Small Banks and the Crisis

... Do we need so many banks? We have 7,500 banks in this country.

... The real point is that lending to small business is local. You have that local information. The big banks don't do a good job of having that local information to determine who is in this community that is good and who is bad. ... So having small banks is a good thing, but you have to regulate them just like you have to regulate the big banks.

One of the other phenomena we have witnessed is "vulture capitalists" going out and buying regional and community banks. Is that a good thing? ...

It depends on what the motive is to buy these banks.

Right after TARP got created, many people bought a bank because it allowed them to tap into money from the Federal Reserve, from TARP. So the government was giving away money through the banking system, and buying on the cheap, a banking license was a license to get that money.

Because you could buy it and flip it?

No, you could buy it and get access to TARP money or Federal Reserve money. Federal Reserve was lending money at a close to zero interest rate. You didn't have to be a genius to take zero interest rate money and put it in a bond, yielding a higher interest rate in relatively safe company and make money. ...

Is that bad for the communities?

It depends on what the bank does with the money.

So if they take it and invest it offshore somewhere, it doesn't do much for the community?

Exactly. If they take the money and lend it to small businesses in the community, then it helps uplift the community. But typically when a hedge fund is buying the bank, it's not bringing expertise in small business lending. It's bringing expertise in speculation, and that's probably not good for the community.

In April 2008, you put together a shopping list of small, struggling banks. ... What are you looking for out there, and what were you seeing? ...

There was similar diseases and different diseases. The littler banks were mostly not originating big securitizations, so that wasn't the nature of their activity. They were more of a buy-and-hold mentality, so they were buying subprime paper created by the big banks, and they were generating some for their own account.

So they were buying loans. They were taking on loans as their assets.

They were doing both. ... Remember, banks have been subject to the Community Redevelopment Act, the CRA. They really have kind of quotas, what they're supposed to do by way of what I would call very weak loans.

And many of them felt well, these were the subprime loan. I've got some kind of collateral. Maybe it's a little safer than some of the other kinds of loans that I need to make for community redevelopment purposes.

In both the cases, the government mandates what they were supposed to do from a sociological point of view, a societal point of view. Frankly, we're in total contradiction to fundamental soundness of the institutions. And as I said, they did the same thing with Fannie and Freddie. They gave them quotas.

But a bank didn't have to take these.

They have to take some sort of loan of that type. ... And what gave them some comfort was if they could simultaneously fulfill the governmental mandate and have something that at least somebody thought was a AAA security, well that's pretty good. So they fell into the trap.

A trap set by the government?

Inadvertently. The government's purpose, obviously, wasn't to set a trap. But I think it's something that we're seeing more and more, and especially nowadays with the consumer protection agency. They just put out an 800-page handbook, alerting the banks that are $15 billion and more what to expect when they come in and audit the bank.

Many of the things that they're going to be wanting the banks to do are quite adverse to the bank's profitability, maybe even to the soundness of the bank. So here you have the OCC [Office of the Comptroller of the Currency], FDIC on one side of things, and now you have the consumer protection agency potentially on the other side. ...

... What are some of the other stories that you found out there as you combed through the rubble of the financial crisis?

... The big banks were doing these enormous real estate transactions. The little banks ... a lot of times they would participate in syndicated loans from the big banks, often just taking it more or less on faith from the big banks. And as far as we could tell, there tended to be an adverse selection of what was shown to the really little banks.

You'd see $900 million syndication, and some little bank in Georgia would be in for $7 million of it. If this loan had been any good to begin with, the big banks would've syndicated it all among themselves. The little tiny banks had no business being in trivial participation relative to the size of the big loan. ...

... That's the big banks treating the little banks like suckers.

What happens is the big bank marketing desk naturally tries to sell it to other big banks first, because that's the quickest way to make a sale. If they can't get it sold to them, then it looked to me like they would keep going smaller and smaller to try to get it sold.

Because the big banks don't really want to keep paper on their books any more than they need to, they'll take it in, underwrite it in effect, but their real plan is to redistribute it and make a fee for doing it. That's what banking has really become.

But in this case, they're victimizing the little bank.

You can call it victimizing.

They're the greater fool in a sense.

I think they turned out to be the greater fool. Not all the loans were bad, but the little banks should've had the sense to understand if you can't fill a big loan from big banks, why are you coming to me in some little town in Georgia, offer me a few million dollar piece? Should've been a sanity check that said there's only one reason I can think of -- that's that the bigger banks didn't want it.

But if some guy with a nice suit comes down from Wall Street to sell you something, you're pretty impressed, I guess.

It depends on your point of view. I wouldn't have been so impressed. I would be thinking why is he coming to me for two pennies? ...

Let's stay with tales from the main street a little bit more.

The other thing that the little banks were doing -- they more or less had to do -- was finance the local shopping center developer, finance the little local developer of a small apartment house, finance the local office park, that kind of thing.

That's very much the lifeblood of the economy.

That's what they should be doing. What happened, though, was they began emulating the bigger banks, because the big people were starting to syndicate those loans into collateralized mortgage obligations. So suddenly the loan-to-value ratios were going up on those.

But the little banks didn't have much alternative, because in many territories, that's the industry. Take much of Florida. What is industry? What is business? It's largely real estate oriented. So when the syndicators of securitizations were paying higher loans-to-value, lower yields and stuff than the little banks, the little banks kept competing.

In that sense, the securitizations hurt them very directly because it affected the normal mainstream business that they would be doing in the normal course.

So those states that have real estate at the core of their economy, such as Southern California, Nevada, Arizona, Michigan even, and Florida, all were hit tremendously hard.

All were hit, but even ones where real estate isn't the main core, all of them have seashore communities or vacation communities where that's true. Even short of that, there's always a local developer, local something. Real estate is an important mainstay of a lot of the little banking institutions. ...

To put this into really simple language: The little banks got sold a bill of goods by the big boys at the big banks, and the regulators weren't watching out for them.

Interestingly, they weren't watching out for either side. They didn't watch out for what the big banks were doing with their own balance sheet, and they surely didn't watch out for what was happening to the balance sheets of the little banks. ...

So you pick through this pile of failed banks, and what do you look for?

What we were mainly looking for were banks with a service territory that seemed appealing, where there was the potential, either because the bank was already pretty large -- for example, BankUnited was the largest independent bank in Florida -- or as in the case of the bank we're invested in in Michigan, where there was a clear roll up opportunity of other, smaller troubled institutions.

The real key was sticky deposits. We think over the long term, the real key to value of a bank is does it have true deposits from true long-term customers? People who actually know the bank, live in the neighborhood, work there, maybe have a mortgage there, credit card. ...

A stable core.

That to us is the key to a bank. And if you have that combined with the territory where there's likely to be any kind of growth, or at least economic recovery, then we think you have interesting set of ingredients.

How many community and regional banks are there in the country?

... There are about 7,000-and-some-odd banks now, roughly half what there were before the first S&L crisis back in the '90s. Of those, 10 percent have 90 percent of the deposits. So 90 percent of them only have 10 percent of the deposits.

So you've got over 6,000 little tiny banks. But I'm just saying, little tiny is under $1 billion deposits. Very few of those are going to be able to survive the regulatory burdens that are being put on them.

What will that mean for communities?

What it's going to mean is that you're going to have the demise of little banks. They're going to get gobbled up either by regional banks, such as the ones we've been doing, less likely by the big banks.

They're going to get gobbled up or they'll just close their doors, because a little bank can't afford the amount of staffing that's going to be required just to deal with these new layers of compliance.

I think that's a serious problem, because the real job creation in this country comes from small and medium-sized enterprises. Bank of America and JPMorgan, however much they try, are never going to be able to be organized to make a $500,000 loan to some little operation. It's just not feasible.

To a mechanic who wants to run a shop.

It's just not going to happen. And particularly as we become more and more of a service economy, services tend to be very locally provided. So I think at the very same time, there's this [greater] need for funding for small and medium enterprises, we're going to have fewer and fewer places where it's logical to provide that. ...

What was your intention when you bought BankUnited? What were you looking at?

What we felt was important was several things. One, people were afraid Florida would become the lost continent of Atlantis. We didn't think so. We'd thought it was a question of how long it would take to turn it around, not whether or not it couldn't.

Second, we felt that the new management would do a very good job with it, and they did. It ended up making more earnings sooner than we had thought, went public a lot sooner than we had thought. So everybody won from that point of view. ...

There are a lot of other funds that have been pulled together to invest in failing banks. Some of these are looking to turn banks around pretty quickly.

We think that's a very hard thing to do. A bank is by its nature a very broadly based, community based activity. It's a lot of little decisions that have to be made within the institution to get it fixed, so we don't believe we can do it very quickly, unless you're very lucky.

How long do you intend to hold onto a bank when you buy?

We had originally thought it would be at least three- to five-year holding period.

This is BankUnited or in general?

Any of the banks.

How many banks do you currently have money in?

When I say "we have," we have investments in. We don't actually control any of the banks.

We're in BankUnited. We're in Sun Bancorp, the second biggest bank in New Jersey. We're in Talmer, which is a very big Midwestern bank. We're in Cascade in the Pacific Northwest, and we're awaiting regulatory approval for Amalgamated, a union controlled bank.

That's the Occupy Wall Street bank.

It turns out it happens to be the Occupy Wall Street bank.

So you're a banker to Occupy Wall Street.

We are, and while that's not a movement that I particularly identify with, given the nature of the bank -- that it's meant to be a progressive bank, it's a sort of underdog bank if you will -- I think it's perfectly appropriate that the management not only is the bank for Occupy Wall Street, the CEO of the bank marched with Occupy Wall Street. ...

Income inequality is one of the focus points of Occupy Wall Street. But it's also fraud, malfeasance and morality on the part of people who were in positions of responsibility.

I think on the fraud part and the immorality part, they have 100 percent good case, and I think those people really should be prosecuted. Not just civil penalties, but really criminal.

Why aren't we seeing anybody go to jail?

I don't understand it to tell you the truth. ...

... One of the criticisms of the bankers is that they're tone deaf to the suffering of millions of Americans.

That may be true of some bankers. It's not true of all bankers, and it's certainly not true in our case. ...