When it comes to moving the prime rate, banks usually act in unison. And as First Fidelity Bancorp. has learned, those who dare to break ranks do so at their peril.
It's been almost four weeks since First Fidelity made headlines by lowering its prime to 5.5% from 6%. The Lawrenceville, N.J.-based company apparently was anticipating that the Federal Reserve would soon cut its discount rate from 3% to stimulate the economy.
But the rate cut never materialized, leaving First Fidelity out on a limb. And it's been hanging there ever since.
How can the bank afford it? For starters, First Fidelity's interest margins are not being squeezed all that much.
Although it was not widely reported, the bank also cut deposit rates by about 25 basis points when it cut its prime.
Executives told analysts that the bank's rates had been higher than those of competitors. That meant they could fall without causing depositors to shop around.
In fact, the saving that First Fidelity is likely to realize from lowering its deposit rates may offset the revenue forfeited with the lower prime.
Profits Said to Be Safe
First Fidelity won't comment but officials have assured analysts that its lower prime rate will not affect the bank's profitability in the fourth quarter.
Cutting the prime is also a good marketing ploy. "You build a lot of goodwill when you do stuff like this, and it enables you to take some shots at your competitors," said Lawrence Cohn, an analyst at PaineWebber Inc.
That's particularly important now, he said, because the recession has forced many customers to reevaluate their banking relationships.
Mr. Cohn said customers of Midlantic Corp., for example, which has limited pricing flexibility due to extensive loan problems, could prove good targets.
Still, analysts say it's only a matter of time before First Fidelity is forced to bring its prime rate in line.
"You can make a lot of hay telling customers your rates are lower than your competitors', but after a while it becomes a competitive disadvantage," said Dennis Shea, an analyst at Morgan Stanley & Co. to gain favor after BankAmerica officials met with analysts in New York on Friday.
These analysts said the drag on earnings from amortizing the intangible assets would be dwarfed by annual earnings in the range of $6 a share, and would be far outweighed by cost savings resulting from the bank's merger.
"I think the market overreacted," said Ronald I. Mandle of Sanford C. Bernstein & Co.
Amortization over 25 Years
Under the purchase-accounting method being applied in the merger, virtually all of the goodwill created by marking Security Pacific's assets to market value can be amortized over 25 years, Mr. Mandle said. The $800 million added in the quarter brought goodwill to $5.4 billion.
The increase represented only an $18 million increase, to $80 million, in the cost per quarter of amortizing the intangible asset, Mr. Mandle said.
"All things being equal, that would be 5 cents a quarter. But all things aren't equal," Mr. Mandle said. He said the impact on earnings would be even less than 5 cents per quarter.
Much of the increase in goodwill reflects decisions to add to assets being held for sale, he said. Once such assets are sold, he said, the nonperforming assets will be replaced by performing ones, improving earnings ratios.
Indeed, given the marginal impact of the goodwill, the drop in BankAmerica's share price created a buying opportunity, said Lawrence W. Cohn of PaineWebber Inc. He changed his hold rating on the stock to buy when the stock dipped below $42.
Thomas K. Brown at Donaldson, Lufkin & Jenrette Securities Corp. said investors and some analysts misunderstood the purchase-accounting method. He said a more accurate measure of credit quality than the change in goodwill was the $300 million increase in nonperforming assets. That decline in asset quality is not alarming, given the weakness in the southern California economy. he said.
Moreover, he pointed out, Bank-America's ratio of tangible equity to assets actually increased in the quarter, to 5.18% from 5.04%.
A Bearish Response
George Salem of Prudential Securities Inc. remained skeptical.
He said the increase in goodwill affirmed his bearish view of the economy. The main disagreement he has with the other analysts, he said, concerns the length of the state's recession.
"We're in the third inning," Mr. Salem said, arguing many more additions to goodwill could be in store. "Some of these guys think it's the eighth inning, that's the difference."
Meanwhile, Francis X. Suozzo of S. G. Warburg & Co. reacted to the earnings statement by saying the bank's long-term prospects were good, but that BankAmerica could be burdened by the deteriorating economy in the near future.