Norm Skalicky, the 76-year-old CEO of Minnesota's Stearns Bank, wouldn't impress Wall Street. His bank has $1.6 billion in assets, a rounding error to behemoths like Citigroup (C) and Bank of America (BAC). Despite a lifetime in the banking industry, he doesn't have a computer on his desk, and he only just got e-mail, which his assistant checks for him. He is still figuring out his new iPhone. He doesn't trust pronouncements from Wall Street: "The people in Washington and New York say the recession is over; I don't believe it," he insists.
To the Federal Deposit Insurance Corporation, however, Skalicky is a big dealmaker on whom they can't lavish enough attention. That's because Skalicky and his tiny bank have bought four failing banks and a $732 million batch of loans through the FDIC's two-year-old auctions of troubled U.S. banks. Of the roughly 8,000 banks in the United States, little Stearns Bank right now is the most frequent acquirer of FDIC-auctioned banks.
Stearns' enthusiastic acquisitions of failed community banks is no anomaly. As the continuing real-estate crisis pushes more tiny banks into failure, the most common saviors have been other small banks: community banks, small thrifts, and modestly sized lenders. These burgeoning banks include Ohio's First Financial Bancorp, North Carolina's First Citizens BancShares, and Georgia's State Bank and Trust Company, which all bought three banks each from the FDIC. Cognizant of their size, some openly play up their scrappiness: Umpqua Holdings Corp. (UMPQ), which bought three failed banks from the FDIC, has a Web site and voice-mail messages that tout it perkily, if immodestly: "Welcome to Umpqua, the greatest bank ever."
These banks tend to look to FDIC auctions to expand cheaply without incurring the cost of opening their own new branches. Steven Alexopoulos, a research analyst with JPMorgan Chase (JPM), said in a recent report that banks like Umpqua and MB Financial, which are hoovering up assets now, "will be the long-term winners post the crisis."
At the same time, bigger banks are still in the process of cleaning up their acts and may not want to go through all the trouble of bidding for failed banks when they already have so many branches to manage and are pulling back. "Many of the regional banks are not in a position to make significant acquisitions. You still have big banks like Wells Fargo (WFC), Wachovia, Citigroup, Bank of America, and JP Morgan Chase still on the sidelines for one reason or another, and a lot of banks are still struggling," summed up John Douglas, a partner with law firm Davis Polk & Wardwell and former general counsel of the FDIC.
No kidding: Right now, about one in 11 banks in the United States is troubled and on the road to failure, according to the FDIC's own estimates. Ralph "Chip" MacDonald, a financial-services partner with the law firm Jones Day, points out that around 28 percent of thrifts in the United States are currently the subject of some formal or informal enforcement action by regulators; about 1,000 of the nation's 8,000 banks have received formal notice that they're in some kind of enforcement trouble.
Relying on small banks, then, is a page drawn from the FDIC's old playbook in the last savings-and-loan crisis, and with good reason: Nearly all the banks in America are small. About 92 percent of U.S. banks have assets under $1 billion, which makes them community banks, FDIC spokesman David Barr points out. Since small banks can't take over large banks, "it's only logical that community banks would take over other community banks," Barr said.
There's another reason that so many small banks participate in FDIC auctions: They're not contending with the same depleted assets as larger banks stuck with hundreds of millions or billions of dollars in bad loans. That's a necessary qualification for the FDIC, which is a notoriously picky matchmaker. Jones Day's MacDonald said that the FDIC's bidding guidelines are so rigorous that it makes the auctions and the selection of appropriate bidders difficult. "There are a lot of ways to get thrown off the bidding," MacDonald notes. Those include everything from capital levels"”the FDIC's requirements run for pages on those, and it is still adding to them"”to the kind of owners and voting power that bidders are allowed to have.
The FDIC has made the auctions more attractive, in part by allowing banks to pay the agency in stock. This incurs less cost to the FDIC and is appealing to banks that may not want to lay out more cash for an acquisition.
The most effective sweetener is a throwback to 1991: loss-sharing. The FDIC agrees to sharing the potential losses of nearly all the failed banks it sells, covering up to 95 percent of the most troubled loans. By the end of 2009, the FDIC had agreed with buyers to share losses in 94 banks, covering $122 billion of assets. The agreements prevented a lot of damage to the FDIC's ever-dwindling fund to cover deposits: The agency saved $29 billion that would have otherwise gone to covering bank failures. The FDIC can also claw back some of its loss-sharing agreements over the next 10 years, which means the agency makes money if loans that look bad now end up being worth money later.
The FDIC offers eye-poppingly generous terms to buyers. One good example is Amtrust, the fourth-largest bank failure of 2009 and a casualty of the real-estate crisis, with 98 percent of its loans and leases connected to residential real estate. New York Community Bancorp got a discount of roughly $425 million to get about $9 billion of Amtrust's assets"”and ended up getting more like $11 billion. The FDIC agreed to cover 59 percent of that, or $6 billion, in case New York Community Bank of Westbury, N.Y., gets stuck with failed real-estate loans any time in the next 10 years. Despite the lavish terms, the total cost to the FDIC of the Amtrust failure was only $2 billion"”a far cry from the $11 billion that the agency would have had to cover if New York Community Bank hadn't shown up. The FDIC also agreed to take some of New York Community Bank's stock as payment; the FDIC cashed the stock in December for $23.3 million.
Skalicky credits the FDIC's renewed focus on loss-sharing with turning his bank into a frequent acquirer. Stearns once experienced what it was like to buy a bank from the FDIC with no guarantees. In October 2008, Stearns bought Georgia's failed Alpha Bank, a two-year-old bank with about $364 million in assets that got drunk enough on the Atlanta building boom to become its own little real estate bubble: Alpha grew its real estate loans to $218 million from $12 million in just one year. Stearns bought the bank's deposits and its branches only to find that most of the customers headed out the door after the acquisition.
The problem: Alpha's deposits were what the industry calls "hot money," or out-of-state deposits that a bank lures by offering high interest rates; the holders of these deposits are shopping for high interest rates and don't have loyalty to any particular bank. Alpha's gave customers interest rates as high as 4 percent on certificates of deposit. The bank's goal was to lure enough money into its coffers that it could then turn around and make what Skalicky termed "rotten loans" to real-estate developers. Stearns cut Alpha's interest rates to about 2 percent, according to Skalicky. Depositors ran out the door. In March of 2009, Stearns closed the chapter on the acquisition by shuttering both of Alpha Bank's branches. Stearns didn't bid on another FDIC-auctioned bank for another 16 months, until the FDIC introduced loss-sharing on a wider scale.
The Alpha experience exemplifies the troubles that small banks face when they venture their money on a failed bank. Skalicky learned from the experience to look for banks that tend to serve their communities and have what bankers call a "core" business: customers who are in the community and are likely to stick around. In August 2009, Stearns bought two Florida banks: First State Bank of Sarasota and Community National Bank of Sarasota County. Combined, they brought about $550 million of deposits to Stearns, about $443 million of which was covered by FDIC loss-sharing, according to data from SNL Financial. Right now, around $370 million of that, a respectable percentage, has stayed with Stearns, Skalicky said. The total cost to the FDIC of the two Florida acquisitions by Stearns, according to SNL: $140 million.
Still, there aren't that many Stearns or Umpquas in the country for the FDIC to lean on. The FDIC's pool of buyers"”large or small"”is getting tapped out, even as bank failures are expected to rise. And waiting in the wings is a big pool of buyers waiting for their big moment: private-equity firms, which have been busy raising pools of capital to buy failing banks even though the FDIC has largely shunned them. The FDIC is worried that private-equity firms will buy the banks and sell them quickly for a profit with little thought to improving their operations. (Private equity investors, naturally, disagree.) The FDIC currently bans investors from working in consortiums that hold more than 70 percent of the voting power in a bank or from selling a bank in less than three years. By necessity, that is likely to change: The FDIC is holding meetings this week to rethink its approach to P.E. firms.
The FDIC's challenge will continue even if private-equity firms enter the fray, however. As hard as these agencies and organizations work, the real-estate loan crisis is far bigger and more pervasive than anything they can fully handle and will continue for years; as many buyers as the FDIC can find, it is not likely to be anywhere as many as it needs.
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