Security Pacific's Safety Net Is Fraying Fast

When Robert H. Smith became chief executive of Security Pacific Corp. last year, his biggest challenge seemed to be finding a way to improve on his predecessor's stellar record. Under Richard J. Flamson III, the Los Angeles-based banking company had quadrupled its assets, to $84 billion, and aggressively expanded into global merchant banking. Soon after taking charge, Smith returned from a management brainstorming session in Palm Springs with promises to boost the stock and push Security Pacific into a fresh round of bank acquisitions.

Promises, promises. For Flamson's legacy to Smith seems to be a slew of problems. To the tune of a $200 million write-off, Smith late last year announced he would disband Security Pacific's international lending and securities trading operations. Meantime, loans on highly leveraged deals were going bad, including a big one to troubled Hawaiian Airlines Inc. And bum real estate loans stretched from Britain to Arizona. Profits fell 78% last year, to $161 million--and another 62% in the first half of 1991.

'OMINOUS.' The latest whammy is coming in Security Pacific's own backyard. Bad loans on California real estate are beginning to take a toll. Security Pacific said in July that about half of the $658 million in loans it classified as nonperformers in the second quarter are California real estate loans. That hurt the stock. But the bad news just keeps coming: On Aug. 2, Keefe, Bruyette & Woods Inc., a prestigious bank research firm, forecast further real estate loan losses in California. There went the stock again, this time down by about 5% in a day.

All California banks are struggling with the Golden State's recession, but Security Pacific has stood out for its reluctance to concede any worries. "They are not as far along in recognizing their problems as other California banks are," says Sandra Flannigan, an analyst at Alex. Brown & Sons Inc. She points to its low level of loan-loss reserves relative to its troubled loans: 58% at Security Pacific, compared with an average of 82% nationally. Crosstown rival First Interstate Bancorp has bent over backward, with reserves amounting to 115% of its nonperforming loans.

Smith and other Security Pacific executives declined to be interviewed. But in the past they've said the bank keeps lower reserves because it has already aggressively written off some bad loans and that it has solid collateral to back others.

Just the same, Security Pacific's reserve ratios are thinning as its loan portfolio is turning sour. Nonperforming loans and foreclosed real estate jumped to 6% of total loans and foreclosures at midyear, compared with 4% nine months earlier (chart). Growth in nonperformers even outpaced the bank's hefty charge-offs of bad loans--$933 million during that period--notes David C. Cates, president of Cates Consulting Analysts Inc. "That's a fairly ominous sign," he adds. Donald K. Crowley, the Keefe Bruyette analyst whose report shook investors, expects bad loans to grow by another $600 million to $700 million in the second half.

Security Pacific earlier this year was forecasting a second-half turnaround in California's economy. Analysts now think it could take longer. "It may be mid-1992 before it turns," says Claire M. Percarpio, a credit analyst at Duff & Phelps/MCM Research Co. California suffered later than most of the nation, and it will likely rebound later, too. Moreover, Flannigan fotes, loan troubles tend to lag behind turns in the economy: "The problems have not yet peaked."

Looming loan problems may have squelched Security Pacific's merger talks with Wells Fargo Bank. When negotiations broke off last December, many analysts suspected that the hardnosed San Francisco rival had been spooked by the unknown depths of Security Pacific's loan problems. Neither side would comment on why the talks ended.

WINDOW SHOPPING. Despite its continued optimism about an impending upturn, the bank's shares, now around 23, are 58% below their August, 1989, high of 54 7/8. And when it comes to mergers, a bank's stock is its "currency," as Smith likes to call it. Security Pacific's weak currency means its managers must stand by while such rivals as Bank of America, which went through its own crisis in the mid-1980s, use their stock to scoop up banking units at bargain prices. On July 31, BofA announced plans to buy Valley Capital Corp., parent of Nevada's No. 2 bank, in a deal valued at $400 million.

Smith gets high marks from industry analysts for his handling of the problems he inherited from Flamson. His task involves a basic repudiation of the fast-growth, global expansion policies that had guided the bank during the previous decade. Smith also has Security Pacific backing away from its strategy of limiting interest-rate risk in favor of fee-based businesses, such as the merchant bank.

The bank's future, Smith said at the April annual meeting, is in its traditional role as a big retail and commercial lender in the West. "We envision ourselves getting back to our core businesses," he said, "not fat or fancy." Keefe Bruyette's Crowley is impressed: "I have to give him credit for being willing to turn the company upside-down," he says. "He's doing what needs to be done, and it's a dirty job." And it's hardly the job he expected when he returned from his desert sojourn to Palm Springs.

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