The American Bankers Association's Community Bankers Council gathered in Washington in November for two days of strategy sessions and meetings on Capitol Hill about regulatory reform, capital standards and other policy issues. Seven of the CEOs took a break from their busy schedules to talk with editor Alan Kline about the state of their industry as it fights through the worst recession in decades.

The participants were: Laurie Stewart, Sound Community Bank in Seattle; H. McCall Wilson Jr., The Bank of Fayette County, Moscow, Tenn.; Robert T. Braswell, Carolina Bank, Greensboro, N.C.; Stephen J. Goodenow, Bank Midwest, Spirit Lake, Iowa; Myron D. Rozell, First State Bank of Mapleton in Iowa; Charles G. Brown 3rd, Insignia Bank, Sarasota, Fla.; and Carolyn Mroz, Bay-Vanguard Federal Savings Bank in Baltimore.

In a lively roundtable exchange, the bankers blasted the plan to create a consumer protection regulator, offered their own ideas for fixing overdraft programs and explained why, contrary to popular belief, they don't really hate big banks.

U.S. Banker: The downturn has hit some pockets of the country harder than others, obviously. What are you seeing in your markets, and with your customers?

Laurie Stewart: The Northwest came into recession later than the rest of the country and we actually thought we might escape it because we were so delayed. But we're just coming out of the cycle later. It's all about jobs. We're seeing reductions we've never seen before. Even Microsoft has had layoffs, and they've never had layoffs.

Charles Brown: Housing at the $300,000 level and below (in the Sarasota, Fla., area) has stabilized - in fact there's actually new construction taking place. However, we think it's going to be another year or two before that really bleeds upward into the higher-price ranges.

Steve Goodenow: Agriculture has fared better than most sectors, though if you're feeding livestock it's not a good thing right now. But [Iowa] has not had extreme highs, so it didn't hit big lows. Things are pretty stable where we are.

Bob Braswell: We've got a variety of different economies going on within [North Carolina.] In the coastal area, we're seeing some of the same issues as in other parts of Southeast, where there's been a heavy dominance on resort homes, and the values have been severely depressed. However, in the Piedmont area of the state, which has been heavy on manufacturing, we have already been through several economic declines, so this did not hit us as hard as it might have. Still, it's very slow. People are hesitant to spend money, and they are being very cautious about their next move.

Carolyn Mroz: I think they are getting better control of their use of credit. The Baltimore/Washington corridor is kind of insulated - we have a lot of government contractors. People are willing to go out and spend, but with money they have and not somebody else's money.

Aside from the challenges of managing through the crisis, what else is keeping you awake nights?

Wilson: Consumer regulation - they keep adding more to it. We're supposed to manage our banks for safety and soundness, but consumer compliance plays such a huge role that you almost have to manage the bank to compliance, and not to safety and soundness.

Mroz: We're in an environment now where we are all struggling to make money, but between regulatory issues and FDIC assessments [on deposit premiums] it's become a managing game. Every new regulation piles on more expense.

Stewart: As importantly, there's a cost to our clients, too. I think sometimes our lawmakers don't recognize there's a cost for compliance and a cost for insurance premiums, and those costs are ultimately borne by our clients. Pending regulations will add more costs to consumers that I'm not sure they are getting fair value for.

It sounds like you'd prefer to keep the status quo, but is doing nothing on the regulatory front an option, given what the economy has been through?

Goodenow: More consumer protection is one of these things we know we're going to have to live with. I had a discussion with a staffer in Sen. Harkin's office about this and one of the things I tried to emphasize was to look at this from the consumer's point of view. We over disclose as an industry, but people don't understand the disclosures, they don't read them, whether it's a credit card product or a mortgage loan. We need to make sure that what comes out of this is that consumers better understand the products.

Braswell: Banks are being targeted because we are easy fodder. We already have a regulatory framework in place with which to execute rules and regulations. The subprime crisis was caused mostly by nonregulated entities - not banks and especially not community banks. The other thing is that Congress never has understood that you cannot legislate behavior, you cannot legislate judgment.

Community banks continue to try to be the economic engine to pull us out of this malaise because the larger banks are fighting their own battles, and the more burden they place on us, the less able we are to fulfill our mission. How can we create value for our shareholders when we are being handcuffed by all these costs? These regulations are never removed, they are just added to, so if Congress would have the courage to review the regulatory burden and make necessary judgments, it might be different.

In other words, if you're going to add new regulations, then take some old ones away?

Braswell: Modify the structure, so it makes more sense. It's becoming more problematic to run your institution in a safe and sound fashion. You have to manage for compliance, not for safety and soundness, not for profitability, not for customer satisfaction.

Myron Rozell: We currently have regulations that are protecting our customers and their best interests, but Congress doesn't know that. It's surprising to us that we have a Congress that's legislatively ganging up on us, and an administration that decides the good regulation we've had in the past isn't good enough for us now. They think their plan is going to be better, and better quickly. That's shocking.

Brown: Many of the drafts [of the legislation to create a Consumer Financial Protection Agency] have words like 'robust,' 'unilateral,' 'sole authority.' We don't have anything in our government with sole authority. We're a government of checks and balances. This is very scary the way it this is being drafted.

What about an issue like overdraft? Congress wants there to be more disclosure because many consumers are not aware what the fees are and what the rules are. Doesn't something need to be done there?

Rozell: The majority of community banks have been doing a great job with overdraft. There's a small number of [institutions] that mishandle it and if [Congress] thinks there's a need to change how checks are cleared in the check order, or for regulations that lets consumers opt in or opt out - I don't think the vast majority of bankers have a big issue with that. But to do away with the great benefit that overdraft protection provides - I'm not sure the public would want that. It's a great service and the majority of people appreciate it.

But no one's proposing doing away with it. [New Federal Reserve rules set to take effect in July would prohibit banks from charging overdraft fees on debit or ATM transactions with customers' consent. One bill proposed in Congress has an opt-in requirement, another doesn't, but both would limit overdraft charges to one per month and a maximum of six per year.]

Brown: It's misunderstood. If the best practices are followed, it's very effective, it saves consumers a tremendous amount of money, not to mention hassle. But if things go forward as discussed right now we are going to have chaos on the consumer side - put all this down in an envelope and file it under 'I told you so.'

I am aware of some abuses in the system. Under my bank's overdraft program, if someone goes to Starbucks and tries to buy a cup of coffee [using a debit card] and there is not money in the account, they will not be able to create an overdraft.

That seems reasonable.

Brown: I know some banks are passing the transaction through as available funds, which included the overdraft, and I understand that being a problem because [customers] don't know they are overdrafting at the time. But it's a much simpler fix than what's being proposed. We might have to get more proactive about whether or not balances can be passed through at points of sale.

Braswell: This goes back to the issue of trying to legislate behavior. If you are caught speeding and found guilty, invariably, you have to pay a ticket. If you do not balance your checking account on a monthly basis, using all the technology that exists to confirm what your balance is, then if you overdraw your account you should pay an overdraft fee. Nobody is forcing you to overdraw. If the more onerous provisions of this bill come forward, what will happen is that after the maximum amount of charges have been assessed to an individual - six per year - the likelihood is that most banks will...close that account.

Brown: Consumers will be pushed out of the banking system, which is something that FDIC years ago was trying to guard against. There is no doubt in my mind that we'll have no choice but to close those accounts because the industry will not be able to afford to handle all the overdrafts.

Goodenow: Congress is trying to protect the consumer and they need to be talking to the consumers. If you ask them they would say they like the programs community banks are offering. [Congress is] trying to correct a problem that's not a problem.

Mroz: My daughter's husband is in construction. His hours have been cut back and they needed medicine for the baby, so she went to the ATM and overdrew her account. She knew perfectly well what she was doing, but what are the other options?

Brown: She could go to a payday advance.

Mroz: Right, and it would have cost her more.

Rozell: Overdraft protection is not only a benefit to consumers, it's a benefit to the small businesses that [Congress] is trying to support. Paying the overdrafts for these consumers saves small businesses the hassle of trying to collect payments [from their customers.]

Let's talk about commercial real estate, since that's the big worry right now. What are you seeing in your markets and your portfolios, and do you think new guidelines on how to treat real estate loans will make much difference?

Braswell: The CRE market has definitely become stressed. The question will be how the regulator on the ground responds to them, because we have on occasion seen leadership of various regulatory bodies say one thing and then the [examiner] in your office will do something completely different. Not that they are trying to be counter to guidance, they just use their own judgment.

Brown: The guidance needs some banker input. It was clearly written with good intentions and it cleared up a couple issues for regulators in the field as it pertains to value of real estate and how a particular credit will be treated. However there are many scenarios that have been laid out in there that aren't realistic. There really needs to be a round two.

As a result of the guidance, we decided to go ahead and foreclose on two properties rather than continue to work with the customer. We decided it just didn't make any sense to continue working with customer if we have to continue treating loans in that form and format. [The guidelines say lenders do not necessarily have to mark down loans on which the borrower was still making payments but the property's underlying value had fallen below the loan's balance. They also included specific examples in which banks should mark down troubled loans and laid out scenarios in which a workout or extension on a CRE loan would help both the bank and the borrower.]

Wilson: There's no doubt that CRE is stressed, but if you're not careful you create a self-fulfilling prophecy. The market hears every day that it's bad. Regulators come in, they force the bank to take action. The bank takes action and dumps a property on the market. That gets the ball rolling. Next thing you know vacancies are down, prices are down, and we have another crisis.

Braswell: It's regretful that so many of these regulatory edicts are being proposed with such limited input from industry experts. It's much like if you have a problem at home and you need to call an electrician to fix it, a plumber shows up. So we're fighting issues where the people who are trying to offer up remedies don't know how to fix the problem.

Let's move on from regulation. I've heard several bankers say one of the big challenges in managing through the financial crisis is fatigue and burnout among employees. Are you seeing this in your banks?

Stewart: Do we look that bad?

Of course not. It's just something I've been hearing.

Mroz: My chairman is also my CFO and about a month ago he announced he's retiring as of Jan. 8. When I asked why, he said, 'This has been the worst year and I'm just tired.'

Rozell: I'm not tired personally, but I'm concerned about some key people on my staff. We're a small bank with limited resources, and as they have to deal with even more regulations. I worry that they are going to look at the alternatives outside of banking. And our potential for replacing key people is in danger.

Brown: The day that the FDIC announced its community bank advisory board [of which Brown is a member] I received a call from another regulator whose concern was that some of the regulatory actions are literally causing bankers to leave the industry. That is almost a direct quote from another regulatory authority asking me to carry that message to the FDIC. In addition to fatigue, some people are choosing to leave the industry, due to the [regulatory climate.]

Wilson: I think it's a great time to be a community banker. The opportunities are unlimited. The changes that will happen over the next five years will be greater than the changes of the last 25 years. Regulation is going to get more intense. Competition is going to be more intense. Nonbank companies will come back at some point.

So it sounds like the environment will actually get more difficult for small banks.

Wilson: For intelligent community bankers, you have the opportunity to grow through acquisitions because there are people wanting to get out of the business. You have the opportunity to shape new regulations, to be more involved in the process. It's an exciting time to be a banker. It really is.

You mentioned acquisition opportunities. Is banking an industry that needs to consolidate? Are there too many banks chasing too little business?

Wilson: In the old days we were the only bank in Moscow, Tennessee. We had 100 percent of the market, unless you want to drive 10 miles to next city. Now you have too much competition from de novos, existing banks, credit unions, from GE Capital, from GMAC. You have 0 percent car loans. How do you compete with that? It's a race to the bottom.

Brown: The first two failures of 2009 took place in our market. It was something that had to happen. Borrowers would come to me and say, 'I want a loan on these terms' and if you don't do it, I'll go to Freedom Bank' - I can say the name because it's gone - and sure enough the loan was made.

There has been a weeding out process that's taking place and quite frankly, some of it, maybe even most of it, has been healthy. But the pendulum has begun to swing too much the other way. Some consolidation needs to take place and now we just need to make sure we push the pendulum back to some level or equilibrium.

What's the lending climate like right now? Are there opportunities out there?

Mroz: We were beginning to get a little nervous about our capital level...so we stopped taking deposits, we cut back in what we were offering, and we stopped lending.

You mean you're not originating new loans?

Mroz: We've done some refinancings for existing customers, but we have brokers that send us loans from time to time. We have investors in Baltimore who come to us and we told them we were at a limit and we couldn't lend them any more money.

Rozell: We're actively lending. Within the last 15 to 18 months loans have grown 25 percent. Deposits have grown roughly 30 percent. That's not because we have any new, innovative loan product, or are targeting new markets. It's with the same market that we've had - agriculture with regard to equipment and operating and real estate.

Is it because competitors are pulling back?

Rozell: No. Banks in our area are very much the same in terms of lending style.

Goodenow: We're also in Iowa and we have not experienced that same growth. We've had a general decline. We've gone from about $390 million of loans to about $370 million since the end of 2008. It's not because we're not lending. A lot of our customers aren't borrowing right now. They are paying off their debt. We're trying to lend but don't have the opportunities right now.

Brown: Everyone is concerned about capital ratios. Depending on the bank or market you're in, many banks (not all) are being asked to maintain even higher capital levels than what is required.

In other words, though well capitalized is defined as 10 percent, regulators want you to have to 12 percent.

Brown: Right. That is a significant change in your strategy. If you've been claiming a certain capital level and all of a sudden it's increased by 20 percent - it goes from 10 percent to 12 percent - that has a significant impact on your bank.

And this is happening in certain markets?

Brown: Yes. I spoke to a regulator about this [and asked] how many of the banks that [have been told to boost their capital ratios the current threshold] have made the number? He said zero. Then I asked, 'OK, what's next?' and he said, 'We tell them to keep trying.' In other words, regulators aren't going to shut down a bank that can't get from 10 percent to 12 percent - but in issuing this edict, they're causing these banks to stop lending. That is the polar opposite of what Congress wants and what regulators want.

Stewart: My colleagues in our area are all sure that they are going to be held to a higher capital standard. The [Office of Thrift Supervision] is asking my board to determine in this economy, what we think is an appropriate capital level. We're certainly not going to have high earnings over the next couple of years, so what do we do? Stop lending. Chase off deposits. Our strategy for 2010 is to try and limit the growth of our balance sheet and look at replacing advances with deposits, replacing investment with loans. We've got a fair amount of capacity, but there are a lot of good banks out there that don't, so their only option is shrinking.

Brown: We have three banks in our market that are still lending. I spoke to all three before I came here. Their plan in 2010, because of higher capital ratios, is to pull back on all the lending. At one point we had over 10 banks that were actively lending.

Braswell: The banks that have traditionally used standard underwriting continue to lend. It's the banks that had gone so far outside of prudent underwriting - 110 percent financing, interest-only for five years-that have pulled back. Any good credit, be it real estate or [commercial and industrial], can still be banked by a responsible bank, not by one that's been pushing the envelope.

We're almost out of time and I imagine there are issues you wanted to talk about that we didn't get to. What else is on your minds?

Wilson: I have a huge issue with certain organizations trying to divide our industry between large banks and small banks. They are trying to create a true divide and it's going to weaken our industry. We're just outside of Memphis - headquarters of Federal Express, and if FedEx wants to go to Asia, a community bank cannot finance that. That's a job for a JPMorgan Chase or a Citibank or whoever. If we weaken our large banks through regulation, then companies like FedEx or International paper will end up going to Asian banks or European banks, and those jobs will go overseas, just like manufacturing did.

Does anyone else agree with that - that big and small banks need to be more united?

Braswell: We cannot handle the largest of the large and the largest of the large are not going to seek out 20 community banks to handle their banking affairs in some type of consortium. The largest banks in our country are clearly needed to help those enterprises. I'm pretty confident that the foreign banks have far less regulatory oversight and less costs, and their capital is probably easier to come by or be managed, so they can easily take the business of a FedEx. We need the big banks, and to a degree they need us.

Wilson: I'd rather compete against Citibank than another community bank. A large bank cannot beat a community bank in our market. We're tied into the fabric of the community. But the credits they serve, I can't do. I can't issue credit cards. I'm too small. And the technology comes from the largest banks down to the small banks.

Goodenow: Going back to regulation, I've heard a lot of people say that Gramm-Leach-Bliley was part of the problem, and I want to say, as we try to fix this crisis through regulation, we need to really look at what's been good about certain things. I operate in a market where there's not a lot of growth and GLB has been a great thing. We can sell insurance products and do it responsibly, we can sell investment products, and our consumer is better off. I hope we don't change what's been helpful to the industry.

Rozell: Regulators have concern about banks and fairness to consumers and small businesses - I can't afford not to be fair with these people. We go to church with them, we go to games with them, our kids run around together. I'm from a town of 1,200 and we have three banks in the town. The competition, not regulation, keeps up honest.

Brown: There is no community bank that I know of that can ever stand to be accused of tricking a consumer. Yet, most of regulation that's being talked about right now seems to make the assumption that the lender might be trying to do just that.

Stewart: I didn't expect in my career for 'bank' to become a four-letter word. The level that we overly focus on consumer protection-type regulation - that hurts us too because it gives the impression that banks did something bad and we spend huge amount of time in our communities trying to prove just the opposite. We're making a difference in our communities every day.

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