2014 Arizona Bankers Association

2014

30 YEARS OF EXCELLENCE

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One size

hurts all

Experts say changes must be made to Dodd-Frank to keep banking industry healthy and competitive

By MICHAEL GOSSIE

36 AB | November-December 2014

t

he Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is the most sweeping financial regulatory legislation Congress has passed since the Great Depression. It was supposed to clean up and stabilize the financial industry.

Experts say it’s had the opposite effect.

“Dodd-Frank has changed the economics of the banking business adversely, particularly for small to mid-size banks (less than $10 billion in assets),” says James Kaplan, a member of Quarles & Brady’s Business Law Practice Group in Phoenix.

“By discouraging and outright prohibiting risk in some cases, (Dodd-Frank) cuts the supply of credit to households and businesses and has done its share in creating a perpetual slow-growth economy. (It has) discouraged residential mortgage lending, discouraged small business and real estate development lending, and in general seeks to reduce greatly the inherent risk in free enterprise activity to too great an extent.”

Here’s what else Dodd-Frank has done: A study says the new regulations have heaped more than $21.8 billion in costs and 60.7 million paperwork burden hours onto the financial industry and turned the industry into one giant guessing game, particularly for smaller banks. Experts say the regulatory burden has had the biggest adverse effect on community banks because the compliance with the regulatory standards and oversight have dramatically increased costs and has hindered the community banks’ ability to come back from the Great Recession.

“Dodd-Frank applied a one-size-fits-all solution for the banking system,” says Candace D. Wiest, president and CEO of West Valley National Bank. “While there have been some carve outs for community banks, the reality is that by and large the community banks have been forced to comply with the same regulations as the behemoth banks. The avalanche of new regulation is still growing. At WVNB, we could easily allocate $10 million per month that is a direct expense of regulatory compliance. The sad part is that the (part of the) banking system that caused the meltdown somehow has escaped much of the reform.”

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Positive impact The intent of Dodd-Frank, which requires oversight from a number of federal agencies, was to hold banks more accountable in response to the worst financial crisis since the Great Depression by imposing stringent new regulations, consumer protection standards, new capital requirements and strict reporting rules on lenders.

“There are things about the Dodd-Frank Act that needed to happen to reign in some of the excesses of the financial industry,” says Keith Maio, president and CEO of National Bank of Arizona.

“The increased capital standards will mean that next time the economy experiences a severe recession, there will be fewer bank failures,” Kaplan says. “(Dodd-Frank) also created the Consumer Financial Protection Bureau, which if it would re-orient its approach, could become a significant force for protecting consumers who need the help. And (Dodd-Frank) will keep some banks out of speculative businesses in which they have little expertise, which does enhance the safety and soundness of the entire system.”

Dodd-Frank has also overhauled mortgage lending and affected the availability of credit. But with roughly 20 percent of the law still left to implement, analysts say the true impact of the legislation may not be understood for years. But there is one area where the impact is clear.

“Dodd-Frank was really intended to focus on the larger banks in the country, the ones that are systemically influential financial institutions, the ones that — if they got into trouble again — could have a negative impact on not just the commercial banks in this country, but globally,” says Ed Zito, president of Alliance Bank of Arizona.

“Unfortunately, the mindset that underlies Dodd-Frank in terms of the regulatory burden has really flowed down unfairly to smaller community banks.”

Experts say the fixed costs of complying with DoddFrank are having the unintended consequence of benefiting the massive banks that can absorb the costs through volume. The institutions that are benefitting may be the same ones that helped cause the financial crisis that created the need for Dodd-Frank in the first place. That doesn’t mean Dodd-Frank isn’t hurting big banks’ bottom line, too.

“In passing the ‘Volcker Rule,’ (Dodd-Frank) has reduced the ability of our mega banks to take part, and thus make significant profits in, formerly permissible areas, like proprietary trading of securities and other assets, merchant banking and hedge fund sponsorship,” Kaplan said.

Big get bigger One of the consequences of the added regulatory cost on smaller banks has been consolidation.

“The number of banks in Arizona has shrunk dramatically,” Zito says. “It’s not all due to failures. It’s due to the fact that you’re now seeing mergers and acquisitions of banks where shareholders and owners have fatigue from working so hard to get through the Great Recession and not seeing a great future ahead of them independently. The same trend is happening across the country.

Zito points out that when he was in Washington, D.C., working for the U.S. Treasury Department, there were approximately 15,000 banks in the country. Today, we’re down to about 6,700.

“I sometimes refer to Dodd-Frank as the ‘community bank genocide act,’” Zito says, “just because it’s had that tough of an impact. There really should be an exemption for small banks that really have no systemic impact. Almost every community in which you find a bank, you will find a competitor, so inherently, they have to serve their community. Otherwise, they are not going to survive.”

John M. Randolph, a member at Sherman & Howard in Phoenix, says that while Dodd-Frank’s premise that objective criteria for mortgage loan underwriting is essential to prevent the abuses that led to the 2008 financial crisis, the imposition of rigid objective criteria contained in the Qualified Mortgage Rules is contrary to the relationship banking and soft criteria that community banks have successfully operated under for years.

“Unlike large banks that have limited knowledge of their customers and that must rely upon objective information in underwriting, community banks have historically forged long-term professional alliances with their customers and have been able to make prudent credit decisions based upon personal knowledge and community standing of the customer,” Randolf says. “The mortgage rules set forth specific parameters to meet Dodd-Frank’s requirements that do not allow any consideration for these factors. While a bank may offer non-qualified mortgages, the liability in doing so appears to be more than what most banks are willing to assume.”

The irony of the new constricted regulation is illustrated by the fact that former Federal Reserve Chairman Ben Bernanke was unable to refinance his Washington, D.C., home recently because he is now self-employed.

What’s next?

Experts say without amending Dodd-Frank, the biggest long-lasting impact of the legislation may not be on the banks themselves, but on the economy as a whole.

“At the end of the day, I think the bankers can all deal with the regulations,” Maio says. “But I don’t think we have yet seen if Dodd-Frank will be any kind of governor on

...the biggest long-lasting impact of the legislation may not be on the banks themselves, but on the economy as a whole.

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economic growth over the long run. Do those that passed the Act rather quickly and those that are interpreting the rules of the Act really understand what changes it might have on the banking industry, which has been the financial engine or the fuel for economic growth? We have not seen any significant economic growth since Dodd-Frank. That’s a concern I have as a banker.”

Most banking experts agree that some changes need to be made to Dodd-Frank to maintain a healthy, balanced and competitive banking system. To get there, most say DoddFrank needs to be amended to lessen the burden on smaller and community banks.

“I would also advocate reining in the power of regulators to deny banks the right to grow and expand their business, absent antitrust concerns,” Kaplan says. “These sorts of decisions on whether to grow, expand, add business lines and so forth are best made in a free enterprise system like ours by those who will primarily live with the economic consequences — the shareholders and management of banks.

Kaplan said he would also be an advocate for the creation

of a regulatory oversight authority comprised of ordinary consumers, business people and bankers (no regulators) that would review the major decisions of bank regulators on applications and regulations and regularly report to the country on the efficacy and desirability of those application decisions and regulation. “(Dodd-Frank) has affected our policies, our procedures, our disclosures, our risk profile, and our ability to offer credit,” Wiest says. “I got into this business because of a banker. I was a 26-year-old single mother with no credit and a car that wouldn’t make it through another Midwestern winter when I received a miracle in the form of an income tax refund that gave me a down payment (for a new car). I went into the Delay Bank in Norfolk, Neb., where a guy named Gib Fisher talked to me about where I worked, why I didn’t have credit, etc. He said he would think about approving the loan and get back to me. He called back within 15 minutes and said he had spoken to my boss, who said I was a hard worker with a good future, so he was approving the loan ... Today, we have limited ability to help people. It makes me sad to think about it.”

What should be changed?

Here is how experts say the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 should be changed to help the banking industry, while achieving what the legislation was intended to accomplish:

James Kaplan

Candace D. Wiest

John M. Randolph

Ed Zito

“Repeal the Volcker Rule. Lower the capital requirements for smaller banks that exhibited a lower risk profile. Re-focus the Consumer Financial Protection Bureau on substantive consumer protection rather than compliance and documentation and fear of enforcement that raises costs to consumers and discourages lending.”

“Banks like WVNB did not cause the meltdown. And if we would have failed, we would have had some very unhappy shareholders, but would not have brought down the economy of the free world. Tailor the regulations to the risk classes of banks present to the system. Let us help the people we were chartered to help.”

“In order for community banks to survive and continue to offer their traditional loan products, it will be necessary to create exemptions from the requirements of Dodd-Frank and the Qualified Mortgage Rules. Deviations from the one-size-fits-all methods of determining the ability to pay for community banks would be an important step.”

“Even as a $10 billion organization, we still think that a healthy banking system and a competitive banking system is one that needs to have the right balance struck, so we would be in favor of supporting lesser burden and amending Dodd-Frank to lighten the load on smaller and community banks.”

Partner, Quarles & Brady:

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President and CEO of West Valley National Bank:

Member, Sherman & Howard:

President, Alliance Bank of Arizona:

Buildingalliances By boosting economic development, Alliance Bank of Arizona has boosted its bottom line By MICHAEL GOSSIE

ED ZITO: “We feel like we are all owners,” said the president of Alliance Bank of Arizona. “We like to preach to our newest members of the team, ‘run it like you own it.’ If you have than mentality from the get-go, that is the hallmark that has made us the largest locally owned an headquartered bank in Arizona.”

PHOTO BY SHAVON ROSE, AZ BIG MEDIA 42 AB | November-December 2014

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Ed Zito began his financial career with the United States Treasury Department. As president of Alliance Bank of Arizona, Zito helped the financial institution cross the $10 billion mark in June, obtain a $2 billion market cap for its stock and grow into the 67th-largest publicly traded bankholding company in the country. Az Business sat down with Zito after Alliance celebrated record earnings in the second quarter to talk about the state of the banking industry.

What is Alliance doing right?

We had a record second quarter and we are very proud of that. We are just a commercial bank, so we focus on commercial business lending, commercial real estate, public finance and nonprofit organizations. As the largest locally owned and headquartered bank in Arizona, we work very hard to pitch local first, buy local and bank local. It’s a lot more blood, sweat and tears since the marketplace is much more competitive now, but we’re hitting on just about all eight cylinders. We’ve had great deposit growth, which in turn funds our loan growth, which has been strong, albeit competitive. It all came together with some great net interest margin, which is the difference between what we pay on our deposits vs. what we take in for our loans.

What sectors are driving your loan growth?

Everybody knows the Great Recession is over. The economy may not have recovered as strongly as everyone had liked, so there is some owner fatigue out there that is driving some merger and acquisition activity. Virtually all asset types or product types and our commercial real estate sector are all very strong. RED Development is one of our biggest clients and we are fortunate to be financing their Town & Country Shopping Center overhaul. Two other notable projects: We are financing Building 3 at SkySong and we are financing the acquisition of Metrocenter by the Carlyle Development Group out of New York City. We feel that economic development is truly within our DNA, so the kinds of projects we are seeing in our commercial real estate area fit within our organization’s makeup.

Both of those projects are revitalizing neighborhoods. How important is that to Alliance?

That is huge. We are a super community bank, as we like to call ourselves. We are about $10 billion in total size, so we are at the upper end of super community banks and the lower end of the regional bank category. We see the importance of reinvesting the deposit dollars we take in back into our local communities to spur job growth, re-employment and economic development. A multitude of our executive team are involved in organizations across the state promoting economic growth and development. We look at it as investing forward, as opposed to giving back. We feel very strongly in taking a leadership role in economic development because that underscores our role as the largest locally owned and headquartered bank in Arizona, but we also feel that it’s just the right thing to do.

How has the commercial real estate space changed over the last four years?

It’s dramatically different. Everybody who was in commercial real estate back in 2007 got a cold shower in 2008 and 2009.

We saw dramatic unemployment, basically no construction and negative absorption. Slowly, but surely, that’s coming back.

The beauty of the difference now is that it was a fairly narrow commercial real estate environment before the Recession. The environment now is much more broad based. It’s underscoring the point that everyone’s economic development efforts are starting to pay off because we have a much more diversified economy. So we are seeing a lot of activity in hospitality, healthcare, education, industrial development, land acquisition for future homebuilding and construction, and multi-family.

Does your record quarter signify anything regarding the economic recovery?

The banking industry in general has enjoyed the better part of three years of gradual recovery. Banking profitability is nearly at an all-time high. Bank capital is setting record level almost on a quarter-by-quarter basis because profitability is good and earnings are being retained. Fundamentally, the cooperation with the regulatory community in building a more stable and sustainable banking environment has been successful. I do think we are seeing banks marching to the beat of the regulatory drum, but also realizing that the capital base that is needed given the risks and challenges that we face daily are important to be sound, stable, prudent, enabling, but also mindful of the risks that are involved. So there is a good balance being struck right now and the earnings are reflective of that.

Will the increase in the use of mobile banking mean the end for brick-and-mortar banks?

Not really. As a commercial bank, it’s important to be close to our customers. I have a saying: When someone asks, “Where is your office?” I answer, “Wherever my customer or prospect needs it to be.” We just opened a new office at Loop 101 and Ray Road to serve the rapidly growing Southeast Valley and we are hoping to purchase a piece of land in Gilbert to build more offices. We are trying to go where the business community is growing. We already have a number of offices in Phoenix and Tucson and we will always go where our customers need us.

What are your goals for Alliance over the next five years?

We are a growth-oriented and goal-oriented organization.

We opened in 2003 and will celebrate our 12th anniversary in February. We think that in five years, we can be between $15 billion and $20 billion because of organic growth and acquisitions. That’s our goal.

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44 AB | November-December 2014

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Ca$h carry and

Mobile banking creates a fundamental shift in banking industry and more changes are coming By MICHAEL GOSSIE

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t wasn’t long ago that people looked forward to going to the bank to cash their paycheck.

Now, they just pull out their phone, take a photo of the check and the money is magically in their account.

“The way we deliver banking services to people now has really fundamentally changed,” says Keith Maio, president and CEO of National Bank of Arizona. “We thought when ATMs were built, it was fundamentally going to change branches and that everyone would use an ATM and no one would use a teller. They used ATMs, but they never stopped using the branches.”

Technology, however, may change that.

“Banking with a mobile device is keeping people from banking in a traditional way,” Maio says, “so we have to modify the way we deliver banking services.”

To understand how dramatically and dynamically mobile banking has change the landscape of the banking industry, consider the findings from these recent reports and surveys: • 90 percent of U.S. bankers expect at least a 10 percent decline in branch numbers over the next five years, with 45 percent expecting the decline to be 25 percent or more. Branch numbers have declined 9 percent in just the last three years.

• More than 50 percent of the United States’ commercial banks now offer some form of mobile banking.

• 82 percent of 18- to 25-year-olds owned a smartphone in the fourth quarter of 2013 and 61 percent of those engaged in mobile banking.

That compares with around 60 percent and 30 percent, respectively, for their parents.

• 61 percent of U.S. internet users bank online and 32 percent of U.S. adults bank using their mobile phones.

• 88.5 million Americans attempted to open an account online or with a mobile device in the past 12 months.

• 53 percent of Millennials don’t think their bank is any different from other banks; 73 percent would be more excited about a new financial services offering from Google, Amazon, Apple or PayPal than their own bank; and 33 percent believe they soon won’t need a bank at all.

“For today’s banking customers, it’s about how easy they can navigate on their mobile device,” Maio says. “That’s become their perception or paradigm of the bank. The ease of use with their mobile device is their relationship with their bank.”

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Changing the industry Based on a study by Forrester Research, Chase, Citibank, Bank of America and Wells Fargo lead the way relative to mobile banking functionality.

“Wells Fargo has 13.7 million active mobile banking customers as of September 2014 and it continues to be the fastest-growing channel in Wells Fargo’s history,” says Pam Conboy, Arizona lead region president for Wells Fargo.

“Increasingly, we’re seeing customers interact with us in an ‘omni’ or ‘multi-channel’ way. They want options in how they bank – whether it’s by phone, in-store, ATMs, online and mobile banking. All of these channels need to work together to provide service and convenience when, where and how they want it. Each channel remains central to our strategy of providing excellent service and meeting our customers’ financial needs.”

The most common uses of mobile banking are to check account balances and review transactions. The second most common use is to transfer money between accounts. Thirtyeight percent of mobile bankers have deposited a check in the past 12 months. The average mobile banking user accesses their account four times per month.

“Bankers are quickly adapting to changing use patterns, looking closely at their branch office locations, branch office designs and customer service staffing,” says Chuck Matthews, chairman and CEO for Valley-based WGM, a business technology company. “As fewer customers make trips to physical bank branches, some members of the banking industry are experimenting with new branch models that are a fraction of the size of traditional locations.”

In response to the exploding use of mobile banking and need for more resources devoted to technology, Matthews says banks including Wells Fargo, HSBC and Citigroup have played around with the size and features of their branches, building smaller locations or ones with fewer human tellers and more video screens. The need for the industry to evolove is only going to increase. Forrester estimates that by 2015, more than 50 million users will actively access mobile banking in the United States alone, representing a compound annual growth rate (CAGR) of more than 33 percent.

Focus on security While mobile banking growth accelerates, consumers are still concerned over security of their mobile transactions and the new wave of payments by smartphones is set to accelerate those concerns and need for hyper vigilance when it comes to protecting customers.

“We have to make sure we’re able to host the mobile experience in a safe and secure environment,” Conboy says.

“Customer privacy and security is always at the forefront of everything we do and Wells Fargo takes significant steps to protect customer information online and in our mobile apps.”

Matthews says perceptions about the lack of security and privacy of mobile banking and mobile payments are some of the main reasons cited by current non-users. Sixty-three percent of consumers who do not use mobile payments cited both security and privacy concerns. The majority of non-users consider traditional methods of banking and payments sufficient for their purposes. Overcoming these perceptions and demonstrating mobile technology advantages will be important to continued adoption of mobile banking and mobile payments.

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“Those concerns may be well justified by recent events,” Matthews says. “JPMorgan said in a regulatory filing in September that the widespread data breach compromised the accounts of 76 million households and seven million small business customers who used the bank’s Chase.com and JP Morgan Online websites, as well as the Chase and J.P. Morgan mobile apps.”

More than 50 percent of the United States’ commercial banks now offer some form of mobile banking.

To further improve the security of mobile banking and payments, the SANS Institute, which specializes in information security and cybersecurity training, recommends the following: • Conduct customer education campaigns • Implement remote wipe and automatic lock-out features • Device encryption • Ensure apps don’t store customer sensitive data locally • Use only reputable sites to download apps • Ensure that apps are tested for security • Avoid jail-breaking phones • Ensure the point of sale device vulnerabilities are addressed • Ensure that software updates are being pushed to devices • Vet the security of the carrier infrastructure and services through targeted questioning • Extend current online fraud tools and controls to the mobile channel “The adoption of more secure technologies like NFC (nearfield communication) and the EMV (Europay, MasterCard and Visa) chip card may also help improve the consumer’s perception of security,” Matthews says.

While the convenience and technology of mobile banking are overwhelming, security remains the key piece.

“It’s extremely important for us to make sure our customers have confidence in us to protect their identities and confidential information and we take that very seriously,” says Ed Zito, president of Alliance Bank of Arizona. “We have a series of firewalls and filters and algorithm-based software programs that alert us to unusual transactions and protect our customers. When I travel and use my debit card, I get an instant notification on my smartphone asking if I’m in suchand-such a state and to please verify. The beauty of that is that it protects our customers and the bank. Mobile security is a big focal point for us in terms of providing our customers with the latest technology products and services, but also being mindful of the risks involved.”

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The future

The beauty of technology is that it’s ever-evolving and mobile banking is no different.

“We will be introducing our business mobile banking in the first quarter of 2015 as a way of further facilitating the introduction of technology in advanced products and services to our business-related customer base,” Zito says.

And in October, Apple announced availability of Apple Pay on the iPhone 6, which will likely have profound implications for mobile payments globally.

“We know our customers want and need payment options like Apple Pay and other mobile wallets as they live their increasingly digital lives,” Conboy says. “Whether it’s using virtual cards to make a payment or paying a friend directly through our mobile app, the service has to be safe, quick and convenient. If it meets those three criteria, customers are more likely to adopt it. Apple Pay is a strong offering in those areas, and we’re pleased to be involved with it.”

To pay, an Apple Pay user can hold their iPhone 6 within a centimeter or two of the contactless reader with their finger on Touch ID. Apple Pay allows users to select which debit or credit card they want to use after adding them to their Passport. Apple’s adoption of NFC and drive to push mobile payments should really help kick start the NFC ecosystem, triggering a wave of merchant upgrades of NFC terminals.

Up until this point, there hasn’t been a catalyst to encourage merchants to upgrade their infrastructure to support NFC payments. Apple’s entry into the space is a potential game changer, given the fact that Apple has also signed up several big-name merchants to accept Apple Pay, including Bloomingdales, Macy’s, Subway, Walgreens and Whole Foods.

“The initial Apple Pay functionality is limited to iPhone 6 and 6 Plus users,” Matthews says. “Apple is expected to launch the Apple Watch in early 2015. The Apple Watch will pair with the iPhone 5, iPhone 5c, iPhone 5s, iPhone 6 or iPhone 6 Plus to provide Apple Pay functionality. Those additional devices will greatly expand the reach of Apple Pay technology. Additionally, new banking partners and merchants are expected to join the Apple Pay ecosystem in the coming months. Competing payment services from Google, Merchant Current Exchange (MCX), PayPal, Samsung and others will also leverage NFC technology.”

Matthews says to watch for additional announcements in coming months.

Despite the constantly evolving technology that is forever changing the banking industry, experts say some things won’t change.

“When you still have a critical need, you’re still going to want to meet someone face to face at a bank,” Maio says, “so it’s not like the switch is going to go completely dark in all the branches and all we’re going to do is mobile. It’s always going to be a balance of both.”

ACTIVITIES CONDUCTED

BY MOBILE BANKING CUSTOMERS

Checked balance/transaction

93%

Downloaded mobile banking app 72%

Transferred money

57%

Received email alert

53%

Made a bill payment

44%

Received a text alert

43%

Located an ATM

41%

Deposited a check with a camera 38%

Person to person payment 26% Pamela Conboy

Chuck Matthews

52 AB | November-December 2014

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