While many businesses, homebuyers and individuals have benefited from the Federal Reserve's continuing effort to keep interest rates low, that same economic policy -- along with heightened pressure from regulators and tepid demand for new loans -- has added up to a time of historic challenge for community lenders in the North Bay and beyond.

Executives at North Bay financial institutions said they saw no clear end for the current conditions, citing the Fed's pledge to keep rates low until U.S. unemployment drops below 6.5 percent and the rapid issuance of new regulatory guidelines by the new Consumer Financial Protection Bureau. While the regional economy has steadily improved, an enduring sense of uncertainty has tempered new requests to finance business expansion and other activity, they said.

Apart from an upward bump following a federal economic stimulus package in 2009 and 2010, the average net interest margin for North Bay banks has marched downward over the past 10 years, according to filings with regulators . (Net interest margin generally is the difference between what institutions must pay on deposits and what it can charge for loans.) Some of the largest declines in margins were in the strained economic environment of the early 2000s, as well as in the period surrounding the 2008 financial crisis. In total, the eight North Bay banks under $3 billion in assets as of last year saw an average margin of 4.26 -- a decline of nearly 20 percent from a margin of 5.29 percent for those banks operating in 2002.  

With increased loan volume being among the current ways that lenders can move the needle for themselves and their shareholders, this environment has created intense competition for new business between financial institutions in the North Bay. Many lenders have already pushed their rates as low as possible, further compressing margins while trying to satisfy a consumer that has grown accustomed to borrowing money on the cheap.

Yet in a market where those lenders compete directly with the even lower rates often available from national banks, North Bay-based institutions are currently finding a competitive edge by retrenching in the traditional niche of community banking. Many consumers, executives say, respond to the prospect of a banking relationship that goes beyond interest rates, drawn to institutions that offer specialized expertise and service along with technology that is increasingly on par with the leading national banks.

Still, more than half of the country's lenders backed by the Federal Deposit Insurance Corp. either sold or were closed by regulators between 1990 and the end of 2012. Remaining lenders across the size spectrum face a markedly different landscape than in years past.

“It’s a very different business environment for small banks,” said Nancy Sheppard, president and CEO of the community bank trade group, the Western Independent Bankers.  Amid the emerging economic stability, Ms. Sheppard said that surviving lenders are on stronger footing.

“Banks are recovering. We’re not seeing the failed institutions, or the risk of that,” she said.Compliance burden increases

While lenders have long been among the most regulated industries in the United States, many executives noted that the rapid issuance of new rules from the Consumer Financial Protection Bureau and demands like the Bank Secrecy Act have significantly increased the workload of compliance personnel. Hires in those departments often command six-figure compensation, adding expense at a time when many are closely watching their margins, said Russell Colombo, president and chief executive at Novato’s $1.4 billion Bank of Marin.

"That can hit pretty hard for smaller banks, and there's great demand for these people," he said.

As chair of the group organizing the Western Independent Bankers’ annual executive conference this month, Mr. Colombo echoed a widespread sentiment that smaller lenders face a disproportionate burden when faced with the industry-wide blanket of new regulations. For the third year in a row, concerns about regulation remained the top concern for community banks in the trade group's annual survey

While Bank of Marin posted strong profits in 2012, Mr. Colombo acknowledged the challenging environment.

"You've got these increasing costs on the regulatory side and decreasing margins. That's not a good formula," he said.

Born from 2010’s Dodd-Frank Wall Street Reform and Consumer Protection Act, the Consumer Financial Protection Bureau and its guidelines affect a broad set of business activities for lenders and are designed to prevent the risky practices that many argue were at the root of the recent financial crisis. The rules are generally considered to target the nation's largest banks, but are required for lenders of all types and sizes.

Some of the rules, like changes to the protocol for international money transfers, have caused executives and their staff to question the feasibility of continuing to provide certain services to customers and members, said Brett Martinez, president and CEO of Santa Rosa’s $2.1 billion Redwood Credit Union. Like banks, credit unions are also subject to the rules issued by the Consumer Financial Protection Bureau.

“We’re all about consumer protection. For an organization like us, these regulations sometimes handcuff what we can do for our members," he said. Even during a strong 2012, the lender has had to direct an increased proportion of its attention to new demands from the national financial services regulator.

"Most of our local institutions are not the kind of institutions that the CFPB is trying to protect people from," Mr. Martinez noted.

The nature of concern towards regulation has evolved in recent years, now focused more on "crossing the T's” and “dotting the I's" than the fear of a crackdown, said Ms. Sheppard of the Western Independent Bankers. For some, a priority on exacting compliance has proven daunting in areas like mortgage lending, she said.

"The pendulum has swung so far that many banks who wanted to get into the mortgage market have been unable to do so," she said.Charting a path for growth

Following a wave of loan failures during the worst of the recession, the re-absorption of money that was previously set aside as a buffer for loans at risk of failure has helped many North Bay financial institutions to post revenue and profit in recent quarters. Those lenders reported better asset quality and strong capital reserves at the end of 2012, charting their strategy for a time of greater economic momentum.

After being freed from restrictions connected to the $43 million its received under the Troubled Asset Relief Program in late 2008, Santa Rosa’s $1.7 billion Exchange Bank restored its shareholder dividend last year and unveiled the results of a major investment in technology that executives said puts the bank on par with its national competition. While those new offerings come at the financial cost of a significant upgrade to behind-the-scenes systems, new offerings in mobile and Web-based banking are an investment in the bank’s relationship with current and future customers, said William Schrader, president and CEO.

“Restoring the dividend was a significant first step,” he said. “We’re invested in almost every corner of this economy. As it improves, we should,”

Santa Rosa’s $445 million Summit State Bank, another TARP participant, has reported improving operating income in recent quarters and reported its highest-ever earnings in 2012. It was in the top 83rd percentile in its percentage of revenue-earning assets for banks in its peer group at the end of 2012 -- up from the 62nd percentile at the end of 2008.

Tom Duryea, president and CEO, attributed those climbs to the appeal of initiatives that include the bank’s specialty in serving the nonprofit realm and pursuit of specialized lending programs for small businesses.

“Sonoma County has the highest density of nonprofits per capita in the Bay Area,” he said. “Our goal is to serve our community, and nonprofits are a huge part of that.”

Other benchmarks for area institutions include the February 2012 acquisition that more than doubled the size of Santa Rosa’s AltaPacific Bank to over $200 million in assets, upgrades to technology at Redwood Credit Union and Bank of Marin’s efforts in Napa County after the FDIC-assisted acquisition of the former Charter Oak Bank in Feb. 2011.Stronger footing for many -- could attract acquisition

Executives said that, while the period of FDIC closures was likely over, strong community lenders in the current environment would be likely to attract the attention of larger institutions looking to acquire another company and set up shop in the growing North Bay market.

Such was the case for Novato-based Circle Bank, which most recently reported 53 consecutive profitable quarters, six branches and over $300 million in assets before acquisition by Portland, Ore.-based Umpqua Bank in late 2012. After attracting a range of interest during the early stages of a public stock offering, the bank’s board ultimately shifted gears and concluded that the merger with Umpqua was a good fit in both a financial and cultural sense.

Umpqua paid an approximately 60 percent premium to acquire Circle Bank versus proposed pricing in the IPO, a potential herald for the kind of interest that area institutions could see from potential buyers in the coming years.

“Because we were thriving in this economy – and we were in a very strong market – when the board was out seeking capital, we started gaining a lot of recognition,” said Kimberly Kaselionis, who served as CEO of the former Circle Bank. “Umpqua was willing to pay a premium to our shareholders because of our strength and our recognition.”

Five North Bay lenders have been purchased or sold by regulators since mid 2008. Financial regulators were accountable for the closure and sale of Tampalpais Bank, Sonoma Valley Bank and Charter Oak. Meanwhile, Rabobank purchased Napa Community Bank and Umpqua purchased Circle Bank. Executives said that, for some, the growing burden of regulatory compliance could inspire greater interest in a sale or merger.

Yet smaller lenders maintain a niche in the current economic environment, said Tom LeMasters, president and chief executive of the $150 million Bank of Napa in the city of Napa. Awarded the Bauer Financial Five-Star Rating for financial strength, the bank reported a nearly 68 percent year-over-year increase in earnings in 2012 versus 2011 and was adopting a “wait and see” approach towards the uncertain impact of new regulations, he said.

“For a little community bank like ours, we’ve yet to find what the total impact will be — but we know it will be significant,” he said.

After a year when Santa Rosa’s Exchange Bank saw the restoration of the dividend that funds the trust administering the much-lauded Doyle Scholarship at Santa Rosa Junior College, Mr. Schrader, the CEO, said he is optimistic that the North Bay economy will help lift area industries, including lenders, out of the recession.

“We’ve been through two world wars, a depression and now a recession,” he said of the 120-year-old bank. “We’ve been through a lot of challenges.”