Nearly half of the nation's largest banks are burdened by securities portfolios that render them vulnerable to further damage from rising rates, according to a new report by a New York analyst.
Linda Stromberg of M.R. Beal & Co. says 46 of 94 banks she covers face significant risk. Her conclusion is based on a model that factors in the sizes of bank securities portfolios relative to assets and their deterioration as rates rose earlier this year.
In the wake of a third quarter in which imbedded losses in these bank portfolios jumped a staggering 43%, to $12 billion, Ms. Stromberg isn't the only analyst coming to grips with this issue.
There is general agreement, in fact, that the handful of charges taken against securities portfolios in the third quarter were only the beginning.
Illustrating just how uncertain the situation is, however, there is little agreement among analysts on which banks are most vulnerable or on which securities pose the most danger.
Ms. Stromberg's report breaks new ground in a number of respects -- including the rhetoric used to describe the problem. Her report, co-authored by Jarius Dewalt, identifies the top "toxic portfolios," and bears the title, "Banks to watch -- from a distance."
What's more, the cover illustration depicts some common bank investment instruments as bombs and the regulator as a blind person about to step into a large crater.
"As interest rates rose, things got worse for everyone in the banking industry," Ms. Stromberg said. At the end of the first quarter, she said, 44 banks reported a negative securities adjustment totaling $1.1 billion. At the end of the third quarter, that figure jumped to 75 out of 94, for an adjustment totaling $3.1 billion.
"The larger the bank's securities portfolio," she said, "the more that bank relies on it for income." And she noted that Beal's data was compiled before the Federal Reserve raised short-term interest rates by 75 basis points in November.
Heading Ms. Stromberg's dubious top 10 is First Commerce Corp. of New Orleans. The report notes an accounting adjustment in the third quarter equal to six times the bank's earnings, and points out that the securities portfolio equals 45.9% of total assets.
Republic New York Corp., long considered a pillar of strength, ranks second. Ms. Stromberg noted that Republic's securities portfolio represented 37.4% of its assets in the third quarter.
"Republic derives a very high percentage of its income from securities," she said. "There has been a $6 per share erosion in their stock price since the end of 1993."
PNC Bank Corp., which is considered by many to have one of the most toxic portfolios, didn't even make Ms. Stromberg's top 10 list, coming in at No. 12. Among the better known names that barely missed the list was Chemical Banking Corp., ranked 17th.
Bankers Trust New York Corp., associated with derivatives problems of late due to its activities as a dealer, came in at 67th on Ms. Stromberg's list, which is confined to banks with market capitalization of more than $500 million.
Other analysts focused on the makeup of portfolios. Veribanc Inc., Wakefield, Mass., noted that a third of the securities losses in banks' portfolios were due to the decline in value of mortgage derivatives.
The research firm said the notional amount of banks' total derivatives holdings rose to $15.8 trillion in the third quarter of 1994, up from $15.3 trillion the previous quarter.
In the third quarter, seven banks reported delinquent derivatives contracts totaling $73.2 million, the highest notional amount ever reported as delinquent, Veribanc said.
Smith Barney Inc. fixed-in-come analyst David A. Hendler blamed the problems on indexamortizing swaps -- instruments banks have used to hedge deposits.
"It seems that the equity markets have become more attuned to these swap structures and are discounting the affects into bank stock prices," he said. "One negative effect is that in the current rising rate environment, especially in the short end, cash flows have been negatively impacted."
Mr. Hendler pointed out that PNC has been most negatively impacted by rising rates. The Pittsburgh-based bank had $11.9 billion in index-amortizing swaps in the third quarter of 1994, representing 280.6% of its equity in the quarter. He said the unrealized loss from this position amounted to 11.45% of equity.
Another big loser, he said, was Banc One Corp., which had $16.2 billion in index-amortizing swaps in the third quarter, representing more than 209% of equity. The Columbus, Ohio-based bank's unrealized loss equaled 8.12% of equity in the quarter.
Mr. Hendler said that banks put on the index-amortizing swaps because they act like collateralized-mortgage obligations but without the prepayment risk. However, like CMOs, the maturities of index-amortizing swaps can extend in a rising interest rate environment.
The analyst said many of the unrealized losses have occurred because the swaps were priced off a London interbank offered rate forward curve. Those that were purchased at 5.5% are now being priced off an 8% Libor yield, he said.
According to Keefe, Bruyette & Woods Inc., the biggest loser in the first three quarters was Norwest Corp., which recorded an unrealized loss of $51.9 million in the third quarter alone, for a total loss of $58.9 million during the nine months.
The Keefe Bruyette figures also show that in the third quarter, 34 of the top 100 commercial banks reported a loss in their securities portfolios. Collectively, however, the 100 banks reported a gain of $602 million in their portfolios.
Top 'Toxic' Portfolios
1. First Commerce
2. Republic New York
3. Central Fidelity Banks(*)
3. Integra Financial(*)
4. UMB Financial
5. National Commerce Bancorporation
6. Dauphin Deposit
7. Commerce Bancshares
8. Magna Group
9. First Empire State
10. Fourth Financial
(*)Tied
Source: M.R. Beal & Co.
