L.A. lenders see narrowing of interest rate spread; difference between deposit rates, loan rates shrinking.

The hefty net interest margins that helped Los Angeles financial institutions enjoy robust earnings through the recession are beginning to shrink, according to bank experts.

Among those suffering shrinking interest margins -- the difference between the interest rates banks and thrifts pay on deposits and the rates they charge on loans -- are Los Angeles County's three largest financial institutions.

Downtown L.A.-based First Interstate Bancorp, Chatsworth-based Great Western Bank and Irwindale-based Home Savings of America all reported that both interest income and net interest margins declined in the third quarter of 1993 from second quarter 1993.

Warren Heller, director of research for Wakefield, Mass.-based bank rating service Veribanc Inc., explained that interest spread "is the difference between rates banks pay on deposits and rates banks charge on loans. Net interest income is the effect that spread has on bank earnings."

Interest income has always been banks' bread and butter, Heller said, noting that bankers used to routinely talk about the three-six-three rule: "A banker pays depositors 3 percent; lends money out at 6 percent and is on the golf course at 3 p.m.," Heller said.

Fred Furlong, an economist with the Federal Reserve Bank in San Francisco, noted that interest margins began to grow in 1991, when interest rates began to drop.

The reason is that banks dropped deposit rates, but "delayed" dropping the interest rates they charged on loans, Furlong said. The result was bigger spreads, bigger net interest margins and bigger earnings. But things have changed, Furlong said.

"Interest margins really topped out at the end of last year and were flat and most recently are coming down," said Furlong.

The average net interest margin for banks in the U.S. dropped to 3.92 percent in the second quarter of 1993, down from 3.97 percent for the first quarter of 1993, Furlong noted. It was the first major decrease since 1991, when interest margins began growing, he said.

Furlong did not have national figures available for third-quarter interest margins as of press time. But interest income and interest margins at L.A. County's three largest financial institutions were down in the third quarter.

At First Interstate Bancorp, net interest income was $523.5 million for the quarter ended Sept. 30, 1993, down from $523.8 million for the prior quarter, said Ken Preston, First Interstate spokesman.

The average net interest margin was also down in the third quarter to 4.92 percent from 4.99 percent in the second quarter, Preston said.

Preston said the decline was "a small drop." Asked why it was declining, Preston would only say that the net interest margin "fluctuates" regularly.

At Great Western Bank, net interest income for the third quarter of 1993 was $349 million, compared with $353 million for the second quarter of 1993, said Steve Hawkins, a spokesman for Great Western.

Great Western's average net interest margin was 3.87 percent for the third quarter of 1993, down from 3.88 percent for the third quarter of 1993, Hawkins said.

Hawkins said, "Spreads are narrowing. The reason our spreads are narrowing is the majority of our loans are tied to adjustable rate indexes and, as interest rates declined, the indexes decline slower than the market."

Great Western and other financial institutions "had greater-than-normal spreads in prior periods, and now we're getting back to normal," Hawkins said.

At Home Savings of America, interest income was $333.2 million in the third quarter, down from $345.2 million in the second quarter, said Mary Trigg, a spokeswoman for Home Savings.

The average net interest margin of 2.87 percent in the third quarter was down from 3 percent in the second quarter, Trigg said.

"As expected, the cost in what we pay our savers is coming down slower now than the cost of what we charge our borrowers," Trigg said.

She explained that much of Home Saving's interest-earning assets are adjustable rate mortgages. And those mortgage interest rates are tied to the Cost of Funds index published by the Federal Home Loan Bank. There is a lag between when interest rates drop and when that drop hits adjustable rate mortgages, Trigg explained.

Richard Thomas, partner in the financial services division of the Los Angeles office of accounting firm Deloitte & Touche, said that financial institutions benefited when interest rates first started dropping because they could drop deposit rates faster than loan rates.

In addition, financial institutions reaped benefits when savers took money out of higher-paying certificates of deposits and put it into unrestricted passbook accounts.

When interest rates first began to drop two years ago, "people didn't want to be holding a six-month CD because they thought that interest rates would go up."

But now, banks cannot drop deposit interest rates lower, Thomas said. If they do, "there's a psychological barrier banks risk crossing where people will say they're not willing to leave their money in at this rate."

Declining interest rates have already spurred record numbers of people to put their money into stocks and mutual funds, Thomas noted. "That's why banks and thrifts are selling mutual funds now. They want to keep control of their customers."