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The California banking industry began to rebound in 1992, well before the state's slow economic recovery took hold. Yet as late as 1994, many of the state's small or community banks still struggled with poor asset quality and weak earnings or losses--indeed, 22.5 percent of the state's 333 community banks lost money; in sharp contrast, countrywide less than 4 percent of small banks recorded losses in 1994, and outside of the West no other group of banks, whether compiled according to size or region, reported losses at more than 6 percent of banks.
This paper examines several factors that may have influenced community bank performance in California, factors that may explain why their asset quality and returns remained weak three years after the national economy began its recovery from the 1990-1991 recession and long after the banking industry had rebounded at the state and national levels.
The first of these factors is the dependence of community bank performance on local or regional economic conditions. Although the California economy is large and well-diversified, with a population of over 32 million in 1995, most community banks are small and typically operate within a limited local or regional market.
Second, in the 1990s the economic performance of several key regions of California differed significantly, as the state endured one of its longest and most severe downturns of the postwar era. Most of the sizeable decline in employment in the state following the 1990-1991 national recession occurred in Southern California, and some of the most severe real estate market problems also took place in that part of the state.
Third, California banks became much more active in real estate lending over the 1984-1994 period. Community banks nearly doubled their ratio of real estate loans to total loans, thus increasing their exposure to a real estate downturn. By 1994 nearly two-thirds of all their loans were secured by real estate, and they had the highest ratio of real estate loans to total loans of all bank size groups.
Finally, over the 1984-1994 period California banks increased their financing of relatively high-risk types of real estate lending. Community banks more than doubled their ratio of commercial real estate loans to total loans, to more than 45 percent in 1994, the highest...