WASHINGTON — Among the 22 failures to date in 2008, thrifts have dominated the headlines. Washington Mutual, IndyMac, Downey — all victims of the housing downturn.
But another large category has been prominent among failed institutions — those chartered since 2000. And critics are claiming that regulators were wrong to assume that these institutions could simply grow on ample capital and rising home prices.
“I’m never big on blaming the regulators, mostly because I feel like it’s the institution’s fault whether or not there’s a policeman sitting there telling them not to jaywalk,” said John Douglas, a lawyer at Paul, Hastings, Janofsky & Walker LLP and a former general counsel of the Federal Deposit Insurance Corp. “But in fairness, the regulators missed this as well. They got lulled by the same sort of complacency that affected everybody else in this market.”
The bulk of the year’s $348 billion of failed-bank assets came from two thrift failures: $307 billion-asset Washington Mutual Bank and $32 billion-asset IndyMac Bank. Of the other four thrifts closed, only one had less than $3 billion of assets.
But an equal number — six — of institutions chartered since 2000 are among the failures, a fact that observers attributed to the spike in new-bank approvals that began in 2003, encouraged by the real estate boom.
Gray Medlin, the managing director in the Raleigh office of Carson Medlin Co., said the success of the housing market led to an excess of bank start-ups, some of which were approved without adequate management.
“During a time when it looked easy to build a loan portfolio, and leverage new capital, too many charters probably were being approved and put in the hands of people who probably weren’t fully qualified to run them,” Mr. Medlin said. “They certainly weren’t qualified to manage through a difficult period of time.”
Observers cited pressure on new banks to grow quickly and said many institutions lacked the deposit base to recover in the current turmoil.
“For most of them, growth is a real factor. But if you had the infrastructure, then growth wasn’t fatal,” said Walter G. Moeling 4th, a partner in the Atlanta office of Powell Goldstein LLP. “We just had a fair number that grew very rapidly without having any infrastructure to handle it.”
In October, a string of start-up institutions failed. On Oct. 10, regulators closed $112 million-asset Main Street Bank in Northville, Mich., chartered in 2004. A week later, two-year-old Alpha Bank and Trust in Alpharetta, Ga., failed with $383 million in assets. The next to fail was Bradenton, Fla.-based Freedom Bank, which was closed Oct. 31 with $271 million of assets after just three years of operation.
Other failures of new banks included the Aug. 29 closing of $1 billion-asset Integrity Bank in Alpharetta, chartered in 2000, and the Aug. 1 failure of $259 million-asset First Priority Bank in Bradenton, which opened in 2003. On July 25, regulators closed First Heritage Bank, a $255 million-asset institution in Newport Beach, Calif., which was opened in 2005. (It was closed in conjunction with the failure of an older, affiliated bank.)
After a three-year decline, new charters began to rise in 2003 as start-up capital — abandoning the declining technology sector — flooded into banking. That year, 118 new charters were granted, 24% more than in the year before, and the total grew steadily, reaching 194 in 2006.
Observers said that a rise in new charters commonly corresponds with positive economic conditions and that newer institutions generally have a higher failure rate than older ones. “You start out with the basic assumption that most new business ventures fail,” said Douglas P. Faucette, a banking lawyer at Lord, Bissell & Brook LLP.
With property values surging, newer banks felt pressure to lend aggressively and produce an immediate return for a new crop of investors.
“There probably was too much capital put into the industry at a time where there was not only not enough good business to go around,” Mr. Medlin said, but “also not enough good management to go around.”
Mr. Faucette said the model for establishing a de novo bank at that time had shifted away from building a core deposit base and finding a stable crop of local borrowers, to making a quick profit and then selling to a bigger bank. This weakened banks’ internal controls, he said.
“Traditionally, the ownership of a de novo bank was principally business people in the local community that had influence and were able to direct business opportunities to the de novo bank. That was a measure of safety that gave the regulators … a lot of comfort,” he said.
When “it became easier and easier to raise the capital to form a new bank … the perverse aspect of that was that, unlike the typical bank of old, which was truly a community bank at de novo formation, these banks were really more like Wall Street banks. The investors are just in it to make a quick killing.”
New charters are now harder to come by.
“Our experience is that it’s a lot harder to get a new charter right now, particularly if you’re doing anything other than playing it right down the middle,” said Mr. Douglas, the former FDIC counsel. “There’s a lot more scrutiny, a lot more concern about where your funding is going to come from, what your business plan looks like, and what kind of loans are you going to generate.”
Banks that have failed recently were pursuing aggressive lending strategies, financing construction and development projects beyond local markets, and funding portfolios with noncore deposits.
Mr. Moeling said the failed banks in the Atlanta area “had virtually no local, real-customer deposits. They were all either brokered or purchased in one form or another.”
John L. Bley, a lawyer at Foster Pepper in Seattle and a former Washington state banking commissioner, said too much blame is being placed on wholesale deposits.
“Usually a bank gets into trouble initially because in hindsight it has either made poor credit decisions or the market has changed so dramatically that … asset quality has gone bad,” he said.
Mr. Faucette said regulators had felt comfortable with newer institutions’ relying on ample capital and rising loan values because past real estate downturns had been gradual, giving examiners a chance to catch an institution’s problems before failure became likely.
“No one calculated the kind of crash into the model that we’ve seen,” he said. “Those models worked during normal times, where the failure of a bank would be gradual. In this situation, we’ve seen wholesale failures because of immediate and sudden accounting writedowns.”
Mr. Moeling said that, if banks did not necessarily start out with overly aggressive lending strategies, management ultimately went in that direction as the market surged.
“Very few banks started out with a business plan that said, ‘We’re going to go super-concentrated, aggressive after residential construction.’ ” he said. “What happened in many, many, many cases — and in most of the cases where you have issues — was, the builders kept selling the houses and the condos, and so the builder would come to the banker and say, ‘I sold my five houses. I’ve still got walk-in traffic. I need to build five more.’ ”
