The Challenge

Bank Capital Group Perspective

Stan Taylor – August 1, 2008

Recently, I have been asked by a number of clients and friends around the country to offer my view on the current downward spiral of the banking industry and I have spent the last several days analyzing all of the elements that should be considered in offering such a perspective.   I decided that with almost 35 years as a banker and the last seven years as a bank consultant in the community banking industry, perhaps my thoughts from a historical and evolutionary standpoint would offer an insight from a banker’s perspective. 

In my years in the industry I had first hand experience dealing with the economic problems that were pervasive in the real estate industry in the mid seventies. As a banker in the Southeast which was clearly the area most devastated in the country, I witnessed first hand the destruction that the collapse of the real estate industry can wreak on the banking system.   However, the country clearly rebounded from that devastation and many of today’s more conservative underwriting and lending philosophies have their genesis in that period. A few years later, industry experts predicted major adjustment of the financial services industry due to deregulation of interest rates.  While demanding creativity and better balance sheet management the industry survived and competition between banks and other financial institutions for customers fared quite efficiently.  Later in the decade of the eighties, we saw the destabilization of crude oil prices and unprecedented panic as reflected in the incredibly long lines and long waits to simply purchase gasoline for what was then an unbelievable $1.40 a gallon. After this came the savings and loan crisis, which did in fact permanently impact a major segment of the financial services industry.  In addition to that we can add the FDIC takeover and the bailout of Continental Bank and the failure of Penn Square.  In the early nineties there was another significant real estate cycle downturn that had a major impact on bank earnings for the next two years.  Perhaps some of these events are beginning to sound amazingly current.

As we jump forward into the early part of 2000 there is the bursting of the dot com bubble and its historic impact on investors, the stock market and the economy as a whole.  How many people remember that day in September 2002 when the Dow dropped over a thousand points and fell below 7,600.  And yet, by October 2007, the Dow had almost doubled to a record high approaching 14,000.  Now, in the last 18 months we have seen financial markets tremble with the effects of subprime lending, another real estate market adjustment and a falling stock market. 

The purpose of this opinion is not to provide a history lesson to the reader but simply to refocus one’s attention on the cyclical nature of our economy. The condition of the financial services industry certainly does not suggest prosperity in the near term; however, based on historical reference points and with the combined efforts of the federal government, the banking regulators and most importantly the resolve and commitment on the part of professional financial managers and bankers everywhere the industry will, as it always has, right the ship and sail into the calmer waters of the next economic upturn. 

At this point I would like to address specifically the differences and in most cases the advantages that community banks have both now and in the future over their larger national and regional counterparts.  Unfortunately, when the media, and as a direct result of their reporting, the investors in this country hear the word “banking” they believe it is a generic term and that all banks are created equal.  Clearly that is not the case.  Just last month in Washington, DC, Cynthia Blakenship, Chairman of the Independent Community Bankers of America (ICBA) said: 

“As common sense lenders, community banks are highly capitalized, well- regulated and more risk averse than big banks. The vast majority of our nation’s banks, especially community banks, even in the midst of these difficult times, are still strong, safe and stable.

ICBA is dismayed at the misinformation being spread by media reports about the state of the FDIC insurance fund and the state of the banking industry.  These reports only fuel unwarranted panic and fear among the general public.”(1)

In addition, Camden R. Fine, President and CEO of the ICBA states: “Even in these challenging times, the over whelming majority of our nation’s more than 8,000 community banks are stable, safe and strong.  Community banks are highly capitalized and well-regulated institutions, helping Americans finance a home or refinance their mortgage.  Each day, millions of people and small businesses count on community banks – as common sense lenders – to help build their financial future”.(2)

There has been an unprecedented increase in the number of new community bank charters granted in the last several years.  The principal reason for this has been the aggressive acquisition of financially prosperous smaller banks creating a total net reduction of banks in this country from over 14,000 twenty years ago to roughly 8,000 institutions today.  The proliferation of these new banks has filled the void and returned service to communities all around the country that would have otherwise been forced into the impersonal cattle lines of the mega banks.

It would be irresponsible to ignore the fact that there are problems in banking from the largest institution to the smallest, but the negative publicity that large banks such as IndyMac has recently received has created problems in many people’s eyes regarding the industry as a whole.  The fact is that of the over 8,000 banks previously mentioned, Sheila Bair, Chairman of the FDIC says there are 90 troubled banks that are in danger of being taken over.  In a recent speech, Blair warned against “needless, unnecessary worry and angst among depositors.”(3)  Also, as most people are aware, each depositors in those ninety banks as well as all FDIC insured banks, will have a minimum of the first $100,000 on deposit insured and up to $250,000 for certain retirement accounts. 

Hugh  Johnson, chief investment officer of Johnson, Illington Advisors in Albany, NY said this past month, “the financial system is in good shape, what you read about and hear about doesn’t make it seem that way but it is.”(4) This opinion is seconded by Joe Smith, the North Carolina State Commissioner of Banking, when he says “I think there is no reason…..to be concerned, period.  Our banks are well capitalized by which I mean they have balance sheets that can withstand the current unpleasantness.”(5)

Now, lastly and probably most importantly to my clients is the issue of raising capital in today’s turbulent market.  Over the last ten years investors in de novo banks have realized tremendous gains both from selling their institutions as well as simply holding the stock while their banks grew and prospered.  Clearly, all of this will be slightly slowed for a period of time by the current economic environment.  Investing in bank stocks should never have been presented to an investor as a quick turn around, fast gain to be realized in three to four years.  I believe, and most of the banks I have worked with over the years have shared the belief, that investors should look to at least a five to seven year time horizon for a community bank’s optimal stock performance.  With this in mind, it is clear that once our current cycle begins to trend upward and large bank’s stock prices return to previous levels, the acquisition trend will continue.  In response, we will see this driving the price of the smaller banks higher along the way.  Investors should take heart in knowing the investment they make today in a new bank may in fact be perfect timing.  The de novos that have recently opened or will open in the next year have the advantage of clean balance sheets, no problem loans, and a new set of experiences which will make the individuals managing those institutions better bankers. Virtually all banks currently operating, be they large or small, have some level of distraction going on within their organizations.  These distractions are primarily focused on problem loans.  This portends well for a de novo that has just opened or will soon open because it allows the bank to take competitive advantage of the distractions and to seek and serve new customers.    I believe all of these investor concerns are important and have to be related to a prospect in order to turn the tide of over reaction.  It is, unfortunately, in my experience, a difficult tale to tell by the average bank organizer and many on the management team; however,  unless investors are made to feel comfortable about the prospects of their de novo bank investment, there will be continued reluctance and I believe the case will become more and more difficult to make. 

In short summary, we’ve been here before, we’ll be here again, the sky is not falling, the industry as a whole is sound and secure, we learn from our mistakes, and this too shall pass.

(1)  Cynthia Blakenship; July 16, 2008 – Statement issued by ICBA
(2)   Camden R. Fine; July 14, 2008 – Statement issued by ICBA
(3)  Sheila Bair; July 14, 2008 – Statement issued by FDIC
(4)  Hugh Johnson; July 15, 2008 – Albany Times-Union
(5)  Joe Smith; July 16, 2008 – Raleigh News & Observer