What I learned as our bank failed

Editor's note: Shortly before the Minnesota Department of Commerce closed Jennings State Bank on October 2, the bank's CEO Paul Jennings released an unusually candid letter about the 119-year-old bank's demise. Jennings said he was eager to dispel misperceptions about bank failures in general—and to share his story with fellow bankers who may be in difficult situations themselves. The 52-year-old former banker spoke with NorthWestern Financial Review 10 days after his bank became the 97th failure of 2009. The bank, based in the southeast Minnesota community of Spring Grove, had a branch in Stillwater, Minn. . My brothers and I were third-generation bankers when the FDIC took over our bank. I had been in the business since 1982. Back then, as the farm crisis set in, I was a loan officer and became the workout specialist at the bank. At one point, I was running six repossessed dairy farms. Cattle and other collateral would disappear down dirt roads on flat beds during the night. If we were very lucky, we had at least some real estate behind an ag loan. I was really glad when that decade ended. We made it through, and I expected never to see another period like that.. What we just went through in this economy made the '80s look like a cakewalk.. After the ag bust, it was clear that farm loans would be a declining part of our business, and we started to develop into more of a commercial bank that dealt with small businesses. We evolved to stay healthy and growing. When I started in the business, community banks like ours made lots of ag loans, personal loans, car loans and home loans. Credit unions had not been allowed to grow un-taxed like they have in recent years. But then the government started competing with us — big-time — for ag loans. Big-bank credit cards replaced personal loans. Auto dealers captured the market for car loans, and mortgage companies — well, I'll get back to that in a minute.. We tried for some time in the '90s to locate the right opportunity to acquire another bank. We had been a single location, small town bank since 1890, and we were looking for ways to grow. Ten years ago we found an opportunity that matched our strategic vision. We branched into Stillwater, Minn. It was a great fit for us. It had a small town sensibility and an affluent population. People were eager to move there, and our niche in small business banking suited the town and the time. True, many of the area businesses were tied to residential or commercial real estate development, but there was no reason to fear that at the time. .Things pile up. Ten years ago — even four years ago — no one would criticize you for making home loans or loans to people who built homes. The federal government has traditionally played an active role in promoting housing and certainly did nothing to discourage us from home lending. In fact, traditionally, that has been a huge role for community banks.. It was a competitive business and we evolved to compete. We started a title company and branded our mortgage department as Jennings Home Mortgage, because by then customers were so used to aggressive promotions from mortgage companies that too often they would not check with their community bank when shopping for a mortgage. We had customers who wanted us to do interest-only products and negative-amortization deals. We didn't touch them. Occasionally, an established customer walked away from us when we refused to sell them one of those products. We would not have any part of it because we knew that those were bad products.. When we made a mortgage loan, state examiners looked at it; federal examiners looked at it. We had to do all this reporting and collect all this data, all at a cost to us. We were under a microscope for every real estate loan we made. The examiners said they were passable loans. Compare that to the non-existent enforcement of the same real estate lending laws when it came to loans made by the non-bank mortgage companies. For them it was the wild, wild West and the federal government absolutely looked the other way: no examinations, no enforcement, no nothing.. We were good bankers. We were fairly conservative guys, as most bankers are. We started to ask ourselves questions long before our 2007 C&D: What if the housing appreciation rate goes back to something more traditional, like 8 percent? What if it slows to 4 percent or stops rising at all for a short time? We pulled back on home equity lending, even though the home equity market was still booming. We could see that our strategy had to evolve again, and we were making changes.. But as the real estate market deteriorated, the FDIC began to criticize us for loans with inadequate collateral. If I had made a home equity loan to a customer who had 20 percent equity, and the market went down 40 percent, as it has in Stillwater, could the FDIC really say we loaned with inadequate collateral? They did. Is it fair? Is it misleading? No, it is not fair, and it is absolutely misleading.. Banks, including community banks like ours, have been broadly blamed for the housing market collapse. What did we have to do with the outrageously bad management at Freddie Mac and Fannie Mae? It was the federal government that allowed that disaster to occur and allowed them to purchase and hold their own junk bonds even after it was well recognized that there was a problem. To this day, they have powerful politicians doing their bidding for them and not holding them accountable. The big New York banks (equally to blame) get the same type of protection.. Also, if banks were behind the big housing bust, why is it that all the municipalities kept approving housing developments? The municipalities — that is to say, the government — didn't see the housing boom and bust coming, and even those of us who tried to plan for a pullback didn't expect things to seize up as much as they did. Nowhere in any of our FDIC examinations or in the cease-and-desist order did they say: "you guys were too heavy into residential real estate or commercial real estate." The C&D required a professional independent review of management, which concluded that our management team members were qualified and competent to be running the bank. The FDIC did not require the removal or reassignment of any of our leadership team, even though that was their right and is sometimes done. We had a really good team. We could have run a bank more than twice our size with the talent and experience we had on staff, and that had been our plan. We re-capitalized the bank in 2005 and had been positioned for growth. Knowing what we knew at the time, we made sound decisions.. But bad things piled up, not just the housing downturn but an extensive employee fraud and later the large theft of collateral used to secure a car dealer's floor-plan loan. That's one reason why I wrote that open letter, to take the mystique out of a bank failure [see excerpts from the letter on page 9]. I wanted the public to understand that in the end there are understandable reasons why a bank can have problems, just as any other business. My hope is that knowing that, customers will support their community bankers and give them the benefit of the doubt through these rough times, just like we try to do for them.. When the FDIC came in to issue our C&D, I said: "you guys left something out. You've said nothing about our real estate concentration and are not requiring us to stop doing home lending." They said nothing. Can you imagine the hubbub that would be raised in the press if they actually started publicly criticizing banks for engaging in residential-related lending?. We thought it was a safe thing being done in a safe way, and under normal circumstances it would have been. .A worse-than-expected end. People we respected in the banking business told us to get lawyers and defend ourselves against the C&D, but we didn't use or consult outside legal counsel. We didn't think it necessary because we knew we'd done nothing wrong. Everything the owners had was tied up in that bank. We had to find a way to make it through. The FDIC said things we did not necessarily agree with; we felt they were being unfair in some instances, but we decided not to fight with them. Our best chance for survival was to use our resources to get the bank back on track. It came down to: What are they asking us to do, and can we do it? We said, "Yes; it's going to be hard, but yes." And we did — to the letter. We worked very closely with the local FDIC examiners; if they had any suggestions to help us through, believe me, we were all ears.. We had three joint regulatory examinations in the last two years plus two 10-day on-site visitations, as is normal for banks under a C&D. This was in addition to weekly and quarterly reports and countless phone conversations. They knew exactly everything that was going on in the bank. We had to get annual appraisals on all our OREO properties, and we wrote them down immediately as required. OREO losses just snow-balled, but we stayed focused and did a good job of selling off OREO and other repossessed assets.. Even when we knew that we would probably be left with nothing, we stayed and ran the bank. Just walking away never occurred to us. Instead, we were determined to stay and do a professional job right up to the end — whatever we could do to assure the FDIC would not have a loss, help our customers, save our employees' jobs and make sure our hometown at least had a bank when it was all through.. But there is no market for banks or bank stock right now. Some banks that were interested were discouraged from making a bid, and perhaps could not have even been approved because of the problems they were having themselves. And why would anyone step up and pay anything for a troubled bank when they could just sit back and acquire it for nothing, or get paid to do it, after it failed? . When it comes down to it, the bank failed because we were concentrated in an area that went through a once-in-a-century contraction, and also because when we had to sell there was no market for banks. At any other time in history we could have raised the needed capital or at least found buyers.. We couldn't have gone on. We weren't surprised when the closing came. But we were in no way prepared for what happened when the resolution team moved in. These were not the FDIC people we had been working with for two years. It was a different team with a different attitude, mission and motivation.. A week before they closed us down, FDIC started asking about our fidelity bonds and our insurance policies, which they said the acquiring bank was asking for. It seemed strange that any buyer would be interested in those policies but we provided what was requested. Then the night we were closed the resolution team "interviewed" (interrogated) bank employees with special attention to the management team. They informed us it was "standard practice" for the FDIC to make a claim against the failed bank's policies if they could find any way at all to allege a basis. They said if we had a problem with that to talk to the on-site ombudsman. This person was apparently put there as window dressing because the first question we asked her she refused to answer.. We felt we had done the right things during two years under C&D. We said, "This is our government and they are asking us to do these things. Can we do them? Yes." We could have walked away at any time. It was hard hanging in there and keeping things together as long as we did. Toward the end we thought, at least we will be able to walk out with our reputations intact. . Now it appears we may need to gear up to defend ourselves against a purely frivolous claim by our government aimed at exacting money from our insurance carriers. Not only is this abusive, but it is a terrible way for our federal government to be conducting itself against its own citizens. Bankers need to start speaking out publicly about these types of unjust abuses or they will certainly continue unchecked. They probably also need to make a much less naïve assessment than we did of how much it is actually in their own best interest to cooperate with any agency of the U.S. government.. I'm proud of what we did together. I can't tell you how proud we were to be part of the Minnesota banking community all these years. Proud of the role we played in our community and the good we did. We were in the front lines of capitalism, and we became a casualty. I can accept that. But don't vilify the local community banks that are having trouble.. I had a good career. I'm proud of it, and our family is proud of what we've done in banking. It's an unfortunate end to what had been a successful family business. We were good bankers. And I think there are many other good bankers out there who are having a really hard time.. This is what they'd be telling you if they could talk. .Paul Jennings can be reached at paul@dpauljennings.com.