Smaller banks feeling the sting of Dodd-Frank
It has restricted how banks and credit unions can raise money, reduced fee revenue and left financial institutions vulnerable to lawsuits on home mortgages.
But community banks will remember the Dodd-Frank financial reform law more for stringent new documentation requirements than any particular rule, said Martin Connors, president and CEO of Rollstone Bank & Trust in Fitchburg.
“It's not changing the way we do business,” Connors said. “It's just forcing us to do more work.”
Rollstone, for instance, now has to rate every corporate or municipal loan in its profile rather than rely on evaluations from rating agencies. Gathering and writing the pertinent financial information has resulted in much more work for his team, Connors said, and almost never turns up anything new.
“S&P and Moody's spend a lot of time coming up with their ratings,” he said, emphasizing the thoroughness of their research.
Charles River Bank President and CEO Jack Hamilton measures the impact of the 2010 law mostly in extra training hours for managers, extra money spent upgrading technology and extra visits from auditors.
Community banks like Charles River, of Medway, can't ship the work to a compliance department in some far-flung office tower, Hamilton said. Instead, bank leaders must shoulder the load, taking their attention away from serving customers or attracting new business.
“It's ultimately going to force a lot of community banks to merge,” he said.
The 2,319-page law has already wiped out some tools for raising capital, scaled back the utilization of fees and reshaped the home mortgage market. And half of it remains to be implemented, according to the Manhattan-based law firm Davis Polk, which has tracked the proceedings.
Qualified mortgages
The newest regulation was crafted by an agency that didn't even exist at the time of the financial crisis.
Dodd-Frank formed the Consumer Financial Protection Bureau (CFPB), which examines banks with more than $10 billion in assets (That means none based in Central Massachusetts, whose largest bank — Middlesex Savings in Natick — has assets of $4.03 billion). But the rules the agency has written can apply to all banks and credit unions.
The National Consumer Law Center was one of several groups pushing for creation of a federal agency with authority to implement measures aimed at safeguarding the public. NCLC legal counsel Margot Saunders said in 2009 that the alternative — requiring banks to sign off on rules to counter predatory lending — would result in regulations that offer the public little protection.
The CFPB's qualified mortgage (QM) regulations took effect Jan. 10 and are meant to reduce the number of foreclosures by preventing banks and credit unions from issuing loans to people who can't afford to make the payments. To qualify for legal protections, loans issued by financial institutions must be income-verified by the institution, have some kind of down payment , avoid negative amortization (in which the monthly loan payment doesn't cover interest costs, causing debt to accumulate), abide by point and fee caps and run no longer than 30 years. Some 92 percent of loans in the marketplace today meet those requirements, according to the CFPB.
But sometimes, credit unions want to offer non-qualifying mortgages to help members, said Paul Gentile, president and CEO of the Massachusetts Credit Union League.
“Not everyone fits a perfect lending candidate profile,” Gentile said. “It's ripe for creating potential lawsuits.”
Lenders making non-QM loans have fewer protections against lawsuits from borrowers should the loans go sour, even if the original lender has resold the loan by the time it fails.
Others, such as Ken Ehrlich of the Boston law firm Nutter, McClennen and Fish, and Collyn Gilbert of Keefe Bruyette and Woods law firm in New Jersey, believe most small lenders' practices already comply with QM.
Raising money
Dodd-Frank forbids banks with more than $500 million in assets from counting trust-preferred securities — which possess characteristics of both equity and debt issues — as Tier I capital (the core regulatory measure of a bank's financial strength). Eight Central Massachusetts banks are subject to the restriction. This is a particular issue for New England banks, Ehrlich said, since most are mutual (owned by depositors) and therefore unable to raise money by selling stock.
Charles River had long participated with other New England mutual banks in a reissuance company, which accepted a higher level of risk on private mortgages in exchange for a small piece of the premium. But the CFPB didn't like the reissuance relationship, Hamilton said, and forced the banks to end it last summer, depriving Charles River of a longtime revenue source.
“The CFPB is on a mission,” Gilbert said. “It's relentless, and it doesn't seem to be waiting at all.”
Recent regulations have cut into two reliable sources of income for banks.
Starting in July 2010, banks had to get customers' permission to opt in to an overdraft program that allows a customer's account to fall into a negative balance with a penalty from the bank. Prior to that, customers could be automatically enrolled. Such programs assist people in need of money without forcing them to turn to payday lenders or pawn shops, Hamilton said.
The change took a big bite out of fee income following implementation, Gilbert said, though banks have adjusted in recent years.
One year later, the Federal Reserve began regulating interchange fees, or the amount banks can charge retailers who accept their debit cards. Financial institutions with assets of at least $10 billion saw their interchange fees capped at 21 cents per transaction. Prior to that, the average fee was 40 cents.
The regulation has trickled down to community banks, which have been forced to cut their card-swiping fees to stay competitive. Both Rollstone and Charles River reported a drop in interchange income since 2011.
Banks had been relying on fees to make up for revenue lost due to sustained low interest rates, Gilbert said, making the new rules all the more challenging. “In the course of legislating fixes, Congress wasn't as sensitive as it should have been,” Ehrlich said. “Dodd-Frank, across the board, is unfairly burdensome to community banks.”
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