PHOENIX -- All of a sudden, things are looking up in Arizona.

In the late 1980s, a devastating real estate downturn brought the state's banks to their knees. But now, Arizona banking is on an upswing, and investors are gambling that the time is ripe to buy in.

Banc One Corp.'s savvy chief executive, John B. McCoy, surprised the industry in April by agreeing to pay a hefty 2.2 times book value of Valley National Corp., the state's last big independent bank company. In light of Mr. McCoy's reputation as a shrewd acquirer, the deal was seen as a ringing vote of confidence in Arizona.

Then a week later, a group headed by former thrift executive Anthony Frank struck a deal to acquire 49 branches.

And more deals are in the offing. Several syndicates are shopping for opportunities. A likely target: Chase Manhattan Corp.'s $600 million-asset subsidiary, which is said to be available.

"This is a pretty good time to invest," says former Valley National chief executive James P. Simmons, who is leading a group on the prowl for a business-oriented community bank.

Patient Is Recovering

The pickup in buyer interest provides firm evidence that a recovery is slowly taking root. The state's battered banks "have put the bleeding behind them," says Richard J. Lehmann, chairman and chief executive of Valley National.

Arizona's banks turned an important corner in 1991, recording modest profit for the first time in three years. And the recovery is gathering steam; Earnings at many institutions improved still further in the first quarter this year.

Meanwhile, the real estate collapse has dramatic changed Arizona's banking landscape: All of the state's old-line banks have disappeared.

Of the top five banks five years ago, only First Interstate Bank of Arizona remains under the same ownership. But even its previous management was purged.

The new top five, after pending deals, will be owned, respectively, by Ohio-based Banc One, San Francisco-based BanKAmerica Corp., Los Angeles-based First Interstate Bancorp, New York-based Citicorp, and Mr. Frank's investor group, which is acquiring branches that BankAmerica must divest because of its acquisition of Security Pacific Bank Arizona.

Mute the Trumpets

Yet while stirrings of life are evident, it's still too early to trumpet a return to prosperity.

Loan volume and revenues remain feeble. The reasons: A still-troubled real estate market and the weak national economy are holding back the state's recovery. At the same time, shell-shocked lenders have cut the flow of credit to a trickle. Business credit have dropped 58% in five years.

Income gains so far have stemmed mostly from lower loan-loss provisions, cost-cutting, securities trading profits, and tax benefits.

"Banks here can't begin a real upswing until they make loans," says Gary A. Dorris, a Scottsdale, Ariz., banking consultant.

Tale of 2 Economies

Truth be told, Arizona's economy was never as awful as the performance of its banks suggested. Unlike Texas, where an energy slump brought the entire economy down, business experienced relatively minor weakness outside of commercial real estate.

"We really had two economies in the state: the real estate economy and the non-real-estate economy," notes John T. Wertheim, former chief executive of Caliber Bank, which was included in the Frank group's acquisition package. "Even in the worst times, we had better-than-average growth."

But the real estate collapse was devastating.

When a feverish land boom crashed in the late 1980s, Arizona banks plunged headlong into one the deepest slumps the banking industry has seen since the Great Depression.

Bad real estate loans - many made on raw desert land -- virtually wiped out the state's thrifts. Many banks also went belly up or were sold while on their deathbeds; others survived only with the help of deep-pocketed parents outside the state.

So far, there's been no recovery in commercial real estate. Arizona's office and shopping center markets have leveled off, with appraised values 25% to 50% below their peak. Raw land still hasn't touched a clear bottom.

What's more, the real estate collapse had a ripple effect, reducing spending and touching off a spurt of bankruptcies by business and individuals.

Robust Job Growth

On the other side of the ledger, Arizona's population has risen more than 2% in each of the last five years. Residential real estate is perking up: Phoenix had the nation's third-strongest home-building market in 1991, with more than 13,800 housing starts.

And, fueled by small business and the sector, job creation has returned to levels above the national average, despite a steep drop in construction employment. Arizona State University economists forecast job growth of about 3% in 1992, compared to projections of less than 1% nationwide.

Banks have made progress working through loan problems. The sale of foreclosed property, usually at a steep loss, has been a top priority. "We concluded the best thing we could do was get rid of the stuff as fast as we could," says Mr. Lehmann of Valley National.

With few new bad loans coming on line, the liquidation of real estate assets is bearing fruit. After three years at lofty levels, bad loans and foreclosed property dropped a sharp 25% in 1991.

Problem loans and foreclosed property totaled $1.05 billion, or 2.96% of total assets, at the end of 1991. That was down from $1.48 billion, or 5.59% of assets, at the end of 1989.

Big Banks' Performance

The biggest banks have made solid progress.

Valley National's nonperforming assets plunged 31% in 1991 and an additional 22% in the first quarter this year, to $258.8 million, or 2.35% of total assets. As a result, Valley has been able to make many of its workout specialists lenders again.

First Interstate Bank of Arizona has also made dramatic progress. Its nonperformers declined 34% in 1991 and another 17% in the first quarter, to $226.8 million, or 3.36% of assets. Federal regulators have lifted a formal agreement on the bank's credit and reserving practices.

"Every quarter is getting better," says First Interstate Bank executive vice president Alan R. Thompson. "But it will be another two years before we are finally at normal nonperforming-asset levels."

Both banks saw sharp increases in profitability in the first quarter, although Valley's gain was mainly due to a $40.2 million tax benefit. Valley netted $19.4 million, up 77% from a year earlier. First Interstate's profit was $20.4 million, up 47%.

No More Cowboys

The slowly improving numbers only hint at the far-reaching transformation of Arizona banking. Gone, perhaps forever, is the boomtown culture in which growth and skyrocketing prices made credit quality almost irrelevant.

"It looked like the Arizona boom was never going to end," recalls Paul Muscenti, chief executive of Firstar Metropolitan Bank and Trust in Phoenix. "Growth itself was an industry."

In the early and mid-1980s. Arizona real estate speculation reached a frenzied pitch, bankrolled largely by the state's banks and thrifts. Unimproved desert land on the fringes of Phoenix and other major cities doubled or tripled in price in a few years or even less.

"We all got caught up in the euphoria of rapidly increasing values," says Mr. Simmons. "The thrifts made the big mistakes, but commercial banks did too - every one of them."

Too Many Handshake Deals

When developers and speculators came calling, bankers asked few questions. "A signed lending agreement was not a common practice," says David S. Hanna, chief executive of Bank of America Arizona. "There were a lot of handshake deals."

After the merry-go-round stopped and real estate values plummeted, lenders were left holding the bag. Bankers say the initial reaction was to deny the crisis then to be overwhelmed by it.

"People were depressed, shell-shocked, internally focused," says Mr. Thompson of First Interstate.

The crisis forced banks to rethink the way they did business. Bankers now demand that borrowers produce audited financial statements and answer tough questions about their businesses. Such practices may seem basic, but they fell by the wayside during the boom days.

A Squeeze on Customers

The new rigor has convinced some customers that banks aren't lending.

"It's very tight," says Steven G. Mihaylo, chief executive of Inter-Tel Inc., a Phoenix telecommunications firm with $80 million in annual sales. "The attitude seems to be, they would prefer to be in the consumer banking business than in the commercial banking business."

Mr. Mihaylo's bank has raised his company's credit line and increased its collateral and documentation requirements. He's a customer of BankAmerica in wake of the acquisition of Security Pacific.

There is no question that banks are being cautions in making loans, particularly any secured by real estate. And bankers say borrowers are having a hard time getting used to new lending procedures.

|Carpetbaggers'

"Banks are putting discipline back in the marketplace," says Mr. Wertheim of Caliber Bank. "Before, if you tried to impose that, borrowers could go across the streets."

Interstate banking is often viewed as suspect by those who see local institutions taken over by giant out-of-state "carpetbaggers." But in Arizona, many are convinced that the financial system was saves by outside ownership.

The Grand Canyon State was one of the first to approve interstate banking without restriction. Between 1985 and 1988, Citicorp. Chase Manhattan, and Security Pacific made major acquisitions. Several midwestern companies, such as Minneapolis-based Norwest Corp. and Milwaukee-based Marshall & Ilsley Corp. also established footholds.

Saved by Parents

When the crunch came, many parent companies were forced to pony up capital to make up for credit losses.

"In the absence of that, there would have been a real collapse of banking in Arizona," says D. Gordon Murphy, executive vice president of the Arizona Bankers Association.

Valley survived without outside help. But when it returned to health, its managers concluded it lacked the size and capital strength to compete successfully in an era of rapid consolidation.

Last year, Mr. Lehmann discreetly contacted four potential buyers, leading to the rich acquisition offer from Banc One. The merger is to be concluded in January.

Meanwhile, BankAmerica has established itself as the state's second-largest player through a series of government-assisted thrift purchases and its merger with Security Pacific, which had controlled the state;s third-largest bank. Citicorp owns the state's fourth-largest bank after its takeover of United Bank of Arizona in 1988.

Bankers say the disappearance of poorly managed rivals and the arrival of several of the nation's leading mass consumer banking organizations promises a more rational and profitable market. The banks are especially pleased to be rid of some of the more aggressive thrifts that periodically touched off price wars in bids for deposits.

"Some of the savings and loans did insane things," said Mr. Lehmann. "Not having them around is a positive change." 5 Largest Arizona Banks -- Then and Now --On Dec. 31, 1987, in billions of dollars AssetsValley National (1) $11.3First Interstate 6.6The Arizona Bank (2) 4.7United Bank of Arizona (3) 2.4Chase Bank 0.9On March 31, 1992,(*) in billions of dollars AssetsBanc One $10.0Bank of America 9.5 (**)First Interstate 6.8Citibank 2.4Independent Bank (4) 2.0(*)Pro forma, based on pending mergers and divestitures(**)Estimate(1)Acquisition by Banc One pending(2)Subsidiary of Security Pacific; acquired by BankAmerica in 1992(3)Acquired by Citicorp in 1988(4)Formed in 1992 by investor group headed by Anthony Frank

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