Community banks in Orange County are working on several fronts to offset the ongoing effects of low interest rates.
The moves come as the long run of historically low rates pinches margins. Smaller banks are responding by targeting the most lucrative lending opportunities and diversifying their services.
It’s a tall order.
“Banks’ profit margins are going to continue to get squeezed, just because interest rates are coming down,” said Scott Kavanaugh, chief executive of Irvine-based First Foundation Bank. “Ever since the [Federal Reserve] started tightening down rates, there have been added regulatory burdens of increased cost and less profitability.”
First Foundation Bank was created in 2007 with $32 million raised by Irvine-based money management firm Keller Financial Group.
The target for the federal funds rate—the interest rate banks pay one another to borrow—has been near zero since 2009. That rate, set by the Federal Open Market Committee, serves as a benchmark for interest rates on mortgages and other loans.
The low rates were intended to drive other rates down to encourage more borrowing and revive the economy. But the situation is pressing banks severely by making loans cheaper, crimping margins.
The Fed committee’s recent decision to keep the rates hovering around zero through 2014 has OC bankers expecting thin margins to linger, especially for small banks.
“The rates that are being offered by some of the larger banks are definitely putting a squeeze for a small bank in order to compete,” Kavanaugh said. “I think it’s going to be very difficult for smaller banks to continue to remain profitable or stay in business. It probably will add to more mergers and acquisitions in the future.”
Anaheim-based Premier Commercial Bancorp is expected to complete its $38 million sale to California United Bank in the second quarter.
“There is a general consensus of consolidation,” said Ash Patel, chief operating officer of Premier Commercial Bank. “The scale in size is important.”
Premier Commercial is Orange County’s seventh-largest bank by assets, according to the Business Journal list. The bank has about $450 million in assets.
California United has assets of about $790 million.
Other deals could be hard to come by.
“When it comes to mergers and acquisitions, there’s still a bit of spread of what they believe they are worth,” First Foundation’s Kavanaugh said.
Shakeout
Ailing banks close to failure have largely been filtered out, said David Blankenhorn, chief executive of American Security Bank in Newport Beach.
“It will be the smaller banks that are looking at what their futures might be like,” Blankenhorn said. “They have to decide if they can really grow two or three years later or if they will sort of just be going along. I think some of those banks will decide that by themselves they aren’t going to go anywhere.”
Banks that manage to hold steady are probably the likeliest takeover targets, he suggested.
Recent Deals
In the past year, Irvine-based Opus Bank acquired Everett, Wash.-based Cascade Financial Corp. and its Cascade Bank, as well as Fullerton-based RMG Capital Corp. and its Fullerton Community Bank. The acquisitions helped boost Opus’ assets to $2.2 billion.
Grandpoint Capital Inc. in Los Angeles bought Orange Community Bancorp last year for about $31 million. The bank holding company’s subsidiary, Orange Community Bank, had about $220 million in assets in 2010, then the 15th-largest bank based here, according to the Business Journal’s list.
“Orange County banking overall is doing all right, but I don’t know if anybody’s really growing,” Blankenhorn said. “It’s just that kind of economy.”
New Services
American Security recently started offering credit-card processing services to merchants.
Community banks need a specific niche target, said John DeCero, president of California Republic Bank in Newport Beach.
California Republic has $400 million in assets and counts auto financing as a niche.
“You’ve got to be a niche player today,” DeCero said. “We can’t try to be all things to all people. We can’t take on the big banks and do everything they’re doing. You have to be a specialist and do things you are best at.”
Pacific Enterprise Bank has narrowed its target to customers who understand the bank’s conditions.
“What we would need to do is be more selective in how we lend, whom we lend to,” Chief Executive Rick Ganulin said. “The pricing has to be higher so we can generate the returns to organically grow capital. If our strategy is not to dilute our shareholders, then the types of customers we would seek are the ones who would accept a higher spread over time.”
That means the bank might have to pass on some customers.
“You could have a larger company that wants to borrow, but at a small margin,” Ganulin said. “We target the family-owned businesses, ones that understand that we need to have a good spread in order to generate the growth to serve them down the road. And they appreciate the good service (despite) paying a little bit higher. Programs like the Small Business Administration or California Capital Access Program can minimize the risk of that loan.”
SBA
SBA loans helped increase Pacific Enter-prise’s lending last year to $208 million from $144 million in 2010.
Competing on commercial real estate could be tough.
“Community banks can’t compete with the big banks when it comes to the rate on a non-owner-occupied building,” Ganulin said. “The owner of the building might want 5.25% fixed, but we can only do so many of those before we run out of capital. But we’re really big in the owner-occupied market. We’re a pooler and wholesaler.”
Pacific Enterprise is one of the roughly 30 approved “pooler” institutions in the U.S. that put together 504 loans and sell to third-party investors. Portions of these loans have government guarantee tacked onto them.
Premier Commercial’s Patel agrees the SBA loans can be useful for small banks.
“The SBA loan program is a good alternative to replacing the (falling) fee income,” he said. “We are very active in Orange County and Los Angeles in SBA 7(A) and 504 loans. The (bank’s) small size has its advantage in terms of being nimble and quick in response time, compared with bureaucratic chains. Smaller banks are far more competitive in their ability to help small-business owners get to a decision maker.”
Tightened margins have also brought a new emphasis on controlling expenses.
“Expense control is extremely important to maintain the profit margin,” Patel said. “Community banks now are having to watch their expenses very carefully, especially because the net interest margin is not growing.”
First Foundation’s Kavanaugh agreed.
“Any time you can gain efficiency—that’s code word for reducing the number of employees (and) operations—any time you can do that, you’re going to be able to drag out additional [margin] in a company,” he said.
First Foundation derives a significant amount of non-interest income from its wealth-management services.
“Our money-management part has $1.9 billion in assets under management,” Kavanaugh said. “It would be a different story if we didn’t have this non-interest income coming in. That includes trust insurance, consulting, financial planning and investment management. We do a lot of different services that don’t fall into what a traditional community bank does.”
First Foundation Bank evolved from First Financial Advisors, a wealth planning and investment management firm established in 1990. The bank holding company and the bank were set up in 2007.
“It’s not easy to just start a money-management firm,” Kavanaugh said. “It takes years and years for attorneys to feel comfortable with a trust company. It’s taken us four years to get our trust department to a point where I feel like certified public accountants and attorneys recognize our firm as having a quality trust department. We were lucky.”
