Banking Law

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.