How big gambles took down small banks

Last year, the Bank of Clark County in Washington state was riding high.

In January, it was named "Business of the Year" by the Better Business Bureau of Oregon and Southwest Washington. In February, it won a "Better Workplace Award" from the Association of Washington Business. And in July, it received Portland Business Journal's "Lighthouse Award" for being one of the region's fastest-growing companies. The bank — a 9-year-old institution with about 90 employees — seemed a model for business in the Pacific Northwest.

This year, on Jan. 16, federal regulators seized the Bank of Clark County (BCC), making it the first bank to fail in Washington state since 1993. The Federal Deposit Insurance Corp. said the failure would cost it up to $145 million.

BCC's story isn't unique. It provides a glimpse of the pockets of vulnerability within smaller banks across the U.S. financial system, which already is strained by massive losses at large banks that are draining the nation's resources.

BCC, like several other recently failed banks, chased growth using unreliable sources of funding to finance the real estate bubble. It proved to be a toxic, unsustainable combination that led to the bank's demise.

"Banks were swept by the 'get big fast' fever, and very basic fundamentals of risk management went by the wayside," says Ali Tarhouni, professor at the Michael G. Foster School of Business in Seattle.

While BCC's problems were mirrored elsewhere, some other banks took it further, opening out-of-state loan offices in hot real estate markets such as California and Florida and even Idaho and Utah, scouring for growth.

"The majority of the failed banks were either migrating their books into high-risk loans such as construction and home equity, or moving to places outside of their comfort zone," says Joshua Siegel, managing principal of New York-based private equity firm StoneCastle Partners, which invests in community banks.

The list of casualties is growing.

During the first three months of 2009, 21 banks failed, compared with just two bank failures during the first quarter of last year and one during that period in 2007. In its latest quarterly report, the FDIC's list of problem institutions included 252 banks at the end of 2008, compared with 76 at the end of 2007.

Mike Worthy, BCC's CEO until it failed, said in an interview that he was "as proud as I could possibly be" of the bank he founded in 1999. He declined to discuss circumstances or reasons behind the failure, other than to say, "It's beyond my worst nightmare."

Perils of 'hot money'

Federal filings show BCC grew quickly to $441 million in assets — loans, deposits and investments — at the end of 2008, from $40 million at the end of 1999.

Outwardly, BCC appeared to be another success story in community banks, a locally focused institution that drew on deposits from the surrounding area in Vancouver, Wash., and lent that money to nearby businesses.

However, that was only partly the case. Although it had just one branch for much of its existence, more than one-third of BCC's deposits came from out of state in the form of brokered deposits.

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