Coming year to be tough on local banks

For 2008, the question is not will the banking industry continue to be sluggish, but how slow can it go?

By the third quarter of this year, the industry was already seeing a slowdown. For the first half of 2007, Northern Colorado-based banks reported combined net incomes of $34.7 million, down from $43.1 million for the same period the previous year.

The 20 percent decline in net income is the first such drop since the FDIC began providing half-year data in 2002. Additionally, the Northern Colorado banking market has not seen a year-over-year decline in net income since 1998.

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Ratings firm Standard & Poor’s detailed “varying levels of weakness” for regional banks in the United States during the third quarter.

“In general, results were anemic, with asset quality measures deteriorating in a waning credit environment and margins soft,” the firm’s report read. “Loan and deposit growth was weak, and deposit portfolios continue to shift toward higher-cost products, keeping margins compressed.”

Nationally, the giants of the banking industry are writing down billions – many related to bad bets made on subprime mortgage-related investments. While most of the locally based banks will not be caught holding such loans, they will not remain completely unscathed by the mortgage market woes.

“The subprime issues are indirectly affecting all of us,´ said Darrell McAllister, CEO of Bank of Choice in Greeley.

Decreasing property prices, increasing inventory and a credit crunch could leave many developers holding properties longer than planned. Colorado has seen a lot of development in the past few years, so the impact on banks holding notes on in-development and recently developed properties could see related losses.

“We started to gear-down our builders a couple of years ago,” McAllister explained. While he admits the bank wasn’t anticipating the subprime issues and the subsequent concerns, he said that they were expecting the building boom to slow.

Tied to real estate

Because the bank took steps then, McAllister expects the slowdown in development to have less of an impact on the institution. Others might not be so lucky.

“Many of the banks around, but not all, are very tied to real estate,” he said.

Centennial Bank of the West recently went through adjustments to reduce the percentage of its portfolio in Northern Colorado real estate loans. The bank’s parent company, Centennial Bank Holdings Inc., based in Denver, sold a portfolio of nonperforming and classified loans for $31.4 million. According to financial statements, the book value of those loans prior to the sale was just under $47.9 million – $20.48 million in non-performing and $27.4 million in other classified loans.

“This loan sale is an important step in the overall strategic repositioning of Centennial Bank Holdings,´ said Dan Quinn, president and CEO of Centennial Bank Holdings, in a prepared statement. “We began this effort in the first quarter of last year with a plan to improve profitability and reduce overall enterprise risk.”

If Centennial’s process of risk re-evaluation is just coming to a close, it could be that other banks in the region might see similar write-downs as the tightening market – and more intense scrutiny from regulators – requires a more in-depth look at asset quality.

Possible opportunity

One would be hard pressed to find a banker not expecting an industry-wide slowdown for 2008. Johnstown-based Bank of Colorado President Tom Goding said he remains “cautiously optimistic,” a sentiment echoed by many, but some local bankers are seeing the troubling conditions as an opportunity.

New West Bank in Greeley has taken a steady, relatively conservative approach to banking, even as many of its competitors were growing by leaps and bounds. The five-year-old bank had about $96.4 million in assets as of Sept. 30, according to data from the Federal Deposit Insurance Corp.

At a time where many of the region’s banks are seeing increases in past dues and non-accruals, New West is seeing the opposite. The bank has $41,000 in assets past due by 30 to 89 days and no assets past due 90 days or more or in non-accrual status.

“Our asset quality couldn’t be better,´ said Leroy Leavitt, president of New West Bank. “From our vantage point, our bank is in as strong a position as we’ve ever been.”

Leavitt acknowledged that credit will be tighter in the coming year, but that banks that are strong and solid going into the year will be able to continue lending at their same standards.

“We feel we’re in a position to move into what could be a challenging year,” he said. “It may be a tough year for a lot of reasons, but we’re not forecasting any slowdown in growth.”

Margins pinched

Growth might not slow for some banks, but margins are likely to be pinched for all of them. In addition to a soft real estate market, banks are going to be dealing with adjustments due to the series of interest rate cuts made by the Federal Reserve Board.

Since September, the Fed has cut interest rates from 5.25 percent to 4.25 percent. Banks that are asset-sensitive cannot respond as quickly to their costs (time-sensitive products such as certificates of deposit) as they are required to respond to their interest income (variable rate loans).

“Our gross income will be about $5 million less because of that 100 basis-point drop,” McAllister said. The bank is cutting costs in hopes of diminishing the impact on net income.

Cost cutting could be difficult in Northern Colorado’s competitive market – where CD rates are often among the highest in the nation. Even if adjustments are made as soon as possible, the rate drops will be putting the squeeze on margins.

Fed rate cuts usually translate into better rates for bank customers. But some local bankers are doubtful that the series of cuts will have much of an impact. Banks are likely to be tightening lending standards during the next year and will be pricing loans with an eye toward risk.

All told, 2008 will be a relatively tough year, but the banking industry will still see strength. Growth for local banks is still anticipated, just not at the rate they have become accustomed to for the past few years.