At Clarkston State Bank in Michigan, 2008 was when the rest of the country caught up to its troubles. Four years later, Clarkston may be out front of its peers again — this time in returning to strength.
As with most banks the downturn burned, real estate drove the suburban Detroit bank's problems. "We recognized significant problems on the balance sheet and then spent the next year and half working through them," says J. Grant Smith, chief executive of the bank's parent, Clarkston Financial Corp. "Then the rest of the economy got hammered."
As the undercapitalized bank addressed its problem credits, it was doing all it could to survive. Smith took the company private to cut costs. In 2008, the company sold its 55% interest in Huron Valley State Bank in Milford, Mich., for $4.3 million. Meanwhile, Clarkston was ever-shrinking; its current $114 million in assets are nearly a half of what it held at its peak.
Failure loomed, but "for us, failure was never an option," said Smith. "If you looked at our numbers, you would have thought for sure that we were going to fail."
Clarkston, significantly undercapitalized throughout 2010, found new equity last year and is trying to get back to solid footing. If it can complete the task, it could serve as a beacon to the more-than-150 undercapitalized banks still struggling.
Smith has perhaps an ideal background for his mission, blending real-world experience with that of a former Office of Thrift Supervision regulator. Smith recognized that running from regulators would be the worst thing for the bank, and decided to keep regulators informed.
"We worked closely with our regulators," he said. "We always communicated with them, whether the news was good or bad," Smith added. "They are more comfortable when they know what is going on. It is when they don't know that they assume the bank is in trouble. Human nature is to assume the worst, but we were always making a little bit of progress."
Smith's regulatory background may have helped his point of view, but it likely didn't win him special treatment from regulators, says Jeffrey C. Gerrish, a partner at Gerrish McCreary Smith.
"They did not go easy on anyone," Gerrish says, adding that regulators are using a more measured hand now. "They are getting a little more rational about what can be accomplished. They are lot more willing to work with you if you've clearly identified your problems and they are not getting worse, you have a plan and you don't have liquidity issues."
Clarkston's biggest stroke of confidence came early last year when it raised $8.5 million from local investors, including directors. It raised the bank's total risk-based capital ratio to 12.03% at the end of the first quarter of 2011 from 3.91% at the end of 2010.
In August, the Federal Deposit Insurance Corp. and the Office of Financial and Insurance Regulation for Michigan lifted the bank's cease-and-desist order. Smith said Clarkston immediately entered into an informal agreement to keep monitoring capital levels.
The rebound has still included hiccups. Clarkston reported small profits in the first half of 2011, but was back in the red by the third quarter. Last week it reported a $3.5 million loss for the fourth quarter, which Smith attributed to two loans. "We had been monitoring them, and we just decided to get it behind us," he said.
Smith said he is cautiously optimistic that no other surprise losses are on the horizon. "We feel the best we've felt in five years. There is nothing material that is sitting in classified that is in danger," he said. "But you never know when the boogey man is going to call."
At Dec. 31, nonperforming assets totaled $6.6 million, or 5.82% of total assets, down about 6% from a year earlier. Karen Dorway, president of BauerFinancial Inc. in Coral Gables, Fla., says that despite a tepid year-over-year decline in problems, the numbers show improvement. Her firm has the bank rated at two stars, which is considered problematic, but a vast improvement from its former zero-star rating.
"There are still fairly high non-performing assets, but the bank is in much better shape than they were a year ago," Dorway says.
Smith said he hopes earnings power will eclipse credit costs this year. Clarkston's interest income rose nearly 10% from a year earlier, to $1.4 million, and interest expense fell 37%, to $193,000.
Smith said improvement should lead to a return to profit, letting Clarkston reclaim a roughly $8 million deferred tax asset, boosting capital ratios further.
"We're building good momentum on our operations. We hope that helps us build a decent-size cushion rather than living on pins and needles," he said. "We feel pretty good about where we are."