Under Pressure

Fighting tight regulations and stiff competition, young community banks turn to well-established banks to turn profits

Back Longreads May 22, 2018 By Russell Nichols

From her corner office on the 23rd floor of a downtown high-rise, Virginia Varela has a spectacular view of Sacramento. For one more month, this leased office space is home to Golden Pacific Bank, which opened in 2010. Last year, the community bank reportedly had its most successful year ever.

How successful? Varela, Golden Pacific’s president and CEO, wants to verify the exact figure.

“Brad?” she calls out to the chief financial officer. “How much did we make last year?”

Right away, he responds: $1.164 million.

Varela repeats the number, noting how easy it was to get the answer. “I wouldn’t be able to do that in a real large bank,” she says, proudly.

In 2018, Golden Pacific Bank is an anomaly, one of the few remaining community banks in the Capital Region to emerge in the past 10 years and not be acquired by a larger entity. After 2008, federal agencies flooded the market with money and put financial reform laws in place to supervise large financial institutions and protect taxpayers from another crisis. Regulations included stricter capital requirements and low interest rates, a combination that shrunk revenue streams from loans while increasing the cost of doing business.

Related: Rising to the Occasion

Related: Back and Forward: Virginia Varela

Now, some lawmakers want to adopt new legislation to ease unfair financial burdens placed on community banks. But opponents want to ensure relaxing these rules doesn’t reignite the dangerous lending and investing that triggered the economic collapse a decade ago.

The regulations, some argue, were overly harsh to community banks, which generally weren’t to blame for the economic collapse. Nonetheless, many of these smaller, regional banks got swept up in the recent surge of mergers. Between 2010 and 2016, about 1,000 community banks around the country were acquired, and nearly two-thirds of them were headquartered in metro areas, according to a 2017 FDIC report.

“Nationwide, our industry has been consolidating,” says Central Valley Community Bank President Jim Ford. “That’s going to continue and whether people feel that’s good or not is for others to decide. In recession times, banks didn’t have choices. If you have a boatload of credit problems, losing money, no liquidity, you may be forced to sell your bank.”

In the Sacramento region, community banks recently acquired have had two key things in common: 1) They formed shortly before the Great Recession and 2) they weren’t generating enough revenue to keep shareholders satisfied. There are community banks with staying power, but they tend to be older with a track record that kept them stable. Merchants National Bank of Sacramento has been holding its ground since 1921. First Northern Bank, based in Dixon, was founded in 1910 and board members pledged to never merge.

In the wake of the downturn, Golden Pacific found success by changing its strategy. Under new management, the bank cut back expenses, reduced its number of branches from seven to three and started focusing more on small businesses, Varela says. In June, Golden Pacific Bank will relocate from its leased office space downtown to its own building in Midtown Sacramento.

“I see Sacramento growing and changing and we want to put our capital in our local community,” Varela says. “We’re one of the last small-sized community banks left standing in the area.”

BRANCHING OUT

A community bank is not clearly defined, but generally focuses on businesses and families in a given region. State regulators use a definition that examines “business activities, funding model and geographic footprint and that does not solely look to asset size,” according to the Conference of State Bank Supervisors, a national organization of financial regulators.

“Today, in general, the regulator burden and this long slow recovery can put a lot of pressure on smaller institutions. Fixed costs rise, but gross profitability does not.”Jim Ford, president, Central Valley Community Bank

When it comes to bank mergers and acquisitions, no two deals are exactly alike. Customers may or may not be impacted by the changes. Shareholders of the acquired bank either become shareholders of the acquiring bank, are cashed out or receive some combination.

The Capital Region has seen several mergers recently, including Auburn-based Community First Bancorp, which was acquired in November by First Foundation, the Irvine-based financial services company. Also, CBBC Bancorp, parent company of West Sacramento’s Community Business Bank, agreed to merge into Visalia-based Suncrest Bank last year. Typically, the younger the bank, the smaller it is, which makes it harder to generate top-line revenues.

“I’ve been on both sides of mergers, banks that have been acquired and done acquisitions,” Ford says. “But today, in general, the regulatory burden and this long slow recovery can put a lot of pressure on smaller institutions. Fixed costs rise, but gross profitability does not.”

Folsom Lake Bank, founded in 2007, had three branches in the region and assets worth $206 million. Sierra Vista Bank was also based in Folsom, opened in 2007 and had three branches, but $156 million in assets. Founded in 1980, Fresno-based Central Valley Community Bank paid $31.3 million and $28.6 million respectively to buy both banks in the past two years, increasing its own assets to about $1.7 billion with 24 branches throughout the San Joaquin Valley and greater Sacramento region.

These acquisitions weren’t aggressive, Ford says. They were organized, agreed-upon “liquidity events,” which allowed shareholders to cash out their ownership shares or have more liquid stock instead of an illiquid stock, which is harder to sell.

Bob Perry-Smith was a key stakeholder in that decision. The veteran accountant and bank consultant was named chairman of the Sierra Vista Bank board in 2013. (His Sacramento firm, Perry-Smith, was acquired by the Chicago-based public accounting firm Crowe Horwath in 2011.)

When Central Valley Community Bank offered to buy Sierra Vista Bank, Perry-Smith called for a planning meeting and brought the option to the board. They asked themselves a simple question: Which path would ultimately lead to the best return on investments for shareholders? The answer, they agreed, was to merge. Perry-Smith’s role ended at the date of the transaction, but he knew the costs.

“It’s a director’s fiduciary responsibility to do what’s in the best interest of the shareholders,” says Perry-Smith, who is now retired.

In his 40 years in the industry, Perry-Smith has seen the landscape evolve. But everything changed with the recession, from how a bank operates and internal controls to financial accounting and the amount of capital banks have to maintain.

“The challenge for regulatory agencies was to ensure we never had a financial crisis like 2008 ever again,” he says. “Safeguards were built in, and some of them made good business sense. But when you push that all the way down to a $150 million bank, the ability to earn a buck becomes very difficult.”

108 YEARS AND COUNTING

Being one of the oldest banks in the region, First Northern Bank’s longevity (and $1.2 billion in assets) speaks for itself.

Jim MacLaughlin has been a business customer there for 30 years. As president of MacLaughlin and Company, a West Sacramento-based commercial real estate company, he hails First Northern Bank’s customer service and fee structure. While he admits getting pressured all the time by the big national banks to do business with them, he refuses to open operating accounts with any other bank.

“For our business model, it doesn’t make sense to deal with every bank in the marketplace compared to establishing a relationship with one bank to take care of different accounts,” MacLaughlin says.

In the past few decades, technology has been the biggest change to the financial industry, says Louise Walker, president and CEO of First Northern Bank. (“I remember we were the first local bank around to have an ATM in 1976.”) But all the new regulations can’t be denied.

“Bank secrecy, anti-money laundering, mortgage regulations — it’s all very involved and very confusing for customers,” Walker says. “What’s worse is, regulation has definitely limited choices for customers. Some banks have simply had to say, ‘We don’t have resource expertise in this area.’ Other banks have decided to get out of offering mortgages due to the immense regulatory burdens.”

Walker’s main strategy in this area has been to add key staff from different fields to make sure compliance is met. Don’t expect First Northern Bank to be acquired in the future. In 1996, its board adopted a Policy of Independence and the directors reaffirm it every year, she says.

Of its approximately 1,300 shareholders, not one owns more than 5 percent. Currently, over 85 percent of employees are shareholders. The bank’s employees also support local organizations and foster lasting relationships that keep First Northern Bank customers loyal, Walker says.

“We’re a small business bank, and small businesses are the bread and butter of vibrant communities,” she says. “Our commitment to the communities we serve is why we’re successful and still here. It all fits together. Community banks are good for the local economies and economic growth in general.” 

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