Small community banks have a banker, called a correspondent bank (more popularly known as a bankers' bank), that offers services such as check clearing, credit card operations, and other things that small banks find too costly to do efficiently and effectively on their own. Essentially, bankers' banks serve as the middle man between community banks and the Federal Reserve.
For the first time ever, one of these bankers' banks failed in April -- Silverton Bank of Atlanta -- and left 1,400 community banks in 44 states scurrying for new service providers. The FDIC contracted with another bankers' bank -- The Independent Bankers Bank of Irving, Tex. -- to smooth out the transition to a new bankers' bank.
As the FDIC cleans up the mess, many are wondering why Silverton failed and whether it can happen to more of the approximately 20 bankers' banks still operating. Was Silverton's model unique, or are other bankers' banks at risk?
Some analysts believe Silverton's problems were unique. It became a national bank almost two years ago and began an aggressive expansion into national markets. Its biggest mistake was getting into construction and development loans just as the real estate bubble was about to burst. Silverton "was in the wrong place at the wrong time," Jason O'Donnell, a senior research analyst at Boenning & Scattergood, told CNN. "I would be surprised to see another large bankers' bank go under in the near term." Most of the other bankers' banks avoided the real estate mess.
The problems for Silverton started when, operating under the name of The Bankers' Bank, it asked for permission from the Office of the Comptroller of the Currency (OCC) to convert to a national bank in August 2007, which allowed it to more easily buy into construction loan participation deals in several markets, as well as to make direct loans. In 2006 it opened four loan production offices in Boston, Cincinnati, Los Angeles, and Seattle, plus a full-service branch in Maryland. By the end of 2007, the bank had lent $1.1 billion for real estate, which grew to $2.1 billion by the fourth quarter of 2008. It was this aggressive loan portfolio that took down the bank.
Right now the OCC is taking the position that the "bank submitted a business plan that we believed was workable, It was subject to supervision, and as we always do with bank failures, we'll be conducting a review," according to a spokesman quoted in Bank Investment Consultant. One key area regulators will look at is how concentrated bankers' banks could impact community banks in certain regions. The concern for bankers' banks is that they tend to serve a concentrated region of banks, so while they aren't a systemic risk nationally, they could be a systemic risk regionally or locally.
The failure of Silverton is expected to cost the FDIC $1.3 billion. Silverton had $3.3 billion in deposits at the time it failed.
Walter Moeling, a banking lawyer who represented Silverton, told Financial Planning that the bank suffered because its community bank clients had loan problems related to construction and real estate. Silverton absorbed these losses from its core community bank clients in the Southeast. Moeling believes, "In this case, the ultimate issue is the community bank portfolio. That has implications for all bankers' banks."
If Moeling is correct, are other bankers' banks also facing failure due to the construction and real estate loans in the portfolios of the community banks they serve? As I wrote yesterday, small banks are facing a commercial lending crisis. Can this lending crisis put more bankers' banks at risk?
Lita Epstein has written 25 books, including Reading Financial Reports for Dummies.