Banking and Finance / Lessons of 1987 Make County Institutions Cautious About New Year
Higher interest rates in the spring and an unprecedented stock market crash in the fall wiped out hopes that Orange County’s independent banks and savings and loans would post improved earnings and continued growth in 1987.
And the lessons of the last 12 months are making them more cautious about their expectations for 1988.
“I see 1988 pretty much as a mirror of 1987, certainly not much worse,” said Clyde H. Gossert, president of CommerceBank in Newport Beach. “People are understandably nervous.”
As always, the major variable facing financial institutions is the future direction of interest rates.
“I expect a good year for us, but the interest rate is the key to the equation,” said Michael G. Rombold, president of Household Bank, a Newport Beach-based S&L; with operations in six states.
“Rates ought to remain stable, at least for the first six months, most likely because of the psychology of 1988 being an election year and politicians not wanting rates to go up,” Rombold said.
10 S&L; Failures Recorded
Savings and loans could be in a more precarious position in 1988 than banks, industry consultants said. Ten Orange County savings and loans have failed in recent years, and five were declared insolvent and seized by state and federal regulators in 1987 alone.
Executives at Downey Savings in Costa Mesa are expecting a good year, but they’re not so sure about the rest of the industry. “It’s difficult for us to understand how so many savings and loans are getting into trouble,” said Downey President Maurice L. McAlister.
Because S&Ls; generally operate with a thinner profit margin, an increase in interest rates could create severe hardships for them. Still, industry consultants said, S&Ls; tend to be doing a better job now than in the past of keeping the amount of interest they earn on investments comfortably above the amount they pay out to depositors and others.
“I think 1988 will be a challenging year for banks and will continue to be miserable for savings and loans,” said Gerry Findley, a Brea-based consultant.
Edward Carpenter, a Costa Mesa-based consultant, said banks and savings associations will find stiffer competition next year from other financial services companies, including Sears, Roebuck with its Discover charge card and General Motors with its automobile financing arm.
In fact, the proliferation of such “nonbank banks” already is draining loans from both banks and thrifts. While both industries consider it appropriate to loan out about 75% of their deposits, the average ratio is dropping close to 60% or, for some institutions, even lower, said banking and savings consultants and executives. The ratio is falling in part because of the competition from nonbank lenders.
Competition also is increasing within the two industries. The barriers separating banks from thrifts have been falling as a result of deregulation, pitting the two types of institutions against each other for checking accounts, consumer loans and other services.
In addition, more than 60 failed savings and loans being operated by federal regulators are offering higher interest rates for big deposits than most S&Ls; and banks. That competition adds to the pressure on healthy institutions to raise rates, which lowers profit margins.
Competition From Big Banks
So keen is the rate competition, in fact, that several failed thrifts in Texas are offering depositors half a percentage point more than similar S&Ls; elsewhere, said Anne Bacon, president of Butterfield Savings, a Santa Ana thrift seized by regulators in 1985.
For Orange County’s independent banks, competition also is coming from the state’s major banks and larger independents. Security Pacific National Bank, for instance, is setting up a major banking center in Costa Mesa to solicit business clients, including smaller firms that the bank never courted before.
Imperial Bank’s Costa Mesa operation is looking for companies with annual sales of as little as $5 million, said Ronald L. Askew, regional vice president of the Los Angeles-based bank.
Besides the competition, both Findley and Carpenter said, the biggest problem for banks and thrifts next year will be increasing non-interest expenses such as salaries and overhead.
“It’s going to be a year in which banks can no longer ignore dealing aggressively with non-interest costs,” Findley said. “They still have banking for the masses, but they have to stop trying to serve everybody under the sun.”
Carpenter said S&Ls; also will have to do “dramatic” cost cutting next year in response to what he expects to be even lower earnings than thrifts will post for this year.
Savings institutions are more vulnerable to a downturn in the economy than banks, Findley said, because S&L; profits are more affected by changes in interest rates.
As rates go down, the difference between the amount institutions earn on loans and investments and the amount they pay out to depositors declines. S&Ls; typically operate on thinner margins than banks.
“And if rates go up,” he said, “nobody buys anything.” As a result, demand for loans declines, and institutions must find other ways to raise revenues.
New accounting changes also are likely to erode S&L; profits, Findley said. Instead of recording fee income--such as loan origination fees--at the time loans are made, financial institutions now must book those earnings over the life of the loans.
‘Tough to Raise Capital’
“I’m not overly enthusiastic about being in the savings and loan business for a while,” Findley said. “It’s tough for them to raise capital, and I expect to see quite a few sales, mainly because they’re not making the money they would like to to justify their survival.”
Banking regulators, meanwhile, are getting tougher with banks that become too involved in selling mortgages and other loans they originate to other parties in the so-called secondary market.
Findley said new mortgage banking regulations are resulting in reduced earnings at well-run banks such as CommerceBank, Landmark Bank and the National Bank of Southern California in Santa Ana, and are causing a big profit decline at Mission Viejo National Bank.
The Mission Viejo bank, which relied on mortgage banking for a dramatic turnaround in 1986, reported third-quarter net income of only $5,000, contrasted with $127,000 in the same period a year earlier.
“But these aren’t real losses,” Findley said. “They’re paper losses. The money is there and will come in over time.”
Both Findley and Carpenter expect to see more mergers and acquisitions in both industries. They predicted that seven or eight county banks and five or six S&Ls; will merge next year.
While generally healthy banks can be expected to merge, they said, consolidations among thrifts will involve poorer performing S&Ls.;
Thrifts were battered in Orange County in 1987 like never before as state and federal regulators took actions against seven S&Ls.; Five were declared insolvent and seized by regulators. Two of the five, South Bay and Equitable, were closed, while the other three, North America, Perpetual and First California, were assigned to a controversial management consignment program under which the government hires new executives to run the S&Ls.;
Thrift regulators also have filed lawsuits alleging widespread insider fraud at many institutions, including $43 million that the late Duayne D. Christensen and associates allegedly took from North America Savings, which was recently relocated to Costa Mesa from Santa Ana.
Regulators File Civil Suits
In the last three years, regulators have seized 11 Orange County-based thrifts and installed a new management team in June at a 12th, Pacific Savings Bank in Costa Mesa.
Seven of the seized institutions are operating under the government’s management consignment program. An eighth, Consolidated Savings Bank, was assigned to the program in May, 1986, but was closed a few months later.
Regulators have filed civil suits against former operators at seven of the seized S&Ls;, and the FBI has criminal bank fraud and embezzlement investigations pending against 10 institutions. John L. Molinaro, owner and former chairman of Ramona Savings in Orange, became the first S&L; operator in Southern California to face criminal charges stemming from the collapse of a savings institution. He pleaded guilty last month to charges of illegally receiving $6.4 million in loan proceeds and is awaiting sentencing.
One institution, Universal Savings Bank in Orange, won an unprecedented court decision in July overturning a conservatorship imposed by the state Department of Savings and Loan. The conservatorship was unprecedented because Universal was a healthy S&L.; The state agency acted on allegations that about $10 million in loans were headed to Australia for the benefit of the chairman of the S&L;’s holding company, Unity Corp. Ltd. in Sydney. The FBI opened an investigation, but regulators returned the S&L; to Unity’s control.
In addition, federal regulators are still trying to decide what to do with Financial Corp. of America, the Irvine-based holding company for the nation’s largest thrift, American Savings. The company needs $900 million in capital, and the beleaguered Federal Savings and Loan Insurance Corp. cannot afford that large an infusion at a time when it has 200 insolvent thrifts across the nation to support. First Nationwide Bank, a San Francisco-based S&L;, has been negotiating with regulators for the purchase of all or part of FCA.
County-based banks had a less strained relationship with their regulators. But what they lacked in regulatory problems was more than offset by merger mania.
Many bankers are trying to form combinations and increase market share so they will be attractive to East Coast suitors, who will be allowed to buy California banks beginning in 1991. If 1987 is a reliable indicator, the wave of mergers can be expected to continue.
Merger Approval Awaited
In July, the financially ailing Bank of San Clemente sued a Woodland Hills developer for reneging on a deal to buy the bank. The institution, which returned to financial health without an outside capital infusion, was sold to Irvine developer John E. Wertin in November.
Also in July, the holding companies for Citizens Bank of Costa Mesa and for El Camino Bank agreed to merge. The deal is awaiting regulatory approvals. Citizens Holdings would be the surviving entity, but El Camino would be operated as a separate unit with its own name intact.
In September, Eldorado Bancorp in Laguna Hills reached a definitive agreement to buy American Merchant Bank, whose principal owner, developer Martin List, had filed for bankruptcy. American Merchant, previously known as List American Bank and Orange City Bank, would operate as a subsidiary of Eldorado, which owns Eldorado Bank in Tustin. The deal is awaiting approvals from state and federal regulators and the U.S. Bankruptcy Court.
In November, CommerceBank signed a tentative agreement to be bought by Independence Bank in Encino, which has long coveted a Newport Beach presence. Executives at the banks expect to reach a definitive agreement soon.
Several proposed consolidations fell through, including a planned three-way merger of Corporate National Bank of Santa Ana and El Camino Bank of Anaheim into the National Bank of Southern California in Santa Ana.
Mergers and acquisitions were not the only big events this year for Orange County banks.
The chairman of American Commerce National, a fast-growing and highly profitable Anaheim bank, told shareholders at the company’s annual meeting in June that the bank has been under investigation by federal regulators since 1985.
Gerald J. Garner, the chairman, said the U.S. Office of the Comptroller of the Currency has been investigating alleged failures to disclose information about Garner’s yearlong suspension from his New York law practice and about the actual amount of his stock ownership in the bank when it was formed in 1983.
Shareholder Complaints
The annual meeting itself raised the eyebrows of the Securities and Exchange Commission, which began looking into reports of faulty notice of the session. Some shareholders claimed that notices were mailed late and that they did not receive them until after the meeting was held.
The only bank seized by regulators and closed was New City Bank in Orange, which had forged a name for itself by making loans to churches. Its deposits and assets sold to newly chartered Colonial Bank, N.A., which moved to Santa Ana.
Though bankers consider loans to churches, especially for construction, to be risky, New City had few problems with its church loans. It was commercial borrowers that caused the bank to lose $3.5 million in 1986 and end the year with only $699,000 in capital.
