Midtier CEOs Fret Over Thinning Ranks, Marketplace Lenders

Webster Financial Chairman and Chief Executive James C. Smith views midsize banks like his as an endangered species.

While all banks are grappling with costly new regulations put in place following the financial crisis, Smith contends that it's banks in the $10 billion- to $50 billion-asset range that are being squeezed the most. Banks with less than $10 billion of assets are exempt from caps on interchange fees, aren't subject to stress tests and aren't directly regulated by the Consumer Financial Protection Bureau, while the largest banks can more easily absorb the additional costs, he said during a recent roundtable discussion in Washington with heads of several other midsize banks.

It's no wonder, he added, that the ranks of the midsize banks continue to shrink. In just the last 10 days, two such institutions — Astoria Financial and First Niagara Financial Group — announced they were selling themselves, while other deals for National Penn Bancshares, Susquehanna Bancshares, OneWest Bank, City National Bank and Hudson City Savings Bank have all either recently closed or are nearing completion.

"Bankers are in business to make judgments and take risks, and that's being usurped by prescriptive regulation," said Smith, whose Waterbury, Conn.-based bank has $24 billion of assets.  "When there's no judgment involved, those that have the lowest unit costs will win and it's one of the reasons that you are seeing attrition in the midsize group."

Smith is a former co-chairman of the American Bankers Council, a wing of the American Bankers Association that lobbies for the interests of midsize institutions. Members of the group were in Washington on Wednesday for meetings with lawmakers and regulators, and in advance of those meetings five bankers met with American Banker over breakfast to discuss the group's agenda.

Besides Smith, the other participants were Michael Scudder, the president and CEO at the $9.9 billion-asset First Midwest Bancorp in Itasca, Ill.; Don Walker, regional executive at the $15.4 billion-asset Arvest Bank Group in Bentonville, Ark; Scott Anderson, the president and CEO at Zions Bank, the lead subsidiary of the $55 billion-asset Zions Bancorp. in Salt Lake City; and Edward Garding, the former president and CEO at the $8.6 billion-asset First Interstate BancSystem in Billings, Mont. (Garding stepped down as president and CEO in September but is staying on for several months to advise the new CEO, Kevin Riley.)

While members of the group insist that they aren't trying to split the industry, they worry that policymakers — particularly members of Congress — are lumping them in with larger, more complex institutions. What they are seeking is relief from some of the more onerous regulations that they argue are making it harder for them to compete with not just banks, but the largely unregulated marketplace lenders that are aggressively going after their customers. What follows is an edited transcript of the discussion.

You're all part of a group that represents midsize banks. Why does this class of banks need its own voice in Washington?

James Smith: We are trying to…reduce the cumulative regulatory effect on banks overall, but are specifically interested in regulations that would ease the burden on [midsize banks] so that we can be more competitive and function as the true community banks that we are. We did not contribute to the financial crisis, but we are being penalized and burdened as a result. We are out to change that.

Don Walker: Most of us started as small banks. We've grown tremendously and now fit in a much larger group, but we didn't change the way we do business. That's a key point for us. We feel that…some of the laws have been punitive to large community banks. We're not the enemy.

Edward Garding: All of us used to be First State Bank of Podunk and none of us will ever be Wall Street Banks. Part of why we're the size we are is, because of the added regulations, all of our friends that were the First State Bank of Podunk called us and said, 'We've had it, please buy me.'

Which regulations have been most onerous for banks your size?

Garding: Trying to put someone into a home to me is the most onerous. Just during that application process we have the customer sign about 12 documents. Then to close a loan — a simple fixed-rate, 30-year loan — we have the customer sign 36 documents. Two are to protect the bank, all the rest have been designed to protect the consumer. The typical conversation during that process is the customer says, 'Please stop telling me what all this stuff is and just tell me where to sign.'

Scott Anderson: Just to take that a bit further, the new TRID rules probably will add 15 days to a closing. [TRID stands for Truth-in-Lending Act/Real Estate Settlement Procedures Act Integrated Disclosures]. So instead of 30 days for closing you have 45.

Michael Scudder: It's more cumulative. We are state-chartered, the [Federal Reserve] is our primary regulator, and as we get ready to cross $10 billion — we're at $9.9 billion now — we'll take on the CFPB. All of that has an effect on consumer credit.

So you are not actively trying to stay under the $10 billion mark?

Scudder: I'm not very good at running backwards. We are going to continue to drive forward.

What kind of reception are you getting from the folks here in Washington? Are they hearing you?

Smith: I would say yes. Originally after Dodd-Frank was passed, it was almost not productive to make a visit but we did so anyway because we knew that eventually there would be the opportunity for a dialogue. That dialogue is taking place now. [Policymakers] are becoming more sympathetic…and may actually be poised to do something to lighten the regulatory load that will allow us to be more competitive than we are.

I want to go back to this arbitrary nature of limits of $10 billion and $50 billion. If you cross $10 billion your revenue is going to get whacked, your expenses will go higher because you've got the CFPB, and you've got stress-testing. That isn't how banks are supposed to be run. Life is not supposed to be that prescriptive. We are supposed to be able to exercise our judgment as bankers, a lot of which has been taken away, the result of which is that credit becomes more expensive and, in some cases, less available to those who we believe need it most. One thing I would add: while we are out complying with all the regulations — not just Dodd-Frank, but [the Bank Secrecy Act], it's a long list — the technology companies are not.

You're talking about marketplace lenders. Do you see them as competitive threats to banks of your size?

Anderson: Online small-business lenders like OnDeck or Lending Club or CAN Capital are doing about $1 billion a quarter and they are not regulated. That really becomes a competitive issue.

Smith: It's not that we are saying to the regulators 'make them more like us.' We're saying, 'let us be more like them.' They are maniacally focused on end-to-end automation and they will let nothing else get in the way. That's not how life is at a bank today. There are lots of things that have to be dealt with…lots of points along the way where we might have to pull [the loan] out and do manually where an online lender would not have to.

Anderson: If you look at online, unregulated institutions, they offer one or two products. They usually aren't the right product for that business. When [business owners] go to a bank, they sit down with a banker who will offer financing that best suits them, whether it's a receivable line or a line of credit or a term loan or whatever. And if the business hits a down point, they can go to their banker and talk about their options. What will happen if that loan is done online at company that has no bankers who can sit down and talk with the customer? What does the customer do?

But what we keep hearing is that they are going to these lenders because they can't get a loan from a mainstream bank. Is that just not true?

Smith: It's not true. Period. They can get a loan faster and with fewer questions and more conveniently in their minds, than they can get from a bank today. Yes, there are some loans that the online lenders will make that banks will not make and that they'll try to offload them to someone else. But the A, B, C, D [credits], those are the people we are competing for. That's why we are saying, 'Allow us to be more like them; allow us to have more end-to-end automation for loan origination, for any kind of consumer loan or business loan.'

So you couldn't create a marketplace-lending-type product because of regulatory constraints?

Anderson: If a bank were to buy OnDeck, OnDeck could not operate like it does today. They don't have to disclose interest rates like we do, so the customer gets the loan, they don't really know what they are paying. If a bank were to buy that it would change the business.

Garding: Go online and apply [for a marketplace loan] sometime. It's an experience. You really have to dig to figure out what rate you are paying. Until you are approved, you don't know the rate.

It's obviously a very challenging climate out there. Is there pressure on midsize banks to get bigger or even sell out?

Anderson: I was looking at a peer group of $10 billion to $30 billion and if you take out some of the specialty affiliates or subsidiaries of the large national banks, I came up with a group of 33. Of those 33, two-thirds had a significant acquisition between 2010 and 2014. It's done really for economic purposes. If you are to comply with these new regulations, add on the new people that you need to add on — we've added 600 people in compliance — it becomes so costly that if you are not of a certain size you can't give shareholders return they deserve.

Walker: We have added 100 people in compliance that we literally didn't have. Our intent…was to provide very low-cost banking for our communities. Today we cannot do that. It doesn't take a genius to figure out why there's no longer free checking. When Congress began setting prices and reducing interchange for retail banks, they removed a big part of our opportunity to expand our services and provide low-cost services.

Smith: Part of the allure of M&A is the synergies and accretion it [provides] to the buyer, provided that the buyer doesn't pay too much. But if [growing through acquisitions] is your strategy, that's not a sustainable strategy. You have to have a sustainable organic model that would benefit from the acquisitions and efficiencies that go with that. We're fortunate that we've got revenue growth because we're expanding into new markets and that revenue growth is sufficient to absorb the new expenses and keep our efficiency ratio under 60. We think about that every day. We can only do that as a stand-alone as long as we have good, consistent revenue growth.

Again, it's really challenging out there, and that's evident in everything we are hearing about loan competition. If there are only so many good loans to go around, does that suggest that there are too many banks?

Smith: Banks are competing for the highest-quality loans very aggressively, that's true, but [it's because] the cumulative regulatory effect has raised the cost of credit and made it less available.

Anderson: If you believe Clayton Christensen of the Harvard Business School, our economy hasn't taken off because we are so focused on getting that return and reducing costs, that we are not putting money into growth.

I don't think there are too many banks. One of our strengths [in the U.S.] is that we have a lot of community banks and those community banks largely fund small businesses. If you don't have those community banks you're going to see less funding of small businesses. We're already seeing a shrinkage in the number of banks in this country and that's why you have this gap…that online lending companies [are trying to fill].

Scudder: I don't think there are too many. There's always a balance. Keep in mind the role that banks play. Jim said it very well; we are at our core community banks. A lot of the institutions our size and even the smaller commercial banks, they are not only lending to small business, they are sitting on the economic development councils, they are part of community affairs, particularly in rural markets. If you start to strip that away and shrink it down you lose some that, which in turn stops the growth of business, stops fueling the growth within the overall marketplace.

So you're dealing with more regulation, low interest rates, intense competition for loans and declining branch traffic. Given all that, what does the bank of the future look like?

Walker: As our costs have gone up, we are being forced to look at our delivery systems. Is it going to be all electronic? There's a possibility that a lot more of it is going to be. But the high touch that we've all grown up with is going to change. It won't disappear, we'll find ways to differentiate ourselves, but I'm afraid that in the bank of the future, we can't make decisions based on character and make exceptions where exceptions should be made.

Smith: Regulators are seen as a big part of the problem, but some of that criticism is undue because they are only doing what they've been mandated to do by Congress. The regulators have shown a willingness to sit down with us and talk about end-to-end automation and inefficiencies in BSA compliance, but they can only do what they can do under the law. We need Congress to take its foot off the throat of the banks.