Double Whammy

Double Whammy

By Jean Gruss

Editor/Lee-Collier

One morning in February, federal bank regulators walked into Chip Black's office and told him they were sure the bank would fail a regularly scheduled exam.

Black, president and chief executive officer of First Community Bank of Southwest Florida in Fort Myers, was taken aback. Regulators hadn't visited for 18 months and hadn't even started digging around the Fort Myers bank's headquarters. First Community Bank had a clean record, was profitable and well capitalized. The bank's return on equity is 22.9%, which ranks it 10th out of 258 Florida banks, according to an analysis by Financial Management Consulting of Louisville. And the bank's parent company, Southwest Florida Community Bancorp, recently injected about $2.2 million of its $6 million capital reserves into the subsidiary to raise its total risk-based capital ratio above the 11% mark.

Why the bad news?

'It was overkill'

Black says now he thinks regulators were on a mission to prick what they perceive to be a real estate bubble and to keep terrorists from using the banking system. First Community stood out because of its high concentration of residential real estate loans and its less-than-aggressive staffing to implement the anti-terrorist regulations required in the Bank Secrecy Act and Patriot Act.

Black thinks other banks are in for similar treatment. His advice to other bankers: Your residential lending will be closely scrutinized, and you'd better hire more staff and develop computer systems to handle bank secrecy issues.

In June, First Community Bank consented to a 12-page "cease and desist" order with the Federal Deposit Insurance Corp. (FDIC) that reads as if the bank is using lax practices with depositors' money (the order is posted at www.fdic.gov/bank/individual/enforcement/ index.html). Most of the issues deal with residential construction loans and bank secrecy. It's the most severe form of enforcement short of shutting down the bank.

"I thought it was overkill," says Black.

But after 30 years in banking, including turning around troubled financial institutions, Black knew better than to fight the feds. He now says the bank has met all the demands of the order except for winding down the high level of construction lending, which will take another year or so to resolve.

"Regulators are like parents," he says. "You may disagree with them, but at the end of the day it doesn't matter."

No one at the bank is happy about the unwanted publicity that followed. The order was posted on the FDIC's Web site in June, and Black has heard competitors are using it to try to steal business. "Just like any other industry, gossip runs rampant," he says.

Still, Black says he hasn't lost any customers and employee turnover is about 1% - low by banking standards. In June, every employee received a copy of a letter to the privately held bank's shareholders explaining management's actions in response to the FDIC order.

But complying with the order has placed a big demand on First Community's staff time. Monthly board meetings that used to last two hours now take five hours.

Chief Financial Officer David Hall worked seven days a week during the spring. Black's cigarette consumption has increased to a pack of Marlboro Lights a day, much to the dismay of his 5- and 9-year-old children. He's worried media scrutiny might lead some customers to close their accounts.

"None of us is enjoying it," Black says.

Too much of a good thing

Bank regulators wield such power that they can force a bank to drop a profitable line of business. In First Community Bank's case, that was residential-construction lending.

The bank started in 1999 focusing on commercial lending and adjustable-rate mortgages (ARMs) for consumers who were buying third and fourth homes as investments. About two-thirds of the business was commercial lending, and the rest was investor ARMs.

But in June 2001, as the residential real estate market was about to take off, the bank entered residential-construction lending. Black worked with three large Fort Myers homebuilders to provide homebuyers with construction loans (he declined to name the builders). These loans were short-term, generally one year or less, until the home was built and the homeowner obtained a permanent loan.

Eventually, construction lending became First Community Bank's leading line of business, accounting for more than half of outstanding loans. It was a highly profitable niche: The bank charged 8% to 10% interest, plus one point. With the cost of money so low in recent years, the spreads were wide. In 2004, Lee County issued 14,000 residential building permits, with First Community Bank providing construction loans for 1,800 of them.

"It became our largest book of business," says Black.

The volume caught regulators' attention. They criticized the bank for having too many construction loans, which still represents about half of the bank's total outstanding loans today. Regulators also were concerned that speculators had borrowed two-thirds of the bank's construction loans, further inflating new-home values in the Fort Myers area.

Black disagreed with the regulators. "I don't consider it risky lending," he says. Construction loans are less risky than many other kinds of residential loans because they're short-term, they're very profitable and the demand for them is outstripping the supply. Besides, he says, Florida has never experienced a real estate downturn without ample warning. The first sign to watch for a real estate downturn in Florida, he says, is falling real estate prices in the northern states. Northerners who can't sell their homes won't buy in Florida, and so far that isn't happening, he says.

"I might be thanking the regulators next year, but I don't think so," he says.

In the end, he acceded to regulators' demands. First Community Bank has abandoned its construction-lending business and is returning to its roots in commercial lending and adjustable-rate mortgages for real estate investors. In the meantime, he estimates it will take a year or so to reduce the level of construction lending. Black says the bank will provide construction loans in the future only on an case-by-case basis to individuals.

Although the construction loans were profitable, Black doesn't expect the bank will be any less profitable as it returns to its original business plan. The booming Fort Myers area will continue to offer opportunities, he says.

How bankers fight terrorism

Meantime, there's the matter of terrorism. Black, like all bankers these days, has found his company on the front lines of helping the government fight terrorism - only at the bank's own cost.

After Sept. 11, 2001, Congress passed the U.S. Patriot Act to strengthen banking regulations relating to the monitoring of bank customer accounts as required by the Bank Secrecy Act (BSA). Congress wanted to prevent what happened at Washington, D.C.-based Riggs National Bank, which hid accounts for African despots and former Chilean dictator Augusto Pinochet.

In the wake of all that, the FDIC's order forced Black to spend $500,000 this year to create an account-monitoring computer system and hire five people to scrutinize every account at First Community Bank to watch for suspicious activity. With 100 employees, that's 5% of his staff not dedicated to making the institution profitable. Rather, they're hunting for terrorists, drug lords and other criminals looking to make Fort Myers their base.

"I probably should have seen the storm clouds gathering and paid more attention to BSA," says Black. Congress grilled the regulators over the Riggs scandal and, in turn, the regulators are doing likewise to any bank they think is lax in enforcing the BSA.

Finding someone who can set up a compliance system for the BSA was no small task, for the main reason that there aren't that many experts familiar with the BSA rules. In fact, until June, the FDIC didn't even have a manual for how to set up a BSA compliance department. Black finally recruited an expert from a failing bank on the east coast of Florida.

The cost and inconvenience is staggering, especially for small banks. When someone opens an account at First Community Bank, he now must tell the bank how much activity he expects to occur in the account. If that deviates at any time, a computer flags the transactions and someone in the bank's new BSA department must call the customer. Money coming into a customer's account will be rejected if the bank doesn't know exactly where it comes from.

The bank is thrust in the unenviable position of policing its own customers. Most customers understand, but others take offense. "Some of them say, 'It's none of your business,'" Black says. "Privacy has taken a way, way back seat." Smooth tal king and explaining the new rules takes care of most unhappy customers.

Black's advice to fellow bankers: Know that the regulators are on a mission, hire a BSA expert and read the BSA manual.

Meantime, Black hopes the FDIC will issue a termination of the order, which may happen within the next year. "It wasn't a pleasant experience," he says, "and I'm very unhappy about that."

First Community Bank

of SW Florida By the Numbers

Statement of Operations (Dollars in thousands)

2003 2004 % Change

Total interest income 7,834 13,680 75%

Total interest expense 2,844 4,182 47%

Net interest income 4,990 9,498 90%

Provision for loan/lease losses 290 1,185 308%

Total noninterest income 2,100 1,747 -17%

Service charges 429 313 -27%

Additional noninterest income 1,671 1,434 -14%

Total noninterest expense 4,200 4,595 9%

Salaries/employee benefits 2,461 2,805 14%

Premises/equipment expense 405 449 11%

Additional noninterest expense 1,334 1,341 1%

Pretax operating income 2,600 5,465 110%

Income taxes 988 2,068 109%

Net income 1,612 3,397 111%

Net charge-offs 101 21

Sale, conversion, retirement

of capital stock, net 500 6,400 1,180%

Net operating income 1,612 3,397 111%

Balance Sheet

Assets YTD 3/31/04 YTD 3/31/05 % Change

Cash and due from

depository institutions 5,912 6,179 5%

Interest-bearing balances 110 122 11%

Securities 4,433 11,988 170%

Federal funds sold/

repurchase agreements 15,046 9,956 -34%

Net loans, leases 128,915 258,433 100%

Loan loss allowance 1,445 2,973 106%

Bank premises, fixed assets 3,305 3,638 10%

Other real estate owned 152 588 287%

Goodwill/intangibles 0 0

All other assets 1,310 3,390 159%

Total assets 159,073 294,172 85%

Liabilities

Total deposits 135,983 242,083 78%

Interest-bearing deposits 119,746 221,252 85%

Federal funds purchased,

repurchase agreements 3,314 10,573 219%

Other borrowed funds 6,000 15,500 158%

All other liabilities 697 1,802 159%

Total liabilities 145,994 269,958 85%

Shareholders Equity & Capital

Equity Capital 13,079 24,214 85%

Common stock 3,800 3,800

Surplus 5,670 12,570 122%

Undivided profits 3,609 7,844 117%

Total liabilities & capital 159,073 294,172 85%

Performance Ratios YTD 3/31/04 YTD 3/31/05

Yield on earning assets 7.11% 8.18%

Cost of funding earning assets 2.32% 2.59%

Net interest margin 4.80% 5.59%

Noninterest income to earning assets 0.82% 0.53%

Noninterest expense to earning assets 3.1% 2.08%

Return on Assets (ROA) 1.24% 1.92%

Return on Equity (ROE) 15.04% 22.92%

Net charge-offs to loans 0 0.05%

Efficiency ratio 55.30% 33.99%

Assets per employee ($M) 3.53 4.53

Condition Ratios

Noncurrent assets plus OREO to assets 0.84% 0.48%

Noncurrent loans to loans 0.90% 0.32%

Equity capital to assets 8.22% 8.23%

Core capital (leverage) ratio 9.09% 9.28%

Tier 1 risk-based capital ratio 9.70% 9.07%

Source: FDIC