This story delves into the following:
- Banks approaching $10 billion are weighing how to strategically cross the barrier.
- Early board discussions should start around the $6 billion mark.
- Enhanced requirements can be costly and burdensome, but aren't a reason to stall growth or sell the bank.
If there’s one magic number in banking, it’s $10 billion. Several important regulatory requirements and restrictions kick in when banks cross that threshold—and all of them carry a lot of additional cost. The Dodd-Frank Act requires $10 billion-plus banks to beef up their enterprise risk management programs, including technology and talent. The Durbin amendment cuts debit interchange fees in half, and banks that cross the threshold are hit with an additional surcharge to the Federal Deposit Insurance Corp. of 4.5 cents per $100 of the bank’s assessment base, which is roughly equal to the bank’s total domestic deposits. Last but by no means least, institutions above $10 billion are subject to direct supervision by the Consumer Financial Protection Bureau (CFPB).
Nashville, Tennessee-based Pinnacle Financial Partners, an $11 billion asset bank holding company with $8.7 billion in deposits, anticipates that the cost of crossing $10 billion will be less than $9 million in 2018, including the Durbin hit. These additional costs didn’t deter the bank’s chief executive officer, Terry Turner, from growing the bank. “Our view all along has been that the $10 billion threshold would not shape our business,” he says. “It’s not like you like it, but it’s not going to keep you from going through.”
The compliance requirements mandated by Dodd-Frank for banks above $10 billion are numerous and onerous. Annual stress tests, also known as DFAST, for Dodd-Frank Act Stress Test, are required. Expectations regarding the bank’s approach to enterprise risk management and internal audit are raised. The board must establish a separate, board-level risk committee, chaired by an independent director and staffed with at least one board member who is considered to be an expert on risk. Oversight from the CFPB comes with its own headaches, with that regulator conducting on-site exams to ensure the institution isn’t violating fair lending laws or engaging in unfair, deceptive or abusive acts or practices (UDAAP).
Banks need to prepare for these requirements long before hitting $10 billion, with early board discussions starting around the $6 billion mark and implementation of required systems and expertise beginning before the bank becomes a $10 billion institution. If the bank doesn’t start the conversation, then their regulator likely will. “The regulators are pretty good at being able to look at the banks that they supervise and understanding where they are, what their strategy is and what that trajectory to the $10 billion mark is going to look like,” says Michele Sullivan, partner at Crowe Horwath LLP. She recommends that banks approaching $10 billion create a road map that details when the bank should hit its implementation goals.
According to several bank executives interviewed for this story, preparing for DFAST seems to be the greatest concern for banks eyeing $10 billion. “The Dodd-Frank stress test—that is a major deal. It has been a very expensive process,” says George Makris, CEO of $8.2 billion asset Simmons First National Corp. in Pine Bluff, Arkansas. He estimates that the bank will invest $2 million in preparing for DFAST over a two-year period, and $700,000 annually after that to maintain the related systems.
For most institutions, DFAST will require updated software, while imposing tougher data demands. A bank should assess the quality of its data well in advance of its first stress test, says Tariq Mirza, a principal at Grant Thornton LLP.
DFAST is also a significant burden on bank staff, and “involves literally hundreds of your people across the company,” says Mark Tryniski, CEO of $8.7 billion asset Community Bank System, headquartered in DeWitt, New York. “It takes a lot of time and money and effort and leadership to do it the right way.” Community Bank System started to prepare in 2014, when it had $7.5 billion in assets, and anticipates making a stress test dry run in 2017, two years before it has to file with the Federal Reserve in 2019. This test should occur after its planned acquisition of Burlington, Vermont-based Merchants Bancshares, with $1.9 billion in assets, which will take the company just past the $10 billion mark.
“There’s a tremendous shortage of resources out there, [including] people with experience in all these areas,” says William Wagner, president and CEO of Warren, Pennsylvania-based Northwest Bancshares, with $8.9 billion in assets. “The labor pool just isn’t that great.” Northwest has filled the compliance and audit gaps through internal training and external hires.
Simmons First brought additional risk and compliance staff on board after its regulators identified anticipated deficiencies, at the bank’s request. The additional talent is a cost Makris says will become scalable as the bank continues to grow. But he warns that some talent will be harder to find, and banks that don’t prepare for DFAST do so at their peril. “The skill set of the mathematicians that we’ll need to have on our staff are not available in the banking business today,” he says.
Oversight from the CFPB can also take banks by surprise. For many institutions, “the examination process by the CFPB is much more thorough, much more extensive, than what banks expect it to be,” says Sullivan. But she says it’s getting better, as banks have, over time, learned what to expect from the regulator.
Does the $10 billion asset threshold truly impact bank performance? A review of performance metrics for individual banks, through a review of Bank Director magazine’s Bank Performance Scorecard, published each year in the third quarter issue, finds that high performing banks continue to outdo their peers. Dallas, Texas-based Hilltop Holdings, currently with $12.4 billion in assets, has ranked in the top 10 of banks between $5 billion and $50 billion in assets over the past three years, despite crossing the asset threshold in 2015; the bank closed 2015 with a return on assets (ROA) of 1.52 percent and a 10.88 return on equity (ROE). (Both metrics measure profitability.)
Phoenix, Arizona-based Western Alliance Bancorp., with $17 billion in assets, came in sixth in the 2016 Scorecard’s $5 billion to $50 billion category, with a 1.62 percent ROA and 15.2 ROE, demonstrating a track record of improved performance even as it crossed $10 billion in 2014. Western Alliance’s high performance is attributable in part to a decision by CEO Robert Sarver and his team to shift gears after the financial crisis and focus on commercial banking in diverse niche sectors, including technology, healthcare and the hospitality industry. These decisions factor into the bank’s profitability—with or without the enhanced regulatory requirements that come along with being a $10 billion bank.
“For the better banks, [crossing $10 billion] really shouldn’t be anything more than a bump in the road,” says Joe Fenech, co-head of research at Hovde Group.
That’s not to suggest that the $10 billion asset threshold isn’t a big deal. The barrier “has dramatically changed the way that banks think about growing through $10 billion,” says Brady Gailey, managing director at Keefe, Bruyette & Woods. The regulations imposed by Dodd-Frank may not deter growth, but soon-to-be impacted banks face three strategic options when deciding if they will cross the barrier, and if so, how.
The first option has been a common refrain for the industry: Gain scale all at once with a sizable acquisition. Chemical Financial Corp., of Midland, Michigan, exploded through the $10 billion barrier with its purchase of $6.5 billion asset Talmer Bancorp in August 2016, bringing the acquirer to $17.4 billion in assets, combined with its own organic growth. Acquiring Talmer allows Chemical to achieve greater scale, and the market overlap—Talmer expanded Chemical’s footprint in its home state—is expected to save the bank $52 million, says John Rodis, senior vice president and research analyst at FIG Partners in Atlanta, Georgia.
Banks pursuing this option want to quickly pass the $10 billion barrier and hit roughly $15 billion in assets, says Vincent Hui, senior director at Cornerstone Advisors, based in Scottsdale, Arizona. “Candidly, that’s how the math works, when it comes to scale and the ability to offset the regulatory burden.”
But even high performing banks can be one bad deal away from losing the market’s favor, says Rodis. Blasting through the barrier with a big acquisition may not be the wisest decision for every bank, which leads to the other options—organic growth or a small acquisition..
The leadership team at Conway, Arkansas-based Home Bancshares initially planned to make a big acquisition to better absorb the expenses associated with enhanced stress testing and revenue loss due to Durbin, says John Allison, the $9.8 billion asset bank holding company’s chairman. But like many institutions preparing early to meet the Dodd-Frank requirements, his bank has already paid for much of the risk and compliance implementation required. Given that, Allison doesn’t want to gamble on a bad deal, as he feels other banks have. “They lose sight of what they’re doing to the company, and what they’re paying for the acquisition target, in order to leap over that. And once they overpay, and they make those mistakes, Wall Street punishes them,” he says.
A growing number of banks appear to be saying that it’s OK, at least in the short term, to take a small deal or even grow organically past the $10 billion, all while remaining opportunistic to later deals that will provide greater scale.
Home’s next acquisition, of $463 million asset Giant Holdings, in Ft. Lauderdale, Florida, should take the company to just $10.2 billion in the first half of 2017 as the bank expands its Florida footprint. A smaller deal is easier for Home to digest and subject to less regulatory scrutiny. It’s less risky for the company than a $4 billion deal, says Allison, and he’s open to future acquisitions after Home has passed the threshold.
Pinnacle passed $10 billion in assets through its purchase of $1.2 billion asset Avenue Financial Holdings, also in Nashville. “We have been thoughtful about the $10 billion threshold,” says Turner. “If you’ve got a well [run] company and you’re just going to go out here and double in size because you’re trying to orchestrate around the $10 billion threshold, that doesn’t make any sense.” Avenue was a good strategic target and was ready to sell. Delaying that acquisition to look for a larger deal to blow quickly past the threshold would have wasted a good opportunity.
The bank is open to expansion into other major southeastern cities, like Atlanta, Georgia, or Raleigh, North Carolina. Nashville is a high growth market, and Pinnacle is growing organically at a rapid clip— by about $1 billion in assets annually. Turner expects to hit $15 billion by 2020, deal or no deal.
In Bank Director’s 2016 Bank M&A Survey, 42 percent of respondents from banks $10 billion and above believed their bank needed at least $20 billion in assets to be competitive.
The third path is a sale or, less likely, a merger of equals. The asset threshold was a factor in the April 2016 sale of $9.6 billion asset National Penn Bancshares to BB&T Corp., and plays a similar role in the upcoming acquisition of $7.5 billion asset Yadkin Financial Corp., in Raleigh, North Carolina, by Pittsburgh, Pennsylvania-based F.N.B. Corp., with $21.2 billion in assets. That deal is expected to close in early 2017. “We did the math ourselves on what it was going to cost us to go above $10 billion on our own, and it was a significant number,” around 10 percent of earnings at the bank’s current run rate, says Yadkin CEO Scott Custer.
Once a bank passes $10 billion, the Durbin amendment curtails income that a bank would earn on debit card interchange fees. The financial impact depends on the strategic focus of the bank, and seems to range from $5 million to $11 million, according to the earnings calls of various financial institutions that are approaching or have surpassed the asset threshold. The impact can be higher: Jay Sidhu, chief executive of Wyomissing, Pennsylvania-based Customers Bancorp, told investors in the company’s second quarter 2016 earnings call that the $9.6 billion bank will stall growth until it has sold its mobile-only BankMobile unit, whose primary source of income is derived through debit interchange fees. “That will cost us $20 million,” said Sidhu. “So, we are not going to cross the $10 billion mark [until] BankMobile is divested.”
Banks can mitigate some of Durbin’s impact by evaluating other fee income opportunities, says Hui. Credit card fees aren’t impacted by Durbin, for example. Other business lines, such as wealth management, can provide fee income.
Even if a bank is evaluating a possible sale, preparations still must be made to cross $10 billion in assets, in case the bank can’t find the right partner at the right time. Plano, Texas-based LegacyTexas Financial Group, with $8.4 billion in assets, is weighing all of its options, including a natural, organic crossing, crossing through an acquisition or even putting the bank up for sale. “You’ve got to prepare and act like you’re going through it alone,” says CEO Kevin Hanigan. The bank started preparing in early 2015. But the bank is growing, and he believes that the related costs aren’t insurmountable. Besides, “there’s not a whole lot of banks in the country that can afford us.”
For most, the additional regulation and oversight that comes from being a $10 billion bank aren’t stopping banks from growing, but could result in strategic delays, achieved through management of balance sheet growth. Home plans to cross $10 billion in early 2017, rather than late 2016, to delay the impact of Durbin and stress testing requirements. “The difference between crossing $10 billion on December 31 versus January 1 is a year’s worth of stress testing and lower fee income,” says Gailey. “It’s very much an advantage for you just to manage your balance sheet, [and] maybe slow growth a little bit” as a short-term delay tactic.
Not being prepared for life as a $10 billion bank is another reason for strategic delay. “I had one client that actually delayed an acquisition,” says Mirza. “They said [they had] a lot of housecleaning to do before we have the CFPB coming in.”
Incoming U.S. president Donald Trump has made clear his distaste for Dodd-Frank, but it’s unclear whether his administration and a Republican-controlled Congress will deliver relief to the industry, or what form that relief will take.
Pinnacle’s Turner believes that the enhanced regulatory demands of being a $10 billion bank aren’t a reason to stall growth or exit the industry. “If I needed to escape regulation, I’d have to get out of the banking business.”