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PCBB Banc Investment Daily December 29, 2014
Banc Investment Daily
December 29, 2014

Do You Speak Dodd Frankish?

The US Navy and environmental groups are at war over military activities taking place off the coasts of CA and HI. War gaming in these areas dates back to 1886 and is designed to train navy personnel in explosives and missiles. Sonar testing and explosives are also harmful to marine creatures such as dolphins, whales, sea turtles and seals. Studies find damage ranges from temporary hearing loss to the death of animals. We can just imagine Flipper the dolphin wearing hearing aids. In all seriousness though, the poor animals have nothing to do with combat training; their circumstance is one of collateral damage. They are the unintended victims of a more prioritized national objective, the defense of the nation.
The expression "collateral damage" also characterizes some of the consequences of the financial regulatory overhaul of the last few years. Dodd Frank and the Consumer Protection Acts passed in 2010 were aimed at giant banks judged responsible for the financial meltdown and resulting Great Recession. Unfortunately, community banks of a more modest size are also feeling the impact of the reform as collateral damage, despite that even 4Ys later the Dodd Frank overhaul is still a work in progress. The 850 pages of legislation text covering 398 new regulations have not been fully implemented. In fact, 45% of the law still needs definition and adoption by the agencies in charge, according to the law firm of Davis Polk.
The effects of only partial implementation are complicated. Agencies such as the Consumer Financial Protection Bureau (CFPB) and the Financial Stability Oversight Council (FSOC) have been created. Nevertheless, key provisions of the reform they are supposed to enforce are still in limbo. TBTF Banks are supposed to submit "living wills" explaining their strategy for a rapid bankruptcy in the event of another financial crisis, and yet the Federal Reserve recognized this summer that it has not received this information. Tougher regulations for credit rating firms are still in the making, as are standards for the mortgage securities market.
Overall, some 19K pages of regulatory text have been produced, according to the Mercatus Center at George Mason University, but there are more to come. These new rules and the uncertainty about future ones are negatively affecting smaller banks. Even though they were not the target of Dodd Frank reforms, they are still obliged to comply with new mortgage rules, capital requirements and rules governing municipal advisors. They are collateral damage.
Few community banks delved into sophisticated structures, they didn't engage actively in securitization, nevertheless the rules made for their giant colleagues trickle down to them. On average, banks have added 1 to 3 employees to assist with regulatory compliance. The Fed in fact estimates that hiring just 2 more compliance personnel could reverse the profitability of up to 33% of the smallest banks.
In addition to shoring up compliance departments, community banks have also changed their product lines in order to avoid lawsuits and regulatory crackdown. Soft data like the character of a borrower that has historically helped smaller banks serve the special needs of their markets is not recognized by some regulators, so some banks have eliminated its use. Given fewer products and less ability to make decisions based on local expertise, community banks are left with a difficult task to define their differences from competitors. Large banks whose risky activities caused all the problems in the first place often still get favorable treatment. Unfortunately, the whale that is too big to fail still has enormous advantages over our chipper Flipper and that equates to collateral damage that affects everyone.