Sanwa Bank Finds California Isn’t So Golden : Banking: Despite record profits last year, its return on assets has been flat for years, illustrating difficulties Japan’s banks have had here.

An instant architectural landmark since it opened early last year, Sanwa Bank California’s 52-story mixture of granite, glass and bronze towers over the western fringe of downtown Los Angeles, a blue-green glow shining at night from its top three stories.

Anchored at a 45-degree angle at Wilshire Boulevard and Figueroa Street, the sleekly designed building is as much a symbol of the Japanese-owned bank’s desire to stake a claim in one of the nation’s most competitive markets as it is a functioning headquarters.

While Sanwa’s name decorates the Los Angeles skyline, along with the names and logos of larger, better-known California rivals, the Japanese-owned bank has found that making it in the big leagues of banking here requires more than putting up a sign.

Sanwa, like most other Japanese-owned banks, has discovered that California is a tough market. Although it has avoided the big losses suffered by some of its rivals, Sanwa’s returns have been lackluster year after year--even when times were good. For Sanwa, the state’s sixth-largest bank with $7.5 billion in assets, key measures of profitability consistently run about half of the industry benchmark for excellence.

“Japanese banks on the whole have not performed as expected. We thought we could do better,” concedes Sanwa Chief Executive Masahiro (Mark) Yoda.

Sanwa’s performance mirrors the troubles other Japanese banks have experienced after expanding into California during the 1980s, partly to set up a beachhead for future expansion in the United States.

Back in the 1980s, when Japan’s economy could seemingly do no wrong, some predicted that Japanese banks could soon control California’s market. By 1988, they appeared well on their way, controlling 25% of the bank assets in the state, double the percentage of just three years earlier.

Instead, Japanese banks have been stung by the competitive--and now softening--California banking market. Executives of the banks say it is largely because they have emphasized growth at the expense of short-term profit.

But bankers throughout California say the Japanese underestimated how tough competition would be in the state. In addition, they bet too much on the volatile real estate industry and have failed to rein in costs, experts argue. A recent article in the publication “Institutional Investor” summed up the result as “Japan’s California Comeuppance.”

Last year, Japanese banks in California as a group finished in the red for the first time, losing 15 cents for every $100 in assets, according to the Federal Reserve Bank of San Francisco. The bulk of that was attributable to a huge $187.6-million loss posted by Bank of California, a unit of Mitsubishi Bank Ltd. that was pummeled by problem real estate loans.

Making matters worse are two developments: The once-hot California economy has fallen into a deep recession, squeezing borrowers for all banks and drying up demand for loans, and Japan’s banks are under unprecedented financial stress at home.

Japan’s so-called bubble economy has burst, marked by a plunge in its overheated stock and real estate markets. Unlike U.S. banks, Japanese banks are free to load up on stocks and real estate. That means that the capital they maintain as a financial cushion looks a lot smaller today than it did in 1989, when Japan’s stock market index was twice what it is now. Moreover, Japan’s banks are under growing pressure to meet tougher international capital requirements.

How vulnerable are the state’s major Japanese-owned banks--Sanwa, Sumitomo Bank of California, Union Bank, Bank of California and Manufacturers Bank--to the problems in Tokyo and Osaka?

Regulators, bank executives and analysts believe that there is no reason to be overly concerned. Because the banks are separately capitalized from their parent institutions, they are shielded from any immediate impact so long as they stay healthy. Indeed, Sanwa Bank California, owned by Osaka-based Sanwa Ltd., the world’s sixth-largest bank, boasts one of the strongest capital cushions of any bank in the state.

That shield contrasts sharply with a lack of protection for Japanese banks that do business in the state through agency offices. Because those offices are directly tethered to their parent banks in Tokyo and Osaka, they are likely to feel quickly any retrenchments ordered from headquarters.

It’s not that there isn’t any impact at all for Japanese-owned banks in the state. Any extra infusion of money needed to either mop up problem loans or finance a major acquisition will be harder to come by as purse strings from the parent companies tighten.

“The effect from Japan is more indirect,” said Jonathan Neuberger, a banking economist with the Federal Reserve Board of San Francisco. “Basically, they have to lay low and do their business and not do anything that might require additional funds.”

The difficulties banks in California are going through has triggered the kind of self-examination at Sanwa some say was long overdue. Reining in expenses, for example, an obsession at such banks as Wells Fargo and Bank of America, has finally become a key goal.

Sanwa has only recently revamped its branch system, for example, looking at such things as doing a better job of staggering the number of tellers on duty to match the busiest hours of the day. Most banks in the state have such management systems down to a science. The bank is also trying to eliminate bureaucratic paperwork and make things work faster.

But cutting costs and paperwork aren’t enough. Bank experts and former Sanwa employees say the bank must speed up what they say can be a sluggish timetable for approving loans to larger business customers. The bank also must figure out a clear strategy for its 105 branches in the state, which some say are spread too thin to compete effectively with such giants as Wells Fargo & Co., First Interstate Bancorp and BankAmerica Corp., especially now that it has acquired Security Pacific Corp.

One change that may help is a recent injection of fresh blood into the executive suite. Sanwa hired Howard N. Gould, the state’s top bank regulator in the late 1980s, as a senior executive vice president. Gould formerly headed the West Coast operation of Secura Group, a well-connected bank consulting firm in Washington.

Although Sanwa has had a presence in California since 1972, its major push came in 1986, when it took advantage of a British retreat from California banking by purchasing the state operations of Lloyds Bank.

Unlike most Japanese banks in California, some of which frequently downplay their Japanese ownership, Sanwa doesn’t shirk from promoting its name. It once based an entire radio ad campaign around the name, emphasizing how odd it sounds for the name of a bank. Company executives contend that, except for a couple of minor incidents, they have not felt a backlash from the recent economic tension between the United States and Japan.

Sanwa does get high marks for getting an early grip on problem loans, which came about partly because it was prodded into doing so back in 1988 by federal bank regulators. As a result, it has not been hurt as badly as many banks by problem real estate loans. In addition, Sanwa specializes in smaller loans, reducing its vulnerability to any one borrower’s problems. Typical size of a business loan is about $2 million, Sanwa executives say.

Competitors and former Sanwa executives credit the bank with capturing a large chunk of the farm lending business in the San Joaquin Valley. And, competitors note, Japanese companies with operations in California will continue to provide steady business for Japanese-owned banks such as Sanwa.

“They have such a referral network that almost every Japanese deal goes to one of those banks,” said Philip Boyce, chairman of Pacific Western Bancshares in San Jose.

Still, Sanwa’s returns have been disappointing. Even though its $38.6-million profit last year was its highest ever, the bank’s return on assets--considered a more important measure of performance--has been flat for years.

In most of the past five years, it has earned about 50 cents of profit for every $100 in loans and other assets. The industry benchmark of a good performance is considered $1 or more. Likewise, the bank’s return on equity has typically hovered between 4% and 8%, less than half of the target most banks shoot for.

Takakura, the Sanwa senior executive vice president, concedes that returns have been too low. He says the bank is aiming at earning about 90 cents for every $100 in assets.

In fairness, however, making a profit, as Sanwa did last year, was something of an accomplishment in one of the worst years ever for the state’s banks. Security Pacific--in its last full year before being acquired by BankAmerica--lost $775 million. First Interstate lost $288.1 million. And Wells Fargo was hammered by bad real estate loans.

The larger question is whether the financial troubles Japan’s banks are experiencing at home--combined with the disappointments they are having in California--will scuttle their plans altogether in the state. One top banker, Wells Fargo Chief Executive Carl E. Reichardt, has already suggested that one or more of the state’s Japanese banks may be up for sale soon because results have been disappointing.

But executives of Japanese-controlled banks say there are no plans to withdraw from California. Developing business in the state, because of its importance in Pacific Rim commerce, remains a priority with executives in Japan, they argue.

Tomio (Tom) Takakura, Sanwa senior executive vice president, also notes that Sanwa’s California operation is only about 2% of its parent, so other areas of the world are likely to demand more attention.

For now, Sanwa plans to expand, albeit it in small, careful steps. It has for the first time bought deposits and branches of failed thrifts from the federal government, last month acquiring five branches of failed Atlantic Financial Federal Savings Bank. Gould says the bank is looking to further expand in such areas as the San Fernando Valley.

Still, nothing of size is expected for now, at least with the outlook for the state economy--and Japan’s own economic troubles--so cloudy.

“We are looking for small acquisitions. Frankly speaking, in this environment, I don’t think we are ready to make a large acquisition,” Chief Executive Yoda said.

Sanwa by the Numbers Sanwa Bank California, which is owned by Japan’s Sanwa Bank Ltd., has grown modestly in the past five years.

1991 1990 1989 1988 1987 Net income, in millions $38.6 $38.1 $19.0 $31.8 $22.2 Assets (12/31), in millions $7,500 $7,100 $6,900 $6,400 $5,300 Return on average assets 0.56% 0.55% 0.29% 0.55% 0.44% Return on equity 6.67% 7.61% 4.50% 8.78% 6.63%