Financial institutions adapt to rising interest rates; mortgage bankers may face toughest short-term future.

Experts are divided on how the recent rise in interest rates is likely to affect Los Angeles' financial institutions.

Banks, thrifts and mortgage bankers will each be affected in different ways. Most analysts agreed, however, mortgage bankers will likely have the toughest time adjusting in the short run. Ironically, the institutions that may most benefit from rising interest rates are the troubled thrifts in Los Angeles, industry sources said.

Rising interest rates are likely to put a damper on loan originations. Thomas O'Donnell, a financial institutions analyst with Prudential Securities Inc. in New York, predicted overall originations nationwide could drop by up to 30 percent for mortgage lenders. That would be a problem for mortgage banks because those companies live and die by originations.

"Mortgage bankers are in more trouble than savings and loans because they have profited from fixed-rate financing," he said.

Signs of strain are already becoming visible in Los Angeles, at the county's largest mortgage banking firm. Pasadena-based Countrywide Credit Industries Inc., also the largest mortgage banker in the nation, has reported significant declines in loan originations in recent months. As was recently reported by the Los Angeles Business Journal, Countrywide's loan originations declined by 22 percent between December 1993 and February 1994.

Banks and thrifts, meanwhile, are more likely to benefit from rising interest rates, although analysts said they are cautious about predicting that this would translate to the bottom line.

"On balance, the economic conditions, the interest rate structure and the expected recovery of the California economy will be favorable to banks," said Ken Ackbarali, senior economist with First Interstate Bank. "The rising interest rates are associated with a stronger economy because that means more business and more borrowing."

However, analysts are tempering their enthusiasm about the future of local banks and thrifts because much of such institutions' success still hinges on the recovery of the California economy. California, and especially Los Angeles, is still at the bottom of an economic downturn. While the rest of the country is beginning to see its way out of the recession, Los Angeles will continue to see tough economic times, according to analysts.

"For those institutions that are still in trouble, this (rising interest rates) won't help," said Warren Heller, director of research for Wakefield, Mass.-based bank rating service Veribanc Inc.

Heller pointed out that California's financial institutions have been harder hit than banks and thrifts in other parts of the country.

As the state pulls itself out of its economic doldrums, as many are predicting will happen in the next six months to a year, banks should be able to add more loans to their books, according to analysts. "That is good because you get a higher yield from adding loans (at higher interest rates)," said Ackbarali. New loans are only one part of the story, however.

On the negative side, for financial institutions, is that higher interest rates mean they will have to pay out more interest on deposits. The fact that the federal fund rate has gone up and may go up again should make consumers happy and may send some back to banks to invest in certificates of deposit, industry sources speculated.

Low interest rates in recent months had sent investors running to Wall Street to put their money in stocks and mutual funds, which offered higher returns on investment. Some analysts said consumers may come back to purchasing bank CDs because of the higher interest rates.

Paying out high rates to depositors, however, "squeezes" lenders' the interest margins -- the difference between the interest rates banks and thrifts pay on deposits and the rates they charge on loans. "(Rising interest rates) could be bad for banks because it could narrow the net interest margin if they are not aggressive enough in raising interest rates on loans," said Ackbarali.

Interest income has been under pressure for some time now and is affecting even the largest financial institutions in Los Angeles. Downtown Los Angeles-based First Interstate Bank, Irwindale-based Home Savings of America and Chatsworth-based Great Western Bank all experienced a decline in interest income last year.

One banking analyst, Campbell Chaney with Dakin Securities in San Francisco, said some troubled thrifts may get a reprieve from the higher interest rates. His prediction is based on the fact that higher interest rates are often associated with inflation.

"Higher-inflation types of scenarios mean that the value of real estate will go up," said Chaney. "Troubled thrifts have too much bad real estate, so the fact that prices are going up may mean that they can sell them at higher prices."

Heller disagreed, insisting that inflation and property values are not likely to go up significantly any time soon. "If the an institution has REO (foreclosed) property, they have to dump it now," he said. "They can't wait for the next real estate bubble." In fact, inflation is only likely in the long term, according to Heller. The Fed's mission these days is guided by a fanatical commitment to not letting inflation occur, he said.