Banks Doing Better Than Street Thinks.

Wall Street is worried that banks have forgotten the lessons of the 1980s, when a booming economy led to a lot of bad loans. But for local financial institutions, those fears look to be unfounded, even with interest rates creeping up and economic growth slowing.

An analysis of banks either located or doing a significant amount of business in Los Angeles shows that memories of the boom-and-bust 1980s loom large. Signs pointing to a slight deterioration in credit quality are being met with aggressive efforts to boost loan loss reserves, and industry observers say that a repeat of the meltdown a decade ago is highly unlikely.

"Credit quality bears watching because it's been an Achilles Heel for banks in the past," said Joseph Morford, banking analyst at Dain Rauscher Wessels in San Francisco. "But banks are increasing their loan loss provisions. And loan losses have been at unusually low levels the past several quarters. Now they're trending up to normal levels, (but) it is in line with expectations."

Public perception, however, is skittish.

When City National Corp. released its second-quarter earnings on July 13, the bank had every right to be pleased with the results. Net income rose almost 30 percent, marking 24 straight quarters of double-digit income growth.

But the stock for the Beverly Hills-based bank dropped almost 8 percent the next day, because it also announced it was setting aside $4 million for bad loans in the quarter, a sign that rising interest rates have made it harder for some of its borrowers to pay off their debts.

The stock drop reflected growing anxiety that the booming economy has led to complacency among financial institutions, which in their rush to cash in have lowered their lending standards and may get burned now that the economy is starting to slow.

But what the market appears to have ignored is the bank's total loan loss allowances, which now stand at $140.5 million, or 2.21 percent of outstanding loans. That's well above the industry median of around 1.5 percent. In addition, while the percentage of City National's non-performing loans edged up to 0.56 percent from 0.53 percent the previous quarter, that number is still exceptionally low, and points to the bank's rigorous loan standards.

"Clearly, if you're running (a non-performing loan ratio) below 1 percent, that reflects very favorably," said Keith Legget, senior economist at the American Bankers Association in Washington, D.C. "It clearly indicates that you are adequately provisioned."

Similarly, East-West Bancorp reported that its non-performing loans actually fell, while loan loss reserves stayed solid. Rank of America and Wells Fargo Corp., the two largest banking presences in Los Angeles though headquartered elsewhere, reported slightly different results in terms of credit quality. Bank of America's non-performing loans were up slightly and Wells Fargo's were down a bit, but still below 1 percent, and loan loss reserves remained healthy.

Worries at federal level

The concerns are real that banks may not be prepared for the anticipated economic slowdown, given the rise in interest rates over the past year. Since June 1999, the Federal Reserve Board has raised its federal funds rate, the interest rate that banks charge one another for overnight loans, six times, until it has reach 6.5 percent, the highest level in nine years.

In a recent report, the Federal Deposit Insurance Corp. warned that rising interest rates have left some institutions unprepared for a possible recession. The report warned that "profitability levels of mortgage and large commercial lenders may be increasingly vulnerable to rising interest rates."

But the FDIC noted that California's economy is performing better than the rest of the country, something bankers and analysts alike point to as key to understanding the health of local financial institutions.

For one thing, they note, the moves by the Fed to limit growth don't mean the economy is about to go into the tank. First-quarter gross domestic product grew at the astonishing rate of 5.5 percent, leading to fears that the economy was overheating and would spark inflation. By raising interest rates, Fed Chairman Alan Greenspan hopes to rein in growth to a more sustainable level.

"I think the first word everybody needs to look at is 'slowdown,'" said City National Chairman Russell Goldsmith. "There is a difference between reducing the rate of growth and having the economy go into the tank. The current anticipation of most economic observers and business people is that the Fed is trying to bring growth down to a level of 3 to 4 percent. In that sort of economy, the concerns about credit quality we're seeing in some sectors are overblown."

A trouble spot

But one area that is raising concerns is the growth in syndicated loans, by which several institutions, lend money jointly to minimize individual risk. Ironically, though, these loans are often given to riskier businesses, and can burn the participants.

Inglewood-based Imperial Bancorp said recently that its loan losses would increase in the second quarter because of its share in a syndicated loan to an insurance company that has filed for bankruptcy (Imperial hadn't released its results for the quarter as of late last week and officials declined comment).

"Imperial is seeing pressure from their participation in syndicated loans, and will be working through those issues for the rest of the year," Dain Rauscher Wessels' Morford said.

But even the participation in syndicated loans is an indication that local banks have much more diversified loan portfolios than they did in the 1980s, when the real estate market drove much of the lending activity. And bankers insist that they haven't forgotten how bad things were then.

"To look at asset quality, a good example is the early '90s, when the real estate market was so bad," said Dominic Ng, president of East-West Bank. "Ninety-nine percent of loans were in real estate for perhaps two-thirds of the commercial banks. We're much more diversified now."