel said regulatory costs were a factor.
A CFPB spokesman said the agency takes seriously community banks’ concerns about regulation and has taken measures to help them comply with CFPB rules.Similarly, an FDIC spokesman said the agency has reached out to community banks and provided them with technical assistance and other information and resources.