Many local banks are continuing to cash state-issued IOUs albeit reluctantly despite moves by the largest national banks last week to stop accepting them.
An informal survey by the Business Journal of regional and community banks headquartered in Los Angeles County revealed that most will accept IOUs but from existing customers only. The terms vary considerably by institution.
Southern California’s largest indigenous bank, City National Bank in Beverly Hills, said it will accept them indefinitely, but reserved the right to stop any time; a competitor said it will only cash them through the end of the month; and another institution said it would only accept IOUs as collateral for a loan. Several banks had not even decided what to do.
Cashing an IOU causes problems for a bank because it is, in effect, making a loan without knowing when it’ll be repaid.
“Any bank’s first reaction is you don’t want to accept them I mean, it’s an IOU,” said Babette Heimbuch, chief executive of FirstFed Financial Corp., owner of the second largest savings and loan in Los Angeles, First Federal Bank of California, which is accepting them on a case-by-case basis only from existing customers.
“It will just depend on the client’s relationship with us. If you have a vendor that has a business account with you and they work for the state, you’re going to have to help them out,” she said.
Facing a $26.3 billion budget deficit and an impasse in negotiations among lawmakers, California took a drastic step this month to save cash as talks dragged on. The state began issuing IOUs, known as registered warrants, July 2 to vendors, taxpayers and local governments in lieu of checks.
Although registered warrants, under the state constitution, are in line for repayment behind regular warrants issued for debt service and education, there is practically no chance the IOUs will not eventually be repaid. Moreover, the warrants carry an interest rate of 3.75 percent when they mature Oct. 2 and the state will pay prorated interest to warrant holders if a budget agreement is reached before then.
However, banks dislike warrants because it lowers their cash positions and there is uncertainty about when a budget agreement will be reached. If lawmakers fail to reach an agreement, the state expects to issue more than $3 billion in warrants this month and nearly $2 billion more in August. And some have suggested that California may use additional warrants in October to pay off the first ones.
IOUs create problems because banks should keep their assets and liabilities balanced. A $100 loan for 30 days, for example, requires an offsetting $100 deposit for 30 days. But if a banker makes a $100 “loan” to cash an IOU, the banker does not know whether to get a $100 deposit for 30 days, 60 days or longer. If the banker does not get an offsetting deposit, he is making a loan from the cash reserve, possibly draining it.
Wade Francis, president of the Long Beach bank consulting firm Unicon Financial Services Inc., said many of the small banks he is aware of will not accept IOUs, afraid they will create a liquidity problem.
“If you give (customers) immediate credit, that means money out of the banks’ pockets,” he said. “Everybody has a limit to how much money they have.”
Customer service
Several large national banks, including Bank of America and Wells Fargo, said they would accept IOUs only through July 10 a move, experts said, likely geared toward putting pressure on lawmakers to approve a budget. That has caused concern among vendors, particularly since most did not receive their IOUs prior to the banks’ deadline. Those who cannot cash them must wait until they mature in October, or possibly sooner if a budget agreement is reached.
Most banks reached by the Business Journal said they would accept IOUs only from existing customers. (The lone exception was Pan American Bank, which said it will also try to assist “affected non-profits.”)
“I’m not a big fan of this (program), but it’s more geared toward customer service,” said Alex Ko, chief financial officer of Wilshire Bancorp Inc., the parent of Wilshire State Bank, which will cash IOUs through the end of the month only for existing customers.
Indeed, several bankers said they saw it as their role as a community bank to serve their customers even when it is inconvenient for the institution.
“We’re just trying to support our customers,” said Emily Wang, director of marketing for East West Bancorp Inc., the Pasadena-based parent of East West Bank. Wang said the bank was cashing IOUs through July 10 and possibly longer, depending on an evaluation of the program this week.
The California Bankers Association, a trade group representing more than 200 institutions, said banks, given little more than one week’s notice, were blindsided by the state’s decision to issue IOUs.
“Many banks have not had adequate time to complete preparations to accept registered warrants,” said Rod Brown, chief executive of the association, in a prepared statement. “California banks highly value the relationship they have with their customers, and the natural inclination for the banking community is to be helpful corporate citizens. However, the current budget situation has certainly created a dilemma for California’s banks.”
Heimbuch, of FirstFed, said one of the difficulties in managing IOUs is that banks do not have an accounting system to do so. Even after just one week, Wang said that the situation has been a major headache for East West. The bank has had to ensure that employees including the marketing, legal, accounting and other departments understand its policy regarding IOUs and are ready to handle customers wanting to cash them.
“This is a lot of internal work,” she said. “I don’t know how many hours we’ve put in.”
To avoid many of the hassles inherent in cashing IOUs, Alan Rothenberg, chief executive of 1st Century Bancshares Inc. in Century City, said his 1st Century Bank would not cash them like a regular check. Instead, the bank will accept them as collateral for a loan.
“We don’t want to change our business practices,” he said.
