California's Palomar Community Bank figured late last year that it had an above-average chance of winning a young technology company's business.

The tech firm, after all, had posted a quarterly profit only once in its three-year existence, so it seemed unlikely that many other banks would be interested in it. "This is a company that a few years ago no bank would have touched," said Richard M. Sanborn, president and chief executive officer of $76 million-asset Palomar Community, which is based in Escondido. "Then we found out we were just one of six banks competing for their business."

Palomar lost the bid.

Such stories are all too familiar to small California banks. Elsewhere in the nation, most banks have been struggling with overwhelming loan demand and deposit stagnation. But small California banks are awash in deposits, thanks to the state's strong economy, and having a hard time finding quality loans to make.

Loan-to-deposit ratios highlight their quandary. In the third quarter, loans equaled 84.99% of core deposits for the average California bank with less than $100 million of assets, and 85.09% for those with $100 million to $300 million, according to Federal Deposit Insurance Corp. call reports.

Such ratios would be considered high if the economy were less robust, but they are far below the 99.53% average for all California banks and the 124.47% for all banks in the country. (Core deposits exclude certificates of deposit, accounts larger than $100,000, and municipal deposits, because such funds shift in and out of banks more often.)

The competition for loans is coming mainly from large banks, many of which have stepped up small-business lending in recent years. And the hot California market is also attracting its share of nonbank lenders.

Meanwhile, banks say they are overflowing with deposits, mostly generated by stock market gains.

"A lot of deposits have been coming in from people who are pulling some of their funds out of the equity market," said Gerald J. Lukiewski, president and CEO of $239 million-asset American Commercial Bank in Ventura. "They're becoming more conservative with the money they've made in the markets."

Indeed, Montecito Bank and Trust in Santa Barbara has had a large influx of deposits from young entertainment companies that have migrated north from Los Angeles and Internet firms that have spilled south from San Francisco.

"These start-ups need a place to store their deposits, because they have a lot of money coming in," said Rodney K. Brown, president and CEO of the $295 million-asset bank. "They do their initial public offering and need a place to hold those funds."

Of course, California community bankers say they are happy to take the deposits. But they worry that too much of a good thing could squeeze earnings, because lending competition has reduced rates of return on loans. They also worry about a scarcity of creditworthy borrowers.

For instance, Palomar Community's Mr. Sanborn said he offering rates of 1% above prime on loans that he would have made at 2% to 2.5% above prime only a couple of years ago. And in his market in San Diego's suburbs, where the computer, biotech, and light manufacturing industries have boomed in recent years, he has been forced to target buyers of mobile homes.

To find borrowers, Mr. Sanborn said, "we're searching for product niches that might be less sexy."

It's a far different story outside of California, especially in the rural sections of the Midwest. Bankers there are more concerned with locating enough deposits to fund surging loan demand.

"Usually you could count on deposits just to grow on their own," said Tim Unger, president and CEO of $411 million-asset Lincoln Bancorp in Plainfield, Ind. "But many banks today think that if they hold their own on the deposit side they're having a pretty good year. I haven't seen anything like this in my 33 years as a banker."

Still, some argue that California community banks might be better off making even fewer loans.

McKinsey & Co., the San Francisco-based consulting firm, recently analyzed the past five years' worth of call reports of 271 California community banks with assets of less than $6 billion and categorized 35 as "winners" on the basis of asset growth and return on equity. The winners averaged 24.4% annual growth in assets and 17.5% annual growth in ROE, versus 14.7% and 7.8% for other community banks.

Winners also tended to have less in loans than deposits. Their loans fluctuated between 90% and 100% of core deposits from 1995 to 1999; the other banks' ratios averaged 100% to 115%.

Michael Bender, a principal at McKinsey, said banks with fewer loans weather economic downturns more easily when credit quality falls.

"Most community banks that will win and survive, stay independent, and perform well … will be deposit-rich," Mr. Bender said.

Even so, probably few community bankers elsewhere in the country would want to be swamped with deposits and hurting for borrowers.

"Back in the mid-'80s our loan demand was depressed, but we still saw some deposits coming in," said David M. Bradley, chairman, president, and CEO of $367 million-asset North Central Bancshares in Fort Dodge, Iowa. "I'd much rather have it like it is today. Too much loan demand is a nice problem to have."

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