George Salem, an analyst at Prudential Securities, cut his rating on Banc One Corp. from "buy" to "hold," citing the bank's big exposure to interest rate swaps.
Mr. Salem is the first analyst to change a rating of Banc One, or any other bank, because of its extensive use of swaps. By his reckoning, Banc One has a bigger portfolio of swaps than any other regional bank, and that portfolio has increased significantly this year.
Risk Seen to Earnings
The Prudential analyst is concerned that if Banc One bets wrong on interest rate movement in its swaps, the bank's earnings are in jeopardy.
"I think their exposure is excessive," said Mr. Salem. "This type of exposure can only lead to a lower PE ratio. Regional banks are not supposed to have this amount of money-center-type activity."
Banc One said that it uses interest-rate swaps as a hedge against falling rates. If rates rise 1%, earnings will be about 3% less than expected over the next 12 months.
Banc One's stock was up 25 cents to $37 Tuesday on heavy volume, a temporary halt in a prolonged decline. The bank's stock has been falling hard for the past three months, down 12% versus 7% for other regionals, according to Mr. Salem.
Shares are down 14% on the year, making it one of the worst performers in an industry that is moving out of favor. "Since rates are rising, which is bad for the bank stocks in general, I can't continue to recommend such a controversial stock," said Mr. Salem.
Concerns about Banc One's exposure to swaps surfaced about six weeks ago among stock traders on Wall Street, based mostly on their uncertainty about why Banc One was using these off-balance sheet instruments.
Dilutive Merger Anticipated
Their worries contributed to the stock's continuing decline. But money managers and traders said the primary reason for the stock's poor performance this year is that investors believe that the acquisitive bank will eventually do a merger that doesn't pay off.
Some money managers believe that both concerns -- dilution and interest-rate exposure through swaps -- are unfounded.
"I don't view Banc One's swaps as risky," said Harry Keefe, a New York money manager. "There is no evidence that Banc One ever does anything risky or silly. These guys are risk averse." As for Banc One's acquisition acumen, he added:
"These guys have done 135 deals and they have always increased earnings per share."
Banc One's use of swaps has jumped this year. At yearend 1992, the face, or nominal, value of swaps contracts was $12.9 billion. At Sept. 30 the amount had risen to $28.9 billion. The aver age regional bank's exposure is $11.6 billion, said Mr. Salem. In the first nine months of this year, Banc One's assets grew by $15 billion.
"Swaps are supposed to be hedge instruments," said Mr. Salem. "I can't rationalize that big of an increase in the swaps portfolio compared to the balance sheet." If the swaps aren't hedges, Mr. Salem said, they could destabilize earnings.
According to Richard D. Lodge, senior vice president at Banc One, all that worry is misplaced. He said Banc One use swaps as other banks use their bond portfolios, as a hedge against changes in interest rates.
Face Value Causes Confusion
That face value, or national amount, of swaps contracts causes undue confusion, he said. In swaps contracts, the notional amount far exceeds the amount of payments that actually are slated to change hands.
If interest rates rise I percentage point, Banc One's earnings will be 3.3% less than the bank expects next year, said Mr. Lodge. "That's not significant in my mind," he said.
Banc One has taken steps to inform Wall Street about its swaps activity. The bank published a booklet last quarter to describe its asset and liability management.
Apparently, the written word didn't do the trick, because Banc One's management will trek to New York next week to meet with analysts and try to clear up the matter.
Most of Banc One's swaps are of one type, said Mr. Lodge. The bank receives a fixed-rate payment from one counterparty and makes a payment to another at a rate that varies. In a falling-rate environment, that's a good position to be in, because the payout rate is typically less than the received rate.
"The swaps look good today and the bank's core business doesn't doesn't look so good," said Mr. Lodge. "But that situation will reverse one day."