Real Estate Develops as Threat to State’s Banks : Finance: California banks are strained by troubled loans, but most should survive the slump.
The kind of excess real estate baggage that California banks are carrying around these days can be found in a 60-page, catalogue-style booklet advertising an auction next month of First Interstate Bank property.
There is a 3-year-old Arcadia apartment complex for the elderly that is barely more than two-thirds full. Another page features a recently remodeled, 26-year-old shopping mall in Kings County with one out of five stores empty. Then there is a 51-acre site in Bakersfield that should have been an auto mall by now but remains a field crisscrossed by two asphalt streets.
All these projects just three years ago seemed like safe places to lend money. Today, they are some of the real estate odds and ends banks are left with as the state’s market continues to soften. The real estate virus that hit the Southwest, spread to New England and then contaminated the Northeast and Southeast, has finally taken hold in California. And the symptoms are starting to worry investors, bankers and regulators sick.
California banks earned $640 million in the second quarter ended June 30, but that was little more than half what they made a year ago in the same period. Earlier this month, First Interstate’s parent disclosed that it will cut 3,500 jobs and lose $200 million in the current quarter, much of it related to growing problems with its California real estate portfolio. And the disclosure that BankAmerica Corp. will acquire Security Pacific Corp. included news that about $1 billion will be set aside to deal with possible losses on Security Pacific loans, many real estate-related.
Investors are nervously awaiting results of a federal examination of Wells Fargo to see if the bank’s dependence on real estate lending will catch up with it. Once-hot banks such as City National Bank in Beverly Hills have been hammered by problems with real estate loans on offices and other projects. Even the state’s Japanese-owned banks, once feared as superior competitors, are caught up in the problems, with Mitsubishi-owned Bank of California posting a $183-million quarterly loss.
A handful of doomsayers are gaining increasing attention by predicting a San Andreas-style financial earthquake that will wreck California’s banks. They go so far as to contend that problems are so bad they will cause failures that in turn will exacerbate the troubles of the Federal Deposit Insurance Corp.
“If you marked California real estate to its real market value, you would wipe out the FDIC’s fund three times over,” said Michael Murphy, editor of the Overpriced Stock Service newsletter and a pessimist on California banks.
But most observers don’t see a banking Armageddon ahead in the state. Nor do they see a downturn as severe as what has been experienced in Texas, New England or even the New York City area. California’s population is growing rapidly. Some interest rates are at their lowest levels in nearly 20 years, helping ailing banks and cash-strapped borrowers.
“California has certainly shown some softness, particularly in the commercial real estate markets in Southern California, but I don’t think it’s a matter that causes us concern about the banks as a group,” FDIC Chairman L. William Seidman said.
Although the FDIC has expressed concern about the state’s softening market, Seidman said he remains more concerned about East Coast banks.
Nonetheless, few experts see even the best-run banks in California dodging the real estate bullet much longer. The state economy is soft and showing few signs of picking up. Unemployment hovers around 8%, and the state is increasingly losing manufacturing jobs to other states.
In addition, the commercial real estate market is so overbuilt in some areas that one out of four offices is empty, with prospects for improvement unlikely for three years or more.
The more likely scenario as the real estate shoe falls is a string of losses or razor-thin profits at institutions used to being among the most profitable in the country. State Banking Supt. James E. Gilleran said he sees profits of the 272 state-chartered banks he monitors as soft for the next six to nine months but adds that “no one is seeing a debacle.”
In addition, weakening financial conditions at some banks could force them into the hands of stronger suitors. Some small to medium-sized institutions whose management bet the bank on real estate when times were good may end up failing. Borrowers, many of whom are uneasy about the economy and too leveraged as it is, could remain scarce.
Still, two things about the state’s banks unsettle some observers: the California market is so big that any significant downturn could dwarf problems in other regions; and, the state’s banks have always taken more chances than banks in most parts of the country. The reason is that loans on real estate, always such an important part of California’s economy, are risky simply because it’s a volatile business.
“California banks are among the riskiest in the country in terms of their portfolios,” said Reid Nagle, president of SNL Securities, a Charlottesville, Va., firm that specializes in bank analysis.
The percentage of loans and other assets considered “high risk” for all U.S. banks was about 15.6% as of March 31, according to SNL. High-risk loans include those used to finance construction, commercial real estate projects, apartment buildings, the purchase of raw land for development, money that financed corporate buyout loans and loans to developing countries.
California banks have 19.7% of their assets tied up in such high-risk loans. Nearly 30% of Wells Fargo’s loans are considered risky, SNL’s data shows--double the national average.
Japanese-controlled Sumitomo Bank of California has the highest percentage of risky loans--62.2%--but the bank has set aside substantial amounts to cover potential problems.
At the same time, problem loans are rising. Non-performing loans as a percentage of assets jumped from 2.9% for California banks last year to 3.5% in June, compared to a national average of 3.25%. Security Pacific’s percentage of non-performing assets has doubled since 1989 to an uncomfortably high 4.8%, SNL’s data shows.
Another concern is that the cushion banks have built is thinner. Reserves--money allocated for possible losses on loans--as a percentage of problem loans fell statewide to 57.7% in June, compared to nearly 73% in 1989, according to SNL. Security Pacific’s percentage fell to less than 40%, while Wells Fargo’s has dropped to 53%, the data shows. The national average is 55%.
Although regulators have been tough in forcing banks to recognize problems, there are subtle signs that that may be easing or that regulators, stung by criticism that they have been overbearing, may be more willing to compromise.
Murphy, the Overpriced Stock Service editor, says he sees signs that bank regulators may be easing up on the pressure. Wells Fargo executives, for example, recently were successful in getting regulators in Washington to overturn a lower-level decision requiring the bank to write off an $85-million loan to a drugstore chain that has been in bankruptcy proceedings but is still making loan payments.
The money California banks have at risk in real estate loans for the most part is locked up in the proliferating high-rise buildings that changed the Los Angeles skyline in the past five years. Those buildings, as the banks are quick to point out, were financed largely by Japanese investors, insurance companies and some pension funds.
Nor were the risky loans made to homeowners.
Although delinquent consumer loans are rising, home loans are among the safest loans for lenders, despite higher unemployment.
Rather, the real estate loans are to such borrowers as a developer of tract homes an hour or two’s commuting distance from Los Angeles or a small shopping center where the landlord’s cash flow is squeezed because there are too may empty spaces between the video stores, dry cleaners and nail salons. Or it may be on mid-size office buildings hurt by the cutthroat rent competition that comes in a tenant’s market.
“Firms are moving out of offices and consolidating. Every landlord is looking for tenants, further driving down rental rates. There is too much excess space,” said Bram Goldsmith, chief executive of City National. Long a standout among mid-sized banks in the state, City National expects to post a loss in the third quarter and omitted its dividend because of problems in its commercial real estate portfolio.
Most top managers of the state’s big banks declined to talk in detail about prospective real estate problems, citing the sensitivity of the subject these days.
Some areas that have been hot are suffering from overbuilding. In Ventura County, long one of the Southland’s hottest growth areas, the office vacancy rate is 26.1% and continues to worsen, according to an FDIC study released in July. To put that vacancy rate into perspective, consider that it is barely below the rate for Phoenix, one of the most overbuilt cities in the nation, and is higher than such cities as Austin, Houston and Denver, which are plagued by office gluts.
Ironically, the turmoil among the state’s large and medium-sized banks could further shift the balance of power toward the state’s biggest bank, BankAmerica, which ironically was on the brink of failure in the mid-1980s. Although not immune from real estate problems, BankAmerica has considerably less exposure to high-risk loans now than its major rivals. SNL data shows only 12.3% of its assets are considered high-risk.
What about BankAmerica’s merger with Security Pacific? Although boilerplate language in its merger agreement with Security Pacific would allow BankAmerica to scrap the deal if loan problems at Security Pacific are much worse than believed, most analysts believe that the giant bank can successfully absorb any unexpected problems, barring a disaster.
The bank plans to devalue the Security Pacific portfolio in the merger. Helping offset problems will be $1 billion or more in cost savings the bank is expected to realize as a result of the merger.
A probable effect of what has been happening to the state’s banks--one that many see ultimately as good for them--is a new realism that may temper some of the unabashed optimism that has characterized California’s real estate and banking industries. Until the past few months, many of the state’s bankers insisted that the nation’s real estate problems would largely pass them by.
“California real estate is unprecedented. You had a 50-year boom that was virtually uninterrupted. No other area of the country has been through anything like that. When that happens year after year, it’s easy to believe the reverse could never happen,” SNL’s Nagle said.
Risky Business
California banks could face increased loan problems because they have a greater percentage of their loans in high-risk areas than the nation’s banks as a whole.
High-risk loans as Bank % of total assets* BankAmerica 12.3% Security Pacific 20.1% Wells Fargo 29.8% First Interstate 15.4% Union 21.0% Sumitomo 62.2% City National 22.0% Imperial Bancorp 29.7% All Calif. banks 19.7% All U.S. banks 15.6%
* High-risk loans include those for construction, commercial real estate, apartments, land, highly leveraged transactions and to lesser developed countries. Data is as of March 31. Source: SNL Securities, Charlottesville, Va.
California Bank Troubles
As bad loans have increased . . .
Non-performing* assets as a percent of total assets Bank ’87 ’88 ’89 ’90 ‘91** BankAmerica 5.95 5.10 4.33 3.04 3.03 Security Pacific 3.13 2.42 2.38 3.30 4.80 Wells Fargo 3.60 2.21 2.37 2.54 3.68 First Interstate 2.95 3.41 3.57 3.41 3.53 Union 1.68 1.95 1.57 1.87 2.16 All California banks 3.92 3.25 3.01 2.90 3.51 All U.S. banks 2.35 2.17 2.21 2.98 3.25
Reserves as a percentage of non-performing assets Bank ’87 ’88 ’89 ’90 ‘91** BankAmerica 59.12 74.65 78.85 86.51 73.51 Security Pacific 74.62 60.59 58.13 51.83 39.97 Wells Fargo 85.41 73.16 64.02 61.98 53.32 First Interstate 81.27 60.20 68.09 57.78 64.21 Union 96.38 96.70 119.69 105.13 93.60 All California banks 69.74 70.27 72.77 68.79 57.72 All U.S. banks 79.73 77.29 82.41 60.25 55.02
* Includes loans not paying interest for more than 90 days, renegotiated loans and other real estate owned. ** As of June 30. Source: SNL Securities, Charlottesville, Va.
