How local banks are handling the downturn
Published 10:22 pm Saturday, December 27, 2008
Community banks in Snohomish County are being drawn into a vortex of the financial storm that has battered megabanks worldwide this year.
The three largest, publicly traded banks in the county — Frontier Bank, City Bank and Cascade Bank — all reported multimillion-dollar losses in the third quarter. The banks are trying to weather the recession rooted in the real estate market as they look ahead to 2009.
“Signs were there, but it all developed rather quickly,” said Pat Fahey, who was named as Frontier’s top executive earlier this month as part of a management shake-up.
The three banks, still capitalized above government requirements, are taking different approaches to survive and to thrive in a time of uncertainty. They’ve also shown a mixed interest in the federal government’s rescue of the nation’s financial system.
The U.S. Treasury Department has set up a program to inject capital into financial institutions, tapping the $700 billion bailout that Congress authorized to avoid a financial market collapse. The goal is to make banks ease their lending so that the economy would start growing again. At the same time, the government wants banks to save more to expand the amount of money that isn’t committed.
City Bank, based in Lynnwood, decided not to use the federal program, as it continues to hunker down with abundant capital it had preserved for rainy days. It recently decided to slash quarterly cash dividends for its stock to conserve that rainy-day money.
Everett-based Cascade Bank has secured new capital from the Treasury Department. That has boosted the money available to lend and could support long-term growth.
Pressure is mounting, particularly on Frontier Bank, to change its culture and to adapt to a new era. The Everett-based bank has applied for the Treasury’s program; it’s yet to get an answer.
As losses in the real estate market continue to rise, Frontier is scrambling to secure capital and to cut back on spending. It has cut bonuses for its executives and suspended the quarterly cash dividend for its stock.
Frontier has created a new business banking division to diversify a loan portfolio that heavily relies on the slumping home construction and real estate market.
“We are taking very aggressive steps to make necessary changes and correct courses in lending practice,” Fahey said.
Going down with real estate
City Bank has depended almost exclusively on real estate loans.
About 98 percent of the bank’s $1.2 billion loan portfolio is tied to real estate in various forms — construction, land development and commercial and residential building — according to the bank’s third quarter filing with the Federal Deposit Insurance Corp.
Frontier has a similar loan portfolio.
Real estate loans occupy about 86 percent of the bank’s $3.8 billion in loans, according to the U.S. Securities and Exchange Commission.
The two banks took hits from the weak real estate market in the third quarter that ended on Sept. 30. City Bank lost $10.96 million, Frontier lost $17.8 million.
Most observers agree that the housing market has yet to see bottom.
“It’s been impacted beyond what everybody had expected,” said Conrad Hanson, president and chief executive officer of City Bank.
The bank would be able to absorb the economic downturn better if its loan portfolio were more diverse, Hanson said. But that diversity isn’t easy to accomplish these days when the recession continues to cripple various industries and hinder investment opportunities for banks.
City Bank has plenty of reserves to deal with more loan losses. Its total capital was about $223 million at the end of the third quarter. That’s much more than $127 million required by government regulations to be considered well capitalized.
“We’ve always operated with extra cash as a safety net,” Hanson said.
Frontier has less wiggle room. Its total capital was about $444 million as of Sept. 30. The government regulations call for a minimum of $413 million from Frontier to consider it well capitalized.
Cascade Bank’s loan portfolio is more diverse than that of Frontier or City Bank.
As of September, the bank’s business banking division, created in 1997, generated 39 percent of its $1.2 billion loan portfolio, while real estate loans occupied the biggest share.
Cascade losses of $6.6 million in the third quarter were largely caused by the government’s takeover of Fannie Mae and Freddie Mac. Cascade had invested in the preferred stock of the mortgage giants at a time when that investment was considered profitable and very safe. But the government takeover essentially made the stock worthless.
“I don’t know what lessons you can draw because the federal government encouraged banks to own that type of investment,” said Carol Nelson, the bank’s president and chief executive officer.
She said her bank remains fundamentally strong.
The bank’s total capital was $134 million at the end of September, according to the Securities and Exchange Commission. That was slightly more than $130 million to be well capitalized under government regulations. Its position has since been strengthened with the money from the Treasury Department.
‘We are in a race’
Frontier and Cascade wanted more capital.
The two banks applied for the U.S. Treasury’s capital purchase program, which aims to shore up financial firms by buying their stocks.
In November, Cascade secured $39 million through the program. The investment should help the bank acquire assets and grow if opportunities surface, Cascade’s Nelson said.
The money doesn’t come free.
The federal government will get preferred stock in Cascade with 5 percent annual interest for five years and 9 percent interest after that. It will also secure warrants to purchase the bank’s common stock.
“That’s quite reasonable,” Nelson said. “This is a very cost-effective form of capital for financial institutions.”
Frontier’s Fahey said that the government program is probably the safest way to raise capital while lenders remain hesitant to take risk and lend money.
Treasury set aside $250 billion in the capital purchase program. To date, it’s committed $162 billion to banks, with investments ranging from $1.5 million to $25 billion.
Frontier is hoping to get up to $115 million through the program, Fahey said. But it could be months before hearing about its application.
The wait had hurt the bank. This fall, Frontier became the target of short-sellers who profit when a stock falls. Rumors that Treasury denied the bank’s application brought down the value of its shares. The bank had to issue an unusual statement to combat the rumors.
The Treasury’s program, the first of its kind in the nation’s history, has pros and cons, said Chris Weber, professor of economics at Seattle University. If a bank gets capital, its book will look better. But if an application gets denied, that could raise a red flag about a bank’s solvency.
“That’s what short-sellers were doing,” Weber said. “It creates an opportunity for that sort of thing.”
Treasury has wavered on how to use the $700 billion bailout.
It originally planned to use the money to buy troubled assets from financial firms to unclog the credit market. When it didn’t work, the department decided to pump capital into banks to achieve the same goal.
Meanwhile, the economy continues to contract, said Peter Dorman, professor of economics at The Evergreen State College in Olympia. That could make banks hold on to capital from the bailout fund, instead of investing it in communities.
“We are in a race,” Dorman said.
Cascade Bank has to yet to change its underwriting guidelines after securing the $39 million from Treasury, Nelson said.
Nobody knows how much more capital is needed to make banks resume lending, said Dorman, who suggests creating a public baking system to solve the credit crunch.
“We don’t have infinite money,” he said. “If we don’t reach the goal before the money runs out, then we will get into a big problem.”
Most big banks that had stakes in risky mortgages have a solvency problem, Dorman said. Community banks such as Frontier, Cascade and City Bank are doing better because they have invested locally and avoided risky markets.
The three banks didn’t engage in subprime mortgage lending, officials from the banks said.
This recession is unique in that it’s global and it has spread to various industries. The wider the economic downturn spreads, the fewer areas banks will have to invest in, Dorman said.
“The problem is that there’s no bright spot,” he said.
Reporter Yoshiaki Nohara: 425-339-3029 or ynohara@heraldnet.com.
