Dodd-Frank Wall Street Reform and Consumer Protection Act: Impact on US financial institutions’ risk profile and small business lending capacity Presented by: Nina Covrljan, CnC Partners Date: 12/16/2011

Legislative background: Dodd-Frank Wall Street reform and Consumer Credit Protection Act Financial institutions: industry profitability impact Community banks: impact on credit and non- credit services Q&A Overview:

Dodd-Frank Act: Most comprehensive overhaul of bank regulations since the 1930s. Created in response to perceived regulatory deficiencies which enabled for systemic risk concentrations that led to the 2008 financial crisis. Establishes a new framework for monitoring and addressing institutions which pose systemic risk. The Act also requires 243 rulemakings and 67 studies. Legislative background: Source: Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No , 124 Stat. 1376(2010) [hereinafter Dodd-Frank Act]

Key aspects of the legislation: Regulatory agency consolidation: elimination of the national thrift charter; establishment of new oversight council for systemic risk evaluation. Financial markets regulatory overhaul: increased derivatives trading transparency. Consumer protection agency: establishment of new oversight body; uniform standards for “plain vanilla” products as well as increased investor protection. Legislative background (cont’d): Source: Dodd-Frank Act

Additional tools for financial crisis management: resolution regime for orderly unwinding of troubled institutions; proposal for extended Federal Reserve powers (credit extension “in extremis”). Increased international standards and cooperation: improved accounting and tightened regulation of credit rating agencies. Legislative background (cont’d): Source: Dodd-Frank Act

Exhibit 1: Dodd-Frank and Basel III reforms summary Source: McKinsey working papers on Risk, no. 25, March 2011

Dodd-Frank Act: establishes mandates for higher capital requirements, limits on proprietary trading and OTC derivatives, interchange fee limits, and mandatory retention of at least 5% on securitizations (except mortgages). Significantly higher regulatory costs for financial institutions deemed to pose higher systemic risk (e.g. FDIC insurance costs, liquidation costs). Increased operating costs: new risk management requirements, increased investor protections and reporting requirements. Financial institutions: industry profitability impact Source: Dodd-Frank; Barclay’s Capital Analysis; McKinsey Analysis

Financial institutions: industry profitability impact (cont’d) Consumer DDAs-2009 estimated profitability impact (1) Pre-tax profit21% Pre-tax profit after Reg. II Min.13% Pre-tax profit after Reg. II Max.-2% Capital and funding requirements-2010 estimated impact (2) % increase Capital requirements at 8%, Tier 1 common, 9.5% total Tier 1 ~ $591 bn ~60% Short-term funding requirement (LCR) ~ $794 bn~45% Long-term funding requirement (NSFR)~130% (1)Source: BIS;SNL; RMA; analysis; Barclay’s Capital Analysis; McKinsey Analysis (2)Ibid

Increased capital requirements, funding and compliance costs will result in further Bank restructuring and rationalization of credit and non- credit services. As a result, continued consolidation and segment divestitures will result in ripple effects throughout the financial industry. Financial institutions: industry profitability impact (cont’d)

Community banks will experience increased competitive pressures due to continuing industry consolidation trend as well as increased regulatory requirements; likely to experience difficulty offering consumers and small businesses competitive rates on deposits and loans. Service rationalization and credit tightening: Due to higher operating costs, community banks are likely to institute fees for services that are currently offered free of charge (e.g. debit cards, checking accounts, online or mobile banking). Community banks: impact on credit and non-credit services Source: Congressional hearing “The Effect of Dodd-Frank on Small Financial Institutions and Small Businesses”, testimony of James D. MacPhee, CEO Kalamazoo County State Bank (member of Independent Community Bankers of America), March 2011

Rules which stipulate “plain vanilla” products (credit cards, mortgages etc.) are expected to have an adverse effect on community banks as product customization will be limited. The “Durbin” amendment - sets forth significant changes regarding debit interchange fees and the economics of consumer banking. Community banks: impact on credit and non-credit services (cont’d) Source: Congressional hearing “The Effect of Dodd-Frank on Small Financial Institutions and Small Businesses”, testimony of James D. MacPhee, CEO Kalamazoo County State Bank (member of Independent Community Bankers of America), March 2011

According to ICBA, community banks are not effectively protected under the statutory exemption for small credit card issuers (less than $10 bn in assets). Small FIs may benefit from the two tier pricing system only to a limited degree, as the new regulations grant retailers (vs. FIs) the choice of network routing. Large retailers will further compete via low interest rate credit cards community banks will be forced to match or potentially exit. Community banks: impact on credit and non-credit services (cont’d) Source: Congressional hearing “The Effect of Dodd-Frank on Small Financial Institutions and Small Businesses”, testimony of James D. MacPhee, CEO Kalamazoo County State Bank (member of Independent Community Bankers of America), March 2011

The combined effect of increased competition, operating costs and reduced product profitability will likely result in rationalization and reduction of non-credit services. As fee revenue from non-credit services is reduced, community banks are likely to increase interest rates on credit products in order to compensate for the loss of non- credit revenue. In addition, credit availability will be diminished due to lower compensating balances, higher cost of capital and more stringent underwriting standards. New borrowers are likely to experience higher interest rates and more stringent qualifying criteria, while borrowers whose credit rating may have suffered are likely to pay higher interest rates for an extended period of time. Community banks: impact on credit and non-credit services (cont’d)

Q&A