Banks Survived Storm, but What Next? : But Slump in Energy, Farming or Housing Could Trigger Crisis
After weathering a crisis of confidence blown in last year by the near collapse of Continental Illinois Corp. and the greatest number of bank failures since the Depression, the banking industry now appears to have hit smoother sailing.
Profits for most major banks rose strongly in the fourth quarter and in all of 1984, and are expected to rise this year as well. Investor and depositor confidence is reviving; many troubled banks are regaining deposits and investors have bid up stocks of some major banks. The Third World debt crisis has eased, at least for now. Banks are boosting their capital and income from fees and commissions. Lower interest rates are helping borrowers repay their debts.
But the industry’s rebound is extremely fragile, many bankers and analysts say. Several dangers--principally falling commodity prices, sluggish economic growth and higher interest rates--could abort banks’ improving fortunes and set off a new round of crises matching or even exceeding the travails of 1984, they warn.
Majority are Healthier
While the vast majority of the nation’s 14,500 banks are healthy, the conditions of hundreds of them remain perilous. The number of banks on the Federal Deposit Insurance Corp.’s problem list has quadrupled from over three years ago and continues to grow, while nearly 200 banks nationwide had problem loans--those earning little or no interest--exceeding their loan-loss reserves and shareholders’ equity, the main financial cushions against loan losses.
About 1,836 banks, or 14.6% of the industry, was unprofitable in last year’s third quarter; the percentage is believed to be even higher among California banks.
“Banks are not out of the woods yet,” says Alan Schreiber, vice president and senior credit analyst with Baltimore-based T. Rowe Price Associates Inc., a major mutual-fund firm which invests in bank certificates of deposit and other money-market instruments. “The same problems we’ve been dealing with over the last two or three years are still there. You never know when they’re going to pop up again.”
Although many banks have already accounted for many of their bad loans--writing them off or adding to their loan-loss reserves to absorb future write-offs--many more loans are in danger of turning sour, bankers and analysts fear.
Many troubled borrowers, particularly farmers, oil firms and real estate developers, have held on largely because of recent declines in interest rates or because banks have extended them new loans to help them make interest payments on their old ones. But higher interest rates, lower commodity prices or a new recession could put these borrowers under.
Oil prices, already falling because of a worldwide petroleum glut, are generally expected to fall further. That would further depress the fortunes of independent oil and gas companies, weakening their ability to pay back loans to Texas banks and other heavy energy lenders, and forcing these banks to write down the value of such loans. Many of these oil firms can survive with oil prices at the current range of $27 to $29 per barrel, but will have serious trouble if oil drops to $25 or lower--a very real possibility, some oil observers say.
Poses Another Threat
The fall in oil prices also poses another threat, that it would in turn drive down prices for its major competing fuel, natural gas. That would further weaken the independent oil and gas companies and lead to more energy-loan losses.
“If natural gas prices go down, it could make the fall in oil prices look like child’s play,” one bank analyst says.
Agricultural loans also could worsen if crop prices and farm-land values continue to fall. This could lead to the failure of dozens of small farm banks in the Midwest, and also could weaken the earnings of several major California banks. Among the nation’s top 50 banks with the highest percentage of problem farm loans at the end of last year’s third quarter, four of top six were based in California, according to figures compiled by Veribanc Inc., a Wakefield, Mass.-based bank research firm.
They were San Francisco-based Crocker National Bank, which classified about $212 million, or 1.33% of its total loans, as problem farm loans; Los Angeles-based Security Pacific National Bank, with $113 million, or 0.43%; San Francisco-based Wells Fargo Bank, with $46 million, or 0.25%, and San Francisco-based Bank of America, with $154 million, or 0.21%.
Losses on its farm loans to tax-shelter-oriented vineyards in California were a major reason for Crocker’s $324-million loss last year, the third-highest annual U.S. bank deficit ever.
Real Estate Threat
Several major California and Texas banks also could face new shocks from their heavy lending to real estate developers. Analysts have predicted a glut of office buildings in downtown Los Angeles. If the glut materializes, Los Angeles will join the ranks of suburban Houston (with a 30% office vacancy rate), downtown Denver (27%) and downtown Oklahoma City (24%), according to a survey by Coldwell Banker, a Los Angeles-based real estate firm.
“I wouldn’t want to be financing any new office buildings in downtown Los Angeles,” says Leonard Weil, chief executive and president of Los Angeles-based Mitsui Manufacturers Bank, the state’s 12th-largest bank which has been working to lower its own high rate of problem real estate loans on projects elsewhere in the Southland.
Other regions of the state and nation also face an overbuilding of high-rise condominiums, hotels or residential housing units. High vacancy rates in these areas will jeopardize developers’ ability pay off massive loans made to fund construction of these projects.
Analysts say many developers have made interest payments only because banks have lent them more money to make those payments.
“A lot of developers are paying out interest without a dime of rental income,” says one East Coast bank analyst, who says this practice of lending to developers to help them make interest payments may have to stop once projects are finished. That presumably is because it will be hard to justify making more loans to developers once their projects are on the market earning rental income.
A number of Orange County banks in particular have already been seriously weakened or have failed due to the slack real estate market of the past three or four years. Santa Ana-based Westlands Bank, for example, had a massive 24.7% of its total loans classified as problem real estate loans at the end of the third quarter. The bank has survived, however, thanks largely to its recent takeover by Edmonton, Alberta-based Canadian Commercial Bank, which injected it with new capital and changed its name to Commercial Center Bank.
These loan problems are compounded by the actions of federal banking regulators, who in the wake of Continental Illinois near-failure and expensive rescue are cracking down on how banks value their loans in real estate, agriculture and energy.
“Banks with heavy agriculture and energy debt have got to be viewed as possible candidates for greater scrutiny by regulators,” says James J. McDermott Jr., research director for New York-based Keefe, Bruyette & Woods Inc., a securities firm specializing in bank stocks.
Some analysts say more major banks may be forced to make heavy loan write-offs and additions to their loan-loss reserves similar to those made last year by Crocker and by First Chicago Corp. First Chicago, for instance, posted a $72-million loss in last year’s third quarter following an examination by the Comptroller of the Currency.
“Two more big bank surprises will be coming down this year,” predicts Edward J. Carpenter Jr., a Los Angeles banking consultant who works closely with federal regulators. He would not name the banks, but said they will be among the nation’s largest.
The rising problems with agriculture, energy and real estate loans are a main reason for a near quadrupling of the number of banks on the FDIC’s list of troubled institutions. That list now totals 824, up from 642 at the end of 1983 and only 223 at end of 1981.
The level of problem loans in the banking system, while beginning to decline, is still near record levels. A total of 191 banks, including nine in California, had problem loans exceeding their loan-loss reserves and shareholders’ equity at the end of last year’s third quarter, according to Veribanc, the bank research firm.
To be sure, many bankers and analysts dismiss the possibility of renewed bank crises, arguing that further sharp deflation or a recession are highly unlikely.
“Clearly banks would suffer from recession . . . and from falling commodity prices,” says Paul Baastad, bank analyst for the San Francisco-based securities firm of S.G. Warburg, Rowe & Pitman, Akroyd Inc. “But it is not altogether clear that these are highly probable,” he said, adding that with little danger of renewed inflation, the Federal Reserve is determined not to allow the money supply to fall so much as to trigger a recession.
Analysts also point to the fact that despite the growth in troubled banks, the vast majority remain healthy. Most troubled banks are concentrated among a few in the top 50 and dozens of small farm banks in the Midwest. About 85% of the nation’s banks are in good condition, the FDIC says.
Some, particularly such regional institutions in the Southeast as Wachovia Bank & Trust Co. of Winston Salem, N.C., are doing quite well, having avoided many of the problem loans dogging other institutions.
The recent fall in interest rates, which began in the third quarter, has come as a relief to healthy banks as well as troubled ones. Low interest rates have allowed many banks to cut the rates they pay for deposits faster than the rates they earn on loans, thus fattening their profit margins.
Lower rates also make it easier for banks to sell the real estate properties that they have acquired through foreclosure. And, of course, borrowers are finding it easier to pay their loans. Lower rates also have helped banks boost their profits on trading of bonds and other securities.
Accordingly, profits for all federally insured commercial banks--which declined in last year’s second quarter to $3.35 billion from $4.26 billion in the first quarter--rebounded in the third quarter to $4.49 billion, according to FDIC data. Fourth-quarter aggregate figures are not yet available, but analyst McDermott estimates that profits for the 175 major banks studied by his firm rose by a median of 18% in the period compared to the year-earlier period.
Some of the strongest gainers among major banks were BankAmerica Corp., which posted a 39% profit increase over the year-ago quarter; J.P. Morgan & Co., up 33%; Citicorp, up 30%, and Manufacturers Hanover Corp., up 23%.
For all of 1984, earnings for those banks rose an average of about 11%, McDermott estimates. He predicts that they will rise by 13% in 1985, in line with other analysts’ estimates, which generally predict increases of between 10% and 15%.
The improved profits were a major reason why stocks of some major banks have rebounded from their lows during the summer in the heat of the Continental Illinois crisis and Third World debt crisis. For example, the price of Manufacturers Hanover’s stock--which fell to as low as $22.50 per share last summer when rumors circulated that the bank was having problems gathering deposits because of its heavy exposure to Argentine loans--has since risen to around $39.
Improved conditions also lead many analysts to predict that the number of bank failures will not match the 79 in 1984, the highest since the Depression.
Banks meanwhile are reducing problem loans, in part because higher profits gives them more available funds to offset write-offs. Mitsui Manufacturers, for example, cut its ratio of problem loans to total loans to 6.78% at end of fourth quarter, down from 7.13% at the end of the third quarter, due in part to charge-offs and to growth in new loans.
At least in California, the decline in problem loans appears to be more pronounced among smaller banks. The level of problem loans among all state-chartered banks in California--which exclude the big national banks such as Bank of America--fell to $3.06 billion at the end of last year’s third quarter, down from $3.6 billion a year earlier, according to John Paulus, deputy superintendent in the state Banking Department.
These lower problem loans and higher profits also have helped many institutions boost their capital and loan-loss reserves, which have helped to restore investor confidence and protect against a further round of loan losses. Bolstered capital positions also will help if regulators force banks to raise minimum primary capital ratios even higher than the 5.5% of assets now proposed. Primary capital includes shareholders’ equity, loan-loss reserves and certain forms of debt.
Higher loan-loss reserves also may help if, as some analysts expect, regulators force major banks to write down the value of their loans to troubled Third World countries such as Argentina. Although the Latin debt crisis has eased with Mexico’s and Brazil’s improving economies and Argentina’s recent agreement to restructure its debts to Western banks, many analysts say that banks may not be able to continue valuing their loans to these countries at or near 100 cents on the dollar.
But banks are not just looking to improve their balance sheets. Many still are working hard to reduce their costs as well, analysts say.
“Expect to see some large-scale cutbacks in branches and staff this year,” says Los Angeles banking consultant Carpenter.
Los Angeles-based First Interstate Bank of California, for example, announced earlier this year that it would trim up to 7% of its 12,500 employees in a streamlining move.
Some analysts also expect giant Bank of America to continue to cut staff and branches. The world’s largest bank, which grew fat in the days before deregulation when banks only had to pay 5% interest on savings deposits, cut about 132 branches and 3,700 retail-branch workers during 1984.
BANKS WITH THE HIGHEST AND LOWEST PERCENTAGE OF PROBLEM LOANS AMONG THE TOP 50 U.S. BANKS
Problem loans as a % of total loans HIGHEST Seattle First Natioal Bank, Seattle 9.29 Crocker National Bank, San Francisco 8.49 InterFirst Bank, Dallas 7.23 Bank of New York, New York 6.90 National Westminster Bank, New York 5.67 European-American Bank & Trust, New York 5.59 LOWEST Sovran Bank NA, Richmond, Va. 0.69 First Union National Bank, Charlotte, N.C. 0.88 Wachovia Bank & Trust Co., 0.99 Winston-Salem, N.C. Citizens & Southern National Bank, 1.02 Savannah, Ga. Southeast Bank, Miami 1.19 United Virginia Bank, Richmond 1.27
AMONG THE TOP 40 CALIFORNIA BANKS
Problem loans as a % of total loans HIGHEST Commercial Center Bank (formerly Westlands Bank), Santa Ana 18.23 California Canadian Bank, San Francisco 12.65 Crocker National Bank, San Francisco 8.49 Bank of Stockton, Stockton 7.74 Bank of the West, San Francisco 7.53 Mitsui Manufacturers Bank, Los Angeles 7.13 LOWEST The Mechanics Bank of Richmond, Richmond 0.18 Bank of Canton of California, San Francisco 0.42 Mitsubishi Bank of California, Los Angeles 1.05 Exchange Bank, Santa Rosa 1.15 Farmers & Merchants Bank of Long Beach, Long Beach 1.52 Santa Monica Bank, Santa Monica 1.54
(Figures are as of end of the third quarter, 1984. Ratios may have changed since then. Problem loans include those overr 90 days past due but still accruing interest and principal, non-accruing loans and renegotiated “troubled” debt. Foreign loans are not included.) Source: Verbanic Inc., Wakefield, Mass., based on Federal Reserve Board data. BANKS WITH HIGHEST PERCENTAGE OF PROBLEM AGRICULTURAL LOANS AMONG THE TOP 50 U.S. BANKS
Problem agricultural loans as a % of total loans. Crocker National Bank, San Francisco 1.33 Valley National Bank of Arizona, Phoenix 0.98 Security Pacific National Bank, Los Angeles 0.43 Ranier National Bank, Seattle 0.30 Wells Fargo Bank, San Francisco 0.25 Bank of America, San Francisco 0.21
(Includes data for the top 50 U.S. banks as of end of the third quarter, 1984. Ratios may have changed since then. Problem loans include those over 90 days past due but still accruing interest and principal, non-accruing loans and renegotiated “troubled “ debt. Foreign loans are not included.) MAJOR BANKS WITH HIGHEST PERCENTAGE OF PROBLEM REAL ESTATE LOANS AMONG THE TOP 50 U.S. BANKS
Problem real estate loans* as a % of total loans Commercial Center Bank (formerly Westlands Bank), Santa Ana 24.72 Imperial Bank, Los Angeles 9.88 Metrobank, Los Angeles 8.34 California Canadian Bank, San Francisco 5.54 Hibernia Bank, San Francisco 5.16 Santa Barbara Bank & Trust, Santa Barbara 4.12
* Also includes real estate assets owned by banks through forclosure.
(As of end of the third quarter , 1984. Ratios may have changed since then. Problem loans include those over 90 days past due but still accruing interest and principal, non-accruing loans and renegotiated “troubled” debt. Foreign loans are not included.) Source: Verbanic Inc., Wakefield, Mass., based on Federal Reserve Board data.
