Banks and banking - California ; Federal Reserve District, 12th ; Bank profits

Gary C. Zimmerman

English

Research Papers in Economics

FRBSF WEEKLY LETTER
January 26, 1990
Small California Banks Hold Their Own
The 1980s were a tumultuous decade for the
nation's small banks. They faced increased
competition from larger banks, thrifts, and money
market funds. Deregulation unleashed new forms
of competition, including both intrastate and
interstate interest rate competition in markets
that formerly had been protected by regulatory
barriers. Many small banks also were unable to
diversify regional market risks. As a result of
these difficulties, there has been considerable
consolidation within the banking system. Over
the decade, the number of banks nationwide has
fallen from about 15,000 to below 13,000. Most
ofthis decline took place after 1986.
In contrast, the number of banks in California
rose dramatically over the decade, increasing
from under 250 in 1980 to 435 in 1989. New
bank formations early in the decade accounted
for the increase. Since 1986, net new bank for-
mation in the state has dropped off, but mergers
have reduced the number ofbanks only slightly.
This Letter examines some of the factors that
influence the competitiveness of small banks in
California. The ways in which small banks have
been able to compete in a state dominated by
large branch banks may have implications for
the competitiveness of small banks nationwide.
The California market
California has a large banking market, account-
ing for about ten percent of u.s. deposits. State-
wide branching has allowed several banks in the
state to build large branch networks that cover
the state. The top ten banks in the state control
more than 75 percent of the state's deposits.
At the beginning of 1989 California had 290
"small" banks, defined as banks with less than
$100 million in assets. These banks accounted for
two-thirds of the state's banks and five percent of
the state's $276 billion in domestic banking
assets.
Holding their own
Over the decade of the eighties, small banks
in California appear to have held their own in
a number of ways. First, although the top ten
banks in the state suffered a ten percentage point
decline in market share during the decade, the
state's smallest banks suffered no such decline.
In fact, when we take into account growth in the
assets of the many banks that outgrew the "$100
million and under" category during the decade,
we find that the state's smaller banks actually
increased their market share over the period.
Small California banks also seem to be holding
their own with respect to profitability. After suf-
fering sagging fortunes through the middle of the
decade, small banks now are enjoying returns
on assets (ROAs) roughly comparable to those of
their larger rivals. As 1989 data come in, we are
likely to find that as a group, small banks' ROA
will be above one percent. Improved asset qual-
ity and wider net interest margins, compared
with earlier in the decade, have led to this
improvement in earnings.
Competitive strategies
To a large extent, small banks in California have
fared well because the state's economy has en-
joyed considerable prosperity throughout the
eighties. In contrast, smaller banks in some parts
of the country have had to cope with stagnant
local economies during portions ofthe decade.
Nonetheless, small California banks still must
compete against some of the largest retail banks
in the country. To do so, they have adopted a
variety of apparently successful competitive
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
strategies. For example, many small banks have
taken advantage of their size to focus on spe-
cialized banking services or limited geographic
markets. These "boutique" banks may focus on a
variety of banking activities, such as local retail
banking, small business-oriented financing, real
estate lending, automobile financing, or con-
sumer lending. A few specialize in agricultural
lending and quite a few more serve the banking
needs of a particular ethnic community.
In this way, the state's small banks have been
able to differentiate their products from the
products offered on a statewide basis by the
larger institutions. Customers often prefer the
specialized service, local convenience, and/or
rapid turnaround on loan approvals and funding
that small local banks can offer. And unlike the
large banks, which tend to set interest rates and
price most services on a statewide basis, small
banks tend to be more responsive to local market
conditions when setting rates and fees.
The ability of small California banks to differ-
entiate their products is reflected in wider net
interest margins (NIM), the difference between
their average yield on assets and their cost of
funds. Small banks in the state reported much
wider NIMs than their larger competitors. As
a group, banks under $100 million in assets
reported a NIM of 600 basis points over the first
three quarters of 1989, versus only 435 for all
banks in the state. And as noted earlier, increas-
ing margins since 1987 have been a factor in the
improved fortunes of these small banks.
Small California banks also have taken advantage
of the growth of shared automated teller machine
networks (ATMs) to compete with their larger
rivals. Shared ATM networks enable the state's
small banks to provide services on a local, state-
wide, and even national basis.
Small banks have taken advantage of other
financial market innovations to overcome some
of the limitations of their size. Many of the state's
small banks are active participants in the sec-
ondary mortgage market. By selling some of their
mortgage loans and taking advantage of govern-
ment credit enhancement, small banks can re-
duce the risks associated with lending in only
one local market. Also, many small banks pur-
chase mortgage-backed securities to make their
portfolios more liquid and more geographically-
diversified. These strategies are important since
small banks in California currently hold more
than a third of their assets in mortgage loans.
Their size also has allowed small banks to avoid
some of the pitfalls faced by their larger competi-
tors. For example, they have not been exposed to
the problems associated with troubled lesser
developed country loans that have plagued the
nation's major banks.
Disadvantages
Of course, small California banks also face
disadvantages on account of their size. Limited
geographic markets still constrain their ability
to diversify asset quality risks, making them more
dependent than larger banks on the health of
local markets. For many small banks this was a
serious problem in the middle of the decade,
when many were hit with problems in their
commercial and credit card loan portfolios.
Moreover, a marketing strategy of providing
"boutique" services often is labor intensive,
and may drive up costs. In 1989, small banks in
the state had an average of 0.73 employees per
million dollars of assets, while banks with over
$15 billion in assets had only 0.46 employees
per million dollars. These more labor-intensive
operations translate into higher costs, on a per
dollar of assets basis, for salaries and benefits
and for net overhead expenses (defined as non-
interest income less non-interest expenses).
In the future
Small California banks have taken advantage
of local market niches to prosper in markets
dominated by much larger banks. Moreover,
innovations such as ATMs and mortgage-backed
securities have enabled them to overcome many
of the disadvantages associated with small size.
Thus, the lesson of California's small banks may
be that while consolidation of the banking sys-
tem through inter- and intrastate mergers and
acquisitions will continue and could significantly
further reduce the number of banks, small banks
will continue to remain competitive providers of
banking services.
Gary C. Zimmerman
EconomistREGIONAL BANKING DATA
SEPTEMBER 30, 1989
(Not SeasonaLLy Adjusted, PreL;m;nary Data)
DISTRICT ALASKA ARIZONA CALIF. HAWAII IDAHO NEVADA OREGON UTAH WASH.
-------- -------- -------- -------- --------
AND LIABILITIES
ASSETS TOTAL 452,404 4,427 26,524 315,688 14,431 7,772 14,982 21,419 10,823 36,340
FOREIGN 41,668 2 N/A 39,257 1,713 N/A N/A 20 98 578
DOMESTIC 410,737 4,425 26,524 276,431 12,717 7,772 14,982 21,399 10,725 35,762
I.OANS TOTAL 319,295 1,800 19,075 224,521 8,599 5,186 11,740 14,226 7,117 27,033
FOREIGN 31,814 0 N/A 30,680 916 N/A N/A N/A N/A 218
DOMESTIC 2B7,481 1,799 19,075 193;842 7,683 5,186 11,740 14,226 7,117 26,814
REAL ESTATE ...,0 ~Ol"l 667 8,084 94,634 3,586 1,348 2,004 4,573 2,896 10,788 I~Q,...UU
COMMERCIAL 75,521 695 4,411 51,375 2,259 1,363 1,549 5,044 1,764 7,060
CONSUMER 57,284 234 4,644 30,927 1,252 1,422 7,865 3,243 1,724 5,973
AGRICULTURE 5,263 7 487 2,531 30 684 21 351 130 1,023
INTERNATIONAL 117 N/A 10 105 0 N/A N/A N/A 2 0
SECURITIES TOTAL 43,402 1,744 3,313 23,066 2,780 1,641 1,885 3,639 1,945 3,390
U.S.T.S. 12,752 1,226 1,207 6,006 832 429 570 980 350 1,152
SECONDARY MARKET 17,m 186 672 11,553 952 710 475 1,185 993 1,051
OTHER SEC. 12,873 332 1,433 5,507 996 501 840 1,474 602 1,188
LIABILITIES TOTAL 424,824 4,001 25,133 297,008 13,541 7,219 13,977 19,970 10,096 33,878
DOMESTIC 383,157 4,000 25,133 257,751 11,828 7,219 13,977 19,950 9,999 33,300
DEPOSITS TOTAL 353,300 3,492 22,431 246,890 12,808 6,256 7,049 16,140 8,701 29,533
FOREIGN 33,554 1 N/A 31,389 1,519 N/A N/A 20 98 526
DOMESTIC 319,746 3,491 22,431 215,501 11,289 6,256 7,049 16,120 8,604 29,007
DEMAND 79,460 1,032 4,359 57,532 2,090 1,021 1,921 3,287 1,648 6,569
TIME AND SAVINGS 240,286 2,459 18,072 157,969 9,198 5,235 5,129 12,832 6,955 22,437
OTHER BORROWINGS 47,413 459 2,272 29,873 246 878 6,314 3,037 1,182 3,152
EQUITY CAPITAL 27,579 425 1,391 18,679 890 553 1,004 1,448 727 2,462
LOAN LOSS RESERVE 8,218 46 689 6,335 136 91 188 196 137 399
STANDBY LETTERS OF CREDIT 33,316 23 629 29,343 438 124 168 576 286 1,728
LOAN COMMITMENTS 140,857 272 4,616 113,302 3,B19 1,090 1,583 4,788 1,682 9,705
LOANS SOLD 114,882 14 524 113,701 100 61 74 171 19 218
LOAN LOSS RESERVE (ALL BANKS) 2.57 2.54 3.61 2.82 1.58 1.76 1.61 1.38 1.93 1.48
NET CHARGEOFFS, TOTAL 0.97 0.87 4.74 0.73 0.06 0.30 2.15 0.56 0.88 0.44
REAL ESTATE 0.61 1.11 7.54 0.06 0.01 0.04 0.78 0.45 0.55 0.40
COMMERCIAL 0.46 0.87 4.56 0.26 -.10 0.17 0.61 0.46 1.31 0.00
CONSUMER 1.82 0.36 1.84 1.93 0.35 0.75 2.81 1.03 1.29 1.15
AGRICULTURE 0.16 N/A 1.58 -.36 -.45 0.27 -.01 0.41 0.10 0.70
PAST DUE & NON-ACCRUAL, TOTAL 5.02 8.95 10.50 5.12 1.10 2.06 5.42 2.46 3.45 3.28
REAL ESTATE 4.90 13.60 17.60 4.01 0.62 2.77 4.15 4.13 5.02 4.62
COMMERCIAL 5.73 8.10 8.00 6.56 1.35 2.33 2.89 1.56 2.62 2.53
CONSUMER 3.02 1.90 2.35 2.66 2.23 1.78 6.35 1.88 2.97 1.98
AGRICULTURE 8.17 N/A 11:90 11.00 8.88 1.97 0.50 1.99 2.80 4.51
INCOME TOTAL 38,495 318 2,225 27,090 1,070 630 1,636 1,652 878 2,995
INTEREST 32,342 269 1,928 22,451 940 567 1,440 1,433 775 2,540
FEES & CHARGES 1,541 13 112 1,033 26 30 37 89 45 155
EXPENSES TOTAL 33,528 278 2,999 22,832 880 536 1,263 1,388 806 2,546
INTEREST 17,656 150 1,123 12,346 533 325 637 772 449 1,321
SALARIES 6,067 55 421 4,285 173 85 136 273 118 523
LOAN LOSS PROVISION 2,639 19 939 1,225 24 16 149 83 58 126
OTHER 7,166 54 516 4,976 151 110 341 260 182 576
INCOME BEFORE TAXES 4,930 40 -774 4,226 189 93 373 263 71 449
TAXES 1,780 6 -311 1,609 68 30 142 80 19 137
NET INCOME 3,397 35 -463 2,813 122 64 256 183 54 332
ROA (X) 1.02 1.06 -2.30 1.21 1.17 1.10 2.37 1.18 0.68 1.25
ROE (X) 16.40 10.90 -44.00 20.10 18.20 15.40 34.00 16.90 9.99 18.00
NET INTEREST MARGIN (X) 4.41 3.59 3.97 4.35 3.91 4.18 7.41 4.25 4.10 4.60
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 of Federal Reserve
publications can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702,
San Francisco 94120. Phone (415) 974-2246.OUt6 V:> 'OJSpUl!J:I Ul!S
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PERCENT OF TOTAL DEPOSITS, FOR NOVEMBER- 1989, BY REGION
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
DEMAND
NOW
SAVINGS & MMDA
SMALL TIME
LARGE TIME
4748 4
93 4 3
62 31 7
5933 8
2869 3
3762 1
70 921
98 1 1
51 14 35
51 842
6521 15
92 5 2
5541 4
93 3 3
71 20 9
71 20 9
4354 3
3266 2
43 54 4
93 4 3
5736 6
5637 7
21 76 3
33 66 1
6530 5
93 4 3
71 26 3
622811
40 57 3
1820 2
86 10 3
93- 1 6
88 8 4
88 8 4
83 15 2
86 10 3
6730 3
99 1 0
7816 7
7619 5
41 57 2
6337 0
66 28 5
95 2 3
7617 6
67 23 10
5244 4
7028 2
67 22 10
92 5 4
74 15 11
68 11 21
55 38 7
7422 4
5735 7
94 4 i
66 22 12
59 26 15
-45 51 5
4950 1
CB =COMMERCIAL BANKS; SL =SAVINGS & LOANS AND SAVINGS BANKS; CU =CREDIT UNIONS; MAY NOT SUM TO 100% DUE TO ROUNDING
TYPE OF ACCOUNT OR LOAN DATE US DISTRICT ARIZ CALIF HAWAII IDAHO OREGON UTAH WASH
MONEY MARKET DEPOSIT ACCOUNTS
(PERSONAL)
92 TO 182 DAYS
CERTIFICATES
2-112 YEARS AND OVER
CERTIFICATES
COMMERCIAL, SHORT- TERM*
COMMERCIAL, LONG-TERH*
LOANS TO FARMERS*
CONSUMER, AUTOM08ILE
CONSUMER, PERSONAL
CONSUMER, CREDIT CARDS
SEP89
OCTB9
NOV89
SEP89
OCT89
NOV89
SEP89
OCT89
NOV89
AVE. RATE
AVE. MAT. (DAYS)
AVE. RATE
AVE. MAT. (MONTHS)
AVE. RATE
AVE. MAT. (MONTHS)
AVE. RATE
AVE. RATE
AVE. RATE
6.55
6.48
6.47
8.09
8.01
7.B9
8.10
8.03
7.91
10.50
53
11.36
43
12.16
8
11.94
15.42
18.07
6.28
6.30
6.28
7.73
7.66
7.56
7.95
7.95
7.81
10.43
78
11.42
30
10.97
6
12.31
16.19
18.25
5.95
5.98
6.OB
7.58
7.58
7.45
7.B3
7.83
7.74
10.29
110
11.74
34
11.36
6
NIA
NIA
NIA
6.58
6.49
6.51
8.09
8.07
7.94
8.22
8.21
8.00
10.20
41
11.54
22
10.68
5
12.50
19.73
19.48
6.33
6.34
6.16
7.15
7.15
7.15
8.07
B.OB
7.95
10.70
96
11.25
26
10.25
NIA
NIA
NIA
NIA
6.12
6.12
6.09
8.05
7.80
7.70
8.09
8.01
7.82
12.66
160
NIA
NIA
11.51
4
13.50
13.50
NIA
5.85
6.00
6.09
8.04
7.87
7.87
7.73
7.68
7.73
10.63
233
10.51
77
11.77
9
11.40
14.37
19.24
6.46
6.43
6.45
7.82
7.82
7.77
7.98
7.80
7.82
12.OB
109
11.41
24
12.84
25
11.95
16.96
20.27
5.67
5.77
5.78
7.17
7.27
7.06
7.80
7.83
7.80
11.09
179
10.87
60
11.87
10
11.71
14.86
15.75
SOURCES: SURVEY OF TERMS OF 8ANK LENDING AND TERMS OF CONSUMER CREDIT; MOST COMMON INTEREST RATES ON SELECTED ACCOUNTS
* U.S. DATA ARE COMPOUNDED ANNUAL RATES, DISTRICT AND STATE DATA ARE SIMPLE ANNUAL RATES.
NOTE: CONSTRUCTION LOAN DATA ARE NO LONGER COLLECTED.

Small California banks hold their own

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Small California banks hold their own

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