H.F. Ahmanson & Co. has undertaken to transform its principal subsidiary, Home Savings of America, from a mortgage factory into a full- service consumer bank. The move, being engineered by chairman Charles A. Rinehart, has stirred controversy.

The article below, adapted from a report by Thomas O'Donnell, an analyst at Smith Barney Inc., supports the Rinehart initiative while outlining some pitfalls.

Why is Rinehart's plan controversial?

The bears insist that Ahmanson should remain a traditional thrift. We are clearly in the bull camp and applaud the transformation. The bearish argument rests on two pillars: that the traditional thrift model still works, so changing it is unnecessary; and that Ahmanson's making the transformation is too risky.

Our view is that - except for the classic S&Ls such as Golden West Financial or Washington Federal, or those fortunate enough to have attractive niches or franchises - the traditional thrift model is simply not profitable enough for major thrifts that employ it to survive, long- term, as independent entities.

What has changed the picture?

High returns have become elusive for traditional thrifts because of the enormous growth of the secondary market and because of overcapacity in the mortgage lending business in the 1990s.

Can Ahmanson make the grade?

Because most S&Ls are playing in a new, more difficult ball game, the risk for Ahmanson lies in not making the change. If it stays a traditional thrift, the company would likely post ever-lower ROE and ROA as the traditional mortgage delivery system declines in profitability and importance.

Doesn't the transition carry its own risks?

Since we see Ahmanson as a takeover candidate, on a two- to five-year time frame, we believe management may be playing for time.

The wrong choices management must avoid making are overpaying to acquire a consumer finance, thrift, or other subsidiary; letting credit standards slip in the pursuit of consumer loans; letting expenses run up in the pursuit of consumer loans; and not paying enough attention to the basic mortgage business while the transformation is being made.

If the balance sheet shrinks from the $49 billion in assets it now contains, those consumer loans could account for 10% to well over 15% of assets. The higher profitability is what would give the company a fighting chance to remain independent, despite our belief that a takeover wave will envelop most California thrifts.

The true earnings-per-share generators in 1997 should be a recovering California economy and ongoing share buybacks.

We believe the transformation will continue to gain adherents as 1997 comes into view.

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