One-Time Gains May Haunt Banks in '92
A handful of banks have made nearly half their pretax income this year by selling fixed-income securities as interest rates fell. But analysts caution that gains from this trading may haunt banks next year.
Banking companies that used gains from securities sales to make up for losses from bad loans will be hard pressed next year to match the one-time gains for 1991.
"I think spreads will narrow next year and a bank can't rely on a bond portfolio to create profits," said Charles Peabody, an analyst with Kidder, Peabody & Co. in New York.
His list of banking companies with the highest exposure includes Fleet/Norstar Financial Group, PNC Financial Corp., Citicorp, and NCNB, where $198 million in proceeds from securities trading produced 45% of pretax profits this year.
The banks that earned the most by liquidating portfolios in 1991 are also the ones most at risk to lose money in trading, or at least experience the biggest devaluation of their portfolio, if rates rise, Mr. Peabody said.
Big gains taken this year lessen the opportunities to take gains next, as the size of the portfolio is diminished. Meantime, funds reinvested at a lower yield produce less income. Interest income at NCNB, for example, fell about $20 million in the third quarter.
A second tier of banks at risk includes First Union Corp., Valley National Corp., and Mellon Bank Corp., which made between 15% and 60% of their 1991 income from securities sales.
Investment securities represented less than 25% of an average bank's balance sheet in 1989. Now, they represent a third of all assets. In effect, banks have swapped credit risk - the chance that a loan will go bad - for interest rate risk.
Ironically, banks swore off that strategy after they took a bath in 1979. Back then, banks plunged into treasury bonds, trying to take advantage of falling rates during a recession. Rates went up and banks lost money.
Mr. Peabody and other observers believe bond trades next year will not generate big profits for banks. Many economists are forecasting interest rates to rebound by mid-1992. That would diminish the value of a fixed income portfolio.
On top of that, banks may be pushed to cut the interest rates they charge borrowers, which would in turn raise the costs of bank's money to purchase new securities. Banks have already had a scare on borrowing rates recently, as the Senate entertained legislation that would cap the interest rates banks can charge on credit cards.
Those two factors may not allow banks to generate as much money from portfolio trading in the near future. That means some of the banks may not be able to offset credit losses with trading gains.
NCNB, for example, took big profits from the sales of securities to cover credit losses, said Mr. Peabody.
Gain Hides Trouble
The Charlotte, N.C., bank, reported $131 million in third-quarter income. Roughly half of that, $66 million, was from securities gains. The Texas bank earned $80 million. That means the lead bank lost money in the quarter.
"If you take away the securities gains, on an operating basis it is a troubled institution losing money," said Mr. Peabody.
That's not to say that if interest rates rise, NCNB will automatically be in trouble. Rising rates indicate an improving economy, and the banking company may be able to take its profits from lending.
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