Sound Management and Hard Work Lead Banks and Businesses Out of Recession

by Steve Studer, EVP/Chief Credit Officer, Scott Valley BankSteve Studer, EVP/Chief Credit Officer, Scott Valley Bank

The recovery from the great recession continues and we see evidence of progress in much of our client base, despite significant headwinds. Revenues have stabilized, earnings are generally trending positive and more businesses are experiencing some expansion. Along with consumer and small business progress, banks in general are seeing new capitalizations, fewer loan losses, and earnings now in positive territory and growing. Although we have experienced industry challenges, Scott Valley Bank has consistently been well capitalized, did not need to recapitalize during the downturn, and has always been profitable.

Despite these positive signs, however, progress has been slow. The economy has once again slowed in the second quarter, and the snap back in economic activity we much expected from the depth of the recession has been microscopic. During these continued strenuous times, the common element present in most of the success stories is management. We have never been so tested for so long in the business world as we have the last five years. As entrepreneurs, our spirits have been challenged along with our resiliency to withstand slow growth, scrupulous expense control, and preservation of capital. During these continuing tough times, management decisions are paramount for both bankers and clients.

The private sector, as viewed through our window into our banking clients, has done an admirable job of repairing balance sheets, deleveraging, reestablishing revenues and earnings and maintaining capital. We are seeing more expansionary finance requests for equipment, and increased short-term credit activity supporting revenue expansion and accounts receivable growth. Further, some construction activity is beginning to appear.  As measured by many of our customers’ results, management has been highly effective.

The economy is also making progress as measured by GDP growth in 2011 of 1.8% nationally, a volatile but directional stock market, and some easing in the commercial real estate sectors. Housing is making some very minor progress in inventory reductions, increased sales volumes, and rising building permit activity in California. Despite this level of measurable progress, most businesses and consumers feel that conditions are still slow and difficult. Unemployment nationally stands at 8.3% and is not moving downward. California suffers a higher unemployment rate at 10.7 %, but did improve from the 6.30.11 level of 11.9 %. With the exception of certain zip codes, housing price increases in much of California are virtually non-existent.

Banks in the 12th Federal Reserve District  (which includes California) have demonstrated and managed some very significant recoveries as well.  For all banks in the 12th District, capital levels at 1st quarter 2012 now total 17% (risk based capital) versus the 13.0% seen at year-end 2009. While capital adequacy measures of 10-12% have historically been adequate, the 4% growth in bank capital over this recovery period has been remarkable.

Earnings for banks in the 12th District also made great strides. For 1st quarter 2012, all District 12 banks managed a composite return on average assets of .59% compared to the negative (-1.0%) seen at year end 2009. At present, 83% of commercial banks in the 12th District are profitable compared to only 45% at year-end 2009.

For small commercial banks in California ($300 M - $500 M in assets), 95.5% were profitable in first quarter 2012 compared with only 49% at end of 2009. 

Asset-quality statistics have shown similar improvements as measured by the “Texas Ratio” (nonperforming loans plus OREO (Other Real Estate Owned, in essence, foreclosed properties) as a percentage of capital plus ALLL (Allowance for Loan and Lease Losses)). For small commercial banks (assets less than $1 B) in the 12th District at 3.31.12, the ratio stands at 27% compared to the high-water mark of 41.6% at year-end 2009.

Likewise net charge-offs district wide dropped to .5% of total loans in the first quarter, compared to 2.1% at year-end 2009.

Banks are carrying fewer OREO assets at this point in the recovery with OREO representing .88% of total assets for District banks, versus the .99% seen at the end of 2009.

While these recovery statistics show the significant amount of progress made in the banking community, we have to remember that this progress, other than the capital levels, does not re-establish the levels of performance and safety seen prior to the recession. Pre-recession 12th District banks turned in ROAA’s of 1.40%, and had Texas Ratios of less than 5% as a district in whole. OREO was an unknown asset class prior to the recession.

The point to these statistics and this economic review is not to disparage anyone on the hard work and great management both banks and their customers have gone through in surviving the recession and snails-pace recovery, but to be sure that everyone understands we have not completed the task yet.

Risk abounds in this economy; gone are the days when prosperity covered up sins of poor management. With increasing asset values and abundant earnings opportunities, managers found success much easier. Today, deep analysis, judicious allocation of resources, and a somewhat-needed emboldened spirit buttress decision making.

With fresh new rounds of capital, many banks are now trying to generate returns to their new shareholders by improving margins and profits. In today’s historically low interest rate environment, that means investing in the loan portfolio to achieve better returns. This is good news for both businesses and banks, as banks are more willing to lend and have shifted the focus somewhat onto new business and expansion versus survival. More banks are talking to clients and prospects today and have a hunger for asset growth they did not have a couple of years ago. Pricing has become the competitive tool most are using. Interest rates are extremely attractive and banks know they can save clients some further expense to the bottom line.

Caution, however, remains the operative approach going forward for both prospective borrowers as well as for banks. Over-zealous growth can return many banks to the higher level of problems recently experienced. For clients, choosing the wrong bank for their future can be very disappointing if this economy does not continue its positive direction. There is still something to be said about staying power, and good financial decision making, for both bank and borrower. The lowest price is not always the best deal, and trust, experience, and reasonableness are the ingredients that got many borrowers and most banks through the recent downturn.

As fellow entrepreneurs, the progress we have all made in this tough economy warrants recognition for our hard work and persistency. The battle-tested entrepreneur makes a better prospect for the future. None of us have chosen the easy path to success. 

“I do not choose to be a common man, it is my right to be uncommon ... if I can, I seek opportunity ... not security. I do not wish to be a kept citizen, humbled and dulled by having the State look after me. I want to take the calculated risk; to dream and to build, to fail and to succeed. I refuse to barter incentive for a dole; I prefer the challenges of life to the guaranteed existence; the thrill of fulfillment to the stale calm of Utopia. I will not trade freedom for beneficence nor my dignity for a handout. I will never cower before any master nor bend to any threat. It is my heritage to stand erect; proud and unafraid; to think and act for myself, to enjoy the benefit of my creations and to face the world boldly and say: This, with God's help, I have done. All this is what it means to be an Entrepreneur.” (Common Sense, written in 1776 by Thomas Paine)

Data from 12 District Banking Profile, Federal Reserve Bank of San Francisco, Banking Supervision & Regulation, June 2012.
View Scott Valley Bank - The Vault - August 2012