Low interest rates seen threatening loan institutions Short-term fees may not offset long-term risks.

WASHINGTON — WASHINGTON -- The lower interest rates that are benefiting homeowners and other borrowers are a mixed blessing for banks and savings and loan associations and may even be pushing them into a riskier position.

In the short term, the tidal wave of homeowners seeking to take advantage of the lowest lending rates in nearly 20 years by refinancing their mortgages has provided the banks a much-needed increase in income from fees on the new loans.


But for the long term, the refinancing trend has raised concerns that many large institutions may be risking significant new losses. Federal regulators, academics and some industry executives fear that banks and savings associations, by locking themselves into long-term mortgages at historically low rates, could be devastated if inflation accelerates in the next few years.

The new rates for homeowners, averaging about 8.2 percent for 30-year fixed-rate mortgages, led to more than seven times as many refinancings last year as in 1990, according to the Mortgage Bankers Association.


Some fixed-rate mortgages are as low as 7.5 percent.

Commercial banks, attracted by refinancing fees, have been encouraging the refinancings.

T. Timothy Ryan Jr., director of the Office of Thrift Supervision, which oversees the nation's savings associations, says that in the next few months his agency would recommend ways to reduce interest-rate risks.

"This becomes more important now than before because of the high volume of fixed-rate mortgages that are being held," Ryan adds.

Regulators have proposed requiring savings and loans with high interest-rate risks to have more capital but have encountered industry resistance.

The sort of interest-rate squeeze that regulators now fear is precisely what savings and loans suffered in the 1980s. Revenues from old, fixed-rate mortgages often failed to cover the increasing interest rates they had to pay to attract deposits, which are shorter term. While deregulation, short-sighted investments and corruption all contributed to the crisis, the negative interest-rate spread is now widely acknowledged as the leading cause of the demise of hundreds of savings associations.

"If rates go up and funding costs exceed the mortgages, then some institutions will have difficulties," says Robert F. Miailovich, an assistant director of supervision at the Federal Deposit Insurance Corp. "That was the problem that got thrifts into trouble. It's not something that can be blithely ignored."

Richard H. Diehl, chairman and chief executive of Home Savings of America, the nation's largest savings association, says the potential harm from higher interest rates was worrying the industry more than delinquencies, defaults and the declining values of real estate and other collateral put up to back loans.


"It's probably the greatest risk that faces a lender," Diehl says.

Bankers and regulators have grown more sophisticated in hedging against interest-rate risk but cannot protect themselves completely.

"We can hedge to reduce the risk against five-year loans," Diehl says. "But it's very difficult, if not impossible, to hedge against longer-term loans, such as 30-year fixed loans. It just gets too expensive."

Many analysts think that the surge of refinancings will grow only stronger in the first few months of this year -- particularly if interest rates are cut again -- as millions of homeowners realize how much they can save.

A new report by Eric I. Hemel, a banking analyst at First Boston, concludes that $1 trillion in fixed-rate mortgages at rates of 10 percent or higher stands to be refinanced.

Since the savings-industry debacle of the mid-1980s, banks and regulators have developed new protections against higher interest rates. Mortgages are sold to other lenders, which then spread the risk by repackaging the loans as securities that are sold on Wall Street.


Still, experts say interest-rate risks are greater than ever. Commercial banks are more heavily involved in real estate lending than ever before -- doubling their exposure in the last decade alone. Analysts say many banks are taking greater risks to achieve short-term gain.