The biggest banks built their holdings of home loans by a stunning 18% last year as the industry rediscovered a basic business.

With rising interest rates stimulating the public appetite for adjustable-rate mortgages, banks dived headlong into the market. Like thrifts, many banks have come to view adjustable-rate mortgages as a good fit with their liabilities.

An American Banker survey found that the top 100 banks in mortgage investments boosted their holdings of home loans by $35 billion, to $228 billion, in the year to Sept. 30. (Tables begin on page 8.)

The surge was enough to more than offset liquidations of complex mortgage securities. As a result, their total mortgage investments climbed a crisp 8.5%.

The gains helped pushed the share of the total mortgage market held by all banks to 25.2%, the highest level in at least a decade.

Bank holdings of collateralized mortgage obligations dropped by more than 12% as the market slumped. Their portfolios of mortgage-backed securities climbed about 8%.

At the same time, the other assets of the 100 banks with the largest mortgage investments were climbing as well, with the result that there was little change in mortgage investment as a percentage of assets. The figure was about 21% in each year for the top 100 banks and for all commercial banks.

"Banks still remain somewhat underlent, so they like to look toward mortgages, and the swing toward ARMs has become beneficial," said Alden Toevs, managing vice president of First Manhattan Consulting Group, New York.

"Collateralized mortgage obligations have been disastrous in performance in recent months, so it's logical to get rid of them and reduce exposure to interest rates," he added.

Ronald I. Mandle, a senior research analyst at Sanford C. Bernstein & Co., said: "CMOs extended in duration as rates went up and got much more rate sensitive."

Duration, a standard measure of rate risk, rises when the repayment period for a loan increases. The average repayment period on mortgages has lengthened with the disappearance of refinancings. As a result, classes of CMOs that receive principal have become much riskier.

Mr. Toevs said banks would have increased their mortgage portfolios even faster, but there wasn't as much adjustable-rate-backed product on the market as they would have liked.

"We're seeing mortgage banks selling their loans elsewhere because the banks won't take them, but then the banks buy whole loans and MBS securities at discounts of one to three points in the open market," he said.

One part of the bank originates mortgages at a loss under competitive pressures, he says, but another part buys other people's product at a discount.

A few banks that were active lenders in the refinancing boom of 1993 saw their figures fall sharply as mortgage industry volume slumped. Among them were Norwest Bank Minnesota, whose home-loan volume dropped by about a third.

It also liquidated about a third of its portfolio of mortgage-backed securities and about two-thirds of its collateralized mortgage obligations. As a result, mortgage investments as a percentage of assets dropped to 34%, from about 50%.

But Norwest remains aggressive in lending directly to households, especially for home purchases, and is easily the biggest retail lender in the country.

The tabulation also shows:

*The biggest gains in dollar volume of home loans held in portfolio were by PNC Bank, Pittsburgh, $3.1 billion; Bank of America, San Francisco, $2.7 billion; Chase Manhattan Bank, New York, also $2.7 billion; and Wells Fargo Bank, San Francisco, $2.1 billion.

*Large liquidations of collateralized mortgage obligations were abundant. Among the bigger holders, Bank of American cut its portfolio by about 60%; Bank of America, 44%; and First Union, Jacksonville, Fla., 55%.

*Some banks among the top 100 that had only small portfolios of CMOs bought them at a rapid pace, apparently attracted by falling prices. Among them were Shawmut Bank Connecticut and Republic National Bank, New York. But their total holdings of the instruments remained modest.

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