Has Consolidation Killed the Community Bank?


4-21-14-jacks-blog.pngAn argument that I hear occasionally is that consolidation of the U.S. banking industry has put community banks on a path towards extinction. Two economists at the Federal Deposit Insurance Corp. (FDIC) have shot down this theory in a new research study whose findings are counterintuitive.

On the face of it, the industry’s consolidation over the past 30-plus years has been pretty dramatic. The FDIC says there were approximately 20,000 U.S. banks and thrifts in 1980, and this number had dropped to 6,812 by the end of 2013. A variety of factors have been at work. The biggest contributor, according to the study, was the voluntary closure of bank charters brought by deregulation, including the advent of interstate banking. A lot of the “shrinkage” that occurred between the mid-1980s and mid-1990s wasn’t so much the disappearance of whole banks as it was the rationalization of multiple charters by the same corporate owner to save money.

A couple of recessions—from 1990-1991, and again from 2007-2009—also played a role in the industry’s downsizing. The FDIC says that bank failures accounted for about 20 percent of all charter attrition between 1985 and 2013—a culling of the herd which is painful but ultimately healthy since it tends to eliminate the weaker management teams.

Interestingly, the study did not look at how many bank charters were eliminated through acquisition, although I think we can safely assume that this has played an important role, particularly among the larger banks. In 1990 the 10 largest U.S. banks controlled 19 percent of the industry’s assets; by the end of 2013 their share had climbed to 56 percent. That increase in financial concentration is almost all the result of acquisitions of large banks by even larger banks, much of which occurred in the 1990s.

While the big banks just got bigger, the really small banks mostly disappeared. In what I thought was the study’s most interesting finding, the number of banks with less than $100 million in assets dropped by a stunning 85 percent from 1985 to 2013. For banks under $25 million, the decline was 96 percent. Again, the FDIC doesn’t say why, although I think we can assume that acquisitions, charter rationalizations and failures all played a role.

A central point of the study is that there are still plenty of community banks around, especially if you define them not by an arbitrary asset size, but rather by what they do and how they do it. Community banks, according to the FDIC, “tend to focus on providing essential banking services in their local communities. They obtain most of their core deposits locally and make many of their loans to local businesses.” Most banks in the U.S. would meet this definition of “community,” including a great many that are well over $1 billion in assets.

How might consolidation affect community banks going forward? The FDIC study ends with the upbeat assessment that community banks will continue to be an important source of funding to local businesses, and I would agree in part because I am uncertain about how much more consolidation is likely to occur.

I pointed out in a February 4 blog that there were 225 healthy bank acquisitions in 2012 and 224 in 2013, according to SNL Financial. And I offered a prediction that there would be between 225 and 250 acquisitions this year and perhaps as many as 275 in 2015. That still sounds about right, and it would put the pace of consolidation back to where it was in 2007—or a year before the financial crisis. Many of those deals will likely involve community banks, and while that would lead to a decline in their overall population, it would also create “local” institutions that are larger in size. It certainly won’t decimate the ranks of community banks.

I don’t believe that community banks are facing extinction, but they are facing some very significant challenges in the years ahead—and not from consolidation. The sharply increased cost of regulatory compliance might lead some community banks—say, those under $100 million in assets —to sell out if they can find a buyer; others will respond by trying to get bigger through acquisitions so they can spread the costs over a wider base.

Gaining access to capital will also prove to be a huge challenge for many smaller banks. By “smaller” I am thinking of institutions with $1 billion in assets or less, although the cutoff point might be higher. The higher capital requirement that has been established under the Basel III agreement is a permanent minimum expectation. Traditionally, banks have had the freedom to manage their capital to fit the environment they found themselves in, preserving it when times were bad and leveraging it when times were good and they wanted to grow. Now, banks that want to grow might need to raise additional capital to support a larger balance sheet. But as the banking industry’s capital level has grown, its return on equity has declined (a function of simple math) and not all investors will be interested in a small bank offering limited returns. I believe there will be a great deal of competition between banking companies to attract capital, and there will be winners and losers.

A third challenge is the dependency that many community banks have on commercial real estate lending, a historically volatile asset class that resulted in hundreds of bank failures in the early 1990s, and again during the most recent financial crisis. The most enduring community banks could be those that are able to diversify into other loan categories so they are not at risk when the next commercial real estate crash occurs. But diversification will require the acquisition of talent and skill sets that most community banks do not possess, so it’s a strategy that must be pursued with purpose.

The challenges facing community banks today are real, but consolidation isn’t one of them.

This article originally appeared on The Bank Spot and was reprinted with permission.

FDIC D&O Lawsuits Surge in 2013


2-19-cornerstone-research.pngFederal Deposit Insurance Corporation (FDIC) litigation activity associated with failed financial institutions increased significantly in 2013. The FDIC filed 40 director and officer (D&O) lawsuits in 2013, compared with 26 in 2012, a 54 percent increase from 2012. The pace of new lawsuits in 2013 slowed in the fourth quarter to only three, however, compared with 10, 15, and 12 in the preceding quarters. 

These findings are included in “Characteristics of FDIC Lawsuits against Directors and Officers of Failed Financial Institutions—February 2014,” a Cornerstone Research report.

Analysis
The surge in FDIC D&O lawsuits in 2013 stems from the high number of financial institution failures in 2009 and 2010. Of the 140 financial institutions that failed in 2009, the directors and officers of 64 (or 46 percent) have either been the subject of an FDIC lawsuit or have settled claims with the FDIC prior to the filing of a lawsuit. For the 157 institutions that failed in 2010, 53 (or 34 percent) have either been the subject of a lawsuit or have settled with the FDIC.

The FDIC’s D&O lawsuits in 2013 particularly focused on the largest institutions that failed in 2010. Of the largest 20 failures in 2010, 15, or 75 percent, have already been subject to FDIC lawsuits or settled claims with the FDIC.

Claimed Damages
From the beginning of 2010 to the end of 2013, the FDIC has filed 84 D&O lawsuits. It has explicitly stated damages amounts in 77 of the 84 complaints against directors and officers of failed financial institutions, for a total of at least $3.8 billion in claimed damages. While nearly half of the 84 lawsuits were filed in 2013, only $1.2 billion, or 32 percent of the FDIC’s claimed damages, is attributable to the lawsuits filed in 2013. This pattern mirrors the relatively smaller size of the institutions that that were the subject of 2013 D&O lawsuits.

Defendants and Charges
Inside and outside directors, together, have also routinely been named as defendants in FDIC D&O lawsuits. This pattern continued in 2013 (75 percent of lawsuits filed in 2013). Outside directors were exclusively named as defendants in rare instances and only in lawsuits filed in 2013 (8 percent). Somewhat more common were lawsuits in which only inside directors were named (15 percent of 2013 lawsuits, compared with 23 percent of lawsuits filed before 2013).

Chief executive officers continue to be the most commonly named officers in FDIC D&O lawsuits. The FDIC named CEOs in 83 percent of the complaints filed in 2013. In contrast, chief credit officers, chief loan officers, chief operating officers, or chief banking officers were named in 43 percent of the 2013 lawsuits.

All 40 lawsuits filed in 2013 included allegations of gross negligence, and 32 included additional allegations of negligence. Thirty-five of the 40 lawsuits included allegations of breach of fiduciary duty.

Settlements
Of the FDIC’s 84 D&O lawsuits, at least 17 have settled in whole or in part and one has resulted in a jury verdict. The FDIC has also settled disputes with directors and officers prior to the filing of a complaint. Settlement agreements published by the FDIC indicate that in at least 82 instances, the agency has resolved disputes with directors and officers. In these settlements, as many as 38 agreements, or 46 percent, required payments by the directors and officers. Directors and officers agreed to pay at least $34 million in these cases. 

Future Trends
While the FDIC’s filings of new D&O lawsuits hit a lull in the fourth quarter of 2013, new filings are unlikely to continue at such a slow pace in the first half of 2014. Three lawsuits have already been filed in January, and as motions and discovery unfold in existing lawsuits, this year will be interesting to follow. For example, a recent ruling in the U.S. Court of Appeals for the Eleventh Judicial Circuit pertinent to the many Georgia-based lawsuits allows directors and officers to assert defenses related to the FDIC’s post-receivership conduct that will directly affect loss causation and damages arguments. These types of judicial rulings may greatly influence the relative negotiating strength of the FDIC and defendants. How this ruling and others like it affect the likelihood of settlements may determine whether we see protracted litigation in the FDIC’s D&O lawsuits or movement to settle cases earlier.

Why Small Banks Will Consolidate


While announced deal volume continues at a tepid pace, key drivers of M&A activity are starting to emerge. With more than 90 percent of the banking companies nationwide operating with assets of less than $1 billion, it is inevitable that consolidation will be concentrated at the community bank level. Six factors that point to a pick-up in M&A activity in this space are as follows:  

1. Bank equity prices are rising with an increasing valuation gap between small and large banks. Bank stocks overall have increased nearly 30 percent in 2013; however, banks with less than $1 billion in assets continue to trade at significant discounts compared to larger banks.   

Austin---Price-Tangible.png

As the chart above indicates, the valuation gap has widened for larger banks, which enjoy a median 51 percentage point premium as of August 31, 2013. Larger banks can use this valuation advantage to present attractive deal pricing to smaller banks.    

2. Very few FDIC-assisted transactions remain. Since 2008, 485 banks have failed representing nearly 7 percent of banking companies in the U.S., according to the Federal Deposit Insurance Corp. Essentially; FDIC-assisted transactions filled the void of traditional open-bank deals. With troubled bank totals dwindling and only a few significantly undercapitalized banks remaining, FDIC-assisted deals are diminishing. Acquisitive companies have moved on from this once lucrative line of business to evaluate more traditional deals.

3. Improved asset quality is leading to reduced credit marks. While merger discussions have occurred in recent years, the due diligence phase often brought deal negotiations to a screeching halt. With elevated credit marks (in some cases exceeding 10 percent), parties were unable to bridge the valuation gap. Over time, banks have made significant progress in reducing classified assets and writing down assets that more closely approximate fair value. With credit marks now modestly exceeding the target’s allowance for loan and lease losses, capital and book value can be preserved, which in turn, translates to more favorable deal pricing.

4. Several high profile deals have been announced at attractive premiums. Achieving certain benchmark pricing levels in M&A often is a catalyst for deal activity. Sellers are always looking for market information to help formulate a strategy on whether or when to sell. On the other side, buyers do not want to be perceived as overpaying, which is usually viewed in the context of pricing relative to other recent deals. Transactions like MB Financial’s acquisition of Cole Taylor Group at 1.82 times tangible book value and Cullen/Frost Bankers’ acquisition of WNB Bancshares at 2.84 times tangible book have already spurred discussion inside many boardrooms.  

5. Economies of scale in the banking industry have never been more crucial. The need and desire to grow exists at virtually every institution. As the chart below indicates, efficiency ratios have remained consistently lower at larger banks.

Austin---Efficiency-Ratio.png

Whether driven by regulatory costs, technology, marketing, pricing power, expanded lines of business/other revenue sources, larger banks appear to have clear performance advantages. This increasingly important trend will spur institutions to grow via acquisitions in order to spread certain fixed costs over a larger asset base and thereby improve operating efficiencies.  

6. Mergers among community banks. None of the preceding points are intended to suggest that banks under $1 billion will not participate as buyers of other community banks. In fact, since 2010, banks of less than $1 billion in assets have announced or completed 280 acquisitions, comprising more than 41 percent of the deal activity during that period.  A recent example of this type of deal involved Croghan Bancshares, which has $630 million in assets and is headquartered in Fremont, Ohio. Croghan is buying Indebancorp, which has$230 million in assets and is headquartered in Oak Harbor, Ohio. After considering other alternatives, Indebancorp chose Croghan, a larger community bank, as a partner. The deal was structured with 70 percent of the consideration in Croghan stock and priced at 134 percent of Indebancorp’s tangible book value. The deal value per share was 28 percent higher than Indebancorp’s stock trading price and cash dividends to Indebancorp shareholders will increase by almost 200 percent. On a pro forma basis, Indebancorp shareholders will own approximately 26 percent of Croghan’s shares following the deal.  

Making M&A predictions is always challenging, but here at Austin Associates, we believe many community banks will make the decision to sell within the next few years. When M&A returns to full capacity, expect at least 300 transactions per year, or 20 percent consolidation of the industry within five years. Pricing will continue to increase, but do not expect to see pre-crisis multiples any time soon. Moreover, pricing will be highly dependent on the target’s unique profile (size and performance), as well as local and regional market factors. 

Update on FDIC Lawsuits: Pace Increases While Few Settle


9-18-Cornerstone-Research.pngThis is the sixth in a series of reports that analyzes the characteristics of professional liability lawsuits filed by the Federal Deposit Insurance Corporation (FDIC) against directors and officers of failed financial institutions (D&O lawsuits). *

  • At least 32 FDIC D&O lawsuits have been filed in 2013: 10 in the first quarter, 15 in the second quarter, and seven so far in the current quarter. The pace of filings in the second and third quarters of 2013 has exceeded the rate of new filings compared with any equivalent period in the previous three years. If the filing of new lawsuits in 2013 continues at the pace observed through August, 53 lawsuits will be filed this year—more than double the 26 filed in 2012. Since 2010, the FDIC has filed 76 lawsuits against the directors and officers of failed institutions.
  • Financial institution failures were most common between the third quarter of 2009 and the third quarter of 2010. Given the three-year statute of limitations for tort lawsuits and the likely existence of tolling agreements allowing the FDIC additional time to determine if it will file a lawsuit, this year has seen, as expected, an increased amount of filing activity. Of the 32 lawsuits filed so far in 2013, nine were against institutions that failed in 2009 and the remaining 23 were against institutions that failed in 2010.
  • Of the 76 filed lawsuits, 10 have settled and one has resulted in a jury verdict. Three settlements have occurred this year, with four in 2012, and three in 2011.
  • Chief executive officers continue to be the most commonly named defendants. They have been named in 88 percent of all filed complaints and 28 of the 32 lawsuits in 2013. Chief financial officers, chief credit officers, chief loan officers, chief operating officers, and chief banking officers are also commonly named defendants. Outside directors have been named, frequently along with inside directors, in 75 percent of all filed complaints and 24 of the 32 lawsuits filed in 2013.
  • To date, the FDIC has claimed damages of $3.6 billion in the 69 lawsuits that have specified a damages amount. The average damages amount has been $53 million, with a median value of $27 million. Lawsuits filed in 2013 have had a lower average claim than lawsuits filed in 2011 and 2012. In the aggregate, the largest claims have related to the failure of California institutions, while the largest number of D&O lawsuits have targeted failed institutions in Georgia.
  • Of the failed financial institutions in 2009, the directors and officers of 57, or 41 percent, either have been the subject of an FDIC lawsuit or have settled claims with the FDIC prior to the filing of a lawsuit. For institutions failing in 2010, the comparable figure is 39, or 25 percent.
  • FDIC seizures of financial institutions continued to decline in 2013 compared with 2012. After only four seizures in the first quarter of 2013, there were 12 in the second quarter and four in the third quarter through August 27, 2013. In total, 20 institutions have been seized so far in 2013 compared with 51 in 2012. Since 2007, 488 financial institutions have failed.

For a full report, click here.

*The FDIC may also file lawsuits against other related parties, such as accounting firms, law firms, appraisal firms, or mortgage brokers, but we generally do not address such lawsuits here.

Bank M&A Midyear Update: Consolidation Pace Remains Lower Than Expected


Many people expected the pace of bank mergers and acquisitions in 2013 to pick up as a result of pressures from regulatory burdens, lack of growth in existing markets, and boards and management teams that had grown weary of banking.

However, deal activity for the first six months of 2013 indicates a consolidation pace consistent with 2012. The pace is ahead of 2011 and 2010 levels but still below levels seen before the credit crisis. Deal volume in 2012 was bolstered by a considerably vibrant third-quarter deal flow. Unless the same deal volume is experienced in the third quarter of 2013, the yearly deal count could slip below 2012 levels.

Number of Deals by Quarter
Year Q1 Q2 Q3 Q4 Totals
2008 45 38 36 24 143
2009 24 34 19 41 118
2010 27 52 49 50 178
2011 35 43 32 37 147
2012 55 51 73 56 235
2013 50 51 101

Credit Quality Concerns Still Affecting Deal Volume

In a survey on merger and acquisition conditions jointly conducted by Bank Director and Crowe Horwath LLP in October 2012, one of the primary impediments to consolidation reported was the credit quality of potential sellers. While current-year levels of nonperforming assets by sellers are better than they were at the peak of the credit crisis, levels are still high compared with historical norms.

Average Nonperforming Assets/Total Assets of Sellers (%)
Year Q1 Q2 Q3 Q4 Totals
2008 1.69 1.15 0.81 2.14 1.40
2009 2.45 2.64 3.23 4.46 3.32
2010 4.07 4.21 4.52 4.13 4.25
2011 4.42 6.49 3.71 4.24 4.84
2012 2.95 4.25 3.78 3.29 3.57
2013 3.28 3.85 3.57

* Totals are weighted averages.

History indicates that when credit problems are prevalent in the banking industry, both the number of deals and pricing are negatively affected.

Pricing for deals announced in the first half of 2013 are consistent with the overall pricing for 2012 and up slightly from the second half of 2012. Credit quality would appear to be dampening overall pricing.

Average Price/Tangible Book Value (%)
Year Q1 Q2 Q3 Q4 Totals
2009 101.48 123.27 125.62 107.24 113.73
2010 147.78 123.49 105.56 111.67 118.39
2011 112.11 105.93 108.88 107.15 108.48
2012 128.88 113.83 109.24 107.55 114.30
2013 115.97 112.53 114.25

* Totals are weighted averages.

FDIC Deal Volume Drops 

Although the Federal Deposit Insurance Corporation (FDIC) continues to work with institutions, deal flow for assisted transactions has diminished from its peak in 2010. Asset discounts, the bid amount for an institution divided by the assets sold, have settled in at around 16 percent, likely the result of the FDIC offering deals without the benefit of a loss-sharing agreement. The average deposit size of the institutions sold has also decreased.

FDIC-Assisted Deals
Year # of Deals Average Deposits
Assumed ($000s)
Average Asset
Discount %
2010 147 403,975 10.83
2011 90 319,549 15.70
2012 47 205,398 15.63
2013 YTD 16 107,881 15.94

Branch Deal Volume Slightly Lower Than Prior Years

Branch deal volume is on pace to be slightly lower in 2013. Deposit premiums dipped in 2012 but have rebounded back to 2010 and 2011 levels in the first six months of 2013. For many community banks, a small one- or two-branch network might be the only feasible acquisition opportunities. While deposit premiums are up in 2013, they still are at a reasonable level and in some regions are still well below the average. As larger and regional bank holding companies continue to evaluate their branch networks, there likely will continue to be acquisition opportunities available.

Branch Deal Volume
Year # of Deals Average Deposit
Premium %
2010 78 3.22
2011 81 3.33
2012 88 2.53
2013 YTD 27 3.40

Possible M&A Indicators for the Next 12 Months

While deal volume has been steady these past several years, it is still at a pace well below the predictions from various industry pundits. The past two Bank Director/Crowe Horwath merger and acquisition surveys highlighted concerns about credit quality, the economy, and regulatory issues as major causes of the slowdown.

While credit quality has been improving in the industry, the levels of nonperforming assets are still high compared to historical averages. Based on the correlation between deal volume and credit quality, the overall level of nonperforming assets will need to improve significantly before deal volume will increase. Economic indicators have been improving, but there are still unknowns both in the U.S. economy and worldwide, which suggests that uncertainty is still at levels that make it difficult to do deals.

The regulatory environment has stabilized some now that regulatory agencies have taken industry concerns into consideration and revised their Basel III rules, but the overall level of concern over regulatory issues is still high. Issues implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act and the new rules from Consumer Financial Protection Bureau are challenging banks as they try to comply with the onslaught of new rules.

As a result, it appears as though bank merger and acquisition levels will remain constant and more moderate than the levels predicted over the past several years.

Final Basel III Rules Revealed: Community Banks Aren’t Completely off the Hook


7-19-13_Naomi.pngThe Basel III final rules recently released make clear one thing: Small, community banks are getting a break. It may not actually feel that way. In fact, community bank CEOs across the country tell me they are very frustrated with new regulation, with Basel III, with the Dodd-Frank Act and with examiners scrutinizing their banks and coming up with problems that never seemed to be a problem before. The overarching theme is that more regulation is coming down the pike, Basel III’s final rules are just one part, and they will be burden to digest and implement.

“It’s a massive rule where they consolidated three notices of proposed rulemakings,” says Dennis Hild, a former Federal Reserve bank examiner and Crowe Horwath LLP director. Even though Hild is based in Washington, D.C. and it is his job to understand this stuff, even he admitted he had a lot of reading to do. So it will be a bundle for a small bank CEO to figure out, too. “There is still much to learn. We need to dig through it. We need to find out what’s important.”

The news in late June and early July that the Federal Reserve Board, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corp. (FDIC) would jointly mitigate some of the proposals most onerous to community banks was a welcome, if small, relief in a heavily regulated industry.

Under the final Basel III rule:

  • Banks under $15 billion in assets can continue to count trust-preferred securities—known as TRuPS—as Tier 1 capital.
  • Banks can continue to risk-weight residential mortgages as they had under the original Basel I regime. The final rule abandons a proposal to institute a complicated formula of risk weights for residential mortgages.
  • All but the largest banks (above $250 billion in assets) can keep available-for-sale securities on the balance sheet without having to adjust regulatory capital levels based on the current market value of those securities. Banks have a one-time opportunity to opt-out on their first regulatory call report after Jan. 1, 2015 from what’s called the accumulated other comprehensive income (AOCI) filter. If they miss doing so, they can’t opt-out later.

FDIC Chairman Martin J. Gruenberg specifically said in a press release that changes to the final rule had been made because of community bank objections. The Federal Reserve even published a guide just for community banks to explain the new rules. The Independent Community Bankers of America (ICBA) acknowledged the gesture on behalf of community banks but said in a statement that it still supported an outright exemption from Basel III capital standards for community banks.

It doesn’t appear that community banks will be getting that. The goal of the new rules is to improve the quality and quantity of capital maintained by banks, should another financial crisis take place.

Most community banks will have to comply with the higher regulatory capital standards under the Basel III final rules. Small bank holding companies with less than $500 million in assets are exempt, but their depository institutions must comply. Thrifts and thrift holding companies also must comply with the new rules. The FDIC estimated that 95 percent of insured depository institutions already meet the capital standards required under the final rules. Still, bank management teams, and the bank boards that oversee them, will have to figure out if their banks need to raise capital, and if so, how.

Many other aspects of Basel III will impact community banks as well. Bank officers have been calling consultants and law firms to figure out the impact of the new rules.

One of the biggest questions has been how an acquisition might subject a bank to new rules under Basel III, say if an acquisition bumps the bank above $15 billion in assets. How will the TRuPS on the merged companies’ books be treated?

The biggest banks might feel deterred from M&A if it propels them into the ranks of “advanced approach” institutions, which are those with more than $250 billion in assets or more than $10 billion in on-balance sheet foreign exposure, such as foreign government debt. Such a category subjects those banks to special Basel III rules and higher standards. Also, under yet another proposed rule from all three federal banking regulators, bank holding companies with more than $700 billion in combined total assets or $10 trillion in assets under custody must maintain double the current minimum leverage ratio of 3 percent to be considered “well capitalized.” Regulators estimate only eight institutions in the country would be subject to this leverage requirement.

One aspect of Basel III that might impact community banks is exposure to certain “high volatility” commercial real estate loans, usually acquisition and development loans, which will require higher risk weights. There also will be limitations on certain kinds of deferred tax assets, says Hild.

His advice? Don’t freak out right now. Banks will have time to figure this out.

Although banks with more than $250 billion in assets will have to comply with new capital rules during a phase-in period that starts January 1, 2014, smaller institutions have until January 1, 2015 to begin phasing in the new standards. That will certainly be enough time to figure out if Basel III is a non-event for your organization.

FDIC Lawsuits Trending Upward


4-8_Cornerstone.pngIf the current pace of Federal Deposit Insurance Corp. (FDIC) lawsuits against directors and officers of failed institutions continues, 39 lawsuits will be filed in 2013—more than any year since the financial crisis began. As the number of filed lawsuits increase, the number of new failures has decreased. The most commonly named defendant in an FDIC lawsuit continues to be the chief executive officer.

These are some of the Cornerstone Research authors’ findings in their fifth in a series of reports that analyze the characteristics of FDIC professional liability lawsuits filed against directors and officers (D&O) of failed financial institutions.

In brief:

  • At least 12 FDIC D&O lawsuits have been filed in 2013, 10 in the first quarter and at least two in the first three weeks of April. The pace of filings in the first quarter of 2013 slowed slightly in comparison with the 12 filed lawsuits in the fourth quarter of 2012, but is higher than any previous quarter in 2010, 2011, or 2012. If the filing of new lawsuits continues in 2013 at the pace observed through the third week of April, 39 lawsuits will be filed this year—more than any year since the financial crisis began.
  • FDIC seizures of financial institutions continued to decline so far in 2013 compared with 2012. Eight institutions have been seized as of April 22, 2013. Since 2007, 476 financial institutions have failed.
  • Institutions that are subject to D&O litigation have historically been larger (in terms of assets) and have had higher estimated costs of failure than the average failed financial institution. While this was not true in the second half of 2012, the FDIC’s recently filed D&O lawsuits have again, on average, targeted larger failed institutions.
  • Chief executive officers continue to be the most commonly named defendants. They have been named in 88 percent of all filed complaints and 10 of the 12 lawsuits in 2013. Chief financial officers, chief credit officers, chief loan officers, chief operating officers, and chief banking officers are other commonly named defendants. Outside directors have been named, frequently along with inside directors, in 75 percent of all filed complaints and nine of the 12 lawsuits filed in 2013.
  • The FDIC has recently begun to publish settlement agreements related to its professional liability cases. Based on the settlement agreements we have reviewed, the FDIC has obtained aggregate settlements of $601 million—$115 million attributable to filed D&O lawsuits, $216 million attributable to claims involving D&Os that did not result in a filed complaint, and $270 million attributable to claims against professional firms and non-D&O individuals associated with failed financial institutions.
  • Since the December 7, 2012, trial verdict of three former officers of IndyMac’s Homebuilder Division resulting in a $169 million award, the parties have filed post-trial briefs on the applicability of pre- and post-judgment interest. The court has ordered that both are appropriate. A mediation to address remaining issues is scheduled for May. The D&O insurance carrier will participate in the mediation. 

C&I Loans: Do Community Banks Have a Competitive Advantage?


3-14-13_CI.pngGrowth in commercial and industrial (C&I) lending is generating a lot of buzz in the industry. As reported in the fourth quarter banking profile released by the Federal Deposit Insurance Corp. (FDIC), C&I loans rose 12 percent during the last year to $1.5 trillion.  A recent phone survey conducted by Bank Director of 142 community bank CEOs and chairmen in the southern United States confirms this growth, with 64 percent revealing plans to grow through C&I lending this year, compared to 29 percent that plan to grow through consumer lending and 7 percent through specialty finance.

Paul Merski, executive vice president, congressional relations and chief economist at the Independent Community Bankers of America (ICBA) explains that while the lending environment as a whole is highly competitive, C&I lending is a growth area where community banks with the right expertise can have an advantage over larger banks.  “It’s highly competitive, and it’s really something that the community banks shouldn’t cede to the larger banks,” says Merski, as community banks have the relationships within the local business community to place themselves at a competitive advantage.  

Cadence Bank, a $5.4-billion asset privately owned regional bank based in Birmingham, Alabama, with locations across Alabama, Florida, Georgia, Mississippi, Tennessee and Texas, saw the highest growth in C&I loans in the nation for the fourth quarter, as reported by SNL Financial.  As the result of three bank acquisitions, Cadence saw overall loan growth, including the bank’s C&I portfolio, which grew 41 percent to $1.79 billion, according to Paul Murphy Jr., CEO of Cadence Bancorp and chairman of Cadence Bank.  Additionally, Cadence “hired 65 people with extensive lending experience,” Murphy says.  “That would be the formula for more growth than normal.”

According to Merski, C&I loans can offer a higher rate of return than standardized loans, like mortgage loans, as these types of loans allow for greater customization and flexibility in the terms and rates offered to the borrower.  In turn, this can help increase profitability for banks squeezed by net interest margins. At Cadence, C&I loans generate additional deposits, and the fee income opportunities that these loans provide are a significant benefit. Cadence has also seen advantages in cross-selling other products like treasury management, “which is also good business, and helps fund the bank,” says Murphy.

The focus of bankers on C&I has, naturally, raised the interest of regulators, who question whether terms are growing too flexible and rates are dipping too low. As with any product, having the proper risk management controls in place is key, says Merski, adding that a diverse loan portfolio that includes C&I can benefit a bank.  “For community banks, not being overly concentrated in one lending area” can help improve a bank’s risk profile, he says.

Murphy stresses that banks wanting to enter the C&I fray should have lenders with the right skill set.  The recent hires at Cadence hold an average of 18 years of C&I lending experience, and Murphy views C&I as the bank’s core business.  “We’re not doing it because it’s en vogue,” he says.  “We’re doing it because this is what we’ve always done.”

Bank Director also surveyed bank CEOs about plans to increase spending in branch technology, branch expansion, mobile applications and ATMs.  Fifty-two percent do not plan additional spending in any of these areas. Twenty-one percent plan to upgrade branch technology, and 19 percent plan increased investment in mobile apps.  “The mobile banking app utilization is just going through the roof,” says Murphy.  “People love it.” 

Cadence Bank is building an automated branch using video tellers near its Birmingham, Alabama, headquarters. The branch will feature one video teller, without in-person staff like tellers and loan officers. Murphy explains that video banking will allow Cadence to extend hours as well as save on man power by having one person handle transactions at several branches.  “I think we can actually do a better job for customers,” says Murphy. 

Thirteen percent of the bankers surveyed plan to open new branches, while just 2 percent plan increased investment in ATMs.

ABOUT THE SURVEY 
Bank Director conducted a brief survey by phone in February and March, polling 142 community bank CEOs and chairmen in Alabama, Arkansas, Florida, Louisiana, Mississippi, Oklahoma, Tennessee and Texas.  The survey focused on growth in that region in advance of Bank Director’s Growth Conference to be held in New Orleans, Louisiana, on April 30 and May 1. Ninety-nine percent of the respondents were bank CEOs; most of the respondents represented the states of Texas (29 percent), Oklahoma (25 percent) and Alabama (15 percent).   

FDIC Lawsuits Increase in Fourth Quarter, Many Target Smaller Banks and Thrifts


cstone-dec12-wp.pngThis is the fourth in a series of reports that analyzes the characteristics of professional liability lawsuits filed by the Federal Deposit Insurance Corporation (FDIC) against directors and officers of failed financial institutions.

Report Summary

  • The pace of FDIC D&O lawsuit filings has increased in the fourth quarter of 2012 compared to earlier in the year. The number of lawsuits filed in 2012 exceeds the total filed in 2010 and 2011.
  • On December 7, three former officers of IndyMac’s Homebuilder Division were found liable for $169 million in damages in connection with 23 loans. This was the first FDIC D&O lawsuit associated with the 2008 financial crisis to go to trial.
  • While there has been a continued decline in FDIC seizures throughout 2012, the number of problem financial institutions has not declined as rapidly.
  • Institutions that are subject to D&O litigation have historically been larger (in terms of assets) with higher estimated costs of failure than the average failed financial institution. The FDIC’s recently filed D&O lawsuits have targeted smaller institutions.
  • Named defendants primarily continue to be CEOs, then (in declining order of frequency) chief credit officers, chief loan officers, chief operating officers, chief financial officers, and chief banking officers. Outside directors continue to be named along with inside directors in a large majority of the new filings.
  • Regulatory management ratings and composite CAMELS (capital adequacy, asset quality, management, earnings, liquidity, sensitivity to market risk) ratings of institutions that are subject to D&O lawsuits do not appear to have deteriorated until one to two years before failure.

Fewer Directors and Officers Get Sued; Pace of Bank Failures has Slowed


cornerstone-0912-wp.pngThis is the third in a series of reports that examines statistics and offers commentary on the characteristics of professional liability lawsuits filed to date by the Federal Deposit Insurance Corporation against directors and officers of failed financial institutions.

  • In our May 2012 report, we had observed a decline in the seizures of banks and thrifts by the FDIC in 2012 relative to 2011 and 2010 levels. This decline has continued during the past four months. In the past four months, the FDIC seized 19 financial institutions. The pace of seizures in May through August is slightly less than the first four months of 2012, when the FDIC seized 22 institutions.
  • FDIC seizures in 2012 continue to be concentrated in the Southeast. Nine of the 41 institutions that failed this year were in Georgia. Since 2007, 84 institutions in Georgia have been seized, representing 18 percent of all failures. Florida has the second highest financial institution failure rate, with five failures in 2012 and 63 failures since 2007. Illinois and California follow, with 53 and 39 failures, respectively, since 2007.
  • Based on the FDIC’s estimates at the time of seizure, California—where financial institution failures have cost $21 billion since 2007—has the highest total estimated failure cost. Florida and Georgia each have more than $10 billion in estimated failure costs, followed by Illinois, Puerto Rico, and Texas.
  • While the pace of D&O lawsuits has increased in 2012 relative to previous years, the FDIC has filed new lawsuits in the past four months at a significantly slower rate than in the first four months of the year. Only three lawsuits were filed in the last four months compared with 11 in the first four months of the year.
  • To date, 7 percent of financial institutions that have failed since 2007 have been the subject of FDIC lawsuits. These lawsuits generally have targeted larger failed institutions and those with a higher estimated cost of failure. The 31 financial institutions targeted in lawsuits had median total assets of $836 million, more than 3.5 times the median size of all failed institutions and more than five times the median size of institutions active at mid-year 2012.
  • Defendants named in the 32 lawsuits the FDIC has filed since 2007 included 266 former officers and directors.

For a full copy of the latest report, click here.