Seas are rough, but '02 could be a profitable trip

Challenges: Despite the economic slowdown and a rising number of bad loans, the industry is stronger than it was before the 1990-1991 recession and better prepared to keep earnings high.

Banking

January 20, 2002|By William Patalon III | William Patalon III,SUN STAFF

With the economy in a downturn, delinquent loans rising and the potential for interest rates to rise later this year, the banking industry faces some significant challenges this year.

Even so, the nation's banking sector is significantly stronger than it was before the 1990-1991 recession, meaning many banks and thrifts could navigate their way to a decent 2002, experts say.

"Maybe it won't be quite as good" as last year, said Robert R. Davis, an economist and managing director of governmental relations for America's Community Bankers, a Washington-based trade group. "But earnings still will be high."

In most parts of the country, including Maryland, the year that just ended was a mixed bag for lenders.

"In Maryland, although the economy has been a bit stronger than what we've seen elsewhere nationally, we've still seen a sort of range of performances on the part of banks in the region," said Susan C. Keating, president and chief executive officer of Allfirst Financial Inc., the Baltimore subsidiary of Allied Irish Banks PLC.

Long boom helped

In the last recession, the U.S. banking industry was not well-capitalized, and many banking companies were overly focused on only one or two sectors of the economy - factors that took many lenders down when the economy headed south. Today, thanks to a long boom that generated years of profits, most U.S. banks have a stronger financial base, are more diversified or have kept expenses in check.

How well the banking industry does in the year ahead depends on how well banks and thrifts handle key challenges, each of them determined by the U.S. economy's health, experts say.

The most significant challenge might be how the economy affects lending, the central business of banks and thrifts. By making loans, financial institutions reap fees and interest income, the raw materials for profit.

After remaining fairly strong in several categories - car loans, home mortgages and mortgage refinancing, for instance - even late into last year, consumer loan growth could fall off sharply in the first half of this year, industry experts say.

In the commercial sector, lending has been tepid for some time, as the weakening economy and declining consumer confidence have prompted many companies to cancel expansion plans and even fire workers. A rise in commercial lending, in particular, would show that companies have enough confidence in the future to begin investing in their own businesses again.

"If loan growth picks back up, that's a good sign," said Edward J. Kelly III, president and chief executive officer of Mercantile Bankshares Corp., the state's largest independently owned bank.

A second challenge has to do with economic activity's effects on overall interest rates. To keep the economic downturn from turning into a free fall, the Federal Reserve cut short-term interest rates 11 times last year, bringing them to a 40-year low. That boosted profit margins for some lenders while crimping them for others.

Where interest rates will go this year depends on the economy's health.

With a prolonged malaise, rates would remain steady and wouldn't encroach on the profit margins of most banks or thrifts. But a powerful recovery could prompt the Fed to raise interest rates aggressively to head off inflation. And such a steep increase could again pare lenders' profit margins, said Davis, the economist for America's Community Bankers.

A third key challenge facing banks this year is the credit quality of their loans. As economies worldwide have gone into a tailspin, the number of problem loans has increased, along with concerns that this trend could continue. When that happens, banks have to increase their loan-loss reserves by putting money aside to cover these loans in case they become uncollectable.

Commercial banks - which since March had reserved $15 billion for problem loans - will probably have to set aside an additional $25 billion by this year's third quarter, the U.S. Office of the Comptroller of the Currency said in mid-December. Loan-loss reserves also erode bank profitability.

If the U.S. economy starts to improve this summer, as many economists predict it will, the loan portfolios of domestic lenders should start to improve this year, Standard & Poor's Inc., the credit-rating agency, said last month. That would bode well for the banking sector.

"That, to me, will be an indicator that the industry has stabilized," said Allfirst's Keating. "It's very important to stay close to what banks are doing with loan-loss reserves."

Strength seen in Md.

Many industry experts expect Maryland lenders to bounce back more quickly than their counterparts in other parts of the country because the state's economy has weathered the downturn much better than most of its rivals have, said Jeff Petry, an economist for Economy.com in West Chester, Pa.

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