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When in doubt, be countercyclical

A Georgia bank survivor—no, winner—offers some plain-spoken thoughts on CRE, capital, risk, consolidation, and more


Joe Evans attributes many of his best business instincts to his father, a Georgia farmer. Two of them relate to livestock.

During the Depression, Evans’ father raised a calf that was just a beautiful animal. A buyer—scarce in those days—saw the animal and offered to buy it. The senior Evans declined, however, thinking he could fetch a better price for the prized calf. Two months later, it died. He told his young son, “Whenever you get a fair offer for something, take it!”

The lesson stuck and in 2005, when RBC Centura came courting Atlanta-based Flag Bank, Evans, who was chairman and CEO, took the offer—right at the peak of Georgia bank (and land) values, and not long before many of the state’s banks began a freefall to failure.

Evans doesn’t claim to have anticipated the “perfect storm” that was soon to sweep through Georgia and elsewhere, but he knew that real-estate valuations were not likely to continue on their steep trajectory. That meant that bank valuations—linked to a large degree to the CRE market—were also at their high point. He admits he didn’t see a precipice, just a period of low or no growth for many years. He figured, “I don’t want to be working for nothing,” and recommended to his board to take the RBC offer.

Asked how he thinks Flag Bank would have weathered the storm, he says it would have faced difficulties, for certain.

But his timing was impeccable and he and his management team—four other senior officers—stayed together doing consulting work for several years until an opportunity came to acquire a failed Georgia bank—Security Bank Corp., a six-bank holding company in Macon, Ga., about 80 miles south of Atlanta. To do that, however, he needed a bank charter. So they first bought tiny State Bank, $30 million in assets, and used it as the vehicle to build what is now a $2.7 billion bank through acquisitions of five more failed banks under FDIC’s loss-sharing program. The holding company, State Bank Financial Corp., is based in Atlanta. State Bank’s 22 branches are concentrated in two markets—Central Georgia, where the company holds the No. 1 market share, and metro Atlanta, where it is No. 10 and pursues a niche-lending strategy.
CRE yea; C&I nay
In a recent conversation, Evans described how he is once again making real estate loans.

“I consider this one of the better times to do real estate lending,” he said. The time not to pursue it, he added, was 2005. “Those valuations were unsustainable.” Now, valuations are down and loan terms are much tighter—“a return to traditional banking standards,” as he put it.

“These are the best real estate loans we’ve made since the 1990s,” he said. It’s a great time, he added, for well-capitalized developers to build, or for well-capitalized banks to build a larger bank. And State Bank is well capitalized. As of the third quarter it had $389.1 million of total shareholders’ equity with a leverage ratio of 14.2% and ratio of total capital to risk-weighted assets of 34.5%.

While CRE standards are much improved, Evans describes trends in commercial and industrial credit standards as “worrisome.” He says that since the crisis and recession there has been “a tidal wave of diversification out of commercial real estate credit,” with much of it going to C&I. The problem, of course, is that the CRE market comprises roughly 60% of commercial-bank lending compared with just 20% for C&I, which is a recipe for excessive risk taking and lower standards.

Although he describes himself as more of a capitalist than a banker, Evans has spent his entire career in commercial banking. He has been a careful observer of trends in the business. In his view, for example, a significant contributor to the mess many community banks got into over the last few years, had its roots in the 1970s and early 1980s with the rapid rise of the mutual fund business. Banks lost 50% of their market share to these funds. This plus the emergence of securitization changed banks’ balance sheets and pushed pricing down while funding costs rose. One type of credit that could not be securitized was acquisition, construction and development (AC&D) loans. With profits squeezed in more traditional markets, said Evans, community banks poured into AC&D looking for revenue.

In Georgia in particular, the transition from a unit banking state to a regional market led to a surge of banker owners selling their banks, and then, flush with cash, opening a slew of de novos in the 1990s and 2000s. The Atlanta area population was growing at a double-digit clip, which fueled a booming construction and development market. Many of these new banks were mainly portfolio lenders and were drawn into the housing boom. It was a perfect storm, said Evans, fed by the treatment of housing as a sacred cow by the government. As mentioned before, the pace was unsustainable, and the bottom fell out in the second half of the decade. It wasn’t only Atlanta banks. Others around the state took participations in AC&D loans in the hot markets.

Evans maintains that some of these banks were good lenders, but ultimately were caught up in an indiscriminate collapse of the greater Atlanta real estate market.
Elusive diversity
Evans spoke a bit about how a community bank can—and can’t—diversify. “You don’t want to diversify into something you don’t understand,” he said. He strongly believes that you can diversify within a broad category of loans—such as real estate. His bank, for example, makes loans not only for housing developments, but also for student housing projects, and assisted living facilities.

Many community banks, however—those in towns dependent on one big employer, or agricultural banks—can’t really avoid concentration. In fact, said Evans, it may not make sense to diversify beyond their geographic area or skill set. Sometimes its better to control the risks you know versus diversifying into something you don’t know, he said. He described the debate between putting your eggs in different baskets and sticking to what you know as one that will never be won conclusively by one view or the other. State Bank itself operates in two distinct markets and has a correspondent banking line of business, but is still imperfect in terms of diversification, said Evans.

“You simply cannot do perfect diversification as a community banker,” he concluded.

The capital paradox
Asked about what the optimum level of capital is—a sensitive topic in the current regulatory environment—Evans said he didn’t know if there was such a level. He pointed out that the level of capital, interest rate margins, and funding costs all interplay in ways that aren’t completely understood by bankers or regulators. If the regulators require you to have higher capital, he explained, you’ll need a higher return on assets to generate the same return on equity. What results will that bring? Banks don’t operate in a vacuum, he said. They compete with the capital markets and with insurance companies to give two examples. Will the market allow the ROA needed to achieve an ROE that is attractive to investors? Further, will banks chase riskier assets to get a higher ROA? If so, that would negate the benefits of higher capital, Evans observed.

“You can’t simply say that higher capital means less risky banks,” he said. “I don’t think any of us have come to grips with the regulatory dynamic, the interest rate dynamic, and the funding dynamic since the crisis. They all interplay. We’re still making decisions based on the pain of the downturn,” he added. “There are so many unintended consequences.”

As an example of that, related to funding, Evans pointed out that if the regulators prohibit a bank in a community from tapping brokered CDs, then that will raise funding costs for all the other banks in that community as the bank has pay up to attract core deposits. This is less true in urban markets, he acknowledged.

“The awareness of how much the community bank market has changed has come upon us quickly,” he noted.
Other observations
• Re consolidation: Evans sees it continuing. The number of independent banks will continue to shrink, he said. Scale matters particularly in dealing with regulations. And diversification matters, even if imperfectly done.

• Re closing branches: It’s a lot easier to do as an acquirer, said Evans. You have more flexibility to remake things, including the ability to terminate lease agreements under the terms of a failed bank acquisition.

• Re technology: “We remind ourselves often of Blockbuster and Borders,” he said. “We don’t want to get behind the curve of what customers want.” Evans cites Check 21 as one of the tidal-wave changes to banking. “You no longer need a physical facility for transactions,” he observed.

For those of you who were wondering, “What was the second livestock lesson from his father?” Here it is: “Never name your cows.”
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