Banking on bad times

Monday, August 4, 2008 at 2:41am
The national credit crunch has hit Middle Tennessee, but some local banks are poised to prosper. Bloomberg News

Trite as it may sound, the maxim that Nashville’s diversified economy takes the edge off national economic problems still holds true — and it is shielding many local banks from the smelliest of the subprime sludge and other credit problems.

There is still a bitter pill to swallow.

A number of Middle Tennessee’s big banking players are struggling with bad loans and capital constraints that are creating losses and forcing them to essentially fire many longtime customers. For these institutions, things look to get substantially worse for much longer than the banks and many industry experts previously predicted.

Poised to capitalize on this disconnect are a crop of start-up banks that, more so even than their established community-banking brethren, have the capital and clean balance sheets to take market share and quickly establish themselves as legitimate players — if they can manage the risks that come with the opportunity.

Companies like Avenue Bank, CapStar Bank and Reliant Bank all have hit the market in the last two years — CapStar celebrated its official opening just last month — promising to bring old-school local relationship banking to consumers and middle-market businesses frustrated with the regional bank business model.

With a good number of those regional banks now in subprime crisis management role, they can also offer them access to capital many of those regional banks can no longer make available.

“This wasn’t exactly in our plan a year ago,” said Mark Mattson, chief credit officer at CapStar, whose leaders raised a whopping $88 million while in start-up mode. “We’ve missed the mess and we’re able to be a little more opportunistic because a lot of the competition is restricted in what they can do.”

Behind Door #3….

The worst of the banking sector’s troubles have centered on regional companies such as National City Corp. and SunTrust Banks Inc. and it appears unlikely Middle Tennessee will produce a bank failure like California-based IndyMac’s. All Nashville-area banks and savings institutions were classified as “well capitalized” according to federal regulatory criteria as of March 31 of this year, though several showed reductions in capital over the prior nine months.

But statistics compiled by The City Paper show how the housing downturn is beginning to work its way through the systems of local, smaller players as well. At the end of the first quarter, the median ratio of delinquent loans to total loans at area banks stood at 0.71 percent, up from 0.43 percent at the end of 2007 and more than double the year-ago number.

On its own, that number in itself wouldn’t be cause for alarm. Typically, eyebrows aren’t raised until the ratio is well north of 1 percent and the superregional banks that have run into the most trouble this year sport noncurrent ratios close to double that.

But the trend is troublesome and set to worsen significantly as more banks — including some smaller community players — turn off the money faucets as they focus on getting to grips on their problems.

“I really think we’re looking at at least another year, maybe even beyond next summer,” said Wynne Baker, member in charge of KraftCPAs’ banking practice. “I don’t know that they’ve really identified their problems yet. It’ll take a good year to really find out.”

One local lender said this summer is likely to produce a big jump in bad loans because it will mark the one-year anniversary of the last loans and lines of credit issued before the credit crunch hit full force.

In good times, such an anniversary would pass with no fanfare and perhaps a “great to do business with you” call from the loan officer to the developer. But this summer, those loan officers are picking up the phone to call the loan.

If they don’t ask for full repayment, bankers will offer their developer clients some variant of the following three equally unpalatable options.

– The first is to immediately reduce the outstanding balance of the loan by a quarter. Given the perilous state of most developers’ balance sheet, that’s simply not an option.

– Option No. 2 is for the developer to try to rapidly sell vacant homes by dropping the prices to a point where only the bank can be made whole.

– And behind door No. 3 lies the auction gavel that will produce essentially the same result as the second choice.

A focus on ’de-marketing’

Whatever medicine the developers choose to take, it will inflict more pain on both the builders and the banks. Those decisions also will have an effect on the bigger commercial lending picture, especially for the small and mid-sized businesses many banks covet. With their capital basis hamstrung by mortgage losses, several banks are having to rein in their lending elsewhere and are telling clients their business is no longer welcome — a strategy some bankers have taken to calling “de-marketing.”

And this is where the region’s newer and nimbler banks have a chance to capitalize. DeVan Ard Jr., CEO of Brentwood-based Reliant, said “a lot of the more emotional factors are coming into play [as] some customers of larger banks are being made more aware that decisions about their business are not being made locally.”

Small and middle-market companies nudged to the sidelines are increasingly looking to region’s new players as well as Pinnacle and Tennessee Commerce, two of the bigger local financial success stories of the past decade.

“To the extent the Pinnacles of the world are willing and able to step up, we’re seeing banks like them take big market share over the weak sisters,” said Jeff Davis, banking analyst and managing director of FTN Midwest Securities Corp.’s Nashville office. “With the credit crunch, the large banks are very inward-focused and they have tightened up.”

Jim Schmitz, Middle Tennessee area executive for Regions Bank, says his company isn’t in the same boat as his peers and sees similar opportunities to build market share. Despite having to deal with rising loan losses that slashed second-quarter profits by more than half from a year ago, he said Regions is a step ahead of its competitors at this point.

“We went through a lot of the efficiency exercises that banks are going through right now,” he said. “We’re in the position, so far, to take advantage of the situations where some of the other big banks have pulled back.”

This flight to capacity is a national story. In an earnings-season webcast last month, Pat Dorsey, director of equity research at Morningstar, said a select group of large banks led by Wells Fargo and JP Morgan are benefiting big time from the troubles of some of their peers.

“If your balance sheet is still strong and you are able to lend, you are printing money at this point,” Dorsey said. These companies, he added, “are taking market share like wouldn’t believe.”

Managing the risk

But with the opportunity also comes a potential pitfall. The lackluster economy means some companies really aren’t in good shape these days. Just because the bank that’s firing them is doing so under some duress doesn’t mean they’ll make a good client at another bank. That, says Kraft’s Baker, is what the newer institutions flush with capital need to keep in mind.

“The issue is how quickly they need to put those dollars to work,” Kraft’s Baker said. “Will their shareholders push them into taking extra risks?”

Fat chance, says CapStar’s Mattson, who said there’s no extra pressure to rush blindly in the fray and put the bank’s capital to work. In a diversified economy like Middle Tennessee’s, his crew “will see enough good opportunities and not be pressed to sacrifice credit quality.”

And because of the bigger economic picture, prospective borrowers can count on a little extra scrutiny of their performance and prospects, he said. It’s about a fatter pipeline, not lowered standards.

“In an economy like this, you’re going to do a little more stress testing and downside analysis than two years ago,” he said, adding that regulators are also stepping up their scrutiny of banks’ risk analysis processes. “Borrowers need to expect that.”

Similarly, despite his bank’s growth, Reliant CEO Ard, who raised $11 million new capital this spring, has retained a healthy dose of caution.

“It’s a tough environment in which to grow really fast,” Ard said. “If you opened a bank in the last six months, the biggest challenge is finding enough loans.”

That’s the ultimate wild card for banks young and old, sick and healthy: Will the broader economy escapes a deep recession and begins to recover late this year or in early 2009? Observers agree that the majority of Middle Tennessee businesses are strong enough to endure the current slowdown. But both FTN Midwest’s Davis and Regions’ Schmitz said they’re concerned about the impact of the housing slump and inflation on the consumer sector.

“Have we seen the bottom in the housing market? I don’t know,” Schmitz said. “What concerns me is how what started as a housing issue works its way through the rest of the economy… It’s going to be a while before things get really good again.”

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