The final three months of 1984 saved most of the nation's major bank companies from what otherwise would have been a lackluster year.
Steep declines in interest rates enabled most big banks not only to report higher profits, but also to substantially improve their overall financial health by squirreling away large amounts of funds as reserves against future losses.
With several glaring exceptions -- most notably San Francisco's BankAmerica Corp., the nation's second-biggest banking company -- the fourth quarter was a godsend.
Even Continental Illinois Corp., whose de facto failure last spring rocked the world's financial markets, was able to take advantage of improved economic conditions and report a major profit increase for the final three months of last year.
Nevertheless, Continental's $37 million fourth-quarter profit made only a tiny offsetting dent in the $1.1 billion loss the bank reported in the second quarter. The Chicago bank -- a ward of the government after the biggest federal business rescue in history -- still reported an annual loss of more than $1 billion as a result of the second quarter.
At the core of the improvement in bank profits in the final quarter of 1984 was the steep decline in interest rates that began in late September and apparently has not yet ended. Banks lowered the rates they charge for loans more slowly than their costs of funds declined, enabling them to boost revenue and profits. The declining rates also made many bank securities -- such as Treasury notes and bills -- more valuable, and the banks sold some of them at a profit.
As a last-minute bonus, the Argentine government settled its debt dispute with its banks and the International Monetary Fund and paid $850 million of the $1.2 billion in interest that was overdue on its bank loans. The New Year's Eve payment permitted big banks to include that money in their fourth-quarter reports.
Bank companies such as J. P. Morgan and Manufacturers Hanover, with big loans to the Argentine government, benefited more than bank companies such as Citicorp or Chase Manhattan, which made a greater portion of their Argentine loans to private companies that still haven't paid.
Most of the big bank companies are fundamentally profitable, according to William J. Welsh, who analyzes the banking industry for the big brokerage firm Sanford C. Bernstein & Co. But in the fourth quarter, most of these bank companies had a run of "temporary extra income" that enabled them to report increases in profits and "build up capital and reserves," Welsh said.
Most of the so-called money center banks in New York, Chicago and California "buy" most of their deposits in the open market. They issue giant certificates of deposit, most of which mature in 90 days or less, or borrow on an overnight basis excess reserves held by other banks. Those overnight reserves commonly are called federal funds.
During the final three months of 1984, open market interest rates fell more than 3 percentage points (or about 300 basis points in financial parlance, in which a basis point is 1/100th of a percentage point). During the same period, banks dawdled in lowering the rates they charge customers with variable rate loans, as they normally do during a period of declining rates.
The prime lending rate -- on which charges for most short-term business loans are based -- declined from 13 percent to 10 3/4 percent, or 225 basis points, giving the banks a wider "spread" between their cost of borrowing and income from loans. The prime rate has fallen since to 10 1/2 percent, and open market rates have declined a little more since year-end as well.
For example, in the third quarter, Citicorp, the country's biggest bank company, reported a spread of 3.55 percentage points. That spread grew to 3.88 percentage points in the fourth quarter, and Citicorp's net interest revenue grew from $1.06 billion in the third quarter to $1.2 billion in the fourth quarter.
Citicorp -- which owns Citibank -- also had a big increase in the money it earned from trading securities. Citicorp added $141 million to its loan loss reserves in the fourth quarter, compared with $61 million in the third quarter, and still was able to report a profit growth of 31 percent to $261 million from $200 million. Other big banks reported even larger increases in their interest rate spreads than the 33 basis-point increase at Citicorp or the 31 basis-point gain at Manufacturers Hanover Corp. At Chase Manhattan Corp., the spread grew 56 basis points. At J. P. Morgan, which owns Morgan Guaranty Trust Co., the increase was 48 basis points.
Morgan also reported big gains from securities trading, and Manufacturers Hanover had gains from sales of some stocks that it has held since the Great Depression. Morgan, the most conservatively run of all the major banks, already had a large loan loss reserve and allowed most of its increased income to flow to the bottom line. Its profits jumped from $120 million in the third quarter to $128 million in the fourth quarter.
Manufacturers Hanover, meanwhile, with proportionately the biggest exposure of all major banks to Latin American loans, used the extra income to substantially boost its reserves while recording a respectable increase in profits, too. Manufacturers boosted its loan loss provision to about $147 million in the fourth quarter from $105 million in the third. Still, its profits rose from $89 million to $106 million.
Chase did not record the trading gains of Morgan or Manufacturers, and also faced high costs as a result of buying a big banking operation in upstate New York. Its profits rose from $93 million to $120 million -- but its loan loss provision of $90 million was smaller than the $125 million it made in the third quarter, although bigger than the $75 million it took a year ago.
Most of the nation's biggest banks are far better insulated against bad loans than they were a year ago. Except for Chase, the nation's third-biggest bank, they were able to build a stronger balance sheet without sacrificing profits (Chase's earnings fell 6 percent last year). In addition, the improving U.S. economy and a return to economic growth among the massive debtors of Latin America has boosted the quality of loans on the books of most big U.S. banks, according to analysts.
But giant BankAmerica -- whose $118 billion of assets rank second only to the $150 billion Citicorp -- was unable to make substantial improvements in its balance sheet and still faces profit problems.
BankAmerica's loan portfolio does not appear to be improving in quality, analysts said. Its major subsidiary, Bank of America, is the nation's biggest agricultural lender by far, and its $2 billion worth of farm loans is feeling the effects of the depression in much of U.S. agriculture. Many of its real estate loans also have problems.
The company also purchased troubled Seafirst Corp. in 1983, and the $11 billion Seattle bank company is a drain on BankAmerica.
Bank of America has a huge and expensive network of bank branches throughout California, and, unlike many other major banks, is finding it difficult to control costs. At the same time, it is reducing its assets -- as federal regulators pressure all banks to raise new capital or become smaller. Furthermore, BankAmerica was unable to take advantage of the decline in open market rates to boost its earnings or improve its balance sheet.
Unlike other major U.S. banks, BankAmerica depends on a base of consumer deposits. As a result, its depositors are far more stable and loyal than the professional investors who buy certificates of deposit in the open market. At the same time, consumer deposits are far less sensitive to interest rate changes.
BankAmerica's interest spread rose only 7 basis points between the third and the fourth quarters. And, with $118 billion in assets, BankAmerica had profits of only $73 million in the fourth quarter and wrote off nearly $300 million of bad loans.
"When you write off that much, it's hard to make substantial additions to the loan loss reserve cushion," said a major U.S. banker.