When The Devil Went Down To Georgia

The 2006 class of de novo banks will go down as the largest in Georgia history. Beyond that, there’s little to crow about.

“There were 19 of us that started that year. About half have failed, and of the ones that remain, about half of those are struggling,” says Charlie Crawford, a 27-year banker and chief executive officer of $200-million asset Private Bank of Buckhead in Atlanta, one of the survivors. “It’s certainly been the toughest period I’ve operated in during my career.”

Well over 400 banks have failed nationally since 2007, but few places have felt more pain than Georgia. The implosion of the subprime mortgage market set off a chain reaction that halted a seemingly unstoppable real estate-based economy-and a thriving and profitable banking market-dead in its tracks.

Through May, 79 banks, including eight from the 2006 de novo class, had failed in the Peach State. That’s 22 percent of Georgia’s banks, second in percentage only to Nevada (25 percent), and a greater absolute number than any other state.

The estimated cost to date of all those Georgia bank failures to the Deposit Insurance Fund: $8.5 billion. More than half of the banks left standing today are operating under some sort of regulatory order, meaning that more failures are likely.

The fallout for boards has been predictable, sometimes tragic. Dozens of directors and officers are facing lawsuits brought by the Federal Deposit Insurance Corp. Allegations of criminal fraud are flying, and some convictions already have been recorded. Congressional hearings have been convened.

Georgia’s banking crisis wasn’t rooted in too-big-to-fail banks or derivative trading operations. Indeed, Silverton Bank, a $4.1-billion asset banker’s bank with 1,400 correspondents, was the largest and most complex bank to fail.

While problems on Wall Street, especially in the subprime mortgage market, get much of the blame for sparking the state’s banking mess, it was a proliferation of young, growth-hungry-and loosely regulated-banks that helped set the table for the severity of the state’s banking woes.

Of the 79 banks that have failed thus far in Georgia, 45 were started in 1998 or later, including 30 that were launched after 2002.

At a time when bankers everywhere complain about heavy-handed regulation, Georgia’s experience represents a cautionary tale, of sorts, for what can happen when regulators are too hands-off. In retrospect, state and federal agencies handed out too many charters during the boom times, and examiners didn’t crack down on riskier lenders when it might have done some good.

It was a potent combination that, when mixed with risky lending behaviors and poor board oversight, left the state’s industry more vulnerable to the 2008 financial crisis fallout than might otherwise had been the case.

Georgia’s economy in the early- and mid-2000s was white-hot, driven by in-migration and the seemingly universal belief that the state’s real estate market was immune to cycles. Between 2001 and 2008, 150,000 or more people a year moved to the state. In Metro Atlanta alone, the population swelled from 2.9 million in 1990 to 5.7 million 20 years later.

The influx created strong demand for housing, along with all of the shopping malls, office buildings, schools and support infrastructure that goes with it. Median home prices jumped by 50 percent in the five years prior to 2007, while lot prices nearly doubled.

“In-migration was our industry,” says Walt Moeling, a longtime Atlanta banking attorney and a partner with Bryan Cave LLP. “We saw a lot of employment gains, most of them related to people moving here.”

Bankers and wannabe bankers wanted in on the action, and on their terms. In the years leading up to the crisis, they complained loudly about excessive government meddling in their business. “The mantra was, less regulation is better, no regulation is best,” says David Kemp, president of Bankers Management Inc., an Atlanta consulting firm.

In 2002, the state general assembly shortened the time required before a de novo bank could be sold to just three years, from five. Other states adopted similar measures, but in Georgia the effects were immediate.

In total, 66 Georgia banks were acquired between 2002 and 2007, many after short lives and for high multiples, according to figures supplied by SNL Financial LC.

Typical was Homestead Bank of Suwanee, in booming Gwinnett County, just north of Atlanta. Launched in 2003 with $10.5 million in capital, Homestead bulked up to $287 million in assets before it was sold for $50 million, or 2.64 times book value, just over three years later. (The buyer, $2.5-billion asset Security Bank Corp. in Macon, failed in 2009.)

Such success stories attracted a flood of capital into the community bank space, and the number of banks competing for business soared. Between 2002 and 2006, investors pumped $800 million into the launches of 70 new banks in Georgia, according to SNL.

“A lot of these banks in Georgia were started simply for speculative purposes,” Kemp says. “The idea was to get the charter, fatten up the pig as quickly as you could, put some lipstick on it and sell it in three years for two-and-a-half times book value.”

The charters seemed relatively easy to come by. Bankers say that sometime around 2003, the requirement that prospective banks demonstrate “convenient populations” whose banking needs weren’t being met was de-emphasized.

“The biggest change I saw over the years … was the ease of entry,” said Gary Fox, former CEO of the failed Bartow County Bank of Cartersville, in August 2011 testimony at a special hearing on Georgia’s banking crisis before the U.S. House Subcommittee on Financial Institutions and Consumer Credit.

“It seemed to me the only requirement [for getting a charter] became whether or not you had enough initial capital to meet the chartering authority’s requirement,” Fox added.

Moeling recalls speaking with a federal regulator in 2006. “He told me, ‘The industry has been asking for deregulation, and we’ve given it to them.’” The new attitude, espoused by this regulator: “If you have $20 million in capital and a president who can spell ‘bank,’ who are we as regulators to second-guess their business judgment? They might lose money, but that’s not our problem.”

Private Bank’s Crawford says it’s unfair to blame regulators for what happened to the 2006 de novos. “If those 19 banks had been more diverse or grown slower and had stricter underwriting, things wouldn’t have been as bad,” he says.

Robert Braswell, who became commissioner of the Georgia Department of Banking and Finance in late 2005, says Georgia’s chartering standards were no different from those of other states, and notes that the FDIC also had to approve new banks.

Even so, he concedes that he was “concerned that the number of charters coming through” was spurring unhealthy competition and outstripping the state’s management talent pool.

To try to slow things down, Braswell says, capital standards were raised, and raised again, but with little effect. “If we required $19 million, they would bring $23 million. One brought in $32 million; another brought in $125 million.”

More charter applications were denied in his first three years than in the 15 years before, he adds, yet 28 new banks were launched in 2006 and 2007. “The applications all showed in-migration of people, growing deposits, board members diversified across industries,” Braswell explains, “and the capital was so plentiful, it was tough to say no.”

The fast-growing Atlanta suburbs beyond the I-285 perimeter were hotbeds of de novo activity. Land was plentiful and folks could get housing for a reasonable price. Banks sprouted up in places like Alpharetta, Sandy Springs and Carrollton, where demand for housing and acquisition, development and construction (ADC) loans was abundant.

The newbies bankrolled developers who built the houses for folks who would arrive three years hence to buy. They grew quickly, using brokered deposits for funding, and many turned good profits. In 2005 and 2006, Georgia’s banking industry earned more than $3 billion a year, and there was little apparent reason to expect things would change.

A Sandler O’Neill + Partners research note on Georgia’s community banking sector, published in November 2006, declared that the state’s “robust population growth, strong pace of business development and … positive tailwinds for banking will persist and likely accelerate” in the future.

With hindsight, Moeling says, the banking industry had become a house of cards, fueled by the “self-deception of developers, bankers, regulators and economists.”

Adding so many banks, all vying for the same business, made it a borrowers’ market. Institutions lowered credit and underwriting standards and looked the other way when consumers bought more house than they could reasonably afford or developers bankrolled multiple projects.

Many directors were far too complacent in their oversight, or too intimidated by dominant CEOs or the industry itself, to be effective, observers say. “They couldn’t tell you if the CEO was performing well or not, and by the time they realized something was wrong, it was usually too late,” Kemp says.

Some got greedy, and pushed management teams to stretch for growth and profits. “I saw it happen all the time: Management would bring a budget and the board would say, ‘You’re sandbagging us, doing just enough to make your bonus,’” Moeling says. “There was tremendous pressure from boards to make a quick buck.”

And it wasn’t just new banks in the suburbs that caught the fever. Rural towns like Ellijay, in the mountains near the Tennessee border, attracted a steady flow of snowbirds. Real estate prices soared, and some established banks grew their loan portfolios two- or threefold in the years before they failed.

Loan demand was highest in residential construction, and that’s where banks focused their efforts. Rates and terms hit ridiculous levels. The typical subdivision takes roughly three years to move from drawing board to filled neighborhoods. To win business, many banks offered “interest reserves”-money added to the loan that borrowers could use to cover interest payments during the development phase-to sweeten the deal.

Others regularly engaged in so-called “loan stacking,” where they made multiple project-based loans to the same individual or developer, even though the underlying borrower lacked the financial strength to back the loans.

“Whoever had the least amount of credit controls got the business,” Kemp says. “There was so much competition; the dumbest banker in town was allowed to set the credit standards for everyone else.”

Rainmaker lenders with strong connections to the construction business were in high demand. Those lending officers would pressure managements to break their credit disciplines.

“The marketing guys would go to the loan committees and say, ‘I know our policy says the owner has to put 20 percent into a project, but the bank down the street is doing deals at 10 percent in. If we don’t match them, we’re not going to get any business,’” Kemp explains.

The competition for ADC loans was fueled in part by banks that had been chartered to provide small-business or consumer banking services, not real estate loans.

Regulators are supposed to ensure that banks stick to their plans, Kemp notes, but in the early- and mid-2000s, “there was too much deference [by examiners] to boards, especially those with prominent directors.”

RockBridge Commercial Bank in Atlanta was launched a month before Crawford’s Buckhead bank, with $36 million in capital and a stated mission to cater to small- and mid-sized businesses. Three years later, it failed with 65 percent of its $211 million loan book in real estate development or commercial real estate loans.

RockBridge’s board had several heavyweights from the Atlanta business community, including Home Depot Inc.’s former general counsel, Lawrence Smith, and William Porter, former partner at the accounting firm Porter Keadle Moore LLP. “They grew phenomenally, and almost exclusively with commercial real estate,” Crawford says. “I don’t think that’s what their business plan said.”

Braswell defends his department’s performance, saying it didn’t willfully allow banks to go off-plan, “but we’re only in there once a year. … We would go in and say, ‘Wow, you have really diverted from what you stated you would do,’” he explains.

Banks would get slapped with some restrictions and “derogatory comments” in their exam reports, Braswell continues. “But they would say, ‘Yes, we diverted. But we’re profitable. We don’t have any past-due loans. No harm, no foul.’”

Tom Dujenski, director of supervision for the FDIC’s Atlanta region, says regulators aren’t the only ones with responsibility for ensuring that banks don’t veer off-course. “It’s not just the regulators who make sure a bank is sticking to its business plan, it’s the board,” he says.

ADC concentrations in Georgia soared to an average of 220 percent of capital, about twice the national average, Dujenski says. “For the banks that failed, the average concentration was almost 400 percent,” he adds.

The metrics might have hinted at trouble, but when the subprime market began to show cracks in early 2007, most thought Georgia would be immune.

“We had economists, business leaders, chambers of commerce, they were all saying the exact same thing: ‘The reasons that people have been coming to Georgia are not changing, and will not change in the future,’” recalls Joe Brannen, president of the Georgia Bankers Association.reasons that people have been coming to Georgia are not changing, and will not change in the future,” recalls Joe Brannen, president of the Georgia Bankers Association.

Bankers initially remained confident. Many had internal studies that showed their loans were going to sound developers building in areas with high housing absorption rates. And besides, they had real estate as collateral. In 2007, few believed real estate prices would drop.

Within just a few months, however, things began to take a dramatic turn south. Brannen recalls getting an uneasy call from one of his members in June. “He said, ‘Joe, I think something’s going on here. It’s Monday morning, and no one is in my lobby who wants anything. That’s never happened before.’”

The recession had made people less willing to pull up roots, and in-migration, the engine of the economy, abruptly stopped. The problem was particularly acute in Atlanta’s outer-ring suburbs, where annual population growth rates fell from above 5 percent in 2006 to less than 1 percent three years later, according to the Atlanta Regional Commission.

“All of a sudden, builders that had been aggressive stopped looking for new loans for expansion, and borrowers weren’t returning calls as quickly as they had in the past,” Brannen says.

Before long, real estate prices began to drop. Construction halted. Tens of thousands of workers in construction-related fields lost their jobs, adding to the problem. Prices dropped more. In no time, the cycle had taken an abrupt 180-degree turn. When banks began foreclosing on borrowers they began to see how bleak things were.

Moeling recalls attending one foreclosure for a client. “There were four other banks foreclosing on houses the guy had bought in the same subdivision,” he recalls. “Instead of selling 100 percent of the homes that were being built, as the [housing absorption] data showed, we were only taking 70 percent of the homes off the market.”

According to the National Association of Realtors, the median single-family home price in the Atlanta metro area has fallen from about $172,000 in the first quarter of 2007 to $88,000 in the first quarter of 2012. Today, the most striking feature of the once-bustling suburban landscape is the acres of PVC “pipe farms”-entire subdivisions of developed lots with no houses on them.

The tenor of board leadership was often what separated the survivors and failures. At $200-million asset Midtown Bank in Atlanta, the board includes several real estate executives. As the market began to unravel, those directors “recommended that we begin discounting prices very aggressively to get the real estate-related exposures off our books, before prices fell more,” recalls R. Stan Kryder, Midtown’s CEO and a director.

Midtown booked loan-loss provisions of $9.5 million in 2009, and had a couple of difficult years. But the aggressive action early in the crisis allowed it to survive. The real estate sales “proved to be the right strategy,” Kryder says. “It reduced our exposures to the more speculative areas.”

Crawford’s Buckhead bank benefited, as much as anything, from timing. It was the last of the 2006 charters, getting started in December. As the market dried up, “we grew much slower than we wanted to, or had forecast,” he says.

In 2007, Crawford says he saw “a lot of crazy deals that didn’t fit our underwriting criteria,” and remained disciplined. “It didn’t feel so good then, but boy do we look wise today.”

Other banks accelerated lending activities during the early stages of the crisis, seemingly oblivious to what was unfolding in front of them.

Alpha Bank & Trust in Alpharetta was the first of the class of 2006 to fail, and it also was the biggest. It began its short life in May with $34 million in capital; just over a year later, Alpha had $182 million in total loans-nearly double what the business plan filed with regulators had envisioned over five years.

Examiners demanded a new business plan, but chalked up the growth to successful loan officers. What they missed, according to the FDIC’s Office of the Inspector General, were shoddy underwriting, which failed to “capture the financial condition of the borrowers,” and compensation policies that violated rules limiting bonus payments during a bank’s first three years of operation. Alpha also ignored legal lending limits and caps on loan-to-value ratios.

The OIG report also assigns much of the blame to a disengaged board, noting that directors regularly missed meetings, and failed to “ensure that bank management identified, measured, monitored and controlled the risk of the institution’s activities.” Nor did it comply with rules governing bonus payments during a bank’s first three years of operation.

Alpha’s failure cost the insurance fund $214 million.

The pain wasn’t limited to suburban de novos. Many smaller banks in no-growth areas, as well as those in Atlanta, participated in risky out-of-market loans to beef up their balance sheets.

The Peoples Bank, an 84-year-old lender in Winder, put together a $100 million loan for an Atlanta developer to build a massive residential community-not in Winder or even Atlanta, but Phoenix. The loan was beyond the $447-million asset bank’s ability to underwrite on its own, so it turned to Silverton, an Atlanta-based banker’s bank, to help parcel out participations to more than 60 other banks, half of them in Georgia.

When the market tanked, the property went into foreclosure before any homes were built. Peoples failed, as did Silverton, which, as a banker’s bank, played the role of middleman for out-of-market loan participations involving hundreds of banks, most of them in ADC lending. Its failure rippled through the balance sheets of community banks across Georgia, many of which owned Silverton stock.

In addition to slipshod underwriting, an FDIC lawsuit filed against 17 former Silverton directors-all of them bank CEOs-alleges that the board approved spending $35 million on a posh new headquarters building and millions more on an aircraft hangar and two new jets.

Silverton’s failure cost the DIF $1.3 billion. Worse, critics say, has been the FDIC’s post-failure handling of loan participations, including those of Silverton. “They sell the stuff for pennies on the dollar, and don’t care that banks get wiped out,” Kemp says.

Those participations are significant parts of many smaller banks’ balance sheets, Brannen says, and complaints about the FDIC’s liquidation sales are common around the country. In many cases, the banks would just as soon work the loans to get the most out of them, but have no control. Dumping properties also dings hard when new appraisals show a fall in values.

“Next, the regulators require more collateral,” Brannen explains. “If the borrower doesn’t have it, the banks have to write down those losses, even if the loan is current. It spills over onto banks that were otherwise alright.”

Clearly, the regulatory community and boards could have performed better both before the crisis and during it. Have lessons been learned?

Braswell knows that when the economy recovers, people will once again be looking to start banks. He’s been making the rounds lately telling bankers that new charters will be tougher to come by in the future.

“We’ll need to see a true need for banking,” he says. “We’re going to dig a little deeper into the numbers, and we’ll be walking the streets in the communities to gauge the demand. If we don’t see a need, we won’t approve the charter.”

Dujenski says the overall quality and rigor of pre-crisis examinations was sound, but also acknowledges room for improvement. He says examiners in the future will be “more proactive in identifying risks” when banks deviate from their stated business plans or exceed recommended concentration limits.

“When the regulators make recommendations to the bank, we’re going to monitor things more closely, to make sure management’s response is timely,” Dujenski says.

The chaos has highlighted the oversight role of boards, and already changed the way many are going about their business. Even at the healthier banks, directors are devoting more time to loan reviews, asset-liability mix and ensuring that the loan book is as diverse as possible.

Boards also are holding more executive sessions with outside experts and regulators to verify that what they’re hearing from management is accurate.

“Don’t just perfunctorily sign your name to loan reviews and audits. Invite those people to your board meeting,” Kemp suggests. “No management; just the outside directors. Go into an executive session, and ask them to give you their candid opinion about the bank.”

“We’re seeing more boards doing that today,” he adds.

Perhaps most significantly, the crisis has “reset” expectations about bank valuations in boardrooms across the state. Crawford concedes that some of his directors signed up hoping they could sell the bank for a big multiple. Now, they’re content that Private Bank has survived the turmoil.

“There’s a new normal that everyone has had to get used to,” Crawford says. “The whole build-to-flip strategy that dominated the industry has vanished.”

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