The 2008 financial crisis has made its presence known in banks and lending organizations throughout America—and, as NorthBay biz reports, Northern California isn’t exempt.
When Treasury Secretary Hank Paulson gathered the executives of the largest banks in the country on that October afternoon last year, he must have seemed like Marlon Brando in “The Godfather” without the cotton in his mouth. The banking royalty took seats in alphabetical order around a highly polished conference table and were each handed a single sheet of paper. The paper said their banks were going to receive a collective $125 billion in new capital in exchange for preferred stock. And Paulson told them to sign it.
In that moment, with the crème de la crème of the banking industry all pinstriped up, buttoned-down and wing-tipped out, Paulson set a tone that was no nonsense. He hadn’t called the meeting to take prisoners. He was telling the CEOs of Bank of America, JP Morgan and even his old shop, Goldman Sachs, how it was going to be.
According to accounts in the Wall Street Journal and the New York Times, Wells Fargo Chairman Richard Kovacevich protested the forced participation of the stagecoach bank, arguing that while other lenders across the country had capitalization problems and a rash of bum loans crowding their books, his bank was healthy and didn’t desire the government handout or the label that might go with it. This didn’t sit well with Paulson. He hadn’t called the meeting to debate his program. He told Kovacevich that Wells Fargo didn’t have to take the cash, but should the San Francisco-based bank run into problems later, it would truly find out what a credit freeze felt like.
Though Paulson didn’t invoke the name of Lehman Brothers, the Wall Street investment bank the Feds left twisting in the wind while instead rescuing insurance giant AIG, everybody at the table knew what Paulson was saying. Kovacevich pulled in his horns and signed on the dotted line.
That single moment was the only time the Troubled Asset Relief Program (TARP) set a clear course and followed it. The program, part of the Emergency Economic Stabilization Act of 2008, has veered wildly since Paulson stared down the nine bankers in his conference room. Originally, the $700 billion program was going to be used to buy up toxic mortgages, bum loans, slick real estate instruments and a stew of securities sprawled across bank and investment house books.
But that never really happened. Instead, Paulson and company decided the way to inspire economic confidence was to invest directly in banks, hence the October meeting. The game plan morphed into a $250 billion equity rollout that was designed to not only capitalize banks but also get them back into the business of lending. As of January, at least 145 banks had either applied for the program or received cash, including locals Bank of Marin, Exchange Bank, Circle Bank, Sonoma Valley Bank and Summit State Bank.
Then, Paulson tried a hybrid play. After investing $25 billion in Citibank back in October, Paulson came back with $20 billion as well as a deal to back $284 billion in toxic holdings on Citibank’s books. The company line was that Citibank, like insurance giant AIG, was simply too big to fail.
You can’t fault Paulson and the lame duck Bush administration for not looking in all directions. Before beating a hasty retreat for the Lone Star state, Bush and Paulson rolled out the Term Asset-Backed Securities Loan Facility (TALF). The $800 billion program was designed to purchase $600 billion in teetering mortgages and $200 billion in securities backing student loans, car loans and credit cards; in other words, the things concerning everyday people.
Because of the dynamics of producing a magazine, this story is being wrapped up on the eve of Barack Obama taking office. This may be more of a backward glance into an economic slide unrivaled since the depression. But it’s also a look at how local bankers view the bank bailout program, and whether it may help keep the North Bay from sliding further south.
Who needs a loan?
Let’s begin with a basic premise that the American dream of owning a home is still a siren song, and that those aphrodisiacal tones were key ingredients in the hip-deep economic meltdown in which we’re currently mired. Let’s travel back to 2005. Times were good, credit was plentiful and debt was cheap by historical standards. Residential real estate values were growing at a speed that made NASCAR drivers jealous—a pace that was, of course, ultimately unsustainable.
Meanwhile, mortgage brokers began processing loans for first-time buyers who, in the past, wouldn’t have qualified for their shot at a three-bedroom, two-bath home with a quaint breakfast nook and white picket fence in a good school district. But this was a modern gold rush and everybody was going to cash in.
For mortgage brokers, the loans were the banks’ problem, not theirs. Besides, brokers were writing loans to match bank specs, weren’t they? As they say, mistakes were made. Borrowers may not have been completely honest when it came to income levels and coming clean on debt. Likewise, it’s silly on its face to look at the record volumes of loans getting done to think every broker was 100 percent honest in dealing with both borrowers and banks. Besides, with some of the stated income loans being offered by banks, weren’t some lenders essentially telling both brokers and borrowers, “We trust you, (wink wink)”?
And it wasn’t just first-time buyers who were picking up easy loans. Real estate investors looking to flip properties were bellying up to the trough as well, only too happy to pick up a mortgage with plans to flip the property in a year’s time and pocket a 30 percent return with just a minimum upgrade. For an update on how well that went, head to Southern Florida and utter the word “condominium.” See how long it takes Southern hospitality to give way to language normally found in locker rooms.
Homeowners weren’t going to be left out of the bonanza either, as they tapped into lenders refinancing to a better rate while pulling cash out or simply taking out equity lines of credit based on inflated home values for toys like 60-inch plasma TVs or new cars.
Homebuilders were building houses at a rapid pace, thanks to easy credit lines from regional banks, as well as Wall Street. Oversupply of new homes really wasn’t on anybody’s radar screen as national players like Toll Brothers churned out subdivisions of starter castles at a velocity comparable to that of McDonalds moving Big Macs.
And then there were the banks. Everybody from small community banks to the titans of Wall Street saw where the action was. And it wasn’t just a matter of offering loans to marginally qualified buyers. There was a raft of products out there for buyers with low initial payment before resetting to a higher level based on a floating interest rate. Nobody was thinking about real estate values slowing down or capital markets going dry. No, it was nothing but blue skies.
While some Mom and Pop banks made loans to buyers with nothing down, investment banks like Lehman Brothers and Bear Stearns were in turn buying those mortgages and packaging them into bonds to be sold to investors in a process called securitization, a favorite investment vehicle on Wall Street for everything from home and commercial mortgages to accounts receivables and credit card debt. Freddie Mac and Fannie Mae, the two government-sponsored entities that hold about 50 percent of United States residential mortgages, bought their fair share of paper that would be saddled with the moniker “subprime.”
Meanwhile, the commercial real estate market was going a little ga-ga. If capital was plentiful on the residential side, it was flowing like wine for investors and developers looking to buy office buildings or construct malls. Turns out the cheap debt was 100 proof and went right to their heads. Once again, Wall Streeters were leading the way as they offered loans with no more than 20 percent down, and frequently allowed mezzanine loans that freed investors from putting any more than 5 percent of their own equity in deals. Loans were often written for full-term interest only, meaning at the end of 10 years, the borrower still owed the entire principal. Loans were routinely underwritten with projected cash flow that was 20 percent more than what was actually coming from the property when the loan closed. And these loans were packaged up and sold as bonds, often rated as top of the line in terms of risk and safety.
In the end, the phrase that’s been thrown around in both residential and commercial lending circles is “perfect storm,” a cultural buzzword taken from the book of the same name by Sebastian Junger. And while it’s fair to say many things lined up to throw both residential and commercial markets into chaos, one condition that hasn’t received its due in this financial crisis is pure, simple and tragic human greed.
Investors saw the ease and the upside of using somebody else’s money to make their deal go. Bankers saw the opportunities lining up in a market that only seemed to know one direction—up. Mortgage bankers saw the loan fees crowding their accounts and the piles of applications on their desks. Collectively, the group basked in brilliant sun, the only real worry being the application of a little SPF 15, with no thought of the old adage that the sun doesn’t shine on one dog’s ass all the time, never mind the more common sense approach of saving a little something for that rainy day.
And now, the sun has gone away, the skies have opened up and the rain’s coming down in buckets. Investors, bankers, developers, consumers and businesses are scrambling for umbrellas that some of them can no longer afford.
What color is your TARP?
[Editor’s note: As of mid-January, the following information is updated and correct. The evolving nature of the TARP program and the U.S. economy have created a sort of “moving target” for NorthBay biz, so some information may be outdated by the time you read this.]
It’s fitting that the acronym for the Fed’s Troubled Asset Relief Program is TARP, as in the vinyl sheets often used to keep objects dry, since the red ink flowing out of some banks has certainly soaked the economy.
The program calls for qualifying banks to receive capital between 1 and 3 percent of assets in exchange for senior preferred stock. And the qualifying condition is important, because 22 different banks have gone belly up this year, the most since 1991. This program won’t bailout banks that are already in bad shape. “One of the common misconceptions about TARP is that the banks receiving the capital are in trouble,” says Bill Schrader, president of Exchange Bank in Santa Rosa. “In reality, TARP is essentially a seal of approval from the government.” Exchange picked up $43 million via TARP.
Bank of Marin president/CEO Russ Colombo put it more succinctly. “Under TARP, banks that are in trouble are either going to go under or get bought out. For the rest of us, it simply encourages the lending of money.” On December 5, Bank of Marin received $28 million under the bailout program.
While Schrader and Colombo’s analysis is no doubt accurate for the most part, it isn’t foolproof. The Fed’s second-swing bailout of Citibank with another $20 billion infusion and a promise to back almost $290 billion in toxic loans is proof that the Feds are willing to prop up a weak bank if the circumstances are right.
TARP calls for the preferred shares to pay at a rate of 5 percent for the first three years and 9 percent thereafter. Payment of dividends requires Uncle Sam’s OK, and executive compensation is limited as long as the bank owes the government money. The government also receives warrants for stock, so if the value of the bank goes up, taxpayers participate in the upside. “The money comes with lots of strings that may not be in the best interest of the bank, its shareholders or the community,” says Circle Bank CEO Kim Kaselionis. “Essentially, this ‘loan’ represents banks taking on the U.S. government as a business partner and, possibly, a shareholder.” Though the funds come with strings, Circle Bank has applied to TARP and could wind up with $5.5 million. For the record, other local banks picking up TARP money are Summit State Bank with $8.5 million apiece. A string of regional and national banks that serve the North Bay, including Umpqua Bank, Mechanics Bank, U.S. Bank, Wells Fargo, Northern Trust, SunTrust Bank, Bank of America and Citibank, have collected $117 billion from TARP.
One string left loose by the Feds is that there’s no requirement that the banks actually use some of the new cash for lending. Considering that having banks spread liquidity via lending was the primary purpose for the funds infusion, you might have thought it was a no-brainer that banks would have to lend.
But you’d be wrong.
When you consider the bailout has been led by Paulson, a disciple of Goldman Sachs (the most successful of Wall Street’s old school investment banks), going a little easy on banks makes sense. It’s been noted in more than a few places in the financial community that Paulson saved AIG but let Goldman rival Lehman Brothers rot. The fact that Paulson and company had the cajones to tell the likes of Merrill Lynch and Morgan Stanley they’d take the money and give up equity is one thing; telling them what they’d do with the cash they received was apparently quite another.
So the Feds have agreed to place $310 billion with banks, but decided to ignore the fact they had all the leverage they needed to place a lending requirement on banks, be it a percentage of funds or a timeline. The argument goes that if more restrictions were placed on the funds, the banks would have balked. But one need look no further than the confrontation between Paulson and Wells Fargo’s Kovacevich to know that it’s a fair bet most of the banks would have taken the money anyway. For the record, Bank of Marin used $27.1 million of its $28 million for loans—in less than a month (December 5 through January 1)—and plans to continue through 2009, Exchange Bank used $14.7 million to reignite the economy and solidify its role in the Sonoma County community, and Circle Bank will use its funds to make financing available to its community.
Another demand from the lending industry was that the Feds not reveal who’s taking the TARP cash, at least until the money is actually dispersed. Originally, the names of banks applying for funds were going to be released, since the funds flow from taxpayers. But bank industry cheerleaders like American Bankers Association President Edward Yingling argued that releasing the names would put lenders in an untenable position. “If you take the money, will you be seen as needing the money, and if you don’t take the money, will you be seen as so weak that the government won’t invest in you?”
Ironically, this isn’t unlike how a loan applicant feels when going to see a lender. In the interest of public disclosure, here’s a link to the U.S. Treasury Department’s list of companies that have either applied for TARP cash or already received funding: treasury.gov/initiatives/eesa/transactions.shtml.
Another interesting angle to the bank equity program is how many banks have plans to go shopping with the loot. Executives from SunTrust, BB&T, Zions Bank, Regions Financial and Umpqua Holdings were all quoted in November 2008 saying they plan on taking at least some of the TARP funding to buy other banks. While this is certainly the free market at work, it’s being financed via the bailout. You might think this would anger the Feds, but again, you’d be wrong. As a matter of fact, seeing banks buying up weaker institutions actually makes the Feds’ job easier. Every time a bank fails, the Feds not only have to pay off depositors, they have to go into the Yentl business, finding another bank willing to buy the assets of the failed institution.
So banks acquiring weaker banks in the present environment makes the Feds very happy. When Wells Fargo picked up Wachovia, the Feds were relieved, though Citibank was put out because it was outbid. Given Citibank’s present financial state, it’s much better that deal didn’t go down.
Insurance should cover this kind of thing
For an illustration of how far afield the bank bailout has gone, let’s zero in for a moment on American Insurance Group (AIG), the mega insurer that, so far, has put the “bail” in bailout. In September, the Feds looked at AIG and the barrels of red ink flowing out of the company’s 66-story Manhattan building and decided it was “too big to fail.” So while Wall Street investment house Lehman Brothers begged for its life, Paulson and company decided to let it go and save AIG instead. At the time, the deal went this way: AIG received a two-year, $85 billion bridge loan carrying an interest rate of 11.7 percent, which entitled Uncle Sam to 79 percent of the failing company. Nobody from AIG complained—they were happy to still be making payroll.
So happy, in fact, the next month the company threw an eight-day party for insurance reps at the über-swank St. Regis Resort in Dana Point, the only five-star accommodation in California, according to Mobil. The $440,000 party and subsequent fallout made AIG look like it was spending cash like a less-than-sober seaman. The company actually defended the post-bailout bash: “It’s as basic as salary as a means to reward performance.” Some of the reward included $150,000 in banquets, $24,000 in spa treatments, $9,000 in room service and bar tabs and $7,000 in green fees. Sure, it looks bad, but AIG dropped a note to Paulson attempting to explain the outing and promising to get things under control: “We owe our employees and the American public new standards and approaches.”
Apparently those approaches worked because, two days later, AIG had an additional $38 billion credit facility from you, me and the Feds. Give the insurer credit; it learned from the colossal PR black eye at Dana Point by canceling a similar outing at Half Moon Bay’s Ritz Carlton, along with 160 other parties all over the world.
In the meantime, AIG picked up a new deal, turning in the $85 billion loan for a $60 billion loan at a 5.5 percent interest rate, shaving $25 billion off the principal and 6.2 percent off the interest rate. The loan term also was lengthened to five years from two. The Feds also agreed to buy $40 billion more in stock. AIG traded the $38 billion facility for an investment of $22 billion in residential mortgage backed securities and an agreement to invest an additional $30 billion in collateral debt obligations, complicated instruments comprised of loans and securities.
But old habits die hard for poor AIG. It seems it hosted a $343,000 outing in Phoenix at the Pointe Hilton Squaw Creek while trying to fly under the radar by banishing all AIG logos, letterheads as well as any trace of the company. “We’re trying to avoid confrontation, keep our profile low,” said Nick Ashooh, a company spokesman. “Some of our employees have been harassed.”
Seriously?
But the best part of the AIG-bank bailout debacle is former AIG CEO Hank and his shameless pimping for his old compadres. In an ill-advised column in the Wall Street Journal, Greenberg complained the interest rate on the initial bridge loan was “punitive” and that AIG wasn’t being treated like other bailout recipients. And he was right. AIG has had not one, not two, but three bites at the apple and now Greenberg was advocating a new bailout for his old company that would have the Feds assuming responsibility for toxic counterparty default swaps, basically insurance against loans going bad, which had AIG bleeding.
Bring it on home
Sonoma State University’s Robert Eyler isn’t sure what overall economic effect the bailout might have, especially since it keeps morphing into different forms. But Eyler, who’s also the director of the Center for Regional Economic Analysis, knows what ingredient has been on the sidelines while Paulson and company have tried to solve the bank riddle. “Problem number one has to do with consumer confidence,” he says. “Unemployment is up, sales of durable goods are down and we’re consuming less overall. People, and banks for that matter, aren’t going to make a move until they’re more confident about the economy and about their own situation.”
Eyler also points to the bank bailout as being a force that’s outside the normal marketplace. “To a degree, it disrupts the process. Banks aren’t feeling confident right now, and risk is being repriced. The result is that banks are more comfortable holding onto assets and not as comfortable lending.”
But not all banks. Russ Colombo reports his bank actually increased the loans it closed last year by 22 percent, at a time when most lenders were pulling back: “Overall, our loan portfolio is healthy.” Of course, Colombo has the benefit of having Marin County as his market. “There’s a per capita income here that’s higher than the rest of California, and since we don’t have a huge residential area, there isn’t a subprime issue.”
Bill Schrader of Exchange Bank says part of the problem facing banks in this bailout is the public perceptions that come with it. “I think there’s a misperception out there that banks may not be lending, which isn’t true,” he says. “It’s true there’s been some tightening of credit standards, but quality projects are still going to find financing.”
Circle Bank’s Kim Kaselionis thinks bank executives and boards of directors need to take a hard look at TARP’s benefits and limitations (including costs and restrictions) before moving forward. “Many community banks have faired well through this crisis. However, when an economy experiences a complete meltdown, everyone will feel it in some way,” she says. “Fortunately, at this time, we have almost no problem loans, but not all of the writing is on the wall yet. The program is still evolving. We need to give it some time.”
Then came Obama
TARP under President Obama looks like a different animal, which, at first blush, seems to please our elected representatives in Washington, D.C. Both the House and Senate have been upset over the lack of direction of TARP, the lack of direct assistance to struggling homeowners and consumers, and the reluctance of banks to loan money.
Even before he took office, Obama managed to get the second half of the TARP funds released. But as all good football coaches do when their team isn’t performing well, Obama and the Treasury have changed the game plan for the second $350 billion. To begin with, Obama has promised that banks that take TARP funds will be required to actually lend money, though the details at this time are sketchy. The program also appears to be changing direction in that bad loans and troubled assets currently sitting on bank books may wind up being acquired by the Feds and placed in a “bad bank.” How this will be accomplished is unclear. Another possibility would be that some TARP funds would be used to guarantee portions of loan portfolios, taking banks off the hook for a portion of possible loan losses.
All of these strategies are aimed at either strengthening the banking system or jump-starting the frozen credit markets. Only time will tell if the second half of TARP succeeds. But it’s hard to imagine the remainder of TARP having less impact than its predecessor.
Bill Meagher pens the Only in Marin column found elsewhere in this periodical. No bankers were injured in the writing of this story, though some were surprised by the questions.
