The recent cut in banks' prime lending rate is taking its toll on some community banks' revenues, squeezing already tight margins.
D. Linn Wiley, president and chief executive officer at CVB Financial Corp. in Ontario, Calif., said that, with half of CVB's $600 million loan portfolio tied to the prime rate, the company expects $75,000 less in revenue from these loans this month.
To offset the revenue decline, he said, the $1.4 billion-asset company may reprice its deposit accounts and adjust its fees. "The bank is still doing well, but this doesn't help," said Mr. Wiley.
William E. Martin, CEO of Pioneer Bancorp. in Reno, said: "We lived off fat margins for several years, and now it is time to pay."
Bank analysts said the loan-revenue reductions hurt community banks more than larger banks. Though large banks typically use the London interbank offered rate as the benchmark for loan rates, community bank loan portfolios are typically linked to the prime rate.
"Lower rates actually hurt smaller community banks as their large prime- based portfolios get repriced downward," Joseph K. Morford 3d, an analyst at Van Kasper & Co. in San Francisco, wrote in a recent report.
Community banks cut their prime rates to as little as 8% after the Federal Reserve cut the fed funds rate-which banks charge each other for overnight loans-by 25 basis points, to 5.25%, on Sept. 29.
And given the fierce competition for loans, many small banks will be hard-pressed to make up the lost interest income with increased loan volume, analysts said.
It could get worse for community banks before it gets better. Fed Governor Laurence H. Meyer said in a speech last week that more interest rate cuts are possible.
"This is just a precursor," said John E. Russell, president and CEO of Heritage Commerce Corp., San Jose, Calif.
To what degree declining rates affect banks depends upon what share of their loans are tied to the prime rate.
At American River Holdings in Sacramento, Calif., 80% of the portfolio is priced off the prime. To make up some of the difference, the $170 million-asset banking company shaved the interest paid on a money market product by one-eighth of a percentage point and knocked a full percentage point off the rate on its six-month certificate of deposit.
"In the near term, this certainly affects our bottom line," said Bill Young, president and CEO. "Our earnings and margins will suffer, but I think things will balance out in the long haul."
But at Abigail Adams National Bancorp in Washington, where only 25% of the portfolio is tied to the prime, there was less concern.
"We're not in any danger," said Kate Carr, Abigail Adams' president and CEO. "We don't expect a great amount of volatility in our portfolio."
In the Pacific Northwest, where the economy remains robust, bankers expect to cover revenue reductions by making more loans.
"We expect the loans will persist and offset the rate declines," said Gregory D. Newton, chief financial officer of Cascade Bancorp in Bend, Ore.
If the Fed cuts rates again, analysts said, community banks should tighten expense controls, reexamine old and new credits, curtail risky construction lending, and cut funding costs.
