Community banks on the upswing, but face higher regulatory costs

A report by Community Bankers of Wisconsin shows that through the third quarter, net income for Wisconsin banks with assets of less than $1 billion is up 87 percent over last year.

The overall conditions at Wisconsin’s community banks have been improving this year, said Daryll Lund, president and chief executive officer of CBW.

“I think the trends are positive,” Lund said. “(There are) still some challenges out there, but from a community bank standpoint, they are addressing the loans and the problems they have.”

Cornerstone Community Bank in Grafton saw portfolio improvements and will be profitable in 2011, said president Paul Foy.

“My customers are doing better than they have in the last few years, and our short-term delinquencies are down pretty dramatically over a year or so ago,” Foy said. “I definitely see credit quality improving in our portfolio.”

Community Bank & Trust in Sheboygan also has done well this year, said president and chief operating officer Paul Farrelly.

“We continue to lend money, specifically in the SBA arena, which was a record year for us at $51 million,” he said.

Banks will be dependent on businesses taking out loans and hiring new employees in 2012, Lund said.

“Community banks only make money when they’re making loans,” Lund said. “Most community banks have adequate deposits available for loan activity, but at this time we’re still seeing a very soft market for loan demand.”

Wisconsin banks have shown year-over-year improvement through the third quarter in non-current loans, return on equity, net interest margins and capital ratios, said Rose Oswald Poels, president and CEO of the Wisconsin Bankers Association.

Federal Deposit Insurance Corp. (FDIC) data shows seven out of eight Wisconsin banks were profitable in the third quarter 2011, vs. four out of five at the end of 2010, she said.

“The industry overall is certainly on an upswing again,” Oswald Poels said.

However, federal regulations have become more of a burden for community banks over the past several years, Lund said. If the cost to comply with those regulations gets too high, some small banks may consider pooling resources through mergers.

“The amount of regulations has increased, and it is causing community banks to have to add additional staff and resources related to compliance on the regulation,” Lund said. “There have been some mergers — not as many as the analysts have anticipated.”

Hartland-based Town Bank is fortunate to have a pool of resources to deal with compliance because it’s a part of Wintrust Financial Corp., said Jay Mack, president and CEO.

“It’ll almost be too difficult to survive, too costly to survive, to burdensome to survive for many community banks,” he said.

Great Midwest Bank in Brookfield has remained stable through the financial crisis by focusing on safe balance sheets rather than high income or high growth, said president Dennis Doyle.

“We’ve been fortunate in the fact that we’re well-capitalized,” he said. “The only thing that is different here at Great Midwest Bank is that we have to manage loan losses and loan loss reserves.”

The bank has processed about 100 loans this year, half as many as in 2009, said Jon Reetz, assistant vice president of loan origination and marketing at Great Midwest.

Community banks have not taken the brunt of regulatory burdens associated with the federal Dodd-Frank Act legislation, but they will see associated costs. The law has created a new office, the Consumer Financial Protection Bureau, which will formulate rules for all financial institutions but will conduct examinations only on larger banks, Lund said.

While larger banks often have the compliance resources to handle new regulations, smaller community banks will likely see increased overhead.

“It’s different,” Foy said “We have a full-time compliance person on our staff and that wasn’t the case several years ago.”

Farrelly expects Dodd-Frank’s interchange fee adjustments and mortgage disclosure regulation changes to have the greatest effect on Community Bank & Trust.

“It’s definitely increased the cost of doing business. It’s lengthened the time for customer applications to be properly completed,” he said. “So far we’ve been able to absorb some of the extra work with the current staff that we have.”

There’s also a lingering uncertainty regarding the legislation, as a large volume of new rules are being handed down gradually. Many community banks must hire additional help just to determine which, if any, regulations affect the institution.

The Dodd-Frank law has a number of exceptions for institutions with $10 billion or less in assets, said Tom Homberg, a financial institutions attorney at Godfrey & Kahn S.C. in Milwaukee.

“(Compliance) has always been a burden for community banks, but it has definitely accelerated as a result of Dodd-Frank and other recent legislation,” he said.

John Reichert, also a financial institutions attorney at Godfrey & Kahn, said the Dodd-Frank law is approximately 2,000 pages, and will result in about 250 rules.

“You probably can point to two or three other times in history where banks have had to digest so much information in such a short period of time,” he said.

Reichert and Homberg have been helping clients understand Dodd-Frank and change disclosure forms and other documents to comply with new rules.

They don’t think compliance alone will drive community bank mergers, but expect consolidation activity to pick up in 2012 because of pent up demand.

“There will be some inevitable consolidation as a result of all sorts of factors in the industry,” Homberg said. “I think there definitely will be an increase because we haven’t seen any activity for some years.”

Jerard Jensen, a shareholder at Whyte Hirschboeck Dudek who represents several Wisconsin community banks, said a benefit from Dodd-Frank is a regulation that provides unlimited insurance on non-interest bearing accounts, a safety net that could benefit smaller banks. On the other hand, a previous regulation that prohibited banks from paying interest on business accounts has been repealed.

“That places competitive pressure on community banks and it increases the cost of operating,” Jensen said.

Weaker players have dropped out of the community banking market over the last several years, and the remaining institutions are stronger overall, Jensen said.

“The profitability is up at community banks over what it was the last two years and it’s getting back to what it was before the financial crisis began,” he said. n

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