Fred D. Price figures to be the bearer of sad tidings this holiday season.

"We're recommending that some of our clients take losses now so they can reinvest in much-higher-yielding instruments," he said this week.

Mr. Price is a principal in Sandler O'Neill & Partners, a New York investment bank that offers asset-liability management services to about 500 small to midsize financial institutions.

His advice will come as no surprise at a time when higher interest rates have taken a toll on the earnings of such liability-sensitive giants as Banc One Corp. and PNC Corp.

But Mr. Price's solutions may be reassuring in their simplicity. In an era of arcane derivative instruments, some of the higher-yielding investments that he recommends are three- to five-year Treasuries, mortgage-backed securities, tax-exempt bonds, and bank-qualified municipal bonds.

"If you take a loss today," he said, "you are building in a capability to improve tomorrow. It has to be beneficial to your earnings."

What's more, he added, most of his clients already are in a pretty good position.

Banks are not as interest rate sensitive as investors tend to think, Mr. Price said. Because rates have been rising since 1993, most banks and thrifts have had plenty of time to react, he pointed out.

"Our experience working with bank and thrift balance sheets has taught us that they play the yield curve less than the investing public seems to think," he said. "These days it is uncommon to find a banking company that has more than 10% of its net interest income at risk, even assuming a 300-basis-point movement in interest rates."

Mr. Price said he thinks most banks can safely have plus or minus 10% to 15% volatility in the balance sheet. It's all a matter of how much risk they want to assume.

For those that do need to make the adjustment, Mr. Price said the first thing to decide is how much of a loss they can safely absorb.

"Part of the responsibility we have is to know our clients well," he said. "We make decisions based on what the client wants to do, not what we want them to do."

He illustrated the firm's approach with the example of a recent client that wanted advice on hedging the liabilities of a thrift it was acquiring from the Resolution Trust Corp. Mr. Price said he presented the investor with a choice of four portfolios: balanced, short term, long term, or leveraged long term.

The portfolios consisted mainly of Treasuries and money market instruments. "We dealt with collateral instruments only," he said. "No derivatives."

Rather than recommend one portfolio over the other, Mr. Price said he presented the four portfolios to the investors and let them decide which one was appropriate.

"There's no one right solution," he said. "There are a lot of good choices. They need to make a decision that is comfortable for them."

The six-year-old company has targeted financial institutions with assets of $500 million to $2 billion, most of them banks. Now it is looking to expand its balance sheet management practice to include small to medium-size pension and mutual funds, insurance companies, and money managers.

Mr. Sandler said most of the firm's clients already have some in-house asset-liability management capability; Sandler O'Neill gives the client a macro-perspective on the market.

"The resources we provide are additive," Mr. Price said. "We may take their portfolio and stress it differently. We take their asset-liability management and extend it to the equity markets because we are market makers."

He said that while Sandler O'Neill sometimes recommends that a bank use derivatives, the firm is not a market maker in derivatives. It does make markets in most on-balance-sheet instruments, though.

"Our clients have never used anything you would call exotic," he said. "They are much more basic in their focus."

While the firm does recommend structured products, Mr. Price said those instruments are no more complex than government agency step-up notes with a coupon.

"The coupon changes on a regular basis and is subject to call. They may be classified as exotic, but there is no mystery to it," he said.

"The industry still has a lot of work to do to prove to investors that it is less interest rate sensitive," he said. "That's the most challenging thing."

Balance Sheet Prescriptions

[prescription] Stress tests

[prescription] Periodic valuations

[prescription] Rate risk management

[prescription] Securities transactions

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