Now is not a good time to be a bank.
Losses on residential construction loans and the ongoing credit crunch has hit banks of all shapes and sizes, from super-regionals like SunTrust Banks and Wachovia, to community banks like Alpha Bank & Trust in Alpharetta. And with debt financing more difficult to obtain, banks are struggling to raise capital.
Investors have taken note of banks’ problems. On Monday, SunTrust shares fell to $30.92, their lowest price since September 1995. Shares of First Horizon National Corp., the biggest bank in Tennessee, at one point Monday dropped to $5.88, its lowest since September 1991.
Other banks are also struggling mightily. Shares of Wachovia, BB&T Corp. and National City Corp. of Ohio have all declined this year. Shares of Washington Mutual Inc., the biggest U.S. savings and loan, have fallen 85 percent in the past 12 months. Fifth Third Bancorp shares have dropped 69 percent in the same period.
Deal Watch Blog spoke with Nelson Mullins Riley & Scarborough partner Brennan Ryan about the state of the banking industry. Ryan, whose clients have included Congaree State Bank of South Carolina and Atlantic Southern Bank of Macon, Ga., said the worst isn’t over and he expects some Georgia banks to fail this year. Here is an edited transcript of the discussion.
Why is now such a bad time for banks?
A multitude of reasons. One is the credit crunch, which created the mortgage crisis, which then created a lack of demand for developed properties. Also, the Fed’s rapid reduction in interest rates caused a margin squeeze for banks. Banks make money on the difference between what they lend out and what they have to pay their depositors. With the Fed’s rate reductions, banks’ loan rates re-set faster than their deposits.
Think of it this way: If you have a construction loan with a customer that’s at a prime rate, it resets when the Fed changes the prime rate. It will work itself out over time, as certificates of deposit and other borrowings re-set over time. It should spread back out where the banks can make money, but in 2008, banks have got credit and demand problems combined with very tight margins.
What really hurt banks was the rapid drop. If the Fed had dropped rates over a 2-year or a 3-year period it wouldn’t have hurt the banks as much, because the re-pricing of loans would have taken place over a period of time.
If the Fed starts to raise rates, and there have been discussions about it, the banks may see the opposite. Loans would re-price upwards, but CDs are fixed, so raising interest rates could potentially help banks. But that’s a double-edged sword; if you raise rates too much, you wipe out the economy because it lowers demand.
Do these problems affect all banks, from super-regionals to community banks to credit unions?
Yes, but each has different issues. Bigger banks have more exposure to sophisticated financial instruments, more exposure to sub-prime loans; look at Citibank. That’s not what’s affecting small banks in Atlanta, but the collateral damage from the sub-prime situation does affect local banks.
Credit problems have caused a drop in demand. There are a lot of people who can’t get a mortgage these days. So what banks may have expected in demand for housing and housing construction, that’s not happening.
The biggest problem in the Atlanta market for community banks has been construction and development loans. Developers would purchase land, or tear down houses and re-build, or buy raw land and develop it, primarily the latter in Atlanta. The credit crunch hit so fast and so hard, a lot of these guys were not able to meet their obligations.
If 5 percent of a bank’s loans go bad, that can wipe out two to three years’ worth of earnings for some banks.
Can you discuss the problems banks are having in trying to raise capital?
A lot of community banks don’t have the access to the public capital markets that the big banks do. Their means are limited. Citigroup can run to the private-equity markets or the public markets, but if you’re a small community bank, it’s not that easy.
Sometimes community banks just pass the hat around to try to raise funds, sometimes bank directors put the money in themselves, but they’re doing that in a very tough environment. A lot of community banks were founded by selling stock to family and friends, and now they’re having to go back to them and ask for money again.
In some cases banks have to sell to outside investors, and for small banks that’s a limited option. Security Bank Corp. in Macon recently conducted that kind of transaction (the issuance of $40 million in subordinated debt to affiliates of FSI Group LLC), but it was at a significantly dilutive price to their current shareholders.
What is the likelihood of banks failing in Georgia?
Most people in the industry believe there will be several failures. Regulators and staffing up in response to the likelihood there will be failures. I think there are some likely candidates in the Atlanta market.
If not failure, certainly the acquisition of some struggling banks is an option. Gainesville Bank & Trust wasn’t in specific trouble with regulators at the time it was acquired by SunTrust, but they were acquired at a price significantly dilutive to their shareholders. However, GB&T’s choice was to raise more capital or to sell the bank. GB&T shareholders received SunTrust stock for their stock, and since they signed that deal the banking industry has probably gotten worse, so I would say GB&T’s board made a good decision to sell when they did.
Do you think private-equity funds will be allowed to increase the size of their investments in banks without invoking the heightened regulatory oversight?
There are some proposals out there about that and a lot is being driven by the larger banks. A lot of the capital that has been raised recently, there has been a private equity component. But private equity is averse to being regulated. I wouldn’t want to speculate on whether bank regulators will approve an increase in the size of private equity investments.