Path: bloom-picayune.mit.edu!snorkelwacker.mit.edu!americast.com!americast.com!americast-post Newsgroups: americast.ibd From: americast-post@AmeriCast.Com Organization: American Cybercasting Approved: americast-post@AmeriCast.com Subject: Executive Update Date: Mon, 9 Nov 92 12:21:57 EST Message-ID: <10.1992Nov9.122158@AmeriCast.com> 11/9/92 TITLE Executive Update Slowing Growth In Banks' Treasury Holdings May Indicate A Pickup American Banker In New York After a long drought, there are preliminary signs that loan demand could be picking up. One indication: Bank holdings of Treasury securities are rising at a slower rate. Banks have pro- fited handsomely over the last two years by loading up on Treasury securities rather than making loans. This has been a no-lose strategy Finance because of the unusually wide spread between funding costs and the rates banks can earn on short- to intermediate-term govern- ment securities. But the slowdown in securities purchases suggests that banks are making more investments in loans - and that the banking industry's wild ride on the steep yield curve may be winding down. To be sure, it's far too soon to draw a firm conclusion. The evidence is largely anecdotal and much depends on whether the economy is really starting to perk up. But some observers are beginning to express cautious optimism that loan demand is on the rise. Sung Won Sohn, chief economist at Norwest Corp. in Minneapolis, says bank holdings of Treasury securities have been rising at a slower rate in recent weeks be- cause loan demand from small and medium- size companies is pick- ing up slightly. "It looks like loan demand is at least bottom- ing and showing some signs of recovery," he said. And though it hasn't happened yet, demand eventually will in- crease for bank loans to finance a buildup in inventories, said Ed Yardeni, chief economist at C.J. Lawrence Inc. One thing is sure: The industry would welcome an increase in lending. In June, bank holdings of government securities surpassed outstand- ing business loans for the first time in 27 years. That opened banks up to charges that they were becoming more like bond funds than lending institutions. And earlier this year, Federal Reserve Board Chairman Alan Greenspan chided banks for being timid lenders. Bankers and private economists generally blame the lending contraction on stiffer capital requirements, harsh bank examiners, a recession-induced decline in borrower creditworthi- ness and - most important - a lack of loan demand. At the same time, though, the Treasury market has probably siphoned off at least a marginal amount of bank funds that might otherwise have gone to private borrowers. If the yield curve wasn't so steep, buying Treasuries would not have been such an attractive alterna- tive to making riskier loans. "Then, I think banks would have had to work a lot harder to find loan demand - and they might have found it," said Yardeni. So far this year, the spread between the federal funds rate - a good proxy for bank funding costs - and two-year Treasury notes has averaged 120 basis points, compared with an average spread of 79 basis points in 1991 and just six basis points in 1990, according to Dana John- son, head of market analysis at First National Bank of Chicago. And in the short run, that spread might get wider. "I think the yield curve will actually steepen," said Johnson. The spread between bank funding costs and two-year Treasuries could widen if the bond market becomes convinced of a credit tightening by the Fed. That spread could approach 200 basis points, says Johnson, who notes that the spread between the federal funds rate and two-year notes was as high as 193 basis points in late April. But any tightening would be in response to a firming economy, which would be accompanied by increased loan demand and improved creditworthiness of borrowers. And banks probably would meet that demand. After all, the spread between the bank funding costs and the prime lending rate is 300 basis points. Moreover, if rates drift upward, banks would want to lighten their holdings of Treasury securities because of the capital losses they would face. The recent spike in interest rates has already eaten into the paper gains that banks have made this year on their securities hold- ings. This article is copyright 1992 Investors Business Daily. Redis- tribution to other sites is not permitted except by arrangement with American Cybercasting Corporation. For more information, send-email to usa@AmeriCast.COM