Life After the Scorched Earth
By Stephen M. KleinAugust 24, 2009
The Beat Goes On
It’s been over a year of economic turmoil and while things haven’t really stabilized yet, there seems to be a glimmer of light at the end of the tunnel. The question that has occurred to me, as we have visited with numerous Boards of Directors and regulators, is what is in store for the next chapter for community banks.
Where We Stand Now
Most banks have encountered some measure of loan pain. As several regulators have commented, a lot has to do with geography. For example, most banks in Eastern Washington have fared better than their peers in Western Washington, reflecting differences in their respective economies, particularly real estate values.
Many banks in the Northwest have received some type of regulatory action, since about 50% have a CAMELS rating of “3” or worse. Earnings have been pathetic and capital significantly eroded. With FDIC insurance premiums up, margins compressed, non performers and provisions up and lending down, it’s hard to make a profit.
Capital: the Elixir of the Gods
For a select number of relatively healthy regional banks viewed as survivors and consolidators, the capital markets have opened up, albeit at varying discounts to market. For the “4” and “5” rated banks, capital has continued to be a struggle. For the banks in between, it has been a mixed bag, with some capital available, mostly from insiders, shareholders or private placements. Clearly, capital is king, particularly with so many banks under administrative actions requiring higher levels of Tier 1 capital.
The Regulatory Front
As I have told our Boards of Directors, in my 35 years as a regulator and legal counsel, I have never seen such a challenging regulatory environment. They are clearly overworked, understaffed and overwhelmed with the problems facing them. Criticized by their own internal review processes, they are clearly risk averse. Processing applications and requests has become a protracted event. Until things stabilize, I fear that this environment will continue for the foreseeable future.
One common theme we have seen is the regulators intense dislike for concentrations in construction lending, especially where it is funded by brokered CDs. In fact, we understand that the FDIC internally characterizes brokered CDs as “the Devil!”
What Will the Banking World Look Like?
There will continue to be a plethora of bank failures, shrinking the marketplace. New bank formations are clearly on the sideline until further notice.
Hopefully, the regulators will approve some troubled bank branch sales and combinations of banks that make sense. Consolidation over the next several years is inevitable. It wouldn’t surprise me if the banking universe shrunk by 20% over that time period, through failures and consolidations.
With the FDIC fund effectively bankrupt, continued high regular premiums and periodic special assessments should continue for a number of years at least. Hopefully unemployment rates and real estate values will stabilize soon or else problems in CRE and C&I portfolios will rear their ugly heads.
The Challenge Ahead
The real challenge going forward for the survivors will be making money. With high FDIC and D&O insurance premiums, narrow margins, high NPAs and provisions, increasing regulatory burden (let’s hope that sane minds will kill the proposed new consumer protection agency) and relatively soft loan demand, profitability will continue to be a challenge as we move into a new decade. It is clear that the traditional community bank model, with a concentration on real estate lending will have to change, with banks becoming less loan and interest rate dependent.
The Opportunity
It is not all bad news. With the inevitable consolidation, the survivors who have capital should be able to grow their business and market share. However, with lingering regulatory actions and the scars from this recession, it will be a slow recovery process. Branch and whole bank deals will return and the banking world as we know it will look very different, with new players emerging. But it will take some time.
