Opposing forces tug on banks

The recession hasn’t been kind to MBH Architects.

As its clients have stopped placing orders for its design services, revenue has plunged 50%, forcing the firm to lay off 160 of its 220 employees.

To make matters worse, in December, City National Bank froze MBH’s credit line and said it might demand immediate repayment of another loan.

The way founder John McNulty sees it, MBH, with offices in Newport Beach and Alameda, Calif., deserves better from its longtime bank, in part because the government invested $400 million in City National under the $700-billion federal rescue of the financial sector.

“They told us in October they had been given $400 million,” McNulty recalled. “I said, ‘What are you doing with it?’ and they said, ‘We don’t know yet.’ And I said, ‘Aren’t you trying to help businesses like us?’ ”

The relationship between MBH and City National highlights the clash of perceptions and expectations surrounding the federal government’s Troubled Asset Relief Program.


Like the 350 or so other banks that have accepted a total of about $250 billion in capital under the Treasury Department program, known as TARP, the Beverly Hills-based bank finds itself pinched between what it views as prudent banking and demands from lawmakers and customers that it expand lending to help reboot the economy.

Treasury Secretary Timothy F. Geithner is expected to outline a revamping of TARP on Tuesday as part of a comprehensive financial-stability plan, including ways to make it easier for people and firms to borrow.

Widely unpopular even before the Treasury used it to invest huge sums in banks to restore confidence in the financial system at the height of its credit crisis last fall, TARP didn’t require the recipients to make more loans.

Moreover, in the wake of the mortgage meltdown and other fallout from this decade’s era of easy money, banks have faced increasing pressure from regulators to reduce their risk -- a goal that would suggest less lending, not more.

“Regulators get heat when banks run into trouble, because it’s always ‘How did this happen on your watch?’ ” said Nancy Sidhu, chief economist at the Los Angeles County Economic Development Corp. and a former economist at Bank of America Corp. “So you’re getting two messages out of the government.”

Lending almost always decreases in a recession, partly because banks tighten their lending standards but also because consumers and businesses borrow less as they also pull away from risk. And banks are indeed making fewer loans in this recession.

An unusual reason for the current decline is the collapse of the market for mortgage-backed bonds and similar securities backed by loans.

The absence of that market means that nearly all the loans that a bank now makes must stay on its books.

As a result, even though banks are making fewer loans, the amount of loans in their portfolios has actually increased during this recession on average, according to Federal Deposit Insurance Corp. data.

For example, the volume of loans held by City National -- after subtracting allowances for losses on bad loans -- rose to $12.4 billion on Dec. 31, up 7.9% from a year earlier.

And each loan added to a bank’s portfolio lowers its capital ratios -- measures of its financial cushion against losses. It is those ratios that stability-conscious regulators have been pressuring banks to increase.

The “perception that the stubborn credit freeze is a banking sector failure seems to be very misplaced,” analysts at investment bank Sandler O’Neill & Partners wrote in a recent report, which asserts that “banks are already lending beyond their capacity.”

City National, which lends to small and medium-size businesses and manages money for wealthy individuals, never got involved with subprime mortgages and was looking to expand before the economic downturn began.

But the bank began tightening its lending standards in 2007 as the outlook for the economy worsened, Russell Goldsmith, chairman of City National Bank and chief executive of its parent, City National Corp., said in an interview late last month.

“What a prudent lender does in making a loan is try to evaluate how that business is going to fare in the future economic environment,” he said.

In a statement given to The Times last month, the bank says it has remained strong because it has adhered to “traditional and reasonable” lending standards.

“We’re eager to make good loans to creditworthy borrowers,” the statement says, “but making loans that can’t be paid back would only invite a repeat of some of the problems that helped push our economy into its current crisis.”

When the Treasury Department announced that it would buy stakes in banks, Goldsmith said City National would “run some numbers” to decide whether to apply. He said the bank was “well capitalized, and we haven’t been looking for more capital.”

After the company accepted a $400-million federal investment, Goldsmith said it would create a “fortress balance sheet that will reassure our clients and attract new clients.”

The City National infusion has drawn attention: As The Times reported Jan. 2, Treasury investigators are reviewing the investment -- looking not at how the bank is using the money, but how Treasury officials decided to invest in the financial institution.

Goldsmith objects to calling the infusion a bailout, noting that the Treasury Department stands to make a nice profit on its investments in City National and other strong banks.

As for its customers, City National declined to discuss specific cases.

“We’re a relationship-oriented bank, and we try to work with clients,” Goldsmith said. “If their economic situation changes, there’s an ongoing dialogue to keep the loan healthy and help them work through it in such a way that we get repaid.”

In its statement to The Times, the bank said, “The overwhelming majority of our clients are doing fine, and we continue to finance them as we always have.”

That’s small comfort to Robert Dewey, whose Lake Forest real estate firm, PGP Partners Inc., is trying to get City National to extend loans on two pieces of land in the Inland Empire on which the firm planned to build industrial space before the recession made that no longer viable.

In a dispute over PGP’s financial strength, City National severed the firm’s $700,000 credit line late last year -- but reinstated it after The Times inquired about the situation.

“Something is definitely wrong with this federal bailout program,” Dewey said. “If the banks aren’t willing to work with people like us, what the heck is going on?”

PGP has banked with City National since 2000, never missing a payment on 11 loans totaling $54 million, Dewey said.

While still trying to work out a deal with City National, Dewey is talking with other banks about moving all his business.

“I just don’t feel I can trust City National anymore,” he said.

At MBH, the architectural firm, McNulty is trying to negotiate lower office rent and says he remains hopeful that City National will unfreeze the firm’s line of credit and rework its $3-million loan. Its dwindling cash flow has put it in breach of some of the loan’s terms, and the bank could force him to make good on a personal guarantee he signed.

“We’ve done everything we can to reduce our costs. Now it’s about trying to save the business, and maybe my house,” McNulty said. “I think the bank agrees with us that MBH is a lot more valuable to City National as a sustainable entity than as an architectural firm gone bankrupt.”