Local bankers look at recession's effect on community banks

While there are pockets of improvement in the economy, the banking industry -- especially smaller community banks -- are still hurting for a variety of reasons.

Banking regulators are requiring banks to beef up their capital -- which requires investors, who are also cutting back -- and regulators are requiring banks to sell those properties with unpaid loans when there aren’t many buyers.

Many of those community banks’ customers are hurting, too. They can’t sell the houses or lots in residential developments, or they can’t sell their products at the same level as when the loans were made, or they have lost their jobs during the worse economy since the Great Depression.

“I have lived through my share of economic downturns,” Joe Evans, president/CEO of State Bank and Trust Co., said recently at a Macon State College presentation about the banking industry. “This is, however, the first financial crisis of my career where community banks have been at the epicenter.”

His speech was titled “The Crisis in Community Banking: How We Got Here and Where We Are Headed.”

In communities around the country, 149 banks have collapsed so far this year -- and this time the banks are mostly smaller than in 2008 and 2009, according to the Associated Press.

So far this year, 18 banks have failed in Georgia compared to 25 failures in 2009. And several of Georgia’s 300 banks have been placed on “watch lists” -- which means in some cases they have even greater regulatory oversight and restrictions.

“This crisis resulted from a great expansion of credit that pushed asset prices to ever higher levels until someone realized the envelope had been pushed too far,” Evans said. “A panic liquidation of the inflated, relatively illiquid assets ensued, causing the prices of those assets to plummet and loans secured by them to default. The financial losses sustained by lenders caused a contraction of credit, which further depressed asset prices and pushed the economy into recession.”

Ben Bernanke, chairman of the Federal Reserve System board, spoke earlier this year at the Independent Community Bankers of America convention.

“Communities all over America are trying to cope with the economic consequences of the most severe financial crisis since the Great Depression -- high unemployment, lost incomes and wealth, home foreclosures, strained fiscal budgets and uncertainty about the future,” he said. “Because community banks are integral to local economies, you have been on the front line, so to speak, deeply engaged in confronting those problems and uncertainties.”

How a community bank is defined

While the definition of community banks differs from banker to banker, the Federal Deposit Insurance Corp. has defined it as a bank with assets of less than $1 billion.

While that may be the statistical definition by the FDIC and it may be a somewhat dated definition, Steve Bridges, with Community Banker Association of Georgia, said his organization has a different way of looking at what constitutes a community bank.

“In our view, it’s more of an operating philosophy ... a bank that adheres to true local decision-making, where the officers at the bank or the branch have real decision-making power particularly on loans,” Bridges said. “As a given rule, it’s a local ownership ... most of the community banks are owned by shareholders in the community where they operate.”

Even though Capital City Bank is headquartered in Florida, and it had assets of about $2.6 billion at the end of the third quarter, Steve Jukes, community president for Bibb County, said Capital City considers itself a community bank.

“Our average office size is $25 million to $30 million in deposits, which is another barometer that industry associations use (for community banks),” he said.

Ed Loomis, president/CEO of Macon-based Atlantic Southern Bank, said it is “a bank that’s primarily dedicated to a focused market area and involved in the activities that take place in that market. If you are focused on a smaller area, then you are more responsive to the needs of that community.”

As of Sept. 30, Atlantic Southern had assets of $853 million.

What created the banking crisis?

In the 1970s, banks were facing stiff competition for household deposits from brokerage firms offering Individual Retirement Accounts and money market mutual funds, Evans said. It wasn’t until the early 1980s that regulations were changed that allowed banks to offer mutual fund accounts, but it limited the number of checks that could be written each month.

“In 1970, bank deposits accounted for 20 percent of total assets of U.S. households while mutual funds made up only 1.7 percent,” Evans said. “By 2006, bank deposits had dropped to 11.5 percent of household assets while mutual funds had grown to 11 percent. That was a huge shift in market share.”

Banks were forced to pay more aggressive rates for deposits, and with more costly funding, banks had to find “higher yielding assets and run higher loan-to-deposits ratios,” he said.

At the same time, the securities industry changed the face of lending. “It dumbed-down credit quality,” he said, because securitized loans are created when one firm originates a loan and immediately sells it to another that puts it with other loans, which it packages and sells as a security.

In the mid-1970s, less than 6 percent of home loans were securitized, but by 2003, 58 percent of home loans, 32 percent of consumer loans and 20 percent of commercial mortgages were funded by the capital markets through securitization, Evans said. This led to “a massive expansion of largely unregulated lending that impacted community banks” in significant ways.

Large banks became adept at packaging and selling loans in the capital markets, but community banks were mostly left competing for a shrinking pool of loans that could not be securitized. Also, when securitization drove down pricing on many conventional forms of lending that community banks couldn’t match, banks had to look for other forms of lending that carried high enough rates to cover funding costs.

“Capital market funded mortgage lending fueled the housing bubble,” Evans said.

“Loosened credit standards in mortgage lending combined with very low interest rates led to unprecedented growth in the housing sector and a tremendous demand for loans to finance land acquisition, subdivision development and residential construction -- what bankers refer to as AD&C lending.”

This created “the perfect storm that caused many community banks to become precariously concentrated in AD&C lending,” he said. “It was not uncommon to find community banks going into this downturn with more than 50 percent of their loans in AD&C. ... I have not seen a community bank failure during this cycle where concentration in AD&C lending was not the principal cause.”

Bridges, with the Community Bankers Association, agrees that concentration of these AD&C-type loans has caused problems for banks.

A lot of the problem, too, has to do with some regulations and new accounting rules that had been put in place before the downturn and with those new rules, banks have to reserve or write down loans. And the downturn created the first real test of those rules.

“I used to be a regulator, I used to sit on that side of the fence for 30 years,” Bridges said. “If we had the same accounting rules and regulatory rules that we have today in place in the late ’80s and early ’90s, we would have had quite a number of bank failures back at that time.”

At an association meeting recently, a banker said that regulators “are requiring a write-down of theoretical losses with real capital,” he said. “From a banker’s prospective, that really puts it in a nutshell.”

Where banks have struggled the most is with real estate loans secured by lots for a residential development, he said.

“You’ve got plenty of willing sellers, but don’t have willing buyers,” he said. “In theory, the value of those lots is zero.”

Georgia had about 15 to 16 years of “really good times,” Bridges said. “Any bank would have been better off if about every five years we would have had a little bit of a downturn and let some of this stuff shake out. Then we wouldn’t have fallen off the cliff, and that’s kind of what ended up happening.”

Whenever the real estate market would show some softening, “Wall Street would come up with new ways to keep people buying houses, and it extended the appearance of a good economy for quite a number of years beyond what was realistic,” Bridges said. “And it made all of these false impressions that things were better off than they were.”

Unfortunately, regulators and bankers didn’t see this coming, he said.

Where is the banking industry now and where is it headed?

“Economically, I think we have several years of sluggishness ahead of us as we wean ourselves from the false sense of prosperity that resulted from loose lending and excessive borrowing in both the private and public sectors,” Evans said.

“Further, I think we have a considerable surplus of developed property that has to be absorbed.”

Until the real estate market stabilizes in Georgia, “it’s not going to feel like much of a recovery -- no matter what the statistics say,” he said.

“A good number of the banks -- big and small -- have lost a considerable amount of money,” said Atlantic Southern’s Loomis. “We haven’t been spared from that, but you persevere. I have to admit, we reflect how well our customers do, and a lot of our customers are having a hard time both in real estate and otherwise. Just a slow down in the economy, sales are down, margins are down and people aren’t able to collect from their customers as well. It puts their businesses under stress and therefore it puts the bank under stress.”

Atlantic Southern was put under an agreement order with the Federal Reserve Board and the Banking Commissioner of Georgia in April, which means tighter regulatory control and oversight.

This past week, Atlantic Southern lost its president/CEO Mark Stevens, two lending officers and an assistant. The four, who resigned voluntarily, joined State Bank and Trust. The employees joined a new commercial banking group created at State Bank as the bank is expected to grow “over the next several years to approximately twice the size it is today,” said Dan Forrester, Middle Georgia regional president for State Bank.

Several bankers agree that the number of banks will continue to decrease in Georgia and across the nation.

“I don’t see there being 8,000 banks nationally 10 years, or probably five years from now,” Loomis said. “I think to some degree, just the cost of regulation in our industry and the complexity of regulation in our industry makes it difficult to operate a very small shop.”

But Loomis said the situation doesn’t seem to be getting worse.

“I think we have seen the bulk of this phase run its course, but thus far I have not seen it getting any better. So hopefully that’s the next stage.”

Capital City’s Jukes somewhat agrees.

“I’m going to suggest that we are past the 50-yard line, but I couldn’t be much more specific than that,” he said.

One barometer Jukes uses is to look at the bank’s mortgage volume and while it’s “quite strong,” the problem is most of it is refinancing. While the lower payments offered by refinancing allows the borrower more cash to spend, which should help the economy, “it’s not a purchase we would really like to see that refinance/purchase mix much closer to 50 percent, if not greater in favor of purchases. Right now more than 90 percent are refinances.”

Some banks handling the downturn in better shape

Spence Mullis, president and CEO of Dublin-based Morris Bank, said the bank had total assets of $355 million as of Sept. 30 and “is very well capitalized.” In October, Morris Bank assumed all the deposits of Gordon Bank after it was shut down by state and federal regulators.

“We’ve grown around $40 million (12 percent) this year,” Mullis said in an e-mail. “We also raised capital to prepare for any strategic opportunities that may become available. Gordon (Bank) exemplified the type of opportunity we were looking for.”

Mullis said it’s difficult to see a situation where the FDIC “has to shut down a bank and perform a payout and lock the doors,” because in a one-bank town it could cripple the local economy.

“We are excited that we could be a part of preventing that from happening in Gordon,” he said.

While the bank has performed “relatively well” during the downturn, it has some of the same real estate issues all banks are dealing with.

“If you haven’t had any loan losses over the past couple of years, you didn’t loan any money in the previous 10,” Mullis said. “I expect a good bit more consolidation in the banking industry over the next few years, especially here in Georgia.”

Some of that will be normal mergers and consolidation as smaller banks reach out for partners in order to compete better, he said.

“It’s getting very expensive to keep a bank in compliance with all the rules and regulations coming down the pike,” Mullis said.

Capital City Bank is “doing better than OK, we are doing well,” Jukes said.

“We are not immune at all, but we do have surplus capital and plenty of liquidity to continue to execute our business plan growth in Bibb County,” he said. “So we are doing relatively well and almost humbled by that.”

Bridges, with the Community Bankers group, said that as long as the general economy continues “to limp along” with gradual improvement, “I think community banks’ plight will get just a little bit better but it’s going to be a kind of a long road and a long struggle for those with that still have a lot of this real estate exposure. There is going to be additional failures. There is no question, a lot of these guys are still struggling.”

Evans said during his speech that community banks are on the cusp of significant change.

“While most of the outright failures should be behind us by the end of 2011, there will remain for several years a significant number of “wounded” banks with elevated problem asset levels and a need for additional capital,” he said. “I see substantial industry consolidation ahead, and believe that regulators will significantly raise the standards for those who want to start a new bank. All this leads me to conclude that we will see the number of banks in Georgia shrink at an accelerating rate.”

But for those banks that can raise enough capital, build its deposits and make sound lending decisions, “I see tremendous opportunity.

It was that “vision of opportunity” that led State Bank to take over the six branches of Security Bank in July after its doors was shuttered by regulators. The bank raised $300 million in capital to facilitate all its acquisitions.

“I am optimistic about our collective future,” Evans said.

“Yes, there are hard choices we have to make and more difficulties that we must work through, but we will. We will address the imbalances that got us here, our economy will recover, and while they may look differently, strong community banks and community bankers will continue to play important roles in our communities.”

To contact writer Linda S. Morris, call 744-4223.