The federal government is making it impossible to be small

Bank Lawyer's Blog

July 24, 2016

Credit Unions and Community Banks Both Face "Shrinkage"

In his recent email newsletter (email marvin.umholtz@comcast.net for a subscription), credit union consultant Marvin Umholtz discusses the fact that credit unions face the same problem of "shrinkage" that we have discussed on this blog for some time with respect to the community banking industry. Not surprisingly, both segments of the financial services industry suffer from the same disease: crushing regulation.

On July 8th the Editor In Chief for the Credit Union Journal, Lisa Freeman, launched an initiative exploring reader attitudes about the serious question of whether 74% of the credit union industry is "too small to survive" www.cujournal.com/news/opinions/forget-about-too-big-to-fail-for-cus­its-too-small-to-survive-1026267-i.html. The massive regulatory burden, much of it sourced by the federal government, had been identified as the primary culprit. There are other reasons why credit unions merge or liquidate, however, the burgeoning compliance burden stands out.

According to the NCUA's statistics on March 31, 2016, the number of federally insured credit unions dropped below 6,000 for the first time in history. This correspondent believes that by 2021 there will be fewer than 600 federally insured credit unions - and they all will be multi-billions in assets because they will have to be large enough to cope with the Dodd-Frank Acts and the FFIEC's compliance-driven culture that it is now too late to stop. An advancing avalanche of costly and complex rules are already in the federal pipeline. Among the next to hit will be the Military Lending Act Rule on October 3, 2016, that will upend the way consumer loans are granted.

Just by itself, the rogue CFPB has been a rulemaking nightmare. In a July 13th letter to the Office of Management and Budget's Office of Information and Regulatory Affairs (OIRA), the American Bankers Association (ABA) and the Consumer Bankers Association (CBA) urged OIRA to reform the "generic clearance process" in federal rulemaking so that the CFPB doesn't end-run procedures to make policy without having to follow the rules. The CFPB intended to use this stealth approach to making policy-related data collections for overdraft rules www.aba.com/Advocacy /commentletters/Documents/cl-PRA-ConsumerEngage2016.pdf.

The CFPB also plans to add 37 new data collection fields for the Home Mortgage Disclosure Act (HMDA) data reporting by mortgage loan originating financial institutions. The CFPB and the other FFIEC-member agencies, including the NCUA, are expected to double-down on fair lending compliance; and the disputed and controversial disparate impact theory has been terribly abused by the CFPB, the Housing and Urban Development Department (HUD) and by the Department of Justice (DOJ) in recent years HTTP://bankingjournal.aba.com/2016/07/associations­challenge-huds-disparate-impact-rule.

The credit unions should not expect any relief from the CFPB's oppressive rulemaking. Regardless of which political party wins the White House, credit unions will not receive exemptions from the CFPB's rules. Exemptions by charter or asset size are incompatible with the DNA of the agency.

The U.S. Treasury's FinCEN has demonstrated its ever-expanding expectations for cybersecurity, as well as for the PATRIOT Act, the Bank Secrecy Act, and for the anti-money laundering compliance. The U.S. Treasury and its FinCEN unit are determined to cut off terrorist financing, and that would for the closing off of the weakest links - including smaller credit unions. The U.S. Treasury Department wants fewer open doors in which cybercriminals and terrorist bad actors might enter and deploy the U.S financial system.

The Financial Accounting Standards Board's current expected credit losses methodology (CECL) will be phased in over several years, but credit union leaders have been encouraged to start working on CECL compliance now because it is that complicated.

The awful economy, with its low-interest rates and diminished interest rate margins, has been particularly stressful for leaders at smaller financial institutions. As was said in the July 16, 2016, edition of The Economist the "Buttonwood" opinion essay was entitled, "Slow Suffocation: The financial system isn't designed to cope with low or negative rates." The op-ed concluded, "The irony is that low rates were initially devised as a policy to save the financial sector, and through the mechanism of higher lending, the rest of the economy. Many voters protested about the bailing out of the very institutions that caused the crisis. Those protesters can take only cold comfort that the same policies are now slowly suffocating the industry."

The NCUA's and the state credit union supervisory authorities' examiners will be scrutinizing credit risk management and interest rate risk management - translated by examiners to mean having appropriate policies, practices, technologies, modeling, and testing - that all must be upgraded. Examiners will be tougher on strategic planning and governance compliance. Capital planning and succession planning will also be on examiners' "deep look" list.

Operational risks like resiliency and internal controls are a big compliance concern at smaller credit unions with fewer staff and uninvolved boards of directors. The credit union industry has experienced too many stories about fraud and criminality, especially at smaller credit unions. The Office of Financial Research (OFR) has huge plans to digitally "tag" every financial service provider and every financial transaction such that both the provider and the transaction can be tracked globally.

The National Credit Union Share Insurance Fund (NCUSIF) is "double-counted" as an asset by the credit union and by the NCUA. The NCUA has the actual possession of the credit union's 1 % deposit. The NCUSIF structure and funding needs to more closely resemble that of the Federal deposit Insurance Corporation (FDIC). Congress is unlikely to allow credit unions to continue paying a fraction of the cost compared to banks for the "full faith and credit of the U.S. Government." That will have costs associated with it, as well. Plus, it is a political dilemma of great magnitude for both the NCUA Board and for credit unions of all sizes.

Small credit unions might not be directly involved in taxi medallion loans, however, do the math. The drop in loan values in those taxi medallion loans and related participation loans add up to large numbers. The NCUA will seek out large credit unions to "buy" those bad loans via mergers and purchase and assumptions, but the costs to the NCUSIF could be substantial. And the actual financial status of the Temporary Corporate Credit Union Stabilization Fund (TCCUSF) won't be known until 2021. The TCCUSF's health is very dependent upon the health of the U.S. economy. Many smaller credit unions won't be around in 2021 to find out the TCCUSF's ultimate fate.

And for leaders at credit unions of all sizes, the challenges listed by this correspondent should be viewed as merely the tip of the iceberg. There has existed a dynamic since before the financial crisis that favored larger organizations. The federal government is making it impossible to be small. And the asset size definition of "small" will grow every year between now and 2021, and it will grow ever more rapidly. Is $100 million small? Is $1 billion small? Is $10 billion in assets small? The federally-mandated regulatory compliance burden is crushing Main Street's credit unions while the compliance hurdles to jump are being set ever-higher. Strategically speaking, the time to plan for it and act on the emerging situation is now.

Some short-sighted community bankers might think that dwindling numbers of their tax-exempt competitors is good news. Unfortunately, this isn't a case of "I don't need to run faster than the bear, I just need to run faster than you." While the old adage that "some day you eat the bear, and someday the bear eats you" might hold true in some areas of life, in the case of regulatory burden, the bear is coming to claim both credit unions and community banks. It's an equal opportunity exterminator.

I've been harping about community banks and credit unions making common cause for some time. While some efforts in that direction have been, and are continuing to be, made, thus far, I don't see the results. Time's a wasting'.