2010 STATE OF THE INDUSTRY REPORT ON THE CONDITION OF CALIFORNIA COMMERCIAL BANKING California Bankers Association Carpenter & Company 1303 J Street, Suite 600 Five Park Plaza, Suite 950 Sacramento, California 95814 Irvine, California 92614 916-441-7377 949-261-8888 Richard P. Smith, Chairperson Edward J. Carpenter, Chairman Rodney K. Brown, President John D. Flemming, President 200404 2010 TABLE OF CONTENTS INTRODUCTION ........................................................................................................... 1 THE ECONOMY United States ................................................................................................... 3 California Trends ........................................................................................... 15 THE BANKING INDUSTRY National Trends ............................................................................................. 23 California Trends ........................................................................................... 31 THE CHANGING ENVIRONMENT Banking Failures ............................................................................................. 39 Commercial Real Estate ................................................................................ 49 INDUSTRY VALUATIONS Mergers and Acquisition Activity ................................................................ 55 National Stock Prices .................................................................................... 57 California Stock Prices .................................................................................. 58 Stock Performance by Asset Size ................................................................ 59 INDUSTRY RANKINGS ................................................................................................. 69 STOCK PERFORMANCE, CALENDAR YEAR 2009 ..................................................... 77 2010 INTRODUCTION INTRODUCTION The recession in the U.S. is over. When can we celebrate and enjoy the recovery? The deterioration in the quality of banking assets is abating. When will the industry return to its former rates of profitability? Clarity remains elusive regarding the future conditions for the economy and banking industry. Although the economy and banking industry are improving, fragile is constantly used as the descriptor for current activity. Why are there lingering fears about the economy? More than 8 million Americans lost their jobs during the recession. In California the ranks of newly unemployed increased by 1.3 million. Can consumers mount a spending rebound without a major expansion in jobs? The federal government and many state governments face record budget shortfalls. Will the fragile economic upturn survive efforts to reduce deficit spending? To foster growth and liquidity within the economy, the Federal Reserve allowed the fed fund rates to carry a zero rate of interest for more than a year. Why did bank lending declining during this period? When will the Federal Reserve alter its policy stance of exceptionally low market rates? How will the economy respond? Financial reform legislation continues to wind its way through the halls of Congress. As of this writing, there is no specificity over which provision will survive the joint committee markup and the final Congressional voting. How will reform affect community banks? These are questions to be pondered when considering the strategic direction for one’s community bank. Challenges Presented The current economic milieu continues to create challenges for commercial banks, especially for California community banks. Unemployed customers and declining sales adversely affect the financial viability of the small business community, the bread and butter business for community banks. The demise of the syndication market for real estate funding contributes to the free-fall in property prices. Those external conditions helped to create the worst asset quality for the banking industry on record. Week after week in 2009 and so far this year, the FDIC would announce that financial institutions failed. There have been 229 failures from the beginning of 2008 until April 30, 2010. The banks that have survived are part of an industry that is greatly reduced in number and constrained in their capacity to meet the credit needs of their local community. Whew, not a pretty picture, but you know that already. Breaking through the dark clouds of the economic and banking atmosphere are glimmerings of improvement. Asset quality stabilized in the second half of 2009. The downdraft on earnings from ever increasing loss provision abated. Operating conditions, net of loss provision, improved, especially for California banks. CALIFORNIA BANKERS ASSOCIATION -1- CARPENTER &COMPANY I NTRODUCTION Net interest margins of banks are increasing, as the decline in funding costs generally exceeded the drop in interest income. The California banking industry reports lower operating costs, in part due to the elimination of failed banks. Although asset quality measures remain poor from a historic perspective, California banks are doing better than the national average. Nationally, banks reported fewer assets in 2009, while California banking assets increased slightly. Loans declined due to the charge-off of existing loans and tighter underwriting curtailing originations. Banks generated more core deposits and reduced dependency on borrowings. Despite the challenging times, the banking industry increased its capital and posted record ratios based on risk-based measures. It is clear that there will be fewer banks in the future. The exclusivity of the banking community makes your existing bank charter a valuable commodity. As such, your challenge is to continue to create value for your core constituencies of shareholders, employees and customers. Such a strategy should be met with improved franchise value, renewed profitability, and more favorable stock pricing. Quarterly Updates Economic and banking trends change frequently and at an ever-increasing rapidity. Thus, an annual report on banking conditions has limited freshness. In an attempt to provide timely information and analysis, while maintaining fiscal responsibility and environmental consciousness, quarterly updates to this report are available by e-mail. Carpenter & Company distributes free of charge quarterly updates to the STATE OF THE BANKING INDUSTRY as well as its monthly stock report. Many of you have already received the monthly stock report, as well as the quarterly updates. If you are on this mailing list, that’s great. If you wish to be added to the e-mail list, please send an e-mail to [email protected] and place “Monthly Stock Report” and/or “Quarterly Report” in the subject line and your name, company affiliation, phone number, and e-mail address in the e-mail message. We hope that these updates will be of interest to you. Acknowledgements This tenth annual report on the STATE OF THE BANKING INDUSTRY has been developed from data and information obtained from a variety of public and private sources. The information contained in this reported is believed to be accurate and reliable. However, no special warrant can be provided. Special thanks are due to the UCLA Anderson Forecasting Project for their economic forecast of the United States and California. The California Bankers Association and Carpenter & Company wish you much success in the year ahead. CALIFORNIA BANKERS ASSOCIATION CARPENTER & COMPANY CALIFORNIA BANKERS ASSOCIATION -2- CARPENTER & COMPANY 2010 THE ECONOMY THE ECONOMY: United States The United States economy is in recovery from the steepest recession of the post-war period. The recovery based upon data available through mid-May 2010, however, has been atypical compared with other cyclical rebounds. A sustainable and robust upturn is not in the current vernacular as a descriptor of recent trends. Yes, the economy is growing. Yes, there have been some increases in jobs. Yes, sales, output and even building are up from basement levels. Yet, the question lingers, is the recovery sustainable? The recovery definitely is not robust. Even the official determiner of business cycles, the National Bureau of Economic Research, opined in April 2010 that it was too early to declare an end to the recession because recent data may be revised and that there still exists a risk of another decline. Clouding the question of the sustainability of the recovery is that fiscal and monetary policy actions have been important triggers for the recent growth. Future growth of the U.S. economy may falter due to the end of federal stimulus, most notably the removal of tax incentives that supported the purchase of homes and autos. The Trends Inside the US Economy Real output of the U.S. economy, as measured by the gross domestic product, began to increase in the third quarter of A recovery, albeit slow ............. 3 2009 and has recorded three quarterly gains through the first quarter of 2010. Through April 2010, retail sales Fiscal challenges to eliminate recorded YOY gains for six consecutive months and budget deficits ............................ 4 reported monthly gains in 12 out of the past 13 months. Monetary policy gradually YOY Change in US Retail Sales Industrial output reducing liquidity ....................... 6 10% posted YOY gains 5% for each of the first Cyclical perspective on 0% four months of Spending ..................................... 8 -5% 2010. Businesses -10% began to rebuild Outlook for employment ....... 11