PFF Bancorp: Are Californian Banks Really That Bad?

In short, the answer to the question in the title above is an emphatic yes. If the results put out by Downey Financial (NYSE:DSL) in mid April did not confirm this, further support can be found in the most recent quarterly report put out by PFF Bancorp (NYSE:PFB). The report was absolutely terrible, as it showed that the bank was taking on gargantuan losses in its loan portfolio requiring it to dramatically increase its loan loss provision and forcing the company to seek additional support in the form of loans from other commercial banks.

PFF Bancorp began the quarter with a book value of approximately $360 million, which has likely dwindled to a third of that after taking a $200 million dollar loan loss provision last week. The news of these write downs sent the stock down over 30% on the day, leaving it down 90% for the year, yet even with this decline there is still no value in this bank as the likelihood of increasing loan losses will eventually lead to the banks insolvency.

With the addition of these reserves, the bank now has about $270 million in loan loss reserves on its balance sheet. With total loans of somewhere around $4 billion, the company has a loan loss reserve ratio of a little over 6%. While in normal times this high of a rate would be considered excessive, it should be clear by now that we are not in normal times. The bank is still likely under funding its reserves as it has substantial exposure to various homebuilders and raw land. Here is a breakdown of the banks more questionable loans:

• 300+ million in land loans
• 200+ million in subordinated debt (probably second mortgages)
• 600+ million in 1-4 family construction projects
• 200+ million in revolving loans (probably home equity lines)

Even if you exclude the majority of their mortgages, PFF Bancorp has over a quarter of their loans tied up in areas that will likely continue to perform poorly. While the bank's loan loss reserves are now a little over 6% of assets, there remains significant risk because of the potential for loan losses in the above listed areas. If loan loss reserves were to be brought up to 10%, the bank would eliminate its equity base forcing the FDIC to take action to protect the bank’s depositors.

If Downey Financial can be seen as a harbinger of future loan loss rates in California, PFF Bancorp and other banks in California will be in significant trouble. For the most recent quarter, Downey Financial had over 12% of its loans classified as non-performing, with this rate likely to jump substantially higher in the months ahead as housing prices continue to fall and mortgage rates reset to higher levels. If PFF Bancorp’s loans were to perform at the same level as those of Downey Financial, bankruptcy would be all but assured for the company.

What I have found especially troubling is the speed by which PFF Bancorp has managed to collapse. The company only recently began taking large loan reserves after taking barely any in 2006 and the first part of 2007, which has forced it to play a painful game of catchup. The most unsettling part of PFF Bancorp’s story though is that its own estimated loan loss reserves for the quarter nearly doubled between April 1^st to May 1^st. This suggests that further deterioration has been occurring in the California market.

Right now, I think that the banks out west will likely need to take a minimum write off of 10 to 20% of their loan portfolios. Even at these high levels, I would not be surprised to see the losses taken by these banks climb above this range should the U.S. economy enter into a protracted recession.

Below is a list of other California Banks and Savings and Loans that I am watching:

• FirstFed Financial Corp (FED)
• Wachovia Corp (WB) (via their acquisitions of Golden West)
• Pacific Capital Bancorp (PCBC)
• UnionBanCal Corp (UB)
• UCBH Holdings (UCBH)
• Cathay Genearl Bancorp (CATY)

For Further Review: PFF Bancorp Press Release

Disclosure: none

Comments

[domeland]

This is too bad about PFF. They were a small town bank with great personal service and a long history in the region. Compared to Wamu, BofA and other banks I have used, these folks were the best. I hope they survive.