BusinessWeek: January 11, 1993

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 Industry Outlook: BANKING

IT'S A BANK EAT BANK WORLD

Battle-scarred banks entered 1992 expecting only mild relief from a mountain of troubles. So it was more than a surprise when a combination of low interest rates and a slowly strengthening economy helped the industry produce a record $25 billion or more in earnings, according to American Bankers Assn. estimates. The industry still faces fundamental problems, and the big banks' profit growth will probably slow this year from last year's 90%. Even so, earnings could set another record in 1993.

The steady decline in short-term interest rates since 1990 has been a godsend to banks. Many of them borrow short-term money to lend for longer periods, so they've been able to reduce their funding costs, hold loan rates relatively steady, and pocket the difference. Most experts believe the cost of money has bottomed out, and note that if rates rise much, bank earnings could suffer. But the damage to profits should be largely mitigated by a decline in the amount of poor-quality assets banks hold. By last September, many big U.S. banks were reporting a slight decrease in problem loans. The Federal Deposit Insurance Corp. says the industry's nonperforming assets fell $2.25 billion last year, to $97.4 billion. And the number of banks on regulators' watch lists is falling.

SMALLER PIE. The industry will also benefit in 1993 from draconian cost cuts it made over the past two years. Citicorp has pared its work force by about 18,000, or 18%, since late 1990. And the merger of Chemical Banking Corp. and Manufacturers Hanover Corp. has led to staff cutbacks there totaling more than 4,500. Industry analysts expect more bank cutbacks and layoffs this year.

Even a slimmed-down industry faces an underlying problem, though: declining demand for bank products and services. Big, healthy companies that used to be bank customers now tap the capital markets directly, for instance. Thus, even if demand for credit picks up, there may not be enough quality investment avenues for all the lending banks want to do. "The revenues available to you in this industry are shrinking," says James M. McCormick, president of First Manhattan Consulting Group. "The industry is probably 30% over capacity."

So, as they did last year, banks will move into businesses where demand is strongest. Minneapolis-based Norwest Corp., for one, is fast expanding its mortgage and finance companies, and offering such new products as mutual funds through its branches. Chief Executive Officer Richard M. Kovacevich even views his branches as retailing operations, and aims for "same-store sales growth," a novel concept for bankers, who used to offer a limited array of products.

Others are expanding their transaction processing, the low-risk, nuts-and-bolts job of moving money around the world for a fee. Since merging with Security Pacific Corp. in 1992, BankAmerica Corp. has become a leader in this field, according to Salomon Brothers Inc. Philadelphia's CoreStates Financial Corp. and Boston's State Street Boston Corp. are both doing more transaction processing.

Still other banks continue to train their sights on a few well-defined segments of the business. Bankers Trust New York Corp. is focusing on securities and derivatives trading and wholesale banking rather than on retail products, such as checking and savings accounts. Vice-Chairman George J. Vojta says Bankers will continue that overall thrust in 1993. "You can see a new kind of a definition" in banks' competitive strategies, he says.

WISH LIST. Banks are also merging to reduce overcapacity. John F. McGillicuddy, CEO of Chemical Bank and a veteran of the first blockbuster merger of crosstown rivals, expects many more combinations. "We'll continue to see consolidation across the country, and hopefully, [Chemical] will demonstrate that an in-market merger can be successful," he says. Experts say there could be fewer than 8,000 banks by century's end, down from 12,000 now.

How many banks survive could depend in part on how friendly the new Administration is. Bankers are eager to press their case on several issues to President-elect Bill Clinton. Six major industry groups got together on Dec. 7 to write him a wish list for '93, which proposes liberalizing financial-reporting requirements and other industry regulation. The bankers also want an end to what they see as regulators' micromanagement, which, they complain, puts them in a straitjacket. William Brandon, president of the American Bankers Assn., has told Clinton that if banks' regulatory burden were lightened, they would lend more--and that a 4% increase in lending would mean $86 billion in new credit. Such a big increase is unlikely, experts say, but any new lending should create jobs, a Clinton priority.

However Clinton reacts, banks seeking help in Washington are going to run into trouble with the chairmen of the House and Senate Banking Committees. Representative Henry B. Gonzalez (D-Tex.) and Senator Donald W. Riegle Jr. (D-Mich.) are proud of the bank-reform legislation they shepherded through in 1991. They're also unhappy about reports that banks aren't lending as much in low-income neighborhoods as the rules say they should--and aren't convinced that the industry's troubles are behind it.

Now that bank profits are healthy again, the industry must turn its attention to long-term challenges. To ignore the fact that borrowers are going elsewhere for credit--a bank's primary product--"is like saying you're not going to make a decision about a train that's six inches from your nose," says Edward E. Crutchfield Jr., CEO of First Union Corp. in Charlotte, N.C. The only question is: Which companies will position themselves successfully enough to be around for the next banking crisis?

Kelley Holland in New York, with Mike McNamee in Washington
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