National source of capital ‘just evaporated,’ local banker says

Published 5:28 pm Friday, October 10, 2008

by Jeff Byrd&bsp;When they were forming Mountain 1st Bank & Trust four years ago, Greg Gibson and the other founders had a clear time-line for their business plans.

Gibson, Mountain 1st chief executive officer, says 2008 was the year to raise new capital. Just 12 months ago, that looked easy.Gibson, a UNC-Chapel Hill graduate and certified public accountant, is a 27-year veteran in regional banking. He had been chief financial officer for MountainBank in Hendersonville from 2000-2003, and prior to that he worked as senior vice president at the Bank of Mecklenburg in Charlotte and as chief financial officer at the Rock Hill National Bank in Rock Hill, S.C.He knew how regional banks, over the past decade, had begun raising capital by pooling their needs and working with Wall Street investment banks.&dquo;This time, a year ago, I could almost snap my fingers and have $20 million,&dquo; he says.That was before the $117 billion market in &dquo;trust-preferred securities&dquo; abruptly shut down last November upon the news that mortgage foreclosures had reached a record high of 2.47% of all U.S. loans.Trust-preferred securities first became popular among bankers in 1996 when the Federal Reserve Board ruled that they qualify as part of a bank&squo;s core capital requirements. Also, the dividends on trust-preferreds ‐ considered to be interest payments ‐ are tax deductible.

At first, only large banks could afford to issue trust-preferred stock. Issues of less than $15 million were cost-prohibitive.Then in 1999, according to Bank Director Magazine, Solomon Smith Barney developed the first trust-preferred pool, bringing together a number of smaller banks in &dquo;pooled&dquo; sales of trust-preferred stock. That began a practice which would enable a significant number of smaller community banks to participate.

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&squo;Market just evaporated&squo;

In no time, most of the trust-preferred stock was being purchased by Collateralized Debt Obligations (CDOs). Now familiar names like Lehman Brothers, Bear Stearns and Goldman Sachs among others &dquo;would pool these again, slice and dice them and sell them off to the Kuwaitis or whoever,&dquo; Gibson says.The cost of funds to regional banks like Mountain 1st was cheap, prime rate plus 1.4 points, Gibson said.&dquo;There were three to four aggregators (pooling bank stock sales) nationwide,&dquo; Gibson recalled. &dquo;It got so efficient, they were running pools monthly, sometimes two times a month, each pool raising $100 million up to $1 billion.&dquo; According to, about $46 billion of trust-preferred CDOs were sold since 2000. None has been sold since last November.

&dquo;In November of last year, the market just evaporated in two to three weeks,&dquo; Gibson says. &dquo;The markets dried up, liquidity dried up, sources dried up.&dquo;

Gibson told in an interview last July, &dquo;I can&squo;t recall a market as deep and wide as this one go to nothing as this one has.&dquo;Following its business plan for 2008, Mountain 1st formed a holding company, 1st Financial Services Corp. in May this year, to allow the bank to meet the legal arrangements required to sell $8 million to $12 million of trust-preferred shares. The money from the sale was intended to finance Mountain 1st&squo;s expansion. However, seeing that the trust preferred market was not coming back, Gibson was quoted by in July as &dquo;standing on the brakes.&dquo; He said the bank was curtailing lending for building lots, golf courses and second-home developments.&dquo;Except for Harry&squo;s market (Harry Grymes is Mountain 1st Senior Vice President and Polk County executive), we actually stopped much of our lot lending two and a half years ago,&dquo; Gibson said. &dquo;The pricing and terms got beyond silly. They were asking for a loan of the entire lot value, plus the club initiation fee, plus interest for two years.&dquo; As recently as 2004, Gibson said loan terms were reasonable ‐ 25% cash down and financing for 75% of the lot price.

Still, even as the terms got &dquo;silly,&dquo; Gibson said some banks were willing to take the deals because the value of the land was seen to be rising. It was further assumed that the clients seeking such loans were wealthy, with Triple A credit scores. How could you lose?Mountain 1st was not one of the takers, preferring &dquo;common sense,&dquo; Gibson says. Neither did Mountain 1st make sub prime loans.

&dquo;Much of that was done by mortgage brokerage outfits,&dquo; Gibson says. &dquo;We have seen some of the most egregious things done. A person will come in and ask for help, and we&squo;ll wonder, &squo;How did you ever get talked into this?&squo;&dquo; Gibson said he heard of one California couple with a $40,000 gross family income who had bought a $700,000 house. &dquo;It would take all their take home pay just to make the payment, and they&squo;d still come up short,&dquo; he says.

With falling home prices, The Wall Street Journal Wednesday reported that 12 million home borrowers now have negative equity in their homes. Thankfully, the Journal reports that Texas and North Carolina home prices have continued to rise slowly or have leveled off.For its part, Mountain 1st has still not foreclosed on a single primary residence in its brief history. &dquo;There are a couple spec houses from builders we are watching closely,&dquo; Gibson says. &dquo;But I am pleased with the performance of our single-family lending.&dquo;Mountain 1st reported holding $73.6 million total in loans for one-to-four family residences on its June 30, 2008 Federal Deposit Insurance Corporation (FDIC) &dquo;call sheet.&dquo; These mortgages and other loans secured by real estate accounted for $14.6 million, or 74% of the bank&squo;s total of $19.7 million in interest income for the first six months of this year.

Orthodontic contracts

It was the national system of home mortgage lending which was flawed, Gibson says. &dquo;You had the greed of the (mortgage) originators, Wall Street was driving the bus. The world was flush with cash. The demand for these mortgage-backed securities was rising.&dquo;About 5% of the pool of mortgages the investment bankers were &dquo;slicing and dicing&dquo; were &dquo;toxic,&dquo; Gibson says.

The Lehman Brothers and other investment bankers of the world kept much of that toxic slice. Being so highly leveraged, up to 30-to-1, it didn&squo;t take much in the way of defaults ‐ 2.47% ‐ and things got real bad, real fast.

&dquo;Bear Stearns had all its lines of credit pulled in two days,&dquo; Gibson says. &dquo;Anything with cash flow, these guys were slicing and dicing. For instance, they were pooling orthodontic services contracts.&dquo;Nonetheless, the effects of the current crisis have reverberated even to the Smoky Mountains. In the same July article, Chris Cole, senior counsel for the Independent Community Bankers of America, said the problem small banks now have raising capital only furthers the economic slowdown. The Standard & Poor&squo;s Small Cap Regional Banks Index had fallen 34 percent by July, and Cole worried that banks with depressed stocks would be unable to sell common stock without diluting shareholders.As of this week, Mountain 1st&squo;s stock was trading around $9, down from its 52-week high of $16.50. The bank holding company, traded on the OTC Bulletin Board, is one of the few publicly traded companies headquartered in Western North Carolina. Billionaire investor Wilbur Ross has said on CNBC as recently as September that he believes 1,000 banks will fail in the current crisis. He hopes to buy some failed regional banks ‐ after the government cleans up their balance sheets.Gibson says Mountain 1st won&squo;t be one of them, and he disagrees with Ross&squo;s figures.&dquo;Of the 8,500 banks in the country, 170 are now on the FDIC watch list,&dquo; Gibson says. &dquo;None are in North Carolina that I&squo;m aware of.&dquo; He says he talked with Joseph A. Smith Jr., N.C. Commissioner of Banks, about that statistic just recently. However, Gibson says upwards of 40 watch-listed banks are in Atlanta, a city which he calls the new &dquo;epi-center&dquo; of the sub prime crisis.As for Mountain 1st, Gibson says it is strong. &dquo;For a four-year-old bank, Mountain 1st is one of the best performing banks in the country of its size ‐ in profits, in all metrics ‐ if not the best in the class of &squo;04.&dquo;Mountain 1st reported, as of June 30, total assets of $684 million, and equity capital of $48.8 million. It is a well-capitalized bank, Gibson says, with a safe risk-based capital ratio of 10.1.Gibson says he expects Mountain 1st will now raise capital locally, continuing to use trust-preferred securities, but likely not seeking as large an amount as was contemplated during more robust economic times.

Real estate &squo;huge driver&squo;

There are any number of options for raising capital, he says. It is just that the price varies between options and the bankers have to ask themselves how much they want to pay, and how productively they can use that capital.&dquo;In this environment, there is a lot of opportunity,&dquo; Gibson says. &dquo;Big banks are shutting down their lending, running off good customers, some of whom we&squo;ve been trying to turn for years. It is time to be collecting new business.&dquo;The banks billionaire Ross expects will fail are those with bad loans, or non-performing assets. When the percentage of loans going bad gets up over 5%, that is hard to overcome in this environment, Gibson says. With enough capital and liquidity, even bad loan problems can be overcome, but that is just the sort of circular problem facing some banks today.Mountain 1st reported non-performing assets as of June 30 equal to just 1.32% of their total loans.&dquo;If real estate turns around, we will be fine and dandy,&dquo; Gibson says. &dquo;If in three years, we are still in the tank, that will be a significant hurdle to overcome. Real estate is a huge driver and industry in Western North Carolina. All the regional banks here have their loan portfolios based in real estate.&dquo;Considering all real estate classes, real estate loans account for betwwen 80 and 85 percent of Mountain 1st&squo;s loan portfolio.

Mountain 1st reported holding $169.4 million of loans for construction of one-to-four family residences and all other construction, and $101.2 million in mortgages and home equity lines. By comparison, the bank&squo;s total commercial and industrial loans were $91 million.&dquo;I feel good about where we are now,&dquo; Gibson says. &dquo;If real estate is down for two or three years, if it is locked up, it will be really tough on realtors, developers, contractors, attorneys. I hope it will level off by next year, perhaps tick up a bit. We are making plans, doing what we need to do to keep everything going. If real estate remained down, we would find other niches to be in.&dquo;Our growth path has been very good this year,&dquo; Gibson says. &dquo;Our loan demand is not as robust as in the last three or four years, but with big banks shutting down, we are seeing lots more requests.&dquo;In fact, the loss of Wachovia, while regrettable, has had one positive effect, he says. &dquo;Wachovia used some irrational pricing on Certificates of Deposit (CDs) in our market,&dquo; Gibson says. &dquo;I am sorry to see them go, but the positive of Wachovia&squo;s demise is that the pricing will get more realistic. Customers used to come to us and say, &squo;Wachovia is paying 4 1/4% on CDs. Why not you?&squo; Well, now the reason is pretty clear.&dquo;As for the prospects going forward, Gibson said Tuesday, the &dquo;most dangerous thing&dquo; would be if Federal Reserve Chairman Ben Bernanke drops rates again. &dquo;That (low interest rates) was the genesis of this problem.&dquo;Bernanke dropped rates a half point Wednesday morning.&dquo;This market is something no one has ever seen before,&dquo; Gibson says, scratching his head in wonder. &dquo;It is just wild. So many things at once. Real estate, an irrational rate environment, irrational pricing, and energy costs. Now the next thing will be if the consumer does the turtle.

&dquo;If people would just turn off the TV and stop reading the newspapers… How many people in Western North Carolina had a significant change in their lifestyle in the last six months? Not many. There is a lot of perception and fear. If people go on and not pay any attention to all this, they will feel a lot better.&dquo;Western North Carolina has strong banks. The worst thing is irrational fear.&dquo;

Editor&squo;s Note: Other regional banks will be profiled in upcoming stories.