Mechanics Bank's earnings slumped in the third quarter, but the Richmond-based bank said Thursday that the decline was triggered primarily by an increase in reserves to shield it against failed loans.

Mechanics also said that it is planning to scout for other banks to purchase, thanks to having plenty of cash on hand for acquisitions.

Mechanics earned $2.5 million and generated revenue of $37.8 million for the July-September quarter, according to a bank regulatory filing. Compared with the year-ago quarter, earnings fell 33.2 percent and revenue slipped 7 percent. Revenue is a combination of total interest income and noninterest income.

The erosion in earnings resulted from a deliberate strategy by Mechanics Bank to pile up reserves to cover potential losses from loans, said Steve Buster, the bank's chief executive officer.

"What is really dragging down our industry and our bank's financial results are contributions to loan loss reserves," Buster said.

During the third quarter, the bank added $9 million to its provision for loan losses. That was down 14.3 percent from the $10.5 million the bank added in the second quarter. Mechanics Bank also added $10.5 million to the loan loss reserves in the first quarter.

"We determined that 2010 would be a year to build up that buffer significantly," Buster said. "We built the reserves in excess of what we need now and what we think we will need in the future."


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The $30 million addition in reserves during the first nine months of 2010 reduced earnings.

"All of our 2010 quarters are down prior to the comparable quarter in 2009 because of the contributions to loan loss reserves," said Garrett Lambert, the bank's treasurer.

At the end of September 2009, the bank's reserves to cover loan losses was 1.4 percent of its total loan portfolio. At the end of September 2010, that coverage level had jumped to 2 percent of all loans, regulatory filings show.

"We have a family ownership that is very conservative," Buster said. "They want good reserves."

The bank is facing a rising level of bad loans.

At the end of September, the bank reported $49.8 million in loans that were more than 90 days delinquent or had ceased to generate income. That was up 5.6 percent from the bad-loan totals at the end of June.

Deposits totaled $2.4 billion on Sept. 30, down 1.3 percent from June 30.

Still, Mechanics Bank noted that its $2.5 million third-quarter profit topped the results of the two previous quarters. In the April-June period, Mechanics earned $2.2 million. In the January-March quarter, the bank earned $2 million.

"We have been able to stay profitable the whole time," Buster said.

The bank's last quarterly loss was in the October-December period of 2008.

Mechanics thinks it will be able to start to reduce the cash it has stockpiled for loan losses. That should bolster the bottom line further.

"We are looking for acquisitions," Buster said. "We are mainly interested in Northern California."

Rising regulatory costs due to congressional approval of new financial rules could usher in a wave of consolidations. Recently, Walnut Creek-based Bay Commercial Bank struck a deal to buy Napa-based Charter Oak Bank.

"Some predict that the 8,000 community banks we have now will drop to 4,000 in the next five years," Buster said.

Contact George Avalos at 925-977-8477.