Bailing Out Some Banks But No Borrowers?

Today's Dallas Morning News contained an article whose headline was less than stunning: "Banks might use bailout funds for acquisitions." Someone needs to notify the News that banks have already used bailout funds for acquisitions. Ask the former National City Bank of Cleveland. PNC got a yummy capital infusion from the US Treasury Department's Capital Purchase Program (CPP) and used it to digest NCB, much to the consternation of Ohio politicians.

The article had a local focus, and is interesting to those of us located in Texas, and perhaps to other people who are curious about how the CPP capital infusions will work. The article begins and ends with a discussion of a regional bank based in Dallas, PlainsCapital, which received an $86.7 million capital infusion from the Treasury last month. While the bank's CEO assures the reporter that the bank will make new loans with the new borrowings that the additional capital will support, "it doesn't rule out using funds for acquisitions."

"As we see this economy shake out, there are going to be some that make it and some that don't make it," said Alan B. White, PlainsCapital's chairman and chief executive. "And there are going to be good opportunities that people are going to be able to take advantage of. I hope I'm one of those."

Former OCC Comptroller Bob Clarke, a partner in Texas-based law firm Bracewell & Giuliani, makes a couple of cogent points. First, while politicians are yapping at banks to make more loans "or else," and while the bank regulators are making public noises that encourage banks to do just that, it seems to those of us in the trenches that the regulators are speaking with a forked tongue.

Some banks say they're holding back on new loans because bank regulators have taken a stricter view of what constitutes a risky loan, Clarke added. In lieu of making loans, the capital can be put to work through acquisitions.

"It's probably easier to evaluate an acquisition if you have excess capital that you don't anticipate needing," Clarke said.

Yes, you heard that correctly: banks are being pressured to make new loans at the same time as the existing loans on their books are being written down and in other ways "hammered" by the bank regulators. Those supervisory actions not only require banks to reserve more capital to handle write-downs and reserves, they make the banks skittish about underwriting new loans or extending existing loans when they come up for renewal. All one has to do is read the "helpful" guidance that the federal bank regulators issued in November to realize that regulators are talking out of both sides of their mouths. "Make loans! But they better not go bad, or we'll hammer you for having engaged in unsafe and unsound underwriting. At the same time, make sure you have plenty of capital on hand to cover future losses, because things are likely to get bad before they get better."

And the public wonders why banks seem bi-polar.

Clarke's other good point by highlighting the fact that many of the banks who most need the Feds capital to pull through the current crisis can't get it.

Clarke said Treasury made another mistake when it restricted its bank assistance to healthy institutions such as PlainsCapital. Some weaker banks could have returned to viability with help, and many are community banks that lend to small businesses, he said.

"It does not seem to make any sense to deny TARP money if they can otherwise bounce back and be effective in their communities," Clarke said.

The Feds are picking winners and losers, and in the process making some mortal enemies. Many community bankers are becoming bitter about the fact that the federal bank regulators and the US Treasury Department are forming a daisy chain of love with big banks and Wall Street firms, and leaving the little guys out in the cold. From my personal perspective, the FDIC has been especially tough on writing down assets and forcing banks for which the FDIC is the primary federal regulator (state-chartered, non-FRB member banks) into a regulatory death spiral by forcing them into a CAMELS rating that fatally hampers their ability to survive, then slapping a Cease and Desist Order on them, which scares away potential investors. Plus, certain supervisory personnel are earning reputations of personal nastiness that may serve them well as long as they stay in thrall to their governmental masters, but may present obstacles to any future transition into the real world of business.

A potential irony is revealed by the story of PlainsCapital, however. Sure, it's a survivor, but it appears that it may not be fully on board with the mantra preferred by Barney and the Boyz: "feed the consumer."

[T]he TARP capital couldn't have come at a better time for PlainsCapital.

Over the summer, White decided to raise about $50 million after committing to buy First Southwest, a boutique investment bank and leader in public finance. Yet even for a top-tier bank like PlainsCapital, the following months were a tough time to raise money – until the Treasury offered funds through TARP.

"That process ended real quick when the TARP money came along," said White, who moved PlainsCapital's headquarters to Dallas from Lubbock in 2000. "Frankly it's a lot better deal to take the TARP ... than it would be to go out and try to raise capital in the marketplace today. The timing on it was really good for me."

Thus, the handout of capital from the CPP allowed a bank like PlainsCapital to secure capital much more easilyand cheaply than it could have raised it from private sources. Good for the bank. At the same time, though, PlainsCapital isn't crazy about "paying it forward."

Democratic lawmakers see another problem – TARP capital isn't being used to stem foreclosures. Top Democrats want to attach that condition to the next round of TARP funding.

Bankers say such stipulations could sap their willingness to participate in the program.

"I am not for handouts," White said. "If that is what I had to do, I'd give it back."

One man's "handout" is another man's "investment in the future." I'm not certain what Mr. White considers to be a "handout" as far as a borrower in desperate need of some forbearance or a decent loan modification is concerned. I agree with him that if bankers are required to loosen their underwriting standards to the point that it imperils the banks' safety and soundness, then it makes no sense to accept or leverage such capital. On the other hand, Mr. White must understand that many "average voters" think the entire TARP and CPP programs are nothing more than an abusive "handout" to banks with their tax dollars, and that those voters are not happy about it. Whether such perceptions are or are not justified, to publicly state that you'll pay back the capital if you're also forced to use it to bail out your borrowers might inflame resentment in certain quarters, including  those quarters inhabited by the Democrats who control both houses of Congress and the White House, and who can do the banking industry some serious harm.

I had a mentor early in my career, a bank CEO who was a former cabinet official in a US presidential administration that existed so long ago that many people alive today think of it as in another epoch, who told me that so many things could go wrong when you communicated with the press, he did it only when necessary, and usually only in writing, so that he could rebut anything taken out of context, misquoted, or omitted. That was sound advice. It's not what you actually meant, or even what you actually said, that counts. All that counts is how it appears by the time a reader finishes a story that contains your quotes.

[UPDATE 01/05/08: Capital Beacon touches on some of the same material today. After noting the difference between recent articles in The American Banker (which takes the position that community banks are looking to lend to any borrower they can get their hands on) and by Reuters (which reveals data that shows that banks are not lending to consumers), the blog's author takes the politically incorrect position that banks shouldn't be lending; instead, they should be hoarding capital.

Whatever the spin, it would be a mistake to start forcing banks to make loans. The banks need to be recapitalized in order to deal with problem loans they made in the past. People in Treasury know this but do not have the political will to say it. The fact is, our overextended society has to come to grips with the fact that at some point you have to pay the piper. I won’t start ranting on this point today but our country has been conditioned to think that someone else can fix our mistakes. Sorry, but some pain must be endured to get out of this. I am in the camp that says we would only intensify the mess we are in if we force banks to make loans to meet some number. We are not done with foreclosures and losses on commercial real estate and C&I (commercial and industrial) loans will mount this year. Like it or not, the TARP investments must be used to increase loan loss reserves and deal with the many problems of distressed loans.

"Pain must be endured." What a revolutionary idea in a culture that expects all gain and no pain, forever and for always.]