Battered Japanese banks in Calif. rebound and dig in for long haul.

SAN FRANCISCO -- Badly battered by the California recession, Japanese-owned banks here are rebuilding profits and consolidating their market position. Although the going is still not easy, bankers say the outlook is brighter than it has been for several years.

"These days, it's quite different from what it was like a year ago;' says Kanetaka Yoshida, president and chief executive of Union Bank, a unit of the Bank of Tokyo and the largest Japanese banking subsidiary in California with $16.3 billion of assets. "A year ago, the main question was how to deal with nonperforming assets."

Hiroo Nozawa, chairman, president, and chief executive of Bank of California, the $7.3 billion-asset California unit of Mitsubishi Bank, agrees. "If we emphasize prudent management and pursue relationship banking and product synergies, I am optimistic that profits will follow," he says.

Executives cite several reasons for renewed optimism. First, many believe the recession has bottomed out, real estate prices have fallen as low as they will go, and consumers are confident

Second, growing trade throught out the Pacific Basin and the healthy small and medium-sized business base in California offer ample opportunities for increased lending and other banking operations.

"A significant portion of the California economy depends on the middle market and small and medium-sized companies still depend on commercial banks" Mr. Yoshida notes.

So far, one of the best improvements in earnings has come at Bank of California. Net profits at the bank for the first nine months this year have more than doubled to $92 million from $39 million over the same period a year earlier.

Mr. Nozawa predicts fourth-quarter earnings will follow this year's trend and profits for the full year will top $120 million.

Improvements in earnings have been slower at some other institutions. But bankers predict earnings are likely to pick up as they continue to dispose of problem assets and set aside lower provisions.

"Earnings have been improving, but we're not yet where we would like them to be," says Kyle I. Tatsumoto, a vice president at $5 billion asset-Sumitomo Bank of California. The bank's goal, he says, is to bring net annual earnings back to over $40 million from $5 million last year, and to achieve at least a 1.00% return on assets.

At Union Bank, meanwhile, net income rose 19% in the third quarter to $25.6 million, but net earnings for the nine months ended Sept. 30 fell to $46.4 million from $70.7 million a year ago.

However, Union Bank's total nonperforming and renegotiated assets were down sharply to $280 million at Sept. 30 from $736.5 million at yearend 1993.

With losses of the last few years still fresh in their minds, Japanese bankers are in a conservative mood. And with the business climate in California still subdued, the assets at the eight California subsidiaries of Japanese banks have not increased. Total assets have barely budged since 1991, after rapid growth in the 1980s.

"Lending practices (at Japanese banking subsidiaries) have become very tight," remarks Gary C. Zimmerman, an economist with the Federal Reserve Bank of San Francisco. "They're still not expanding."

Profitability at Japanese banks in California has also remained consistently lower than average. According to Federal Reserve data, return on assets for Japanese-owned banking subsidiaries averaged 0.48% for the first six months this year compared with 0.95% for all banks in California.

For all of 1993, one of the most difficult years for Japanese-owned banks, return on assets averaged 0.05% compared with 0.76% for all banks.

Analysts believe that a large part of the lower-than-average returns at many Japanese banks can be attributed to lack of shareholder pressure. Only two banks, Union and Sumitomo, have a minority of their shares in public hands, while the other six are wholly owned by parent companies.

Higher-than-average problem loans also account for lower-than-average earnings. As of June 30, for example, problem real estate loans at Japanese banking subsidiaries amounted to 8.4% of all real estate loans, compared with 6% at all banks in California, according to Fed data.

One important reason for lagging profitability, analysts and bankers say, is cultural. Japanese bankers are far slower to cut costs by cutting staff, believing that constant sudden changes can damage their operations and long-term business prospects.

"We're very concerned about our current return on assets but keep in mind that for Bank of Tokyo, Union Bank is not just an investment," Mr. Yoshida explains. "We also tend to proceed more cautiously and take more time to make decisions because we believe it's important to help people understand what we're trying to do and why."

Analysts note that even if institutions like Union Bank may not be particularly profitable by U.S. standards, they still make a fair amount of money which is welcomed by parent companies back home in Japan, where profits continue to sag.

"Profitability may be limited by U.S. standards but it's rather strong for a Japanese bank," says Ricardo Kleinbaum, an analyst with Fitch Investors Service. "They get a good cash flow to the parent, a beachhead in the U.S., and their time horizon is much farther out."

The current conservative mood at Japanese banking subsidiaries in California is a far cry from the 1980s, when Japanese banks embarked on a hectic round of acquisitions and expanded their retail, commercial, and real estate lending across the United States.

Between 1985 and 1991, assets at Japanese-owned banks in California rose from $16.8 billion to $40.2 billion, at least partially as a result of a major acquisition spree. Sanwa Bank, for example, bought the California operations of Lloyds Bank in 1986 while Bank of Tokyo acquired Union Bank in 1988 from Britain's Standard Charter PLC and then merged it with California First Bank.

Four years later, Union Bank went on to acquire 33 branches from the former Security Pacific Bank, bringing the total number of its branches in the state to 206. Most recently Union paid $1.65 million to acquire certain assets of the Bank of Newport, adding 10,000 customers in the affluent Newport Beach area.

The expansion may not yet be over, although it will probably be far more selective in the future. "We're Certainly prepared to consider other acquisitions if there are good opportunities," says Mr. Yoshida at Union Bank. He singles out Northern California and southern coast areas Such as Santa Barbara as areas Union Bank is targeting for further expansion.

"It's never been our goal to grow for the sake of growing but we will consider opportunities as they arise and possibly acquire specialized institutions where there's a strategic fit, "'says Sumitomo Bank's Mr. Tatshmoto.

Analysts give Union Bank and other Japanese banking units high marks for weathering the crisis of the last few years. "Union Bank has done a good job managing through a very difficult real estate market and remained profitable throughout," says Bear Steams & Co.'s Lawrence R. Vitale.

Nonetheless, some question whether it really makes sense for Japanese banks with hundreds of billions of dollars to maintain relatively small operations in a rapidly consolidating retail market thousands of miles from home.

"From a strategic point of view, there isn't much rationale," says one analyst who declined to be named. Logically, he adds, "they've got to do one of two things: either grow, or sell out."

However, others believe Japanese-owned banks have a viable role to play in the California economy. They note Japanese-owned banks account for four of the top 10 banks in the state, holding slightly more than 10% of total California banking assets. These banks provide'. $28 billion in loans, or 11.42% of the state's total, and $8.25 billion in business loans, or 12.7% of the total.

They also point out that these banks serve the 200-odd Japanese firms with manufacturing operations in the state and that Japanese units offer small and medium-sized California companies an alternative to becoming completely dependent on the state's three big banks: BankAmerica Corp., Wells Fargo & Co., and First Interstate Bancorp.

Japanese banks provide a responsiveness and level of service that a lot of big California institutions don't have," says Mr. Kleinbaum.

Japanese bankers themselves reject any talk of selling out. "We've been in California since 1953, we're not under any capital constraints to sell, and we're here for the long term," says Mr. Yoshida.

Adds Mr. Tatsumoto: "I can't speak for the parent bank but we represent less than 1% of the total assets of the Sumitomo Bank, Ltd. I think it would be unlikely they would gain much by selling off the California bank."

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