Financial Industry Sees Series Of Changes

September 13, 2008
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GRAND RAPIDS — Change in the banking business has been dramatic rather than incremental — so dramatic that the industry’s name changed from “banking” to “financial services.”

Deregulation

The industry was highly regulated at both the state and federal levels for many years, recalled David Frey, former chairman of Bank One West Michigan, in a previous interview with the Business Journal. Branching restrictions limited bank size and geographic scope, and there were strict limits on the kinds of products and services commercial banks could offer.

John Canepa, former chairman of Old Kent Financial Corp., recalled that when he came to Grand Rapids in 1970, a bank could only branch 25 miles from its head office, and then only in a location where no other bank’s branch existed. As he summed it up: “The government told you where you could be, what products and services you could sell and what you could charge a customer.”

With the start of federal banking deregulation in the 1980s, the barriers to mergers and acquisitions fell away. Frey, in fact, led Union Bank through two mergers in the years following deregulation, first with NBD Bancorp in 1986, and then with Banc One Corp. in 1998.

Consolidation

“We saw the industry consolidate very rapidly in the early stages because it had been so restricted for so many years,” Frey reflected. “We saw some pent-up competitive forces unleashed suddenly in the ’80s and I don’t think they’re done.”

Perhaps one of the most notable acquisitions  locally — and one of the biggest surprises to the West Michigan community, was Cincinnati-based Fifth Third Bancorp’s purchase of Old Kent Bank Corp. in April 2001.

During that earlier period of consolidation, the industry adopted a sales culture, Canepa said, and financial institutions also sharpened their focus on shareholders. Prior to the 1990s, there tended to be less focus on shareholders.

“As consolidation took place, the acquiring banks, in particular, became more and more aware of the price of their stock in the marketplace because they were using their currency to make acquisitions,” Canepa said. “So shareholder return and return on equity became much more important, because it built itself into the price of their stock.”

Technology, too, was a real engine of change in that period, enabling the industry to handle enormous volumes, Canepa said. Technology also affected the channels of distribution with the advent of ATMs and Internet banking. Furthermore, it gave management a tool to segment the markets and target specific customers, he added.

Rise of “Community” Banks

A lot of community banks were born out of the fertile market created by massive bank consolidation. One of the most notable catalysts for new bank formation in Michigan was Huntington Bancshares 1997 acquisition of First Michigan Bank Corp. Four former FMB employees established four new banks on the heels of that deal, namely Macatawa Bank, Mercantile Bank, Community Shores Bank and Greenville Community Bank.

Another driving force behind the boom in community banks was Capital Bancorp Ltd. of Lansing, a bank holding company that operates as a bank development company. In an era of consolidation, Capital Bancorp created new banks rather than creating new branches of itself, often filling the voids where big bank consolidation had eliminated some of the competition.

Subprime Mortgage Implosion

Then came the subprime mortgage meltdown followed by a wave of home foreclosures. The crisis began with the bursting of the U.S. housing bubble and high default rates on subprime and adjustable rate mortgages. As a way of funding their businesses, mortgage lenders bundle loans — pooling subprime, prime and prime-plus and selling them as a mortgage-backed security to different investors and banks. As subprime loans began going into default, the investments began to lose money, and investors started bringing actions against those who sold the ‘pool’, explained T.J. Ackert, a business litigation attorney and member of Miller Johnson.

“Their argument was that the people who pooled the subprime mortgages misstated the value of these mortgages and failed to tell investors there were problems with the originations that made them much more risky investments,” Ackert said.

In the fall of 2007 many consumers began seeking protection from bankruptcy or tried to protect their credit by either bringing suits to bankruptcy court or bringing direct claims against their lenders for predatory lending practices.

Tightening Credit

The continued downturn in the credit cycle combined with lingering weakness in financial markets had a pronounced negative effect on bank performance, and banks reacted by tightening credit. In the second quarter of this year, for example, banks experienced sharp increases in nonperforming loan levels and higher loan loss provisions. According to the Federal Deposit Insurance Corp., second quarter earnings this year were 87 percent below their 2007 second quarter level.

Carol Lopucki, director of the Michigan Small Business & Technology Center, housed at Grand Valley State University, said many of the small businesses she works with have complained about the difficulty of getting bank loans and lines of credit, particularly startup companies. She said that’s particularly unfortunate given the fact that Michigan wants to build and attract the “new economy” kinds of companies.

“If you don’t have a track record right now, don’t have SBA-guaranteed backing, or don’t have some real good, solid cash on the line and some real demonstrated wherewithal, it’s very difficult to get startup money,” Lopucki said. “It’s always hard, but particularly right now.”

In the Small Business Association of Michigan’s first quarter 2008 Small Business Barometer survey, small business owners rated their “accessibility to credit for the purpose of business expansion” as either positive, negative or neutral. The number of respondents that rated credit accessibility as “positive” fell to 42 percent, said Michael Rogers, SBAM vice president of communications.

“That’s the highest ‘negative’ rating in the history of our Barometer, which goes back to 1993,” Rogers said. “The historical average is 14 percent ‘negative,’ so that’s more than double. In addition to the usual anecdotes about the difficulty of getting credit, we have some hard data that says the accessibility of credit is by far the worst it’s been since 1993.” 

What’s Next?

Richard DeKaser, chief economist for National City Corp., said the heightened risk aversion amongst creditors will likely last a while — at least until the middle of next year. In the meantime, people who are looking for credit either to finance working capital or for expansion purposes will have to forgo those investments, DeKaser said.

“The overwhelming majority of strong, creditworthy borrowers will not be constrained, but on margin, those that might just pass with a nod in the best of times will be declined credit in the current environment,” he added.

What will it take to turn the current environment around? DeKaser said economic growth has to improve because as long as economic growth remains sub par, unemployment will rise, consumers will experience financial distress and will increasingly default on their debt, and businesses will see their profit margins diminished and have further difficulty in meeting their principal and interest payments. 

“No. 1, we need the economy to perk up, say, with GPD growth closer to 3 percent rather than 2 percent as has recently been the case,” DeKaser said. “No. 2, we start to see economic growth filter its way through to household incomes and business profitability — both becoming more able not only to service existing debts but take on additional debt. That’s where I arrive at my opinion that it will be the middle of 2009 that we will start to see things loosening up.” 

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