PPP loans, excess liquidity push 10 banks over $10 billion in Q1

Ten U.S. banks crossed the critical $10 billion threshold during the first quarter, a move that brings growing pains for U.S. community banks. But banks that recently jumped over the asset level have until 2022 before feeling some of the effects, thanks to temporary relief regulators implemented due to the COVID-19 pandemic.

For community banks, jumping over $10 billion in total assets temporarily reduces revenue through regulatory changes such as a cap on interchange fee income and reduced Federal Reserve Bank dividend payouts. Simultaneously, the move can increase overhead costs associated with more intense regulation.

"Certainly, we don't like to give up any income we can have for our customers, but it doesn't change the overall profitability of the bank very much at all," OceanFirst Financial Corp. Chairman and CEO Christopher Maher said in an interview. "There's a temporary impact [when] you cross $10 billion that is not much fun. But within two or three years after that, if you continue to grow, you hopefully put that behind you."

OceanFirst crossed $10 billion in total assets in the first quarter of 2020 when it closed two bank acquisitions. Maher said the loss of interchange fee income had the biggest financial impact. The Durbin Amendment, a provision of the Dodd-Frank Act, kicks in at $10 billion in assets and limits the amount of interchange fees a financial institution can collect. OceanFirst estimates that it will lose about $4 million per year of interchange fee income.

Most community banks that crossed the asset threshold in 2020 were granted temporary relief from the impact of the Durbin Amendment, which allowed banks to avoid the costs associated with the threshold if they shrank below $10 billion by Jan. 1, 2022. The final rule from the Federal Reserve, Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency was a recognition of the ballooning of community banks' total assets as a result of an influx of cash and a crush of temporary loans from the Small Business Administration's Paycheck Protection Program.

Fort Lee, N.J.-based Cross River Bank reported the most assets among community banks that grew over $10 billion in assets. The bank's total assets have fluctuated greatly through the pandemic as it has been a prolific issuer of PPP loans, many through its numerous fintech partnerships. The bank crossed $10 billion in total assets during the third quarter of 2020, fell back below the threshold during the fourth quarter of 2020 and jumped back above it again in the 2021 first quarter. Cross River reported $13.48 billion in total assets at March 31, up from $9.71 billion in the fourth quarter of 2020 and $2.53 billion at March 31, 2020. It reported a 43% increase in PPP loans quarter over quarter, with a total of $10.28 billion PPP loans at March 31. Cross River was the fifth-largest 2021 PPP lender through March 7.

"The increase is due to our participation in the second round of PPP, and we expect that as forgiveness is accelerated by the bank and the SBA, we will return below $10 billion," said Phil Goldfeder, a senior vice president for the bank, in an email.

Maher said he is unsure if OceanFirst will become subject to the Durbin Amendment this year or next year. Regulators have discretion to exclude banks from the relief if they crossed as a result of M&A.

Community banks welcomed the relief from the regulators, but it does not delay other costs associated with the growth community banks experienced during 2020.

For example, the Federal Reserve issued a final rule in 2016 that reduced the dividend rate applicable to reserve bank depository institution stockholders to the lesser of 6% or the 10-year Treasury rate. All Federal Reserve member banks must own capital stock of their district bank. The rate decrease kicks in once a bank reaches a certain asset threshold. The asset threshold for 2021 is $10.78 billion.

OceanFirst, which is a member of the Federal Reserve Bank of Philadelphia, estimates that it will lose about $1.7 million in 2021 as a result of the dividend decrease.

"That is one of the hidden costs of crossing [around] $10 billion because your dividend gets lower and your yield, if you will, on your Federal Reserve stock decreases," Maher said.

While interchange fee income and Fed dividend revenue declines, expenses escalate as additional regulation kicks in, such as oversight from the Consumer Financial Protection Bureau. To prepare for additional oversight, OceanFirst hired a third-party company to review its compliance and audit functions. The company also invested in more infrastructure and staff to maintain its compliance structure.

"Having an extra regulator means that you really have to make sure that your documentation is very good, that your audit program is significant and that you have the right number of people in compliance," Maher said.

While the lost revenue and increased expenses associated with crossing the critical threshold is not ideal, the impact is temporary, he said.

"You have all those expenses, but as you grow beyond that, you get the benefit of additional scale. Somewhere around $11.5 billion or $12 billion, you're back ahead of the game," he said. OceanFirst had $11.58 billion in total assets at March 31.

To offset the impacts of crossing $10 billion in total assets, some banks turn to M&A.

First Foundation Inc.'s announced acquisition of TGR Financial Inc. will push the company's total assets to about $9.4 billion once the deal closes. First Foundation has hired consultants and begun stress testing to prepare to cross the threshold, CEO Scott Kavanaugh said in an interview. First Foundation may use M&A to jump above $10 billion in total assets and offset the headwinds that come with crossing the threshold.

First Foundation is open to M&A in Texas, Florida, Tennessee, Colorado and Arizona, Kavanaugh told S&P Global Market Intelligence.

"Costs go up tremendously by crossing over the $10 billion mark," he said. "What I'd like to do is something that got me over. ... Hopefully, I don't have to wait that long for the next transaction."