CHICAGO - Midwest banks have found some room to run.

Coming off a torrid second quarter that saw bank after bank reporting double-digit earnings increases, many institutions are regaining their confidence. This sureness rests on three pillars: improved asset quality, efficiency gains, and expanded non-interest income.

For at least the rest of this year, it appears, these strengths will offset narrowing interest margins and slack loan demand.

"We are near, if not at, the peak of building [loan-loss] reserves," said John Westman, chief financial officer of Banc One Corp. With credit costs falling, he said, "margins don't need to be as high" to sustain profits.

Several big Midwest banks remain encumbered by delinquent loans and foreclosed properties. However, they still managed to report improved profits on the strength of tax breaks and one-time gains from securities sales.

1980s Seem Far Away

Throughout the Midwest, few are anticipating robust loan growth any time soon.

Firstar Corp. chief executive Roger L. Fitzsimonds, for example, expects a 3.5% increase in loans this year and an increase of 5% to 7% next year. That compares with the 8% annual growth rate his Milwaukee-based company sustained during the 1980s - and his growth forecast was one of the brighter ones from a Midwest banker.

The prospect of shrinking net interest margins and flat loan demand over the long run "means we've got to find other ways to sustain our income," said John Canepa, chief executive of Old Kent Financial Corp., Grand Rapids, Mich. He is on of many Midwest bankers seeking growth through acquisitions and expanded fee-based businesses.

Still, the short-term picture is fairly bright, and almost every big banking company in the region is in better shape now than a year ago.

Good Year in Sight

Cleveland-based National City Corp. is representative: Stabilizing credit quality, falling loss provisions, and efficiency gains mean "we can [do well] another year without much asset growth and with a flattening net interest margin," said chief financial officer Robert G. Siefers.

A major factor in the revival has been falling deposit rates, and the phenomenon's restorative power showed again in the second quarter.

Norwest Corp., for example, reported a 4.2% decline in interest income for the 12 months ended June 30 but saw net interest income grow by 15%, to $491 million, as its net interest margin widened by 29 basis points, to 5.36%.

Similarly, Fifth Third Bancorp saw interest income drop by 2.85% even as its net interest income grew by 17.3%, to $96 million, on the strength of a 16-basis-point increase in its net interest margin, to 4.74%.

Minneapolis-based Norwest earned $127.9 million, a 1.27% return on assets; Fifth Third, Cincinnati, earned $40 million, a 1.71% ROA.

Reduced loss provisions also figured strongly in some Midwest turnaround stories. Continental Bank Corp.'s $25 million provision was 60% less than in the second quarter of 1991, for example, and National City Corp.'s $39 million provision was 30.8% less.

Chicago-based Continental earned $51 million, up 65%; National City earned $85 million, a 30% increase.

Gains in noninterest income also surfaced in the quarter as Midwest banks wrung greater profits from trust, data processing, and credit care operations and from service charges.

Fee-Based Income Rises

St. Louis-based Boatmen's Bancshares, for example, reported a 23.6% increase in noninterest income, to $87 million. In Chicago, Northern Trust Corp. reported a 23% rise in noninterest income, to $249 million. Boatmen's earnings were up 31.3%, to $52 million; Northern posted a 15.6% increase, to $37 million.

Midwest results were not uniformly robust, in the eyes of analysts, who noted that improved results at several major institutions hinged in large measure on special gains.

Gains from sales of varying combinations of debt and equity securities accounted for roughly one-third of pretax income at Columbus, Ohio-based Huntington Bancshares; 41% at First Chicago Corp.; 58.8% at Continental; and 27.2% at PNC Financial Corp., Pittsburgh.

Mellon Bank Corp., Pittsburgh, said its first-half earnings of $176 million would have been lower by $51 million, or 29%, if not for tax-loss carryforwards.

Somewhat clouding the outlook at a few Midwest banks are nagging credit-quality problems. Several big Midwest banking companies took loss provisions as large or larger than the year before.

Although some provisions came as banks improved upon already-solid reserve positions, others came amid fresh deterioration.

Persistent Realty |Depression'

Mellon's $50 million provision was unchanged from the year before, and realty charge-offs of $41 million were up 46%,

First Chicago's $105 million provision was up 16.7% from the year before. The company reported a 35% increase in troubled realty loans during the second quarter alone, and its top officers continue to use the word "depression" in describing the realty industry.

Two other big Midwest banking companies took earnings tumbles because of merger-related charges. But each institution said underlying results were encouraging.

Comerica Inc. lost $15 million after booking a pretax charge of $128 million for expenses of its merger with Manufacturers National Corp. If not for the charge, the Detroit-based company would have earned $77 million, up from $68 million in pro-forma results of the year before.

First of America Corp., Kalamazoo, Mich., reported a 33% earnings decline, to $28 million. Excluding one-time charges stemming from its recent acquisition of Security Bancorp, however, the company would have earned $52 million, a 22% increase from its pro-forma results of the previous year.

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