One happy problem that many bankers may soon have is handling the public's reaction when the industry's profits start to rebound.

"Let them rebound first" is, of course, the typical banker's response to this, as nonperformers continue to plague the profit statement and as real estate owned means trouble.

But to many observers, the dawn is almost here.

Harry V. Keefe Jr., chief executive of Keefe Managers Inc., for example, states in his letter to investors: "The risk takers have been discredited. In the decade of the '90s, banks will be led by managers and marketers. Both expenses and loan losses will drop. Guaranteed."

Carrying Costs

Keefe explains that the overall carrying costs on foreclosed real estate range from 10% to 20% a year. These costs include legal, accounting, taxes, property maintenance, and various incidental expenses.

Except for California and Washington, D.C., he adds, most regions are nearing the peak in nonperforming assets and related expenses. And as the level of nonperformers and foreclosed real estate declines, a sizable expense factor will also decline and set the stage for a significant earnings rebound.

In a recent Weekly Letter of the Federal Reserve Bank of San Francisco, economist Jonathan A. Neuberger buttressed Harry Keefe's point.

Mr. Neuberger attempted to explain why bank stocks have become so much more risky in the past decade. His research shows some obvious and some not so obvious conclusions.

Formerly, a Safe Investment

The obvious: Returns on bank stocks are far more volatile than they used to be. The stocks have become about as risky as other investments, whereas in the past they were far safer and less volatile.

The basic reason is that banks have had to concentrate more on real estate loans since competitors have made so many inroads into other bank lending areas.

Thus bank assets no longer have the diversification that used to moderate risk, and bank earnings rise and fall to a greater degree based on this one area of lending.

But Mr. Neuberger also pointed out a "good news" factor that most people fail to observe: With banks doing such a good job of managing interest rate risk by developing hedging strategies, using variable-rate loans, and perfecting gap management, they are far less subject to interest rate risk than in the past.

This means that bank profits and losses will be more dependent on loan quality and yield and less on general developments in the money markets.

Tying this information in with Keefe's picture of the turn-around in real estate loans, and you get a pretty positive outlook for the banking industry.

The question remains, though, why should we have to prepare for good news?

One answer is that the public still has an image of banks as a group of overly profitable companies that grow fat at the publics expense. Look at the popularity of the proposal to cap credit card interest rate charges and the unwillingness of politicians or even the media to point out the high loss rates and the risks inherent in credit card lending.

The Public Would Lose Out

They also refused to provide a true picture of who would be the losers if banks curbed their credit card issuance and thereby denied a vast portion of Americans this convenient credit and payment vehicle.

You can spell out the scenario:

First, banks have been forced by "once burned, twice shy" regulators to write off losses and build reserves to an unprecedented degree. Thus we see bank earnings plummet and banks subject to the irony of having even to write down "performing nonperformers' - loans that are current but whose collateral assets have dropped in value.

Later, as these loans are paid off or their collateral value rises, banks will again reverse the writeoffs and profits will rise, augmented by tax-loss carryforwards.

Then you can expect the outcry, "Banks are making too much money!"

Setting the Record Straight

The fact that this is just a recovery of losses that have burned banks and their investors is not good press or good political propaganda. "Bash the banks" is.

So, just as banks have to make the public realize that they are not in the same class with those high-flying thrifts that are now in such trouble or with Wall Street operators who brought so much grief to the stature of our financial sector, they also have to explain where these future profits came from and what they really mean.

Otherwise, there is likely to be more adverse legislation proposed, such as the interest rate cap idea.

Mr. Nadler is a contributing editor of the American Banker and professor of finance at the Rutgers University Graduate School of Management.

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