Advisor sees threat to Calif. recovery in rising rates.

Donald K. Crowley started an investment and consulting firm in California for community banks a little over a year ago, at the nadir of that state's worst community banking slump since the Depression.

Teaming with Robert H. Smith, the former chief executive of Security Pacific Corp., he helped found Smith & Crowley Inc., a San Francisco-based boutique to advise independent banks on mergers and perhaps to put together deals of its own.

Mr. Crowley, 54, spent 17 years following West Coast banks as a manager for Keefe, Bruyette & Woods Inc. When Keefe closed its San Francisco office, he hung out his own shingle.

Despite his reliance on the industry's health, Mr. Crowley hasn't sugar-coated his descriptions of his potential clientele. A former analyst, he puts together quarterly analyses of the independent bank industry in California, a universe of about 360 banks that is shrinking fast through consolidation and failures.

Last year appeared to be the worst for independent banks in the state, and Mr. Crowley was not alone in predicting early in 1994 that a gradual but discernible improvement in chargeoffs and earnings was in the offing.

Now, he's not so sure.

Mr. Crowley talked about his outlook for California, the nation's largest market for independent banks, and how the region 's independents are changing - structurally and permanently.

Q.: Independent banks earned only a 0.15% return on assets last year, with Southern California independents having a negative 0.09% ROA. What's your read on independent bank performance in the second half of this year in California?

CROWLEY: I would have to say I'm less optimistic than I was earlier in year.

The run-up in rates, I think, is cooling things down a bit in terms of loan growth and in terms of credits. My worry is that, if you had credits on the edge of going bad, a higher interest rate might be enough to put them over the edge.

Q.: So what's bottom line?

CROWLEY: This year is going to look a lot like last year. Overall, community banks will be profitable but not terribly profitable. Their margins will be under pressure. It will continue to be the case that new problem credits will surface.

Meanwhile, your chargeoffs last year were in the neighborhood of 150 basis points. It's hard to see any improvements in that area this year.

Q: There have been 23 community bank failures in California since 1993 began. Are there any indications that regulatory pressure has eased on troubled institutions?

CROWLEY: That's the one other factor besides interest rates that worries us. We have a feeling that the regulatory agencies are stepping up the pressure on institutions that are at the tipping point. By and large, [the regulators] feel like it's rime to clean up the issues facing troubled banks now rather than later.

We don't have any concrete evidence of that, but it's just what we're seeing and hearing from bankers: close encounters, if you will.

Q: How have independent banks structurally changed in response to the problems with the economy and the regulatory environment?

CROWLEY: The banks have done very well with personnel expenses, which traditionally have been very high here. But, with all the problem credits and regulatory issues they are facing, their non-personnel expenses have gone up pretty substantially. Those expenses may flatten out this year, but won't get much better until next year.

Q: Is the reduction in staff permanent?

CROWLEY: I would think so. Consolidation of large banks and pricing pressures by large banks in terms of their lending rates - essentially they are trying to buy business - means that smaller banks are going to have to realize some way to keep those expenses they can control under control.

Q: How will they do that?

CROWLEY: Strategic combinations, mergers between two $250 million banks creating a $500 million bank, will be the preferred method of keeping those expenses down.

Q: How many banks will be left when things get back to normal?

CROWLEY: If you figure that it will take another two years until things get back to more normal for California, I can see 15% per year reduction in franchises. The independents that we track closely number around 365. After it's all said and done, I expect that number to be in the high 200s.

Donald Crowley's Prognosis for Community Banks in California

Earnings:

No real improvement this year from dismal 0.15% performance in 1993.

Regulators:

Regulatory agencies continue to be hard on marginal banks, though there are fewer of them.

Expenses:

Permanent reductions in personnel from cutbacks and mergers, Nonpersonnel expenses, especially problem asset expenses, will remain high through yearend.

Community Bank Universe:

The number of independent banks will shrink about 15% a year for next two years. dwindling from 365 to about 250.

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