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FRBSF

WEEKLY LETTER

July 22, 1988

Western Banking Recovery
Western bank performance in the first quarter of
1988 points to the potential for strong improvernentf6r the year. Aggregate earnings jumped to
$850 million in the first quarter of 1988 from
$555 million in the first quarter of 1987. Earnings
were up across the region, with California, Nevada, and Hawaii showing the most improvement. Over 80 percent of the region's banks were
profitable in the first quarh~r.
More important, the improvement signals a turnaround for western banks, which are rebounding
from a dismal 1987. Last year the banking industry in the West suffered an aggregate loss of $133
million, the industry's first loss since the 1930s.
One out of four banks in the West lost money
during 1987. The most notable losses were suffered by the larger banks, particularly those with
significant exposure to lesser developed country
(LDC) debt.
Not only did the western banking industry fail to
make a profit in 1987, it also failed to expand. It
continued to stagnate at around $400 billion in
assets. Regulatory and market pressure on banks
to consolidate and strengthen capital bases,
combined with sluggish loan demand, limited
growth opportunities for many banks in the West.
Against this background, first quarter results
showing strong earnings and an upturn in lending are encouraging.

Improving fundamentals
Several factors account for the strong first quarter
performance, and are likely to account for continued strength through the rest of 1988. First, the
western economy (with the exception of Alaska)
continues to perform well, and to out-perform
the nation as a whole. Second, expenses associated with increased loan loss provisions are
running well below year-ago levels, in part because of the continued strength of the economy.
First quarter data indicate reductions in net loan
charge-offs, and in the levels of nonperforming
and past due loans. Moreover, this pattern is ex-

WESTERn BAnKinG

pected to continue due to forecasts of continued
favorable economic conditions. Third, net interest margins, or the difference between the average return on earning assets and the average cost
of funds, widened, particularly in California.
Much of this improvement is due to conservative
pricing of consumer-type deposits at western
banks. Finally, in the aggregate, consolidation
and cost control measures have helped to reduce
fixed overhead costs relative to the level of
assets.

Lingering concerns
Prospects for the industry have brightened, but
asset quality problems linger. Even after the extraordinary $3.5 billion increase in loan loss
reserves in 1987, western banks still may need to
increase loss reserves in 1988 because of uncertainty over LDC debt reschedulings and repayments and ongoing problems with energy, real
estate, and farm sectortoans. In this regard, if a
widespread downgrading of LDC loans were necessary, an additional boost in loan loss reserves
would be required, which would have a significant impact on earnings.
Otherfactors besides the LDC situation also
could derail the turnaround. For example, while
analysts paint cautiously optimistic forecasts for
the industry, some have expressed concerns
about asset quality in the event of an economic
downturn, especially in the area of leveraged
buyout (LBO) debt. And given continued weakness in demand for bank loans, others are concerned that competition to build loan volume
may lead to lower credit standards and narrower
interest rate spreads on new loans. This may be
particularly worrisome in the commercial lending area, where emphasis has shifted from the
nation's major corporations towards smaller
"middle market" firms. Aggressive lending practices, especially if they exacerbate existing asset
quality problems and/or reduce spreads, would
erode future earnings.

Western Banking is a quarterly review of banking
developments in the Twelfth Federal Reserve District. It is published in the Weekly Letter on the fourth
Friday of January, April, July, and October.

FRBSF
On the positive side, however, the large increase
in loan loss reserves last year means that some of
the West's largest banks already have set aside
reserves against a large proportion of their LDC
and troubled farm and energy loans. That action
provides a buffer for future earnings even if such
loans are shifted to nonaccrual status or written
off altogether.

Spreads
Data on interest rates on loans and consumertype deposits over the last year do not indicate
any significant narrowing of spreads between
new loan rates and the current cost of deposits.
This suggests that concerns about narrowing
spreads associated with increased competition in
lending are at least premature. More important,
because spreads on new loans remain steady, net
interest margins should remain at their present
levels for the near term.
Moreover, the available data indicate that spreads
generally are wider in the West. Data for a sample of western banks show that in May 1988
banks in the West continued to charge higher
rates on commercial and consumer installment
loans than banks elsewhere in the nation. Only
on agricultural production loans did western
banks charge lower rates, on average.
Furthermore, survey data on interest rates paid by
banks on consumer-type deposits indicate that
western banks tend to pay lower interest rates
than the national average. That differential has
not changed substantially over the last year.
Moreover, over a period of several years, western
banks' .interest rates on deposits also have been
lower than the rates paid by western savings and
loan associations (S&Ls) and credit unions. For
example,.data published by the Bank Rate Monitor indicate thatthe sampledCalifornia banks
have consistently paid lower rates than the leading S&Lsin the state.

Costs vs. market share
Setting lower interest rates on MMDAs, savings
accounts, and smallcdenomination time certifi-

cates of deposit has had an impact on western
banks' market share. Because deregulated consumer deposits are moderately interest-sensitive
in the long-run, banks' share of the deposit market has fallen relative to that of S&Ls and credit
unions.
As recently as December 1985, commercial
banks in the West held 51 percent of the domestic deposit market. Savings and loans trailed with
45 percent, and credit unions accounted for the
remainder. By May of 1988, S&Ls had captured
half of the market, while commercial banks'
share had slipped to 46 percent, a loss of five
percent of the deposit market in less than three
years.
S&Ls now control 55 percent of the domestic
deposits in California, the largest market in the
region, and have an even wider lead if one focuses on the market for time deposits alone.
Savings institutions have made significant inroads
in other western states as well. In Arizona and
Washington, thrifts account for around 40 percent of the deposit market.
The banking industry appears to have made a
strategic decision to price consumer deposits
conservatively to reduce the cost of funds. Such
a pricing strategy can improve earnings in the
short run, especially during a period when deposits are plentiful. However, the loss of market
share may prove detrimental in the long run.

More challenges ahead
The banking industry in the West has returned to
profitability, and barring any shocks, should continue to improve in the coming quarters. .As the
industry recovers, though, it faces increasing
challenges, not only in rebuilding asset quality
and earnings, but in retaining leadership in commercial and consumer lending, and in remaining
competitive. in the battle for consumers' deposit
dollars.
Gary C. Zimmerman

REGIONAL BANKING DATA
(Not Seasonally Adjusted, Preliminary Data)
ALL COMMERCIAL BANKS (MARCH 31, 1988)
DISTRICT

TOTAL

ALASKA

ARIZONA

CALIF

IDAHO

HAWAII

NEVADA

OREGON

WASH

UTAH

18,759

27,230

280,779

12,757

6,973

10,414

43,133

1

N/A

40,590

883

N/A

N/A

0

93

1,566

DOMESTIC
LOANS

4,693

FOREIGN

361,552

4,692

27,230

240,189

11,875

6,973

10,414

18,759

10,404

31,016
23,442

TOTAL

279,272

2,563

19,817

195,384

7,234

4,431

7,622

11,751

7,029

FOREIGN

34,883

1

N/A

33,058

612

N/A

N/A

64

N/A

1,147

DOMESTIC

244,389

2,562

19,817

162,326

6,622

4,431

7,622

11,687

7,029

22,294

99,620
71,216

1,098

8,687

69,141

3,237

1,102

1,596

3,645

2,766

8,349

833

5,009

1,795

1,315

1,299

4,580

1,711

6,231

49,952

187

4,052

48,442
29,713

1,884
106

246
41,112

542
104

4,428
18

4,960

7
N/A

1,229
491

2,365

4,525

1,133
18

1,193

3,682

U.S. T.S.

14,111

777

SECONDARY MKT.

14,278

202

12,723

REAL ESTATE
COMMERCIAL
CONSUMER
AGRICULTURE
SECURITIES

INTERNATIONAL
TOTAL

OTHER SEC.
LIABILITIES TOTAL
DOMESTIC
DEPOSITS

135
22,524

0

N/A

N/A

310
N/A

2,416

1,565

1,551

3,243

1,590

6,655

979

703

589

423

10,430

479

352

443

214

1,670

5,439

957

510

519

2,226

806

2

4

1,564

3,375

950

505

1,362

714

446

790

1,579

613

1,223

382,066

4,232

25,517

266,313

11,942

6,472

9,772

17,553

9,745

30,520

338,934

4,232

25,517

225,723

11,059

6,472

9,772

17,553

9,652

28,954
27,125

326,540

3,707

23,513

226,423

11,087

5,675

5,925

14,676

8,409

FOREIGN

34,544

1

N/A

32,507

576

N/A

N/A

N/A

93

1,367

DOMESTIC

291,996

3,707

23,513

193,916

10,510

5,675

5,925

14,676

8,316

25,758

TOTAL

TRANSACTION
NONTRANS.

71,994

827

4,685

51,759

1,865

869

1,766

2,863

1,546

5,812

220,003

2,879

18,828
1,588

142,157

8,645

4,805

11,813

6,770
880

19,947

1,198

2,733

OTHER BORROWINGS

32,150

466

20,420

267

716

4,159
3,463

TOTAL CAP ITAL

38,166

2,185

27,489

941

596

970

2,106
1,432

402

7,192

110

85

174

187

132

453
35
688
37

2,244

LOAN LOSS RESERVE

8,891

622
155

STANDBY LETTERS OF CREDIT
LOAN COMMITTMENTS

1,390

15

245

766

23

84

148

24

51

13,271

83

975

560

764

428

19

30

23

22

1,332
32

348

626

8,092
420

33

10

LOAN LOSS RESERVE

3.18

6.05

2.03

3.68

1.52

1.93

0.76

0.95

0.86

0.66

0.22

0.47

2.29
1.85

1.88

CHARGEOFFS

0.94

1.14

1.07

REAL ESTATE

0.17

1.26

0.39

0.09

0.07

0.14

0.24

0.31

0.24

0.33

COMMERCIAL

0.93

1.14

0.92

0.83

0.42

0.58

1.05

1.06

2.01

1.85

CONSUMER

6.24

1.05

33.8

9.45

1.65

0;51

2;69

7.80

1.67

N/A
4.48

0.22

0.56

9:90
0,76

3.70

4.52

6.53

6.83

LOANS SOLD

TOTAL

AGRICULTURE
NON PERFORM . TOTAL

0.03

N/A

1.48

-.79

0.52

1.33

6.32

22.5

7.97

6.59

2.07

3.05

REAL ESTATE

6.15

36.3

12.2

5.20

2.02

6.26

COMMERCIAL

6.14

18.6

6.40

6.52

5.47

2.58

3.78

5.11+
5.05
5,49

CONSUMER

9.56

9.05

14.5

1.83

3.86

10.3

4.83

13.8

AGRICULTURE

17.2

4.56

38
13

2.06
10.3ยท

3.64
3;26

24.1

2.82

5.65

0.60

10.2

4.54

8.70

85

585

260

154

294

384

236

485

5

35

329

a

10

12

24

14

48

9,075

107

632

6,286

251

150

272

5i7

249

751

843
INTEREST
FEES & CHARGES
EXPENSES

TOTAL

706

INTEREST

4,510

54

326

3,101

138

83

121

195

126

365

SALARIES

1,921

23

138

1,350

57

26

41

80

40

165

539

7

43

361

7

6

34

16

23

43

2,104

23
-5

125

1,474

49

34

76

85

60

177

42

861

45

22

64

63

20

92

7

305

14

7

19

18

4

24

40

589

32

16

44

45

16

74

0.58

0.84

0.99

0.93

1.69

0.96

0.60

0.91

10.8
1+.69

18.2

12.6

5.22

7.60

4.95

4.96

10.8
5;05

LOAN LOSS PROV.
OTHER
INCOME BEFORE TAXES
TAXES

1,204
399

NET INCOME
ROA (%)

850

1
-5

0.84

-.46

ROE (%)

8.91

-3.4

7.27

8.57

13.4

NET INTEREST MARGIN (%)

4.78

3.70

4.66

4.68

4.46

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank Of
San Francisco, or Of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Barbara Bennett) or to the author.... Free copies 'of Federal Reserve
publications can be obtained from the Public Information Department; Federal Reserve Bank of San Francisco, P.O;Box 7702,
San Francisco 94120. Phone (415) 974-2246.

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PERCENT OF TOTAL DEPOSITS, FOR MAY 1988, BY
DISTRICT

ALASKA

ARIZONA

CALIF

HAWAII

IDAHO

NEVADA

WASH

UTAH

OREGON

CB SL CU
CB SL CU
CB SL CU
CB SL CU
CB SL CU
CB SL CU
CB SL CU
CB SL CU
CB SL CU
CB SL CU
DEPOSIT TYPE
-----,...-_ .... _--------------------------------------------------------------------------------------------------------------------5340 7
5734 9
65 30 5
6333 4
86 11 4
TOTAL DEPOSITS
46 50 4
71 920
5343 4
42 55 3
65 29 6
95 3 1
91 5 3
95 2 3
98 0 2
DEMAND
94 4 2
99 1 0
98 1 1
92 4 4
93 4 2
93 2 4
NOW

60 34

SAVINGS & MMDA

5735

SMALL TIME

2672 2
3366 1

LARGE TIME

6
9

48 15 37

62 29

8

5639

5

71 24

52 939
7417 9

64 29

7

7

60 30 11

3959

2
1

55 38
2078

2
1

40 57

3

87 7 6
86 9 5
81 17 2
85 11 4

80 17

4

77 19

5

6724

6529

6
3

6922

9

60 20 21

35 63
5444

2871
81 17 2
6 2
44 56
CB = COMMERCIAL BANKS, SL = SAVINGS & LOANS AND MUTUAL SAVINGS BANKS, CU = CREDIT UNIONS

TYPE OF ACCOUNT OR LOAN

93

5

DATE

US

ARIZONA

64 24 12
52 33 15

3
5049 1
64 34 2
2
6334 2
MAY NOT SUM TO 100% DUE TO ROUNDING
4750

IDAHO

CALIF

9

41 55

3

OREGON

4

UTAH

3958

WASH

----------------------------------------------------------------------------------------------------------------------------MAR88

5.34

5.09

5.08

5.09

5.06

5.05

4.89

5.28

5.04

APR88

MONEY MARKET DEPOSIT ACCOUNTS

5.35

5.09

5.08

5.09

5.06

5.05

4.85

5.34

5.05

MAY88

5.40

5.12

5.08

5.14

5.14

5.06

4.82

5.31

5.09

MAR88

6.50

6.06

6.20

6.09

5.67

5.75

6.05

6.04

6.23

APR88
MAY88

6.55

6.06

6.08

6.07

5.67

5.94

6.13

6.18

6.17

6.71
7.57

6.20
7.19

6.08

6.15

6.04

6.36

6.41

6.47

6.23

7.07

7.25

7.05

7.30

7.20

7.08

7.04
7.10

7.25
7.39

7.45

7.07

7.26

MAY88

7.58
7.72

7.91
7.72

7.30

7.49

7.19

7.45

7.55

7.56

7.20

7.28

COMMERCIAL LOANS, SHORT-TERM
AVERAGE MATURITY (DAYS)

MAY88

8.49

8.63

9.31

8.67

9.18

N/A

8.73

N/A

7.74

49

98

246

105

116

N/A

78

N/A

14

COMMERCIAL LOANS ,LONG-TERM
AVERAGE MATURITY (MONTHS)

MAY88

9.05
49

9.%

10.08

9.88

9.46

N/A

11.15

N/A

9.97

51

33

53

34

N/A

37

N/A

80

CONSTRUCTION LOANS

MAY88

9.29

9.70

10.04

9.65

9.83

N/A

8.32

N/A

N/A

11

6

N/A

6

6

N/A

7

N/A

N/A

MAY88

10.68

9.26

10.70

9.23

7.64

N/A

10.25

N/A

9.60

13

6

8

5

2

N/A

11

N/A

9

MAY88

10.55

11.08

N/A

11.21

N/A

N/A

9.74

N/A

10.78

6-MONTH CERTIF ICATES

2-1/2 YEAR CERTIFICATES

MAR88
APR88

AVERAGE MATURITY (MONTHS)
LOANS TO FARMERS
AVERAGE MATURITY (MONTHS)
CONSUMER LOANS, AUTOMOBILE

16.25
N/A
N/A
12.32
N/A
N/A
15.75
19.24
N/A
N/A
19.12
SURVEY OF TERMS OF BANK LENDING & TERMS OF CONSUMER CREDIT; MOST COMMON INTEREST RATES ON SELECTED ACCOUNTS

CONSUMER LOANS, PERSONAL

MAY88

13.49

15.33

N/A

CONSUMER LOANS, CREDIT CARDS

MAY88

17.78

18.02

N/A

SOURCES:

J

16.84