Federal Reserve District, 12th ; Banks and banking - West

Gary C. Zimmerman

English

Research Papers in Economics

FRBSF WEEKLY LETTER
July 22, 1988
Western Banking Recovery
Western bank performance in the first quarter of
1988 points to the potential for strong improve-
rnentf6r the year. Aggregate earnings jumped to
$850 million in the first quarter of 1988 from
$555 million in the first quarter of 1987. Earnings
were up across the region, with California, Ne-
vada, and Hawaii showing the most improve-
ment. Over 80 percent of the region's banks were
profitable in the first quarh~r.
More important, the improvement signals a turn-
around for western banks, which are rebounding
from a dismal 1987. Last year the banking indus-
try in the West suffered an aggregate loss of $133
million, the industry's first loss since the 1930s.
One out of four banks in the West lost money
during 1987. The most notable losses were suf-
fered by the larger banks, particularly those with
significant exposure to lesser developed country
(LDC) debt.
Not only did the western banking industry fail to
make a profit in 1987, it also failed to expand. It
continued to stagnate at around $400 billion in
assets. Regulatory and market pressure on banks
to consolidate and strengthen capital bases,
combined with sluggish loan demand, limited
growth opportunities for many banks in the West.
Against this background, first quarter results
showing strong earnings and an upturn in lend-
ing are encouraging.
Improving fundamentals
Several factors account for the strong first quarter
performance, and are likely to account for con-
tinued strength through the rest of 1988. First, the
western economy (with the exception of Alaska)
continues to perform well, and to out-perform
the nation as a whole. Second, expenses associ-
ated with increased loan loss provisions are
running well below year-ago levels, in part be-
cause of the continued strength of the economy.
First quarter data indicate reductions in net loan
charge-offs, and in the levels of nonperforming
and past due loans. Moreover, this pattern is ex-
pected to continue due to forecasts of continued
favorable economic conditions. Third, net inter-
est margins, or the difference between the aver-
age return on earning assets and the average cost
of funds, widened, particularly in California.
Much of this improvement is due to conservative
pricing of consumer-type deposits at western
banks. Finally, in the aggregate, consolidation
and cost control measures have helped to reduce
fixed overhead costs relative to the level of
assets.
Lingering concerns
Prospects for the industry have brightened, but
asset qualityproblems linger. Even after the ex-
traordinary $3.5 billion increase in loan loss
reserves in 1987, western banks still may need to
increase loss reserves in 1988 because of uncer-
tainty over LDC debt reschedulings and repay-
ments and ongoing problems with energy, real
estate, and farm sectortoans. In this regard, if a
widespread downgrading of LDC loans were ne-
cessary, an additional boost in loan loss reserves
would be required, which would have a signifi-
cant impact on earnings.
Otherfactors besides the LDC situation also
could derail the turnaround. For example, while
analysts paint cautiously optimistic forecasts for
the industry, some have expressed concerns
about asset quality in the event of an economic
downturn, especially in the area of leveraged
buyout (LBO) debt. And given continued weak-
ness in demand for bank loans, others are con-
cerned that competition to build loan volume
may lead to lower credit standards and narrower
interest rate spreads on new loans. This may be
particularly worrisome in the commercial lend-
ing area, where emphasis has shifted from the
nation's major corporations towards smaller
"middle market" firms. Aggressive lending prac-
tices, especially if they exacerbate existing asset
quality problems and/or reduce spreads, would
erode future earnings.
WESTERn BAnKinG Western Banking is a quarterly review of banking
developments in the Twelfth Federal Reserve District. It is published in the Weekly Letter on the fourth
Friday ofJanuary, April, July, and October.FRBSF
On the positive side, however, the large increase
in loan loss reserves last year means that some of
the West's largest banks already have set aside
reserves against a large proportion of their LDC
and troubled farm and energy loans. That action
provides a buffer for future earnings even if such
loans are shifted to nonaccrual status or written
off altogether.
Spreads
Data on interest rates on loans and consumer-
type deposits over the last year do not indicate
any significant narrowing of spreads between
new loan rates and the current cost of deposits.
This suggests that concerns about narrowing
spreads associated with increased competition in
lending are at least premature. More important,
because spreads on new loans remain steady, net
interest margins should remain at their present
levels for the near term.
Moreover, the available data indicate that spreads
generally are wider in the West. Data for a sam-
ple of western banks show that in May 1988
banks in the West continued to charge higher
rates on commercial and consumer installment
loans than banks elsewhere in the nation. Only
on agricultural production loans did western
banks charge lower rates, on average.
Furthermore, survey data on interest rates paid by
banks on consumer-type deposits indicate that
western banks tend to pay lower interest rates
than the national average. That differential has
not changed substantially over the last year.
Moreover, over a period of several years, western
banks' .interest rates on depositsalso have been
lower than the rates paid by western savings and
loan associations (S&Ls) and credit unions. For
example,.data published by the Bank Rate Moni-
tor indicate thatthe sampledCalifornia banks
have consistently paid lower rates than the lead-
ing S&Lsin the state.
Costs vs. marketshare
Setting lower interest rates on MMDAs, savings
accounts, and smallcdenomination time certifi-
cates of deposit has had an impact on western
banks' market share. Because deregulated con-
sumer deposits are moderately interest-sensitive
in the long-run, banks' share of the deposit mar-
ket has fallen relative to that of S&Ls and credit
unions.
As recently as December 1985, commercial
banks in the West held 51 percent of the domes-
tic deposit market. Savings and loans trailed with
45 percent, and credit unions accounted for the
remainder. By May of 1988, S&Ls had captured
half of the market, while commercial banks'
share had slipped to 46 percent, a loss of five
percent of the deposit market in less than three
years.
S&Ls now control 55 percent of the domestic
deposits in California, the largest market in the
region, and have an even wider lead if one fo-
cuses on the market for time deposits alone.
Savings institutions have made significant inroads
in other western states as well. In Arizona and
Washington, thrifts account for around 40 per-
cent of the deposit market.
The banking industry appears to have made a
strategic decision to price consumer deposits
conservatively to reduce the cost of funds. Such
a pricing strategy can improve earnings in the
short run, especially during a period when de-
posits are plentiful. However, the loss of market
share may prove detrimental in the long run.
More challenges ahead
The banking industry in the West has returned to
profitability, and barring any shocks, should con-
tinue to improve in the coming quarters..As the
industry recovers, though, it faces increasing
challenges, not only in rebuilding asset quality
and earnings, but in retaining leadership in com-
mercial and consumer lending, and in remaining
competitive. inthe battle for consumers' deposit
dollars.
Gary C. ZimmermanREGIONAL BANKING DATA
(Not Seasonally Adjusted, Preliminary Data)
ALL COMMERCIAL BANKS (MARCH 31, 1988)
DISTRICT ALASKA ARIZONA CALIF HAWAII IDAHO NEVADA OREGON UTAH WASH
TOTAL 4,693 27,230 280,779 12,757 6,973 10,414 18,759
FOREIGN 43,133 1 N/A 40,590 883 N/A N/A 0 93 1,566
DOMESTIC 361,552 4,692 27,230 240,189 11,875 6,973 10,414 18,759 10,404 31,016
LOANS TOTAL 279,272 2,563 19,817 195,384 7,234 4,431 7,622 11,751 7,029 23,442
FOREIGN 34,883 1 N/A 33,058 612 N/A N/A 64 N/A 1,147
DOMESTIC 244,389 2,562 19,817 162,326 6,622 4,431 7,622 11,687 7,029 22,294
REAL ESTATE 99,620 1,098 8,687 69,141 3,237 1,102 1,596 3,645 2,766 8,349
COMMERCIAL 71,216 833 5,009 48,442 1,795 1,315 1,299 4,580 1,711 6,231
CONSUMER 49,952 187 4,052 29,713 1,133 1,229 4,428 2,365 1,884 4,960
AGRICULTURE 4,525 7 542 2,226 18 491 18 310 106 806
INTERNATIONAL 246 N/A 104 135 0 N/A N/A N/A 2 4
SECURITIES TOTAL 41,112 1,193 3,682 22,524 2,416 1,565 1,551 3,243 1,564 3,375
U.S.T.S. 14,111 777 1,590 6,655 979 703 589 950 505 1,362
SECONDARY MKT. 14,278 202 423 10,430 479 352 443 714 446 790
OTHER SEC. 12,723 214 1,670 5,439 957 510 519 1,579 613 1,223
LIABILITIES TOTAL 382,066 4,232 25,517 266,313 11,942 6,472 9,772 17,553 9,745 30,520
DOMESTIC 338,934 4,232 25,517 225,723 11,059 6,472 9,772 17,553 9,652 28,954
DEPOSITS TOTAL 326,540 3,707 23,513 226,423 11,087 5,675 5,925 14,676 8,409 27,125
FOREIGN 34,544 1 N/A 32,507 576 N/A N/A N/A 93 1,367
DOMESTIC 291,996 3,707 23,513 193,916 10,510 5,675 5,925 14,676 8,316 25,758
TRANSACTION 71,994 827 4,685 51,759 1,865 869 1,766 2,863 1,546 5,812
NONTRANS. 220,003 2,879 18,828 142,157 8,645 4,805 4,159 11,813 6,770 19,947
OTHER BORROWINGS 32,150 466 1,588 20,420 267 716 3,463 2,106 880 2,244
TOTAL CAPITAL 38,166 622 2,185 27,489 941 596 970 1,432 1,198 2,733
LOAN LOSS RESERVE 8,891 155 402 7,192 110 85 174 187 132 453
STANDBY LETTERS OF CREDIT 1,390 15 245 766 23 84 148 24 51 35
LOAN COMMITTMENTS 13,271 83 975 8,092 560 764 1,332 348 428 688
LOANS SOLD 626 19 30 420 23 22 32 33 10 37
LOAN LOSS RESERVE 3.18 6.05 2.03 3.68 1.52 2.29 1.88 1.93
CHARGEOFFS TOTAL 0.76 0.95 0.86 0.66 0.22 0.47 1.85 0.94 1.14 1.07
REAL ESTATE 0.17 1.26 0.39 0.09 0.07 0.14 0.24 0.31 0.24 0.33
COMMERCIAL 0.93 1.14 0.92 0.83 0.42 0.58 1.05 1.06 2.01 1.85
CONSUMER 6.24 1.05 33.8 9.45 1.65 0;51 2;69 7.80 1.67 9:90
AGRICULTURE 0.03 N/A 1.48 -.79 0.52 1.33 N/A 0.22 0.56 0,76
NONPERFORM. TOTAL 6.32 22.5 7.97 6.59 2.07 3.05 4.48 3.70 4.52 5.11+
REAL ESTATE 6.15 36.3 12.2 5.20 2.02 3.64 6.26 6.53 6.83 5.05
COMMERCIAL 6.14 18.6 6.40 6.52 2.06 3;26 5.47 2.58 3.78 5,49
CONSUMER 9.56 9.05 38 14.5 10.3· 1.83 3.86 10.3 4.83 13.8
AGRICULTURE 17.2 4.56 13 24.1 2.82 5.65 0.60 10.2 4.54 8.70
843
INTEREST 85 585 260 154 294 384 236 706
FEES & CHARGES 485 5 35 329 a 10 12 24 14 48
EXPENSES TOTAL 9,075 107 632 6,286 251 150 272 5i7 249 751
INTEREST 4,510 54 326 3,101 138 83 121 195 126 365
SALARIES 1,921 23 138 1,350 57 26 41 80 40 165
LOAN LOSS PROV. 539 7 43 361 7 6 34 16 23 43
OTHER 2,104 23 125 1,474 49 34 76 85 60 177
INCOME BEFORE TAXES 1,204 -5 42 861 45 22 64 63 20 92
TAXES 399 1 7 305 14 7 19 18 4 24
NET INCOME 850 -5 40 589 32 16 44 45 16 74
ROA (%) 0.84 -.46 0.58 0.84 0.99 0.93 1.69 0.96 0.60 0.91
ROE (%) 8.91 -3.4 7.27 8.57 13.4 10.8 18.2 12.6 5.22 10.8
NET INTEREST MARGIN (%) 4.78 3.70 4.66 4.68 4.46 1+.69 7.60 4.95 4.96 5;05
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank Of
San Francisco, or Of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Barbara Bennett) or to the author.... Free copies'ofFederal Reserve
publications can beobtained from the Public Information Department; Federal Reserve Bankof San Francisco, P.O;Box 7702,
San Francisco 94120. Phone (415) 974-2246.uo~6U!4S0m 4o~n U060JO
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PERCENT OF TOTAL DEPOSITS, FOR MAY 1988, BY
DISTRICT ALASKA ARIZONA CALIF HAWAII IDAHO NEVADA OREGON UTAH WASH
DEPOSIT TYPE CB SL CU CB SL CU CB SL CU CB SL CU CB SL CU CB SL CU CB SL CU CB SL CU CB SL CU CB SL CU
-----,...-_...._---------------------------------------------------------------------------------------------------------------------
TOTAL DEPOSITS 46 50 4 71 920 5343 4 42 55 3 65 29 6 86 11 4 6333 4 65 30 5 5734 9 5340 7
DEMAND 94 4 2 98 1 1 92 4 4 93 4 2 93 2 4 99 1 0 98 0 2 95 2 3 91 5 3 95 3 1
NOW 60 34 6 48 15 37 62 29 8 5639 5 71 24 5 87 7 6 80 17 4 77 19 5 6724 9 64 24 12
SAVINGS & MMDA 5735 9 52 939 64 29 7 55 38 7 60 30 11 86 9 5 6529 6 6922 9 60 20 21 52 33 15
SMALL TIME 2672 2 7417 9 3959 2 2078 2 40 57 3 81 17 2 35 63 3 4750 3 41 55 4 3958 3
LARGE TIME 3366 1 93 6 2 44 56 1 2871 1 81 17 2 85 11 4 5444 2 6334 2 64 34 2 5049 1
CB = COMMERCIAL BANKS, SL = SAVINGS & LOANS AND MUTUAL SAVINGS BANKS, CU = CREDIT UNIONS MAY NOT SUM TO 100% DUE TO ROUNDING
TYPE OF ACCOUNT OR LOAN DATE US ARIZONA CALIF IDAHO OREGON UTAH WASH
-----------------------------------------------------------------------------------------------------------------------------
MONEY MARKET DEPOSIT ACCOUNTS MAR88 5.34 5.09 5.08 5.09 5.06 5.05 4.89 5.28 5.04
APR88 5.35 5.09 5.08 5.09 5.06 5.05 4.85 5.34 5.05
MAY88 5.40 5.12 5.08 5.14 5.14 5.06 4.82 5.31 5.09
6-MONTH CERTIF ICATES MAR88 6.50 6.06 6.20 6.09 5.67 5.75 6.05 6.04 6.23
APR88 6.55 6.06 6.08 6.07 5.67 5.94 6.13 6.18 6.17
MAY88 6.71 6.20 6.08 6.15 6.04 6.36 6.41 6.47 6.23
2-1/2 YEAR CERTIFICATES MAR88 7.57 7.19 7.91 7.07 7.04 7.25 7.25 7.05 7.30
APR88 7.58 7.20 7.72 7.08 7.10 7.39 7.45 7.07 7.26
MAY88 7.72 7.30 7.49 7.19 7.45 7.55 7.56 7.20 7.28
COMMERCIAL LOANS, SHORT-TERM MAY88 8.49 8.63 9.31 8.67 9.18 N/A 8.73 N/A 7.74
AVERAGE MATURITY (DAYS) 49 98 246 105 116 N/A 78 N/A 14
COMMERCIAL LOANS,LONG-TERM MAY88 9.05 9.% 10.08 9.88 9.46 N/A 11.15 N/A 9.97
AVERAGE MATURITY (MONTHS) 49 51 33 53 34 N/A 37 N/A 80
CONSTRUCTION LOANS MAY88 9.29 9.70 10.04 9.65 9.83 N/A 8.32 N/A N/A
AVERAGE MATURITY (MONTHS) 11 6 N/A 6 6 N/A 7 N/A N/A
LOANS TO FARMERS MAY88 10.68 9.26 10.70 9.23 7.64 N/A 10.25 N/A 9.60
AVERAGE MATURITY (MONTHS) 13 6 8 5 2 N/A 11 N/A 9
CONSUMER LOANS, AUTOMOBILE MAY88 10.55 11.08 N/A 11.21 N/A N/A 9.74 N/A 10.78
CONSUMER LOANS, PERSONAL MAY88 13.49 15.33 N/A 16.84 N/A N/A 12.32 N/A 16.25
CONSUMER LOANS, CREDIT CARDS MAY88 17.78 18.02 N/A 19.12 N/A N/A 19.24 N/A 15.75
SOURCES: SURVEY OF TERMS OF BANK LENDING & TERMS OF CONSUMER CREDIT; MOST COMMON INTEREST RATES ON SELECTED ACCOUNTS
J

Western banking recovery

http://www.frbsf.org/publications/economics/letter/1988/el88-30.pdf

Western banking recovery

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