Bank stocks languish as profits rise

THE BALTIMORE SUN

What's wrong with this picture?

A big industry goes through a week of companies' earnings reports. They are uniformly fabulous, with fatter profit margins, bigger overall gains and financial ratios that were unusual even during the boom times of the late 1980s and unheard of during the debacle of the early 1990s, when it looked like many of the industry's biggest players might not survive.

So why are bank stocks generally languishing?

The answer, ultimately, is interest rates. But as with interest rates themselves, what is hitting bank stocks is more a fear of the future than what has happened so far.

Just as the bond market plunges on signs of future inflation -- rather than the current picture revealed in monthly price data -- so banks are getting pounded by fears that eventually short-term interest rates will rise, matching the sharp rises in long-term rates throughout 1994.

"It's not a next-quarter event, not even an early 1995 event," said John Heffern, a regional bank analyst for NatWest Securities who is based in Baltimore. "But it's out there. That's why investors may hesitate to push bank stocks much higher."

Mr. Heffern is not alone in thinking last week's news was too good to last.

Baltimore Bancorp said its third-quarter profits rose 354 percent. Provident Bankshares Corp., which owns Provident Bank of Maryland, saw earnings jump 62 percent. Signet Banking Corp. of Richmond, Va., which owns Signet Bank/Maryland, saw operating profits jump 25 percent, though big one-time charges depressed final results. And Mercantile Bankshares Corp. said its earnings climbed 12 percent on a strong 1993 performance.

NationsBank also up

NationsBank Corp. of Charlotte, N.C., which finished converting Maryland National Bank branches to their new identity Friday, said companywide profits jumped 26 percent. First Maryland Bancorp, the parent of First National Bank of Maryland, posted a modest 7 percent gain.

There is no great mystery as to why this all happened, bankers and industry analysts say. Losses from loans that don't get paid back are way down because the commercial real estate industry, while still stagnant, has wrung out almost all its bad loans. Also, the consumer is back, and loan products like car loans and credit cards tend to command fairly high interest rates.

But most of all, there is an exceptionally wide gap between short-term interest rates -- like the rates banks pay to attract customers' deposits -- and long-term rates, like the ones they charge to lend money.

"Banks borrow short and lend long," Mr. Heffern said. "That's why they are making so much money now."

Long-term rates have skyrocketed since February, when the Federal Reserve began raising rates to head off future inflation, and long-term lenders began demanding higher yields to pay them for taking the risk of being repaid in cheaper dollars.

"Everyone thought bank profits would slide when interest rates went up. But they have gotten a shot in the arm. It could last another two quarters," said Arnold Danielson, a Rockville bank and thrift consultant.

David E. Borowy, Mercantile's investor relations officer, said his bank has stayed away from aggressively pursuing consumer business. Its loan growth has been small, and mostly on commercial loans. He said the bank doesn't want to compete with the automakers' finance divisions, because it can't match the money-losing finance rates they are willing to absorb in order to sell cars.

Mercantile in minority

But Mercantile is in the minority. Baltimore Bancorp's investor relations director, David L. Spilman, said the Bank of Baltimore was able to ride the wave well because it has concentrated much of its growth in consumer-oriented sectors like auto and credit card loans.

The bank's credit card portfolio, aided by a summer mail solicitation sent to 1.2 million people, has grown by 30 percent since June.

"The best returns in our loan portfolio come from credit cards," Mr. Spilman said. "It's a consumer-driven economy."

NationsBank is almost as aggressive. Its consumer loans have grown 18 percent in the past year, even after adjusting for the fast-growing bank's acquisitions and its securitization of credit card receivables. Commercial loans have grown only 10 percent.

Provident President Peter M. Martin said his bank has also boosted its assets in home equity loans and residential construction loans.

"The numbers are so high they begin to seem a little scary," said Mr. Heffern, who said many Southeastern banks are posting 15 percent year-over-year growth in overall loans. "Risks may be on the credit side. Banks say they are holding to credit standards, but I am hearing that concessions abound."

In addition, said Mr. Heffern, banks will be forced to narrow the gap between deposit rates and loan rates. He said that's why most local banks' stocks continued to trade in the lower half of their range for the past year even after the strong earnings reports.

Mercantile, for example, closed Friday at $20, off its 52-week high of $23.125, while Provident closed at $24.50, down $3.25 from its peak. Signet, at $33.375, is $10 off its 52-week high, and NationsBank, at $49.125, more than $8.

Mr. Spilman said the Bank of Baltimore has seen the trend begin already. The bank has had to bid up the price of longer-term certificates of deposit to hold investor interest, he said, with one new product tied to federal Treasury bill rates. He said banks will need to raise deposit rates in order to have the financial base to meet rising loan demand.

Competition watched

"We watch our competition very closely, and people are beginning to raise rates very smartly," he said. "The biggest issue in bank stock today is interest rates. . . . That always, always translates into a negative for banks. When interest rates go up, bank stocks get hammered."

But some experts say the case for rising short-term rates is not that strong. For all of the bond market's hedging of inflation risks this year, the consumer price index has risen at an annual rate of only 2.8 percent so far this year, and producer prices at a 1.9 percent annualized rise.

If inflation fears subside, banks' recent run would have a better chance to keep running, said Mahlon Straszheim, chairman of the economics department at the University of Maryland College Park.

"I think we could go for some time yet with this gap between short and long rates," said Mr. Straszheim, who is also an economics adviser to Gov. William Donald Schaefer. "Lenders in the long market have been burned so many times in the past that even if inflation remains good, the fear of [long-term] inflation will still be with us."

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