This is the third in a series of articles featuring interviews with local financial institutions to find out how their role in the community has changed in light of the financial crisis of the last 19 months.
Temecula Valley Bank
Temecula Valley Bank made national financial news in December when it was announced that the bank’s founding CEO and chairman, Stephen Wacknitz, was abruptly retiring. The bank has not otherwise commented on the resignation but that announcement was shortly followed with announcements by new CEO Frank Basirico that signaled a strategic change in direction for the bank, which has deep roots in the local community.
“We are retrenching to the communities where we have those roots,” Basirico said in a personal interview. This change in direction will mean closing all out-of-state SBA (Small Business Administration) loan offices and reducing staff by 36 people to save operating expenses during this difficult economic time.
Since this interview at the end of January, the bank released the news February 18 that it had consented to a cease and desist order from the FDIC and the California Department of Financial Institutions. In regulatory speak, the bank has committed to a series of reforms to strengthen its capital base. A review of SEC filings indicates that the consent order occurred December 1. This likely precipitated the management and policy changes.
Basirico noted that since his appointment in December, “Many of the prudent actions required in these agreements have been completed, while others are nearing completion.” Issues that the bank is required to address are already part of the new three-year strategic plan. They include plans to raise capital, dispose of some assets, reduce problem loans and increase portfolio diversification. To preserve capital, the bank will need Federal Reserve approval to pay dividends.
Everyone in southern California connected with real estate and business drank the economic Kool Aid of the real estate bubble and economic growth. The thinking was that good times would continue. Temecula Valley Bank and others enjoyed the fruits of expansion in the years from 2003 to 2007. Temecula Valley became the eighth largest SBA lender in the nation. They had SBA loan production offices in places far from their base in Temecula: Nevada, Oregon, Arizona, Texas and Florida.
The lifeblood of a community bank is its depositors and its local community support. As Basirico wryly pointed out, “We might make loans in Texas and Florida but we don’t get many depositors from there.” Although he has only been CEO for a short time, Basirico articulated a clear vision of focusing on customer service in the communities where it has branches. Temecula Valley has 11 branches throughout Riverside, San Bernardino and San Diego counties.
Its strength has been community support. Many of its current board of directors were original founders and investors back in 1996. The annual report lists more than 100 founders and investors, most from the Temecula and Fallbrook area.
Temecula Valley has taken very seriously over the years its mission to give back to the communities that support it. It has given money and time and expertise to local nonprofits and service organizations. Basirico reaffirmed that commitment but noted that given the need to cut expenses and conserve cash, more of its contributions for the short term will be in-kind.
Management intends to prudently “shrink the balance sheet.” Loans are, by far, the largest asset category. Shrinking loans to manage risk better can take several forms. Loans can be sold off to third parties; loans the bank has made can be paid off by borrowers or loans can be restructured or written off. The largest component of non-performing loans is real estate-related.
Shrinking the balance sheet takes time. In the December 2008 quarter, non-performing loans as a percent of assets rose a bit to 7.75 percent. The bank applied for TARP (Troubled Asset Relief Program) funds, but to do so, it needed shareholder approval to issue preferred stock to the government. Approval was not granted, so this capital-raising idea has been shelved for now.
Temecula Valley Bank is still strong. Its regulatory risk-based capital healthily exceeds the 10 percent required to be designated “well capitalized” by the FDIC. Its current asset base of about $1.56 billion is hefty enough to work through the problems on troubled loans.
While it is profitable on an operating profit basis, it has reported accounting losses in recent quarters because of the need to increase the provision for loan loss reserves. Forty percent of its loans are still in the troubled real estate sector and a majority of the non-performing loans are in real estate.
Temecula Valley is still making new loans. SBA loans are still an important component of its product offerings, although there is now a short-term crimp in the secondary market for SBA loans.
One of the ways a bank regenerates its lending capacity is to sell the guaranteed portion of SBA loans into the secondary market. That market is showing symptoms of the pervasive credit crunch and is not working the way it should. Basirico seemed confident that this will be a short-term problem.
Temecula Valley’s advice to borrowers is simple: “Become a depositor, get to know one of our helpful community bankers who know the community well; have collateral and a good business plan. Qualifying for a loan may be just a bit harder but loans are available.”
Basirico noted, “Community banks, in these difficult times, are in a good position to compete with the large money center banks. The FDIC is guaranteeing all our deposits up to $250,000 and has an unlimited guarantee for non interest bearing deposits.”
This provides a customer with the best of both worlds: security and the personalized service of bankers who know and care about the community and its businesses.
Mike Natzic of Stone & Youngberg Securities in Big Bear was interviewed about several of the banks focused on. Natzic is a community bank analyst. His firm makes a market in community bank stocks. Natzic is convinced that Temecula Valley management is making the right moves in responding to the credit crisis and economic downturn.
“The announcement of the consent order adds clarity,” he said. “These orders are fairly common in the industry. Raising capital will be the biggest challenge. Management execution is key. Temecula Valley Bank should be a survivor.”
Pacific Western Bank
Mathew Wagner, CEO and board chairman of Pacific Western Bank (PWB), assured all customers and shareholders: “The problems faced in the financial services industry over the last several quarters have centered mostly on risky investments and derivatives.
“These investments and derivatives include sub-prime and so-called Al/A residential mortgages, certain residential mortgage-backed securities, collateralized debt obligations, credit default swaps, and investments in Fannie Mae and Freddie Mac.
“Pacific Western Bank has neither originated nor owned any of these investments or derivatives, and management has no intention of ever doing so.”
PWB has done what it was chartered to do: serve as a small- and medium-sized bank focused on serving business needs. In southern California these days, that means some of its loans to contractors, builders, developers and other businesses have gone sour.
Pacific Western is the largest bank we are focusing on, with $4.5 billion in assets. It is headquartered in San Diego and has 60 branches, including several in our market area. There is a branch in Murrieta, two in Temecula and one each in Fallbrook and Bonsall.
PWB is still profitable on an operating income basis. This means that on an operating basis, mainly concerned with the interest rate spread between what they pay depositors and what they can charge for loans, the bank is doing well.
From an accounting point of view, which does not affect regulatory capital and operating strength but does affect shareholders, 2008 was rather grim. The bank’s net loss was $728.1 million or $26.79 per share in 2008. This compares to net income of more than $90 million in 2007.
A considerable portion of this accounting loss was related to a decision to write off goodwill on the bank’s balance sheet. The bank had been on an acquisition spree in the last few years. When a company pays more than book value for assets, the excess price is booked as goodwill on the asset side of the balance sheet.
Goodwill is intangible since it can’t be touched or easily valued like real estate or loans that pay interest every month. In tough times, the value of goodwill, usually measured by profits, can lose value.
If the value of that goodwill is questionable, accounting rules require a write-down to its true value. Taking a very conservative position, management wrote down to zero all the goodwill on the balance sheet.
Conservative balance sheets with assets that are easily valued is a good thing in the long term, but 2008 was hard on Pacific Western’s shareholders (stock symbol PACW). The stock price has plunged from a high of $58.37 in July 2007 when the credit crisis began to about $18.50 a share the second week of February 2009. This is a 68-percent decline, but Bank of America shareholders have lost more than 90 percent of their stock value in the same timeframe.
PWB, meanwhile, has beefed up its loan loss provisions. The bank has not announced any application for TARP (federal bailout funds), but in a sign of the confidence it still enjoys among investors, it closed a deal with a private partnership, CapGen, to receive an injection of $100 million in fresh capital into the bank. CapGen took common stock in this deal.
The bank’s risk-based capital (an important regulatory measure of strength) is 11.87 percent. Ten percent or more is considered “well capitalized” by the FDIC. We can compare this to a ratio of 11.69 percent in the September 2008 quarter for Bank of America. Pacific Western, with its concentration on serving small- and medium-sized businesses, is continuing to serve its communities and most surely will survive.
Pacific Western’s management declined to be interviewed without insisting on full review and editing privileges on the article, which left this writer to rely on regulatory filings and press releases.
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