Slack economy in California weakens banks.

SAN FRANCISCO -- California's banking woes deepened in the third quarter, with earnings reports providing scant hope for a quick turnaround.

The Golden State's economy, especially in the southern part of the state, continued downhill. And commercial real estate values were still falling.

As a result, problem assets for California banks rose again, forcing many institutions to keep adding aggressively to loan-loss reserves. The heavy provisions and the drag of non-performing assets depressed earnings at institutions throughout the state. It out the state. It didn't help that loan volume fell at many banks.

But the picture for the region as a whole was brighter, thanks to soaring bank profits in Arizona, the Rocky Mountain States, and the Pacific Northwest.

Despite California's problems, western regional banks recorded a healthy average return on assets of 1.02% for the quarter, according to the brokerage firm Keefe, Bruyette & Woods. That's just a shade under the nationwide composite return on asset of 1.05% for banks tracked by the firm.

Western banks were bolstered by the widest gap in the country between interest income and the cost of funds. The average net interest margin for western banks was 4.86% in the third quarter, compared to 4.67% for banks nationwide, Keefe said.

Rates Keep Many Afloat

Analysts say California banks would be in more dire straits were it not for low interest ratess.

"The thing keeping California banks afloat is low interest rates," said Campbell K. Chaney, an analysts with Sutro & Co., San Francisco. "You would see a lot more banks failing if interest rates were where they were in the mid 1980s."

Low rates are benefiting California banks in two ways, Mr. Chaney noted. Banks can keep margins high by pushing down rates paid on deposits, while the cost of carrying problem loans and foreclosed property is reduced.

Indeed, some banks are able to earn a positive yield on foreclosed property because rental income exceeds carrying costs.

How much longer will California banks suffer?

The UCLA Business Forecasting Project predicts the state's recession will last until at least late 1993, with job growth not resuming until the following year.

The forecasters say that another round of defense industry layoffs, government cutbanks and, ominously, further declines in home prices are likely to prolong depressed conditions.

Other are even more bearish. Prudential Securities' analyst George M. Salem was one of the first to sound the alarm on California, and he remains one of the most gloomy about prospects for the state's banks.

"It's just the beginning of the pain," said Mr. Salem. "California is becoming the Texas of the 1990s."

The third quarter in California provided plenty of fuel for the pessimists.

Among the state's major banks, BankAmerica Corp. and First Interstate Bancorp had increases in earnings in the quarter. But Wells Fargo & Co.'s net income plunged to $24 million, down 72% from the level in the 1991 period.

A Mixed Picture

Meanwhile, credit problems caused quarterly losses at independents such as City National Corp., Beverly Hills; Silicon Valley Bancshares, San Jose; and Bank of San Francisco Co. and Pacific Bank, San Francisco.

City National's loss however, was $2.3 million, down dramatically from a loss of $62.6 million in the second quarter. The bank is moving rapidly to shrink the balances sheet and trim expenses.

Sumitomo Bank of California reported earnings of $8.6 million, down 32% from earnings a year ago. The quarter's results reflected a $16 million loan-loss provision.

Union Bank, 77% owned by Bank of Tokyo, earned $17.4 million. Net income, representing a 0.71% return on assets, was up sharply from the level in the third quarter of 1991. The gain stemmed form a smaller addition to loan-loss reserves to $33 million, from $90 million a year ago.

Nevertheles, Union's problems loans and foreclosed property continued to rise. Nonperforming assets totaled $851 million at the end of September, up 7.9% for the quarter and 79.9% from September 1991. As a result, reserve coverage dipped to 50.4% of nonperforming assets, from 86% a year ago.

Resisting the Drag

Some banks, especially those with little commercial real estate exposure, managed to buck the trend and register strong profits. Westamerica Bancorp., San Rafael, for the example, earned a record $3.7 million, equal to a return on assets of 1.06%

Outside California, many banks took advantage of hefty margins and improve credit quality to set profit records.

Among the banks achieving new earnings highs were First Security Corp., Salt Lake City, and West One Bancorp, Boise, Idaho.

Despite the weak national economy, the Rocky Mountain region has recorded healthy growth. Both First Security and West One have been able to build loan volume at a pace far above the national average, while trimming credit problems.

Puget Sound Bancorp, Tacoma, Wash., and Valley National Corp., Phoenix, also reported strong results. The two are set to be acquired by KeyCorp, Albany, N.Y., and Banc One Corp., Columbus, Ohio, respectively.

Valley's net income of $29.9 million set a company record, reflecting the bank's success in moving problem assets off its books. Valley's nonperforming assets dropped to $217.1 million at the end of September, down 45.3% from a year ago and 6.5% from the end of the second quarter.

A Weak Spot in Oregon

U.S. Bancorp in Portland, Ore., was a major exception to the brighter western profit picture outside California. The company's earnings fell 19.1%, to $41.6 million, partly because of the sale of $70 million in nonperforming credits to leveraged transactions.

U.S. Bancorp said the loan sales were part of a plan to get rid of problem assets outside the bank's five-state service area. It said the sales reduced nonperforming assets 21% to $336 million.

Elsewhere, Hawaii's two major banking companies continued the recent trend toward slower gains in earnings as the Aloha State's economy cools off.

Bancorp Hawaii Inc. and First Hawaiian Inc. both reported profits up from those a year ago, but down from level in the second quarter of 1992. [TABULAR DATA OMITTED]

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