Community banks across the world are facing a barrage of changes as new regulations come into force. However, those regulations weren't originally aimed at them, they were aimed at the too big to fail multinational banks. For community banks, which by their nature have smaller resources meeting compliance requirements, cleaning up toxic assets and managing non-performing loans is a daunting task. Observers of the industry have also noted other factors including a wave of retirement from top management of many of these banks, and growing consolidation.
Taken together, it may well look like we could be facing a world without community banks. But new financial firms are stepping in to line up private capital behind community banks in a variety of ways. These companies are buying portfolios of non-performing loans, acquiring community banks as management retires, and setting up joint ventures to help manage the load.
Signature Group Investments is one such firm, it recently purchased a pool of non-performing and performing loans from a New York City based community bank. When firms like Signature step in, community banks can remove portfolios of business that could keep them from being in compliance with new financial regulations or could just be a drag on the overall profile of the bank. In turn, firms like Signature can use their expertise to deal with the non-performing loans and rebuild returns. In this purchase, Signature joined with a private equity firm to complete the transaction. In other cases Signature has directly partnered with community banks. And most recently, Signature decided to secure more permanent funding from family offices and high net worth individuals by engaging the GrowthCap team to manage its capital raise on the GrowthCap platform.
Deals like this are likely to become more common as private capital providers like private equity and hedge fund firms, along with specialty finance shops step in to provide capital where the big banks won't. As new regulations like Dodd-Frank, and Basel III have come into force worldwide, making small loans is no longer economical for the big banks and the compliance burden for community banks means resources are tight for them as well. The advent of this reality prompted some industry sources to note that there is a greater incentive for community banks to just close up shop in the face of new regulations, especially if retirement was already imminent for top management.
Capital and margin requirements for banks also forced an early sell off of certain loan types that banks used to lend to each other, and non-performing parts of bank balance sheets have readily come up for sale. For private capital firms, they've capitalized on the opportunity to provide capacity and buy up that paper.
Now, regulatory relief for community banks may be on the horizon. New Fed Chief Janet Yellen said earlier this month that there should be a tiered regulatory structure in place that takes into account the size and loan profile common to a community bank. The Independent Community Bankers Association (ICBA) has been pushing for changes to the rules to reflect a more realistic picture of banking since Dodd-Frank was passed. So far, the ICBA has been successful at getting community banks exempted from the Volcker Rule and setting up differing tiers of compliance could be another victory for the organization.
"Community bankers know we can't rest on our laurels. We have to strike while the iron is hot – whether it is a loan to a local small business or grass roots outreach on important legislation," ICBA President and Chief Executive Officer Cameron Fine wrote in a blog post on April 11. The add-on investment went to Towncare Dental which is now part of the Dental Care Alliance, another Quad-C company. "DCA has been growing by acquisition and Towncare represents a significant addition there," Burns adds. So is it the end for community banks? Not yet. But, times are tight and community banks may look wholly different when the dust settles. Watch this space.
This article was published in Opalesque's Private Equity Strategies our monthly research update on the global private equity landscape including all sectors and market caps.