Long On Liquidity and Short On Profitability

Bonehead move of the 1st Quarter goes to the FDIC. They placed a negative rating on a bank located in Massachusetts due to the fact that it was not lending enough. You heard that right, the FDIC slapped East Bridgewater Savings with a rare “needs to improve” rating after evaluating the bank under the Community Reinvestment Act. The FDIC also faulted the bank for not advertising and marketing its loan products enough.

What does the bank CEO have to say about his conservative bank? “We’re paranoid about credit quality,” says Joe Petrucelli.

Let me get this straight. Here’s a conservative bank, where they supposedly have no bad loans, bad debt, or foreclosures, and not one itty-bitty need to set aside funds to cover anticipated future loan losses? Is there something wrong with this picture?

I discussed this exact issue with a friend who works for a credit union. He described how a community bank has certain benefits and is presumed to exist to serve their community. The point he makes is that it is questionable if they are indeed serving the community if they lend out only 1 in 4 deposit dollars.

My counter point: what if they can’t justify a loan on its merits? Isn’t one of the causes of the current economic meltdown that banks made huge loans to people who weren’t qualified?

So, the conundrum turns back to the fact that this East Bridgewater Savings Banks is barely profitable. About 25% of their deposits are turned into loans at rates of 5 or 10%, while the other 75% is roughly breaking even for them. This translates into low profitability after overhead and everything else.

But here’s the rub: even the credit union guy tells me they are in a similar situation. They have ample liquidity, but little demand for loans or other investment opportunities that yield greater rates of return.

How can a bank (or credit union) be faulted for maintaining a conservative strategy, as opposed to making loans or investments that may be too aggressive in light of current economic conditions? I applaud the conservative stance and not the loosey-goosey approach that got us in this mess in the first place.

What doesn’t work in my mind is when government officials try to “stimulate” the economy in ways that are precisely the reason we are upside down. They want us to spend spend spend and live beyond our means. That’s not a recipe for a viable economy.