Banking Pulls Back From The Brink

For the past year or two, there have been frequent warnings of a cascade of bank failures that would rival the savings and loan fiasco. One recent book, Banking on the Brink, by Cleveland State University professor Edward W. Hill and consultant Roger J. Vaughan, said that more than 1,000 banks were insolvent and another 1,000 were on the "lip of insolvency." These doomsayers have found a high-profile spokesman in Ross Perot, who used the final Presidential debate on Oct. 19 to raise the specter of a huge taxpayer bailout. "Right after Election Day this year, they're going to hit us with a hundred banks," he warned. "It will be a $100 billion problem."

Perot's prediction appears badly overstated. True, starting Dec. 19 federal regulators will be required to close institutions that don't meet strict new capital standards. But the real "December surprise" may turn out to be how few institutions will be shut down. Banking consultant Ferguson & Co. estimates that no more than 55 banks, with total assets of $17 billion, are at risk--and the Bank Insurance Fund's exposure is probably less than $3 billion.

Why no meltdown? Look to the Federal Reserve, which is largely responsible for engineering an apparently successful rescue of much of the banking industry. With interest rates driven down to the lowest levels in three decades, banks are enjoying a widening spread between what they pay for funds and what they charge for loans (tables). As a whole, the income of the nation's 12,000 banks soared to a record $15.7 billion in the first half of 1992--54% more than the same period a year earlier. "As long as interest rates stay low, a lot of banks will get healthy in a hurry," says Andrew C. Hove Jr., acting chairman of the Federal Deposit Insurance Corp.

Banks' failure to pass interest-rate savings through to borrowers has undoubtedly contributed to a sluggish economy this year. But banking regulators, conscious of the need to beef up institutions' balance sheets, made no effort to jawbone those rates down. "We've been encouraging banks to lend, but we're happy to let market forces work on the price of lending," says Treasury Under Secretary Jerome H. Powell.

BULGING POCKETS. The resulting profit upturn sent bank stocks soaring. That in turn has enabled even struggling banks, such as Citicorp and Riggs National Corp., to raise enough new equity to bring capital ratios to the highest level since 1966. As a whole, banks have come up with $20 billion in new equity over the past two years. "Whatever ails banks can be paid for out of the industry's own pocket," says James J. McDermott Jr., president of New York analysts Keefe, Bruyette & Woods Inc.

Of course, wider margins don't work for every ailing bank. Many institutions have been taken off the critical list through private deals put together with the encouragement of regulators. MNC Financial Inc. and Ameritrust Corp. were both acquired by stronger rivals eager to expand their consumer-banking franchises.

At other institutions, regulators have been more aggressive. Midlantic Corp. was told to replace its management and slash assets by 35%. The New Jersey holding company sold its New York and Pennsylvania banks, as well as other units. That enabled Midlantic to cut its corporate payroll by 28% and report its first quarterly profit in years. "The worst has passed for them," says Keefe Bruyette analyst John B. Works. "This company is a survivor."

The industry's improved condition appears to have taken taxpayers off the hook. A year ago, the FDIC predicted that 200 banks, with assets totaling $80 billion, would fail in 1992. Regulators now expect 110 to 120 failures--and don't foresee an increase next year.

`INTO THE SOUP.' To be sure, the banking industry isn't completely out of danger. While total bad loans are now lower than when the crisis began in the late 1980s, many institutions remain vulnerable to a further decline in commercial real estate. "Another drop in the economy, rise in rates, or need to take deeper discounts in real estate will cause a number of banks to go back into the soup," says consultant Edward E. Furash. "We need another 18 months of low rates." And California, where the recession hit late and has lingered longer, is a special problem: A quarter of the state's banks are still losing money.

The long-term problems facing all banks persist, though. The industry's retrenchment and the growth of competitors have eroded their plum businesses, perhaps permanently. And banks still must live within a regulatory structure better suited to 1935 than 2005. But their recent improvement in health means that, despite the warnings of doomsayers, most banks will still be around to see the new century.

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