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Federal Deposit
Insurance Corporation

Each depositor insured to at least $250,000 per insured bank

Home > Industry Analysis > Research & Analysis > San Francisco Regional Outlook - Fourth Quarter 1997

San Francisco Regional Outlook - Fourth Quarter 1997

Regular Features

Regional Banking Conditions

  • Favorable performance continues in 1997 for most banks and thrifts in the San Francisco Region.
  • Deposit service charges are becoming a more important source of revenue at the Region's large banks, widening the disparity between them and their community bank counterparts.
  • The Region's community banks have significantly more equity capital exposed to commercial real estate, construction loans, and other real estate owned than do community banks nationwide.
  • Exposure to higher-risk real estate lending warrants monitoring.

Second-Quarter Reports Reflect Overall Good Earnings, Capital, and Asset Quality

With the exception of a few slower-growing metropolitan areas in California, the Region's banks and thrifts overall continue to report relatively strong financial conditions. For the quarter ended June 30, 1997, insured institutions in the San Francisco Region reported:

  • a return on assets (ROA) of 1.13 percent, down slightly from first quarter's ROA of 1.17 percent because of a slight decline in the net interest margin at the Region's banks and thrifts;
  • an average leverage capital ratio that continued to improve, climbing from 7.48 percent during the quarter to 7.54 percent; and
  • a decline in past-due loans to 2.09 percent of total loans from 2.38 percent in the first quarter of 1997, primarily due to improvement in the real estate and commercial loan portfolios.

Fewer institutions reported losses during the second quarter of 1997 than during the second quarter of 1996. Eighty-one insured institutions, with combined assets of $25 billion (2.5 percent of the Region's total assets), reported net losses in the second quarter of 1997. Together, these institutions lost a total of $89.6 million. These statistics compare favorably with those from the second quarter of 1996, when 92 insured institutions with combined assets of $30.5 billion reported a $151.1 million loss.

Large and Small Banks Take Divergent Approaches to Deposit Service Charges

One reason for the improved financial condition of insured institutions in the San Francisco Region is the increasing effort banks and thrifts are making to generate more noninterest income and diversify their revenue streams. In many cases, traditional sources of noninterest income, such as service charges on deposit accounts and surcharges on automated teller machine (ATM) transactions, are being reevaluated and repriced.

In the San Francisco Region, service charges on deposit accounts have become a more important source of income. Since 1990, service charges on domestic deposits have climbed from 4.4 percent of gross operating income to 6.2 percent for the first half of 1997. However, Chart 1 reveals that in the San Francisco Region, large banks, those with assets greater than $1.0 billion that are not credit card banks, generate significantly more income per dollar of deposits from service charges on deposit accounts than do community banks (institutions with assets under $1 billion).

Chart 1

The service charge disparity has arisen in part because several of the Region's larger banks made efforts to expand revenues by charging nontraditional service fees. In addition to the traditional minimum-balance maintenance charges, withdrawal penalties, stop-payment orders, and returned-check fees, these institutions also now are charging for such services as telephone access, personal teller service, home-based electronic banking, and ATM use for both bank customers and other users.

ATM charges for noncustomers started after MasterCard and Visa--the owners of the Cirrus and Plus ATM networks--lifted their ban on surcharges on April 1, 1996. The new noncustomer ATM surcharge has become popular with ATM owners across the nation. According to a nationwide survey conducted by Carmody and Bloom, Inc., the share of ATM owners imposing surcharges on noncustomers grew from 40 percent to 65 percent in the six months ending February 1997. The same study found that in the West, noncustomers paid a surcharge at 87 percent of the ATMs owned by the banks that were surveyed. Large financial institutions own an overwhelming majority of these machines.

In contrast to the large banks that implemented surcharges, many of the Region's community banks (those with assets less than $1.0 billion, excluding credit card banks) are not imposing ATM surcharges, in a strategic attempt to retain, and possibly gain, market share. According to a 1997 Grant Thornton survey, community banks recognize that ATM surcharges and other deposit fees could provide a means of paying for expanded ATM services. However, they also recognize "free" ATM access as a potential customer drawing card. These factors may in part explain why in 1997 deposit service charges collected per hundred dollars of domestic deposits at small banks continued to decline to less than half the amount collected by larger banks.

Implications: In light of the increased use of fees at some large banks and the reluctance of many small banks to raise fees, the disparity in deposit service charge income between the large and small banks in the Region may widen. However, as noted by Atlanta consultant George Albright, over the long term, higher profits from ATMs may result in an increased supply of these machines and, eventually, downward pressure on fees.

Institutions in Several Areas of the Region Have Increased Their Risk Profiles

The Region's economic expansion over the past several years not only has revived several of the Region's real estate markets but also has resulted in significant asset and loan growth and improved profitability at many banks and thrifts. However, during this period of prosperity some institutions may have assumed additional risk in their loan portfolios by increasing their exposure to higher-risk types of loans, such as construction and commercial real estate loans. This exposure warrants monitoring, particularly in metropolitan statistical areas (MSAs) such as Fresno and Las Vegas, where the real estate markets appear to be softening and the economies are, in the case of Fresno, beginning to show signs of weakness (see San Francisco Region's Large Metropolitan Areas Experience a Wide Range of Conditions and Risks).

The Region's high level of exposure to commercial real estate and construction lending is most evident at community banks--defined here as institutions with total assets less than $1 billion that are not primarily credit card banks. Chart 2 reveals that community banks in the San Francisco Region have significantly more equity capital exposed to commercial real estate and construction loans, direct real estate investments, and other real estate owned than do community banks nationwide. The chart also shows that the Region's community bank exposure to these higher-risk real estate assets, at 235 percent of equity capital, not only is well above the national average of 147 percent but also has been trending upward since 1995.

Chart 2

Renewed interest in commercial real estate lending in many areas of the San Francisco Region over the past three years has occurred because strong economic growth has reduced vacancy rates and spurred construction of commercial properties. As discussed in Strong Demand and Financial Innovation Fuel Rebounding Commercial Real Estate Markets, the Region's renewed interest in commercial real estate parallels national trends. In a recent national report on commercial real estate, Donaldson, Lufkin, & Jenrette (DLJ) identified Las Vegas and Salt Lake City as the two most active smaller-area office construction markets in the nation. They also cited Portland, Phoenix, and Seattle as larger areas with booming office construction sectors. Note, however, that DLJ's ranking of these markets as leaders in commercial real estate is based on the area's high level of construction activity, not the viability of the projects or overall market conditions.

Because the resurgence in the commercial real estate market has not been uniform throughout the Region, the Region's community banks' exposure to real estate lending has a geographic component that also is not uniform across the Region. Chart 3 shows that during the second quarter of 1997, community banks in several MSAs reported combined commercial real estate and construction loans approaching 30 percent of assets, which is in excess of exposure of 23 percent and 15 percent, respectively, for the Region and the nation. MSAs with exposures exceeding 30 percent of assets include Reno, Nevada; Eugene, Oregon; and Santa Rosa, Riverside-San Bernardino, Sacramento, San Diego, and San Jose, California. Furthermore, many institutions in these areas also are disclosing significant unfunded commercial real estate and construction commitments. The combined exposure to commercial real estate and construction loans in these areas is noteworthy because it has risen to levels not seen since the commercial real estate downturn in the early 1990s.

Chart 3

In addition to variances in risk exposure between metropolitan areas, profit and problem loan levels at community banks with concentrations in higher-risk real estate assets also differ significantly among the Region's MSAs. Table 1 (next page) lists seven MSAs, most with robust economies, where community banks significantly outperformed the Region. In each of these MSAs, the banks, as a group, reported an ROA exceeding 1.5 percent during the second quarter of 1997, with most well above the 1.3 percent earned by peer banks in the Region. Community banks in Utah's two largest metropolitan areas, Salt Lake City and Provo, lead the Region, with ROAs of 2.6 percent and 2.3 percent, respectively. Two Oregon MSAs also have community banks that, as a group, reported ROAs of more than 2.1 percent. Such high ROAs may be an indicator that these banks are accepting an above-average level of risk.

Table 1

Performance Varies across MSAs with Higher-Risk Real Estate Exposure


> $500
% Equity
RE &



> $500
% Equity
RE &





(1)(2) (3)(4) (1)(2) (3)(4)
More profitable...Less Profitable...
Salt Lake, UT$3,504111%44%1.7%2.6%Napa, CA$1,007308%51%4.6%0.7%
Provo, UT$656212%102%0.7%2.3%Stockton, CA$2,533178%33%5.0%0.7%
Salem, OR$605251%68%0.7%2.1%Riverside, CA$1,485444%70%2.3%0.7%
Eugene, OR$821312%125%2.5%2.1%Honolulu, HI$2,254183%31%6.5%0.6%
Monterey, CA$972327%45%1.1%1.7%Fresno, CA$724316%115%5.6%0.6%
Billings, MT$755173%16%2.2%1.7%Region (5)$99,723235%51%2.2%1.3%
Phoenix, AZ$2,933196%60%1.1%1.5%Nation (6)$984,362147%29%1.9%1.3%
Source: June 30, 1997, Bank Call Reports
(1) MSAs where Community Bank assets (5) in the aggregate sum to more than $500 million, amounts shown in millions.
(2) Higher-Risk Real Estate: (construction + commercial real estate loans + other real estate owned + real estate investments)/equity.
(3) More than 30 days past due plus nonaccrual commercial real estate and construction loans as a percentage of total commercial real estate and construction loans.
(4) Annualized earnings as of June 30, 1997, as a percentage of average assets.
(5) Community banks are defined as banks with assets less than $1.0 billion, excluding credit card banks.
(6) Community banks are defined as banks with assets less than $1.0 billion.

The Region also has several MSAs where community banks are underperforming relative to the Region and the nation. Five of these moderate- to slow-growing MSAs--Napa, Stockton, Riverside, Fresno, and Honolulu--also are highlighted in Table 1. Not only did institutions in these MSAs report ROAs of less than 0.75 percent, typically due to abnormally high provisions for loan losses, but most also had above-average exposure to high-risk assets and higher levels of nonperforming assets relative to both the Region and the nation.

Although profits at most of the Region's banks and thrifts are at record levels and nonperforming assets are declining, changing economic conditions within individual MSAs can adversely affect the performance of an area's insured financial institutions. Table 2 reveals five major markets in the Region where office vacancy rates, a key economic indicator, are trending upward. Table 2 also shows that a total of eight markets continue to have vacancy rates in excess of the national average.

Table 2

Metropolitan Office Vacancy Rates
Edge Up in Five MSAs

Vacancy Rates
Los Angeles21.6%20.3%19.9%18.8%18.0%
Las Vegas11.7%7.2%8.9%11.9%13.2%
Orange County17.2%16.7%15.8%14.7%12.9%
San Diego21.9%18.7%17.7%15.4%12.2%
San Francisco12.4%10.0%9.9%6.5%6.7%
Salt Lake15.1%8.8%6.4%5.5%5.6%
San Jose1.3%1.4%1.4%7.7%2.6%
Source: CB Commercial Office Vacancy Index of United States
*Vacancy rates for 1993 and 1994 reflect year-end rates

Four of the Region's eight underperforming real estate markets--Riverside, Bakersfield, Los Angeles, and Honolulu--remain well-identified problem commercial real estate markets, with office vacancy rates much higher than the rest of the Region and the nation. In contrast, Fresno and Las Vegas may be considered to pose risks either because of rising vacancy rates or, in the case of Fresno, generally weak economic conditions (see San Francisco Region's Large Metropolitan Areas Experience a Wide Range of Conditions and Risks).

In Fresno, where the economy is showing signs of weakness and the construction market has softened, community banks already are recording deterioration in asset quality. For example, as the Fresno economy has slowed over the last year, the past-due ratio (loans 30 days or more past due plus nonaccrual loans divided by total loans of this type) for construction loans climbed from 5.6 percent in June 1996 to 10.7 percent in June 1997. In contrast, the comparable ratio for the Region fell to 2.9 percent in June 1997 from 3.2 percent a year earlier.

Although office employment and construction growth in the Las Vegas area remain robust, the area's office vacancy rates have been trending upward since 1994 and are currently 2 percentage points above the national level. Moreover, Chart 4 reveals that, in spite of the steadily increasing vacancies, Las Vegas-area community banks continue to increase their concentration in commercial real estate and construction loans, which is already well above both the Region's and the nation's peer levels.

Chart 4

Implications: The Region's MSAs with very high concentrations of lending in construction and commercial real estate may warrant additional monitoring, even though profitability in many of them remains high. In some of these areas, community banks in the aggregate have more than 30 percent of their assets and 100 percent of equity capital exposed to these higher-risk loan categories, with some individual banks reporting higher exposures. A significant deterioration in real estate markets or construction activity in these MSAs could have a disproportionate impact on their asset quality and profitability. This is particularly true in Las Vegas and Fresno, where some real estate market indicators are already showing signs of deterioration (see San Francisco Region's Large Metropolitan Areas Experience a Wide Range of Conditions and Risks).

Catherine I. Phillips-Olsen, Regional Manager
Roger Stephens, Financial Analyst
Millen L. Simpson, Examiner, Division of Supervision

Regional Outlook Information
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Last Updated 7/26/1999

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