Dodd-Frank Reform Creates New Strategic Considerations For Community Banks
In May, President Donald Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act (the "Growth Act"), which provided long-awaited—and in some cases modest—regulatory relief to financial institutions of all sizes. Due to the adjustment of certain assets thresholds that subject banks to various regulatory burdens, the biggest winners from the regulatory reform are community banks with assets below $10 billion and regional banks with total assets above the $10 billion threshold and aspirations for future significant growth. As a result, it is incumbent upon these institutions to include in their strategic planning a new set of issues, examples of which are provided below.
Congress Eases Regulatory Environment for Community Banks
For community banks under $10 billion in total consolidated assets, the Growth Act repealed or modified several important provisions of the Dodd-Frank Act. In particular, the Growth Act:
- Increases the total asset threshold from $2 billion to $10 billion at which banks may deem certain loans originated and held in portfolio as "uo;qualified mortgages" for purposes of the CFPB's ability-to-repay rule;
- Requires the federal banking agencies to develop a Community Bank Leverage Ratio of not less than 8 percent and not more than 10 percent, under which any qualifying community banks under $10 billion in total assets that exceeds such ratio would be considered to have met the existing risk-based capital rules and be deemed "well capitalized" and
- Amends the Bank Holding Company Act to exempt from the Volcker Rule banks with total assets of $10 billion or less and which have total trading assets and trading liabilities of 5 percent or less of their total consolidated assets.
- It is expected that these changes will have a significant effect on the operations of community banks. As an example, qualifying banks under the Community Bank Leverage Ratio will be relieved from the more stringent international capital standards and, as a result, may be better able to deploy capital.
Crossing the $10 Billion Threshold is Now a Lot Less Ominous, but There is Still a Price to be Paid
The revisions to asset thresholds are not limited to those affecting smaller institutions and offer significant regulatory relief to institutions with greater than $10 billion in assets and less than $100 billion in assets. Such relief changes the calculus of whether to exceed the $10 billion threshold.
On the plus side, the $10 billion threshold at which financial institutions were previously required to conduct annual company-run stress tests, known as DFAST, has been moved to $250 billion in assets. In addition, publicly traded bank holding companies no longer have a regulatory requirement to establish risk committees for the oversight of the enterprise-wide risk management practices of the institution until they reach $50 billion in assets. We anticipate, however, that most if not all institutions near or exceeding $10 billion in assets will continue to maintain board risk committees and will be conducting modified forms of stress testing for safety and soundness purposes.
On the downside, and perhaps most important, is what the Growth Act did not change: financial institutions with assets over $10 billion in assets continue to be subject to the Durbin Amendment, the Volcker Rule and the supervision and examination of the CFPB. In addition, the regulatory benefits the Growth Act newly provides to community banks will be lost when the $10 billion asset threshold is crossed.
New Strategic Issues To Consider
Based on the changes described above, senior executives and boards of directors should continue to carefully consider the regulatory impact of growing (or possibly shrinking) their institution's balance sheet. Such considerations may include:
- How will the institution's capital position change under the simplified capital rules applicable to qualifying community banks?
- Will compliance with the Community Bank Leverage Ratio rule ultimately result in a more efficient capital structure, or result in a need for more capital, compared to compliance with the current multi-faceted capital requirements?
- Will near term compliance with a simplified Community Bank Leverage Ratio be outweighed by the cost of transitioning back to the existing regime once $10 billion is assets is achieved?
- Given the institution's loan portfolio and target market, would the institution benefit from the automatic qualified mortgage status now afforded to institutions under $10 billion?
- Will the institution meaningfully benefit under the revised provisions of the Volcker Rule, and how might that affect the institution's financial position?
- Will the new benefits of being under $10 billion alter an institution's strategic plan to grow over $10 billion, or is the relief from the company-run stress test and risk committee requirements enough to outweigh the regulatory relief provided to institutions under $10 billion?