Retooling portfolios in response to market-value accounting, banks plan to slash investments in fixed-rate mortgage securities, a new survey found.

The survey, by Ernst & Young, drew 216 responses.

The new rule, approved by the Financial Accounting Standards Board last month, will force banks to value a greater portion of their securities holdings at market value. Banks traditionally valued their holdings at book.

Specter of Rising Rates

The survey found that bankers are especially worried that rising interest rates could cause losses in bond portfolios that would reduce bank capital levels. This, in turn, could trigger higher deposit insurance costs or new regulatory constraints on their operations.

To cushion themselves against rising rates, banks plan to cut fixed-rate mortgage securities to about 20% of their portfolios from 30%, according to the survey.

Switching to Adjustables

At the same time, they are looking to increase holdings of adjustable-rate mortgage securities.

The surveyed banks plan to increase ARM-backed mortgage securities from about 9% of total securities holdings to 14%.

Big banks, those with more than $10 billion in assets, plan to increase ARM-backed holdings to 17% of their portfolios from 9%, the largest rise among the surveyed banks.

These portfolio adjustments would be aimed at ensuring that the banks are protected against sharp increases in interest rates. Interest rates on securities backed by ARMs are reset periodically.

Under the new rules, banks must make additions to or subtractions from equity based on the changing market values of their securities holdings.

$323.5 Billion Held

Mortgage-backed issues are the biggest components of banks' securities holdings. Banks owned $323.5 billion in mortgage securities at the end of the first quarter, according to the Federal Deposit Insurance Corp. Treasury holdings, meanwhile, totaled $257 billion.

In another move aimed at containing the volatility in their portfolios, half the surveyed banks said they plan to shorten the maturities of their debt securities.

Interest rates on short-term securities fluctuate less than longer-term issues.

Almost two-thirds of the big banks said they would reduce maturities.

But only 45% of small banks, those with less than $150 million in assets, said they planned to shorten the maturities. Medium-size banks fell in between the two other groups.

Big banks are more active traders than small banks and therefore have more reason to fear the new accounting rules.

Three-quarters of the small banks surveyed had turnover of 10% or less in their investment portfolios during the first nine months of last year, while only 50% of the large banks had such low levels of turnover.

As a result, the small banks surveyed expect to have 16% of their portfolios classified as "available for sale" under the new rules, compared with 45% of the big banks and about 25% for banks with $150 million t $10 billion in assets.

Securities deemed as available for sale - those which a bank may sell in the future - are valued at market value under the new rules. Changes in market value affect equity but have no direct impact on reported earnings. Securities held to maturity continue to be valued at cost and have no effect on earnings or capital.

"The traditional role of the securities portfolio as a potential source of liquidity will change," said Marti Sworobuk, program manager for the Savings and Community Bankers of America.

"Portfolio managers that are thinking about this have said, |I'll hold these securities to maturity, and look to other sources of liquidity, such as Federal Home Loan Bank funds,'" Ms. Sworobuk said.

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