ARTISAN ADVISORS, LLC - Regulators and Bankers: Two Views of the Current Stress in the Banking Industry Jim Adkins Jeffrey Voss Daniel Kadolph

Regulators and Bankers:
Two Views of the Current Stress in the
         Banking Industry

    ARTISAN ADVISORS, LLC
              Jim Adkins
              Jeffrey Voss
             Daniel Kadolph

             September 27, 2011

"Success is not final, failure is not fatal: it
  is the courage to continue that counts."
  Winston Churchill

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NPAs to Total Assets
    The Problem Defined

Industry NPA to Assets %

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Asset Quality Issues

– Borrower inability or unwillingness to service its
  contractual debt … NPAs and TDRs.
– Collateral valuation problems stemming from macro
  economic issues, and more specifically real estate market
  recession … ALLL Impairments and Charge-offs
– Concentrations by geography, type or borrower.
– Poor underwriting … high original LTV’s, no real global
  cash flow and limited guarantor support.
– Inability to resolve asset quality problems without
  significant negative impact to bank capital.

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Capital to Total Assets
  Compounding the Problem

Industry NPA to Assets %

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Capital
                   (the Buffer between the Bank and FDIC)

■ Capital ratios were falling as credit risk was increasing.
■ Regulatory capital requirements increase with risk.
■ Difficulty raising capital from outside the Boardroom
  and existing shareholder base.
■ M&A activity has been virtually non-existent in Chicago
  during this cycle.
■ Sellers are competing with FDIC for qualified Buyers.
■ Private equity investors today are not equal partners …
  they are risk averse and IRR driven.
■ Holding company debt creates problems with recapping
  the bank.

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Leverage Capital
                                    at June 30, 2011

 All US Banks                     10.10% (UBPR Peer Averages)
 All Illinois Banks                9.52% (UBPR Peer Averages)
 All Chicago Banks                 8.53% (FDIC Chicago Region)

 Illinois Problem Banks (SNL Data for June 30, 2011)
   – Banks 0.00 to 5.00% leverage capital = 16
   – Banks 5.00 to 5.99% leverage capital = 9
   – Banks 6.00 to 6.99% leverage capital = 21
        State authorities have said there are 46 problem banks.
        Bank holding company capital ratios are even lower.

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Failed FDIC-Insured Institutions
               1979 -2011 (2Q)

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Failures by Year and State

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The Regulatory View

 The Board and Management are ALWAYS responsible
  for the problems of the institution!
 The Board and Management implemented inadequate
  risk management systems.
 The Board and Management did not effectively plan for
  a downturn in the economy.
 There was inadequate oversight by the Board, which is
  dominated by bank management.
 Management ignored recommendations from the exams
  (e.g. repeat violations).
 Disregard for regulatory and accounting guidance.

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The Regulatory View
                          (quotes from examiners)

 Stop blaming the economy for your problems!
 The economic downturn is not the primary factor in the
  poor performance of your bank. It is only a contributing
  factor.
 There are over 6,000 healthy banks in the country.
  How come your bank is not one of them?
 Management is paid to manage through the highs and
  lows of the economy. The economy just didn’t go bad
  overnight.

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The Bankers’ View
                         (quotes from our clients)

 The worst economy since the Great Depression caused our
  credit problems, and the bank to fail!
 Real estate lending has always been a good model. Why
  should I take the blame as a community banker for a
  national depression in the real estate market?
 We are treated like criminals … guilty until proven
  innocent!
 Regulators told me that they are my partners!
 The regulators have an agenda … fewer banks!
 They are out to get me. They want to put me out of business
  and are succeeding.
 I am tired and worn out fighting with the regulators.
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The Bankers’ View
                          Issues of conflict

 Inconsistent application of Rules and Regulations …
  examiners often do not understand technicalities.
 Interpretation of rules is often subjective (ALLL),
  ambiguous (TDRs), and inconsistently (Appraisal
  requirements) applied.
 Every regulatory action has a negative effect on the
  ability of the bank to overcome its problems.
 Asset quality determines outcome of CAMELS ratings.

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The Bankers’ View
                            Issues of conflict

 Inconsistent treatment among banks where
  Management is considered a problem or a strength.
 Added problems now occurring in areas of Compliance
  and BSA, where management has diverted attention to
  resolve Safety and Soundness Issues.
 Losses could be amortized over ten years providing
  critical time for the market to stabilize and regulatory
  capital relief.
 The FDIC receivership machine is efficient, accepted
  by Congress, and the “only” method of resolution that
  has been used.

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Troubled Bank Pipeline
Failures Still likely on the Horizon

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Texas Ratios by State for Troubled Banks

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Straight Talk From the Trenches
                                     Asset Quality

 Watch your loan concentrations!
   – Geographic
   – Industries
   – Type … niche programs can quickly become concentrations,
      if unchecked.
   – Related or affiliated
 “Best practices” calls for community banks to establish a loan
  risk management function. The regulators like to see a portfolio
  approach to loan management.
 Most banks are in a defensive mode and are ignoring their good
  customers. Now is the time to reach out to customers. If capital
  is tight, reserve loan money for existing clients.

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Straight Talk From the Trenches
                                          Capital

 Think like BUYERS, not SELLERS, if you want to raise capital.
 A DISTRESSED approach should be considered when
  evaluating capital needs … you must understand the MARKS on
  your balance sheet … DO YOUR HOMEWORK … then
  negotiate with capital sources.
 Most banks that have raised capital have significantly
  underestimated the actual need … WHY?
 Finding capital is very challenging, but not impossible for
  proactive Board and Management teams that understand the
  reality and severity of their situation. Survival versus Control.
 Holding company capital and debt structures are a major
  impediment to the capital raising process (BANK STOCK, SUB
  DEBT, TARP, TRUPs).
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Straight Talk From the Trenches
                                      Management

 Do not be in denial if you have a problem. Problems do not go
  away on their own. Many bankers wait too long to make
  important decisions.
 Planning is an important part of the regulatory puzzle. The
  regulators want to see a strategic plan and budget that is current,
  realistic, and is being followed by senior management.
 Repeat exam violations only serve to make the regulators mad
  and belief that Management is not capable of fixing their
  problems. Don’t go there!
 Make sure you understand regulatory guidance. Get help if you
  need it.
 Do not lose you temper with the regulators. You have to stay
  calm, professional, and trustworthy. Don’t make it personal.

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“The Fear Factor”
 The Fear Factor is very real and a Regulatory lever to
  get the Bank to comply!
 It’s the fault of the Board and Management if the bank
  is not operating well, not the economy, or the real estate
  market, or Washington-driven economic policy.
 The Board and Management MAY be held responsible
  if the Bank does not adhere to Regulator directives, or if
  the Bank fails.
 Time is a precious asset … or your worst nightmare …
  use it wisely to resolve the Regulatory Stress!

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Jim Adkins, Managing Member
             630-742-1052
      jadkins@artisan-advisors.com

 Jeffrey Voss, CPA, Managing Member
              630-768-2124
       jvoss@artisan-advisors.com

Daniel Kadolph, CPA, Managing Member
             708-805-3197
     dkadolph@artisan-advisors.com
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