The Capital Corporation, LLC
n Independent Bank Advisory Firm

June, 2010


Thoughts on the banking industry


As you are aware, The Capital Corporation works with a large number of banks in the Midwest on mergers, acquisitions, divestitures and other consulting projects.  During the past few months we have been spending more of our time talking to bankers, boards of directors and ownership groups about what is happening in the industry and what the future may bring. We decided to outline our talking points and share them with you.  We hope you find our thoughts and opinions on the banking industry helpful to your organization.   



We have also included part of a handout that was passed out at a FHLB meeting in Kansas City that we felt was very insightful.  Ed Krei of The Baker Group prepared the handout and we want to give him full credit for the handout, but again thought it was very relevant and wanted to pass it on.


Below, in no particular order, are the highlights of some of our talking points we have used recently.


A.   Primary issues with banking today – Midwest market.


City Community Banks.  Many were are too concentrated, especially in Commercial Real Estate, Land Development and Construction.  Question is what is the business plan for these banks moving forward?  It is unlikely that the regulators will allow these concentrations in the foreseeable future. 


Rural Community Banks.  Those that stayed home are okay; those that did not are a whole different story.  The following is a list of specific issues in Kansas and Missouri, primarily for rural banks:


Brooke Insurance                                        Sterling Leases                               

Allstate loans (similar to Brooke)              Stonebridge Leases                                   

Participations                                              Airplane Leases

Cattle Fraud                                                 Marshall/Bank First                        


Significant shift in the regulatory environment.  The regulators have made a sudden and drastic change in how they look at bank credits, concentrations and capital ratios.  Banks are now criticized for loans they made a couple of years ago that at the time they were made were pass credits – even if there is no change in the quality of the credit.  Although the regulators allowed these concentrations to rise, they did little to stop the banks from continuing this line of business.  Now they expect banks to stop making new loans and want the banks to substantially reduce their concentrations – it can’t happen overnight.


Regulatory uncertainty.  Both the House and the Senate versions of Financial Reform will have significant negative impacts on community banks – interchange fees, treatment of Trust Preferred Securities, consolidated capital, etc.   Recently added to the mix is FASB’s new proposal for full fair value accounting that will require banks to value all assets and liabilities on their balance sheet.  In addition to the tremendous amount of work required by banks to comply, this could have a dramatic impact on a bank’s desire to lend.  The ABA calls the proposed FASB rule the biggest accounting event that banking has ever seen.


B.   How did we get into this situation:


1.    Greed – banks needed the loans and fees, they did not question the quality of the borrowers or the value of the collateral.  No one anticipated that values could decrease.

        2.  Appraisals – no one questioned the appraisals, or the fact that values continued to climb.

      3.    Short Memories – bankers forgot that bubbles burst, prices drop, the economy and cash flows can stop.

      4.    Over leverage – the banks helped their customers over leverage themselves.

5.    Lack of understanding – Many banks made loans or bought participations on credits that they did not understand, collateral they did not see, and loaned to borrowers that they did not know.  They relied on the bigger bank selling participations assuming that the bigger bank understood the credit and the risk.


C.   Future Earnings Capability


We believe over the next several years that Bank earnings will be materially affected by the following:


      1.     FDIC costs – the FDIC fund will need additional money to cover the continuing bank failures.

    2.    Compliance / Regulatory Costs –Consumer Protection, etc.

    3.    Lower Loan to Deposit Ratio – Regulators will want to see  balance sheet liquidity

    4.    More Loan Loss Reserves and continued losses in the portfolio

    5.    Higher Capital Requirements

      6.    Fair Value Accounting


D.   Cycle of Value/Price


We believe that these issues could affect valuation for an extended period of time.  Historically, bank values moved fairly consistently in a cyclical pattern that lasts about 5 to 8 years.  The impact of these changes, along with the age of current owners and the significant number of banks in the Midwest could stretch out the current pricing cycle for much longer than historic models show.  Valuations could remain low for an extended period of time.  However, well positioned banks should still bring a premium over the market.


E.   Capitalize on Shareholder Value


We believe that Banks should focus on improving and solidifying their value during this period of turmoil in the industry.  Banks need to develop and follow a strategic plan for the future.  Each Bank’s plan will be different depending upon the ownership’s ultimate goal – sell, grow, improve earnings, etc.


F.    Priorities going forward


   1.    Community Banks must focus on what they know, not chase yields and “new” opportunities.  Fundamentally, banking has not changed.

    2.    Capital will be more difficult to get, and more important to have.

    3.    Core deposits and customers will set a community bank apart from the investment banks and Wall Street.

   4.   Banks need to focus on real growth and real earnings.  Too many banks loaned interest carry and fees which resulted in short-term, but not true, earnings.

   5.    Management and key employee succession is very important – there are fewer good bankers available, and your location may make it more difficult to attract key personnel.

    6.    Board of Directors will be held to higher standards by the regulators and be required to have a better understanding of banking, and the laws and regulations that affect banks.




The next few years in banking will continue to be very difficult for the industry as a whole, but create great opportunities for strong organizations.  No matter where you are in the spectrum you must have a plan to move forward and devote the time, energy and thought to execution of that plan.


Thank you for letting us share our opinion on the banking industry with you.   If you have any questions or comments, please feel free to give us a call.  We would be happy to discuss any of these issues with you.




The Capital Corporation, LLC