Under the Gun

Under the Gun

banking by Jean Gruss | Editor/Lee-Collier

Regulators are taking a harder line on commercial real estate lending. Just ask Florida Community Bank chief Stephen Price.

Commercial real estate lending is the bread and butter of community banking in Southwest Florida.

But state regulators appear to be on a mission to curtail loans for commercial real estate on the basis that they're riskier than many other types of loans. That could be a serious threat to community bankers who have a big stake in that business.

Community bankers with big exposure to commercial real estate loans may want to speak with Stephen Price, the chairman, president and chief executive officer of Florida Community Bank in Immokalee. For the last six months, Price has been battling regulators who alleged the bank engaged in unsafe or unsound practices regarding commercial real estate loans, among other issues.

Florida Community Bank is one of the largest and most profitable banks on the Gulf Coast. It has nearly $1 billion in assets and its 1.99% return on assets made it the top-ranked bank in that category, according to the most recent figures from the Federal Deposit Insurance Corp. (FDIC).

"Regulators always have a hot button," Price says. Congress has been putting pressure on regulators to prevent a real estate lending scandal. "The only predator that the regulators have is Congress," he says.

Regulators with the state's Office of Financial Regulation in November threatened to issue a "cease and desist" order based in part on Florida Community Bank's substantial commercial real estate loan portfolio. It also found borrowers' financial stability had weakened and it criticized the bank and the board for having inadequate controls and supervision.

Nearly half the complaint centered on the bank's lack of compliance with the Bank Secrecy Act, a provision that has dogged Florida bankers for the last three years.

But on May 25, Florida Community Bank and the regulators agreed to a less stringent "consent agreement" that doesn't force the bank to curtail its commercial real estate lending. Instead, it urges the bank to take extra precautions to monitor and review its loans, something Price says it was doing anyway. It also forces the board of directors to take a more active role in the lending decisions.

Meanwhile, Price believes Southwest Florida's real estate market is due for a rebound next year based on the continued influx of new residents. "I wouldn't be surprised if by 2008 we're not out of it," Price says. "I think [the downturn] is going to be short-lived."

A different strategy

One of the reasons Florida Community Bank has been so profitable, Price says, is because the bank seeks low-cost deposits wherever it can find them. A bank makes money by paying the cheapest interest rates to depositors and lending that money out at the highest rate to borrowers. The bank pockets the difference after accounting for non-interest expenses such as salaries and rents.

One of the cheap sources of deposits has been brokered deposits, which are deposits gathered around the country and sold by brokers who specialize in that field. "We go after the cheapest source of funding, regardless of the source," Price says.

Regulators criticized what they saw as Florida Community Bank "using a large amount of brokered deposits to fund aggressive commercial real estate loan growth." As of June 30, 2006, the ratio of brokered deposits to total deposits was nearly 45% versus the low single digits for its peer group, regulators said.

"When you do things differently, you attract attention," Price says.

The regulators also targeted Florida Community Bank's commercial real estate loans, some of which they say are speculative commercial loans secured by unimproved real property. "Commercial real estate loans secured by unimproved real property pose a higher risk of loss to a bank because there is no underlying cash flow from the property to support debt repayment, and the value of the collateral is subject to greater market volatility than improved property," they wrote in the initial complaint.

But in the final agreement, regulators' concern over the large concentration of brokered deposits and commercial real estate loans had disappeared. Price says the bank has a well-tested asset and liability management strategy and regulators apparently agreed.

He calls the cash-flow metric to assess commercial real estate loans as regulators' "flavor of the month." Says Price: "Commercial property has held up better because there's been less speculation."

Price says commercial real estate lending is one of the few areas where local community banks can compete effectively with the national and regional lenders and be profitable. By contrast, it's tough to compete against bigger players on consumer loans such as mortgages and car loans. "I can't play that game," Price says.

Instead, regulators required Florida Community Bank to create a credit department and hire a chief credit officer to oversee lending, which Price says has already occurred. They want the bank to "shock-test" the loan portfolio to see how it would hold up under a worst-case scenario and analyze it to be sure it's not overweighted by one type of property, such as condos or hotels.

Price does acknowledge that the bank has grown to the point where it needs to centralize its credit decisions. Previously, the bank's four area presidents made many loan decisions. "The underwriting was done to that personal style," Price says. "It was easier when the market was good for loan officers to cherry pick deals."

Now that construction and development have slowed, it's harder to find good deals. "We haven't grown in the past year," Price says. Now, a chief credit officer and a credit department in Immokalee make sure underwriting is more uniform.

What's more, the bank's directors must now take a more active role in overseeing the management of the bank. Five years ago, Price estimates bank directors spent about five hours a month in board meetings. Today, that has stretched out to as many as three days per month.

"They're saying the board relies too much on me," Price says. "Directors are now more responsible for day-to-day operations than for just policy."

In addition, regulators demanded the board write more detailed minutes of its board meetings. But Price says these minutes can be subpoenaed in court and the board secretary has to be mindful of liability.

A patriotic act

Like so many banks in Florida, regulators have been particularly aggressive about enforcing the new provisions of the Patriot Act, which added requirements to the Bank Secrecy Act (BSA) for banks to track suspicious activity.

Florida Community Bank says it is now spending $1 million a year to comply with the new requirements. It has also closed 200 accounts, most of them small grocery stores that couldn't vouch for their check-cashing operations.

The bank has had to recruit a full-time expert to track accounts and buy costly software for thousands of dollars. "It's becoming a big burden," Price says.

While the regulators have been forgiving on commercial real estate loans, their agreement with Florida Community Bank does not relent on the issue of the BSA. For example, the bank has to review all currency transactions exceeding $2,500 and all wire transactions since 2006.

"We've already done it," Price says.

REVIEW SUMMARY

Industry. Banking

Bank. Florida Community Bank

Key. Regulators are focusing on commercial real estate lending and national security issues most.

BY THE NUMBERS

Florida Community Bank

(Dollars in thousands)

ASSETS AND LIABILITIES 3/31/06 3/31/07 %Change

Total assets 992,037 993,578 0%

Net loans and leases 855,713 817,715 ‑4%

Total liabilities 907,243 878,295 ‑3%

Total deposits 840,274 816,912 ‑3%

Equity capital 84,794 115,283 36%

Noncurrent loans and leases 9,168 56,255 514%

Average assets, year-to-date 949,090 1,001,439 6%

Insider loans 8,204 7,536 ‑8%

Tier 1 (core) capital 84,794 115,283 36%

INCOME AND EXPENSES YTD 3/31/06 YTD 3/31/07 %Change

Total interest income 18,859 20,536 9%

Total interest expense 6,763 9,080 34%

Net interest income 12,096 11,456 ‑5%

Provision for loan and lease losses 980 242 ‑75%

Total noninterest income 963 596 38%

Total noninterest expense 3,422 3,802 11%

Salaries and employee benefits 2,243 2,599 16%

Pre-tax net operating income 8,657 8,008 ‑7%

Net income 5,323 4,983 ‑6%

PERFORMANCE RATIOS YTD 3/31/06 YTD 3/31/07

Net interest margin 5.43% 4.83%

Return on assets 2.24% 1.99%

Return on equity 25.92% 17.67%

Efficiency ratio 26.20% 31.55%

Noncurrent assets plus other real estate owned to assets 1.15% 5.94%

Core capital (leverage) ratio 8.96% 11.48%

Tier 1 risk-based capital ratio 8.83% 12.40%

Total risk-based capital ratio 10.08% 13.63%

Source: FDIC