Capital is king these days, and community banks that either cannot or do not want to raise it are focused on preserving what they have.
With regulators keeping close tabs on capital ratios, many smaller banks have already taken the obvious first steps of cutting or suspendeding dividends, as well as halting stock repurchase programs.
But often that isn't enough and, as a result, some measures that might have seemed drastic a year ago are becoming more commonplace. Those include suspending fees paid to directors, shrinking investment and loan portfolios, and reducing head count, locations and business lines.
Bankers are looking inward because the alternative to improving capital ratios — hitting up investors — is becoming more challenging as the economy weakens, said James Rockett, a co-chairman of the financial institutions group at Bingham McCutchen LLP in San Francisco.
Many banks that have planned to raise capital to shore up loan-loss reserves have been disappointed by the lack of interest from hedge funds, private-equity firms, and even their own shareholders. Those that have raised capital are paying more for it, because investors are demanding higher returns for the increased risk.
Rates are as high as 5 percentage points above the three-month London interbank offered rate, or a fixed rate of 10%, on trust-preferred securities, according to Carson Medlin Co. This time last year they were paying about 1.5 percentage points above Libor.
The rates have increased because the market for pooled trust-preferred securities dried up after last year's subprime mortgage blowup, so banks that want to issue the securities are doing so on their own, and that can be pricey.
"Banks are looking for ways to build capital without having to go into the marketplace, given the expense of capital right now and the dilution to existing shareholders," Mr. Rockett said.
The $1 billion-asset Columbia Bancorp in The Dalles, Ore., reduced its second-quarter dividend by 9 cents, to a penny a share, after projecting a loss of 4 to 6 cents a share for the quarter as a result of an increased provision for losses on residential construction loans. This month it said it is suspending director fees for the rest of the year.
Robert J. Rogowski, the managing director of corporate finance at McAdams Wright Ragen Inc. in Seattle, said eliminating business lines is another way bankers are cutting expenses. They are choosing which lines to jettison by "focusing on funding those business lines that are continuing to give them the greatest returns and starving those business lines that are losing money," Mr. Rogowski said. "Today that's the mortgage business or construction lending."
This month the $3.4 billion-asset TierOne Corp. of Lincoln, Neb., which has bank branches in three states, said its loan production offices in six other states would be closed.
Bankers also are selling or closing branches. The $3.4 billion-asset First State Bancorp in Albuquerque said last week that it would close its two Utah branches by Oct. 31.
H. Patrick Dee, First State's chief operating officer, said the closings are meant to reduce overhead, shrink assets as loans run off, and allow the company to avoid the overly pricey capital markets.
"Because of the turmoil in the capital markets, we feel that it is very difficult right now for banks to raise capital in a way that makes sense for our shareholders," Mr. Dee said. "So we made the decision to shrink some part of our balance sheet, to keep our capital ratios at an acceptable level for regulators."
Brett Rabatin, an analyst at First Horizon National Corp.'s FTN Midwest Securities Research Corp. in Nashville, said other bankers are reducing their investment portfolios or curtailing lending in certain sectors. Practically all the regional banks are tightening their standards on customers' home equity lines of credit, he said, while many community banks are shrinking their construction portfolios — a decision made easier by the weak demand for new homes.
Other ways to improve capital ratios are to make more money and cut expenses. Some bankers are increasing earnings by charging more on loans, to make up for decreased loan demand, according to Bert Ely, a banking consultant in Alexandria, Va.
"It's much more of a lender's market right now, particularly since a lot of lenders are cutting back on certain lines of business or pulling out of various markets," Mr. Ely said. "But banks have to be cautionary about this, because banking is still very competitive, particularly in terms of going after your best customer."
Ron Farnsworth, the chief financial officer of Umpqua Holdings Inc. in Portland, Ore., said his $8.4 billion-asset company has cut expenses by reducing employee hours and not filling vacant positions. Its ratio of noninterest expenses to average assets has fallen to about 2.5%, from a peak of 2.75% in 2006, when loan demand was still high and the need for more employees was stronger, Mr. Farnsworth said. The lower ratio demonstrates that Umpqua is "doing more with less."
Still, the cost-cutting for some banks could be offset if credit quality continues to deteriorate. Mr. Rabatin said problem loans beget appraisal costs and attorney fees. "If a bank is going to have to foreclose on someone, attorneys tend to get heavily involved in that, and many banks may actually see increased expenses," he said.
