Loan Losses Hammer Bank Profits

Last updated Tuesday, November 18, 2008 12:48 PM CST in Business

By Kim Souza
THE MORNING NEWS

Despite the challenges, a handful of local banks returned respectable profits over those earned a year earlier.

Arkansas Bank Commissioner Candace Franks noted recently in her quarterly newsletter that Arkansas banks were “holding their own” through difficult times.

Franks said the operative word to describe the outlook is “cautious” as no bank is immune from a slowing economy and the ripple effects of volatile credit markets.

Reversing Losses

Pinnacle Bank of Rogers and Signature Bank each reversed negative fortunes in the annual period, according to call reports on file with the Federal Deposit Insurance Corporation.

Both banks are less than five years old and sprang up as the region was booming with loan demand and one of the fastest-growing populations in the nation.

Fayetteville-based Signature Bank earned $356,000 in the third quarter and $808,000 since January, reversing losses of $393,000 from a year ago.

Bank president Gary Head said the turnaround was not magic but merely a function of the bank’s larger size.

He said the bank’s rapid growth had eaten up profit in recent quarters. “We have finally grown to a size that allows us to generate more than enough income to cover our expenses,” Head said. “Conservative lending standards and luck have also helped.”

Head said Signature’s partnership with the Bank of Brinkley has been blessed with strong earnings from the farming sector that have helped profitability this year.

From a year ago, Signature’s asset size has grown more than 20 percent to roughly $600 million as of Nov. 1, according to Head. He said the bank is digging in its heels to serve its existing customer base, with no expansion plans soon.

The biggest challenge currently facing bank managers is the uncertainty with respect to how long the economic slump will last, said Head.

Scott Franklin took over as president of Pinnacle Bank in August 2007 when the bank was reporting deep losses — $1.11 million through the first nine months of 2007. A year later, the bank’s net income is in the black, despite the challenging climate. The bank earned $139,000 in the third quarter and $387,000 since January.

Part of Franklin’s strategy was to shrink the asset size, reel in growth and concentrate on cleaning up a troubled loan portfolio. In the past year, nonaccrual loans have shrunk 94 percent, but charge-offs increased 84 percent.

Franklin said the bank has been proactive in writing down problem loans and setting aside the necessary reserves to clean up the credit quality of the portfolio.

Analysts have credited Pinnacle Bank’s head-on approach in tackling the challenges it faced a year ago.

Head Of The Class

The Bank of Arkansas and First State Bank of Northwest Arkansas led the banking class with the highest net income returns when compared to a year ago. Bank of Arkansas reported a 53 percent gain while the First State’s profits grew by 27.3 percent in the first nine months of the year.

Earning $583,000 in the third quarter, the Bank of Arkansas also sat aside $1.5 million to loan loss reserves.

Jeff Dunn, president of the bank credits the profits to conservative lending strategies.

First State Bank of NWA posted a solid third quarter net income of $483,000, while also setting aside $262,000 in loan loss provisions to offset future delinquencies. The bank’s return on assets — a measure of how well the bank uses it assets to generate profits — was 1.67 percent, well above the industry benchmark of 1 percent.

“These are challenging times and we have worked hard to keep profits respectable,” said Bruce Loftin, president of First State Bank.

The future is somewhat hazy, Loftin said with respect to the earnings outlook for the entire banking sector in the next quarter.

With $70.2 million in assets, First State Bank is anywhere from three to 40 times smaller than the other four banks that reported stronger net income over a year ago.

Three of the state’s largest banks reported net income gains through the first nine months of the year — Simmons First National, up 8.2 percent; First Security Bank, up 7.3 percent; and Bank of the Ozarks, up 2.7 percent. Delta Trust & Bank’s net income rose 5.56 percent in the year-over-year period as well.

Banking analysts said while some of the local banks managed to return modest profits there is continued pressure on future earnings as interest rate margins have tightened with recent rate cuts by the Federal Reserve.

“With rates this low, it’s very hard for bankers to build in profitable interest spreads between the loans they write and the cost of deposits to fund the lending,” said John Dominick, Arkansas Bankers Chair and banking professor at the University of Arkansas.

He said all local banks are afloat in largely uncharted waters with respect to their exposure to real estate, which presents deeper challenges.

The top-performing banks continue to post escalating delinquency rates among loans that are no longer accruing interest — totaling $46.64 million at the end of September. Another $27 million was past due between 30 and 89 days, giving these banks a cumulative exposure of $73.6 million, with a reserve balance of $61.7 million to offset those potential losses.

Dominick said even the most conservative banks in the region have real estate loans on the books that were made during more profitable times when lending standards were relaxed.

“Banks can’t clean up their portfolios overnight, it takes time. My guess is two or three quarters for some banks and longer for others,” Dominick said. “In the meantime earnings will likely be lean.”

Underweight Performers

In the third quarter, 13 underperforming banks doing business in Northwest Arkansas set aside $80 million in loan loss provisions to offset future delinquencies related largely to residential real estate and land development loans. In retrospect, those same 14 banks set aside just $27 million in the year-ago quarter.

Dominick said higher loan loss provisions equals lower net income in most cases, and that proved true among the majority of banks who posted slimmer earnings through September.

A loan loss reserve is not money lost, it simply does not flow through to a bank’s earnings.

Through Sept. 30, these 13 banks reported a cumulative net income of $98 million, compared with $121.3 million earned in the year-ago period, a decline of 19.2 percent in profits.

The underperforming banks have already taken back more than $75 million in real estate this year, and faced another $278 million in nonaccrual loans at the end of September, with $95.6 million more past due from 30 to 89 days, according to FDIC call reports.

Cumulatively these 13 banks have a loan loss exposure totaling more than $373.6 million, with loss reserves of about $189.8 million set aside.

While the coverage exposure varies widely among the banks, this shortfall is an indication the local banking industry has more work to do in the coming months to collect on or write down the problem loans, analysts said.

Four banks reported net losses in the first nine months of the year — Chambers Bank, Legacy National, First Western and Parkway Bank. All of these losses relate to higher loan loss provisions due to nonperforming loans.

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