Are local banks entering the age of austerity?

Local community banks have emerged from the recession with consecutive quarters of healthy earnings growth, but many see lean years on the horizon.

The spread is narrowing between the interest rates banks can charge on loans and the ones they pay for deposits, making it harder to make money.

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At the same time, fewer and fewer healthy businesses are looking for loans, out of fear they may overextend themselves in the sluggish economy.

And the federal government is imposing a raft of new regulations, raising costs for compliance and placing new restrictions on income such as overdraft fees. The result is a coming squeeze on profits, forcing many in the industry to take a fresh look at how they do business.

Alexandria-based banking consultant Bert Ely advises small banks to examine whether they should continue offerings such as mortgage servicing or construction lending.

“Unless you have enough scale and can deal with all of the compliances,” Ely said, “you’re better off not doing it.”

Which sounds easy, except in a saturated market such as Washington customers can easily find banks offering multiple services, said Paul Aguggia, a banking attorney at Kilpatrick Townsend & Stockton, a law firm in the District.

“You can’t be a one-trick pony and expect to compete in this market,” he said.

Some analysts argue the tension could push weak banks into the arms of stronger ones in hopes of gaining scale. Others hope to grow organically, adding new product lines that generate fee income. Congressional Bank in Bethesda, for instance, now offers second-round venture capital funding and “green financing,” or funding for alternative energy companies.

“It makes sense to look for different verticals aside from commercial real estate,” said Congressional Bank chief executive John Lane. “It drives more revenue and can differentiate you in the market.”

For its part, Bethesda-based Monument Bank has been generating fee income from selling off the guaranteed portions of the Small Business Administration loans booked at the bank, a business it entered into in 2009, said president and chief executive H.L. Ward. A year ago, the bank also began originating residential mortgage loans for sale into the secondary market.

Cutting costs

Beyond adding products, many banks are looking to cut costs. Consultants say more banks are moving to outsource information technology and processing functions, as well as shrinking staff at branches.

“We’re telling our clients to take a look at their noninterest expenses and consolidate positions, not give out raises in some cases,” said Dennis Gibney, a managing director with FinPro, a financial consulting firm.

Institutions also have been cutting rates for certificates of deposit and money market accounts to lower costs.

So far that has not hurt deposits. Customers continue to stash more money in banks, as evidenced by the $7 billion increase in local deposits at the end of June.

Deposits at Monument, for instance, jumped 29 percent to $279.8 million, while Virginia Heritage Bank in Fairfax gained $103.5 million in deposits (Capital Business’s calculation excludes corporate and other nontraditional deposits).