LEGAL NEWSLINE

COLUMBIA, Mo. (Legal Newsline) - When this small-town bank in a vibrant Midwestern college town announced in early September 2012 that it would be closing due to increased federal regulations, the community and financial industry felt ripples of shock and dismay. Shelter Financial Bank was considered to be very well-capitalized.

The Sept. 30, 2012 quarterly financial statement filed by the bank reported $160 million in assets, of which $78.6 million were deposits, according to Banktracker, a website produced by the American University. The bank reported $79,000 in loans that were past due 90 days or more, and $1.3 million in "troubled assets." For the same time period, the bank reported a profit of $689,000.

"By many measures, it was healthier than most or healthier than average," said John Berlau, senior fellow for finance and access to capital at the Competitive Enterprise Institute. "A lot of the provisions of Dodd Frank are hitting community banks."

On its website, the bank states that increased federal regulations of banks owned by insurance companies - Shelter Financial offers life, property and commercial insurance, amongst other products - was leading to the closure of its banking business. The culprit is increasing federal oversight by the Dodd-Frank Wall Street Reform and Consumer Protection Act, the bank states.

"Over the past few years the government regulations imposed on banks owned by insurance companies have expanded, becoming more cumbersome and expensive than when Shelter Bank began its operations. More importantly, compliance with new regulations now being discussed would potentially cost more than the income generated by Shelter Bank. As a result, and after a long and thorough analysis of the continued operations within these constraints, Shelter has made the decision to discontinue the operations of Shelter Bank," according to a statement released in September by the insurance company.

When the decision to close was announced, the bank was profitable, by both the institution's accounting and by independent third parties.

Dodd-Frank was enacted in response to the financial crisis and resulting recession in the late 2000s. It was intended to curb what popular sentiment saw as excesses by the multi-national banking system in mortgages and derivative transactions.

The law is intended to force greater transparency on the behemoth banking institutions many in Congress blamed for the financial crisis of 2007-2008; what it is doing, Berlau said, is creating layers of regulation so thick that regional community banks can't afford to compete with larger institutions.

"Frank-Dodd is 2,500 pages," he said, "and more than half of it hasn't been implemented yet. ... We don't know how this is going to be interpreted."

The Government Accountability Office issued a report in September on the impacts of Dodd-Frank on small community banks and credit unions, acknowledging that much of the law's impact is unknown and carries the possibility of negative ramifications for community banks and credit unions.

"Although the Dodd-Frank Wall Street Reform and Consumer Protection Act's (Dodd-Frank Act) reforms are directed primarily at large, complex U.S. financial institutions, regulators, industry officials, and others collectively identified provisions within 7 of the act's 16 titles that they expect to have positive and negative impacts on community banks and credit unions," according to the GAO's report.

While some provisions of the law - namely changes to deposit insurance regulations and the involvement of the Bureau of Consumer Financial Protection - could lessen the cost of doing business for small institutions, changes to the mortgage lending industry are expected to impose more stringent and expensive requirements on banks of all sizes. The different, simultaneous methods of accounting and reporting were often duplicative and conflictive, said Berlau, leading the directors of Shelter Financial to make the drastic decision to close the thrift arm of its operations instead of suffering losses or greatly diminished profit margins.

Berlau said that while he's never heard of a thrift shutting down and returning deposits voluntarily, many banks owned by mutual insurance companies are now considering the move as well.

"I've heard of pulling lines of businesses, but just closing down when the statistics bear them out that they were healthy, this is the first I've heard of it."

While Berlau said he's been a critic of Dodd-Frank, he expected community banks to merge or combine in the wake of increased federal oversight and reporting requirements.

"But to close down to the point of returning deposits? That surprised even me," he said.

It likely won't be the last, he said, pointing out that more than half of the legislation hasn't gone into effect yet.

"Community banks don't have the resources of compliance offices like their big brothers and sisters do," Berlau said.

Another wave of difficulty is ahead for community banks - new rules for the mortgage industry are mandated by Dodd-Frank act are coming out Jan. 21. These rules, governing qualified residential mortgages and other aspects of mortgage lending, met with bipartisan opposition during debate on Capitol Hill - both Democrats and Republicans thought the provisions too onerous on the banking industry, Berlau said.

Other difficulties for community banks will arise from Basel III, an international banking agreement that will make it much harder to issue mortgages in general, but easier to buy lofty financial products like foreign government bonds, Berlau said. Regulation is not going to get any easier for community banks, he said.

"Dodd-Frank and the Volcker rule were intended to target large banks," Berlau said, "But Shelter Financial is not a large bank."

Editor's note: This story has been updated. A previous edition incorrectly referenced data from Shelter Federal Credit Union of Columbia, Mo.