PACB President/CEO Nick DiFrancesco recently sat down with Milestone President/CEO John Spier and Allegheny Valley Bank President/CEO Andy Hasley to talk about how Governor Wolf’s proposal to raise the bank shares tax rate by 40% would affect community banks’ ability to serve their customers’ need for financial services, like access to credit, and reinvest in community projects.
Nick DiFrancesco (ND): The Governor’s proposing a pretty substantial increase in the bank shares tax at a time where the country is seeing some pretty significant losses in community banks. There’s a lot of merger and acquisition activity happening right now throughout the state and nation. One of you has a presence in the eastern part of the state (Milestone Bank) and the other the western part of the state (Allegheny Valley Bank) but are both taxed under the bank shares structure. Can you share some of the history of your bank and a little bit on your portfolio and the type of lending done by each of your institutions?
John Spier (JS): Our bank is relatively new in comparison to some of the other community banks in the state. We were a de novo that opened for business about seven and a half years ago down in the southeastern part of the state. Our business model is primarily concentrated in commercial banking and small business lending so while we do single family mortgages, they aren’t a significant portion of our portfolio.
Andy Hasley (AH): Allegheny Valley has had its roots in the Pittsburgh community for one hundred fifteen years now and has a strong history of responsible banking that’s survived the Great Depression, Savings and Loan Crisis, and more recently the Great Recession. Our portfolio has a healthy amount of commercial and mortgage loans. We close between $30mm and $50mm annually in traditional single family mortgage lending business.
ND: Talking a little about the climate. I’d like you to share your perspective on what it’s like to be the President or CEO of a small community bank right now. Why would you say this is a bad time for the Governor to be imposing a tax on capital? Obviously this isn’t a tax on the income you may or may not be generating, but rather a tax on the capital that’s held through retained capital or some other capital raising means.
JS: It’s helpful to establish a little background when we’re talking about this subject. I’ve run three banks, going back first to the old Bucks County Bank. Following that I started a new company, another small community bank, First Service Bank, in 1995. When you start a company you see every penny that goes out and every penny that comes in. When I started First-Service Bank we raised about $14 million in capital and, since we were a de novo, the expectation was that you don’t start turning a profit until a year and a half or two years later.
So right out of the gate here we were paying this tax, not on earnings or profit, but just because we exist. At that point, and that was in the mid 1990’s, I was convinced that this tax was just wrong. Turn the clock twenty years forward to 2015. Our bank, Milestone Bank, which is down in Doylestown, is a small shop that has about 35 employees.
I had our Chief Financial Officer do a little calculation and if the bank shares proposal would go through, a little bank like ours would pay about $169,000 in additional taxes. Right there we’re talking about four very real, well paying, family jobs. In terms of workforce, that’s more than 10% of our workforce. In the most literal of terms our employees would be decimated. It’s doubtful that we would actually be forced to make that draconian decision but business wise our ability to hire additional employees and create more job opportunities is negatively affected.
This tax, simply put, a job killer. We’re proud of the fact that in seven years we went from zero jobs to thirty-five jobs. Next year, before this proposal, we had been talking about forty-five jobs but now, with this proposal on the table, it might be forty jobs. That’s only talking about this in terms of impact on jobs. We aren’t even scratching the surface on what it means for our capital.
It’s a classic case of raising taxes that kill jobs. Shareholders are not going to accept the fact that you didn’t make $169,000 more. You have to find it somewhere. So if we’re writing a bigger check to the state, the savings have to come from somewhere at the bank. Community banks already operate as efficiently as possible so there aren’t overhead or operational expenses you can look to offset without considering the high cost of personnel.
We’re a small business and I feel awful that four jobs would not be created in Bucks County for the sole reason of an injudicious tax increase that isn’t right for the community.
ND: That’s certainly some interesting commentary because if that’s going to be the impact in Doylestown, there are hundreds of similar communities in the state that are going to be faced with the same economic fate of either jobs lost or not created in the financial services industry. Andy, what is your take on this proposal?
AH: Let me expand on what John said a little bit because we’re a $425 million bank and we’ve done similar calculations about what it means for our Allegheny Valley Bank community and it’s essentially increasing our taxes by 30-40%. The retroactive impact of the tax to January 1, 2014 is absurdly punitive. That’s a significant additional burden that we have never seen before. You talked about the timing of this tax and the reality is that we’re operating at razor thin margins and with escalated costs associated with basic compliance matters that we have to operate within at our individual institutions.
Banks are at best earning 70% of what they were earning during good times. Now that our earnings are down the state wants to come in and take away a significant component of what we counted on as earnings. As an institution we can’t allow this to affect our bottom line. If you’re a publicly traded company, and there’s a good many community banks that are in that boat here in the state, you can’t make excuses for why your earnings are going down. Banks have two approaches to consider in dealing with the Bank Shares Tax increase: they can pay the tax and reduce expenses to offset this cost, and since personnel are clearly the largest component of all of our operating expenses, that’s the first place most banks are going to have to take a look, or banks can pay the tax and not reduce expenses resulting in less earning, reduced capital levels and they will be forced to offer fewer loans. Both approaches are detrimental not only to our immediate community, but to our overall economy.
JS: It really comes down to a simple premise. If this legislation does not pass, if the shares tax stays where it is, it’s literally four more jobs that our small business will create. If it does pass as it’s been proposed, you’re going to have four jobs taken away. It’s a mathematical computation.
It’s interesting because there are only three or four states that are still taxing banks under a “shares tax” scheme1, so Pennsylvania is one of three on an island doing this tax. We readily accept the premise that if we make money, we’ll pay our fair share and we don’t have a problem with that. The problem is that this is a tax that doesn’t even assume earnings or losses. This is a tax where if you lose money, you pay the same tax. If you break even, you pay the same tax. If you make money, you pay the same tax. I think it’s inherently unfair as a tax structure.
We’ll sign on the bottom line if you say, “You make money, you pay your x percentage”, like with the federal tax structure. We get that, we understand that. But just to be taxed because some people put their capital at risk to have this institution thrive in the community? That’s patently antithetical to the idea of commerce in our country.
ND: Talk to me a little about your business model. I think we’ve heard many times from different personalities, “Well you’re banks and you ought to be paying your fair share”. Of course part of our responsibility is to make the break from financial services institution, to actually talk about community banking. What types of things are your banks doing in the community, that again basically get eliminated because that money now has to go to a tax rather than something like an affordable housing project?
JS: It isn’t like the legislators can’t do good things. One of the things our bank does is participate in the Educational Investment Tax Credit (EITC) program offered through the Pennsylvania Department of Community and Economic Development. For us that means that instead of paying that money to the government, up to 90% of our liability can be directly invested in our local schools and communities.
All of our employees are involved in the community and one of the things we tell them is that if you are involved in a community endeavor, the company will support you in some capacity. That could be either cash, or an in-kind donation, or through our time and resources. That pool of dollars gets minimized because of that tax. This bank shares tax proposal makes it much harder, and possibly even untenable, to find a way to continue to serve our community and our customers to the same measure we are now. It really does affect our ability to accumulate capital, so that we can lend more, and it’s obviously affecting our expense base.
We’re a community bank and it is good business to do right by the community. It’s as if someone is coming to our wallet and taking $169,000. We aren’t a big company. We’re a small business operating in the heart of our community. There may be folks that see us as just another bank but the reality is we aren’t CitiGroup or Wells Fargo. We’re a community bank that’s in Doylestown trying to improve life for our neighbors.
AH: I think about some of the things other than personnel that could be affected by this and certainly one of the things banks are going to have to take a look at is charitable contributions. At our particular institution we give away over $100,000 a year just in charitable contributions. That will have to be an area we sit down and evaluate; what percentage of those contributions can’t be made as we’re trying to figure out how to offset the tax jump?
Thinking about how those contributions affect our community, we give thousands of dollars away each year to buy basic supplies for kids to allow them to go to school with the tools they need. We aren’t talking about unnecessary supplies but things like pencils, pens, erasers, calculators, backpacks, you name it.
I think of neighborhood housing partnerships we’ve put thousands upon thousands of dollars into every year to try to give lower income families the means to be able to purchase a house in a safe environment. We spend time to really identify these projects and charities that are going to have a direct and real impact so that our neighbors are truly benefitted and are able to grow. This bank shares proposal means that some of those funds aren’t going to be available any longer for the community because the offset has to come from somewhere.
JS: Our bank participates in a host of great charities and projects like the local YMCA, Big Brothers & Big Sisters of Bucks County, The Pearl S. Buck Foundation, the Doylestown Free Library and the like. These worthy projects and resources are going to have to be carefully evaluated if the state is going to come in and take a big bite out of our hard-earned capital.
We aren’t trying to overdramatize, these are just the facts.
AH: You bring up a good point. The education tax is one which can be reallocated but one of the programs we participate in is a neighborhood partnership program where up to 75% of the taxes we pay can be allocated back to certain neighborhoods within our community. But that also means a 25% hit to us in order to participate in that program. Those dollars at some point may no longer be reallocated. That would be a huge concern to me as someone who has to balance my responsibility to both the community and the bank.
ND: Another issue with the bank shares tax proposal has to do with the idea of the goodwill deduction. John, I’m not sure if this would apply to you as much as it would to Andy. One of the other concerns that we have is the Department of Revenue coming in and tweaking the definition of goodwill, specifically referencing the idea of rules being changed midstream. You know, it is one thing if you make a decision based on the rules of today, but if you’ve made that decision based on the rules, and those rules change, what does that mean for your bank?
AH: What we’ve seen now is a change in position relative to the state Department of Revenue on the deductibility of goodwill. For many banks that have been paying bank shares tax for years and have purchased thrifts in the past, with the latter institutions paying the thrift tax, when we’ve purchased those institutions the goodwill which was booked as a result of that acquisition was deducted from our capital and the bank shares tax was calculated based on total capital minus goodwill.
The repositioning that the state has taken now is that if you have purchased a company which has not paid bank shares tax beforehand (i.e. a Thrift that paid the Thrift Tax), it’s no longer deductible. In circumstances where a bank has purchased multiple thrifts, that can have a significant impact on your tax liability. The combination between the tax rate increase and this deductibility of goodwill will have an extremely detrimental impact on many institutions.
ND: What impact does this tax potentially have on your lending to new businesses and start-up companies which have traditionally been the bread and butter for this industry? Community banks make up about 65% of small business loans under $1 million in the country so I would imagine that’s going to be felt in the business community.
JS: The bank shares proposal would immediately decrease retained earnings, and retained earnings obviously contribute to the growth of capital, and our lending limit is basically based on 15% of our capital, that’s our legal limit. That roof gets lowered because of this tax. So you take 15% of whatever amount that is and you apply that across the whole state, it’s a lot of dollars that aren’t being injected into small businesses that are looking to grow.
There’s another element that is a little disturbing for those that have been in community banking for a long time, and for me that’s been 40 years, and that’s the stereotype that banks are hoarding all of this money. That model doesn’t work for community banks. Unless you’re involved in the community, and you’re contributing to those things the community cares about, you’re not going to have a successful bank. That means there’s a distribution of caring dollars that go out into the community. It’s an important fundamental to our business model.
ND: So breaking it down to the simplest point of a bank. When a dollar is deposited into your bank, where does that dollar go?
JS: Many things happen to that dollar. There’s a good portion of that dollar that gets redistributed to the community either through lending to small business, where we’re both taking a risk. Part of our job is to evaluate that risk. If we say that this person has a good idea that’s worth supporting, we’ll support with our lending dollars, but there’s also a community interest.
In Parade magazine, the insert you get in your Sunday paper, there was a story a few years ago about the 25 best small towns in America and Doylestown was one of those listed. Part of our earnings goes to the Michener Art Museum, a great community asset for the area, and to the Mercer Museum. When we contribute to those museums it goes to educational programs to the kids where they learn about art and the history of the local community. We enjoy being a business partner with them because every child, public or private school, is able to be impacted and sometimes inspired by those dollars being reinvested.
We just ran an art competition for public school students where we received 450 entries. It was thrilling to be able to give out $3,500 in prizes to these kids who have serious art potential, but more importantly to be able to encourage them to pursue their passion.
I would much rather our elected officials say, “What can we do so that our community banks can invest more dollars”? It’s not only job creation but it makes our communities stronger. I wish they’d go beneath the surface and not just look at our balance sheet, but look at what is happening in the community because local community banks exist.
I would like nothing more than to open our books totally to any legislator who wants to take a serious look at where it goes. We would be very proud for them to look under every rug and in every closet so they can see where our dollars go.
AH: I venture to believe, although I don’t know it as fact, that banks are the most giving of any industry when you look at giving back to the community. It’s everything from parades, community events, farm markets, and everything in between those banks are helping to promote and support.
Getting back to your questions about the impact on lending, should banks decide not to cut expenses to offset this bank shares tax increase, we are a leveraged business and so for every $100,000 of increased tax liability, assuming we want 10% of leveraged capital, that’s $1,000,000 in loans we cannot invest in the community by way of lending. If you think about the impact of $350,000,000 in additional Bank Shares Tax to be raised statewide and the effect of that, not just in one year but the cumulative impact over a ten year period of time, the calculation I had prepared for the PACB Board of Directors noted that all banks would be making $13 billion less in loans in the next decade.
The reality is that when you take capital away from banks, you take loans away from consumers. Those are very real loans like houses we aren’t able to finance, small businesses which won’t have an opportunity at getting a loan because we will have lost capital that went back to the state.
The question becomes are those tax dollars better spent staying with banks, to allow us to leverage that capital in order to help support our local businesses, or are we better off taking that tax and giving it to the state and letting them figure it out.
JS: It’s ironic to me that while we’re required to keep an 8% capital level, our Governor is proposing draconian measures to reduce that capital. I don’t see how that helps our employees, our community, or our local economy.
AH: The timing of this is critical because this is coming at the same time the Basel requirements are coming into play.
ND: We’ve got a real conflict here between what you’re dealing with at the national level and what you’re dealing with at the state level so let’s talk about that. I’m not sure every state official understands the conflict. The reason the original legislation passed, talking about Act 52 of 2013, which gave a reduction in the bank shares tax rate was because national policy forced you to increase your capital level along with the entire industry. With the dramatic increase in capital, your taxes at the state were beginning to skyrocket and become unmanageable. The strain that you have on your capital now at the national level, do you expect that to continue? Do you see policy requiring you to continue to hold more and more capital?
JS: It’s the ultimate hypocrisy. You have the federal government saying you have these capital requirements that we’re going to tighten, and then the state comes along and says we’re going to tax you in a manner that’s going to decrease capital. My advice is that Harrisburg needs to be talking to Washington before this damage is done to our communities.
AH: The other thing that is deeply concerning to me is the larger institutions we have in the state that are multi-state, multi-national companies.In calculating the bank shares tax, is that the base that will be used to calculate the tax?
If Pennsylvania is taxing those banks far more than surrounding states, then those banks are going to find ways to get deposits, assets and capital to the other states, increasing the burden on the remaining community banks and putting us at a competitive disadvantage.
This interview can be found featured in the May 2015 issue of Transactions. Not a subscriber? Visit the Transactions page on this website or call PACB at 717-231-7447 to start receiving the magazine.