Risky Lending Concentrations Spell Trouble for Community Banks

Regional and community banks are continuing to get hammered by regulators who monitor the declining levels of bank capital closely. San Joaquin Bancorp is a one bank holding company located in Bakersfield, California with assets slightly exceeding $686 Million as of June 30, 2009. On September 22, 2009, the Federal Reserve issued a Prompt Corrective Action Directive ordering the company to augment the capital base to adequately capitalized levels by October 15, 2009. To comply the bank would have to raise at least $27 million or more.

The bank appears to be desperately trying to comply with the directive. Earlier this week the bank announced major restructuring changes in their senior management. Bruce Maclin, the founding chairman since 1980, announced his retirement along with several other key management moves such as establishing a new Corporate Governance and Nominating Committee as well as restructuring the board to add more qualified individuals. These moves are commendable, but are only effective if we can assume the bank will meet its upcoming deadline and remain an independent entity--which at this point seems unlikely.

San Joaquin Bank has invested heavily in the local real estate market. Over 86% of the loan portfolio are real estate loans. These concentrations are inherently dangerous even when they are originated with conservative underwriting standards. This risk coupled with the dreary economic figures for the State of California have spelled trouble for the bank. California’s median home prices are continuing to fall and unemployment in the state is 12.1%, which is worse than the national average of 9.8%. In addition, all of the bank’s branches are located in Kern County which has an unemployment rate of 14.3% as of August 2009.

Such a serious downturn in the local as well as the nationwide economy is difficult to predict. However, the use of a forecasting tool would have greatly helped this bank. Most bank figures, such as ORE and default rates, are lagging indicators. This doesn’t help a bank stay out of trouble. Stress testing new loans as well as periodic testing of the entire portfolio can help identify concentration segments that present more risk to the institution than management may have possibly realized. If these are forecasted, management will still have time to act accordingly and take mitigating steps.