Since the passage of the Dodd-Frank Act, aimed at preventing another financial crisis like the one that crippled the world’s economies in 2008, the nation’s banking industry has been in flux.
The end of the last decade saw massive institutions like Bank of America and Citi in need of bailouts after failing, and others like Merrill Lynch, Countrywide and Washington Mutual swallowed up after their own failures. In states around Kentucky, smaller state banks folded in droves.
Georgia has seen 68 bank failures since late August 2008, with four failing so far in 2012. Florida has lost 61 banks, with one as recently as May. North Carolina and South Carolina have lost five and nine respectively, including one this month in both states. Tennessee has only seen two banks fail since the start of 2008, but both of those have come in the past six months.
In Kentucky, Charles A. Vice, commissioner of the Kentucky Department of Financial Institutions, takes pride in the fact that his 155 state-chartered banks have made it to this point. The lone exception, Vice said, comes “with an asterisk.” Irwin Union Bank failed shortly after moving to Louisville from Indiana in September 2009, when its Indiana-based holding company shuttered.
“That was not an entity that we regulated,” he said.
Other than that, Kentucky hasn’t seen a bank failure in more than 20 years, when two federal savings banks, one in Louisville and one in Prestonsburg, failed on the same day in the summer of 1991.
“From my perspective, I think the banking industry in Kentucky remains stable,” Vice told Business Lexington. “We’ve weathered the storm through the financial crisis, the recession, fairly well. Banks are still dealing with some of the aftermath of the recession.”
Vice said simplicity explains why banks in Kentucky made it while others elsewhere did not.
“The banks that thrived during that period basically just did core banking operations very well,” Vice said. “If you look at our 155 state-chartered banks, that’s a common characteristic of our banks in Kentucky: We concentrate on core banking issues. They’re very tied to the communities that they serve, and they didn’t go out and get involved in a lot of the unusual products and loans that other banks throughout the country did, and that gave them some sort of staying power and allowed them to do well during this crisis. And we started out with a little higher capital ratios than most banks throughout the country.”
The toxic assets that nearly crumbled Wall Street in the form of defaulted loans and bank-seized property worth far less than what was owed played a role in the commonwealth, but not as prominently as elsewhere, according to Chris Hargrove, chairman and CEO of Professional Bank Services, Inc., a Louisville-based consulting company for financial institutions.
“Kentucky, in relation to all the other states around us, and especially in the Southeast, is doing significantly better,” Hargrove said. “The reason is we didn’t really experience the dynamic growth that Georgia, Florida and Tennessee — to a certain extent — did, so we didn’t have the big ride-up other states did. So we had significantly less far to fall than other states did when the real estate market turned south.”
While there was a rash of bank closings in the aftermath of the economic downturn, the nation’s mega banks have made a comeback at a time when community banks, which make up the vast majority of financial institutions in Kentucky, haven’t rebounded as fast, according to Hargrove.
That’s actually for a good reason.
“The big institutions … they did, at the expense of their shareholders,” he said. “What’s different for a community bank … is they aren’t willing to do that, because they are the shareholders. Their communities are the shareholders, so they’re not willing to sell out the community and themselves at dirt-low prices.”
“When the financial crisis hit, most of those [large] institutions sold out their existing shareholder base by raising capital at very, very low prices, and then after they got the TARP money from the federal government, they went out afterward and raised capital again at significantly low prices. So the shareholders of these large institutions prior to the financial crisis have been diluted down to almost nothing,” he said.
That has kept the value of banks low — much lower than prices offered or estimated in the previous decade. This comes at a time when banks otherwise would be combining forces through mergers and acquisitions to face the onslaught of regulations coming down the pike in their industry, according to Walter Byrne, an attorney with Stites and Harbison focusing on banking (see Byrne’s guest column, “Too Small to Survive,” on page 15.)
Smaller banks are facing the fact they need to hire people with higher skill sets, Byrne said. But compliance officers aren’t earners, and postgraduate degrees and experience cost money.
“Community bankers historically have been much more resilient; they’ve been innovative, finding changes. They just find themselves at a very difficult time where changes are needed, and some of them are going to need to change their business plans, diversify and do things that generate non-interest income that maybe they hadn’t thought about doing before. The model is going to need to be tweaked a bit. I’m confident they’ll be able to do that, but that’s not done overnight,” he said.
(For a look at options under consideration at some local banks, see the article “Local Banks Look to Lessen the Pinch of Increasing Account Fees” on page 18.)
The crunch on capital and more stringent lending requirements aimed at big banks but also regulating community banks that don’t usually operate in such a formal way have taken their toll, Byrne said.
“This has been a pretty exhausting last three years … Banks ask more penetrating questions. The banker, the community banker that used to just lend you money because they knew you well, now because of the process and the protocols the examiners require, have to ask you all these hard, penetrating questions,” he said.
But as consolidation starts to happen, Byrne said an increase in worth wouldn’t be the major factor.
“A lot of my clients today are tired and they’re frustrated, and there’s a little fear there. And there was a time not too many years ago they wouldn’t have admitted being tired. They’d have come up with something else as the reason they wanted to sell or consolidate,” he said.
Fatigue is also Hargrove’s main concern within the industry.
“I hear that with almost every board or every bank manager that I talk to now that they’re tired,” he said.
“When the industry improves just a little bit more, within the next six to 18 months, we’re going to see a significant increase in acquisition activity because of that alone,” Hargrove said.
No small part of the fatigue is the uncertainty of what new regulations, or changes to old ones, will mean to the way they conduct business.
“The Dodd-Frank required, like, 250 new rules and regulations, and 30 to 40 percent of those have been drafted in, put into a form either as a proposed regulation or have passed. So there’s still a lot to come out, and what our banks are struggling with right now is just to keep up,” Vice said.
Vice has hired an attorney at the Kentucky Department of Financial Institutions “whose primary responsibility is to monitor requirements of the Dodd-Frank Act. We’ve offered her to our banks as a resource, and she tried to keep track in a spreadsheet of what regulations have come out, what’s due and what’s the potential impact to our banks.”
Hargrove and Byrne agree community banks have their work cut out for them to keep up with the new and evolving regulatory environment, but they don’t see it being too high of a hurdle.
“Community banks have been saying [they can’t handle regulation changes] for 20 years, and they’ve always found a way to get the job done. It’s been a concern of community banking since I’ve been in banking for more than 28 years,” Hargrove said with a laugh when asked if the changes were too much to handle.
The way Byrne sees it, there will always be small community banks, because there will always be a niche for them.
“The big banks don’t want to be in 80 percent of the land mass of Kentucky. They want to be in the dynamic, the urban, the areas where they can do wealth management and sell other products; they don’t want to go to the hinterlands,” he said.
Community banks in Kentucky, Byrne said, also have the advantage in what is usually an ugly stereotype of the Bluegrass State: being behind the times.
“Our banks will witness what’s going to go on nationally, and it will happen elsewhere and we’ll be prepared to sort of deal with it. Bankers do sort of believe in the herd instinct; what they see their brother and sister banks doing around the country, they’ll feel like they need to do it themselves. But we won’t be leading the charge here in Kentucky,” Byrne said. “We’ll be followers, and that’s not a bad thing.”