We’ve always looked up to the local banker, pillar of the community, whose loans provide the catalyst for growth in local businesses. No? Well, I guess one needs to be somewhat advanced in age for this to be your image of the bank. Times have changed.
Bank mergers and failures have left us with about 2,300 fewer community banks than in 2000, a decline of 28% in 15 years.
Small banks share of deposits have declined from 40% to only 22% of deposits over that time.
For an overview, check out the Mercatus Center at George Mason University: http://mercatus.org/publication/small-banks-numbers-2000-2014
From the beginning, Lynx Loan Fund, LLLP, our private loan fund, has worked with local banks to fund a portion of our loan portfolio. In the course of working together, we discuss business and market trends. The banks want to hear what we are doing, so they know whether we’ve been bad or good and I want to know what’s going on with the banks, so I have an inkling of how willing they will be to further support our business. We both win when we know each other better.
Regulation is killing community banking. It is a death by a thousand cuts.
- Loan guidelines are used by regulators as a cudgel against management. If the “guideline” is not followed, the deviation is grounds for criticism, additional scrutiny and worse. Prudent deviation from a guideline is good judgment, not grounds for summary execution.
- Compliance with consumer regulations has become so complex and convoluted that compliance requires one or more staff people devoted exclusively to making sure that each element is perfect. Absent a compliance department, individual loan officers are overwhelmed with the intricacy. The moral of the story is that community banks will often avoid making consumer loans due to the risks of a meaningless error in the process. The result is that competition is reduced for consumer loans, the variety of consumer loans is reduced, and the local banker’s flexibility to “work with” a consumer customer is virtually lost. Big banks don’t keep their consumer loans. They are sold off and securitized. The big banks don’t “work” with anybody.
- Regulations have also created a loan review hierarchy. Bank Presidents are not “the man (or woman)”. The Chief Credit Officer wields the big stick. Why? Regulators like them. Sadly, however, loans these days all go to the “loan committee” and/or the “board”. Well, committees represent the zenith of group think. A well structured loan request can go down in flames due to a single committee member’s comment: “Well, I don’t know. It sounds good, but what if there is nuclear Armageddon?” Bank boards, sadly, are often made up of owners who have never been a banker (Grandpa was a really good banker) and a few hangers on, or golfing buddies, who often also lack the breadth of business judgment or knowledge to evaluate many credits.
- Banks operate with huge leverage. Banks have skinny margins, especially in this era of low interest rates. These low margins are compounded by overhead demands for compliance staff, support of brick and mortar branches and the risks of dopey “Community Reinvestment Act” loans which are generally somewhat sketchy, but help them satisfy the regulators.
- The capital allocation of a certain share of capital allocated to loans that fall within various categories are arbitrarily assigned a higher risk level. This requirement leads banks to limit lending in traditionally lucrative loan categories like construction and other loan types that fit the community banking model. This means less loans, more regulator scrutiny and often whole categories of loans banished from a bank’s offerings.
- When a bank does have a loss, it’s a big deal, since it takes so long to recover the loss due to the high leverage and skinny margins. Regulators feed on troubled loans like piranha. They pick their teeth with the bones of the loan officer, chief credit officer and everyone else, too.
- In case my point isn’t clear, bank regulation has become so extensive and intense that banks are unable to use their judgment and skills as community bankers to make loans to worthy credits. At one time, bankers spoke of the 4C’s of credit. It went something like this: Credit, Collateral, Capacity and Character. The last C has virtually been expunged from the lexicon of banking due to rigid guidelines, checklist based regulators, ever expanding compliance rules and the ultimate fear of any bank stock holder.
The ultimate fear of bank stock holders and managers is to be seized by their regulator (we have used “regulator” in the generic sense, but remember banks are subject to at least two and sometimes more regulators – FDIC, Federal Reserve Bank, OCC, State Regulators and others). A bank seizure does two things. It takes over all management and control of the bank from management – permanently. Second, it extinguishes the bank equity completely. The shareholders irrevocably and permanently lose their equity in the bank. There is no appeal. Bank stockholders have attempted to sue to have seizures undone or modified, but have not succeeded. Of course, this is only supposed to happen when the bank’s in such tough shape that it can’t recover. One problem, the sole arbiter of this decision is the regulator. No input, no appeal, no recourse. When they say it’s over, it’s over. Harsh.
The regulatory environment is bad for community banks, bad for their community, bad for borrowers, bad for depositors, bad for the economy, that’s odd. Ben Bernanke and Janet Yellen, after him at the Federal Reserve Bank, tell us that banks should be lending more money. The State and Federal legislators keep telling us that all this consumer regulation will make consumer loans easier to obtain and better for consumers. So, folks get mad at the local banker and write their representative, asking for more regulation. I feel sorry for the local banker.