Many community bankers have found themselves in a precarious position in 1995. After months of denial, they have finally realized that rates have gone up, portfolio losses have mounted, and it's not all Alan Greenspan's fault.

It just may be that we are going through another interest rate cycle.

To compete effectively, a bank must be able to*

*Analyze its ability to react to changing interest rates.

*Understand what rate factors within the balance sheet drive changes in net interest income.

*Determine how they relate to the bank's competition in finding new opportunities.

Many banks feel that with inherent limitations in their portfolios, their ability to adjust to new rate environment from a year ago is limited.

One option seems to have been overlooked and doesn't involve complex hedging formulas or derivatives.

How about growth?

Management should be able to analyze its asset-liability position relative to current rates and the shape of the yield curve.

Trying to time an inversion turn could be costly, and it would be wise for bankers to have a consistent investing strategy that blends with the bank's overall asset-liability policy and maximizes the yield curve trends, not turns.

This strategy might include a slight bias toward asset sensitivity with rising rate trends, and liability sensitivity with declining rate trends. Even in a matched strategy, a bank should be able to manage and increase margin in either rising or declining rate environments due to the inherent lags in rate relationships.

With the extreme steepness of the yield curve only a year ago (as of January, the one-year had moved 359 basis points, while the 30 moved 146), banks had the opportunity to earn an incredible spread.

Today, many banks are asset sensitive, which would naturally result in an increasing net interest margin. Yet others are liability sensitive and are squeezed with a decreasing net interest margin. The opportunity to improve margins in both scenarios presents itself through growth if new spreads are higher than existing ones.

The difficulty lies in the investment portfolio, which reacts instantly to Treasury rates. Existing margins were created over the past few years in a bull bond market.

In today's environment, Treasury rates have risen sharply in the short end. Bankers have predictably reacted by raising loan rates, but have been reluctant to raise deposit rates. This has helped cause Treasury-CD spreads to be the widest in history.

This spread relationship should logically flow through a bank's loans. However, as of January, the prime rate had risen only 250 basis points, while the one-year bill had doubled by 359 basis points.

This basis shift presents an opportunity for banks to increase their net interest margin in the securities portfolio, an avenue not as readily available a year ago.

This opportunity exists because many community banks are still in the lag period in raising their deposit rates. This is not fated to last, however, as competition will eventually force deposit rates upward.

Yet many community banks can still raise relatively low-rate "hot" deposits and invest in short-term securities to increase margin.

This spread opportunities that weren't available last year provide balance sheet growth which should help bankers gain market share and become more competitive.

A bank should undertake an analysis of its peers and competition and determine where these spread opportunities lie. If your competition finds these opportunities before you do, then you may lose deposits, or even worse, become a takeover target.

The key to analyzing rates and making strategic decisions is to recognize that if the spreads between deposits and securities/loans are higher than those on the books ... there lies an opportunity for growth.

Growth in deposits is a natural fit in today's environment. Community bankers have good control over their cost of funds and with quick rises in rates, most want to maximize margin spreads by holding their cost of funds down.

A banker raising rates to grow must realize that competitors will eventually do the same. By growing the liability side through existing rates or slightly higher, a bank should be able to earn a healthy spread in a security or open up a new high-rate loan.

By leaving pay rates low, banks risk losing their big dollar deposits. Where many community banks are missing the boat is in funding new loan growth through securities runoff.

While this generally increases margin, it doesn't have the effect that leveraging does. (Why not fund new loan growth with an increase in cheap deposits?)

With this strategy, short-term securities can still be purchased for liquidity and income. Many banks find themselves with large portfolios and little capital, so growth should be explored through newly contributed capital.

If in today's environment of "hypercompetition" your bank doesn't maximize its opportunities, its ability to react strategically to changing interest rates, and to grow through spread opportunities, your competition will gain a first-mover advantage and possibly buy you in the process.

Mr. Wiley is vice president of the financial institutions group at Dallas-based Rauscher Pierce Refsnes Inc., an investment banking firm.

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