Banking On The Brink
By Stephen M. KleinJuly 6, 2009
The Cloud Under Which Banks are Operating
Most banks are operating under a bleak cloud. It is composed of two elements: a dismal economy and a stressful regulatory environment. Unfortunately, the economies in most areas of the West – primarily fueled by rising unemployment and deteriorating real estate values – have not bottomed out yet. Compound that with aggressive regulatory exams designed to look under every rock – and you have a bad recipe. Feedback from our clients suggests that exams are very harsh, the standards for classifying loans have changed – with single and double downgrades on CAMELS ratings the norm. Regulatory enforcement actions abound and are now commonplace.
All of these elements make for a difficult operating environment. No wonder credit is so scarce as banks struggle with troubled loans and challenging regulators.
The Next Shoe to Drop
While the large banks and credit unions have to deal with the unpleasant thought of defaulting HELOCS and credit card loans, community banks are starting to feel the effects of declining CRE and C&I loans, reflecting high unemployment, accelerating business failures and bankruptcies. We expect that second quarter community bank earnings will be disappointing as banks increase reserves and take the first FDIC special assessment in this quarter.
Proposed Regulatory Reform Legislation
While, undoubtedly, changes need to be made in financial services regulation, the current proposal is flawed – a product, in part, of another knee-jerk piece of legislation. Have we learned nothing from SOX and TARP? The horse already has left the barn. Clearly, a high priority has to be to regulate “fringe” areas that were either not regulated or poorly regulated. But, how does creating a separate consumer protection agency with its own agenda fix anything?
It will just add to the enormous regulatory burden imposed on banks in a time when they can least afford it. There will be more special FDIC assessments on the horizon, in addition to increased regular premiums. With banks’ CAMELS ratings down, they will be in a higher risk category. Margins are narrow, good new loans scarce, and provisions and impairments are up. This is not the time to add another burden for banks.
The Challenge Ahead
For most community banks, 2009 is simply a year of survival. The next challenge will be how to return to consistent levels of profitability. Certainly, the regulators will criticize you if you have any concentrations in real estate lending. Finding other profitable avenues of lending will be the task ahead.
What the banking universe will look like by the end of 2010 is subject to speculation. However, I suspect that a reduction of 1,000 banks through failure or consolidation is not beyond the realm of possibility.
What To Do Now
If you have enough capital and sufficient liquidity, you should be able to manage through the storm. If you don’t, getting additional capital is critical. We recognize that raising capital in today’s market is very challenging at best. Private placements with investors or board members or private equity or “rights” offerings seem to be the best alternatives for most community banks. If you are a “3” or better rated bank, there is some chance of success. Raising capital as a “4” or “5” rated bank under a regulatory action is a tough hurdle.
Conclusion
These are tough, unprecedented times. Hopefully, things will bottom out as early as year-end, so real estate values and unemployment will stabilize and we can begin the process of recovery. In the meantime, we suggest that you be proactive, maintain good and open relationships with your regulators and wait out the storm.
