Banking Law

Lawyer and former McKinsey & Co. management consultant David W. McCombie III wrote an opinion piece for Monday's The Miami Herald about the state of the banking business in Florida. According to David, the situation is grim and is likely to get even more grim before the dust settles. In other words, if you think things are bad now, you ain't seen nothing yet.

Loans continue to deteriorate, requiring additional loss provisions. Macquarie Equities Research estimates southeastern U.S. banks have only realized about 40 percent of estimated losses. Given this scenario, Florida Office of Financial Regulation Commissioner Thomas Cardwell indicated that more than one-third of financial institutions, representing 48 percent of the assets held in state banks, were on Florida's ``watch list.''

The erosion of capital reserves will cause banks to falter. Throughout this credit cycle, an estimated 100 Florida institutions will fail, according to John Kanas, president and chief executive of BankUnited.

The health of Florida's banking sector is universally poor. Bauer Financial assigns its highest five-star health rating to one-third of banks nationwide, yet only four percent of Florida institutions recently earned that honor. Even though the FDIC has a preference for merging failed banks with nearby acquirers, few local institutions have been healthy enough to qualify. Of the 26 Florida bank failures to date, local, independent institutions acquired only 7 percent of assets. Instead, purchasers came from as far as Minnesota, Michigan and Canada.

In addition to outright bank failures, loan write-downs will significantly handicap many remaining banks, leaving them as ``zombies.'' Although these institutions may survive, their problematic loan portfolios leave them with little capital to engage in traditional lending activities that drive desperately needed profitability. These banks must quickly restructure their problem assets, through renegotiation or outright sales.

Of course, more capital might be a nice renedy for these ills. Shoring up the balance sheet and battening down the hatches to ride out the storms seems like the wisest game plan in the face of such dire predictions. Unfortunately, David sees capital sources for troubled banks to be awfully scarce.

[T]he current environment has been inhospitable -- investors are assuming the worst. Consequently, regional banks find it extremely difficult to raise non-government-backed funds without accepting substantial equity dilution.

Investors like Bond Street Holdings are waiting for the FDIC to formally shut down banks before injecting needed capital. In doing so, they avail themselves of advantageous ``loss sharing'' agreements, which minimize downside risks. Functionally these deals facilitate a fresh start, providing a competitive advantage. While peers focus on working out problem loans, these institutions can underwrite ``cherry picked'' loans at attractive spreads, while aggressively building market share

David sees two principal consequences that will result from this "tsunami" of bad news: (1) continuied consolidation of the banking industry in Florida, and (2) the increased domination of the state's banking business by large national banks. These results, in turn, may lead to less lending to small businesses at a time when such lending is likely to be required if the economy in Florida is to dig its way out of the economic hole.

National banks dominate Florida (two-thirds of deposits are in interstate banks) and the upcoming wave of failures should only increase their importance. Yet, community banks disproportionately support small business lending, accounting for 38 percent of the loans, while representing just 11 percent of assets. Ironically, over the past year, community banks have slightly increased loans to small businesses, while larger, national banks have reduced this lending by four percent.

Given the state's dependence on small entrepreneurial businesses as well as national banks' dominance in the market, economic recovery vitally depends upon these national institutions stepping up to the plate.

I'd add that it depends on them not only stepping up to the plate, but also taking a healthy swing and making contact with the ball. Notwithstanding that I'm such a cock-eyed optimist, I have my doubts that either will occur.

Looking at it from a bank lawyer's perspective (which, shockingly, I occasionally do), it appears that if you represent capital sources that are chasing FDIC rseolution transactions or healthy banks that are likely to be acquirers of the less-than-healthy, then Florida will be a land of opportunity over the near term.

If any reader is interested in learning more about capital raising for community banks in the current distressed economic environment, he or she might want to consider listening in on an upcoming Bank Law Stuff webinar on the topic.