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Crossing the Threshold

Remember the regulatory implications of a merger and acquisition deal

By Paul Schaus

Community banks might be chomping at the bit to acquire another institution or merge as equals to achieve growth faster, or get into new lines of business and geographical markets. However, bank executives and their boards need to seriously consider the ramifications of crossing certain asset thresholds that bring with it significantly more regulatory scrutiny and capital requirements.

When banks achieve $1 billion, $2.5 billion, $10 billion or $50 billion in assets, they are then subject to increased regulatory compliance requirements—and the larger the bank, more capital requirements. When banks reach $1 billion in assets, Community Reinvestment Act compliance requirements increase, including the implementation of lending, community development and service tests.

At $2.5 billion in assets, the Dodd-Frank Act rules for mortgages apply, and if banks offer higher-priced mortgages then additional disclosure rules apply. Some of the requirements that banks this size now have to comply with include the ability to repay and qualified mortgage standards under the Truth in Lending Act (Regulation Z); homeownership counseling amendments to the Real Estate Settlement Procedures Act (Reg X); escrow requirements under the Truth in Lending Act (Reg Z); 2013 Real Estate Settlement Procedures Act (Reg X) and Truth in Lending Act (Reg Z); mortgage servicing final rules, appraisals for higher-priced mortgage loans, disclosure and delivery requirements for copies of appraisals and other written valuations under the Equal Credit Opportunity Act (Reg B); and loan originator compensation requirements under the Truth in Lending Act (Reg Z).

Moreover, when banks reach $2.5 billion in assets, Federal Reserve requirements are more stringent on how they make decisions, and how they document those decisions. Regulators want to see more of the process, more involvement on impact of risk decisions.

A number of new regulatory requirements kick in at the $10 billion threshold, many of which were newly created with the 2010 passage of the Dodd-Frank Act—such as the capping of interchange fees and the subjection to regular exams by the Consumer Financial Protection Bureau. Moreover, at $10 billion in assets, banks must comply with more stringent Basel II capital requirements, and starting in January 2015 new BASEL III requirements, which will impact all banks to some degree.

Finally, when banks reach $50 billion in assets, they are then considered a “systemically important financial institution,” with a host of new operational and capital regulatory requirements, including the implementation of periodic stress tests. If regulators deem banks to be having difficulty after reviewing their stress tests, regulators may force banks to postpone share buybacks, curtail dividend plans and raise additional capital.

Still, growing larger might be worth the new hassles. Indeed, there is an increasing trend to merge as equals—two banks coming together, sharing management and board members. For example, the CEO of one bank becomes the president of the combined bank and the other becomes the chairman, and six board members from each bank now sit on the combined bank’s board.

Such banks combine because their resulting larger size often increases shareholder value, not to mention often improves margins and overall profitability by achieving economies of scale and entering new lines of business. But are executives and boards directors at all community banks always ready for the possible regulatory impacts from entering new lines of business and other requirements if they merge? Do know whether they have the right people in place? The right compliance procedures in place? The right accounting system?

Moreover, new requirements at differing thresholds can specifically impact the duties of bank chief financial officers. If their bank boards are considering a merger or an acquisition that would put their institutions over a threshold, chief financial officers and other bank executives should research what they need to do to bring themselves up to speed to tackle the requirements of larger institutions.

Paul Schaus (consultant@ccg-catalyst.com) is president and CEO of CCG Catalyst Consulting Group, a bank consulting firm in Phoenix, Ariz.