While the Giants Reel, Many Small Banks Are Thriving

By: Barbara Kiviat/Eustis

Last fall, soon after Congress decided it would spend $700 billion to shore up the nation's flailing financial system, about 100 shareholders of Reunion Bank of Florida gathered for a party. Over crab fondue and London broil, they toasted the start of their spanking new bank. It had been decades since a locally grown bank had opened in Tavares, an old citrus hub about an hour by car from Orlando. "We had folks drive from 45 miles away recalls Reunion co-founder and CEO Mike Sleaford. "Everyone was so excited."

Partying bank investors? That doesn't seem quite right. Since September, the bad news about banks has been nonstop — and not just at the top of the food chain. Although teetering giants like Citigroup and Bank of America grab the headlines, at the end of last year 252 institutions were on the problem list of the Federal Deposit Insurance Corporation (FDIC), up from 171 three months earlier. Seventeen banks have failed so far in 2009; expect hundreds more over the next few years. (See the top 10 financial collapses of 2008.)

Yet amid all that carnage, there's celebration too. The industry as a whole may be reeling from bad loans and investments, but start-ups like Reunion don't have to wrestle with those problems. Entrepreneurs like Sleaford, even in hard-hit Florida, are setting up shop with completely clean balance sheets. They've got millions of dollars in fresh capital to write loans — and to pursue borrowers cast aside by banks focused on mopping up the mess from the years of excess. "New banks see people having a tough time getting loans, plus their funding costs are cheap since rates are low and they pay next to nothing for deposits," says Richard Sylla, an economist at New Yor University's Stern School of Business. "There's a profit opportunity there." Odd as it may sound, it's a great time to start a bank.

Bankers get that. Since last summer, at least 30 groups have filed to start new banks, according to SNL Financial. From Richmond, Va., to Tulsa, Okla., to Pacific Palisades, Calif., community bankers are hitting the pavement, raising funds a few hundred thousand dollars at a time from stock-market-wary investors. It's not an easy sell, and regulators, spooked by the wave of failures, are making it tougher than ever to win approval. For entrepreneurs who can run that gauntlet, though, the stars are aligned for small independent banks in a way they probably never will be again.

Last March, when Kenneth LaRoe set out to start a bank in Eustis — the next town over from Tavares — the speed bumps were already starting to pop up. Building a bank was old hat to LaRoe. The one he founded in 1999, he sold to a larger company in 2006, quadrupling investors' money. This time around, he lined up $24 million in commitments in three months. Then came IndyMac. On July 11, the FDIC moved to take over the nation's seventh largest savings and loan, a casualty of aggressive home lending and one of the biggest bank failures in U.S. history. Images of depositors lining up to pull their money out of the bank flooded the media.

LaRoe started getting calls immediately. People who had pledged to invest half a million dollars were dialing back to $200,000. Those who had been offering $200,000 were opting out altogether. Throughout the fall, the hits kept coming. Washington Mutual collapsed. Wachovia was sold off. Treasury Secretary Hank Paulson went before Congress begging for money, looking as if he'd seen a ghost. "It got to the point where I didn't want to pick up the paper or turn on the TV," says LaRoe. "The mantra I kept singing was 'This is perfect, guys. This is perfect. The banks won't even loan banks money.' "

Eventually, LaRoe won out. First Green Bank opened its doors on Feb. 17 — and business has been booming. On a recent weekday morning, loan officers and account reps zipped between desks and offices, sidestepping exercise equipment (the bank is operating out of a defunct fitness center until it completes its new eco-friendly headquarters). When First Green was applying for a charter, it figured to make $39 million of loans in its first year. The bank already has nearly $60 million worth in the pipeline.

That's partly because First Green is picking up qualified borrowers that other lenders are shedding. Banks that have placed too many bets on real estate and construction loans are stumbling and cutting back lending. "Banks are looking to lessen the risk on their balance sheets," says Gerard Cassidy, managing director and banks analyst at RBC Capital Markets. "Even a good customer may be encouraged to leave."

Consider Perth Blake, a family physician who has rented a building in Eustis for a decade. Three years ago, he took the first step toward his dream of constructing a building for his practice and borrowed money to buy a parcel of land. Last October, having paid off more than half his land loan, he went back to his bank and said he was ready to start building. His bank declined to lend him more. So Blake figured out how to shave some $130,000 off the construction cost and applied again. Still no dice. Three banks later, he got the same result. Then LaRoe came along. "It befuddles me," says LaRoe. "We looked at it, and it underwrote fine."

It's not just business owners who benefit. Last fall, Ivan Lefkowitz, a tax attorney in Orlando, says he got a letterfrom Morgan Stanley telling him his $150,000 home-equity line of credit was being frozen. He was current on his account and owned his home free and clear — though the value had dropped from $800,000 to about $625,000. Now he has a line of credit with New Traditions National Bank, another start-up. "Were it not for the financial crisis, we wouldn't have grown to the size we are," says CEO David Dotherow, who after 6½ months finds himself at the helm of a bank with $148 million in assets — a size he didn't expect to hit for at least a year and a half.

For banks moving down the chute now, though, winning clearance is decidedly tougher. LaRoe's First Green was the last bank to be approved by the FDIC, and getting that blessing was "without a doubt the biggest challenge of my career," says LaRoe. He drew up a spreadsheet of potential customers and how much each would probably deposit or borrow, hiding their identities. The FDIC sent the list back, wanting to know names. "Keep in mind, these are start-up businesses," says Mark Schmidt, the FDIC's regional director in charge of the Southeast. "We ask a lot of questions about how they're going to carry out their business plan when the economic headwinds are against them."

You don't have to leave Central Florida to understand why regulators are so cautious. An hour's drive north of Eustis, up in horse country, sit a handful of CenterState Bank branches. Until Jan. 30, the signs outside said Ocala National. That was the day FDIC agents swooped in and took over. For years, Ocala had ridden the real estate boom for all it was worth, indiscriminately lending money to home buyers (often speculators) and to builders putting up more houses. The bust took the bank down, and the FDIC is spending some $100 million to clean it up. "The system is imploding," says RBC's Cassidy. "Regulators are in batten-down-the-hatches mode. Opening up new banks is the last thing on their mind."

If the same fraction of banks fail this time around as did during the last downturn — the S&L crisis of the late 1980s and early '90s — we will eventually see a thousand-plus banks close, Cassidy figures. Since mid-January, the FDIC has been shutting down a couple a week. Yet at the same time, the system could use the extra capital. Since October, the government has plowed hundreds of billions of dollars into banks to bolster their balance sheets. Last year the average start-up bank brought more than $18 million of fresh capital into the system, according to SNL Financial.

That juxtaposition makes things particularly frustrating for Geoffrey Longstaff. After months of getting nowhere, he and his colleagues at Mercantile Commercial Capital in Altamonte Springs, a suburb of Orlando, decided to give up on the idea of starting a bank. "We were willing to put $37 million in capital into a new banking organization with no past-due loans," says Longstaff. "If we want to foment new lending, wouldn't it be nice to have those investor dollars instead of taxpayer dollars?"

The answer is yes. That's not to say the FDIC should simply bless every application. But this is how the downslope of the business cycle is supposed to work — weak companies get wiped out, and fresh ones rush in. Dropping millions of dollars here and there is hardly going to cure the banking system's sickness. But it might make it a little easier for a few more doctors to set up shop.

© 2009 Time Inc.