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San Francisco Regional Outlook - Second Quarter 1997

Regional Banking Current Regional Banking Conditions Overall, the strength of the San Francisco Region's economy is providing a foundation for favorable bank performance; however, banks in four of the Region's slower-growing states are experiencing minor increases in past-due loans. TInstitutions with assets under $1 billion increased an already high exposure to commercial real estate loans in 1996. The number of banks in the Region is falling due to mergers, especially in California and Montana. Earnings at the Region's thrifts continue to improve. Banks Continue to Outperform the Nation, Despite a Slight Dip in Profits in 1996 Return on Assets (ROA) at commercial banks in the San Francisco Region exceeded the nation for the third consecutive year.  Favorable economic conditions contributed to healthy loan growth, strong net interest margins, and hefty fee income growth.  An annualized ROA of 1.22 percent compared favorably to the 1996 national average of 1.19 percent but reflected a decline from the Region's 1995 ROA of 1.39 percent.  This decline was primarily the result of  substantial increases in credit card loan loss provisions and merger-related expenses. Despite strong earnings performance at the Region's banks, there are several trends that warrant closer attention.  Past-due loan ratios (loans 30 days or more past-due plus nonaccrual loans, divided by total loans)  trended upward in all states except California.  In Alaska, Hawaii, and Montana, past-due loan ratios climbed between 50 and 80 basis points for the year, topping 3 percent by year-end.  Past due loan ratios in Wyoming also climbed over 50 basis points but remained below 2 percent at year-end (see San Francisco Region:  Following Separate Paths). In addition, commercial real estate lending activity picked up in the Region's midsize and smaller banks.  Exposure in the Region's smaller banks (with assets less than $1 billion) is high relative to levels held at institutions in other asset size groups.  Finally, increased merger activity has occurred throughout the Region, particularly in California and Montana. Chart 1 Source: Bank Call Reports Commercial Real Estate Loan Portfolios Growing Once Again After declining from 1991 through 1993, commercial real estate lending began to pick up again in 1994.  As shown in Chart 1, by year-end 1996, commercial real estate loans (including loans secured by commercial properties, construction projects, and multifamily properties) had returned to levels last seen at the beginning of the decade. Commercial real estate exposures in this Region vary substantially by bank size, with the smaller banks generally having the greatest exposure (see Chart 2).  Smaller institutions (with assets less than $1 billion) have continued to build their commercial real estate portfolios throughout the 1990s.  Over the past year, midsize institutions (with assets of $1 to $10 billion) also have begun adding to their portfolios. As of year-end 1996, more than one-half of  institutions with assets of less than $10 billion had commercial real estate exposures exceeding 25 percent of their total loan portfolios. In contrast, the Region's largest institutions generally had much lower commercial real estate concentrations. Chart 2 Source: Bank Call Reports Region's Merger Activity Picks Up Similar to the nationwide trend, the San Francisco Region has seen the number of insured commercial banks decline by 228 since 1990.  This decline includes 257 unassisted mergers, 57 failures, and 12 other  closures and absorptions resulting from charter conversions and self-liquidations.  However, the declines were offset, in part, by 98 new charters.  The rate at which the Region's banks are merging has gradually increased over the past six years.  In 1996, the Region reported 50 mergers as compared to 44 in 1995 and 35 in 1994. (Wells Fargo's acquisition of First Interstate Bancorp accounted for seven of  the 50 mergers in 1996.)  New bank activity also has increased. There were 24 new charters granted in 1996, which is up from  21 in 1995 and only 5  in 1994.  Alaska and Hawaii were the Region's only two states that did not add new banks in 1996. The decline in the number of banks is not evenly distributed across the Region.  The number of banks in California declined by 122 in the last six years, representing 54 percent of the Region's total  contraction in bank charters.  However, California continues to hold a  dominant share of the Region's financial institutions, with 360 banks or 45 percent of the Region's total banks.  The pace of mergers in Montana, the second most active state in terms of numbers of mergers,  picked up after the 1989 change in that state's mergers and acquisitions banking law.  Since 1990, Montana has experienced a net reduction of 56 banks, or a 36 percent decline in the number of banking charters in that state.  Table 1 shows rapidly expanding Nevada at the opposite end of the spectrum with seven new banks. Increased competition from banks and nonbank financial institutions, coupled with the arrival of interstate banking this year, likely will result in further industry consolidation.  Prospects for further consolidation are particularly evident in Montana where legislation to allow intrastate branching recently passed.  Under the old regulations, Montana's 100 banks could branch only on a countywide basis.  Passage of this bill could result in a reduction in the number of banks in the state by at least 20 if all 12 multibank holding companies in the state convert their subsidiary banks to branches. A Thrift Recovery in Progress The third quarter SAIF deposit insurance assessment  temporarily depressed an otherwise improving thrift industry performance (see Chart 3).  Exclusion of this one-time charge from 1996 thrift earnings reveals a 0.74 percent ROA for the full year versus an unadjusted ROA of 0.31 percent.  Improved earnings are attributed to a reduced cost of funds and a loan growth rate of 9.24 percent.  The 1996 loan growth was centered in consumer, single-family residential, and construction loans.  Rising earnings at the Region's thrifts appear to be fostering merger activity, particularly in California where earnings are catching up with the Region as a whole.  In the San Francisco Region, 12 nonaffiliated thrifts merged in 1996 compared to only five in 1995.  Nine of the 12 thrifts that merged in 1996 were headquartered in California.  This is more than twice the number of 1995 nonaffiliated California thrift mergers.  Chart 3 * 1996 ROA adjusted for SAIF assessment Source: Thrift Call Reports Analysts are predicting further merger activity in the near term.  Among the reasons cited are the following: A 39 percent market share of California's bank and thrift assets; Extensive retail branch networks; Favorable tax accounting provisions enjoyed by thrifts with respect to bad debt reserves; and An improving state economy. Table 1 As has been widely publicized, both San Francisco-based First Republic Bancorp, with $2.2 billion in assets, and the $41.3 billion  Great Western Financial headquartered in Chatsworth, California, have been targeted by suitors as potential merger candidates.  Catherine I. Phillips-Olsen, Senior Regional Analyst Roger Stephens, Financial Analyst David Pfeifer, Examiner, Division of Supervision Regional Outlook main page