Regulatory costs are devouring a greater portion of revenue, time and resources at small banks.
That has been the experience for Douglas Manditch, chairman and chief executive at Empire National Bank in Islandia, N.Y. Last year, the $455 million-asset bank allocated 16% of its revenue to compliance and governance, up from 13% a year earlier. And Manditch says he expects those costs to keep rising.
Lawmakers and regulators haven't done enough to address the risky and complex nature of the largest banks, while community banks are being harmed by new regulations, Manditch says.
Empire, which focuses on small and midsize privately owned businesses, found itself on the wrong side of regulation when it was hit with a formal agreement with the Office of the Comptroller of the Currency in October 2010. The order, lifted last year, was a further impediment to growth for a bank in an already difficult environment, Manditch says.
(A spokesman for the OCC said the agency does not comment on specific banks.)
The following is an edited excerpt from a recent interview with Manditch.
Empire opened right before the economic downturn. How did it weather that period?
Douglas Manditch: We were fortunate. When we opened in February 2008 the real collapse was in September, so we didn't have a long time to get into a lot of trouble. We are fairly conservative in our approach to lending anyway, so I would like to think we would have been able to survive anyway.
We ran [Long Island Financial] for 16 years and we never lost a penny to a commercial real estate loan. We opened that bank in 1990 and the time wasn't a whole lot different than it is now.
What lessons did you learn from running Long Island Financial?
People shouldn't borrow unless they need to borrow. I received a christening when I was a younger fellow at a bank that almost failed because of bad loans. That is really where I learned the idea that it is sometimes hard to say no to people when it looks like there really is no reason to say no. But sometimes you get a feeling that they are leveraging too much or that they are not quite sure of their plan. Sometimes you just have to walk away.
What are your biggest challenges?
I'm concerned about interest rates climbing in an unmanageable way. If things get out of control with inflation and increasing rates, it could be very difficult on a lot of community banks because there's no way we can hide from that. Second, the regulatory burden is just becoming impossible. The burden is extremely costly and it seems to be never-ending.
Is there a specific regulatory change that is the most troublesome?
It's just everything. We are being required to manage risk at unbelievable levels. Even if we are not regulated by the Consumer Financial Protection Bureau, you can bet more regulations will come from our primary regulator, the OCC, regarding consumer protection just because it is part of what is happening.
The more the big banks get themselves into trouble, the more all of this regulation has filtered down to the community banks, which is very perplexing and frustrating.
What is the solution? What should regulators be doing?
They need to realize that it is a different industry between community banks and the mega banks. I just read something like the five biggest banks in this country have 19,500 subsidiaries. When you think about the complexity of the systematic banks it's hard for me to believe anyone can manage companies that size.
Should the government break up the big banks?
I think it should be done. People tell you that the big banks wouldn't be able to compete globally. I don't believe that for a minute. You have to pass something that resembles Glass-Steagall or a more modern version of it. It worked for 70 years separating commerce and banking. I think it would still be a good thing. Everyone says you can't go back, but sometimes going back is going forward.
Have you added staff to handle regulatory changes?
We have a new department, which is headed by our chief risk officer. The primary reason for putting that in place is so we could better handle compliance. She has someone under her that basically runs compliance on a day-to-day basis. That woman also has someone under her and I'm sure there will be another person in that area.
We are still a fairly small bank with only about 60 employees, so 5% of our employees are dealing with compliance and governance. And it is a lot more than that. I spend a good portion of my time on it and so does the president, CFO, chief lending officer. Everybody is involved one way or another.
There's a growing view that small banks need to merge because of regulatory costs. What size do banks need to become?
I think banks will have to grow to more than $1 billion of assets.
There have been some boards that have thrown up their hands and said we don't want to do this anymore. I think there will be more of that. The regulators, especially the OCC, expect a lot from bank boards. It's to the point where you almost have to be a full-time banker to understand everything. It will be harder to get board members.
Community banks have been the life blood of small business for so long that if community banking went away it would be very difficult on the small businesses.
What is Empire's growth strategy?
We fell under the scrutiny of the OCC right after we opened. In 2009 we booked about $160 million of loans. That scared the OCC. Even though we were only under the agreement for a year, it took them so long to get us the agreement and then to let us free of it that we were prohibited from soliciting new loans for two years. When they released the agreement it was like starting the bank all over again from scratch. It was a very difficult time. But we survived it. We do have a very good backlog right now.
It sounds like you didn't agree with the OCC order.
I think they were overzealous and I don't think they gave credence to the management capacity we had. They just looked at bulk numbers and I think it was sort of covering their bases.
You sold your previous company, Long Island Financial, to New York Community Bancorp (NYCB) in 2005. Is that the goal for Empire?
People ask me that all the time. It is not my decision alone. It will be the decision of the board. We haven't considered a sale at this point. It is a little premature to think about that. It is something that can go either way, but we don't have a plan to sell the bank.
What are you some of your predictions for the banking industry in coming years?
I'm anticipating more regulation coming out of Dodd-Frank and the CFPB. The housing market seems to be picking up a bit and, if interest rates don't go too high, that might be sustained. If interest rates get very high, and for mortgages anything over 7.5% or 8% becomes prohibitive, you will probably see a downturn in housing.
I don't know where unemployment is [headed]. Most of the jobs being created are part time, and wages seem to be going down. I don't think the economic indicators are necessarily going in the right direction for a strong recovery.