Rise in interest rates will put pressure on California, regulators say
Date: 2005/Jan/06 03:20 AM
Jan. 6--Federal banking regulators are keeping an extra-sharp eye on California this year to see what impact rising interest rates have on the state's economy and its banking sector.
The reason: If short-term interest rates continue to rise, as the Federal Reserve made clear earlier this week they probably will, the higher borrowing costs will "affect the state disproportionately" because of California's appetite for variable-rate loans.
With its high house prices and low affordability rate, Orange County is one of the regions in the state where adjustable-rate mortgages are especially popular. This September, a record 79 percent of local homebuyers used ARMs, according to an industry group.
"To the extent that California borrowers tend to be more heavy users of adjustable-rate product, there's more vulnerability there," said Richard Brown, the chief economist for the Federal Deposit Insurance Corporation because as rates rise it will not only crimp consumer spending but also make it harder for borrowers to make their monthly payments.
"Ultimately it could have a negative effect," said Catherine Phillips-Olsen, the regional manager of the FDIC's San Francisco office, which oversees banking in 12 western states.
In its quarterly analysis of the economic and banking conditions in the 50 states and the District of Columbia, the FDIC said California's economy did well in 2004 and the financial performance of banks and thrifts here was "solid."
But the FDIC said lenders here were particularly exposed to the housing sector because of the role that construction and development lending plays in their business.
Adding to the FDIC's concerns about the region: the rapid rise in house prices. Although unwilling to call the price increases a bubble, Brown pointed out that the house-price gains have outstripped increases in personal income by a wide margin -- a situation that becomes unsustainable as rates rise.
But the FDIC doesn't worry that the bubble will be followed by a bust. Historically, Brown said, real-estate busts don't necessarily follow booms, unless they're triggered by events such as recessions or out-migration.
The FDIC also said it wasn't concerned that the explosion of new banks in the state over the past five years has resulted in lax lending.
The agency says more than a quarter of the new banking offices opened in California since 1999 have been added by banks that didn't even exist five years ago. That's led some observers to worry that these lenders may lack the institutional memory to avoid the mistakes that led to the downturn in the late 1980s and early 1990s.
But Jack Phelps, the acting associate director of the FDIC's division of insurance, said the FDIC had stepped up its regulation of new banks.
"We've learned as supervisors that you have to scrutinize them before they open and be intense about the supervision once they open for the first three to five years to make sure they're on a strong footing," he said.
The FDIC, which was set up in the early 1930s, insures deposits in banks and thrift institutions for up to $100,000 per person and supervises how insured banks operate.
(714) 796-6726 or jkelleher@ocregister.com
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