By Edward Mongon

When Robert Patrella, Chairman, President and CEO of Guernsey Bancorp, was asked this week why his Westerville, Ohio based bank decided to sell itself after only 13 years in operation, the rationale given should not come as a shock. Rising compliance costs as a result of increased regulatory scrutiny was the main culprit. New regulations put in place, including but not limited to, Dodd-Frank, Basel III, the Bank Secrecy Act, the Consumer Financial Protection Bureau and the Volcker rule, have put many of the nation’s 6,728 FDIC-Insured Commercial Banks and Savings Institutions in an unenviable position: either sell, or go under, just as 495 banks did from the beginning of 2008 through the end of April 2014. Additionally, pressures on net interest margins due to the low rate environment, and concerns regarding cyber security and high profile data breaches have left many banking executives looking for the exit sign.

To be fair, industry consolidation, regulatory oversight and interest rate risk are not new to bankers. Prior recessions have helped to trim the size of the marketplace – you don’t have to look much further than the Savings and Loan crisis of the 1980’s and 1990’s for another example. However, what is most shocking, as reported by the FDIC’s most recent research study and highlighted by in a recent article titled “Has Consolidation Killed the Community Bank?”, is the fact that the total number of FDIC-Insured Banks with Asset sizes of $100M and less has declined by 85 percent between 1985 and 2013. Indeed, M&A activity has played a big part here, but the true underlying problems here are higher regulatory/compliance costs, issues in obtaining capital in a more restrictive lending environment, and operating at a time when the demand for loans has slumped.

Further, keeping up with changing consumer demands (i.e. the rise of virtual/mobile banking) in managing one’s household finances has created a new set of issues unknown to bankers of past generations. Safeguarding confidential financial information and personal data is of paramount importance in this day and age. From the implementation of a strong security and privacy policy, to the hiring of a Chief Privacy Officer, encrypting data, having a business continuity plan, carrying out an IT security audit, and more, there are a number of steps which Community Banks must undergo to reassure its customers (as well as regulators) that they are taking every possible precaution to protect themselves against security breaches. The recent high-profile data breach at Target is a perfect illustration in the financial and reputational costs that occur when not all of the proper controls and procedures are in place.

So, what does all of this mean for insurance carriers operating in the Community Banks marketplace, or their insured’s? For starters, the reduced size of the market has created more competition among carriers for the “healthy” banks. Some Insured’s are starting to see three-year deals coming back in the marketplace at renewal in the “standard market.” Secondly, an increase in interest rate risk, which can cause asset-liability mismatches on a bank’s balance sheet, has caused carriers and the industry to do one of two things: a) focus on stress-testing banks for financial solvency, in order to make sure they don’t succumb to underwriting issues which affected the D&O marketplace during the most recent financial crisis; and b) focus on providing different professional services (i.e. financial advisory, trust services and specialty lending) to stem decreases in the bottom line for the bank. Thirdly, an increase in M&A activity and bank failures has spawned an increase in shareholder and regulatory claims, which has caused insurance rates at most carriers to increase, and capacity to decrease.

Last of all, the rise of identity theft and cyber fraud has helped spur the increase in state regulations for guarding consumer data, as well as the use of insurance by businesses as a risk mitigation mechanism. In the past couple of years, Cyber Insurance has been one of the fastest growing specialty insurance segments. However, because coverage is limited, and often does not include theft of intellectual property, it is important now more than ever for businesses, and banks especially, to maintain solid internal controls and audit procedures over IT exposures.

Rising regulatory/compliance costs, low interest rates and concerns over Cyber security are three key issues facing the Community Banking industry, and the carriers that insure them. While a number of banks have decided to close up shop or sell to a larger competitor during the last couple of years, how the rest of the market deals with these issues will be of great importance to insurance carriers wishing to steer clear of future underwriting losses in this sector.

About Oak Street Funding

The materials in this paper are for informational purposes only.

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