Small banks flexed muscles

By Russell Grantham

The Atlanta Journal-Constitution

Small banks, which have accounted for most bank failures over the past two years, have recently won breaks on some requirements in the financial reform bill that may go to a final vote in the Senate next week.

Before and after House and Senate lawmakers reached a compromise over two weeks ago, lawmakers, regulators, banks and other financial institutions big and small continued to battle over key pieces of the proposed financial overhaul, such as how to pay for it.

The result: The nation’s thousands of small but politically well-connected community banks won important concessions, including a years-long delay of higher deposit insurance fees that will affect larger banks first. They avoided a tougher capital requirement to be imposed on large banks. A new federal consumer-protection agency’s authority also will be limited to large banks.

When lawmakers ditched plans for an $18 billion tax on large financial institutions and hedge funds to pay for the reform bill, they partly replaced it with a measure that will allow the Federal Deposit Insurance Corp. to hike premiums it charges banks to guarantee accounts up to $250,000.

However, the higher premiums won’t apply to banks with less than $10 billion in assets until 2020.

The $10 billion limit also applies to banks overseen by the new Consumer Financial Protection Bureau to be created under the proposal. The Federal Deposit Insurance Corp. and other agencies would continue to enforce consumer protection laws at smaller banks.

Likewise, the bill allows banks with less than $15 billion in assets to keep counting a controversial type of investment as part of their capital reserves. Bigger banks can’t count them in reserves after five years.

Community banks often sold the investments, known as “trust preferred” securities, to other banks as a way to raise cash and cut taxes. About 1,400 banking firms had issued almost $150 billion of the securities before the financial crisis hit in 2008.

That’s when some banks defaulted on the debt-like securities, turning them into toxic assets for the banks that bought them and used them as part of their capital.

The Georgia Bankers Association, which represents many of the state’s nearly 300 banks — most of them small — opposes the financial reform bill because it also creates a new Consumer Financial Protection Bureau and restricts banks’ ability to charge fees for processing debit card purchases.

But GBA President Joe Brannen praised the lawmakers’ decision to allow small banks to keep trust preferred securities as part of their capital. Without the break, he said, “in Georgia, we would have had banks ... fail.”

To be sure, Congress’ focus has mostly been on bigger problems. The bulk of the sweeping financial reform proposals are aimed at avoiding a repeat of the financial crisis triggered by a flood of mortgage defaults and the collapse of some of Wall Street’s giants.

During the height of the crisis, the federal Treasury Department’s $700 billion Troubled Assets Relief Program bailed out several of the nation’s largest banks, financial firms and automakers.

Still, failures of small community banks with assets of $1 billion or less have cost the FDIC billions of dollars. Such banks accounted for the vast majority of the nation’s 200-plus bank failures over the past two years. The FDIC estimates that bank failures since mid-2008 will cost its deposit insurance fund more than $56 billion over several years. The agency’s insurance is funded by bank-paid premiums but is also backed by the Treasury Department.

The FDIC said the high percentage of failures by small banks is consistent with the fact that more than 90 percent of the nation’s 7,900-plus banks have less than $1 billion in assets.

A spokesman for the agency praised the proposed legislation’s focus on reducing the risk of collapse of the most massive financial institutions, and the recent deal to boost bank’s payments into the FDIC’s deposit insurance fund.

“As an insurer, you want that to be a higher number,” said spokesman David Barr.

Mounting losses

Losses from the growing pace of bank failures are expected to cost the Federal Deposit Insurance Corp.’s fund more than $50 billion. Most of the failed banks are tiny compared to the Wall Street behemoths that are the focus of pending financial reform legislation.

Quarter / FDIC insurance fund balance / Bank failures / Estimated losses on failures

3Q 2008 / $34.6 billion / 9 / ($11 billion)

4Q 2008 / $18.9 billion / 12 / ($4 billion)

1Q 2009 / $13.0 billion / 21 / ($2.2 billion)

2Q 2009 / $10.4 billion / 24 / ($9 billion)

3Q 2009 / ($8.2 billion) / 50 / ($14.3 billion)

4Q 2009 / ($20.9 billion) / 45 / ($10 billion)

1Q 2010 / ($20.7 billion) / 41 / ($6.3 billion)

Source: Federal Deposit Insurance Corp.