Commercial banks may be earning record profits, but they aren't winning any plaudits for the way they are managing their vast portfolios of securities holdings.
In the two years through last December, banks eked out average annual returns of 5.84% on their portfolios of investments, said John Ward Logan, executive vice president of First American Corp., Nashville. He alternately described the performance as "relatively poor" and "awful."
Had banks simply invested their portfolios in two-year Treasury notes, they would have reaped returns of 6.02%, he pointed out.
Mr. Logan led a panel discussion on the American Bankers Association's eighth annual portfolio managers survey, unveiled Saturday at the trade group's annual convention here. The ABA poll of 2,000 banks drew responses from 174; their assets averaged $5.1 billion.
The survey provides extensive detail on banks' investment portfolios - far more than can be gleaned from call report data, according to Mr. Logan. These portfolios, consisting of a wide range of mostly fixed-income securities, hold nearly one-third of bank assets, making them an important lever of profitability.
Banks did improve their portfolios' performance in 1995, boosting average total returns to 9.92%, versus 1.74% in 1994. But Mr. Logan said the rise simply reflects 1995's market rebound.
He blamed the weak results on "the negative convexity imbedded in bank portfolios." He explained that banks tend to buy investments on the basis on current yield and often fail to weigh adequately the market shifts that affect the value of the investments.
In a striking finding, the latest survey showed that banks - particularly the smallest ones - have become major consumers of callable agency securities. On average, these investments made up 8% of the banks' investment portfolios.
A callable security is one that can be redeemed by the issuer before its scheduled maturity.
For the 55 respondents with under $100 million in assets, callable securities made up 10% of their portfolios; for the seven with over $20 billion in assets, noncallable securities accounted for 1%.
Mr. Logan noted that the survey in past years didn't distinguish between investments in callable and noncallable securities, making it impossible to measure precisely how much banks' stake in these investments has grown.
But he said banks clearly emerged as "major investors" last year. And there is every indication that they continue to pile into the callable market, which has exploded: issuance has reached $235 billion through the first nine months of 1996, according to Securities Data Co. Issuance for 1994 totaled $202 billion, and $253 billion in 1995, SDC reports.
Mr. Logan added that bankers appeared to have begun shifting investments to callable securities partly because federal regulators recently imposed a high-risk security test that dampened banks' appetite for mortgage-backed securities.
A fellow panelist said banks that are loading up on callable securities may be underestimating their volatility.
"You get a better yield up front - that's the temptation to buy," said Jackson Lehman, chairman of Fort Wayne (Ind.) National Bank. "But we don't use callable bonds - it's a no-win situation."
In other key findings, the survey showed:
*75% of banks' securities holdings were in available-for-sale accounts in 1995, up from 49% in 1994.
*The proportion of banks maintaining available-for-sale accounts climbed five points, to 98%.
*25% of banks used derivatives in their securities portfolios, up from 22% in 1994. The most pronounced trend was toward purchasing interest rate floors; 28% of derivatives users said they had increased these positions.
*In response to a new survey question, 21% of banks said they were using money market funds as an alternative to the federal funds market.
