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County banks riding out the storm
Exchange, First Community hit by weak ratings as they work to recover from bad loans
Published: Sunday, January 11, 2009 at 4:22 a.m.
Last Modified: Sunday, January 11, 2009 at 8:43 a.m.
Two of Sonoma County's largest community banks, Exchange Bank and First Community Bank, received weak grades in a new set of national ratings that awarded mostly strong marks to the other banks based in the county.
All but Exchange Bank have remained profitable despite the headwinds of the nation's worst financial storm since the Great Depression, and even that beleaguered Santa Rosa institution has been bolstered by last month's infusion of federal funds.
Top marks went to Luther Burbank Savings and Summit State Bank, both of which made an early retreat from construction lending that has been the chief source of problem loans.
Exchange Bank, the county's largest local bank, has been grappling with mounting losses largely from loans made to developers. Builders continue to fall behind on loans, and banks are writing off more with the housing sector's fall yet to hit bottom.
"The problems there have put a shadow over our entire financial performance and balance sheet," said William Schrader, Exchange Bank president. "Our numbers are not something we're proud of. Those numbers are systematically going to be improved on."
For First Community Bank, the county's third-largest local bank, the problem areas are loans to businesses, as well as developers.
"We're looking at 2009 as a year of continued struggle," said Debbie Fakalata, First Community Bank's executive vice president. "The key for us is that we continue to have positive earnings. We just have to look for signs of weakness as the economy continues to weaken."
Despite the challenges, both banks appear able to absorb the losses and continue to grow even with potentially more trouble ahead, analysts said.
"Nothing looks alarming, even with their difficulties," said Harry Eisenberg, manager of a community bank investment fund in Lafayette. "Overall the community banks in Sonoma County are very strong. I consider it probably a terrific time for community banks in terms of picking up new business."
The five banks and one savings and loan headquartered in Sonoma County survived a year that saw 25 banks fail across the United States. Large and small institutions alike tightened lending as loan defaults and foreclosures soared to record levels.
The grades were given by two of the industry's leading bank rating firms: TheStreet.com gives letter grades ranging from A for excellent to E for very weak; and Bauer Financial issues ratings that range from five stars for superior to one star for troubled.
Both Exchange Bank and First Community Bank received a D-plus from TheStreet.com. Exchange was given two stars, and First Community had three stars from Baur.
Dodging bullets
The strongest grades went to Luther Burbank Savings and Summit State Bank. Both were rated with five stars from Bauer Financial; Luther Burbank earned a B-plus from TheStreet.com and Summit earned a B.
Both lenders reacted early to the decline in the housing market and reduced their exposure to construction loan defaults and foreclosures.
"They dodged the bullet," said Fred Ptucha, who tracks community bank stocks as investment adviser for Financial West Group in Santa Rosa.
Sonoma Valley Bank received B-plus and four-star grades. Atlantic Pacific Bank earned C and four-star grades.
The two banks also steered a conservative course away from construction loans.
Investors considering purchasing bank stocks and consumers looking to make deposits buy the ratings reports.
Locally based Redwood Credit Union is also a major lender, but was rated only by Bauer Financial, receiving high marks with four stars. TheStreet.com does not grade credit unions.
Together, locally owned financial institutions control more than one-third of the county's $10 billion in deposits. The rest of the market is divided among regional and national banks.
Ratings are based on quarterly financial reports, with the latest round pegged to financial results for the third quarter of 2008. They take into account indicators of financial strength including long-term funding sources, profitability, loan delinquencies, reserves, asset quality and historical trends.
All six institutions measured up in one key area that tells how much of a bank's own money -- and not depositors' money -- is available to cover unexpected losses. Each is considered well-capitalized.
Nonetheless, both Exchange Bank and First Community Bank still fared less favorably than other local banks.
"Even though they are well-capitalized, they are facing some challenges," said Karen Dorway, president and research director for Bauer Financial.
One critical function of capital is to absorb losses.
Exchange Bank's poor marks follow its posting $11 million in losses through the first three quarters of last year.
"That's a fairly large loss for a bank that size," Dorway said.
Exchange Bank has set aside more money to cover loan losses and is writing off a greater number of bad loans concentrated in construction and development.
"They're taking huge loan losses. The pace of charge-offs was very high and their capital position was pretty weak," said Philip Van Doorn, senior banking analyst for TheStreet.com. "If all this continues, they're in trouble. They get the D-plus rating because of the uncertainty."
Exchange Bank's numbers
Exchange Bank officials said they are being aggressive in dealing with problem loans and the worst should be behind when 2008 is in the books.
"I think we're getting near the bottom of it," Schrader said.
After three quarters last year, Exchange Bank ranked lower than similar-sized banks nationwide in several measurements of assets and reserves. Bauer Financial provided the following:
More than 5 percent of all Exchange Bank loans were delinquent 90 days or longer. The bank's peer group averaged 2.3 percent.
Exchange Bank charged off 4.5 percent of loans minus recoveries from earlier write-offs. Its peer group average was 0.7 percent.
The bank beefed up loan loss reserves, setting aside funds to cover 2.3 percent of all outstanding loans. Its peer group average was 1.6 percent.
Bauer Financial rated Exchange Bank "problematic." TheStreet.com rated the bank "weak."
Despite the poor ratings, Exchange Bank's numbers are still in the ballpark of similar-sized banks, Eisenberg said.
"That reflects them taking action on the problem loans. That's not to say more can't go bad. But they're not a troubled bank," Eisenberg said.
First Community's loan quality numbers also have declined, but remained comparable or better than similar-sized banks, according to Bauer Financial:
About 2 percent of its loans were delinquent 90 days or longer, similar to the bank's peer-group average.
First Community Bank charged off 0.02 percent of loans minus recoveries from earlier write-offs. Its peer group average was 0.43 percent.
The bank increased loan loss reserves, setting aside funds to cover 1.3 percent of all outstanding loans, similar to its peer group average.
Bauer Financial rated First Community Bank "adequate."
"Its delinquent loans are a tad on the high side, but it's not into the problem area. That still appears to be manageable," Dorway said.
TheStreet.com rated First Community Bank "weak." It gets a lower rating because the bank has more problem loans than it should for a relatively new bank, Van Doorn said.
"That's a concern," he said.
Still, there is plenty to like about First Community Bank, analysts said.
"They're moving aggressively and obviously there's some poor timing with the economic collapse," Van Doorn said. "They're efficiently run. They're making money, which is great for a bank that's less than five years old."
The growing pains are manageable, Fakalata said.
"Our bank is really diligent in trying to work with the borrowers to get the best out of it for the bank and the client. And when we can't do that, we have had to face some foreclosures. We've kept that to a minimum," Fakalata said.
The bank's dozen or so owners have invested more money to boost loan loss reserves and provide for capital to expand lending, Fakalata said. First Community Bank's legal structure doesn't allow it to qualify for funds the federal government is injecting into the financial system, she said.
The Treasury Department is purchasing stock in local banks through the Troubled Asset Relief Program, or TARP, to boost lending by healthy banks. The aim is to unlock frozen credit markets and stimulate the U.S. economy.
Federal infusion
Exchange Bank last month received $43 million through the effort after gaining initial approval from federal banking regulators. The bank initially committed $14.7 million of the funds to the Santa Rosa redevelopment agency to support affordable housing efforts, Schrader said.
The remaining funds have not yet been committed. Bank officials said the money goes into overall capital reserves and will be used over several years as a foundation for the broad range of loans the bank traditionally makes, from home purchases and auto lending to business credit lines and other commercial lending, in addition to public projects.
"In spite of the rough spot the bank is going through, the government had the faith to award this money to the bank as an investment. It allows reinvestment in the community," Schrader said.
The infusion strengthens Exchange Bank's capital position and significantly increases funds available for lending over the next several years, analysts said.
"They still have to run the business properly. But this enables them to grow the bank faster than they would normally have and produce a lot more income to their shareholders," Eisenberg said.
The federal funds should help Exchange Bank eventually return to profitability, analysts said.
"The bottom line is you have to make money," Van Doorn said.
(You can reach Staff Writer Michael Coit at 521-5470 or mike.coit@pressdemocrat.com.)
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