Bank Lawyer's Blog

Reading Between The Lines

Kevin LaCroix commented last week on the recently released FDIC Quarterly Banking Profile for Q2 2013, and had some cogent observations. While the FDIC tried to put a positive face on the statistics, namely that things aren't as bad as they have been, both the agency and LaCroix also drilled down a little deeper and what they saw is disconcerting.

The press release accompanying the report quotes the agency’s Chairman as saying “overall these results show a continuation in the recovery in the banking industry.” However, the Chairman is also quoted as saying that “industry revenue growth remains weak, reflecting narrow margins and modes loan growth.” In addition the current low interest rate environment “creates an incentive for institutions to reach for yield, which is a matter of ongoing supervisory concern.”

[...]

The number of problem institutions is down by over 40 percent from the high quarter-end number of 888 problem institutions at the end of the first quarter of 2011. The quarterly decline in the second quarter represented the ninth consecutive decline in the number of problem institutions.

One of the more noteworthy effects of the crisis in the banking sector has been the dramatic shrinkage in the number of banks. At the end of 2007, there were 8,534 banking institutions, meaning that between December 31, 2007 and June 30, 2013, 1,584 banks went out of existence, representing a decline of over 18.5%. Yet despite that substantial decrease (resulting from closures, mergers and so on), there are still 553 problem institutions in the industry, as of June 30, 2013.

With the declining number of banks, the percentage of banks that are rated as problem institutions still remains high, despite the decline in the absolute number of problem banks. The 553 problem institutions at the end of the second quarter still represent nearly eight percent of all reporting institutions (down slightly from the 8.7% of all banking institutions at the end of the first quarter of 2013). . In other words, roughly one out of twelve of every bank in the United States is still regarded by the FDIC to be a “problem institution.”

 And not only that – banks are continuing to fail...While it seems likely that the number of banks that fail in 2013 will be below the 51 that failed in 2012 and a far cry from the 157 that failed in 2010, the fact is that banks are continuing to fail. Even at this late date, five years after the peak of the financial crisis.

There are two trends here, neither of them good. One is that unlike any other economic recession I have experienced in the nearly 40 years I've been practicing law, the banking industry (along with the rest of the economy) is coming out of this downturn much, much more slowly than ever before. The pain continues, and there is the unpleasant feeling among many bankers and business people in general that the recovery is fragile and could be derailed by a less-than-robust shock. We're simply not coming back from this last one like we have from all the others since the Great Depression.

The other trend is one we've been harping on for some time: the number of banks in this country is trending downward and the only questions in the mind of those of us who represent community banks is how low will the number go and how fast will the shrinkage occur. The "merger tsunami" that many have predicted has not (yet) occurred, but the pace seems to be picking up. These trends have implications not merely for banks, but those service providers, like law firms, that work with community banks. The business will shrink, and the competition for the survivors will increase. Expect not only the number of banks to decrease, but the number of bank lawyers and law firms to decrease also. Competition will be fierce, not only in terms of expertise, but in terms of pricing, as well. The expense side of the P&I statement will be as important for banking law firms as it will for their clients. As is true of most business sectors in a "free" market, those with foresight and the ability to adapt quickly will be the likely survivors.

De Novo Thaw?

The American Banker reported last week (paid subscription required) that where wise men fear to tread, the Amish rush in.

De novo banking could find a spark in an unusual place: Amish country.

A group of organizers has raised $20 million and is seeking regulatory approval to create Bank of Bird-in-Hand, named for the town near Lancaster, Pa., where it will be based. If approved, the bank, which would also target Mennonite farmers and small businesses, would become the first de novo bank to open in the United States in more than two years.

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Bank of Bird-in-Hand's group has an specific niche; the "vast majority" of its target market is family owned farms with less than $500,000 in annual sales, the organizers said in an application to the Federal Deposit Insurance Corp. The group projects that farm loans will make up half of the proposed bank's loan portfolio.

No wise cracks about "two-in-bush" from me.

Ag lending has done well during the recent downturn, so that should be a favorable factor for the application. Naturally, anything that's doing well is subject to being crushed by bank examiners who live in mortal fear that today's gold will be tomorrow's lead. However, if you're picking a market niche and you can show the regulators that you've got the chops, they may not shoot you down solely on that basis. They've got plenty of other grounds to sink your application.

The linked article contains speculation that perhaps the filing of this application indicates that the oft-denied, supported-by-the-facts, theory that the FDIC has instituted a "de facto" moratorium on de novo charters (last one granted: 2010) is either false or is yesterday's news, and that this application may signal the dawning of a new day of de novo promise. If you believe that, we need to discuss your future investment in my proposed Bank Lawyer's Blog theme park on the asteroid Vesta.

There are some unique features about the proposed bank's business plan and community that separate it from the customary de novo proposal.

Farming communities east of Lancaster have few options for financial services, says Nick Bybel, legal counsel to the proposed bank's organizers. The two biggest banks, in terms of retail deposit market share, in the Lancaster area are Susquehanna Bancshares (SUSQ) and Fulton Financial (FULT). Each hold about a quarter of the market's deposits, according to June 2012 data from the FDIC.

The organizers "have reviewed recent de novo bank history and they've worked out a very conservative, prudent and thorough business plan," Bybel says.

The bank also isn't planning to offer Internet or mobile banking, which removes a potential sense of heartburn to the regulators. They had their fill of Internet-centric banks bursting into flames or spontaneously zombifying themselves in the past decade. On the other hand, it's not surprising that the Al Gore-invented "Internets," as well as mobile banking, are missing from the business plan, since the targeted customer base, the Amish, use neither the Internet nor cell phones.

And speaking of the Amish, before we all jump up and down with unrestrained glee over this portent of the opening of the de novo floodgates, let's not forget (as I'm sure the FDIC will not), that this is the same group of folks whose members have been accused of being involved in bootlegging unpasteurized milk and refusing to place warning triangle decals on their buggies. Not to mention renegade beard trimming.

No, the FDIC might determine that the entire potential customer base is seeded with too many potential Tony-Sopranos-in-suspenders-and-a-beard-like questionable characters to make it a safe bet for any FDIC-insured institution. That would be the safe play. I hope I'm wrong, of course. Any crack in the de novo dam would be welcome, even if it's delivered in a wild and crazy corner of the banking universe.

Add Community Bankers To The Endangered Species List?

Reuters columnist Rob Cox issued a hot business opinion in a column today. He called the community banker "the most endangered species in finance." Cox isn't talking merely about the community banks that have failed over the past several years, but the many community banks that "will disappear in the next few years — a consequence, unintended or otherwise, of government and regulatory decisions codifying the biggest banks as infallible."

With that set-up, you might think that Cox would bemoan this prospect. To the contrary, his "hot opinion" is that he thinks it's likely to be a good thing for regulators, shareholders, and "perhaps surprisingly, even consumers."

As proof of how great things will be, he points to our cousins to the north.

[H]aving a few, heavily-regulated banks might actually be safer. Canada has just five giant institutions. But because they were regulated like utilities, the country’s financial system averted the need for big bailouts. It’s also more profitable for shareholders. According to the FDIC’s third-quarter industry survey, big banks have better efficiency ratios and generate higher returns on assets and equity.

Finally, consumers might benefit from a smaller universe of stronger banks competing for their affections. At the very least, there might be more credit available to them. In the third quarter, for every dollar of deposits customers stowed in the vaults of big banks, 96 cents were extended to borrowers, according to SNL Financial. Smaller banks lent out just 84 cents for every dollar of deposits.

George Bailey may have been a nice banker. But he might have been even more effective working as a senior loan officer for Bank of America.

There's no question that life would be easier for regulators in one respect if they didn't have many banks to regulate. That's one reason why you don't see (and won't see for awhile) many de novo applications being approved by the FDIC. But would it be "safer" for the financial well-being of the banking system to have "five giant banks" in the US (or even 50, as former OFHEO head James Lockhart has proposed)? With that kind of concentration of power comes the very real risk of regulatory capture, a concern voiced by pundits on both ends of the political spectrum (albeit for different reasons).

Arguing that big banks have economies of scale, efficiencies of operation, and greater opportunities to deploy capital profitably, and, therefore, that's good for their shareholders does nothing to convince me that what's good for the shareholders of five giant banks translates into what's good for the rest of us. Why stop at five? Why not one giant bank, run by the US government, or perhaps one giant bank which runs the US government. Those who loved the bail outs handed to Wall Street will love that result. It certainly would be "efficient" and "easy to regulate."

As for the proposition that consumers will be better off because in the last quarter, large banks loaned out a greater percentage of deposits than did smaller banks, I'd point out that traditionally, smaller banks use deposits as a larger percentage of their total funding sources than do big banks. That was the principal reason that community banks liked, and large banks did not, the recent change to calculating FDIC insurance assessments on the basis of "assets" rather than "deposits."  I don't think using deposits as the funding source for the comparison is support for the contention that big banks will be better lenders to consumers than will smaller banks. Also, community banks have had greater difficulty raising capital than large, publicly traded banks and, as a consequence, have had to be more conservative in making loans over the past two years than have big banks. Hank Paulson didn't call nine of the nation's smallest community banks to the White House in the fall of 2008 and shove TARP capital down their throats, did he?

Does anyone really believe that if the commercial banking business of this country is concentrated in a few large banks, US consumer and small business borrowers will be better served than they are when large banks compete with community banks? Apparently, Rob Cox does.

You can put me in the "extremely skeptical" camp.

False Hope

American Banker editor at lareg Barbara Rehm wrote an article last week (paid subscription required) that contained an opening paragpraph that might lead someone who is grasping at straws one more thin reed at which to claw.

In a sign that the banking business is bouncing off the bottom of the economic trough, the Federal Deposit Insurance Corp. is ready to start insuring new charters.

With the very next sentence, however, Barbara turned a cold water hose on anyone whose de novo dreams might have reached a turgid fever pitch.

It will be a trickle, not a torrent of approvals, but it is a significant shift considering the agency is widely viewed as the single biggest reason why just two banks have gained deposit insurance this year.

That's like saying it's "a significant shift" when a bully stops beating you with a baseball bat and starts in on you with a billy club. You're still being beaten and it still hurts like Aretha Franklin used to moan:

Sometimes it hurts to even laugh
Sometimes the pain is just too much
And it hurts like hell
that's the way it feels

It was only a couple of months ago when attorneys who represent de novo bank applicants where widely quoted in the trade press as claiming that you'd be better off taking the high-six-to-low-seven figure amount you're going to spend trying to get a new charter approved and using it to fly first class to Las Vegas, walking into The Palazzo and up to the roulette wheel, and telling the croupier to put all the scratch you have left on red 14. Even with odds of 35-to-1 against you, your chances of having "a happy ending" that way are far better than they will be trying to work through the de novo bank application process over the next couple of years.

Cold comfort is given by a FDIC representative who "encourages" the submission of de novo bank applications.

"We would encourage and we do expect, it's hard to predict when, traditional community bank proposals to come through," he said. "And we expect we would approve" applications pledging adequate capital, qualified management and diversified business plans.

There are enough "outs" in those two sentences to give anyone who's seriously considering submitting such an de novo insurance of accounts application a serious case of gimpiness in his or her get-up-and-go.

Two de novo applications have been approved this year. Two. The latest one, Bank Midwest, is actually a new charter granted to NBH Holdings to facilitate a major branch acquisition transaction to bail out the existing Bank Midwest, which is operating under an order by the OCC to, essentially, "sell yourself or die." That's not a group of traditional community investors seeking to start a bank from scratch to serve the local community.The latter types of investors don't want to spend two and one-half years of their lives (the length of time it took the last de novo bank to open this year to wind its way through the FDIC de novo maze) and hundereds of thousands of dollars on the off chance that they might one lucky drop in the "trickle."

I remain convinced that the view stated in my most recent post on this topic remains correct, at least for the near term.

The bottom line: until things loosen up (again, don't hold your breath), the only viable way into the banking game is to find an existing bank and buy it.

I'll change that view when I see action, not words, that indicate that, as Jeff Gerrish puts it at the end of Barbara's article, the foot is coming off the brake.

Life In The Trenches

The Colorado Bankers Association (via Larry Martin) requested that I take down today's post. Apparently, they're worried that it might upset some bank regulators. Although I can't imagine there's any response a banker would make these days that the regulators wouldn't expect, I'm honoring the request and taking it down.

De Novo No A Go-Go

Over at the Bank Safety & Soundness Advisor (paid subscription required), the experts confirm what the wingnuts at Bank Lawyer's Blog have been blabbing about regarding de novo banks: holding your breath until the FDIC approves your application for insurance of accounts for your de novo bank is a great way to ensure that you pass out.

"Indeed, regulators have been so loathe to approve new charters that most folks stopped applying."

The article quotes D.C. lawyer Robert Freedman, a long-time de novo banking expert, to the effect that he's completely stopped doing de novo applications because he's sick and tired of having been "beaten up" by the regulators. Instead, he's turned to helping investors try to buy failed banks, on the quite reasonable assumption that until the FDIC "clears out the inventory" of failed banks, new charters will be likely a rare sight. Unfortunately, it appears to me that the inventory of failures will be steadily replenished over the near term, so the "clearing" burden is going to be a heavy one.

Peter Weinstock of Hunton & Williams' Dallas office claims that the FDIC has taken the "internal position" that it will approve a new bank charter only "if it won't destabilize any of the other banks in the market." As Weinstock correctly notes, that is a test that is hard to pass.

The example of Lakeside Bank, discussed in a previous post on this blog that is linked above, appears to be a "one-off" situation. That bank had "a good local economy and strong banking competition" that could survive its entry into the local market. The organizers also had the patience of Job, since it took them 2.5 years to make it through the application process. That's too long for most investors, especially when prospects for approval appear so dicey and the costs of the applications, lawyers, consultants, and investment bankers/advisors can be substantial.

Not that the shelf charter route that a number of investment groups have pursued as an alternative appears to be much more promising. Notwithstanding a couple of high profile exceptions, Weinstock claims that the approval process for such charters has turned into a "quasi de novo process," which means the imposition of exacting and difficult-to-meet conditions and covenants on applicants. Other lawyers, like Venable's Ron Glancz, claim that all this is evidence that the regulators really want "qualified investors" (which yesterday's post discussed) to buy an existing bank or buy a failed one rather than start a brand new one. Like a number of us who toil in these fields, Ron thinks the regulators changed the rules without admitting they'd changed the rules, and definitely without going through the rule-making process.

The bottom line: until things loosen up (again, don't hold your breath), the only viable way into the banking game is to find an existing bank and buy it.

A Green Shoot?

An exception that may prove the rule appears to be Lakeside Bank, which opened its doors on July 26, 2010 in Lake Charles, Louisiana. According to a press release issued by the State of Louisiana Office of Financial Institutions, the bank "is the first de novo bank to open in the US in 2010, and the first new commercial bank to open in the state of Louisiana since July 1, 2008." According to other sources who corresponded with my about the opening of the bank, it's the first de novo bank to open anywhere in the US since October of last year. According to a news blurb from SNL, the fact that 95% of the capital came from investors located in the same zip code as the bank's office, and the strength of the local economy (including defense contractor Northrup Grumman), were significant reasons why this de novo application actually made it from filing to consummation.

That's great news for this community bank, which is opening its doors at a time when a bad loan is hard to make unless you try really, really hard. The management sounds like it's very experienced, so I doubt that will the case. However, the fact that the opening of this de novo is such a rare event is an indication that while there may not be an absolute "moratorium" by the FDIC on the approval of de novo applications, they are (as I said last month) going to be a rare occurrence for the foreseeable future.

One opening a year is not exactly a tidal wave.

Is The Small Bank Headed To Extinction?

A business reporter speculates on a subject that we've been concerned about for some time: the prospect of the drastic reduction in the number of community banks in the wake of the current economic recession (and perhaps "double dip" recession). In New Mexico, New Mexico Business Weekly reporter Dennis Domrzalski asks the question, "Are federal regulators on a mission to decrease the number of banks in the United States?"

As regular readers know, my personal opinion is that the answer to that question is "Yes." Other talking heads either agree or disagree. Jerry Walker, CEO of New Mexico's Independent Community Bankers Association agrees, and wonders "Why should they [federal bank regulators] be picking winners and losers?" Well, Jerry, because they can, that's why, and that's the only justification they think they need to give, other than when it comes to picking macro trends that affect all of us, who better than lifetime bureaucrats? Or circus clowns? Or a trained cockatoo? Certainly, the "unseen hand" of the market shouldn't be trusted to pick winners and losers! Nobody has believed that since...oh...November 2008 or so.

Of course, bank regulators publicly scoff at the notion of a "hidden agenda." Julie Stackhouse, senior vice president of supervision at the Federal Reserve Bank of St. Louis flatly denies the very existence of such an agenda, hidden or exposed.

“I can assure you that there is no agenda to reduce the number of community banks,” Stackhouse says. “But with the challenges they are facing with commercial real estate [loans] and with profitability, it is going to be hard for some of the institutions to survive.”

Banks in small, shrinking agricultural communities will have a hard time surviving, as will those in more populated areas with lots of competition, Stackhouse adds.

She says small banks might not have the resources to keep up with increasing regulatory burdens or changing technology, and might consider merging with other banks.

“We have had little consolidation activity in the past few years, and that signals that there might be opportunities,” Stackhouse adds.

I don't know about you, but when a federal bank regulator assures me that something doesn't exist I immediately call my broker or bookie and "go long" on the existence of whatever has just been denied. It's just a little personal quirk of mine, but I've yet to lose money on it.

Many community bankers and their trade representatives and advisors also come down on the side of "hidden agenda" and point to the too-small-to-save bias of the FDIC and other federal bank regulators for the past several years. Karen Thomas of the ICBA contends that the "harshness" that bank regulators have shown toward community banks has led many small bankers to believe “that they are being run out of business.”

Bank consultant Joe Badal declares himself an evangelical agnostic on the issue of the existence or nonexistence of a hidden agenda, but says that motives don't make much difference, because the effect of the regulators' actions is the same whether they are consciously engaged in an downsizing effort or just inadvertently acting like a crazed water buffalo running amok in a rice paddy.

...[H]e says regulators’ actions in requiring banks to write down commercial real estate loans could have a disastrous long-term effect.

“I can’t determine motives, but it makes no sense,” Badal says. “They’re telling every community bank in New Mexico to cut back on exposure to commercial real estate. In most communities, if you can’t do commercial real estate, you can’t do anything. The impact this is having on small banks, in my opinion, is insidious.”

When regulators demand that a bank write down its real estate loans to reflect current market values, they are creating a “self-fulfilling prophecy” that will lead to more bank failures, says Badal, owner of Joseph Badal & Associates Inc.

Badal says once a loan is marked down and a property sold for less than the amount of the original loan, it creates a “comparable” price in the real estate market that appraisers, loan officers and regulators use to analyze other loans and properties.

“Every time they liquidate collateral, they send the comparable down, and that undermines the collateral of every loan in the system,” Badal explains. “It’s an avalanche that grows in size and speed and power every time another bank is taken down. It doesn’t just affect the valuation of the troubled bank, it affects the collateral of every bank and of every lender.”

I hear choruses of "Amen, Brother Badal" singing forth from community bankers across the country.

Taking a more Panglossian view of things is the CEO of a small New Mexico bank, Ron Shettlesworth, who thinks that bank consolidation will inevitably lead to a wave de novo bank start-ups, as happened after the banking and savings and loan crisis of the late 1980s and early 1990s. The problem with that view is that when the wave of de novo bank applications commenced, there was no federal regulatory bias against de novo banks. That is no longer the case. As readers of this blog are only too well aware, the FDIC believes that too many of the failures in the current crisis are de novo banks. Also, as anyone who's been involved in the process can tell you (even those few who ultimately have successfully completed the process), getting a de novo bank charter through the federal regulators over the last several years has been as difficult as getting Lindsey Lohan not to self-destruct, and I don't see that process becoming any easier if bank regulators think that de novo is synonymous with de-lousy. Regulators will fight the last war by making it very difficult to start a new bank so that there are no de novo banks that might fail in the future. If there truly exists an agenda to permanently reduce the number of banks by 25% to 30%, then don't expect a "wave" of de novo banks to again occur as we've seen in the past.

Wal-Mart Bulks Up On Small Biz Lending

With the same perverse fascination that compels us to watch Godzilla crush Tokyo, we can't tear our eyes away from the sight of Wal-Mart's inexorable march into the land where, lately, many banks have feared to tread: small business lending. Through a venture between Wal-Mart's Sam's Club unit and nonbank small business lender Superior Financial Group, Wal-Mart plans to offer small businesses loans in the $5,000 to $25,000 range. As DBJ Confidential blogger (and Dallas Business Journal associate editor) Chad Watt so aptly puts it, "The Bank of Wal-Mart has come a step closer to reality."

The Sam’s venture hits banks while they’re vulnerable. Wal-Mart says 15 percent of its small business members have been denied a loan in the past year, up from 12 percent in spring 2009.

[...]

The deal with Superior is for an online loan application. That’s something Superior does anyway, so what is Sam’s Club bringing to the table? Put simply, a 20 percent discount on Superior’s application fee and a 25 basis point discount on Superior’s finance rate.

That should free up some more money for coffee cups and creamer.

As I said in March when discussing Wal-Mart's plans to rapidly expand its in-store MoneyCenters, Wal-Mart is on a mission to beat banks at their own game, and without the psychological and emotional pain (and financial burden) of dealing with federal bank regulators, like those who denied it an opportunity to enter the banking business through acquiring an industrial bank charter. Not being able to leverage insured deposits is a funding disadvantage, but one with respect to which a giant retailer like Wal-Mart can always find a work-around.

Love it or hate it, you have to respect Wal-Mart's persistence and ingenuity. If Wal-Mart's "lucky," however, they'll continue to grow their financial services business until they eventually become a too-big-to-fail, systemically important nonbank financial company that is drawn into the web of the soon-to-be-created "Financial Stability Oversight Council," where it can be hounded by bureaucrats like most of the rest of the financial institutions in this country.

I'm such a glass-half-full kind of guy, aren't I?

Wal-Mart's Revenge

Under the title "Wal-Mart Marches On," last November we profiled Wal-Mart's post-banking plan to capture retail financial services from traditional banks (and other financial service providers) through its partnerships with General Electric's Money Centers and Fiserv's CheckFreePay unit. Yesterday, the marching cadence increased to double-time.

Wal-Mart Stores Inc. will be opening another 500 Wal-Mart MoneyCenters this year. Wal-Mart has more than 25 stores located in the North Texas area alone.

As part of its current plan, Wal-Mart said MoneyCenters will be located in about 40 percent of Wal-Mart’s 3,763 stores nationwide, including 158 in Texas, according to a spokeswoman. A total of 102 stores in the Lone Star State will have a MoneyCenter by the end of 2011.

Love it or hate it, the Beast of Bentonville is becoming a force in retail financial services. Moreover, Wal-Mart's getting to expand at this rapid pace without dealing with growth-killing Sheila Bair and the rest of her crew at the FDIC. As everyone recalls, Ms. Bair slapped a moratorium on FDIC insurance for industrial bank charters when Wal-Mart filed an application and eventually stiff-armed Wal-Mart out of the realm of the FDIC-insured.

At the time, Wal-Mart expressed disappointment and community banks expressed joy. Now, Wal-Mart is going full blast forward, unimpeded by the gentle ministrations of FDIC examiners and social justice engineers like The Care Bair. Simultaneously, many community banks are being beaten about the head and torso by the FDIC and other federal banking regulators in ways that are making it difficult not only to make a buck, but, in many cases, even to survive.

Irony: it's often bittersweet.