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Thursday, May 17, 2012
Feature: March 2009
The Great Bank Coax
Landing a loan on bankers’ new terms
Story by Adam Weintraub
Chirping crickets and the rustling of dusty stacks of cash shoved farther into a vault — that’s the sound of banking in early 2009, if you believe some of the stories you’re hearing.
Bankers, as you might imagine, disagree.
“We’re a small bank, and we’re writing loans every month,” says John DiMichele, president and chief executive officer at Community Business Bank in West Sacramento.
Sound bites and headlines about the $700 billion in federal bailout money for the financial sector have raised concerns that banks that got the cash are sitting on the capital or using it to buy other banks, not lending it to customers.
That worry led some politicians to call for restrictions on the federal cash to guarantee that it goes to new loans. Others say forcing the money out into the hands of individual borrowers could lead to more loan defaults and more financial woes down the road — without fixing the present problems.
“We certainly want to make loans,” says Steve Fleming, president and CEO of RCB Corp., the parent of Sacramento-based River City Bank, which had more than $850 million in assets as of Sept. 30. “But we don’t need political pressure to make bad ones.”
James Beckwith, president and CEO of Five Star Bank in Sacramento, called the notion of unavailable loans “hogwash.”
“The common banks, they’re making loans,” Beckwith says. “Our loan total was up 25 percent in 2008.”
Still, there’s no question that the landscape has changed.
The downturn has many businesses battening down the hatches, which reduces demand for loans.
Eager to avoid losses, most banks are tightening underwriting standards or holding them steady, making it tough to find cash for risky ventures unless the borrower brings substantial equity to the deal. That’s a major shift from the easy-money days of a few years ago.
With the secondary markets still in turmoil and wounds still fresh from the subprime mortgage mess, banks have lost much of their ability to free up capital by bundling loans into securities and selling them to investors. Regulators require banks to have sufficient capital to back the loans they make, so as existing credit lines are used up, they’ll have to find new deposits or other sources of capital.
So what can local businesses expect in the near future?
“I don’t think there’ll be a lack of credit availability, but conditions won’t be as favorable” for borrowers, says Anat Bird, president and CEO of SCB Forums Ltd. Bird worked in banking and finance for years before launching her Granite Bay-based business, which organizes networking and information-sharing sessions for bankers around the United States.
In a market where local banks had to compete against big players, “the bankers were not paid enough for the risk” they assumed, Bird says. “When everybody else is charging 4 (percent), you can’t charge 7.”
Now some of the big players have abandoned whole sectors of lending. “There is no free lunch,” she says. “The credit is there, but you have to pay for it.”
Strengthening capital positions was part of the point of the federal Troubled Asset Relief Program, commonly known as TARP, which has sent hundreds of billions of dollars to banks around the nation since it was approved last fall.
But almost none of that cash went to banks based in the Capital Region.
The Treasury Department website in early February showed only two local institutions had accepted capital from the program — about $17 million to Bank of Commerce Holdings in Redding, parent company of Bank of Commerce Roseville and Bank of Commerce Sutter, and $10.4 million to Citizens Bancorp of Nevada City. Both stressed the program provided capital to financially healthy institutions.
“There is no free lunch.
The credit is there, but you have to pay for it.”
— Anat Bird president and CEO, SCB Forums Ltd.
The bulk of the cash went to big national and regional players. While it’s hard to tell how many local players applied, there haven’t been any other takers, for a variety of reasons. For one, many local banks are pretty conservative with their lending standards — most typically keep loans in their own portfolio rather than selling them in the secondary market. For another, many weren’t happy about the strings attached to the federal largesse, including the requirement that banks sell preferred stock to the government.
“Some of them would have had to change their bylaws to allow preferred stock,” DiMichele says. Still, many banks weighed taking the cash. “In markets like this, it’s very good to have extra capital,” he adds, stressing that Community Business Bank is considered well-capitalized.
“We were extraordinarily well-capitalized to begin with,” says Kent Steinwert, president and CEO of Lodi-based Farmers & Merchants Bank. The bank, formed in 1916, has exercised “conservative stewardship,” he says; it has more than 20 branches in the Central Valley, from Sacramento to Turlock, and fewer than 1,500 shareholders. “The TARP capital wasn’t needed to bolster our capital position,” and exec-
utives had concerns that the cash would be subject to a changing set of rules and conditions.
Those concerns have been borne out. While many community bankers were cool to the program at first, industry surveys showed that they warmed up quickly. But by early 2009, some local bankers voiced renewed concerns.
River City Bank applied for the program, but as of early February hadn’t received approval or decided whether it would accept TARP funds. “We are considering it,” Fleming says. “There are a lot of pros and a lot of cons. It seems the political winds are pushing for new restrictions.”
American River Bankshares also applied for the capital purchase program funds and won approval in November for $6 million, but the board of the
Sacramento-based bank holding company eventually turned the deal down.
Executives were concerned about the dilution of stock that selling more shares and issuing warrants would cause, bank president and CEO David Taber said shortly after the decision. Once they saw the details, they were particularly troubled by the provisions that allow the government to unilaterally change the terms if Congress adds new rules to the program, he said.
The rhetoric about TARP has changed over time. Initial talk called for using the funds to acquire problem assets, such as mortgages in default, and get them off the books of U.S. banks. Later it was discussed as a way to infuse more capital into healthy banks through government purchase of preferred stock, a tool to loosen the credit squeeze.
But as passed by Congress and implemented by the U.S. Treasury Department, there were few hard-and-fast requirements for how banks should use the TARP money. Many banks saw the program as a source of inexpensive capital — it must be repaid with a premium of 5 percent to 9 percent a year, cheaper than some other funding sources — and used it to shore up their books, pay off debt or stash in a war chest to use for acquisitions.
Complaints arose that banks were benefiting, but few of those benefits were reaching customers who needed loans or faced foreclosures.
There were no requirements that the recipients disclose what the cash was being used for, but The New York Times reviewed transcripts of conference calls and analyst presentations by about two dozen financial firms that discussed the use of TARP funds. It found that few mentioned lending as a priority, and most “saw the bailout as a … windfall” they could use to cut debt, acquire other businesses or invest to emerge from the downturn stronger.
Among banks with a major Capital Region presence, an Umpqua Bank executive said in November that the Portland, Ore.-based bank expected to use some TARP proceeds for acquisitions. In January it took over a troubled bank in Washington state.
In early January a congressional oversight panel also raised concerns that the Treasury program was doing nothing to address lawmakers’ intent that it “maximize assistance for homeowners.” Timothy Geithner, the Treasury Secretary choice of President Barack Obama, said during confirmation hearings that the $700 billion bailout plan had favored big financial institutions and did too little for families and small businesses. Key lawmakers were talking by January about restricting executive pay at banks that accept the money and requiring that some of the proceeds be loaned out.
It’s that ‘moving target’ aspect of the program that worries some bankers; they understand that every financial transaction has specific terms but say few people would sign a deal where the terms were subject to change without warning.
So where does that leave businesses and other borrowers who need financing in the months ahead? Working within a more conservative and disciplined market, local players say.
“We certainly want to make loans,
but we don’t need political pressure to make bad ones.”
— Steve Fleming, president and CEO, RCB Corp.
The U.S. Office of the Comptroller of the Currency reviews underwriting practices at the largest national banks each year, and found that 52 percent tightened standards in the year ending March 31, 2008, the most recent data available; 78 percent expected risk to increase in the year ending March 31, 2009. Standards tightened for both commercial and retail loans after four consecutive years of easier money, the study found.
Standards for commercial residential loans were cranked down even tighter; 62 percent of the surveyed banks reported tougher standards for that category.
The strictures have taken a toll on some businesses. Recent media reports note that because of the tougher standards some banks have pulled small builders’ credit lines — even though they’ve never missed a payment.
“I don’t think we’re doing too many construction loans,” says Five Star’s Beckwith, but that’s mostly a reflection of market demand. “Underwriting standards have tightened,” and some lenders have all but abandoned certain sectors, he says, but that creates “more opportunities for the people who are loaning money.”
Fleming says River City, which had a couple of problem loans in the third quarter, is “really going to focus on the fundamentals when it comes to banking relationships,” going back to basics: A slightly more conservative approach, requiring more equity, less leverage, adequate cash flow and due diligence. “We’re aggressively seeking new relationships with top-notch borrowers and customers.”
Other community bankers also stressed that focus on well-qualified borrowers, long a hallmark among the specialists in local business banking, and long-term customer relationships can allow flexibility when problems arise.
“You’ve got to make sure you’ve got good quality customers who can withstand a downturn, and for the most part we do,” Beckwith says.
Steinwert, of Farmers & Merchants, says his bank’s underwriting standards have stayed largely unchanged, and the institution’s stability has attracted customers unnerved by the recent turmoil in the market. “We saw a record level of growth in deposits over the past year, close to 10 percent.”
Taber also stressed the value of consistency and said American River held its underwriting standards steady through the boom. “When our competitors were being foolish in ’05, in ’06 and to an extent in ’07, we grew more slowly” as borrowers flocked to less stringent deals. “We’ve been a cash-flow lender from the beginning,” and to the extent his lenders are requiring more equity it’s because market fundamentals have changed, such as higher vacancy rates in commercial real estate.
Bird says the retrenching by national players opens opportunities for local banks. “For certain types of borrowers, credit will be much more available from community banks,” she says. Small builders, for example, will likely have an easier time with their local banker, especially if they have some history together.
But don’t expect to leave the bank without filling out more paperwork and seeing tighter conditions. For variable-rate loans, borrowers are more likely to see a rate floor so that even if the prime rate or LIBOR drops, the bank is guaranteed a minimum interest payment, Bird says. Another probable shift is to add prepayment penalties to limit borrowers from hopping back and forth between fixed or variable rate loans, making returns more stable and predictable.
You give loans a bad name
It was good advice in “The Hitchhiker’s Guide to the Galaxy,” and it’s good advice if you’re having trouble repaying your business loans: Don’t panic.
Also, don’t hide, return phone calls and let the lender know of potential problems, local bankers say.
“The No. 1 thing that clients need to do is communicate,” says David Taber, president and CEO of American River Bankshares. “Just like in a marriage, if you don’t communicate the other partner assumes the worst.”
Community banks make their hands-on relationships with borrowers a selling point, and “community banks stick with their customers a lot longer than their regional or national counterparts” when things start to go wrong, says Anat Bird, president and CEO of Granite Bay-based SCB Forums Ltd., a bank networking business. While the big banks generally pull back from a whole sector when things get risky, she says, small banks are more willing to work out a deal with individual customers.
But they can’t work with you if they don’t know there’s a problem, and they’re not big on unpleasant surprises.
“Make an appointment immediately” if you see trouble looming, says John DiMichele, president and CEO of Community Business Bank in West Sacramento. “Some people just hide from it. They just stop talking to the bank.”
Bad idea.
“If you notify us early, we’re more willing to work with you; you want to be accommodative,” says James Beckwith, president and CEO of Five Star Bank. “It’s in nobody’s interest to take a property back.”
Fixes can run from simple tweaking — of interest rates, repayment schedules or other terms — to the elaborate. Local bankers have helped borrowers become more aggressive in collecting receivables, paired them up with management consultants, arranged a new line of credit for big customers and even helped them find a buyer for a struggling business to help avoid a shutdown and preserve local jobs,
“If our clients don’t succeed,” Taber says, “we don’t succeed.”
— Adam Weintraub
