The California energy crisis is affecting banks in the state differently, depending on their size. The vast majority, the mid-sized and smaller banks, are weathering the crisis about as well as can be expected. The large banks may take some hits, but they, too, seem to be riding out the storm.The big question is the long-term effect. Some observers believe the high cost of electricity, or lack of it, could put California at a disadvantage to other states, and that could hurt its banks. Meanwhile, along with most businesses, smaller banks are concerned that their electricity might be shut off for a couple of hours. Prospects of such problems, however, aren't causing those surveyed by U.S. Banker untoward grief. Loan quality, they say, is holding up, at least for the time being. That's to be expected, they admit, given that the impact of higher energy costs will take a toll only as time passes.For the bigger banks, the exposure to the energy crisis may be more immediate, namely in the form of loans to the big utilities—Pacific Gas and Electric Co. and Southern California Edison Co., which are already in "technical" default on millions of dollars in payments. (The two utilities went into technical default when their bonds were downgraded to below investment grade.) Essentially, the question is whether the utilities will go bankrupt.Bank of America Corp., Charlotte, NC, and Wells Fargo & Co., San Francisco, have significant credit exposure to the two utilities, though it's difficult to gauge the degree because the banks are reluctant to discuss the subject.A January audit of Pacific Gas and Electric by the Barrington-Wellesley Group found that the utility has "outstanding debt principal and interest payments in 2001 of $3.2 billion," and that it has "exhausted its borrowing capability under existing lines of credit."Paul Patterson, an equity research analyst at Credit Suisse First Boston, says credit quality concerns regarding the utilities are going to increase. The chances that the utilities will file for Chapter 11 bankruptcy are "a little less than even," says Patterson. From the middle of December to the middle of February, California's government spent almost $2 billion buying electric power on the notoriously volatile open market. "There's a tremendous amount of risk related to the utilities," Patterson says.In November, BofA put in place an $850 million line of credit to PG&E, but a spokesperson says that credit line was cancelled in the wake of the problems hitting the utilities.The BofA spokesperson added that, "nationally, energy loans—loans to utilities—are little more than 1% of the total loan portfolio of the bank." One percent of the BofA loan portfolio would amount to about $4 billion. The bank declined to discuss its credit exposure to the two California utilities. "There has been concern about BofA being a major lender to some of these utilities," says Jeff Thredgold, an economist who serves as the main economic consultant to Zions Bancorp, Salt Lake City. Zions owns the San Diego-based California Bank & Trust, the sixth largest commercial bank in the state.Thredgold says the state will either issue bonds to strengthen these utilities or in some manner make sure that both bond holders and lenders "are taken care of." Bank of America, however, is also the biggest or second biggest bank lender to the California farm industry (with Wells being the other), according to the American Bankers Association. The agricultural industry is known as a heavy user of electric power, which is becoming increasingly expensive.The BofA spokesperson says that agricultural loans also are "not a big percentage" of the portfolio, and that, in any case, BofA would not, as a rule "make any generalization regarding a particular industry, because so much depends on individual companies." She says the bank "is keeping close to our customers and hasn't seen any material impact from the energy crisis."In the case of Wells Fargo, a spokesperson says the bank "has a long-standing relationship with PG&E and Southern California Edison, but we are not their lead lender." And though Wells is a big lender to the ag industry, the bank says it factored in the possibility of an energy crisis when making loans to the sector. Many believe that agricultural loans in the state carry more than the usual burden of risk. Michael McMahon, an equity analyst at Sandler O'Neill & Partners, New York, quotes a California banker who contends that "the best ag loan is one that was never made."A Wells spokesperson said the bank would not elaborate on its exposure. "Nobody here wants to talk about the subject, one of the reasons being there's not much to say. We're not seeing any significant impact, and have nothing further to add."The smaller bankers in the state say the best they can do for now is monitor developments in the ongoing energy saga. According to the California Bankers Association, its members carry loan portfolios in which from 5% to 15% or 20% of loans would be considered "energy sensitive." That is to say, loans made to companies that use heavy amounts of electricity. "I'm certainly sitting up and paying attention," says Sherry Skinner, president of Ojai Valley Bank, a $74 million-asset community bank. She has made it a point to contact those customers that are big users of energy. "We do lending to residential care facilities, hotels, our local hospital—and they may not be able to effect enough conservation measures to mitigate the impact or rising energy prices."The experience of Ojai, though a small bank—"a speck on the map," is how Skinner puts it—matches that of other banks U.S. Banker contacted, namely, that any effect on credit quality has yet to show itself. "We haven't seen enough yet. But energy prices are going up and we anticipate they will continue rising," says Skinner.Silicon Valley Bank, based in Santa Clara, is doing what many prudent bankers are doing, says David Grandey, public relations manager—its account officers are gauging their clients' exposure to rising energy prices. "We determined that we have minimal exposure since our clients are mostly start-up, high tech ventures and they have minimal exposure to the energy crisis." Customers of the bank that are engaged in manufacturing, the area where energy use is greatest, have most of their factories outside California, he says.But this is early in the game as regards any adverse effects. For one thing, it's been winter, and energy use—and upward pressure on prices—is certain to increase as temperatures rise and air conditioners jump into action. Already overall prices have increased 9% or more. The utilities are in debt to their suppliers for between $6 billion and $12 billion (the utilities insist the higher number is accurate, but others contend the figure is more like half that amount). Depending on how the governor and the State Legislature fashion a bailout, the price of electricity could rise considerably. In fact, some sort of bailout or rescue plan is the most likely scenario, and the head of CalFed expresses what seems the consensus opinion: "The problem will be fixed at a cost that ultimately will be passed on to consumers, both corporate and private. And it will be inflationary," says Carl B. Webb, president and chief operating officer of California Federal Bank, San Francisco.Whatever else, the California energy crisis threatens to derail an economy that has sailed along on what's seemed a boundless expansion. For one thing, rising energy prices are particularly unwelcome since there are already indications that the economy is slowing.On top of that, and maybe more significant long term, is that companies are afraid to build new facilities or add jobs in the state when something so basic as reliable and affordable electricity is in question.The huge computer chip company, Intel Corp., Santa Clara, CA, for example, has vowed it will not add a single job so long as the energy crisis remains unresolved. "And if you don't have those high tech jobs, what do you have?," asks James Clark, vice president for government relations at the California Bankers Association, San Francisco. Citing anecdotal reports of other high-tech firms looking to do their expansions outside of California, Clark says, "it's bad for everybody." In fact, the population of the state, now at nearly 35 million, is growing, which means more jobs must constantly be created just to keep the rate of unemployment at a standstill level. "To the economic development people around the country trying to entice California companies, this is Christmas early," says Thredgold, the economic consultant to Zions. Though the dislocation in the energy industry is "bad news for California bankers," it's potentially good news to bankers in other Western and Central states who may find new customers coming into their markets via the problems in California, says Thredgold.That companies are concerned is borne out by a survey sponsored by Manufacturers Bank, Los Angeles, which focuses on lending to companies with annual revenues of between $10 million and $200 million. In December, the bank polled the top management of about 100 companies to gauge their expectations for 2001. Three-quarters said they expect revenue growth this year to match or exceed last year's results. But in follow-up interviews with these same managers a month later, after the advent of the energy crisis, a majority said rising energy prices could upend growth prospects. "There's real concern because of the uncertainty," says John Chavez, executive VP at Manufacturers.The "key is to know your customers, know the nature of their business," Chavez says, repeating what seems to be the mantra of California's banking community.

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