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Small banks caught in regulation crackdown

By   /   Monday, October 26th, 2009  /   Comments Off on Small banks caught in regulation crackdown

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[Editor’s note:  A clarification regarding Community West Bank’s profits has been added at the bottom of the story.]

Two banks with tri-county operations have received orders from federal regulators to raise capital.

The parent companies of Solvang-based Los Padres Bank and Woodland Hills-based Western Commercial Bank both now face a series of deadlines to boost their cash. The banks hit trouble with real estate loans but say they have had plans in place for months to deal with a liquidity crunch and have raised or are about to raise the money they need.

Federal regulators have come down hard on small banks, with some industry observers estimating that three out of every four California banks are operating under some kind of regulatory agreement, whether in public or private. The government has closed more than 100 banks this year, with perhaps hundreds more to follow in coming years.

But the capital-ratio crackdown on small banks raises new and troubling questions about the coherence of federal regulators’ strategy. Professional economists wonder how, when much of the cause of the financial crisis lay in “too-big-to-fail” banks, thinning the ranks of financial institutions could contribute to financial stability. They also note that hefty capital requirements keep banks from lending and slow a recovery in job growth.

But not all news is negative in tri-county banking. At least two community banks, Montecito Bank & Trust and Goleta-based Community West Bank, turned in profits in the third quarter.
Here’s a closer look at recent developments in the tri-county banking sector.

Western Commercial Bank

Western Commercial Bank, a business lender with a loan production office in Oxnard and about 20 percent of its shareholders in Ventura County, was expected to consent Oct. 23 to an order from federal regulators to raise $1 million and boost its tier-one leverage ratio to 9.5 percent within 90 days. At June 30, the bank had a tier-one leverage ratio of about 8 percent.

Carl Raggio, chief executive officer of the $122-million-asset Western Commercial, told the Business Times that the bank has already raised $900,000 of the $1 million it was ordered to raise and is confident it will secure the rest in time.

“We will be in full compliance with the cease and desist order. We take it seriously,” Raggio said. “We have no intention of trying to fight the regulators.”

Federal regulators also cracked down on Western Commercial’s reliance on so-called brokered deposits. Those are deposits that come in from brokers who put client money into whatever bank promises the highest return. Sometimes called hot money, brokered deposits have drawn regulatory scrutiny because of their perceived volatility – they can leave a bank in search of a better deal almost as quickly as they came.

Western Commercial was founded in 2006, and at that time, Raggio said, federal regulators approved his business plan — including the reliance on brokered deposits for growth. While he acknowledges that the deposits may remind some observers of past banking crises, Raggio says he feels like regulators have pulled the rug from under him after giving him a green light three years ago.

“We understand that this is going to change and has to change,” Raggio said. “But what we don’t understand is why you have to put in a cease and desist order to move on it.”

Los Padres Bank

Harrington West Financial Group, which has about $1 billion in assets and owns Los Padres and other banking operations, reported on Oct. 16 that it consented to the entry of a cease and desist order from the Office of Thrift Supervision.

Los Padres is the third-largest bank in the tri-county region, with 13 branches. At June 30, the bank had a tier-one leverage ratio of 6.46 percent. Although the bank hasn’t released third-quarter numbers, the federal order suggests its capital position took a hit.

The order replaces a milder supervisory agreement reached in April with regulators. In it, Harrington West and Los Padres agree to raise Los Padres’ level of core capital to 4 percent and risk-based capital to 8 percent of assets by Nov. 6 with a further boost to 8 percent and 12 percent respectively by Dec. 31.

Craig Cerny, Harrington West’s chief executive officer, said the bank already raised more than $12 million in a stock offering earlier this year and is on track to gather the money it needs. Step No. 1, Cerny said, is the sale of the firm’s Kansas City division, Harrington Bank, to Arkansas-based Arvest Bank, a transaction that will shrink Harrington West’s balance sheet and bring in cash.

“We’re selling $100 million of our deposits and loans in their market, plus a $4.1 million premium,” Cerny told the Business Times. “That’s the first leg in plan — we subtract $100 million in assets, and add $4.1 million in capital.”

The second leg, Cerny said, is going to investors to raise more capital.

“We are in a number of discussions and are far along with those discussions,” Cerny said. “We are and have been working hard and think we have a viable plan there to put our capital in a position that would materially exceed these ratios.”

Cerny said the order was not a surprise but that “timelines just didn’t mesh” for the banks and regulators, even though deals were in the works.

“It just happens that it takes us time to negotiate a definitive agreement [to sell Harrington Bank],” Cerny said. “They [the regulators] would like the capital sooner. They keep you on a tight leash. They want to show they’re taking action.”

Questions raised

Though there are no hard numbers because federal regulators have come down on many banks behind closed doors, there’s no question that there’s a policy in place to thin the ranks.

Cerny, of Harrington West, estimates that one in five West Coast banks are under some kind of federal orders, though some aren’t public.

“When you have 20 percent of our industry under cease and desist orders, you can’t say it’s just everyone mismanaging,” Cerny said. “Its systemic.”

Raggio puts the figure higher – at perhaps three out of four California banks. But what economists don’t understand is why the federal government thinks culling small banks while bailing out big ones will solve a system financial crisis spurred in part by too much risk accumulating in too few hands.

“It makes no sense to me,” said Bill Watkins, an economic researcher with California Lutheran University in Thousand Oaks and a former banking economist. “I think the regulators would just prefer to have a smaller number of banks to regulate because it makes it easier for them. It’s reducing some diversification.”

Moreover, Watkins said, tight capital requirements might help keep individual banks alive, but they translate into a systemic hoarding of cash that makes credit hard to come by.

“It’s really important that we get these banks cleaned up and lending as soon as possible,” Watkins said. “If we don’t, we may technically end the recession, but it’s not going to be a good economy anytime soon. We’re not going to create jobs at a satisfactory rate.”

Finally, some better news

Troubled as the tri-county banking sector may be, Montecito Bank & Trust and Community West Bank turned in profits at the end of the third quarter.

Montecito Bank & Trust turned in a profit of $7.7 million for the first nine months of this year, compared with $5.2 million for the same period last year. Deposits and loans at the $818-million-asset firm also grew, the bank said in a statement.

“We are extremely pleased with our performance, especially given the continuing stress in the economic environment,” Janet Garufis, president and chief executive officer of Montecito Bank & Trust, said in a release. “We continue to benefit from our disciplined management practices and our long-term strategic approach to growth and profitability.”

Though $674-million-asset Community West Bank is at a $5.8 million loss since the beginning of the year, it has been profitable since the second quarter. The bank eked out a $69,000 profit in the third quarter despite recording a $2.6 million loan loss provision.

Lynda Nahra, president and chief executive officer of the bank, attributed the small profit to controlling costs and keeping an eye on details without losing sight of the larger landscape.

“We’re looking around to see what we don’t need to spend money on. It’s back to basics,” Nahra said. “With that said, we don’t want to over-control the expense side because we know we’re going to emerge from this as one of the remaining players, and we want to be positioned for the growth that will come out on the other end.”

[Editor’s note: As originally posted, this article suggested that Community West Bank swung from a loss to profit in the third quarter. The bank has been profitable since the second quarter.]

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