Times are good. Bank stocks have never performed better. Bankers who want to sell out are getting unbelievable multiples. But we all know that when everything looks fantastic, trouble may be around the corner.

I asked some top observers of the banking scene what problems could emerge in the near future. Several major ones were mentioned.

Margins

One reason banks are so profitable today is that the margin between cost of funds and returns on loans and investments is at record levels. Banks are earning traditionally high returns on credit card outstandings and solid yields on other loans and investments.

Yet the typical bank is paying a stingy rate to depositors of about 1% or 2% on their funds-and this only if an ever-rising minimum balance is maintained.

What happens if competition or market conditions reduces loan and investment yields further? Can rates paid on deposits decline any more without insulting bank customers?

In sum, the next likely move in spreads is down.

Loan-to-Value Ratios

Some banks are lending over 100% of value on mortgages either directly or through home equity loans piled on top of outstanding mortgages.

What happens if borrowers cannot pay? Are banks in a position to foreclose? And even if they are, how much of what they have lent will they get back in a foreclosure sale?

Very few bankers, except in farm areas, know about Chapter 12 of the Bankruptcy Act, whose "cram-down" provision allows lenders to get back only as much as a property is now worth, rather than the full amount lent. Could not similar requirements be imposed on home loans, even assuming that a bank has the gumption to default and throw people out of their homes?

Credit Card Losses

Nonperforming credit card balances are running at about 5% of outstandings!

In other industries this would be catastrophic. Can you see an airline telling you that 19 out of 20 planes make it from Newark to Chicago without crashing? Yet banks seem to feel that the profit from those who do pay is so great that far from worrying, they should keep beating the bushes for new customers-many of whom are already way behind with their credit card accounts.

One can easily see regulators, lawmakers, and "public advocates" crying out that the rates charged on credit cards are far too high if they can subsidize such losses on the deadbeats. Who knows what such publicity could lead to?

Stock Buybacks

Many banks have so much excess capital that they are buying back their own stock even though it is selling well above book. This obviously dilutes bank capital, even if it is raising earnings per share right now. As banks grow, many will regret having let their capital drain out with so little to show for it.

The Stock Market

Bankers must be prepared for a downturn in the stock market.

A market that keeps setting records has given consumers a sense of wealth; they are borrowing more from banks to buy second homes, boats, and other items. And businesses are also borrowing more, counting on consumers' stock-market profits to buttress sales.

Some observers feel that the flow of pension fund and annuity money into the stock market will provide protection against sharp declines. Indeed, professional observers look at the United States in the past two decades and remember that most of the people who bet against the market and the economy were losers.

But others fear that the flow of funds will go the other way as boomers now nearing retirement age start living off their investments. They urge bankers to be prepared for a stock market decline.

After all, you do not plan on for a tire to blow, but you want to be ready if it does.

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