Before starting the interview process for her current job at the Bank of Marin, Christina Cook did what any candidate for the CFO position would do — she reviewed her potential employer’s financial results. What’s unusual, however, is that she found herself laughing.
“I couldn’t believe it. I was looking at the numbers and reading ‘zero’ in accrual loans. I had never heard of that,” the finance chief told CFO.com in a recent interview. As a finance executive at Bank America Corp. and Citicorp, Cook had never seen a set of bank books that didn’t have any nonperforming loans.
It was 2004, and the country was not yet in the grips of the economic crisis. Cook took the job, and, as it turned out, the Bank of Marin’s solid loan performance and conservative lending policies helped the company — which has $1.1 billion in assets — successfully weather the current credit-crunch storm.
Cook, 43, says that although she was always interested in financial institutions, she never planned on a career in banking. “The opportunities that presented themselves just tended to be in banking.” She started her career in 1986 as an auditor for Coopers & Lybrand — a predecessor of PricewaterhouseCoopers — after graduating from DePaul University, and made the jump to Bank America four years later.
Eventually she was named vice president of corporate planning and financial reporting at Bank America, and next moved to California Federal Bank, a $65 million savings and loan in San Francisco, “where I had the opportunity to be kind of a bigger fish in a smaller pond.” As director of financial reporting at Cal Fed, which was bought by Citibank in 2002, Cook added internal reporting to a résumé that already included external reporting duties.
As for the current credit crisis, Cook points out, not all areas of the country were hit hard by the subprime mess. Case in point: areas of northern California served by Bank of Marin, which include San Francisco and its neighboring Marin and Sonoma counties. Homebuilding growth in the area was limited, especially with respect to Marin County, where only 2% of the land is developed. As a result, the subprime sickness didn’t run rampant.
“We returned the money within four months, after being one of the first banks to participate in the CPP program. We said it’s time for us to return the money and take back control of running our business.” — Bank of Marin CFO Christina Cook
Nevertheless, nonaccrual loans — those not paying interest and in danger of default — did inch up during the past year, and broke the 0% barrier at the Bank of Marin. Still, as a percentage of total lending, nonperforming loans remain below 1% for the bank.
Below is an edited account of a CFO.com interview with Cook in which the finance chief opined on the credit crunch, the bank’s foray into a government-lending program, the metrics that she watches like a hawk, and her new appreciation for capital.
In June of 2007, the Bank of Marin made a prescient — or at least a serendipitous — move and sold off its consumer auto loans, as well as its Visa portfolio. What was behind that decision?
Interest rates. We had high-quality borrowers who were qualifying for very good auto loan rates. As a result, we were not making any more money on the loan and Visa portfolios than we would have made just borrowing funds overnight from the Federal Home Loan Bank (FHLB). We needed a whole back office to support the Visa business, but borrowing from the FHLB took one person to pick up the phone and make a five-minute call.
Were liquidity concerns another reason for the sell-off?
At the time, it seemed like we could have used some liquidity. But we knew that the loans we were selling weren’t really relationship loans. They were made through dealers, which meant that the ultimate customer was not a direct customer of the bank. We decided we would rather use the money on relationship loans, so we sold the portfolio and re-lent the funds in other areas where we had direct relationships, including commercial lending and mortgages.
Have you had to tighten your commercial-lending criteria because of the credit crunch?
No, our underwriting standards are the same as they’ve always been. When we underwrite, we always make sure we have a primary and a secondary source of repayment. So we’re underwriting to cash flow as well as looking for guarantees by the borrowers to back the loan. For example, for a commercial real estate loan, we look at the rental income. But we also look for guarantors with liquidity outside of their own money. In that way, if it lost tenants, the borrower is capable of stepping in and supporting the project. In the real estate example, we underwrite the cash flows and look at the lower end of market rents to support the loan. It’s a conservative view.
What metrics do you keep a close eye on, especially now that the credit crisis has a grip on the economy?
Nonaccrual loans. If the payments are delinquent more than 90 days, we will automatically put a loan on nonaccrual and stop reporting the interest income. If at any point — even within the period before it goes 90 days delinquent — we identify an issue or the borrowers come to us with a problem, and we don’t think we’re going to recover the full amount of the loan, we’ll stop accruing it. For the Bank of Marin, nonaccrual loans as a percentage of total loans is less than 1% — 0.7%. That’s the lowest out of all the peers we track, which includes all banks in California in our asset range of about $750 million to $1.5 billion.
What other metrics do you track?
We manage our credit quality very carefully — especially our capital liquidity. Also, we look at our earnings-per-share growth and loan-deposit growth. Really we track the fundamentals, credit quality and capital metrics, and look at our efficiencies.
What does the efficiency ratio tell you about the bank’s performance?
The efficiency ratio is calculated by taking the bank’s noninterest expense as a percentage of revenue. Essentially it represents how much you spend to earn every dollar. So our ratio during the first quarter was about 54%, which means we spend 54 cents to earn a dollar. We’re the lowest of our peers for [the] first quarter, but it rose a bit during the second quarter. We don’t have information on all of our peers for [the] second quarter yet, but I think everybody is going to move up because of the Federal Deposit Insurance Corp. assessment.
The FDIC regularly assesses banks a fee to pay for depositors’ insurance. Why was the second quarter assessment different?
The FDIC did a special one-time assessment in the second quarter, and for us it was $496,000. The FDIC also raised our base assessment rate on top of that. In the first six months of 2009, we paid $1.1 million in FDIC assessments, compared to last year when we paid $235,000 for the first six months. That’s the burden that the banking industry is bearing now to replenish the FDIC fund for failed banks.
That’s the cost of the bailout for healthy banks?
Yes, all the banks are being assessed, so everybody’s going to feel the effects. But it’s not the first time in history that the FDIC has collected a special assessment. Whenever there’s a bad economic cycle, the FDIC tends to announce a special assessment — or at least it increase rates.
You say the bank is in good shape financially, yet you received some government money. Specifically, the Bank of Marin participated in the Capital Purchase Program that was announced last winter. Why?
We thought through that decision very carefully. At the time, there was so much volatility in the marketplace, and so many companies — big companies — failing unexpectedly, that we felt it was prudent to take the capital even though we didn’t need it. If you remember, the program sentiment was that the CPP was for healthy banks to help jumpstart the economy and encourage new lending. And so we took the money. We were encouraged by our regulators to take it.
Oh yes. The state Department of Financial Institutions and the FDIC wrote a joint letter to the presidents of all the banks and encouraged them to take the money. The thought was that if banks were lending then the economy would get going again.
When you signed up for the CPP, had lending activity at the Bank of Marin slowed down?
No, our lending was as strong as ever at that point. We used the capital to support some of the lending. And then the sentiment, and the rules, really changed. The Treasury Department changed the terms of the initial contract after the fact. We were originally told that if we wanted to raise our dividend to shareholders we would need approval. We were told that as long as we were operating a strong, healthy bank, there would be no reason that we couldn’t raise dividends by a penny or so. But there was no approval process. Treasury basically said flat out that no one taking government money could increase dividends.
Were there other unexpected rule changes?
The original CPP contract said that if you default on your dividend payments to the U.S. Treasury, the government could put a regulator on the bank’s board. The revised contract said we had to amend our bylaws to permit the addition of two seats to the bank’s board that the Treasury Department could fill. Treasury could drop regulators onto our board at any time. There was a third change, related to limits on paying out incentive compensation, which is a big part of our culture. That stipulation would have affected everyone in the company because our incentive program reaches down to the teller level.
How did you handle those mandates?
We returned the money within four months, after being one of the first banks to participate in the CPP program. We said it’s time for us to return the money and take back control of running our business. We didn’t return the money and immediately raise our compensation. We just wanted to keep the compensation system we always had in place. It was working well. Also, the rules were changing so fast and so drastically that there was just no way to predict where it would go from there.
How much money did you take from the CPP?
We issued the government $28 million worth of preferred stock, as well as 10-year warrants to purchase common stock at some point in the future. So we returned the $28 million, but Treasury keeps the warrants. The Treasury Department can buy 154,000 of our common shares at $27.23. Right now we’re trading at over $32 per share. They could exercise the warrants today, instead of selling them on the open market. They probably will do an analysis on what will give them the best return.
Could you buy back the warrants?
We could, but if we bought them back it would be a hit to our capital, and we don’t really want that to happen. The warrants will likely be auctioned in the open market.
Suppose a third party buys the warrants through an auction and exercises them when there’s a spread of, say, $10?
The warrants owner would pay us $27.23 times 154,000 shares, in exchange for newly issued common shares. So it would actually increase our capital by $3 million or $4 million. Also, it’s a small amount of dilution, say 3.5% or 4%. So we’re not concerned about the warrants being out there, and we don’t really feel like we have to bid on our own warrants and win the auction.
The bank’s loan-loss provision for the first six months of the year increased from $1.1 million last year to $1.9 million in 2009. Is that because of loan growth?
Loan growth was one of the factors. But also, our market is not completely immune to the problems going on around the country. Our nonaccrual loans are about $5.9 million, or 0.7%. But we used to run at zero or almost at zero. So for us to have $5.9 million in nonaccruals, even though it’s out of $909 million, seemed like a lot to us.
Compared to your peers, do you consider Bank of Marin more conservative or aggressive regarding liquidity policies?
We don’t get to see the other banks’ policies. But from looking at results, I can see that we’re not as highly leveraged as many other banks. Also, our loan-to-deposit ratio, which shows what percentage of loans are funded with deposits, puts us right at about 100%, and that’s a good place to be because it means we are 100% funded.
But you still borrow to fund loan growth?
We still borrow, but it is very minimal. We have a credit line with the FHLB of $180 million and we’re borrowing $55 million against that. We also have correspondent bank lines of another $65 million and a discount window of another $30 million. So what we’re borrowing is just a fraction. Actually, our loan-to-deposit ratio was under 100% at the end of June, and many banks were at 110% or 130%. At 110%, a bank has 10% of their loan portfolio funded with borrowed money. So as soon as they experience some liquidity issue, some lenders will pull in their lines.
In this environment, are you satisfied with your capital ratio?
The regulators say you have to be at 10% risk-based capital or better to be considered well capitalized — and you want to be considered well capitalized. We’re at 11.7%, so we have a buffer. In fact, the difference between 10% and 11.7% means that we can actually absorb $33 million of pretax losses. That’s what it would take to bring us down to 10%. I won’t say that we have a set ratio that we want to meet, but we’re not comfortable with 10%. We are comfortable at 11%.
Are there any practical lessons that you’ve taken away from the financial crisis?
I have a whole new appreciation for capital. Before the crisis, everyone was buying back their stock and bringing down their capital because they wanted their return on equity to be high. But there’s something to be said for having a capital buffer and liquidity. Although our liquidity is fine, I think I have a deeper sense of appreciation for it. Just look at Washington Mutual and Lehman Brothers. They went down so fast because their credit availability disappeared. In a crisis situation I think people are either at their best or their worst as leaders.