NorthWesternFinancialReview.com Blog

The Minnesota Department of Commerce closed Mainstreet Bank of Forest Lake, one of three banks closed on Friday, Aug. 28. Central Bank of nearby Stillwater, Minn., is assuming the bank’s deposits and most of its assets. The FDIC provides the details here.

A number of speculative media stories appearing during the last few months mentioned Mainstreet Bank, which at the end of the second quarter was the 26th-largest bank in the state. While the bank grew rapidly in the last year (assets grew to $463 million on June 30, 2009 from $403 million on June 30, 2008, and deposits grew to $432 million from $342 million), it struggled. At the end of the second quarter, it was reporting a loss year-to-date of $23.9 million and a negative equity capital position of about $5 million.

Main Street’s holding company, BancMidwest Corporation, also owns White Rock Bank, a $152 million institution in Cannon Falls, Minn. Its latest call report indicates it is running smoothly.

With 416 banks on its “problem list,” the FDIC must decide every week which bank(s) it will close. It does not have the staff to immediately close all the banks that technically may be operating in an insolvent or otherwise unsafe/unsound manner. So there is some judgment that takes place every week about which bank will be next.

I don’t think the public really appreciates or understands the extent to which judgment is a factor in the banking business, and the business of regulating banks. The earnings numbers released last week for the second quarter provide an example.

The FDIC reported that the industry lost $3.7 billion on an aggregate basis for the second quarter. But it also set aside $66.9 billion for loan loss reserves. The loan loss reserve is a number entirely dependent upon collective judgment, some better than others. In the second quarter, the industry charged off $48.9 billion in bad loans, which is about $11 billion less than it reserved for loan losses in the first quarter.

The industry may, in fact, be over-reserving. If the industry had reserved only $60 billion in the second quarter, it may still cover all its losses and it would have been able to report a $3 billion aggregate profit. It is all just a matter of where you put the numbers on the balance sheet; it is all a matter of judgment.

The public would get a better picture of what’s going on in banking if it understood the role that judgment plays in the industry. I heard several news stories last week that cited the latest bank earnings to suggest the economy may still be sinking. It’s faulty analysis given that bank earnings are a lagging indicator of economic conditions, but furthermore, it suggests that people think bank earnings are much more science than art, when in fact it is the other way around.

The media is making the most of the news out of the FDIC yesterday. The media outlets I scanned this morning seemed split three ways on their focus. The Wall Street Journal and this extremist over at CNBC focused on the problem bank list, which grew to 416 banks. The Milwaukee Journal Sentinel and the Des Moines Register focused on bank earnings. The New York Times focused on the shrinking balance at the FDIC fund. These articles report concern for the future of the banking industry; they communicate worry about an economic recovery. Sensationalism sells more papers than even-handedness, so if the media is going to lean toward either alarmism or neutrality, you can easily bet which way they’ll go.

The FDIC is a business reporter’s dream because of all the data the agency provides. Numbers delivered every quarter, on every aspect of the banking business, broken down in every way you could imagine. Every statistic is a story. But all the focus on numbers leaves the public with an incomplete and inaccurate story. Every business owner, and certainly every banker, knows that in addition to hard data business includes the intangible — something I call “the X factor.”

Business owners survey customers and examine census data and consider market reports before they offer a new product, but most business owners also take into account their gut feel. If they have been at it for a while, they get a feel for the business which plays as great a part in decisions as the hard numbers.

Bankers understand this better than anyone. In addition to collateral, credit and the other C’s, bankers — particularly those in smaller institutions – consider character when making a loan. Character isn’t documented by the FDIC or any set of data. Bankers who have been in their communities for a while get a sense for what will work and what won’t, and good bankers make the most of that sense.

I am not so sure newspaper reporters understand this X factor. The stories in this morning’s newspapers lead me to believe they don’t. Industry earnings are down; the problem bank list is grow — sure, but that is only part of the story. If you really want to be able to see what’s ahead you need a lot more information than just the numbers published by the FDIC.

Banks increased loan-loss provisions to $66.9 billion in the second quarter from $60.9 billion in the first quarter, and FDIC Chair Shelia Bair said increased reserves were “by far…the largest drain on industry earnings compared to a year ago.” Bloomberg has a roundup of FDIC’s quarterly report, which includes:

• a surging problem bank list, comprised of 416 institutions with $299.8 billion in assets
• a second-quarter net loss of $3.7 billion from insured institutions, the second quarterly loss in 18 years

“For now, the difficult and necessary process of recognizing loan losses and cleaning up balance sheets continues to be reflected in the industry’s bottom line,” Bair said.

FDIC’s statement is here.

The home page for the web site of Stearns Bank, N.A., in Saint Cloud, Minn., features portals to five separate internet banking programs. That’s right, five. On the upper left corner is the standard icon welcoming customers to the bank’s online banking service. Listed under it are icons for online banking programs at four other banks. After a spate of acquisitions, those banks are now all part of Stearns Bank.

Last Friday, August 21, the bank purchased ebank of Atlanta, Ga., which was closed by the Office of Thrift Supervision. In a purchase and assumption agreement, Stearns Bank assumed the failed bank’s $130 million in deposits and virtually all of its $143 million in assets. It was the latest of several recent acquisitions for Stearns Bank, which is led by Norman Skalicky and Harley Vestrum.

On August 7, Stearns Bank acquired the Community National Bank of Sarasota County in Venice, Fla., which was closed by the Comptroller of the Currency. On the same day, it also acquired the First State Bank in Sarasota, which was closed by the Florida Office of Financial Regulation.

The buying spree began on June 26, when Stearns Bank purchased the Horizon Bank in Pine City, Minn., after it was closed by the Minnesota Commerce Department.

June 26 is the day Stearns Bank sold $24.9 million in preferred stock to the U.S. Treasury through the Troubled Asset Relief Program, or TARP. Stearns bank is one of about a dozen Minnesota banks getting TARP money. Read more here.

According to the FDIC, Stearns Bank had assets of $872.5 million at the end of the first quarter, which is actually down from the $1.1 billion in assets it had at the end of the first quarter 2008. Here is a summary of the assets its has picked up with these four recent acquisitions:

Horizon Bank - $84.4 million; First State Bank - $451 million; Community National Bank - $94 million; and ebank - $143 million. That adds up to $772.4 million in assets from the closed institutions.

Stearns Bank had been very active prior to these recent acquisitions. Last February, the bank acquired a $730 million portfolio from the FDIC containing loans from the former First National Bank of Arizona and Nevada. And, last October, the bank acquired the failed Alpha Bank and Trust of Alpharetta, Ga.

In NorthWestern Financial Review’s quarterly listing of banks by state, accessible to paying subscribers from the home page of this web site, Stearns Bank was listed as Minnesota’s sixth-largest bank at the end of 2008. It will be interesting to see where the bank places at the end of 2009.

Sung Won Sohn, Ph.D., reviewed Fed Chairman Ben Bernanke’s results earlier this summer during a presentation to Minnesota bankers. At the time Sohn said he was going to write a letter to President Obama, urging him to reappoint Bernanke. Whether due to a letter from Sohn we can not say, but the president nominated Bernanke for a second term this morning.

Without Bernanke and the stimulus package passed early this year, “I honestly believe that the nation would have gone into another Great Depression, the cost of which is so high it is not comprehensible,” Sohn said. Sohn was the longstanding, Minnesota-based chief economist for Norwest and Wells Fargo. He is now a professor of economics and finance at California State University and vice chairman of Forever 21, a retail chain.

“I really give good credit, strong credit to Chairman Bernanke,” Sohn said during the presentation. “He and I used to present papers at different economic meetings. If I had known he was going to be this important I should have been very nice to him, but it’s too late,” Sohn quipped.

For a business owner, it is always a little frightening to sign an agreement with another company to provide a service in your name. The shuttering of Taylor, Bean & Whitaker makes the point. The Independent Community Bankers of America trusted Taylor Bean to deliver mortgages through ICBA Mortgage; the problems at Taylor Bean mean problems for ICBA Mortgage customers, and ICBA suffers a blow as a result. Jim Reber, president and CEO ICBA Securities, explained the situation at the annual convention of the Independent Community Bankers of Minnesota on August 7. He explained that ICBA was making arrangements with other mortgages services to handle mortgages in process. The problems will all work themselves out, but not without a certain amount of frustration and inconvenience.

ICBA, a community bank, NFR Communications, or any company wants to provide services requested by its customers. When those customers ask for a service outside the core competence of the company, management often looks to partners to help fulfill that need. That’s what ICBA did when it created ICBA Mortgage. And, that’s what NFR Communications — the company that publishes NorthWestern FInancial Review magazine and sponsors this web site — did briefly in the late 1990s when customers started asking for a web site hosting company. At the time, we were building web sites for banks, in addition to publishing a magazine We knew what banks wanted and we knew how to design web sites, but hosting was another matter. So we partnered with an internet services provider; the service was provided under our name, but the service was actually delivered by a third party.

It didn’t take long before I realized problems associated with such an arrangement. Problems with the third party meant that unhappy customers would call me to complain. It didn’t do any good for me to explain the service was provided by another company. As long as the service was delivered under the NFR name, I got the complaints and the problem was mine, even though I had no ability to solve the problem. We got out of the business of hosting web sites in short order.

Certainly, the business model that provides for the delivery of a service through a third party can be successful. Banks do this frequently to deliver insurance and investment services. But I think the Taylor Bean situation serves as a reminder that these arrangements cannot be taken for granted. If someone is marketing a service under your name, it is important that you understand what they are marketing, and the company’s ability to sustainably offer the service with the quality you expect. You need to have contact with the third party frequently, and you should be prepared to speak up should you detect something that you think might impede the company from delivering as you want.

The monthly economic report from Ernie Goss, the economist at Creighton University in Omaha, shows that considitions across the region — except North Dakota — remain subdued. In North Dakota, home sales are up and farmland prices are rising. Following are highlights from the report. 

For a third straight month, the overall index for the Rural Mainstreet economy declined, continuing to indicate significant economic weakness, according to the August survey of bank CEOs in an 11-state region.

The Rural Mainstreet Index (RMI), which ranges between 0 and 100, slipped to a weak 32.0 from 32.6 in July and 34.0 in June.  However, August’s reading was well up from February’s record low of 16.9.  “The RMI has remained below growth neutral for 18 consecutive months. After appearing to bottom out earlier in the year, the index, which gauges overall economic activity, appears to be moving sideways or with little change,” said Creighton University economist Ernie Goss.   

The weak national economy has affected the farm sector significantly. With net farm income under pressure, both land prices and sales of farm equipment have weakened over the past several months.  This month, bankers were asked about their expectations for 2009 crop yields.  More than three in five bankers, or 61 percent, expect crop yields to be significantly up from last year.  Only 8 percent of the bankers forecast a decline in crop yields from 2008 levels.  Despite this increase in yields, weak farm commodity prices will mean a downturn in 2009 farm income from 2008.  Said Bradley Robson, CEO of First State Bank in Belmond, Iowa, “We have missed the bad weather to date, the hail and wind.  Crops look excellent and should be 20 percent above last year’s yields.  But, with crop prices down, look for 2009 farm income to be off 2008 levels significantly.”

Despite a lot of positive economic news over the past several month, the confidence index, which tracks expectations for the Rural Mainstreet economy six months out, advanced to a still weak 46.0 from July’s 44.6.  Bankers have become a bit more pessimistic regarding the rural economy over the past several months.      

Hiring in rural areas remains very frail for the Rural Mainstreet Economy. The new-hiring index for August was unchanged from July’s 25.0.  This is the 20th consecutive month that the index has been below growth neutral, due in part to the national and global recessions and weakening farm and energy commodity prices.  “Over the past 12 months, rural areas of the region have lost almost 5 percent of their jobs,” said Goss.  

Despite the federal tax credit for first time home buyers, the Rural Mainstreet home-sales index declined for a third straight month. The August reading dipped to 39.2 from 40.0 in July.  This month we asked bank CEOs to compare home mortgage volumes for August of this year to the same period in 2008. Almost 60 percent reported either no change or a decrease in home mortgage volumes. Kurt Henstorf, president of the First National Bank in Shenandoah, Iowa, said, “Home sales seem to be improving, but our commercial sector remains steady in the doldrums.”

Rural Mainstreet reported slippage in banking numbers for the month. The loan-volume index stood at a cool 45.3, up slightly from July’s 43.1. For August, checking deposit growth softened a bit to 52.0 from July’s much stronger 58.5.  The index for certificates of deposit and other savings instruments dipped to 49.4 from 53.8 in July.    

Below are reports for each state:

Colorado: Colorado’s Rural Mainstreet Index (RMI) rose to 24.2 from July’s regional low 18.6.  The August ranch- and farmland-price index advanced to 35.9 from July’s 27.4.  The state’s August home-sales index grew to 31.4 from July’s 26.0.

Illinois: The Illinois RMI once again moved below growth neutral. The RMI for August declined to 28.3 from 30.5 in July.  Farmland prices continue to show weakness with an August index of 33.2, down from July’s 39.4.  The August home-sales index remained unchanged from July at  38.0.

Iowa: Iowa’s RMI once again slipped below growth neutral according to the monthly survey of bank CEOs.  The RMI for August slipped to 27.8 from July’s 30.6. The farmland-price index was also below growth neutral with an August reading of 39.5, almost identical to July’s reading of 39.4.  August’s home-sales index sank to 35.0 from 38.0 in July. However, Larry Winum, president of Glenwood State Bank in Glenwood, sees some positive changes in the economic pullback and consumer caution. “Savings are up considerably, and people have become more prudent in their spending habits. In my view, this is a positive thing.”

Kansas: The Kansas RMI, like much of the region, was below growth neutral.  The August RMI slumped to a regional low of 15.7, from July’s 25.1 and June’s 26.6.  The farmland-price index dipped to 27.4 from July’s 34.0.  The August home-sales index stood at a regional low 22.9, down from 32.6 in July.  Even so, farm yields look very good.  According to Dale Bradley, CEO of Citizens State Bank in Miltonvale, “Crops are in excellent condition in our region and received good rains this past weekend. Over all the economy is pretty stable in the agriculture area.”

Minnesota: Minnesota’s RMI slumped to 19.1 from July’s 22.2.  The state’s farmland-price index declined to 30.8 from 31.1 in July.  The August home-sales index stood at 26.3, which was down from 29.7 in July.  Tourism spending for rural areas of Minnesota continues to be challenged according to bankers. Mark Hewitt, president of Northwoods Bank in Park Rapids, reported, “We are in a resort-tourist area and resorts are reporting good results for the first few months of summer, but with many more cancellations than in the past and more last minute bookings. Vacationers are spending less money when they do come.”

Missouri:  Missouri’s RMI expanded to 34.0 from July’s 28.9 and June’s 30.4.  The state’s August farmland-price index grew to 45.7 from July’s 37.8. The home-sales index stood at 41.2, which was up from 36.6 in July.       

Montana:   Montana’s RMI declined to a weak 29.8 from July’s 33.5.  The state’s farm and ranchland index was also a frail 32.1 while the state’s home-sales index was 35.4. Ken Walsh, CEO of Ruby Valley Bank in Twin Bridges, said, “Moisture conditions have improved over the past year. While this has been much welcomed, it has caused problems with haying.  Early calf prices show a 10 to 15 percent decline from a year ago, and the prospects for improvement are very limited.”

Nebraska: As in past months, Nebraska’s RMI remained below growth neutral. The August RMI inched up to 35.9 from July’s 35.6.  The Nebraska farmland-price index for August expanded to 47.6 from July’s 44.4.   The August home-sales index rose slightly to 43.1 from July’s 43.0.  Bankers across the state reported good crop conditions.  Jeffrey Gerhart, CEO of the Bank of Newman Grove in Newman Grove reported, “We have the potential for a very good corn and bean crop in our area. Timely rains have benefited our area in southwestern Madison County.”  Likewise John Schmaderer, president of Tri-County Bank in Stuart reported, “Row crop conditions in North Central Nebraska are good and hay production was strong as well.”    

North Dakota:  For a third straight month, North Dakota’s RMI was the highest in the region.  The August RMI climbed to 66.5 from July’s 57.6.  The state’s August farmland-price index advanced to 78.2 from 66.4 in July and 70.9 in June.  The August homes-sales index was a very strong 73.7 which was up from 65.0 in July and 70.8 in June.  As in other states, farm yields look good for this time of the year.  “Small grain crops excellent, row crops look good but cool weather all summer has slowed development and created maturity concerns, especially for corn,” said Scott Tweksbury, CEO of Heartland State Bank in Edgeley.

South Dakota: South Dakota’s RMI remained below growth neutral with an August reading of 44.1 from July’s 40.5.  The state’s farmland-price index expanded above growth neutral to 55.8 from July’s 49.3.  August’s home-sales index was 51.3 which was up from July’s 47.9.

Wyoming: Once again, Wyoming and North Dakota were the only states with RMIs above growth neutral.  Wyoming’s RMI dipped slightly to 51.3 from July’s 51.8. The August ranch- and farmland-price index was also a very healthy 63.0, up from July’s 60.6. The August home-sales index dipped slightly to 58.5 from July’s 59.2.  However some of the state’s bankers were less optimistic.  Jim Durfee, CEO of Sundance State Bank in Sundance, for example, said, “It feels like Wyoming’s economic decline is either behind the rest of the country or we are entering the recession more slowly.”

The $2.8-billion tab tied to last Friday’s failure of Colonial Bank in Alabama may push FDIC toward a third-quarter special assessment, especially if there’s another large failure in the weeks ahead. ICBA president Cam Fine told Bloomberg “with the failure of Colonial Bank and the possible near-term failures of one or two more large banks, the FDIC may be forced to levy a special assessment on the industry sooner than it had planned.”

The Bloomberg story mentions Chicago-based Corus Bankshares and Guaranty Financial Group out of Austin, Texas as banks in extreme circumstances. We track Corus in NorthWestern Financial Review’s quarterly earnings roundup and noticed that the bank had not filed its earnings report for the second quarter. SEC paperwork tells the story: The bank could not complete a timely filing of its June 30 10-Q; it estimates a second-quarter loss of $487.3 million or $9.07 per diluted share; its second-quarter loan loss provision was $333.6 million, and nonperforming assets rose to $3.1 billion; then there were FDIC special assessment fees and the expense of regulatory compliance, audits, legal counsel and consulting.

The bank is battling back. In a news release yesterday, Corus said it expects to meet a 60-day deadline for compliance to preserve its listing on the NASDAQ stock exchange.

As a source in the Bloomberg story notes, special assessments are painful. The squabble over who pays what and whether they should pay on assets or deposits can also be trying. James MacPhee, chair-elect of the ICBA and CEO of Kalamazoo County State Bank, Schoolcraft, Mich., describes the fight over the year’s first (so far only) assessment in the Sept. 1 edition of NorthWestern Financial Review. See page 12.

Goldleaf Financial Solutions, Inc., a well-known name in technology to community bankers, is being purchased by Jack Henry & Associates. Jack Henry, a well-established industry leader in computer and software services to community financial institutions, announced on August 14 that it is buying Goldleaf in a deal that is expected to close later this year. Here is the press release the companies issued. Jack Henry is paying 98 cents per share, or $19.4 million, in addition to picking up $42 million in Golfleaf debt.

Goldleaf did an impressive job over the past four years of building itself into a major provider of technology services to community financial institutions. It made several acquisitions to grow into the global company that it is now. Here is a summary, presented on Goldleaf’s web site.

Furthermore, Goldleaf has been active among the state banker associations. Lee Wetherington, a young and entertaining speaker, delivered interesting presentations about technology on behalf of Goldleaf at many state association conventions in the past few years. Wetherington, a senior vice president at the company, spoke at the Nebraska Bankers Convention in May. Also, Goldleaf struck deals around the country over the past few years to design many association web sites.

The company was in the news late May of 2006 when it suffered a security breach that affected about half of the company’s 600 web site customers in the United States. On May 25, hackers got into Goldleaf’s computers and altered code so that links on bank web sites set up by Goldleaf misdirected customers to a phishing computer screen. Customers were asked to leave personal data on the bogus screen. It was never determined how many customers fell for the scheme, and Goldleaf said that within 90 minutes it had solved the problem. NorthWestern Financial Review interviewed one Illinois banker at the time who said he could not be certain how many of his customers were affected so he sent letters out to all 1,200 of his customers alerting them of the security breach.

The price of Goldleaf’s stock had slipped about 60 percent in the last year, and the 98-cent price Jack Henry proposes to pay represents a 40 percent premium from its August 14 close. Nonetheless, there are shareholders who feel the price is too low; according to this web site, some apparently are attempting to sue Goldleaf over the sale price.

Nicole Gelinas concisely reviews 25 years of too-big-to-fail, going back to the 1984 rescue of Continental Illinois and on through the 1998 bailout of Long Term Capital Management to the current crisis. Immediate government responses to the crises may have been “understandable” in context, she says, but “what’s unforgivable is the government’s response after each crisis.”

At any point along the way regulators and elected officials could have signaled, through new laws and regulations, that investors once again stood to lose their investments in big financial firms, that failures would not merely be allowed but facilitated with new processes for orderly dissolution. Didn’t happen then, and doesn’t seem to be happening now, Gelinas says.

“After the most recent and destructive round of explosions, the government’s response threatens to be more of the same. The Obama administration claims that it wants to create a way for bad financial firms to fail. Yet in its June financial-regulatory proposal, it formalizes ‘too big to fail,’ giving the Treasury new power to ’stabilize a failing institution…by providing loans to the firm, purchasing assets from the firm, guaranteeing the liabilities of the firm, or making equity investments in the firm.’ The proposal says nothing about making sure that bondholders and other uninsured lenders take losses.” (Emphasis and elision in original)

Gelinas also details the virtues of failure, chief of which is that it improves economic efficiency:

“When a company fails, a more successful firm can buy its good assets, releasing them from incompetent management. Failed firms’ workers can likewise find more useful outlets for their labor. Even people who made the mistakes that led to a firm’s failure can start anew. Vitally for the economy, failure helps ensure that bad ideas die, so that government and private resources aren’t wasted on a business model that doesn’t work.”

Gelinas concludes that markets have been trying for decades to correct “our unsustainable financial system,” and it’s a “fearsome certainty” that the correction will come–more painfully–”if real reform doesn’t happen.”

Read “‘Too Big to Fail’ Must Die” in City Journal.