Better Profits Buoy Banks as Competitors Pour on the Pressure

BANKERS are giving the "thumbs up" sign these days, as the industry anticipates strong second-quarter earnings. The reports will be coming out in the weeks ahead.

Thanks to a "spread" that works in favor of the industry - enabling banks to earn a greater return on their own investments than they pay out to depositors in the form of interest - as well as declining bad debt losses, banking officials are heading off to summer vacations with a slightly lighter step than in the past. "In the short term, everything is looking sort of rosy" for the United States banking industry, says Warren Heller, research director for Veribanc Inc., a research firm in Wakefield, Mass.

The upbeat mood has not been lost on the stock market. Although bank stocks took some sharp jolts in April and May, reflecting concerns about inflation, Wall Street has shined on selected bank stocks this year. For the first six months of 1993, for example, the Salomon Brothers 50-bank stock index has risen almost 8 percent, compared with a rise of under 4 percent for the Standard & Poor's 500 index. For the four weeks ending June 28, the Salomon Brothers bank-stock index advanced 4.5 percent, more than three times the 1.3 percent gain of the S&P 500.

Bank stocks' solid performance reflects the continued recovery of the banking industry, with the number of "problem banks" steadily declining. At the end of March, Veribanc listed 77 problem banks, down from 150 at the end of March 1992. At the end of March 1991, Veribanc had counted 249 problem banks. The Federal Deposit Insurance Corporation (FDIC), providing federal insurance protection for deposits, listed 743 problem banks in March 1993, which had assets of $428 billion. A year earlier, the FDIC had

listed 1,051 problem banks, with assets of $607 billion.

Despite the decline in problem banks, the industry is facing other challenges. Enormous competition from aggressive nonbank financial institutions, such as American Express and Sears, Roebuck & Co., have forced banks to expand services just as they have slashed costs, laid off employees, and entered into mergers. There are now 11,867 banks in the US, compared with 12,700 two years ago. The industry's deposit base has also been shrinking, as customers withdraw funds from low-interest accounts to invest el sewhere - such as in mutual funds. At the end of March 1993, deposits were valued at $2.83 billion, down slightly from $2.86 billion in March 1992.

Still, there is much for the industry to be pleased about, say analysts such as Dr. Heller. Regions where banks have been in trouble, such as California, are now posting economic improvement. Most banks have set aside sufficient reserves for nonperforming loans. Consumer-loan demand has been inching upward. And the Clinton administration has passed the word along to the banking industry that it welcomes an expansion of lending - even if it conflicts with strict new federal bank guidelines.

Banks have plenty of capital to lend, according to Veribanc. Some 11,473 banks now exceed required capital levels by wide margins, Heller says. More than 11,000 could increase lending by 10 percent or better and still have excess capital on hand. All told, as much as $778 billion worth of new loans could be made without violating capital requirements, Veribanc says.

Despite short-term gains for banks - such as the upbeat second-quarter earnings reports - the long-term challenges for the industry remain formidable. Analysts George Salem and Ruchi Madan of Prudential Securities Inc. predict that bank loans will grow far more slowly in the 1990s than in the 1980s, while consumer bank deposits will continue to expand only sluggishly, reflecting consumers' growing appetite for high-yield investments.

While the Prudential analysts do not see any "downside risk" in owning bank stocks, they caution that the economic environment for banks will be difficult in the 1990s.