This Week, Industry Snapshot Looks at
Big Banks

BankAmerica Corporation Chase Manhattan Corporation Citicorp J.P. Morgan & Co., Incorporated NationsBank Corp. Wells Fargo & Company Subscribers Online Discuss Industry Snapshot

ALEXANDRIA, VA (September 05, 1997) -- The following is anabbreviated version of the Motley Fool's "Industry Snapshot," an educational subscription product available for delivery via e-mail or fax. We feel that it is the best tool available for learning how to invest in stocks.

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Every week we will offer up a taste of what is available to Industry Snapshot subscribers by providing a short summation of the industry and the companies that appear in the most curent issue.

This Week's Industry Snapshot

This week, Industry Snapshot looks at big banks -- those institutions that measure their assets in the hundreds of billions of dollars, rather than just the billions. In the past, many of these companies might have been called "money center banks," since they functioned as the reserve depositories for smaller, correspondent banks. As the wholesalers in the banking system, these banks would take in the federally mandated reserve deposits of small banks, which in turn could count on the liquidity, or quick payment capabilities, of these larger banks. Today names like super regional, mega regional, and "international" are routinely kicked around.

A Little History

Before and after the Federal Reserve Act of 1913 codified more stringently a national reserve system for banks, the money center banks acted as anchors in the U.S. financial system. During the liquidity crunches following the breakdown of the world trading system in the 1930s, as well as in the Latin American and lesser developed countries (LDC) debt crisis of the late 1970s and 1980s, these banks took on the most negative connotation of the word "anchor" by exacerbating downturns through tightened credit policies.

Traditional money center banks used the "float" -- cash entrusted to them as reserve and commercial deposits -- to finance higher-risk, higher-reward investments. These ranged anywhere from the trading of securities, to making short-term industrial loans, to the modern day structuring and speculating in derivatives markets. Abuses of fiduciary responsibilities, though, led to Depression-era regulations, most notably the Glass-Steagall Act, which forbade banks to engage in securities underwriting, even if the banks weren't using customer deposits to finance such activities.

With a resurgence of international trade in the post-War world, banks like Citicorp, Chase Manhattan, and Chemical Bank were building commercially oriented enterprises wherein "relationship banking" made it possible for multinational U.S. corporations to finance working capital needs, borrow for longer-term fixed asset expansion, deposit receipts in international branch offices, and facilitate foreign currency exchange transactions all with the same bank.

Banks Today

For large, specialized, money-center banks, the industry has really changed over the last few years introducing a lot of new competition. Now that a letter of credit does not take weeks to travel across the ocean by boat, the risk and reward of being a prime facilitator of international transactions is not confined to only a few players. Foreign exchange dealings and international lending tasks can be handled just as effectively for a corporate client by a company like NationsBank as by J.P. Morgan. Corporate clients of the large-cap banks don't have to come exclusively to these companies any more for short-term and overnight financing of working capital. With the flourishing of the commercial paper market in the 1970s, which is a major component of the "money market," short-term financing rates became market-based and ultra-competitive.

It has not been all a loss for the old, money-center banks. The Citicorps of the world are no longer focused entirely on the commercial banking segment. Like a super regional bank such as Wells Fargo, Citicorp is also a huge lender to the consumer. As of the first quarter of 1997, in fact, Citicorp was the largest consumer lender in the country, followed by BankAmerica, Chase Manhattan, and NationsBank. Because of its low cost of capital (the higher the P/E of a stock, the lower the equity cost of capital, and the better a company's debt rating, the lower its cost of debt capital), these companies can lend huge sums of money.

A favorite way for these companies to boost net income is to make consumer credit card loans (Citibank is the country's largest such lender). On a young account, this generates upfront fees and usually lower credit losses. After all these loans mature, the company sells the loans to a trust that it manages. The loan is then not seen on the balance sheet of the company, but the late fees, over-limit fees, and management fees from these trusts (which large institutions buy into) do show-up on the income statement. With these assets off the balance sheet, the banks show a higher return on assets, return on equity, and higher operating margins (the efficiency ratio).

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