Realty Woes Hitting Home In California

For more than a year, bankers up and down the East Coast have wondered why California seemed to escape the ravages of the commercial real estate downturn. Now there's fresh evidence that the West Coast banks won't escape unharmed, after all.

Security Pacific Corp. and several other California institutions have signaled that second-quarter results will be battered partly by sound real estate loans.

And many experts agree that this is just the beginning. The state's banks and thrifts can expect real estate losses to hurt earnings for at least several more quarters. Real estate executives agree that the California market hasn't bottomed out.

To be sure, only a few experts think things will get as bad as they did in Texas or New England, where commercial real estate problems caused gushers of red ink and bank failures.

Divergent Views

"I'm hopeful that in the next few months things will begin to turn around," said Phillip Nicholson, a partner in the Lost Angeles real estate law firm of Cox, Castle and Nicholson.

But a substantial minority of knowledgeable executives think things will get much worse. "We are at the front end of this real estate problem," said one real estate executive, who did not want to be identified because he has many banks as clients. "It will be a free fall for the next couple of years."

Close Watch on Wells Fargo

Some big banks have not said much about problems lurking in their real estate portfolios. Wells Fargo & Co. had $14.5 billion of commercial real estate loans outstanding at yearend in a $48.9 billion loan portfolio. Analysts are particularly worried because Wells has not taken extra-large reserves to cover problems in those real estate loans.

"The extent to which the real estate problems linger depends on the California economy," said James McDermott, president of Keefe, Bruyette & Woods Inc., New York.

California's unemployment rate stands at 7.7%, compared with 7% for the entire nation.

"Recovery in California will take as long, or perhaps longer, than in the rest of the country," said David G. Hensley, director of business forecasting for the business school at University of California, Los Angeles.

All this has not been lost on investors and analysts. They have been stewing about California real estate for months, which has pushed the stock prices of California financial institutions down at times. But most of the big banks have been relatively sanguine on the issue.

Big-Bank Problems in the Open

That ended last week when Security Pacific announced its second-quarter earnings would plummet 74%, to $50 million. The company said it expects its nonperforming assets during the period to rise about 21%, or $658 million. About half that increase comes from problems in California commercial real estate.

Others feeling a pinch from realty problems include City National Corp., Beverly Hills, First Interstate Bancorp; Los Angeles; and Glenfed Inc., Glendale.

Security Pacific executives were not available to discuss their particular real estate demons. But Robert H. Smith, the chairman and chief executive, said: "We don't have much commercial real estate," in a phone interview two weeks ago.

Fewer Residential Problems

Security Pacific had $12.2 billion in commercial real estate loans at yearend; about $5.8 billion in construction loans and $6.4 billion in mortgages. That is 18% of total loans and 301% of tangible equity, according to Lawrence Vitale, bank analyst at Kemper Securities in Chicago.

About 57% of Security Pacific's commercial real estate portfolio is in California. About 61% is to borrowers in the residential business, which is in significantly better shape than those in properties such as office buildings and shopping centers.

But if the real estate executives are right and California commercial properties get worse before they get better, Mr. Smith and his counterparts at other banks may find they have a lot more commercial real estate than they want.

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