For the Southland’s Independent Banks, a Mixed Financial Report

Southern California’s independent banks and thrifts are doing better by almost every measure. They’re making more money, suffering from fewer bad loans and piling up fatter financial cushions than a year ago, a Southland bank study commissioned by The Times shows.

There are also more of them. Twenty new banks cropped up in the state last year, outpacing the number lost to mergers--17--for the first time in seven years. Up to three dozen more start-ups are in the works.

But 1998 data also show that most independent banks still badly lag their giant cousins in profitability and efficiency.

And although some appear to be benefiting from the fallout of big-bank mergers--scooping up customers dissatisfied with service disruptions or the lack of a personal touch--many may be angling to become merger targets themselves.

More worrisome, there are signs that smaller banks’ best days may be behind them.

Lower interest rates have squeezed profit margins at many independent banks. Competition for loans is increasing. Analysts say community banks are having to take more risks to generate the same revenue.

For example, community banks have rediscovered commercial real estate lending, leading to concerns about how well their loan portfolios would survive an economic slowdown or downturn. Meanwhile, regulators are clamping down on lenders that have strayed too far into risky lending in the effort to boost profits.

“There are a number of loans being made by independent banks today that are overly aggressive, and that will lead to losses,” said Ed Carpenter, an Irvine banking consultant whose company, Carpenter & Co., handled many of the failed-bank workouts for the government’s Resolution Trust Corp. during the late 1980s and early 1990s. “We’re seeing some retail development loans that are questionable. We’re seeing speculative apartment construction that’s a little questionable.”

Southern California’s banking scene continued to be transformed in the last year. Home Savings of America, with $50.2 billion in assets, was purchased by Seattle-based Washington Mutual, which now also owns Great Western Bank ($42 billion in assets) and Coast Federal Bank ($9 billion). Glendale Federal ($16.4 billion) was bought by San Francisco-based California Federal.

Meanwhile, the state’s two largest banks, Bank of America and Wells Fargo, were bought by out-of-state rivals.

Now the region’s largest independents are Imperial Bank with $6.2 billion and City National Bank with $5.9 billion.

Today, nearly 90% of Southern California’s 212 banks and thrifts have less than $1 billion in assets, and 75% have less than $500 million.

The smallest banks--those under $500 million--have taken to commercial real estate lending with a vengeance. Whereas such loans make up about 36% of Southern California loan portfolios in general, they take up 46% of the smaller banks’ loan portfolios, according to the bank study performed for The Times by Bauer Financial Reports of Coral Gables, Fla.

“Lending by small banks [in Southern California] increased by $2.6 billion in the past five years, and 62% of it was commercial real estate lending,” Carpenter said. “And guess what got us in trouble last time?”

Bad commercial real estate loans helped lead to the demise of dozens of California community banks in the early and mid-1990s, when an economic recession and declining property values drove many banks under, or into the arms of merger partners.

In recent years, however, the picture has brightened considerably. Bad loans at the smallest banks fell by nearly half between Sept. 30, 1997, and Sept. 30, 1998, and now average 1.07% of total loans for all Southern California independent banks and thrifts, and 1.27% for institutions under $500 million.

Profitability has also improved. Southern California’s independent banks and thrifts had a return on assets--a key measure of profitability--of just under 0.945% in the 12 months ended Sept. 30, up from 0.728% a year earlier.

That pales beside the returns generated by the nation’s big banks, however. The 14 largest banks--giants that include Bank of America, Wells Fargo, First Union and Citibank--boast returns on assets averaging 1.5%.

The biggest banks also enjoy efficiency ratios, or expenses as a percentage of income, of 57% on average. By contrast, Southern California’s small independents have an average efficiency ratio of 72.6%.

“Big banks clearly have economies of scale; community banks do not,” said Michael J. Ancell, a banking analyst with Edward Jones in St. Louis. Community banks “are still doing business with the more marginal customers, the marginally profitable customers that the larger banks don’t want to deal with.”

Mid-sized banks have some economies of scale but must often find a niche to be truly profitable. City National matches its much-bigger rivals with a return on assets of 1.6% and an efficiency ratio of 57.6% largely by concentrating on wealthy individuals and entrepreneurs.

Similar-size Imperial, meanwhile, has a return on assets of 0.54% and an efficiency ratio of 71.5%, after one of its multiple spinoffs, a consumer finance unit, stumbled badly last year.

Some community banks are stretching for profits by taking on customers with poor credit, Ancell said. Whereas big banks are large enough to absorb such risk, smaller banks are not, he said.

“If the economy curls over in the next couple of years and the smaller banks are loaded up with marginal customers, they’re going to be in trouble,” Ancell said. “They don’t have the big capital base to fall back on like the larger banks do.”

Federal regulators are particularly worried about so-called high loan-to-value home equity lending, in which a bank lends more than 100% of a home’s worth, and subprime lending, in which banks lend money to people with shaky credit.

San Bernardino’s Life Bank, which boasts a return on assets of nearly 3%, specializes in such lending. Another local bank, FirstPlus Bank of Irvine, is owned by Dallas-based FirstPlus Financial Group Inc., a high loan-to-value lender that ran into trouble last year when investors began balking at buying the company’s risky loans. The parent company drastically cut its staff and is selling assets as part of a reorganization.

Sometimes the risks don’t pay off. Regulators stepped in after Los Angeles-based Fidelity Federal Bank suffered a $59.8-million third-quarter loss because of the thrift’s disastrous experiment issuing credit cards to borrowers with poor credit. Delinquencies have spiked to 22%, and the thrift’s capital cushion plummeted from 11.22% of total assets as of June 30 to 8.66% as of Sept. 30.

The regulators have slapped restrictions on Fidelity Federal and its parent company, Bank Plus Corp., until its capital has been restored.

Community banks and thrifts face a constant tug of war between taking too much risk and losing out on loans and other deals, said John Rebelo, chief executive of San Diego’s Peninsula Bank and president of the California Bankers Assn.

Banks that stick to strict underwriting standards often lose out to lenders willing to take more risk for a slightly lower price, said Tom Kramer, chief credit officer for Foothill Independent Bank in Glendora.

Many community banks also face an earnings squeeze, thanks to lower interest rates that have forced them to cut rates on their loans to stay competitive. A survey by Washington-based Hovde Financial Inc. found that average interest margins--the average point spread between what banks earn on loans and what they pay for money--fell to 4.5% for community banks last year, compared with 4.7% five years ago.

Still, community bankers see plenty of opportunity to grow--particularly by catching the disgruntled overflow from nonstop mergers.

A Carpenter & Co. survey of 200 independent California banks found that 40% of the banks’ new loan growth came from borrowers who expressed displeasure with their previous bank.

Carpenter said other surveys have shown 27% to 31% of California bank customers willing to pay extra for service but that independent banks in Southern California have only 18% to 19% of deposits.

“You have $8 billion of deposits and relationships floating around out there that want service,” Carpenter said. “Any time you have that gap, you have a tremendous upsurge in the number of independent banks.”

Carpenter said the last such cycle of unmet need and bank creations took place from 1975 to 1984. In 1982 and 1983 alone, 80 new banks were created in California.

Bankers have far to go to catch up with that level of bank creation. In San Diego County, for example, there are now six independent banks, compared with 42 in 1984. In Orange County, there are seven, down from 46. Los Angeles has lost fewer banks and gained more start-ups, but the 112 based here are 30% fewer than 15 years ago.

Most of today’s boom in new banks is being driven by bankers displaced by mergers, Carpenter said. That’s a far cry from the last small-bank boom of the early 1980s, when most start-ups were driven by investors and businesses seeking community-based lending.

The majority of new banks are also starting life as publicly held institutions, making it easier for outsiders to gauge their value--and possibly make takeover bids.

Ray Dellerba was president of Tustin’s Eldorado Bank until it was sold in 1997 to Commerce Security Bancorp of Sacramento. After a brief career as a consultant, he is launching a new bank based in Newport Beach’s tony Fashion Island.

Dellerba believes his nascent bank, to be called Pacific Mercantile, will fill a gap by providing both high-tech Internet access and high-touch personal service for its target audience of small-to-medium-sized businesses. But he also acknowledges that having publicly traded shares was a priority.

“Every day you’re priced, and that provides liquidity to shareholders,” Dellerba said.

Not that mergers are a given. The pace of takeovers has slowed in recent months as banks digest previous acquisitions. Banks and thrifts are also busy making sure their systems are free of year 2000 bugs.

Perhaps most important, the currency used in most mergers--strong bank stocks--has weakened in recent months as investors worry about how banks might hold up during an economic slowdown.

“Their stocks have dropped, and they haven’t come back up,” Carpenter said.

There’s also no guarantee of success. Start-ups face all the economic uncertainties and problems of other community banks, with the added problem of being unknown, Ancell said.

“A lot of start-up banks are going to struggle,” he said. To succeed and grow, or get to the point that anyone wants to buy them, “they have to show a decent level of profits, and that’s not easy.”

Times staff writer Liz Pulliam can be reached at liz.pulliam@latimes.com.

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Southland Banks and Thrifts: How They Stack Up by Key Measures

Profitability and capital levels have improved for Southern California banks and thrifts over the last year.

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Return on Assets

This is a key measure of bank profitability. An ROA of 1% or more is considered a decent return.

All Southern California banks and thrifts

12 mos. ended Sept. 30, ‘97: 0.73% 12 mos. ended Sept. 30, ‘98: 0.95% *

Southland community banks and thrifts*

12 mos. ended Sept. 30, ‘97: 1.04% 12 mos. ended Sept. 30, ‘98: 1.10%

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Risk-Bsed Cpital

Risk-based capital measures a bank’s financial cushion relative to the credit obligations, or risk, the institution is taking. To be considered well-capitalized, a bank or thrift must have risk-based capital of at least 10% of total assets.

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All Southern California banks and thrifts

Sept. 30, ‘97: 12.73%

Sept. 30, ‘98: 13.37%

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Southland community banks and thrifts*

Sept. 30, ‘97: 14.89%

Sept. 30, ‘98: 114.86%

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*Community banks and thrifts are institutions with $500 million or less in assets.

Source: Bauer Financial Reports, based on data as of Sept. 30, supplied to the Federal Deposit Insurance Corp.

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Trouble Spots

The Southland banking industry overall is better capitalized and has fewer bad loans, relative to total loans, than it did a year ago. But some small banks and thrifts have run into problems, as indicated by data for the third quarter ended Sept. 30.

Capital Levels Below 10%

The following banks and thrifts had risk-based capital--a key measure of an institution’s financial cushion against losses--below the 10%-of-assets level that regulators have set as a minimum to be considered well-capitalized. Data as of Sept. 30:

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Assets Risk-based Institution City (millions) capital Industrial Bank Van Nuys $29.67 6.89% Brentwood Bank Los Angeles 64.32 7.39 Centennial Bank Fountain Valley 61.00 8.53 Western Security Burbank 136.44 8.58 Fidelity Federal Glendale 3,823.37 8.66 Banco Popular Commerce 169.72 9.13 Valley Oaks Solvang 45.95 9.22 Fallbrook NB Fallbrook 131.11 9.28 Vineyard NB Rancho Cucamonga 113.82 9.57 Alliance Bank Culver City 76.34 9.58 First Fed S&L; San Bernardino 107.98 9.68

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High Levels of Bad Loans

The following banks had the highest proportion of loans that were at least 90 days past due, as a percentage of total loans outstanding. Data as of Sept. 30:

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Bad Institution City loans Farmers & Merchants Long Beach 14.24% Industrial Bank Van Nuys 13.73 Mercantile Natl Bank Los Angeles 13.51 Valley Bank Moreno Valley 7.64 Asian Pacific Natl Bk San Gabriel 7.32

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Source: Bauer Financial Reports

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Fewer Bad Loans

Bad loans as a percentage of total loans declined for Southern California banks and thrifts in the 12 months ended Sept. 30, with the smallest banks showing the biggest improvement. Bad loans are those that are 90 days or more past due.

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All Southern California banks and thrifts

3rd-quarter 1997: 1.35%

3rd-quarter 1998: 1.07%

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Southland community banks and thrifts*

3rd-quarter 1997: 2.52%

3rd-quarter 1998: 1.27%

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*Community banks and thrifts are institutions with $500 million or less in assets.

Source: Bauer Financial Reports

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How Is Your Bank Doing? You can check the performance of independent Southern California banks and thrifts at https://www.latimes.com/socalbanks. The list includes key financial measures such as capital ratios, return on assets and delinquent loans. It also breaks down each institution’s loan portfolio by type.