The Silverton Effect

Originally appeared October 1, 2009

The Silverton Effect

Regulators, recession test bankers’ bank business model

By Tom Bengtson and Tony Telschow

The impact of the financial crisis on the industry’s bankers’ banks is noticeably different from the financial crisis of the 1980s. While the fledgling bankers’ bank initiative was barely on the regulatory radar screen during the agricultural-based economic crisis of 25 years ago, in the current environment the multi-billion dollar industry is drawing close regulatory scrutiny.

Furthermore, the failure of Silverton Bank, N.A., earlier this year has raised the visibility of correspondent banks as systemic players in the industry. Although Silverton was a wholesale bank with general public ownership, its bankers’ bank origins have spurred regulators to look more closely at the nation’s bankers’ banks.

“I think the fallout of it is the bankers’ bank model is being looked at; there’s more heightened scrutiny. I think it’s really coming from folks that don’t necessarily know us that well,” said Bill Mitchell, president and CEO of Denver-based Bankers’ Bank of the West.

Mitchell said that “people east of the Potomac River” may not understand that thousands of community banks use bankers’ bank services in order to compete with larger banks.

“Ask any community banker and they’ll tell you we’re critical to them, and ask any small business owner and they’ll tell you community banks are critical to them. Sooner or later the government will get that idea,” Mitchell said.

Other factors make today’s environment for bankers’ banks distinct from the 1980s.

“One of the biggest differences was that the crisis back then was rural, today it is urban,” said Bill Rosacker, president of United Bankers’ Bank in Bloomington, Minn. Founded as the Independent State Bank of Minnesota, UBB is the country’s first bankers’ bank, chartered in 1975. “Bankers’ banks are also much larger today than they were back in the 1980s. Back then, they were too small to care about.”

Rosacker noted two other distinctions. First, in the 1980s, there were many robust competitors in the correspondent banking business. Today, he said, “bankers’ banks are the only full-service correspondent banks.” Second, bankers’ banks currently operate over a much wider geographic area than they did in the 1980s. Rosacker noted that 25 years ago, bankers’ banks typically served customers in their home state; now most of the banks serve customers in several states.

As the bankers’ banks have grown, they have attracted more attention from regulators. As a bank for banks, regulators cannot overlook the systemic role the nation’s bankers’ banks play in the banking system. When the Office of the Comptroller of the Currency closed Silverton Bank, N.A., on May 1, the FDIC created a bridge bank to assure service to the failed banks’ customers. It was only one of a handful of times in its 75-year history that the FDIC has used the bridge bank tactic. Silverton Bridge Bank, N.A. is controlled by the FDIC, which hired Texas Independent BankersBank to provide day-to-day operational management.

Although founded in 1986 as the Georgia Bankers’ Bank, Silverton Bank, N.A., modified its charter in 2007 so that 25 percent of its ownership could be held by the general public. The move disqualifies the institution from being considered a true bankers’ bank, which limits ownership to customers. At the time of the closing, Silverton had $4.1 billion in assets, $3.3 billion in deposits, 1,400 clients in 44 states, and six regional offices. Silverton Bridge Bank will operate until most of its clients have moved their business elsewhere, or until another bank buys what’s left of the Silverton operation.

Wake-up call

Silverton has become a wake-up call to the bankers’ bank movement. “They’re looking at us now with more scrutiny because of Silverton,” Rosacker commented.

Ron Slater, president of the Bankers’ Bank in Madison, Wis., said the Silverton failure tainted the entire bankers’ bank industry. “They are painting us all with the same broad brush,” he said.

“It’s a focused scrutiny on a non-similar segment of the banking industry,” Slater said. “If they’re concerned about the systemic risk that was raised by Silverton, then that should apply to all correspondent banks or to everyone that operates in that same business environment, and not specifically to bankers’ banks.”

Even without Silverton, managers at most of the 20 bankers’ banks will note differences between the institutions. “We can’t all be lumped together because while some bankers’ banks are real strong in the investment side of things, others are real strong on the operations side, and still others on the loan side,” commented L.D. McDonald, president of Midwest Independent Bank in Jefferson City, Mo.

“All of us are not the same,” Rosacker emphasized. “Some of the bankers’ banks don’t loan money the way we do. Some are bigger in investments, and even though they are full-service, they have their own specialties.”

Despite the differences, regulators apparently are looking at all bankers’ banks more closely than they have in the past. “On a national level what they’re doing is looking at the bankers’ banks, increasing scrutiny as it relates to systemic risk, as it relates to our business model. That’s unfortunate,” McDonald said. “I think a lot of that it due to the fact that Silverton failed, and Silverton is still lumped in with the bankers’ banks, although they changed their charter some 18 months ago. Nevertheless, federal regulators and others are lumping us all together.”

The consequences of that additional scrutiny are evident: On June 30, Independent Bankers’ Bank and its holding company, Bankers’ Bancorp., entered into a written agreement with the Federal Reserve Bank of Chicago and the Illinois Department of Financial and Professional Regulation’s Division of Banking. On August 5, Nebraska Bankers’ Bank entered into a written agreement with the Federal Reserve Bank of Kansas City and the Nebraska Department of Banking and Finance. And on August 28, Midwest Independent Bank and its holding company, Midwest Independent Bancshares, Inc., entered into a written agreement with the Federal Reserve Bank of St. Louis. Midwest Independent Bancshares also is the holding company for Nebraska Bankers’ Bank.

John Munn, director of the Nebraska Department of Banking and Finance, told media after the announcement was made about Nebraska Bankers’ Bank that regulators were concerned about the business model, not about specific operational concerns at the bank.

Reflection of customers

“We will continue to serve our customers as we always have,” McDonald said. “Now, are there some issues we’re dealing with? Of course. We’re dealing with CRE concentration. As our downstream respondents originate commercial real estate loans they over-line that to the bankers’ banks. As the economy has turned south, as the portfolio has become challenged in the downstream respondents, in turn, ours has become challenged.”

“The challenges occur because we’re a finite industry, subject to the challenges that affect our clients,” Slater said. “It rolls up, if you will. It doesn’t roll up just in the bankers’ bank. It rolls up in correspondent banks.

“The real difference if you look at a Milwaukee or Minneapolis-based correspondent bank is that they are also a retail bank. The reason bankers’ banks were formed was so that community banks could do business with a correspondent who was not also a competitor. That’s why bankers’ banks have been so successful over the years.”

“Bankers’ banks reflect their customers,” Rosacker observed. “Bankers’ banks are under stress because our customers are under stress.”

Rosacker knows a little about what it means to run a bank under stress. He was brought into United Bankers’ Bank in 1985, when it was in danger of closing due to its connection to a very troubled farm economy in Minnesota. The bank worked its way through those problems. Referring to colleagues at the bank, Rosacker said: “Some of us have been here and lived through that tumultuous time in the 1980s. As a result, our mindset is different here from the new, young, aggressive bankers.” Emphasizing its conservative nature, Rosacker said of United Bankers’ Bank: “We do not have a hot balance sheet. We are a plain cake doughnut; we’re not a jelly-filled bismark.”

As community banks around the country are working to beef up their capital, bankers’ banks are doing the same. Bankers’ Bank of the West received $12.6 million in funds through the Capital Purchase Program. Mitchell told local media last February that it plans to use the money to buy loans from customers, among other uses. Pacific Coast Bankers’ Bank, which is based in California, also obtained money through CPP.

Other bankers’ banks are calling on customers to raise more capital. McDonald said Midwest Independent Bancorp is in the middle of a capital drive that had raised $3 million in its first three weeks. McDonald said he expects to raise much more in a drive that he characterized so far as being “steady.” Rosacker said United Bankers’ Bank is making plans to announce a new capital drive soon.

Although the current economy represents a new test for the bankers’ bank movement, much confidence remains in this unique business model. “Our growth has come from community banks,” Rosacker said. “There are still 400-plus community banks in the state of Minnesota, and there are more than 700 that we are doing business with in the region.”

“The comments that I get from our clients are that it’s extremely important to them to have a bankers’ bank to provide service to them,” Slater said. “Absent that, they may be priced out of offering a product or their cost of doing business goes up, and that doesn’t benefit anyone.”