Rising rates have their plus side, too BANKING

January 01, 1995|By David Conn | David Conn,Sun Staff Writer

For all the concern about the damage higher interest rates may do to banks, it's important to remember one thing: Rates are higher because the economy is on the move, and that's always good for banks.

Still, 1995 may prove to be a year on the tightrope for many banks, according to industry members and analysts.

Banks will have to balance the benefits of a stronger economy, namely more consumer and business loans, with the potential costs: higher deposit rates. At the same time, some popular sources of nonlending income, such as securities sales and mortgage banking, are drying up.

"Banking in 1995 will probably be as difficult as it was in 1994, for all the same reasons, and maybe some more," said analyst John A. Heffern of the NatWest Securities office in Baltimore.

Banks last year were able to maintain high net interest margins -- the spread between interest earned on loans and money paid to depositors -- by promptly raising loan rates after every Federal Reserve Board move, while keeping rates low on deposits. It hasn't made them many friends in the consumer sector, but it has kept profitability high.

But one major reason bank stocks performed poorly last year is that "investors are concerned that there will be some catch-up [in deposit rates] if a growing economy increases loan demand enough that banks have to bid more aggressively for deposits," Mr. Heffern said.

The Federal Reserve raised rates six times last year, and most expect at least another move this month.

Still, some bankers believe there is enough liquidity to avoid hefty deposit rate increases, and that increased business borrowing will make up the slack.

"I think a lot of businesses have put off capital expenditures and can no longer afford to," said H. Victor Rieger Jr., Signet Banking Corp.'s executive vice president for commercial banking in Maryland.

Also, securities that mature this year can be reinvested at the same or better rates than a year ago. But that's hardly a major fTC source of growth in profits. Instead, most banks will continue to focus on making new loans and looking for nonlending sources of income.

Unfortunately for banks, their major area of "fee" income is securities sales, and the higher interest rates have placed a dark cloud over the stock and bond markets. With interest rates higher, it's more difficult for banks to attract mutual fund investments.

The same holds for mortgage banking, another source of fee income: With higher rates, there are fewer homebuyers seeking mortgages.

"What's left?" asked David Sochol, a Legg Mason bank analyst. "Operating expense reductions. Most banks are really focusing on that now," he said.

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