The level of bank equity jumped dramatically in the third quarter, and a growing number of banks are trying to combat that buildup through boosting dividends or buying back stock.

The median level of tangible equity to assets for the top 50 banks jumped 32 basis points, to 7.31%, in the third quarter, according to J. Richard Fredericks, an analyst with Montgomery Securities in San Francisco.

That's a far bigger buildup than in the four previous quarters and puts the equity levels at a 30-year high.

"It's nice that the balance sheets are getting stronger," said Mr. Fredericks. "But it makes me wonder about how much capital banks need. You want a return on assets and equity."

3-Year Trend

Equity cascaded onto bank balance sheets in the third quarter through retained earnings, as a sluggish economy did little to spur loan growth. For the past three years, banks have built up equity and reserves as they tried to crawl out from the load of bad loans that hit in 1990.

As a consequence of that equity buildup, nine banks in the group of 50 had common-equity -to-assets ratios of at least 8% on Sept. 30, led by Cincinnati's Fifth Third Bancorp with 9.75%. Of the group of 50 banks, 28 have equity ratios over 7%.

Two years ago, that number was only eight. Banks piled up equity in other forms as well in the third quarter. For the top 50 banks, the median loan loss reserve was 181.9%, said Mr. Fredericks. He and other analysts consider those reserves a "segregated" equity account.

At the same time, credit quality improved dramatically again in the third quarter, which means a lower level of reserves may be needed. The median ratio of nonperforming assets to loans fell under 2%, to 1.77%, Mr. Fredericks said.

How much equity banks should have is the subject of debate, but some bankers believe their institutions are overcapitalized.

"If you assume the economy won't get better than this, we are overcapitalized," said Eugene Putnam, a vice president with Crestar Financial Corp. Richmond, Va. "If you assume there will be some growth, the level of overcapitalization is less."

Crestar's tangible equity ratio at Sept. 30 was 8.08%, the seventh highest of the top 50 banks.

ROE Up, Assets Down

In the third quarter, Crestar's assets fell 2%, while equity grew by 3%. That falloff in assets dampened a growth in return on equity, said Mr. Putnam.

The return on average equity was 13.8%, versus 13.2% for the second quarter. The improvement in ROE came from a higher return on assets, not from a leveraging of the balance sheet.

To hold down the equity growth, Crestar has a plan to buy back common stock. Of the top 50 banks, 11 have stock buyback programs in place. That list is expected to brow.

"I wouldn't be surprised if J.P. Morgan or Bankers Trust followed," said Mr. Fredericks.

Other banks, such as Milwaukee's Firstar Corp., are buying back or plan to buy back preferred shares. By reducing the preferred stock, banks make more earnings available to common-stock holders. Still other banks are boosting dividends and canceling dividend reinvestment programs to hold down equity growth.

"In general, banks are at a level where they are beginning to lean against the ratios," said Mr. Fredericks. His biggest fear: Banks will put their excess equity to use by paying too big a premium in an acquisition.

Firstar has one of the industry's highest levels of equity, at 7,97%, and reserve coverage, at 302.6%. And that equity is growing leaps and bounds. For the past 12 months that ended Sept. 30, Firstar's loans grew 9%, while its equity grew 15%.

But William Risch, chief financial officer at Firstar, said his bank is not overcapitalized.

"You have to have a strong equity level to pay the minimum insurance on deposits," Mr. Risch said.

George Meiling, treasurer of Banc One Corp., said concerns about capital levels are a "Seventh Avenue syndrome," a reference to New York's fashion district. Equity levels, like skirt lengths, change with the times.

"I don't agree with the talk about overcapitalized," he said. "We've cranked out 17 years of ROE in excess of 15%. We believe can continue to do that."

One reason for the continued high-levels of ROE is that Banc One's loans are growing at nearly the same rate of equity, which is not typical for banks these days. Last quarter, Banc One's equity rose 2.8% while loans were up 2.3%.

The Columbus, Ohio-based company has long had one of the highest levels of capital in the industry. Mr. Meiling said that the high levels of equity are needed to purchase expansion opportunities. The industry is still not even halfway through consolidation, for starters.

"If you look at the opportunities going forward to make investments and to grow the company, and you look at the absolute pain of not having enough capital, I can't be easily swayed to change my opinion" about the need for high levels of equity, said Mr. Meiling.

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