Rates cloud financial sector outlook

January 02, 1994|By David Conn | David Conn,Staff Writer

Bank profits have stabilized, businesses say they're ready to start spending again, and investment in the stock market remains strong.

Sounds like a sure-fire recipe for continued success in the financial services sector this year, right? Not necessarily.

"There's a lot of haze in the crystal ball right now," said Alex Hart, a Ferris, Baker Watts Inc. analyst who studies regional banks. "A lot of haze."

The biggest source of fog in the banks' future this year is interest rates. While most economists expect the Federal Reserve Board to raise rates this year, no one can predict by how much and exactly when.

The consensus has been that a rise in rates will squeeze bank profits, which swelled in the last two years as interest rates fell precipitously.

But higher rates don't necessarily mean bank profits will drop. There's growing evidence that the demand for loans will pick up this year. Late last month, the Commerce Department said American businesses plan to spend a strong 5.4 percent more this year on plant and equipment. More good loans tends to mean higher profits.

At the same time, "I think banks are generally going to be slow to raise deposit rates," said Mr. Hart. So with more consumer and business lending, but no rise in deposit rates, banks actually may see an increase in their net interest margins, or the spread between the average rate paid to depositors and the interest earned from borrowers.

David Sochol, a banking analyst at Legg Mason Inc., agrees. "I don't think they're necessarily going to kill themselves in raising rates," he said.

Most banks are keeping more than enough reserves to cover future loan losses. So they won't have to deduct from earnings by adding to those reserves any time soon, Mr. Sochol points out.

Asset growth from increased lending won't necessarily diminish banks' appetite for mergers. "We've seen no reduction in banks viewing acquisitions as a way to produce growth," Mr. Sochol said.

The bank most often mentioned as a possible buyer is First Union Corp., which entered the Baltimore area last year with the purchase of the First American banks of Virginia, Washington and Maryland.

"I think you'll see First Union go into 'Phase Two,' " said Arnold Danielson, a Rockville bank consultant. "I can't believe that they would be in Maryland without wanting to match the position of NationsBank a little more significantly than they do now."

The likely candidates, all the analysts agreed, are Baltimore Bancorp, Provident Bankshares Corp. and any number of savings and loans in the area. Or, as Mr. Danielson puts it, "The logical candidates are everybody but the unsellables: First Maryland [Corp.] and Mercantile [Bankshares Corp.]."

There may be more consolidation, but don't expect First Union to be a player, said Ronald C. Fowler, president of the company's Maryland subsidiary.

The shares of larger banks, such as First Union, have fallen in recent months, making it more difficult to pay for acquisitions. At the same time, Mr. Fowler notes, the smaller Baltimore area banks are at record highs because of the takeover speculation.

"Probably we're not going to be in the acquisition game in the next couple of years in this region," Mr. Fowler said. Look for the company to start buying around four to seven years from now, he added.

Like the banks, Baltimore's securities firms, such as Alex. Brown Inc. and Legg Mason Inc. also could be hurt by a rise in interest rates. "If interest rates go up any more than, say, 75 to 100 basis points" -- or 0.75 percentage point to 1.0 percentage point -- "one would anticipate that [stock trading] share volume will decline," said Perrin H. Long, director of equity research at First of Michigan Corp. in Detroit.

Another reason for brokerage and mutual fund executives to stay up nights is the fear of a stock market correction, which could drive skittish investors back to safer bank certificates of deposit.

But Mr. Long said there's little chance a correction would lower the Dow Jones industrial average more than 8 percent to 10 percent. "It would be no earthshaking correction," he said.

That means Alex. Brown, Legg Mason and Ferris can expect JTC profits to rise 8 percent to 10 percent next year, Mr. Long said.

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