Big Win for Small Banks in Overhaul

Wall Street Journal

by Robin Sidel

Some of the smallest U.S. banks are heading toward a big boost from financial-overhaul legislation.

A string of provisions tucked into the bill being voted on by the House on Wednesday would reduce the premiums that small banks pay to the Federal Deposit Insurance Corp., exempt them from parts of the newly proposed consumer-protection agency and reduce their financial exposure to some mortgages by allowing the small banks to sell the loans to investors.

The bill also would permit small institutions to count certain types of securities toward their capital requirements. Larger U.S. banks wouldn't be permitted to do so. Democrats put off the Senate vote on the bill until mid-July as they try to find enough votes from Republicans.

"We won more than we lost," said Camden Fine, president and chief executive of the Independent Community Bankers of America, a trade group representing about 5,000 small U.S. banks.

Although small banks typically didn't offer the riskiest types of mortgages or dive into sophisticated derivatives that blew up during the financial crisis, many such institutions are hobbled by commercial-real-estate loans and their own investments that soured. As a result, small banks have bristled at the prospect of more legislation, contending they didn't cause the financial crisis and have less flexibility than big banks to offset costs that will accompany new rules.

Harold Keen, president and chief executive of KS Bancorp, Smithfield, N.C., is worried about costs that would come with rules likely to be issued by the new consumer-protection agency. Community banks would be required to follow the agency's rules, although enforcement will up to the banks' usual regulators.

"Anytime you create more requirements and regulations, it impacts everybody," says Mr. Keen, whose bank-holding company owns a savings-and-loan institution with nine branches.

Small banks also won an exemption from new regulations that could reduce the revenue generated from fees charged to merchants for debit-card transactions. Bankers remain unhappy about the new rules, however, claiming that the exemption won't help them because they will be forced to lower the so-called interchange fees to compete with the bigger financial institutions.

The likely financial impact of the looming changes still is being calculated. So far, the community bankers' group estimates that the bill would save the industry $4.5 billion over three years by basing the amount of a bank's contribution to the FDIC deposit-insurance fund on the amount of a bank's assets. Premiums now are assessed based on the amount of a bank's deposits.

The community-banking industry also is breathing a sigh of relief over a measure that exempts them from the phase-out of trust-preferred securities. Large and small banks raced to issue such securities, which are a hybrid of equity and debt, in the past decade after regulators decided they could be used toward capital requirements.

The bill requires banks with more than $15 billion in assets to phase out trust-preferred securities over three years, starting in 2013. Banks below that threshold can continue to count existing trust-preferred securities as capital. That could be significant for hundreds of small banks that might otherwise have been forced to raise fresh capital without the exemption.

Dan Bass, an investment banker who advises small banks, says the costs of the legislation still are likely to outweigh the financial benefits to small institutions. As a result, he expects more consolidation among community banks.

"There are a lot of boards that are tired and feel beat up and will want to sell out," says Mr. Bass, a managing director at FBR Capital Markets in Houston.

Meanwhile, Wall Street analysts are scrambling to assess the financial impact on medium-sized banks that don't fall under the community-bank exemptions. For them, the biggest issues of concern are the loss of revenue from lower interchange fees and the phase-out of trust-preferred securities.

Ken Zerbe, a regional-banking analyst at Morgan Stanley, says the new restriction on trust-preferred securities could prompt M&T Bank Corp., based in Buffalo, N.Y., to raise more capital to make up for the elimination of its trust-preferred securities.

An M&T spokesman couldn't be reached for comment.

Analysts also are keeping an eye out for the potential impact on banks with operations similar to those at larger banks likely to face drastic changes under the bill. For example, SVB Financial Group, the Santa Clara, Calif., parent of Silicon Valley Bank, could be forced to sell off its private-equity business as part of the bill's so-called Volcker rule, Mr. Zerbe said.

Although the private-equity operation at SVB has lost money for the past two years, "this could have been a much bigger business for them longer-term, thus reducing organic earnings growth," Mr. Zerbe wrote in a research report.

Mary Dent, SVB general counsel, said the company is waiting to see if its investment activity, which it considers venture capital, would be covered under the bill. She noted that the bill provides an extensive period of time for banks to reduce such investments.