Jan. 29, 2010 ---

In Heritage Oaks Bank's 13th Questions and Answers series, the bank's president Larry Ward explains how 2010 will differ from 2009 in the banking industry, share his thoughts on the FDIC's proposal to tie bank's deposit insurance premiums to the design of the bank's incentive compensation program, discuss possible reactions to President Barack Obama's proposal to tax the largest banks, and, lastly, share his opinion on Huffington Post's campaign to encourage consumers to move their deposits from large banks to local community banks.

Question: How will 2010 differ from 2009 in the banking industry?

Answer: Interest rates are almost impossible to predict any more. That being said, we are expecting interest rates to remain at their currently historic low levels for at least another 6-9 months. If and when we do begin to see interest rates climb, they will be moving up at a slow pace. The Fed does not want to do anything with interest rates that may send the economy back into a double dip recession. There are several factors which impact a bank’s ability or willingness to lend money. Interest rates are not at all a part of the decision process to make a loan, but rather once the decision has been made to make a loan, the rate is determined by what level of profitability a bank needs to see from each and every loan to meet its
earnings targets. What impacts a bank’s ability to make loans is the level of capital a bank has on its balance
sheet.

Today more than ever, capital is the primary driver in a bank’s ability to grow the loan portfolio. However, no matter how much capital a bank has, if there is no demand for new loans or if the borrowers making requests for new loans do not meet bank underwriting requirements, the loan will not be made.
No matter how hard the President pushes banks to make loans, they will not make them if there is no demand or if the quality of the demand does not meet regulatory muster. Remember, we are in a deep recession and most companies are struggling to survive. They are not out seeking new credit to expand. I do want to make it clear however, that as a community bank, we make our money by making loans. We make loans to qualified borrowers every day because that is our business.

On the regulatory front, there is no question that the environment we are operating in has and will continue to change. Bank regulators are taking a much more aggressive position with respect to the asset quality of banks. Banks are being required to hold higher levels of capital on the balance sheet due to the risk factors associated with the poor economy. Regulators have banks under a microscope these days, and Congress has literally thousands of pages of new regulations on the table. I can only assume that the banking industry will only become more highly regulated, which ultimately drives up costs for the consumer.

Q: Do you think the FDIC's proposal to tie banks' deposit insurance premiums to the design of the banks' incentive compensation program is wise?

A: In a word, no. The reason is that it sounds like a great idea but it will never work. First of all, there are over 7,000 banks in the country. Only about 50 are large enough to fall into the arena where compensation is a real issue. No community bank in the country pays multi-million dollar compensation to its bankers, but we would all be governed by these proposed regulations.

A much better method for setting the level of deposit insurance premiums for each bank is to base it on the level of risk on the balance sheet. If the bank is heavily concentrated in speculative lending, it should be paying a higher insurance premium. If the bank is managed on a conservative basis, it should be rewarded with lower premiums. The FDIC should also look closely at large banks’ off-balance sheet activities to assess the risk of that activity on the deposit insurance fund. Looking back over the past two years, it was this off balance sheet activity that helped cause the housing bubble and resulting recession.

Q: How is the public likely to react to President Obama's proposal to tax the very largest banks to offset the government's TARP expenditures?

A: For some reason, the government has decided to pick on banks this year. The unfortunate thing to keep in mind is that when the media refers to banks, they are lumping together into one group investment banks such as Goldman Sachs, Morgan Stanley, Citibank, Bank of America and all of the community banks across the country. They also lump finance companies such as GMAC into that group. Many of the very large banks such as JP Morgan Chase and Bank of America have already repaid to the government the money they borrowed under the TARP program prior to the end of 2009. Now the President is suggesting that banks step-up and pay the government back the money it lent to the auto industry and the insurance industry.

I am concerned that Washington’s current trend of picking on banks may have a negative impact for our country's economy in its effort to emerge from this recession. It will be the banking industry that provides the financing for this economy to grow out of the recession.

Q: What do you think of the Huffington Post's campaign to encourage consumers to move their deposits from large banks to local community banks?

A: I think it is a great campaign. Community banks are the banks that will make loans to businesses on
Main Streets across the nation. These Main Street businesses will grow as a result. Employment will increase
as our local businesses prosper. We as community bankers have a vested interest in the health and well being of our communities. We work with local businesses and business people we know by name to help them grow their businesses. We work with our community businesses daily to help them through these difficult economic times as well as serve them in good times. We feel the pain when a business within our community fails or residents of our local communities are laid off. Community banks will be the heart and soul of our economic recovery and, for that reason, everyone should support their community banks by taking their banking business there instead of to the ultra-large national or international banks.