The second quarter raised an important question about the banking industry: Will sufficient loan growth emerge to offset the now visible declines in net interest margins?

That question won't be answered until next year. But short-run prospects for continued robust profits should make the wait fairly painless.

Many of the nation's largest banking companies reached turning points in the second quarter as net interest margins began long-anticipated descents. According to statistics compiled by American Banker, the average net interest margin of the 25 largest banking companies sank 9 basis points from the first-quarter level, to 4.29%. (See table on page 4.)

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That is a modest slide, to be sure. But from this point forward, some experts contend, loan growth will be increasingly necessary to sustain profitability at many banks.

Linked with the maturation of higher-yielding securities, moreover, is a dwindling potential for gains from securities sales, deflating a cushion that has provided crucial support for numerous reviving banking companies over the past two years.

Credit Quality Improves

Amply offsetting these concerns in the short run, however, is widespread improvement in credit quality - a swing factor in earnings.

During the second quarter, the top 25 banks shed $4.44 billion of problem loans and foreclosed properties, slashing their backlog by 9.8% to $41 billion, according to American Banker statistics. The concentration of nonperforming assets plunged by 31 basis points, to 2.29% of total assets.

And revenues from equity and foreign exchange trading have proved more extensive and sustainable than previously imagined, providing a hefty earnings supplement for a cadre of the largest banks.

This provides breathing room for the banking industry as it stretches for loan growth.

Signs of Life

By booking instead of selling newly originated residential mortgages, boosting card loans, and refinancing consumers, a number of banks are delivering palpable portfolio growth.

But some experts want to see more signs of life in the moribund commercial and industrial lending market.

"We have few swallows, but not a full Capistrano in terms of loan growth," said George Salem, a banking analyst with Pru-Bache Securities.

"Still, the industry is looking healthy."

Falling credit costs fueled many earnings revivals, and progress was evident in most parts of the country.

In Los Angeles, First Interstate Bancorp slashed its loss provision 43% from the first-quarter level, delivering a 13.5% increase in pretax income. In Jacksonville, Fla., Barnett Banks Inc. lowered its provision 20% and posted an 11.4% earnings increase. And in Cleveland, Society Corp. cut its provision by 23.3% while boosting net income from an already-high first quarter by 2.1%.

Trading Gains

Far more compelling for certain banks was a bonanza of revenues from foreign exchange and equity trading.

Citicorp engineered a colossal $572 million of trading revenues, up 25% from the first quarter. Bankers Trust New York Corp. posted a 17% increase, to $405 million. And First Chicago Corp.'s trading revenues skyrocketed by 68% from the first quarter, to $91.6 million.

Analysts have been hesitant about impounding trading revenues into bank stock prices, arguing that such gains are not sustainable. But top officers of the banking companies reaping trading rewards insist the trend has room to run.

At the least, experts say, trading gains will help recovering banks such as Citicorp cope with portfolio cleanup costs.

Rights' Value Slides

One sour note surfacing in the second quarter was deterioration in the value of purchased mortgage servicing rights, provoked as refinancing consumers paid off residential mortgages earlier than envisioned.

Bank of Boston Corp. took $20 million of accelerated servicing write-downs in the second quarter.

First Union Corp., Charlotte, N.C., took a $23 million charge. Michigan National Corp., Farmington Hills, took a $21.6 million amortization charge.

And Fleet Financial Group, Providence, R.I., took a whopping special charge of $100 million for accelerated amortization.

Retaff Strength

On the whole, however, consumers were good to the banking industry in the second quarter, sparking much of the loan demand recorded during the period.

Tapping its 1,340 banking offices, Columbus, Ohio-based Banc One Corp. mustered a $499 million, or 5.29%, increase in average residential mortgages during the second quarter, accompanied by an increase of $348 million, or 17.7%, in consumer loans.

And NationsBank Corp. in Charlotte said consumer lending largely was responsible for a $2.8 billion loan expansion in the second quarter, for a 16% annual growth rate.

One emerging story of well-balanced growth in the second quarter was at Bank of Boston, analysts said. Its $700 million increase in average loans represented an annual expansion rate of 13%.

The company credits marketshare gains for much of the progress.

Post-Merger Blues

Growth remains a touchy question for some banking companies, however - particularly those coming off mergers premised on efficiency gains that soon will run their course.

In San Francisco, for example, BankAmerica Corp. reported a roughly $2 billion contraction in average loans from the first quarter to the second - results attributed to the weak California economy.

At the same time, some large banking companies are winning converts simply by virtue of their return to normal, healthy results.

Consolidation Benefits

In Pittsburgh, for example, PNC Bank Corp. posted a snappy $169.1 million of earnings - for an ROA of 1.35% - that did not hinge on special gains from sales of securities and operations, as in past periods.

Similarly, other institutions showed improved second-quarter results on the strength of merger assimilations.

Consolidations in Indiana helped Cleveland-based National City Corp. deliver a 1.45% ROA in the second quarter, up from 1.38% in the first.

Similar progress helped Detroit-based NBD Bancorp boost its ROA to 1.23%, from 1.17%.

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