Schafer: St. Paul's American Bank gets back to banking basics

American Bank of St. Paul made a profit in its first quarter, which would be unremarkable except that the last time it did so was in 2007.

It's got a long way to go to earn back the roughly $60 million it has lost since then, but CEO Tom Palmer is optimistic that the rest of 2013 will show more progress and 2014 will be even better. "It's been good to get the word out that we have turned the corner," he said.

That a bank like American is still upright in 2013 is perhaps a bit remarkable, too. It's had more than its share of bad news, and if you recall 2009 and the depths of the Great Recession, a lot of smaller community banks were not expected to make it out alive.

It was in early 2009 when an RBC Capital Markets analyst made a splash for estimating that 1,000 U.S. banks might fail in the following three to five years, as losses mounted on commercial real estate loans. He was far from alone in offering such a gloomy outlook, and even a Florida bank CEO went on TV that summer to predict 1,000 upcoming bank failures.

Turns out they were too pessimistic. From the start of 2009 through last week, there have been 448 bank failures. It was much worse during periods like the savings and loan crisis of the late 1980s and early 1990s. Regulators seized 534 banks and thrifts just in 1989 alone.

The higher-than-expected survival rate this time can be explained in part by the actions of regulators. Edward Drenttel, a prominent bank attorney with the Minneapolis firm of Winthrop & Weinstine, said "there may have been an element of de facto capital forbearance," meaning bank regulators would be aggressive enforcers on issues such as lending practices but give bank management time to rebuild capital.

Many smaller community banks were well capitalized as the Great Recession hit, and even if stung by losses they were largely able to get additional capital from their shareholders. Low interest rates helped, keeping costs low for banks and borrowers and helping the recovery of asset values that secured loans.

Oak Ridge Financial senior adviser and analyst Ben Crabtree noted that the speculative lending that kills banks was largely a disease with local or regional hot spots, tied to the most speculative real estate markets. About 45 percent of the nation's bank failures from the start of 2009 through 2012 took place in just the states of Illinois, Georgia and Florida.

To erode a community bank's capital to the point of failure in a place like the Upper Midwest, Crabtree said, "it takes either really bad luck or really bad management."

American Bank, with headquarters in St. Paul and branches in Twin Cities area and southern Minnesota, likely had some of both. Evidence of the latter would have to include financing Florida entrepreneur Louis Pearlman's plan to acquire a British music television show.

To say this deal of Pearlman's didn't work out is an understatement, as the Federal Bureau of Prisons said Pearlman is still a guest of the Federal Correctional Institution in Texarkana, Texas.

Pearlman was once best known for creating the popular "boy-band" acts Backstreet Boys and 'N Sync, but much of his business empire was revealed to be a fraud. He has a long prison stay still ahead of him.

But it was given time to dig its way out of the hole, and it used the traditional means of doing so, by shrinking the balance sheet and the cost structure and working to recover the value of its loans. It closed branches and now has about 90 employees, down from 125 in 2011. It had $714.3 million in assets at the end of 2005, and today that has shrunk has about $350 million. Palmer bemoans losing good employees through layoffs, but added that "it was better than losing 125" jobs.

Palmer said the first-quarter profit resulted largely from backing out reserves it had previously booked for anticipated loan losses, and the bank is now conservatively reserved. Now comes the challenge of growing loans in a very competitive market.

Palmer noted that for the many banks that came through the Great Recession mostly unscathed, "there must have been times when they had to have the fortitude to say no" to some loans, he said.

Like, he volunteered, the Pearlman deal. Palmer said litigation related to Pearlman still has not been fully resolved, five years after Pearlman pleaded guilty.

"What do I know about the music business?" Palmer said. "Not enough to make a 5 or 6 or 10 million-dollar loan. That is craziness."