Last week, the Federal Reserve raised interest rates and warned that inflation was on the rise. One question is whether regional lenders will get clobbered by a real estate market that’s bound to cool off as borrowed money gets more expensive.
The SNL Small Bank Stock Index, which includes banks and thrifts with assets between $5 billion and $10 billion, is down 9.6 percent this year. (The group includes several local players, including East West Bancorp, Cathay General Bancorp and Commercial Capital Bancorp in Irvine.)
Jack Sweeney, chairman and chief executive of First Regional Bancorp in Century City, says he’s seeing a slight downturn in demand for real estate bridge loans. First Regional, a 25-year-old holding company for First Regional Bank, provides an unusual snapshot of whether banks can sustain a significant downturn in the Southern California real estate market.
First Regional specializes in short-term real estate and construction loans. The parent also owns two trust subsidiaries that draw deposits that may help it weather a real estate slump.
The bank has tripled its assets in the past five years to more than $1 billion. Its thinly traded stock has doubled in the past year to around $64 a share.
“We don’t look for loans, we look for deposits,” said Sweeney, who at 75 continues to run the bank’s day-to-day operations along with two longtime lieutenants.
There has been published speculation that because of Sweeney’s age, he might cash out his 35.6 percent stake by selling to a larger bank. Steven Sweeney, Jack’s son and First Regional’s general counsel, said the bank plans to remain independent.
Clayton Kuntz, a banking analyst at Keefe Bruyette & Woods in San Francisco, believes First Regional will continue to see “strong momentum” in the first half of 2005, justifying his $72 price target on the stock.
“The market may change as interest rates rise, but First Regional has really been in a sweet spot in the past few quarters,” Kuntz said.
Shifting market
As interest rates rise, the bank is being careful about potential problem loans, said Jack Sweeney, who serves as chief credit officer and personally approves every loan.
He chided developers who built speculative tract houses before the 1991 downturn. “That’s what got them into trouble before,” Sweeney said. “I don’t see any of those problems now.”
First Regional also runs trust subsidiaries that administer self-directed IRA accounts and trust services. Those units account for roughly one-third of all deposits, which might help the bank keep steady during rising interest rates by generating higher margins on floating-rate loans while its payout on deposits stays low.
First Regional’s loans, typically for the purchase of shopping centers, strip malls, apartment buildings and industrial warehouses, range from $4 million to $7 million, but can go as high as $20 million. Last year, First Regional’s deposits jumped 50 percent, loans increased 62 percent, and net income skyrocketed 140 percent.
Institutional investors including Wellington Management Co., Sunova Capital LP and Capital Research and Management Co., a unit of Capital Group, have taken minor stakes in the bank.
Though loan growth for all banks is expected to slow as the real estate market cools, bankers continue to believe that conditions in Los Angeles differ from the real estate downturn of the 1990s.
At that time, many developers had engaged in speculative building. Large layoffs by defense contractors caused unemployment to spike. When regulators stepped in to examine loans held by banks and thrifts, many were reclassified because property values no longer supported the original loan amounts and a number of financial institutions collapsed.
For more than a year now, economists at the UCLA Anderson School who correctly predicted the last real estate downturn have sounded a warning cry about a real estate bubble. As a result, many bankers are on high alert.
“Every bank is heavily involved in real estate and it’s just a matter of proportion,” said Dick Cupp, president and chief executive at First Century Bank, a year-old business bank in Century City. “Banks are in a much better position to absorb a real estate slowdown, with strong reserves and underwriting. Of course, that doesn’t mean there won’t be issues for some banks.”
*Staff reporter Kate Berry can be reached at (323) 459-5225, ext. 228, or at
[email protected]
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