Back In My Day: Civilized War – Bank Autopsy

A tale as sad as any told about a bank during the economic meltdown of the Great Recession.

https://www.usbanklocations.com/community-south-bank-19849.shtml

To sum up the lesson of this part of the BIMD story: The years of plenty followed by the years of famine. Biblical – as found in Genesis Chapter 41.

Wisdom – Git Sum

All the owners of Community South Bank (CSB) needed to do was listen and consider what was happening in front of them. They had long term relationships with national and local politicians, regulators, other bankers, business associates and so on. If they no longer wanted me to lead the division and advise them on the bank side, at least pay attention to everything and everybody else who had a pulse and a resemblance of useful knowledge.

Why trust a vagabond investment banking loan buyer/seller who would sell his soul for a buck and move on? Yes, he was very intelligent and had a strong work ethic in what he did. However, why hand total trust of the bank’s balance sheet to somebody who had not been there when the owners acquired the bank, grew it, and hired us to build the division that went from ground zero to #15 in the nation with SBA in combined program loan volume? Why trust so many other people, antiquated methods and systems that were no longer of value?

All of that and more escaped their understanding, which was odd since they were not dummies. The ownership was comprised of a well heeled General Contractor with over 30 years experience; an attorney who was also the CEO of an ESOP controlled nursing home chain; and the Chairman with over 30 years of banking experience including being the former CEO of the former shareholder’s larger bank as well as President of the state’s banking association. They all owned other businesses as well.

And yet…

Motivations Were Different

During the earlier days of our great growth, profitability, and national lobbying activities; the owners were all in. You can track the strong increase in net income beginning in our second full year of operations in 2005 via the information in the link. Over time greed and pride began to dominate their hearts and decisions. Their expectations were not rooted in reality despite our transparency of explaining the nature and cycles of our business prior to and during employment. Of the three, only the Chairman had a soft heart for the Lord as well as a decent understanding of commercial banking. However, he was a minority shareholder who would not buck the others and acted unsure of himself at times. The three owners had been lifelong friends going back decades. There was no way for me to isolate and address the issue as their hired gun. In addition, the bank’s President was also a young, local guy in the pocket of the Contractor who stayed at odds with the Chairman and openly lobbied for his job. This had become very detrimental to the morale of the bank’s employees in their headquarters.

None of that insider ownership information was known to our group prior to joining forces. It usually takes time and working closely with people to get the lay of the land in business. We wanted the opportunity to prove we could get it done and they were the only option we felt we had considering the situation with our former employer that would have led to the total disruption of what we had built. In the eastern U. S. there were no other banks we were aware of who had previously or would consider going national with small business lending as we could do it. All we asked for was reasonable expectations and flexibility to ebb and flow with the economic cycles. They acknowledged it when we first began, however, they reneged over time. It was not to be, again. This group of owners never believed in or accepted our vision, but never told us that until several years had passed. They just wanted more money.

In the final analysis their lack of understanding did not stop them from eventually exerting their ownership authority to force it to happen. In their attempt minus me, Judas was given authority over some key areas of the division while credit administration was handled by the SCO and sales by the NSM temporarily. All reported directly to the Chairman, at least in the first couple of years. The same Chairman who had exhibited the deer in the headlights look about what we did most of the time I was employed there.

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Bank Financial Downturn

As shown in the financial information provided in the link their downturn began in 2008 not long after I was gone, although they remained in denial for a couple of years. The owners would call occasionally to chat and get my opinions, of which they ignored until it was too late. I wanted them to succeed for the division employees had trusted us with their careers and income as well as to receive the compensation from the parachute, so I would always take the calls and offer advice when asked. Their pride would never allow them to publicly admit it, however, it was obvious during the calls after a couple of years that they realized they stepped in it. I will refrain from posting an image of what they stepped in; you the reader already know.

Several key division staff contacted me to discuss their issues. Sometimes it would be as they were in the process of exiting to better opportunities. The SCO would try to spin how they were doing in his calls. Which was silly given that their quarterly call (financial) report was published and I saw it every quarter. At one point a few years in he finally realized he had been a major contributor to their downfall by continuing to approve requests that added to the backlog of loans that had become nearly impossible to sell despite the claims of Judas. I repeatedly told him and the owners to move the loans as soon as possible both during and post employment even if it was just for a small fee or at breakeven; to sell everything not bolted down on the ship. I knew there were still buyers available who would pay reduced fees. Yet, they refused to sell.

I asked the SCO if he remembered when and why I urged him to tighten the reins on credit approvals in the second half of 2007. He said he remembered, but the owners would not let him; they wanted more loan volume. I asked him how that worked out for everybody. He had no response. Without being contracted, he chose to be yoked and contribute in a major way to the eventual demise of the bank. He knew better, could have resisted, left his job if necessary; yet, he did what they wanted anyway. More on him later.

The NSM would tell it like it was. He let me know he would be leaving to take over as the small business finance unit’s eastern region manager for a top ten national bank later in 2008. He had driven sales from zero at start-up to over $400 M annually in credit worthy loan volume in less than five years at that small community bank. He deserved the opportunity and is still a force in the industry today. More on him later as well.

At the time of my termination the bank had around $550 M in assets with a capital ratio in excess of 8% that passed regulatory requirements as well capitalized. This was a manageable size that could be sustained based on existing capital and liquidity. The key issue for the bank’s viability was to routinely sell the pooled loans held for resale. During my leadership period we managed the balance sheet with pooled loans for resale at less than 25% of total assets at all times as disclosed in the financial data provided in the link. The high point at FYE 2007 was just below $120 M. One year later after I was gone they had increased it to $282.5 M on $715 M in assets, which was nearly 40%, during the worst period in the debt market collapse. In other words, they did the exact opposite of what they should have done in those market conditions, even beginning the process of increasing pooled loans secretly in the fourth quarter of 2007 while I was still there. Judas slowed loan sales with ownership approval under the guise of completing sales in the first half of 2008 to get off to a good start (for himself).

After the previously committed loan pool sales closed in early 2008, instead of selling the future pooled loans for lesser returns to the buyers who remained, Judas and the owners chose to hold them to sell at a later date when conditions and returns improved. Ordinarily that does not have to be a bad thing since the bank would receive increased interest income during the period instead of receiving premium (fee) income as well as servicing income earned from loan sales. However, the economic collapse occurring nationwide was increasing delinquencies and loan defaults at a rapidly increasing rate with all businesses and consumers. This would lead to a big liquidity and capital crunch as the buyers of pools exited the market no matter the debt instruments involved.

Which leads to the Biblical story referenced at the beginning of this part found in Genesis Chapter 41. Since the owners had been personally taking everything they could out of the bank’s income in the form of compensation and dividends during the years of plenty, there was no reserve of capital and liquidity to cover for the expected increasing loan defaults and lesser profit margins during the years of famine. Pharaoh was willing to listen and adapt to the strategy of Joseph. He was willing to accept that there are good times and bad times, so prepare in advance. As a result, not only did Egypt survive, they thrived and became even wealthier.

Counting the excessive executive overhead charge annually, our division had delivered approximately $25 M of income in 4.5 years from startup to a community bank operation that contributed less than $10 M in the same period. Before my termination the bank reported $10.1 M net income for FYE 2007. The division provided in excess of $7.5 M of that after paying the large executive overhead charge to the bank; $8.9 M excluding it. We had pushed the Return on Assets (ROA) to around 2% consistently while the traditional banking operation was going the opposite direction due to their branch expansion. For the less financial types reading this – 1% ROA was a traditionally acceptable return for banks during that period.

A cash dividend of $3.5 M was paid. Combined bank and division net charge-offs for the year were only $1.1 M, which had already been adequately reserved in previous years. Only $500 K of that paltry total was attributed to our division, which at that point had closed approximately $1.1 B in small business loans in 4.5 years. The rest of the bank only provided about $1.2 M of the total 2007 net income. That low number, half what it had been when we started there, should have been a clue that they were overextending the expansion of branches.

For 2008 and after my termination the overall bank managed a positive net income of $4.6 M, of which the division provided $3.3 M according to the NSM excluding the executive overhead charge. So basically, the traditional community bank side provided no net income and was beginning to have excessive commercial real estate based loan defaults in its expanded branch locations. The income was less than half the previous year. Instead of gaining even more income with my termination that the owners believed they could do, the opposite happened as they went on their merry way. Yet, they still took a cash dividend of $2.7 M. Please note that regulators must approve the payout of dividends. So they obviously believed whatever story the owners were telling them. During the years following 2008 the bank lost money, a lot of money. Despite that, regulators allowed a $787 K cash dividend to be paid for FYE 2009, ostensibly paid to the Chairman who bailed out of the organization per the SCOs comments.

Throughout 2008 and 2009 they continued to approve SBA 504 loans that they could not sell immediately. The use of the program had been the “opportunity” CSB needed previously, but should have been discontinued at the beginning of 2008 since it involved the acquisition and construction of commercial real estate for business purposes. The economy was clearly tanking. The $150 M of loan commitments for construction loans were in various stages of completion during the collapse. Some borrowers were already in deep trouble due to the economy. Over $60 M of the total was to be partially taken out by the funding of SBA’s guaranteed debentures. The SBA began waffling on their commitments because they could not sell the debentures. They delayed settlements due to a lack of federal funding and access to institutional buyers to purchase the debentures.

The division staffing remained high in 2008 for the volume of business as they did not implement the division’s expense reduction plan until well into 2009. They also never implemented a bank-wide expense reduction plan at all. They simply never believed the downturn would last long, much less become The Great Recession. Judas had them fully convinced all would be well, until it wasn’t.

Fortunately, my compensation continued to be paid even if it was slow in receipt at times. Over the years that ensued their difficulties became worse and they were forced to make drastic cuts in division staffing of those who remained. Many good people had left voluntarily as opportunities presented themselves. Three years into the parachute and non-compete agreement, the division’s senior attorney contacted me to partner with her and a group of Nashville investors to develop a lending unit. In addition a couple of other local banks wanted to do one as well. I passed on all of the opportunities to live within the spirit of the agreement, which would have needed the bank’s release to change. My freedom had become much more important than career aspirations.

During 2011 the SCO called to say that he had finally talked the owners into selling what was left of the division for $1 M to an expanding regional bank who wanted the unit for their branch system to refer customers. The benefit to CSB would be the cash and reduced expenses from staff leaving. It was actually amusing to hear in light of the $21 M Bear Stearns offer they previously rejected. They turned over all of the CDO servicing rights to the master servicer. The SCO had the opportunity to lead his own small unit for the purchasing bank – a big fish in a very small pond with no outside sales force. It was at this point that he told me that Judas had gone through some personal changes of heart, that he had returned to his former employer in Memphis. All of the bank and economic challenges had humbled him and he had accepted Jesus; that I should reach out to him.

Maybe I should have. Or maybe the SCO was trying to make himself feel better about his own choices. Maybe the change of heart was real and I sincerely hoped it was. However, Judas needed to be the one to reach out to make amends. Reconciliation would have been possible as I had already forgiven him and moved on. I had not harmed him in any way during our times working together or afterwards. I had offered him a career lifeline with a good compensation plan. It was a role that he had abused along with the bank itself. The ball was in his court to make the first move if he was sincere; a simple phone call he never made.

Winding It Down

I could belabor the points and details, but it is time to move on. The bank failed in mid-2013. My last check from the agreement was received in August for what was due in April. They made it the five years I hoped they would achieve. I was thankful they honored the agreement to the best of their abilities during difficult times as I honored mine. Another larger, regional bank purchased the facilities and took over the deposit accounts. The FDIC took over the loan accounts. The recognition of the losses incurred from the defaulted loans and CDO tranches had already occurred a few years before. The loan recovery process had also begun, which would have improved CSB’s balance sheet as foreclosed properties (REO) were sold in better market conditions. The SBA had begun working through their backlog of funding guaranteed loans and debentures with appropriations from each federal budget CR approval as quantitative easing was kicking in.

Had they listened, all would have been well in about four-five years if they had injected the trust preferred funding into bank operations instead of buying out the former shareholder and/or sold the division to Bear. It would have helped to not take the large cash dividends. If the division remained, there would have been an increased emphasis on making SBA 7(a) program guaranteed loans that remained financially attractive throughout the downturn with a division staff trimmed to match the needs of the program per the plan I provided them in January 2008. All of the servicing portfolio would have remained with the income it provided to cover all division staffing expenses. The new operations and servicing platform would have been finished and implemented by early 2009.

All of it would have been dependent on leaving greed and the thirst for control out of the equation.

They did none of it.

Conclusion

Oh well. Shiz happens. Right, brother Forrest?

As I wind down BIMD, the next chapter will be the wrap-up on CSB along with the answers to any related “whatever happened to” questions.