Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: SUNDAY, November 6, 1994 TAG: 9411080070
SECTION: BUSINESS PAGE: F1 EDITION: METRO
SOURCE: MAG POFF STAFF WRITER
DATELINE: LENGTH: Long
Can you recall Ross Perot's so-called December surprise, his prediction during the 1992 presidential campaign of a post-election government seizure of hundreds of failing banks? He was mistaken, of course, but the economic situation in 1992, when the savings and loan crisis was just winding down, caused many people to believe him.
Welcome to the autumn of 1994 ,when what went down has come up, when the business cycle has made a 180-degree turn. As of their third-quarter financial reports made public last month, Virginia's major banks are sitting pretty, thank you.
Nationwide, banks reported a return on assets of 1.16 percent for the first six months of this year, according to Virginia Stafford, spokeswoman for the American Bankers Association. They earned a collective $22.3 billion, the largest amount for any six-month period in banking history and $1.2 billion more than during the same period in 1993.
Now the question is whether the banks can sustain this blistering pace into 1995 and beyond.
Opinion on that subject among a dozen bankers and bank analysts is mixed, but investors obviously don't think they can. Despite their strong financial reports this year, bank stocks are trading at or near their annual lows.
A case in point is Signet Banking Corp., which closed Thursday at $33.621/2 a share, compared to a low of $30.50 and a high of $43.875 over the past 52 weeks. Another example is Crestar Financial Corp., which closed Thursday at $40.50 versus a low of $37.75 and a high of $49.75
First Union was in a somewhat better stock position to acquire more banks, with a price of $44.25 on Thursday compared to a high of $48 and a low of $37.25.
Low stock prices usually mean that larger banks cannot acquire smaller - or less efficient - competitors without undue dilution of their own stocks. The fact that most acquisitions are financed by stock issues may largely explain why long-predicted major mergers have not come to pass this year.
In addition to the healthy increases in bank profits, measured by dollars, the industry's two key measures of financial strength and profitability are less obvious, buried deeper in the quarterly reports: return on assets and return on equity. They are reached by dividing the company's profit by assets and by average net worth respectively. The higher the figure over industry guidelines, the better.
The mechanics of reaching the figure are an accountant's game, but the results are important to any and every business.
Every banker's goal has always been to achieve a return on assets ratio of 1 percent, showing solid financial strength.
Today, however, Virginia banks are reporting ratios that range from 15 percent to 59 percent above that general guideline.
And the dream of every banker - indeed, of every American business - is to achieve a return on equity or profitability ratio of 15 percent.
For the first three quarters of 1994, all but one of the Virginia banks' holding companies surpassed that mark - and by as much as 23 percent.
The exception was Signet, which reported a near-14 percent return on equity and said the reason for its shortfall was that it took an accounting charge on internal restructuring and layoffs to lower its costs over the long term.Such steps generally come with a high initial expense.
Without that one-time charge, said Signet vice president Teresa Jones, the return on equity would have been 20.3 percent and the return on assets would have been 1.86 percent. And the expense this year, she said, will make Signet a more profitable bank in the future.
\ "Banks had a dramatic improvement in profit," said Henry J. Coffey Jr., who follows the industry for J.C. Bradford & Co. in Nashville, Tenn. He attributed the turn-around to three factors:
nThe improvement in credit quality. The commercial real estate market, especially in the Washington metropolitan area, has about returned to normality after a collapse in the early 1990s. That crisis in commercial real estate caused major Virginia banks to set aside millions in loan loss reserves every year and so weakened Dominion Bankshares of Roanoke that it was forced to pursue acquisition by First Union Corp.
nBanks are starting to see loan growth. Loans have a higher yield for banks than alternative investments such as government securities.
n"Most banks are pretty conscientious about cost control." Most of them in the last few years have reduced expenses, often by cutting back on staff.
"Add them all up," Coffey said, "and you make a lot of money."
Guy W. Ford, director of research for Scott & Stringfellow Inc. in Richmond, said banks demonstrated this year that they have learned to operate in a rising interest rate invironment. Rising rates, he said, put pressure on banks' operating margins of profit.
But because loan business has been slow for the last few years, he said, banks also have found they can rely on alternative products (like government securities) for their earnings.
A weakness, Ford said, is that banks have not been in a position to take advantage of the surge on the stock and bond markets. "They are working in that direction."
David West, banking analyst for Davenport & Co. in Richmond, said interest rates were low until February, so banks had low-cost deposits. Interest on deposits has not changed all that much, West pointed out, while rates on assets such as loans have gone up. Many of these assets have rates that float with the market.
In the last few months, West said, the demand for commercial and consumer loans has grown at double-digit rates, bringing new income to the banks. That demand has been triggered by an improving economy and higher customer confidence.
Banks also face "an extremely good environment for asset quality." So-called nonperforming assets, or bad loans, are at a low level. Banks have had to set aside only modest amounts of money to cover loan losses. At Crestar, for instance, the provision for loan losses was $18.7 million in the fourth quarter of 1992 and $8.1 million in the last quarter.
"Banking really is at the high point of its cycle," according to David Stumpf, who follows the industry for Wheat First Butcher Singer of RIchmond.
They are well capitalized, Stumpf said, and their asset quality is strong.
So far at least, he pointed out, they have not been under pressure to pass along higher interest rates to their deposit customers.
"The economy is clearing doing better, noted Jones of Signet. "Asset quality issues are behind us."
Customers, she said, are more confident about their finances. The industry has a lot of capital, Jones added, and banks "are making wiser decisions." Read that as tough decisions such as laying off employes.
Rick Bowman, chief financial officer of Falls Church-based First Virginia Bank, said that until recent times the industry as a whole never met the traditional measurement of a one percent return on assets.
But as the Federal Reserve Bank lowered interest rates over the last few years, he said, the cost of holding deposits fell faster than the banks' return on fixed assets such as securities and loans. Banks developed good earnings flows.
In the early 1990s, Bowman said, banks had to charge off commercial real estate loans and set aside a large portion of earnings to offset these losses.
As time passed, he said, these loans became healthy again. Banks were able to return to earnings the amount charged off. That gave a boost to 1994.
WHAT THE SMART MONEY SAYS
Randolph McElroy, president of NationsBank of Virginia, cited the good economy, especially in Virginia. "Business is good in the state."
But he also said that the ratios on earnings excel "because these are very well run banks."
Carson Quarles, president of the Southwestern Region of Central Fidelity Bank, said banks cleaned up credit problems so that they enjoyed lower loan loss reserves.
"Cost cutting and efficiency measures added to the profits in the last two years," Quarles said, along with an improved economic environment.
Eugene Putnam, director of investor relations for Crestar Bank, said consolidation of the industry has created more competition, forcing banks "to do things better." He believes that the old financial benchmarks may be revised upward permanently.
Ben Jenkins, president of First Union National Bank of Virginia, said the industry was involved in "a bit of a struggle" only five years ago with bad loans and lack of growth and profits.
The loan situation was resolved, Jenkins said, and the spread between the Fed funds rate (at which banks borrowed) was 2.5 points lower than the prime rate (at which they lent).
by CNB