Deregulation: What Many Bankers Have Been Waiting For

Miami-based Apollo Bank, in its current incarnation, has largely existed in a post-financial crisis world. Which means it’s been operating under the Dodd-Frank Act for most of its existence.

And, like those at many community banks, Apollo Bank executives say that the regulation – while well-intended – is excessive and far from effective. The good news for those pushing for loosened financial controls is that President Donald Trump seems to have put Dodd-Frank and other aspects of financial regulation on the chopping block.

For South Florida, where a strong community bank culture helps bolster an economy largely supported by small and medium-size companies, watering down banking regulations could make it easier for businesses and consumers aiming to secure loans.

“For community banks, these regulations, specifically Dodd-Frank, have restricted our ability to offer residential mortgages and small business loans,” Apollo Bank Chairman and CEO Eddy Arriola said. “I agree with the sentiment that we need to protect consumers and there needs to be an independent government agency that protects consumers form Wall Street and big banks.”

Community banks have long called for a loosening of regulations, arguing that they were not the entities that brought about the financial crisis. And it looks like they may get their wish.

“There are many bankers that argue there was very aggressive oversight, and community bankers argue that we were being punished for the misbehavior of Wall Street banks and banks that were overall aggressive,” Arriola added. “For community banks, this aggressive oversight was restricting our growth, and left us very inflexible for how we can service small business and the community.”

Déjà vu

The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by former President Barack Obama in July 2010. The suite of legislation, passed in response to the 2008 financial crisis, was named after former U.S. senators Chris Dodd, D-Conn., and Barney Frank, D-Mass. The sweeping regulations were intended to protect consumers and help prevent another financial crisis.

But while many may agree with the intent of Dodd-Frank, there’s mixed opinions on whether the act has delivered on its promise.

One of the most recent vocal critics also happens to be the leader of the free world: President Donald Trump. On Feb. 3, Trump signed an executive order that laid out “core principles” for regulating American businesses, and directed the U.S. Department of the Treasury to review existing legislation and report back to the White House on what is and isn’t working.

The Treasury was given 120 days, which means the financial industry should expect specifics on what could happen with Dodd-Frank and other regulation before the second half of the year.

“We saw this with Dodd-Frank in ’09, when the Treasury under Timothy Geithner put out a white paper in May. This is a bit of déjà vu,” said Carl Fornaris, a shareholder in the corporate and securities practice in the Miami office of Greenberg Traurig. “In late May, early June, a white paper will come out and it will be the blueprint.”

What that blueprint will be, at this juncture, is speculative. But the white paper will be viewed as the road map for regulatory reform.

Judging by statements from White House Press Secretary Sean Spicer, who said the Dodd-Frank Act is a “disastrous policy that’s hindering our markets, reducing the availability of credit, and crippling our economy’s ability to grow and create jobs,” a likely goal is to roll back financial oversight over the next four years.

“There’s this culture of deregulation that is going to be part of the broader mandate for all the regulators to look internally and start to roll back,” Fornaris said. “But once that is passed, as we saw with Dodd-Frank, it takes a couple of years to see those policies and procedures implemented. You’re looking at 2018, 2019 at the soonest.”

The ripple effects

Trump’s order lays out seven core principles as guidelines for financial regulation. Core principle “C” states that regulation should “foster economic growth and vibrant financial markets,” and principle “F” says regulation should be made “efficient, effective, and appropriately tailored.”

“I think ‘appropriately tailored’ is a euphemism for substantial deregulatory efforts,” Fornaris said.

Bankers, and especially community bankers, would welcome regulatory relief. In South Florida, even the smallest rollback of regulation would lessen the burden on financial professionals in a high-risk sector.

The Financial Crimes Enforcement Network, an arm of the Treasury, has identified High Intensity Financial Crime Areas since 1999. And the tri-county area – in addition to Indian River, Martin, Monroe, Okeechobee and St. Lucie counties – has been identified as one of seven regional HIFCAs, which means added scrutiny.

“What I think will happen to South Florida financial services will be positive, and will hopefully inculcate with regulators a sense that regulation should not be heavy-handed,” Fornaris added.

A swing away from stringent financial regulation could benefit smaller community banks, which have been limited in growth and earnings potential, in part because of increasing compliance and regulation costs. Less regulation means that banks may be freed up when it comes to lending, which equates to better bank profits and better accessibility to loans for businesses and consumers.

Regulation under Dodd-Frank became very strict for banks that hit $10 billion in assets, but even smaller community banks suffered from increased compliances costs and a regulatory culture that trickled down from the top.

Because the cost of compliance is too high, small banks have had to exit certain product lines because the operation costs don’t make sense. And that lack of choice hurts both businesses and consumers.

One product line many smaller banks have eliminated or don’t consider offering because of Dodd-Frank is residential mortgages. Compliance for originating residential mortgages became very rigorous, and the Consumer Financial Protection Bureau, which was created and awarded power through Dodd-Frank, can levy strict penalties against banks for mistakes on a mortgage application.

“What does impact community banks in South Florida are the requirements of the CFPB,” said Ivan Garces, principal in the risk advisory services department at Miami accounting and consulting firm Kaufman Rossin. “Conceptually, it’s a good idea. It’s a consumer watchdog, it’s a protection agency, but it’s very hard to lend in such a competitive market with so many disclosure rules. The cost of compliance does affect banks in South Florida.”

Residential lending isn’t an option for $275 million-asset Fort Lauderdale-based American National Bank.

“If I thought about doing residential lending, Dodd-Frank is definitely an obstacle that would be too big to overcome,” President and CEO Ginger Martin said. “It would definitely prevent me from going into residential lending, and even lending on automobiles, anything in that consumer arena. And when you have less people in the market, the consumer has less choices – and that’s not good for them.”

American National is a small commercial bank, which means that it escaped the brunt of Dodd-Frank’s effects. However, the culture of compliance, coupled with being in South Florida, means that even a small, low-risk bank needed to up its number of compliance employees.

“Go figure. I’ve got 35 employees and three of those I’ve got in the compliance area,” Martin said. “You hear that the industry is over-regulated, but the thing is, it’s not just Dodd-Frank. It’s the Bank Secrecy Act, it’s anti-money laundering, it’s the mere fact of being in South Florida.”

The burn of regulation isn’t only felt at banks, but at credit unions, as well.

“Obviously, the mortgage regulation was a huge piece of increased compliance that really caught us off guard,” said Allan Prindle, president and CEO of Pembroke Pines-based Power Financial Credit Union, which has about $615.1 million in assets. “It was a lot more effort for us, and it has manifested itself in the need for additional staff.”

While it’s one thing for bankers and credit union executives to say that regulation has gone too far, it’s unusual for a regulator to say that. But in a 2015 American Banker article, Florida Office of Financial Regulation Commissioner Drew Breakspear wrote that Dodd-Frank may be hurting community banks.

“The effect of Dodd-Frank seems to be a perversion of its original intent. Rules and regulations intended for bigger banks and financial institutions are adversely affecting smaller banks, delaying growth and recovery,” Breakspear said. “Dodd-Frank has standardized lending practices, which works to the advantage of large banks, and punishes community banks.”

Breakspear pointed to overburdensome compliance as one reason why community banks continue to consolidate. And consolidation has certainly been rampant in South Florida. Between the end of 2006 and the end of 2016, the number of banks in South Florida shrunk by almost two-fifths – to just 49 locally based institutions from 79.

Too small to fail?

There’s a running joke among bankers that they’ve been deputized as agents of federal law enforcement, Garces said, chuckling.

“And it’s tough – nobody wants to launder money for a narcotics trafficker or terrorist, of course,” he said. “But the governments’ approach is one of the stick and the hammer. Forget about the carrot and the stick; there is no carrot.”

For banks with trillions of dollars in assets and thousands of branches, a complex system of checks and balances is just part of conducting day-to-day business. But for small banks with just one or two offices, the regulatory stick without a carrot can mean the end of lucrative product lines, including business loans.

But should smaller banks be regulated less than large money center banks? The answer is complicated.

“You’re still going to want to do things right, you’re still going to want to protect your institutions,” Garces said. “One side of the coin is enhancing shareholder value; the other side of the coin is to protect shareholder value.”

When it comes to economic impact, the fact is that the failure of a $500 million bank, or even a $20 billion bank, won’t devastate the economy like the failure of a $1 trillion bank could. Miami Lakes-based BankUnited, the largest South Florida-based bank, has a market capitalization of $4.11 billion. Charlotte, North Carolina-based Bank of America has a market cap of $240.11 billion, and San Francisco-based Wells Fargo has a market cap of $286.96 billion.

If Bank of America or Wells Fargo fail, markets would be affected. It’s highly unlikely that a failure of a community bank would devastate the New York Stock Exchange.

Then there’s the bailout. Banks were awarded a piece of a $700 billion bailout following the financial crisis, and the banks that received the most were, unsurprisingly, the “too-big-to-fail” banks. Bank of America and South Dakota-based Citigroup received about $45 billion, in addition to other federal aid, according to ProPublica. New York-based JPMorgan Chase Bank and Wells Fargo received $25 billion.

Doral-based U.S. Century Bank, a less than $1 billion-asset community bank, received the largest taxpayer relief among banks in Florida following the financial crisis. U.S. Century received just over $50 million from the Troubled Asset Relief Program, a sort of taxpayer loan.

So what does a post-Dodd-Frank world look like? In all likelihood, Dodd-Frank will remain, or at least parts of it will stay in effect for years to come.

But bankers, attorneys, accountants and other financial professionals are looking forward to what financial regulation will look like in the future.

“Dodd-Frank had good intentions, and there was definitely a need for additional oversight in certain areas,” Prindle said. “But sometimes the compliance regulation pendulum swings too far, and I think it went way to the other side, where there is over-oversight.”