Profit margins at the big California thrifts are being squeezed by declining yields on adjustable-rate mortgages, says Bruce Harting, a Salomon Brothers analyst.
And, Mr. Harting says the situation could get worse.
The thrifts have tried to protect themselves against a rate squeeze by holding only adjustables, whose rates are generally keyed to the cost-of-funds index compiled by the Federal Home Loan Bank in San Francisco.
But the strategy isn't fool-proof. Lately, Mr. Harting says, the index has been falling faster than the actual cost of funds at most large thrifts.
Index Trailing Market
Because of averaging and lags in reporting of data, the index is just now catching up with declines in market rates that occurred last year.
In a report last week, Mr. Harting pointed out that the index fell 18 basis points in the first quarter to 4.25% Salomon Brothers says the index will fall another 30 points by yearend.
"These projections imply that the weighted-average yields for the California S&L are vulnerable to another 70-basis-point decline over the next 12 months," Mr. Harting writes.
"Part of this decline will be offset by declines in the weighted-average cost of funds at the S&L, but most managements concede, and we agree, that the majority of their cost improvement has already occured."
The combination of margin compression, lack of growth in adjustable loans outstanding, and credit losses "could make for some earnings disappointments in the next few quarters," Mr. Harting writes.
He is somewhat optimistic about credit losses, pointing out that "the inflow of new nonperforming assets leveled off" in the first quarter. Still, he expects nonperformers to exert some drag on earnings this year.
He is less sanguine about asset growth, pointing out that originations of adjustable loans have declined as a percentage of total originations. Because thrifts prefer adjustables for their portfolios, assets shrank at many California thrifts in the first quarter.
The shrinkage wasn't uniform, however. Mr. Harting notes that both H.F. Ahmanson & Co. and Golden West Financial continued to show healthy asset gains.
The behavior of the cost-of-funds index is likely to be a problem for the thrifts even if interest rates rise, Mr. Harting points out. The index tends to lag behind rising rates, so the thrifts' costs tend to rise faster than the rates they charge.