Falling Rates Fail to Help Shares of Nation's Thrifts

The stock market is disregarding conventional wisdom that low interest rates should boost thrift stocks.

Instead of rising in response to falling interest rates, thrift issues have languished since August. "There is currently a view among investors that lower rates are no longer helping the thrifts," said David S. Hochstim, an analyst at Bear, Stearns & Co., New York.

The nation's three largest thrifts, all in California, have seen their stock prices skid. Shares of Great Western Financial Corp., Beverly Hills, have dropped 22.5%; H.F. Ahmanson & Co., Los Angeles, nearly 19%; and Golden West Financial Corp., Oakland, almost 7%.

Looking at Profitability

Earlier in the year, the standard view had prevailed -- that lower rates would help thrifts' profitability, as well as banks', by widening margins.

Investors now are nervous about a lack of asset growth at the thrifts, which tend to make adjustable-rate mortgages, or ARMs. Rates have fallen so low that customers are opting instead for fixed-rate mortgages.

"Every ARM lender is just treading water" in mortgage originations, said Mr. Hochstim. "The concern is that this is going to impact earnings, since margins are beginning to narrow again."

Margins are narrowing because of what Peter Treadway, thrift analyst at Smith Barney, Harris Upham & Co., New York, called "the reset factor."

Widening ARM Spread

Earlier in the year, rates thrifts paid for funds were falling faster than the thrifts were required to cut rates on ARMs. This spread was highly profitable.

"This seems to be just about at an end," said Mr. Treadway, "and on the way back up, the reset factor works against them." An earnings squeeze occurs if the cost of funds rises faster than mortgage rates can be adjusted upward.

Moreover, said Mr. Treadway, in the cases of Great Western and Ahmanson, parent of Home Savings, "there is some fear that they will have to take more losses in selling OREO [foreclosed properties]. It won't be life-threatening, of course, but it would be an earnings drag."

The sluggish California economy, where the top three thrifts all focus their operations, is also a factor, said Mr. Hochstim. "The job picture is not great. People are less inclined to make home purchases or move if they are uncertain about the economic future."

Fixed-Rate Competition

He noted no unusually high level of ARM prepayments in the 11th Federal Home Loan Bank District, which covers California. But the only growth in new mortgages has been concentrated in fixed-rate loans.

Mr. Hochstim said the market has overreacted to the low-rate problem for thrifts. "When things turn, they could turn dramatically," he said, with a pick-up in ARM lending paralleling a decline in nonperforming loans that would let loss reserves be reduced.

But he said he does not expect that to happen until the first or second quarter of next year. "We're already in the fourth quarter, and I see no imminent switch in the fixed-rate trend right now," he said.

Mr. Treadway has strong "hold" recommendations on both Ahmanson and Great Western, whose portfolio size has been static, and a "buy" on Golden West, which has managed this year to increase its relatively smaller cache of loans.

And he said the stocks probably present no downside risk for investors now. Dividend yields, above 5% at both Ahmanson and Great Western, probably will effectively create a floor for the stock prices near their current levels.

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