hit by drop in long-term rates
Los Angeles' high-flying savings and loans hit a patch of severe turbulence last week, as concerns that falling interest rates would hurt S&L profits sent stock prices into a tailspin.
Shares of H.F. Ahmanson & Co., the Irwindale-based parent of Home Savings of America, had fallen to $56.06 as of Jan. 8, down more than 17 percent from a high of $68 just a week earlier.
Similarly bruised was Golden West Financial Corp., parent of World Savings, which was off 11 percent at $86.38 as of Jan. 8.
Growing concerns about the effect of falling l-term interest rates on thrifts' profitability came to a head Thursday after Lehman Brothers downgraded the entire industry.
In his report, Lehman analyst Bruce Harting stated: "We are downgrading most of our S&L universe on the basis of the current flat yield-curve interest rate environment, compounded by the low absolute level of fixed-rate mortgage rates."
The yield curve illustrates the difference between short- and long-term interest rates, the "spread" on which S&Ls make their money.
The spread is between the amount thrifts pity to "borrow" money in the form of certificates of deposit (short term) and the money they earn from mortgages (long term).
The flatter the yield curve, the smaller S&Ls' spread, or profit margin.
The difference between the yield on 90-day Treasuries, a benchmark S&Ls use to determine CD rates, and the yield on 30-year Treasuries, used to determine mortgage rates, has narrowed to around 0.5 percent. down from 1.6 percent a year ago, Harting said.
The narrowing of the spread affects S&Ls in a number of ways.
As lending rates fall. more home buyers opt for fixed-rate mortgages. So even when interest rates rise, S&Ls will be stuck with lower-yielding assets.
Rather that keep such loans on their books, S&Ls might be satisfied to pocket the loan-origination fee and then bundle and unload the low-yielding mortgages onto the secondary market, analysts said.
By doing so they would receive immediate cash, which they could use to buy hack stock.
Another problem caused by filling rates is that they prompt many existing homeowners to refinance, further reducing the S&Ls' interest income.
While long-term rates are falling, short-term rates have held fairly steady. So S&Ls are not getting much relief on the amount of interest they must pay on certificates of deposit.
"The impact of a flat yield curve is a challenge to growing profitability. If it stays flat through the year it could downgrade earnings by 10 percent," said Martin Freedman, an analyst at Freedman Billings Ramsey & Co. in Alexandria, Va.
Analysts blamed much of last week's sell-off on investors using the Lehman Brothers downgrade. They pointed out that the yield curve has been flattening consistently for several months with little negative impact on S&L share prices until last week.
"These companies had a phenomenal year in 1997, so there is a whole lot of profit-taking to be done. But I think a lot of people are running without thinking." said Charlotte Chamberlain, an analyst at Jefferies & Co. in Los Angeles.
In 1997, Ahmanson's stock surged more than 100 percent, while Golden West's rose 67 percent. Much of those gains were fueled by speculation that the thrifts would get caught up in the dramatic consolidation sweeping the industry.
Two factors could help the long-term performance of local thrift stocks - even if the yield curve remains flat, analysts said.
One is the rebounding Southern California economy, which will likely keep the local housing market active for several years. Analysts say the sheer volume of new mortgages will offset the slimmer profit margins.
The other factor is the expectation of further consolidation.
"We've seen drops like this before and what people have found again and again is that you buy at these levels," Chamberlain said.
The one company that benefits from falling rates and the trouble it brings S&Ls is Countrywide Credit Industries, a mortgage bank based in Calabasas.
Unlike S&Ls, Countrywide does not have a large portfolio of CDs on which to pay interest or a branch of retail branches to maintain.
Countrywide's share price close Jan. 8 at $44.68, a new 52-week high.
source: find articles.com
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