An Icon's Struggle

Exchange Bank survived the Great Depression, eight wars and six recessions by taking a conservative approach to lending.

The strategy helped make it the biggest bank in Sonoma County, an icon of stability in a fast-changing world.

Now Exchange Bank finds itself atop a different list. The Santa Rosa bank has more bad loans than any other local financial institution, the result of a risky bet on builders in the Sacramento region near the peak of the housing boom.

The bank is saddled with $57.3 million in loans to borrowers who have fallen behind on their payments, according to an analysis of data reported to federal bank regulators at the midpoint of 2008.

While there is no threat to its survival -- indeed, Exchange Bank easily passed a key test used by regulators to assess the bank's solvency -- the surge of overdue construction loans is taking a toll.

Exchange Bank reported its first quarterly loss in at least a half-century in December and posted another loss in June. Its top executive, J. Barrie Graham, resigned last month, telling friends that he took responsibility for the bank's misfortunes. Graham could not be reached Friday for comment on this story.

The bank will likely have to write off more delinquent loans in the second half of 2008 and could end the year with an annual loss. The losses could even impact the bank's time-honored policy of paying dividends to its shareholders -- including the trust that funds scholarships for Santa Rosa Junior College students.

Now, the bank has turned to a pair of veteran executives to lead it through the turmoil. Chairman C. William Reinking, who served as CEO of Exchange Bank for 18 years until he retired in 2003 from day-to-day management, returned to his job as CEO in the wake of Graham's abrupt departure. He is joined by William Schrader, the bank's chief operating officer, who was promoted to president.

Reinking and Schrader are confident the bank will work through its problems, just as it has overcome challenges before in its 118-year history.

"We get through these things," Schrader said.

Exchange Bank is the oldest and largest bank in Sonoma County. It safeguards $1.25 billion in deposits, or 12 percent of the deposits in the county, according to an analysis of data reported by banks to the Federal Deposit Insurance Corp.

Aggressive expansion

The root causes of Exchange Bank's difficulty are its level of construction lending and its decision to expand into the Sacramento region to aggressively seek new loans in the then-booming area, analysts said.

"A fair part of their loan portfolio was in these construction and development loans and that has been a real Achilles' heel, a real hurt to earnings," said Fred Ptucha, investment adviser for Financial West Group in Santa Rosa and longtime analyst of bank stocks.

The strategy left Exchange Bank exposed to a downturn in construction. As of June 30, the bank had 19 percent of its loan dollars in construction and development companies, according to FDIC figures. The concentration puts Exchange Bank at the high end of what most community banks lend in that sector, said Harry Eisenberg, manager of a community bank investment fund in Lafayette.

For a while, the strategy paid handsome returns for Exchange Bank as the housing market boomed at the beginning of the decade. Builders eagerly borrowed money to start new developments and repaid those loans.

Home sales slump

But when home sales stalled, construction companies started to fall behind on their loan payments.

Today, Exchange Bank has more money tied up in delinquent loans than any other Sonoma County-based lender. An analysis of data recently released by the FDIC shows:

Nearly 5 percent of all Exchange Bank loans were overdue by 90 days or more on June 30, up from less than a half-percent a year earlier. The average for all local institutions was 1.4 percent.

Of Exchange Bank's construction and development loans, 22 percent were past due, based on dollar amounts. The statewide average was 11 percent.

The pool of bad loans has grown rapidly. The bank reported $57.3 million in past due loans, up from $4.7 million a year ago. As a result, Exchange Bank now accounts for more than half of the $94 million in delinquent loans reported by all local lenders.

Exchange Bank needed to add $16.3 million to reserves to cover potential loan losses in the first half of 2008, up from $1.5 million it added during the same period a year ago.

In seven decades as a residential construction lender, Exchange Bank has not faced such a downturn in its loan portfolio, officials said.

"That's been a bigger business line for us. We've had an enviable relationship with these builders. As they hit hard times, we hit hard times," said Bruce DeCrona, the bank's chief financial officer. "These are kind of unprecedented levels for us."

About three-fourths of Exchange Bank's problem construction loans were made to builders with projects in the Sacramento area, according to bank officials. The bank would not identify its borrowers, citing privacy laws.

Sacramento-area offices

Exchange Bank opened a real estate loan production office in Rancho Cordova, near Sacramento, in March 2004 -- its first office of any kind outside Sonoma County. Two years later, the bank opened a commercial and construction lending office in Roseville and also moved in the loan processing staff. Last year, the bank opened a branch in Rocklin.

"They were proven developers with proven market success. They went to a market with very attractive performance. It was what we perceived as an intelligent risk," Schrader said. "If you look back now, you might call that an aggressive move. We certainly didn't see the full magnitude and I don't think any of the major players there saw a correction coming like this one."

What once was a promising region for Sonoma County builders has become a quagmire of homes that take months to sell.

Cheaper land and swifter approvals had attracted Sonoma County builders to the Sacramento region, where strong sales meant robust profits. Their fortunes now dimmed, they have slashed prices and put off new construction.

Market 'more tumultuous'

"The Sacramento market was really hot there for a while," said Matt Watson, project manager for Cobblestone Homes, an Exchange Bank customer. "But it's a more tumultuous market."

Cobblestone is staying current on its loans as the Santa Rosa builder rides out a rough housing market by tapping reserves and holding back on new construction. Other builders must refinance loans and work out payment plans with their lenders.

"The solutions out there are not easy ones," Schrader said. "Good, well-capitalized builders with the right balance sheets are going to still find lenders. But quite frankly there were some builders who were overextended and are going to have a hard time rebounding from this."

Bank officials defended the decision to follow Sonoma County builders into the Central Valley and court other developers in the Sacramento area. While the bank is not now picking up stakes, officials said they are cutting back on construction lending with losses growing and more foreclosures looming. Both of its Sacramento-area offices are still open.

"The correction was pretty intense and severe for these customers. Certainly coming through a market like this we're going to have to rethink our positions. There will be less lending activity and we will have less of a presence," Schrader said.

Stock price plummets

Like other U.S. banks, Exchange Bank has seen the value of its stock drop sharply as investors sort through the wreckage left by the implosion of the housing bubble. Exchange Bank stock has lost more than half of its value over the past two years, falling from $158 a share in May 2006 to $65 on Friday, an eight-year low.

But officials said the bank's local ownership is not in jeopardy despite the steep drop in its stock price, which would make many companies an acquisition target. Exchange Bank is closely held, with fewer than 500 shareholders. A little more than half of the company's stock is owned by the Doyle Trust, created by bank co-founder Frank Doyle to provide scholarships for SRJC students.

The trust, which has given away $76 million to students over the past 60 years, is dependent upon dividends to fund its scholarships. But the bank's recent losses could impact its ability to pay dividends, Schrader said. The board of directors will hold its regular quarterly meeting this week to decide whether to pay a third-quarter dividend and, if so, determine the amount.

Despite the magnitude of its loan problems, the bank's overall stability is not in question, analyst Eisenberg said.

"Now their situation does not look pretty. Things could get worse for them, but this is not desperate at all," Eisenberg said.

Freelance writer Mary Fricker contributed to this story. You can reach Staff Writer Michael Coit at 521-5470 or mike.coit@pressdemocrat.com.