How to Make Money Off Community Banks (continued)

Credit Quality

Every time Federal Reserve Chairman Alan Greenspan speaks these days, bankers groan. Interest rate cuts—rates are now at 1960s levels—squeeze the profit margins that bankers make on their loans even thinner. "Banks are very asset-sensitive and with the rate cuts coming so often, earnings are under pressure," Schroeder says. He looks for pristine loan quality in the first few years of operation as well as banks who do "primarily local lending within or near their market areas."

San Diego has long been a competitive hotbed for small and medium-sized business loans, and in recent prosperous times, bankers found themselves shaving margins to book those loan assets. The better credit officers established interest rate floors on those loans. Those who dealt in floating rates are looking at impending red ink.

At Palomar, which began its life as a savings and loan association, Sanborn inherited some low-yield mortgage loans. But as rates drop, those fixed-rate mortgages are looking better; those that are cashed out through refinancing are turned over into higher-yield business loans.

"I want to see a bank that's well reserved (against loan losses) and well capitalized," says Schroeder. "Actually, right now, the whole industry is pretty well-off in capital. Anyone who's not is on a watch list."

The state of California's Department of Financial Institutions reports that as of August, the average bank reserve ratio is 1.53 percent. Also, as of that date, the state-chartered financial institutions showed a healthy average 13.3 percent return on equity and 1.1 percent return on assets.

Operational Expertise

Bank economics are relatively simple. Money comes in as deposits and goes back out as loans. The interest charged on those loans is income, which pays the salaries, rent and utility bills. Finding additional sources of income is what has set many banks apart over the years, and will continue to do so, say the experts.

From the time it opened two years ago, Southwest Community Bank's game plan included growing its Financial Data Solutions Inc. subsidiary alongside its banking operations. FDSI provides item processing for other banks and credit unions as well as provides lock box services for condo homeowners associations and the like, bringing in a steady income stream.

Most successful banks will find their niche and learn to work it to their advantage.

Bank of Commerce had many enormously profitable years as a Small Business Administration loan specialist, knowing when to sell the packaged loans off to secondary markets—hence increasing income—or when to hold them—increasing its loan quality. Scripps Bank made a specialty of spec real estate and construction loans, providing that service better and faster than its competitors. Since a good portion of those loans were in and around the sun-kissed shores of La Jolla, Scripps' back yard, that niche market was a great moneymaker.

It took Rancho Vista the better part of a dozen years to pull itself out of the doldrums, recalls Stewart. "Once we realized we really knew construction lending and that we were better than anyone else at it (in the inland North County market), we could focus our resources there and let peripheral stuff, like credit card processing, go."

Peninsula Bank took a different, but equally effective, tack to success. Although it did its share of SBA loans, construction financing and other specialty areas, its claim to fame was its never-wavering financial performance. Every quarter for more than 20 years, Peninsula always was predictable and profitable. Which is how the cult of Peninsula Bank stockholders came about. At one point, market maker Levenson says, there was a waiting list of 12 months to purchase that stock. "Peninsula never stopped telling its story, to customers, to shareholders or to prospective investors and was remarkable at cross-selling," he says. "They had their telephone lists and their regular lunches and kept in touch. When they wanted to open a new branch, they were exceptionally good at identifying customers and investors right away."

Even the failed Bank of San Diego, which couldn't manage to keep the doors open through basic banking operations, nonetheless returned money to its holding company shareholders before the end. BSD Bancorp was able to sell its successful data processing subsidiary, Datatronix, to FiServe and its North American Trust Co. to Govette before closing its doors.

Market

When banks are organized, they must identify the market they intend to serve, both geographically and demographically. Neighborhood leaders and residents like the idea of a bank tailored especially to the needs of their community, which is where a lot of investment capital is based.

Bank of Coronado's market is pretty clear-cut, as is Santee-based Cuyamaca Bank. First International Bank, a closely held institution in South Bay, markets on both sides of the border. While Palomar is Escondido's only local commercial bank at present, by the first quarter of next year, Community National Bank (nee Fallbrook National) will be setting its headquarters branch there. Rancho Santa Fe National Bank does business throughout the county, but considers its home base coastal North County.

Both Southwest Community Bank, based in Encinitas, and Rancho Bernardo Community Bank can claim not only geographical, but also historical market. Both banks have taken their names—in Southwest's case, a number of managers and directors—from namesake predecessor banks in San Diego.

Borrego Springs Bank's majority owner is the Viejas Indian tribe, and therefore its market is not only the small desert community of Borrego Springs, but also the employees of Viejas business interests, primarily its casino, and other growing Indian interests.

The spate of acquisitions of the recent past has left the region pretty wide open for new entrants to claim a market as their own. In La Jolla, for example, two groups are trying to organize banks in an attempt to fill the void that Scripps Bank left. The University Towne Centre area is being used as a base of operations to attack the Golden Triangle to La Jolla; northern coastal communities like Encinitas, Carlsbad, Oceanside also are tabbed.

The Long Haul

Economic conditions are uneasy at best, and while the Greenspan rate cuts should kick in within the next six to 12 months, other lagging indicators, like unemployment, could spell leaner times for all businesses. Should businesses start to default on loans, much of the banking industry's capital cushion could dry up.

But, say the experts, not all is dire. Rate cutting is about over, which could provide a bit of relief to pinched margins. And after the first of the year, an accounting change relating to the booking of goodwill will punch up some bank's income numbers in year-to-year comparisons.

"Banking goes through very distinct cycles, and in my career, I've seen stocks at multiples of book falling to under book and jumping back up to multiples again," says Peter Q. Davis, former CEO of Bank of Commerce. "My take right now is that there are simply no clear favorites for investors among local banks. Returns aren't impressive. Management teams and particularly boards of directors are unseasoned and untested for the economy ahead."

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