There is nothing like a good boost in interest rates to concentrate the minds of bankers.
While the Federal Reserve's moves on Wednesday were widely anticipated, putting the federal funds target at 5.5% and the discount rate at 4.75%, their magnitude was not.
Major banks sprung quickly into action by increasing their prime rates a parallel 75 basis points, to 8.5%, then getting down to assessing the likely impact on net income and on various interest-sensitive lines of business.
The general consensus is that bank depositors can look forward to a resurgence in rate competition; borrowers will pay more; and during the lag time for repricing liabilities and assets, banks' margins will narrow, pinching profits into next year.
Commercial Lending
Bankers in the commercial and industrial market looked at interest rates in the context of overall economic activity. They said if loan volume declines, it will not happen fight away.
Josh Feinman, a global markets economist at Bankers Trust Co. in New York, said he expects the dampening effect on the economy will become noticeable in the loan market in the next year.
Frank Lourenzo, executive vice president in Chemical Bank's middle market banking group, said the rate hike might send a psychological signal to his customers, "but a rise in interest rates doesn't deter customers from borrowing if they see opportunity."
One market that might be affected is mergers and acquisitions, which remained robust through the earlier rate increases this year, Mr. Lourenzo said. A 75-basis-point rise may prove more significant.
Derivatives
Higher rates could cause more losses on derivatives portfolios.
For most banks, analysts said this poses no problem. A decrease in value should be offset in other areas, such as fixed-rate instruments and core deposits.
"That's what hedges are designed to do," said Ronald I. Mandle, an analyst with Sanford C. Bernstein & Co.
Hedges have not worked so well at PNC Bank Corp., Pittsburgh, he said.
The bank has been undertaking a balance sheet restructuring by swapping fixed-rate for variable-rate instruments, particularly index-amortizing swaps, which has left it vulnerable.
"More banks have swung into the liability-sensitive position in the third quarter," said Frank DeSantis of Donaldson, Lufkin & Jenrette. "As rates go up, their cost of funds go up [faster] than their yields."
One bank that analysts are watching, Huntington Bancshares of Columbus, Ohio, has adjusted for higher rates, said investor relations officer Debra Dendahl-Hadley. She said the proportion of assets at risk has declined to 2.5% from 6%.
Keycorp's chief financial officer Jim Wert acknowledged the bank is a little more liability-sensitive than it was, but that is offset by rapid earnings asset growth. Though the net-interest margin fell from 5.30% in 1993 to 4.80% in the third quarter, Mr. Wert said, Keycorp's is still sixth-highest among U.S. banks.
Deposits
"There's a lot of latent demand out there," said Mitch Ratliff, a vice president at Chase Manhattan Bank in New York. "People want to reinclude deposit products into their portfolios now."
Chase, he said, has taken out full page ads in The New York Times and other major dailies, comparing yields on CDs with those of bond and equity funds that have suffered dramatically in the past year.
"We should be asking if the tide [of assets toward mutual funds in recent years] will start to turn back now," said Mr. Ratliff.
"I think there's money out there that's feeling uncomfortable about where it's housed, and I think that's money that will be coming back to the [banking] industry," said Daniel Rowe, executive vice president at State Bank of Long Island, New Hyde Park, N.Y.
The loser in all this may be bank sales of investment products, which have slowed to a crawl.
"I think it will definitely impact negatively on our brokerage business, especially our equity-based business," said B. Randolph Bateman, senior vice president of the trust investment department at Star Bank in Cincinnati.
Mortgages
First-mortgage lenders, already hurting from the end of the refinancing boom, may see a slowdown in purchase lending as well.
Rate shock should push new loan originations down, lenders said, especially with the holiday season at hand. And first-time homebuyers, a staple of this year's market and drawn to adjustable-rate loans, may be driven to the sidelines by rising short-term rates.
"Our fear is if the yield curve flattens or inverts, the first-time buyer may not be able to purchase that home," said Dale Westhoff, a mortgage analyst at Bear, Steams & Co.
Home-equity lending also could slow, experts said, as credit lines tied to the higher prime rate look less attractive.
Credit Cards
Credit card issuers have largely cushioned themselves against interest rate movements by offering variable-rate products, which already have been resetting. The bigger question is how card spenders will react.
RAM Research Corp. of Frederick, Md., estimates the latest Fed hikes will cost consumers an additional $1.4 billion in interest charges next year, or about $13 on the average cardholder balance of $1,700.
That means a decline in discretionary income, said John A. Ward 3d, senior vice president at Chase Manhattan Corp. "So there will be probably a slowdown in consumer spending."
But Ruth Susswein, executive director, Bankcard Holders of America in McLean, Va., said, "I suspect [higher rates are] not going to have a great impact, we're heading into holiday shopping."
Cynthia A. Graham, president of Barnett Banks Card Services in Jacksonville, Fla., said cardholders may switch to fixed-rate cards as the variable rate cards rise above fixed rate cards.
-- This article was written by Jeffrey Kutler, with reporters Daniel Dunaief, Mickey Meece, William Plasencia, James H. Saft, and Dean Tomasula.
Broad Repercussions
* Certificates of deposit should gain appeal.
* Securities losses are likely to mount.
* Home loan rates may discourage first-time buyers.
* Credit card transactions may be curbed.
* Interest margins expected to tighten.
