The bad bets made by executives at Independent Bank of Michigan are on display in spots across the state: a defunct bowling alley, a new but never occupied shopping center and the luxurious Whispering Woods Estates, which offers prime lots for never-constructed dream homes.
Now it is the federal government making the big bet here.
The Treasury Department has invested $72 million out of the $700 billion in federal bailout funds to help prop up this community bank, which traces its roots back 144 years in Michigan. It is a small chunk of the giant rescue fund being wagered by Washington to encourage banks like Independent to resume lending and jump-start the frozen economy.
But Independent, hard put to find good borrowers in a suffering economy, and fearful of making the kind of mistakes that got it into trouble in the first place, is not doing much lending these days. So far it is using all of the government’s money to shore up its own weak finances by repaying short-term loans from the Federal Reserve. “It is like if you are in an airplane and the oxygen mask comes down,” said Stefanie Kimball, the bank’s chief lending officer. “First thing you do is put your own mask on, stabilize yourself.”
This is not what the Treasury Department had in mind when it started this program, saying it would give the nation’s “healthy banks” enough money to start lending again, so that people could buy homes and businesses could invest and create jobs, thereby invigorating a disintegrating economy.
A close look at Independent Bank’s handling of its government money demonstrates just how much harder this has turned out to be, and the conflicting challenges that banks across the United States are confronting in the new bailout era. Like hundreds of other banks, it is caught between the government’s push to increase lending and its own caution.
As of Tuesday, 257 financial institutions in 42 states had received $192 billion in capital injections from the Treasury’s Troubled Asset Relief Program, or TARP, out of $250 billion set aside for this purpose. Seven giant banks — like JPMorgan Chase and Citigroup — have received more than 62 percent of the total so far, and have gotten most of the attention.
But it is the smaller community banks like Independent that are seeing the largest number of investments, with 186 banks so far getting allocations of less than $100 million. With little public attention, this money in recent weeks has been streaming out to community banks across the nation, in dollops as small as $1 million — the amount set aside for Independent Bank of East Greenwich, R.I. Ultimately, more than 1,000 banks are expected to take part in the program.
While most of the banks that have received money appear to be relatively healthy, dozens of other banks that received federal funds are, like Independent Bank of Michigan, financially stressed by a high volume of delinquent loans.
Bailout Is Questioned
Economists say the decision by banks like Independent to use the federal money for purposes other than lending, while perhaps disappointing, is not surprising, given that the Treasury Department did not honor its plan to give the money only to healthy banks.
“It’s a matter of logic — when you are in a perilous position, like many of them are, you try to bolster your balance sheet,” said Alan S. Blinder, a monetary policy economics professor at Princeton. “But this is a real flaw in the program.”
Some banking experts are even questioning if the bailout may be doing more harm than good, in some cases, by giving banks like Independent a cushion as they struggle to fix their problems, rather than forcing them to sink or swim on their own. It could also delay mergers of weaker banks with healthier ones.
“You are keeping a lot of troubled institutions in kind of a status quo state,” said Eric D. Hovde, the chief executive of a Washington-based hedge fund that invests in the banking industry. “They can continue on their merry ways.” In Congress, anger over the management of the TARP program runs deep. Many lawmakers say that there is little oversight, and that they can see no evidence that the taxpayer money is making its way from the coffers of banks to businesses and consumers. The program is likely to be fundamentally changed under the administration of Barack Obama, who on Monday asked President Bush to request that Congress release the remaining $350 billion.
Some lawmakers have criticized the Treasury for allowing banks to use the government’s bailout money to acquire rival banks.
As additional evidence of the growing anxiety, bank regulators on Monday sent a notice to banks receiving federal money ordering them to disclose how they are using it. It also pushed them to emphasize new loans. “A lot of the money is already out there and the inspector general needs to get up to speed on how banks are using it,” said Senator Claire McCaskill, Democrat of Missouri. “We need to make sure we get this money back and the only way we can do that is with strong oversight on how this money is spent.”
Neel Kashkari, the interim assistant secretary at Treasury running the bailout program, said he was convinced that it was delivering the promised results by stabilizing banks while also encouraging them to help out their communities. Even if overall lending is not up, it is higher than it would have been without the program, he said.
“We’re still in a period of fairly low confidence,” he said. “So, banks are understandably nervous about extending a lot of new credit. And consumers are nervous about taking on new credit.”
Independent, which has 106 branches and $3.1 billion in assets, illustrates all of these complexities.
By no means is Independent the worst off among the country’s community banks. Some banks that sought TARP funds were considered so weak that Washington officials discouraged them from even applying. Other banks were rated slightly stronger but still were required to raise private capital before they were approved for federal help.
When it applied, Independent was considered “well capitalized” by federal standards. It had not been subject to any recent regulatory orders to change management or lending practices, for example.
But it was struggling nonetheless. Indeed, of all the banks that received bailout money as of Jan. 6, it had the second-highest ratio of bad loans, when compared with its capital and its cushion of reserves in case of further loan losses. Its assets are shrinking and it lost money in the third quarter. It began cutting its dividend last year, when it stood at 21 cents a share. It is now a penny a share. And it had lost millions of dollars from bad stock market investments.
But Independent is hardly a high roller plagued by gold-plated executive perks, and it was not a big subprime lender, as many banks were.
Based in Ionia, Mich., 30 miles east of Grand Rapids, it is the kind of local institution that foots the bill so the state’s high school bands can march in the annual Grand Rapids Santa Claus Parade. This month it has George Foreman grills stacked up in its lobbies to reward customers who bring in friends and neighbors to open new accounts. Independent is one of the biggest employers in Ionia, a city of 10,000 with classic, turn-of-the-century storefronts dominating its main street. Driving across suburban Detroit in his black Mercedes sedan, Keith Lightbody, a senior vice president at Independent Bank, said it was easy, in retrospect, to see how banks like his ended up where they are today.
Mr. Lightbody, a former JPMorgan Chase bank executive hired almost two years ago by Independent, tours the sites of the bank’s many broken dreams, like the Whispering Woods residential subdivision in Farmington Hills. The bank financed the construction of roads and utilities for the subdivision, only to see the developer go belly up before most of the lots were sold. Snowdrifts now nearly cover the “for sale” signs.
Perhaps even more distressing are the empty storefronts in Shelby Township, Mich., where a developer backed by the bank built what was supposed to be a vibrant streetscape, bustling with shops and shoppers.
Instead, other than a restaurant at the front of the complex, there is only a row of darkened windows, with the work halted on the would-be stores even before their floors were built, leaving the insides looking like a sandbox filled with random construction debris.
As of the end of September, the bank was burdened by $115 million in bad debts, or nearly 5 percent of its overall loan portfolio, compared with less than 1 percent in 2005. Each of these failed projects has something essential in common, Mr. Lightbody said.
“We didn’t step back and look at the big picture, asking ourselves, are we really doing the right thing with this loan?” he said. “Everyone was making a lot of money.”
Independent is publicly traded and under pressure from investors to shrink its troubled loan portfolio before lending anew. Yet it still very much wants to make loans, said Robert N. Shuster, Independent’s chief financial officer.
In normal times, Independent would lend up to $8 for every $1 in bank capital. The $72 million in federal money, therefore, could generate up to $576 million in loans — a powerful leveraging effect that was the goal of the TARP program.
“Our whole business is predicated on making loans — that is what we do, that is the mission of the bank,” he said. But the bank cannot afford to simply pass out money, Mr. Shuster said, or everyone involved will lose — the borrower, who would probably default on the loan; the bank, which would experience bigger losses; and the federal government, which is counting on Independent to pay back the $72 million, along with 5 percent dividend payments.
“That is what got us where we are today,” Mr. Shuster said, of the bank’s past easy-lending practices. “You can’t put consumers in a position where they aren’t going to be successful.”
Making Loan Decisions
Ms. Kimball, the chief lending officer, comes face to face with this debate each day.
She has continued to tighten lending standards, generally turning away applications, for example, for single-use commercial buildings, like restaurants, because of the difficulty in selling the properties if the bank needed to foreclose on the loan, she said. Independent is also taking a more critical look at appraisals submitted to justify housing loans, which is considered a necessity now, because national companies that buy up mortgages from banks like Independent are demanding such scrutiny.
“We are not going to lower our credit standards at this point to make a whole bunch of extra loans just to deploy the money,” Ms. Kimball said. “We need to make loans that are reasonable in this day and age.”
Working from the Troy office, Ms. Kimball, who has a cool, stern tone, and a self-confidence that comes from 25 years in the financial services business, is overseeing this effort as the bank moves, in particular, to cut the size of its real estate loan portfolio.
“It is not something that changes overnight,” she said from her corner office overlooking Troy. “It is like turning a ship around in the ocean.”
She knows many of the bank’s big commercial borrowers personally — taking the time to go out on the road and visit their factories or businesses to get a better sense of just how well positioned they are to repay their loans.
One manufacturer from western Michigan, a customer of another bank, came to Independent looking for a business loan. Her examination of the company’s books showed that its sales were slipping and, worse, that it was having a hard time collecting on bills it had sent to its remaining customers, who also were suffering from the economic downturn.
So the bank had to make the hard choice of turning the company down.
“That is just not something we can do,” Mr. Shuster said, declining to name the company. “We just can’t lend there.”
With the tighter lending standards and the damage the miserable Michigan economy has done to so many of its businesses, the pool of eligible borrowers has shrunk considerably. The net result is that the overall balance of outstanding commercial loans the bank carries — which was about $1 billion as of last June — has shrunk by $50 million and will most likely continue to shrink through much of the first half of this year, Ms. Kimball said.
There are, of course, exceptions.
Ultimate Hydroforming of Sterling Heights, Mich., which makes prototypes for the aviation and automobile industry, like the battery casing for the new Chevrolet Volt, a planned electric car, has been able to obtain new credit recently and will probably get even more from Independent.
A Growing Business
The company’s manufacturing plant is only a few miles from a half-dozen giant automobile assembly plants. But Ultimate Hydroforming had started several years ago to look for ways to diversify, so its business is still growing, even as the automobile industry goes into a deep slump.
Ms. Kimball, on a recent visit, was greeted by the plant operations manager, Shane Klyn, and then given a tour of the factory, which is installing towering new hydraulic presses — thanks to loans from Independent — as part of an expansion that it hopes will lead the company into profitable work making parts for solar energy devices.
“This will allow us to move into new projects and markets,” Mr. Klyn said as he walked through the plant with Ms. Kimball, who by then had a big smile on her face, despite the freezing winds and piles of snow just outside. “The bank is giving us the opportunity to expand.”
But companies like Ultimate Hydroforming are extremely hard to find, particularly in Michigan, where the unemployment rate is far above the national average.
With no surge in lending taking place right away — and the bank very much looking for a way to improve its own balance sheet — Independent took the $72 million check that arrived from Treasury in mid-December and immediately transferred it to the Federal Reserve to pay down short-term loans it had taken out.
This month, the bank is planning to leverage that bailout money to buy about $160 million in mortgage-backed securities from institutions like Fannie Mae, an investment that it hopes will produce enough interest income to pay the dividend it owes the federal government. Again, this will bring little immediate benefit to Michigan businesses and residents. In essence, the $72 million has been stuffed into Treasury’s own mattress.
Mr. Hovde, the hedge fund investor who says he believes the bailout program is putting off judgment day for many banks, said his fear was that many of the banks would burn through their federal money only to face a squeeze again. And they will never have made the extra loans that the Treasury had hoped would jump-start the economy.
Treasury officials remain confident that the investments are wise ones.
“There’s going to be more lending than had we not done this,” Mr. Kashkari said. “Even if the overall numbers are down year-over-year, it’s going to be a lot more than if we had not put the capital in the system.”
And Mr. Shuster, back in Michigan, said he was determined to prove that Mr. Kashkari — whom he has never spoken to or met — is right.
“Even if things get tougher, I am confident we can work our way through this and pay every dime back to the U.S. Treasury,” he said. “There is no stone we won’t turn over to make sure we are good stewards of this money. We feel an enormous responsibility to this Treasury. I am a taxpayer too.”
Eric Lipton reported from Troy, Mich., and Washington, and Ron Nixon from Washington.