Surviving local banks are healthier but 'not as exciting'

At the end of March, Eastside Commercial Bank marked its best quarter in two years: The tiny Bellevue bank lost only $81,000.

"At least it's not in free fall anymore, so that's good," said Dick Ducharme, Eastside Commercial's president. "We've improved basically because our customers have improved."

By and large, the epidemic of Washington bank failures appears to be over: Only two have failed so far this year, compared with seven at this time last year, and 14 during the past two years.

A strengthening economy helped many of the epidemic's survivors, like small-business bank Eastside Commercial, and several banks found buyers or raised fresh capital.

Of the 79 Washington-based banks and thrifts insured by the Federal Deposit Insurance Corp., only 27 percent were unprofitable in the first quarter, compared with 41 percent in the same period last year.

Under pressure from regulators, banks and thrifts in Washington now have shored up their core capital to pre-recession levels.

But even though the industry seems to have pulled out of its dive, banks face the same gnawing question: How to grow in a climate with fewer quality borrowers, more regulation and low interest rates that compress their profits?

"This is becoming a healthier industry, but in terms of growth, it's not as exciting," said Jeff Rulis, a senior research analyst at D.A. Davidson & Co. in Lake Oswego, Ore.

At the end of the first quarter, Washington banks' total loans and leases stood at $42.8 billion, down from $52.2 billion a year ago, according to the FDIC.

Banks are lending more cautiously partly because regulators are requiring higher reserves, said Sara Hasan, an analyst at McAdams Wright Regan, a regional brokerage.

Still, she said, "If you are a borrower in a good position, there should be plenty of capital available to you."

Bank stocks down

Even with new capital stacking up on bank balance sheets, many still are posting "paltry returns," Hasan said.

Reflecting that outlook, bank stocks in the Russell 3000 Index are down 10.7 percent so far this year, compared with a 2 percent increase overall for the index as a whole.

Many banks are more profitable now simply because they're setting aside less money for loan losses, so more goes to net income, Rulis said. To grow, banks have few options, he said, among them are selling niche products, expanding their market share and buying weaker competitors.

Several banks on regulators' radar have recapitalized this year, including Seattle Bank and two Lynnwood-based institutions — The Bank of Washington and Prime Pacific Bank.

Perhaps the most optimistic is Seattle's HomeStreet Bank, which had one of the weakest capital ratios among Washington banks and thrifts in 2011's first quarter.

The bank's parent company, HomeStreet Inc., filed papers in May to raise up to $210 million in an initial public offering.

Only two other Washington banks have recently sought capital through an IPO — Fortune Bank last year and Venture Bank in fall 2007 — but both have come up short, according to Renaissance Capital, an IPO research firm. Venture Bank withdrew its IPO and was closed by regulators in 2009. Fortune Bank also dropped its IPO.

First-quarter data

The Seattle Times examined first-quarter data from 73 banks' filings with regulators and ranked them according to two metrics:

• Tier 1 leverage ratio: A bank is considered "well capitalized" if this ratio is at or above 5 percent.

• Nonperforming assets ratio: This measure captures what percentage of a bank's assets aren't producing income and includes all loans more than 30 days past due.

A low Tier 1 ratio is a strong indicator of trouble: The two Snohomish County banks that failed last month — Summit Bank and First Heritage Bank — had four consecutive quarters of falling Tier 1 ratios, ending below 2.2 percent in the first quarter.

After these, the five Washington banks with the weakest Tier 1 leverage ratios in the first quarter were First Sound Bank (4.22), HomeStreet (4.71) and Regal Financial Bank (4.93), all in Seattle; Prime Pacific Bank (4.96) in Lynnwood; and Eastside Commercial (5.19).

These banks had nonperforming asset ratios ranging from 13.5 percent to 15.7 percent, compared with a median 4.74 percent for the 73 banks in The Times review.

These measures are likely to change when second-quarter numbers come in this summer, reflecting new capital and perhaps an improved economy.

Prime Pacific Bank's holding company, Prime Pacific Financial Services, reported it had raised $780,000 in new capital in a private placement in the second quarter.

First Sound Bank likewise raised $4.1 million after the first quarter's end, for a total of $6.3 million in new capital, through a private offering for accredited investors.

Meanwhile, Eastside Commercial's Ducharme said his bank hasn't put a penny into its loan-loss reserve this year, a big shift from the $4.2 million it set aside over the past three years.

Ducharme said his bank will raise capital by the end of this month that will lift its Tier 1 ratio above 8.

"A lot of the new shareholders are old shareholders," he said. "They're essentially averaging down the value of their shares."

By contrast, Washington's biggest banks and thrifts — Washington Federal, Sterling Savings Bank, Columbia, Banner Bank and Washington Trust Bank — have Tier 1 ratios above 10 and nonperforming asset ratios between 3.3 and 7.3.

(Those that have bought failed banks in FDIC-assisted deals, such as Washington Federal and Columbia, have most of their losses on acquired assets covered by the FDIC. The Times didn't exclude those "covered assets" from its analysis because of inconsistencies among banks in reporting them.)

Sheila Bair, whose term as FDIC chairwoman ends July 8, said in her last news conference that banks' recovery could be threatened as they compete for market share and growth.

"We're approaching a critical point in the credit cycle, where banks are starting to compete more aggressively for quality loan customers," Bair said. "So we may face the risk of the pendulum swinging too far back in the other direction, with banks having incentives to substantially relax lending standards in the pursuit of scarce loans."

Sanjay Bhatt: 206-464-3103