Armed with an additional $9 million in capital from the U.S. Treasury Department’s $700 billion “bailout†of the country’s financial institutions, Paul C. Hudson, chairman and CEO of Broadway Financial Corp. (No. 4 on the be banks list with $356.8 million in assets), is ready to put that money to good use.
Credit deterioration and securities write-downs have hobbled even large, long-established lending institutions, both in the U.S. and abroad, causing many to severely curtail lending. According to Bloomberg, the finance and information services media company, banks have reported more than $745 billion in write-downs and losses globally since the credit crisis began. With the bailout, the Treasury encourages banks to increase lending by purchasing certain assets, thereby providing capital. When lending occurs and money circulates, it stimulates the economy. “It does not benefit the Treasury or the economy to have a lot of failing banks,†Hudson says.
Also chairman and CEO of Broadway Federal Bank, the wholly owned subsidiary of Broadway Financial Corp., Hudson plans to use the investment to make new loans, weather difficult economic times, and sustain the bank’s growth. Over the past five years, deposits at the bank have risen nearly 64%, to $295 million as of late September. So far, $4.5 million of the $9 million has been used to increase bank capital, increasing Broadway’s total risk-based capital ratio to 11.99%; it was previously 10.23%. To be classified as well capitalized, the regulatory capital requirement for risk-based capital is 10%. Bank capital, also known as equity, is the cushion that covers creditors if a bank’s assets are liquidated. It’s also considered a key measure of a bank’s soundness.
Banks that fall below the 10% requirement are typically ordered by their regulator to take corrective action. “The Treasury investment allowed the bank to continue to lend in our market,†Hudson says. “We did not have the capital to support the bank’s loan growth, and in this economic environment it would have been very difficult to raise additional capital.†The remaining $4.5 million will support future loan growth. Hudson projects he’ll need to invest up to another $2 million in the bank later in the year to support projected loan growth.
According to William Cunningham, senior investment adviser with Washington, D.C.-based Creative Investment Research Inc., which specializes in minority banking, Broadway Federal became the first black-owned bank to receive funding from the Treasury’s Troubled Asset Relief Program. With tight credit markets, capital–the lifeblood of the banking business–is in short supply. This is especially true of smaller, black-owned banks that are often cornerstones in their neighborhoods and are more likely to provide necessary business and housing loans within their communities.
IS RELIEF IN SIGHT?
Broadway has remained profitable in part because, like other black-owned banks, it avoided the subprime debacle. Broadway earned $1.9 million in the first nine months of 2008, up from $1 million for the same period in 2007. Its relatively small size kept the bank out of trouble since unethical subprime lending involves volume production that’s securitized and then sold on the secondary market, and Broadway had neither the production volume of single-family loans to support the loan pricing necessary to compete, nor the internal operations or staff experience to efficiently deliver the loans to the secondary market. Moreover, Hudson adds, the loans didn’t make sense from a credit or interest rate risk perspective. “We don’t believe that we should put consumers in loans they cannot afford,†he says, “or originate loans without verifying income.â€
Hudson’s team realized the bank needed additional capital at
the beginning of 2008. So management contacted Broadway’s primary regulator and expressed interest in participating in the Treasury’s Capital Purchase Program, in which the bank would sell certain securities to the federal government. A two-page application was filed with the bank’s primary regulator; then it was reviewed and forwarded to the Treasury for final approval, a process that took less than 30 days. All told, the Treasury acquired preferred stock in Broadway Financial, the parent company, as well as a warrant to purchase about 183,000 shares of the company’s common stock. The common stock underlying these warrants represents less than 11% of the parent company’s outstanding common shares as of Sept. 30, 2008.Hudson asserts that the bank is on solid financial footing. “The bank did not need financial assistance because of problem assets or negative earnings,†he says, although the bank’s stock was trading in the $5 range in early January, down about 44% from a year ago primarily because of a lack of investor confidence in the financial industry. “Bank profits were strong and credit quality was healthy. What we needed was capital to continue to grow assets.†Broadway also sought the Treasury investment because regulators have been advising banks to keep more capital on hand to protect against future loan losses. Broadway issued preferred shares and a warrant to purchase common stock to the Treasury in exchange for the investment.
Buddy Howard, president and banking analyst at Equity Research Services Inc. in Raleigh, North Carolina, says the Treasury’s investment in Broadway affirms its belief that the bank is likely to survive and use the increased capital to make new loans. But even with an investment from the Treasury, banks in general may continue to face challenges that include maintaining good asset quality, good expense control, and balance sheet growth. “They’ve got to maintain profitability, because if they start losing money they will burn through that capital,†Howard says.
BANKING ON GROWTH
With the added capital, Hudson’s goal is to make $90 million in total loans in 2009. He plans to fund loan growth with new deposits, loan repayments from borrowers, and money borrowed from the Federal Home Loan Bank of San Francisco. He concedes there is no magic solution or single strategy to deposit acquisition. “We plan to continue the hard work of reaching out to consumers and organizations, marketing our products and services, and providing outstanding customer service.â€
Hard work, yes, but these are hard times. In December, the unemployment rate hit a historic high of 7.2%, but Hudson sees the glass half full and notes that despite an increased credit risk, about 93% of people are still working. In light of President Obama’s goal to create 3 million new jobs, he feels there’s reason for optimism because individuals and businesses still need loans. “Even in this economic environment, people will still require financing.â€
Hudson expects Broadway’s single-family mortgage lending to now account for 35% to 40% of new originations; in contrast, it historically accounted for 10% to 15% of originations. He also expects that Broadway will benefit from reduced competition resulting from the closure or acquisition of banks such as Countrywide, IndyMac, Downey Savings, and Washington Mutual, as well as from banks that have canceled loan programs or eliminated certain loan products. As of Sept. 30, 2008, Broadway’s assets exceeded $400 million; the bank operates five full-service branches, four in Los Angeles and one in Inglewood, California.
The economy dictates that banks change the way they do business, and Broadway is no exception. The bank isn’t
lending to out-of-state borrowers. It has also reduced its loan-to-value ratio for home purchases, from 90% to 80%, and it now requires a 20% down payment from borrowers, compared with 10% previously. Such changes may reduce the number of eligible borrowers, Hudson concedes, but they may deter borrowers from overleveraging themselves.“The ethical question is, do banks have a responsibility to verify that borrowers can afford the loans they’re requesting, and do they have an obligation to offer loan products that best meet the consumers’ financial interests?†Hudson theorizes. “We believe that verifying that the borrower can afford the loan, and offering the best loan product to meet the borrower’s financial needs are not only in the best interests of the borrower, but also good for the company and its shareholders.†Broadway’s average home loan is $350,000, so Hudson projects that the bank could reach 143 new customers if it lends $50 million home loans this year. The new lending could also boost the bank’s profitability by generating fee income from things such as servicing mortgages. But the biggest gain would come from an increase in the bank’s net interest margin, the spread between what the bank charges on loans and pays on deposits. Even so, the bank increased its loan loss provision, an expense set aside to offset future loan losses, from $194,000 during the same period in 2007 to $947,000–a move that reflects the realities of the sluggish economy and how it may affect borrowers.
Hudson says it’s likely that more black-owned banks will seek capital from the Treasury. “In the current economic environment, most banks, particularly black-owned banks, will need to acquire additional capital.â€
This story originally appeared in the March 2009 issue of Black Enterprise magazine.