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Amazing What Borrowing Low And Lending High Will Do


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AMAZING WHAT BORROWING LOW AND LENDING HIGH WILL DO

Rebounding sharply from a dismal 1991, the nation's largest banks found making money in 1992 as easy as withdrawing cash from an automatic teller machine. The chasm between banks' low short-term funding costs and their return from much higher-yielding long-term investments and loans virtually guaranteed a huge boost in profits. Net income for the 100 largest U.S. banks in BUSINESS WEEK's annual Bank Scoreboard (page 150) more than doubled, and return on equity followed suit. First-quarter 1993 results have been strong as well, with many companies reporting profits above most analysts' forecasts.

The good times, though, may not keep rolling. Spreads between short and long rates have been at record levels for longer than anyone has expected, and almost no one expects them to remain this wide for another year. That means the industry may not be able to sustain stellar earnings growth through the end of 1993 and into next year. "It's not possible to double and triple earnings several times in a row. The world doesn't work like that," says Diane Glossman, an analyst at Salomon Brothers Inc.

There's no question, though, that banks will long remember 1992. They were able to rake in gobs of net interest income in two ways. Most important, they borrowed short-term money at low rates and invested it in higher-yielding long-term securities. They also used their deposit accounts, for which they pay depositors around 3%, to make loans to consumers and small businesses, who typically paid more than the prime rate, currently 6%.

PRIME TIME. Take First Empire State Corp. The Buffalo bank pays customers 2.75% on a six-month CD these days and can borrow in the Fed funds market at 3%, but it can lend at the prime rate of 6%--or more. Gary S. Paul, senior vice-president and head of corporate finance, says the rates on about $2 billion of First Empire's $6.98 billion in loans are tied to the prime. Paul doesn't expect the wide spread to last forever--"it has shocked the heck out of me that it has lasted this long," he says--but he's enjoying it while he can. The lavish rate differential was the main reason his company's net interest income increased 30% in 1992, to $438 million, he says. MBNA Corp., a bank specializing in credit-card loans spun off from MNC Financial Inc., has been the most profitable of the nation's big banks for two years in a row because of the lofty rates it has been able to charge credit-card customers. MBNA's return on equity has been 28.5% for two years running.

First Union Corp. also generated net interest income gains of nearly 15%, even excluding the effect of acquisitions in 1992, according to treasurer Ken R. Stancliff. As at First Empire, a lot of First Union's gain was because of the wide spread between lending rates and borrowing costs. But First Union also benefited from its use of derivatives to increase the effective maturity of its assets. That let the bank reap the benefits of a decline in the cost of its borrowing while its lending and investing rates remained high.

Bank of Tokyo Trust Co. was the least profitable of the big banks, generating a return on equity of 9.5% and losing some $44.8 million. The company continued to suffer from the bank-lending spree of the late 1980s: Its loan-loss provision increased 62%, to $164.7 million. Charge-offs represented 2.6% of the bank's loans.

For many banks, however, credit quality improved. Nonperforming assets averaged just 2.5% of loans, down from 3.3% a year earlier, and loan-loss provisions declined an average of 19%. That's a big change from 1991, when loan-loss provisions grew 13%. Bank of New York Co. was a prime beneficiary of improving credit quality. The bank took its hits a little earlier than many other big banks did. As a result, its loan-loss provision declined 43%, to $427 million, in 1992, and charge-offs shrunk from 2.6% of loans to 1.8% of loans. Those factors helped the bank triple its net income, to $369 million.

Most banks on the two coasts showed ebounding sharply from a dismal 1991, the nation's largest banks found making money in 1992 as easy as withdrawing cash from an automatic teller machine. The chasm between banks' low short-term funding costs and their return from much higher-yielding long-term investments and loans virtually guaranteed a huge boost in profits. Net income for the 100 largest U.S. banks in BUSINESS WEEK's annual Bank Scoreboard (page 66) more than doubled, and return on equity followed suit. First-quarter 1993 results have been strong as well, with many companies reporting profits above most analysts' forecasts.

The good times, though, may not keep rolling. Spreads between short and long rates have been at record levels for longer than anyone has expected, and almost no one expects them to remain this wide for another year. That means the industry may not be able to sustain stellar earnings growth through the end of 1993 and into next year. "It's not possible to double and triple earnings several times in a row. The world doesn't work like that," says Diane Glossman, an analyst at Salomon Brothers Inc.

There's no question, though, that banks will long remember 1992. They were able to rake in gobs of net interest income in two ways. Most important, they borrowed short-term money at low rates and invested it in higher-yielding long-term securities. They also used their deposit accounts, for which they pay depositors around 3%, to make loans to consumers and small businesses, who typically paid more than the prime rate, currently 6%.

PRIME TIME. Take First Empire State Corp. The Buffalo bank pays customers 2.75% on a six-month CD these days and can borrow in the Fed funds market at 3%, but it can lend at the prime rate of 6%--or more. Gary S. Paul, senior vice-president and head of corporate finance, says the rates on about $2 billion of First Empire's $6.98 billion in loans are tied to the prime. Paul doesn't expect the wide spread to last forever--"it has shocked the heck out of me that it has lasted this long," he says--but he's enjoying it while he can. The lavish rate differential was the main reason his company's net interest income increased 30% in 1992, to $438 million, he says. MBNA Corp., a bank specializing in credit-card loans spun off from MNC Financial Inc., has been the most profitable of the nation's big banks for two years in a row because of the lofty rates it has been able to charge credit-card customers. MBNA's return on equity has been 28.5% for two years running.

First Union Corp. also generated net interest income gains of nearly 15%, even excluding the effect of acquisitions in 1992, according to treasurer Ken R. Stancliff. As at First Empire, a lot of First Union's gain was because of the wide spread between lending rates and borrowing costs. But First Union also benefited from its use of derivatives to increase the effective maturity of its assets. That let the bank reap the benefits of a decline in the cost of its borrowing while its lending and investing rates remained high.

Bank of Tokyo Trust Co. was the least profitable of the big banks, generating a return on equity of 9.5% and losing some $44.8 million. The company continued to suffer from the bank-lending spree of the late 1980s: Its loan-loss provision increased 62%, to $164.7 million. Charge-offs represented 2.6% of the bank's loans.

For many banks, however, credit quality improved. Nonperforming assets averaged just 2.5% of loans, down from 3.3% a year earlier, and loan-loss provisions declined an average of 19%. That's a big change from 1991, when loan-loss provisions grew 13%. Bank of New York Co. was a prime beneficiary of improving credit quality. The bank took its hits a little earlier than many other big banks did. As a result, its loan-loss provision declined 43%, to $427 million, in 1992, and charge-offs shrunk from 2.6% of loans to 1.8% of loans. Those factors helped the bank triple its net income, to $369 million.

Most banks on the two coasts showed dramatic improvements in profitability and credit quality. Chemical Banking Corp. booked a 605% increase in earnings after taking a $625 million restructuring charge in 1991. Boston's BayBanks Inc. reported a 514% increase in net income, the second biggest gain. Chairman and CEO William M. Crozier Jr. says the results are "nothing to crow about because we're coming off such a low base." But he thinks the bank's operating profits will improve as spreads remain high and the costs of managing bad assets decline.

EARLY SIGN. Citicorp, the nation's largest bank, went from losing $914 million in 1991 to earning $722 million last year and $370 million in the first quarterof 1993. The bank has reduced operating expenses, and while its credit costsremain close to record levels, they are falling.

And in California, First Interstate Bancorp posted profits of $282.3 million after reporting a loss in 1991. Like Bank of New York, First Interstate began contending with problem loans before many of its competitors, and it's now benefiting from the early action. Its loan-loss provision was down 61%, to $314 million.

The improving health of the industry is an early sign of a long-term trend, says David S. Berry, director of research at Keefe, Bruyette & Woods. Investors have long viewed bank earnings as less dependable than those of, say, consumer-products companies, he says. But "consolidation should lead to less overcapacity, so there will be less incentive for banks to go out and make risky loans."

Berry may well be right. But after striving mightily to pare expenses in the last two years, BayBanks and others are starting to hire again. And lending is still meager: Loans grew just 2% in 1992 and declined as a portion of banks' assets. What's more, low interest rates are cutting into bank revenues. If banks start letting their operating costs rise before they've boosted their lending or otherwise assured themselves of higher revenues, they can be almost sure that they won't enjoy a repeat of 1992's rebound anytime soon. Kelley Holland in New York, with Chuck Hawkins in Atlanta and Geoffrey Smith in Boston


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