After turbulent 2007, banks looking toward better 2008

Denver-area banks faced a rough road in the second half of 2007, as the subprime crisis spread into financial markets. But is the worst behind them?

The possibility of a recession, coupled with rising pressure on consumers, may continue to weigh on bank profits in 2008. On the other hand, recent short-term interest rate cuts should help some banks, such as Lakewood-based FirstBank, that rely heavily on interest income.

Other banks that wrote off bad real estate loans last year no doubt hope they've taken most or all of the hit already, and will enjoy improved profits in 2008.

"Some of the banks that have been aggressive in lending and very strongly real estate-focused may have some issues to deal with in 2008, in terms of credit quality concerns, classified loans, those types of things," said Larry Martin, president of Bank Strategies LLC, a Denver-based bank consultant. A "classified loan" is one that has been identified as troubled.

"They may be trying to clean up their portfolio, and may not be that aggressive in lending in 2008," Martin said. "Others that have run a fairly conservative bank and don't have those same issues will probably take advantage of the situation and be able to pick up some market share that they wouldn't otherwise have gotten."

John Ikard, president and CEO of FirstBank, the No. 2 bank in Denver by deposits, is optimistic about 2008.

"We have pretty flat earnings when there's a flat yield curve, but when short-term rates drop, we look pretty smart," Ikard said. "I have looked kind of dumb in the past, but suddenly I'm looking smart. It's amazing how that works."

In the past five months, the Federal Reserve has lowered the federal funds rate from 5.25 percent to its current 3 percent. The rate was dropped by 125 points in January alone.

FirstBank is arguably more "liability sensitive" than any other bank in the area, meaning its liabilities -- such as deposits, which are classed as liabilities because the bank has an obligation to pay the depositor back -- reprice faster than its assets, such as loans. When short-term interest rates rise faster than long-term rates, as they did from 2004 through 2006, it creates what is called a "flat yield curve," which is particularly hard on liability-sensitive banks.

"I'm actually pretty optimistic over the next 12 months, with rates dropping," Ikard said. "We're pretty liability-sensitive -- most of our assets are fixed notes, three- to seven-year range -- so when rates drop like this, we're able to drop our cost of funds.

"The one thing that keeps you from being too aggressive about dropping rates is you've got some competitors in the marketplace that have been pretty aggressive with short-term CD rates and stuff like that," Ikard said. "We've decided to sort of split the baby in the sense that we're lowering our rates somewhat, but we're trying to stay pretty aggressive in terms of our offerings just to maintain market share."

The Fed's recent rate cuts also should aid banks by helping to keep their customers solvent, said Don Marshall, the Denver-based regional president of San Francisco-based Wells Fargo (NYSE: WFC), the No. 1 bank in Denver.

"Banks really are a reflection of the underlying economy, and if their customers, both the consumers and their business customers, are doing better and investing more and are more confident about their own financial returns, banks are going to do better in that environment than otherwise," Marshall said.

The rate cuts should ease the pain for subprime borrowers and others holding adjustable-rate mortgages (ARMs) that are about to re-adjust, Marshall said. ARM rates typically are tied to a short-term benchmark, such as prime rates or the London Interbank Offered Rate (LIBOR).

"Even if they do nothing, the rate that that mortgage will adjust to will be a lot lower than it would have been otherwise," Marshall said. "And if they do need to refinance, the ability to do that is much more reasonable. The manager who runs our mortgage organization tells me that they're seeing a tremendous volume of refinancing, and they're also seeing a lot of originations."

Denver-based Centennial Bank Holdings Inc. (NASDAQ: CBHI) took perhaps the biggest hit in 2007, writing down $142 million in the fourth quarter on previous bank acquisitions. It also sold nearly $50 million in bad loans, largely for Northern Colorado home construction.

The bank holding company, which owns Guaranty Bank and Trust and Centennial Bank of the West -- which it recently merged under the Guaranty name -- is working to diversify its loan portfolio and reduce its exposure to real estate and construction.

As of Dec. 31, 2007, the bank's energy and middle-market commercial loan portfolio balance was $123.6 million higher than in the previous year, while its residential and commercial construction and land development loans declined by $193 million.

But Centennial may face a continued headwind in 2008 if the economy weakens, according to David Rochester, an analyst at Friedman Billings Ramsey & Co.

"A recession would likely drive meaningfully higher delinquencies and charge-offs in the commercial business portfolio, having a material impact on [Centennial], given its high concentration of commercial business loans," Rochester wrote in a Feb. 1 research note.

Centennial's president and CEO, Dan Quinn, couldn't be reached for comment.

Centennial's president and CEO, Dan Quinn, couldn't be reached for comment.

United Western Bancorp (NASDAQ: UWBK), another large, Denver-based public bank holding company, hasn't yet reported fourth-quarter earnings, but is expected to do so on Feb. 12.

The strength of the economy in 2008 remains a key factor in how well banks will perform.

"Pretty much the only dark cloud we see out there is on the consumer side," Ikard of FirstBank said. "We're seeing a bit of a spike in our credit-card losses -- not extraordinarily high, but we're seeing a little more stress on the consumer. The commercial side has held up amazingly well, so I continue to keep my fingers crossed there."

A recession, if it were to occur, could hurt banks, Martin of Bank Strategies said. "When you have businesses that are based on consumer sales, and the consumers aren't buying, then the business can't make the interest or principal payments on its loans."

Patricia Silverstein, chief economist for the Metro Denver Economic Development Corp., in January forecast that the financial services sector wouldn't contribute as much to local job growth in 2008 as it has in recent years. The latest Fed rate cuts could change the picture a bit, she said.

"To the extent that we do see some life in the financial markets, we could see job growth in the financial services sector," Silverstein said. "I don't write it off totally, but ... I'm not willing to go out there and say it's going to be a big growth industry in 2008."