Reading the Regulatory Roadmap

Bill Isaac has seen plenty of ups and downs over a four-decade career that includes stints as chairman of the Federal Deposit Insurance Corp. and Fifth Third Bancorp. But the surprise election of Donald Trump and a Republican takeover of Congress has ushered in something he has rarely experienced: the real possibility of reduced financial regulation.

“This is the first time in at least 30 years where there is some hope that the small and midsized banks may get some relief,” he says. “If I were sitting on a bank board right now, I’d be cautiously optimistic.”

That’s a good way to describe the vibe at many banks in 2017. Many bankers are hopeful a Donald Trump administration will be able to deliver on promised rollbacks to Dodd-Frank Act regulations. They’re eyeing a possible restructuring at the Consumer Financial Protection Bureau (CFPB). Yet, there’s caution about moving too far ahead while so much is still unknown.

“You have to plan for the way things have been-have the compliance cost built into the budget,” says Steve Hovde, a bank director and investor who also is chairman and CEO of the Hovde Group, an investment banking firm. “Then, if we get any relief it will be gravy on top of the mashed potatoes.”

We asked bank directors and advisers how conversations and strategies in the boardroom may shift in this era of promised regulatory changes. Here are four common themes to watch.

Dodd-Frank Rollback
What’s possible: One of the promises Republican lawmakers and Trump administration officials have made is to unwind burdensome financial regulations in the 2010 Dodd-Frank Act that put new layers of oversight, capital requirements and compliance costs on banks of all sizes. After winning the White House, Trump’s team promised to “dismantle” the Dodd-Frank legislation, which could include changing capital requirements, repealing the Volcker Rule and changing the rules around stress tests and how the federal government would intervene when banks are at risk of failing.

Boardroom reaction: Get involved with banking associations in tune with pending legislation, Isaac says. As new bills are put forth and appointees begin to influence government agencies, strong voices from industry trade associations will have the potential to shape outcomes. He says engaged directors will be actively researching and networking to learn how and when proposed rollbacks could impact their institutions. “I’d want my executive management involved with our trade groups, too,” he says.

Board members may also raise questions about long-term compliance strategies and costs. Isaac says it would be appropriate in this era of changing regulatory emphasis to have more open dialogue with your bank’s primary regulator. Bank lobbyists will press hard for regulatory relief for small and midsized banks, especially. So asking regulators for additional time while proposals are settled is fair game.

“You have to take the laws and regulations as they are now written and make sure you’re trying to comply to the maximum extent possible, as quickly as possible. But if some of the changes are very expensive, I think I’d be having a conversation with my regulator about that,” Isaac says. “I think regulators will be sympathetic to the dilemma banks face. Do I spend $2 million on a new system required by Dodd-Frank? Or should I wait it out?”

Changes at the CFPB
What’s possible: Analysts and politicos believe the CFPB will be reformed to look more like other federal agencies where a bipartisan board provides oversight and funding is subject to Congressional approval. If this happens, powerful individual influence, as is the case now under CFPB Director Richard Cordray, will be minimized.

Boardroom reaction: It’s no secret that bankers and CFPB regulators have had a somewhat adversarial relationship in the years following the agency’s formation. Much of that stems from objections by bankers to the CFPB’s structure, even if many agree rules to protect consumers can be beneficial.

But the agency is unlikely to disappear. So Bill Nolan, a senior managing director at FTI Consulting, believes the CFPB is still a new relationship that should be nurtured, even as things change.

“You have to believe the regulators are dealing with their own levels of uncertainty right now. If you work at the CFPB, you read the paper. You have to be wondering what will happen to your agency,” Nolan says. “An engaged board is going to be pressing senior management to maintain a dialogue with regulators so they can work with them as things change and they morph in line with the new administration.”

Higher Interest Rates, Lower Taxes
What’s possible: Economic fundamentals are poised to change as interest rates rise and taxes decrease. The Trump team has suggested corporate tax rates should be lowered to 15 percent, from the current maximum rate of 35 percent. This would create a drastic shift in how banks project profits and the profitability of customers. Simultaneously, forecasts point to three more rate hikes in 2017, ending a decade-long period of rate slashing designed to stoke a weak economy.

Boardroom reaction: It’s time to tune in closer to external economic indicators. Boards of directors for years have been focused on internal restructuring and cost-cutting, new regulations and surviving low-rate, slow-growth environments. “There’s more uncertainty in the economy than I’ve seen in a long time. The bank board has a lot to pay attention to in this time of uncertainty,” Isaac says. “I’d be looking very closely at the economic situation in the country and where it may be going.”

M&A Options
What’s possible: The factors motivating mergers and acquisitions have suddenly changed. Regulations that made life difficult on small banks may now be repealed. Equity prices jumped to close out 2016. Boards now have new criteria and outlooks to consider when weighing M&A.

Boardroom reaction: Hovde says boards now have two distinct paths to consider with M&A. On the one hand, now is a good time to cash in on higher stock prices, which are empowering buyers to make bigger offers. Meanwhile, many sellers may choose to rethink plans to sell and explore an independent future with higher interest rates and fewer regulations.

“Bank stocks are up significantly from the Trump bump. So buyers can pay the seller’s price target now, and some sellers may decide to take the money,” Hovde says. “On the other hand, if we have a stronger economy, higher interest rates, tax cuts and some cuts to regulatory cost, it might be worthwhile to delay a sale and see how this plays out.”

Hovde says he’s hopeful small community banks will see a path forward as independent institutions. Since 1990, banks with under $100 million in assets have declined by more than 80 percent. If regulations are indeed rolled back, or modified to reduce the burden on small lenders, there could be less motivation in the boardroom for those smaller institutions to sell.

“What’s good for the big bank isn’t good for the little,” he says. “I hope they can find a way to create a two-tier regulatory system and make the right exceptions for small to midsized banks. If not, true community banks won’t exist anymore.”