Prospects for Star Banc Dimmed by an Acquisition

Normally conservative Star Banc Corp. of Cincinnati reached into the bank-acquisition grab bag and came out with its fingers stuck in a mousetrap.

When Star acquired First National Bank of Miamisburg, Ohio, two years ago, little thought was given to First National's holdings of municipal revenue bonds. Only last year did it emerge that the bonds, in an arbitrage scheme attempted by the municipalities, were backed by guaranteed investment contracts issued by California's First Executive Corp., now defunct.

In this year's first quarter, with First Executive in ruin, Star Banc was forced to take a reserve for possible securities losses. Analysts say the reserve totaled $1.8 million pretax and was linked to the municipal bonds and the related First Executive contracts.

"The reserve wasn't an overly shocking event. Mostly, it caught attention because it came from a conservative organization," said Fred A. Cummings, banking industry analyst at McDonald & Co., Cleveland, who is neutral on the company's stock.

Indeed, while the bond snafu brought down first-quarter earnings only marginally, it illustrates the difficulty of knowing a bank inside out before acquiring it. "We would not have acquired the securities on our own," laments Gust J. Totlis, Star's chief financial officer.

Attempts at Arbitrage

Municipal revenue bonds differ from general obligation bonds because they rely on underlying projects for repayment. In this case, the underlying project seems to be guaranteed investment contracts from First Executive.

The securities were seen as triple-A credits by rating agencies until last year, Mr. Totlis said, but First Executive's troubles caused their rating to be dropped to below investment grade. The Office of the Comptroller of the Currency requires banks to set reserves in such cases.

The provisioning contributed to a reduction in first-quarter earnings to 52 cents a share from 59 cents a year earlier. Weak loan demand was also cited as a factor in the sluggish results.

A Lift from the Rally

Star's shares have risen with other banking stocks this year, peaking at $23.50 on Feb. 28. On Tuesday they traded at $21.50, off 25 cents in the session.

There were no other surprises in the quarter, Mr. Cummings said, but earnings at Star are expected to be flat in 1991 and to grow only modestly in 1992. That makes the stock appear fully valued at its current level, about 9.3 times his 1991 earnings estimate of $2.25 a share and 120% of book value.

Star, with assets of $6.1 billion, has no appreciable credit quality problems. Indeed, the loan-loss provision was slightly lower than expected, reflecting a 40% reduction in net chargeoffs from the fourth-quarter level.

In addition, analysts anticipate that Star Banc's planned acquisition of Kentucky Bancorp., Covington, Ky., will provide a strong boost to Star's earnings, adding $380 million of earning assets to the balance sheet in the third or fourth quarter. [Graph Omitted]

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