The rumbling effects of the Federal Reserves interest-rate reductions are changing the landscape for Spokane-area lenders.


As the Feds rate cuts in 2000 and 2001 have pushed housing starts to record levels, theyve fueled demand for mortgages and mortgage refinancings.


All you have to do is look at the performance of Action Mortgage in our year-end results, says Heidi Stanley, Sterling Savings Banks executive vice president of corporate administration. On Jan. 27, Sterling Financial Corp., Sterlings parent, reported that its residential loan originations shot up last year to $350.9 millionalmost 72 percent higher than 2001s total of $204.5 million.


Jack Heath, president and chief operating officer of Washington Trust Bank, says the spike in mortgage refinancings has eaten into consumer lending as borrowers have rolled other types of debt into their mortgages.


Now, Heath says, People are taking home-equity lines and rolling them into 30-year mortgages.


At the same time, the crush of refinancings has saddled banks with writedowns of mortgage-servicing rights, Heath says. He says banks assign a value to the servicing rights of the mortgages they service and show that value on their books as an asset. When mortgage rates fall, however, the chances increase that those mortgages will be refinanced, which means income from servicing fees could fall. That possibility reduces the value of the servicing rights, and the bank must write it down.


All of the banks that have held mortgages in their own portfolio have had to write them down in a big way, he says. We wrote down a $3 million portfolio by $1 million last year.


In a succession of reductions the last two years, the Fed has cut its so-called fed funds rate, the rate at which banks lend their balances at the Fed to other banks, to 1.25 percent from 6.5 percent and also reduced its discount rate, which it charges banks for loans. The Feds reductions of those rates affect banks right away because they tie their prime rates, which they charge their best customers for loans, to the Feds rates. As the Fed increases or reduces its rates, banks typically move their prime rates up and down immediately.


Randall Fewel, president and CEO of Inland Northwest Bank, of Spokane, says, Something like 40 percent of my loan portfolio is tied directly to prime. The minute prime goes down, those rates go down. That means Im going to have less interest income.


It also means that when the Fed cuts rates, banks must lower the rates they pay for deposits as quickly as they can to reduce their interest expense. Yet, that repricing of deposits can take time, because deposits can be held in the form of long-term instruments, such as certificates of deposit, Fewel says.


Says Fewel, This current environment is different than what you usually see. Usually, when rates fall, loan demand goes up, and deposits go down. This time, loan demand is down and deposits are upbecause rates fell just as the stock market went down.


The low-rate environment also has given rise to a host of portfolio-management issues for banks. Fewel says Inland Northwest Bank is sitting on a $1 million unrealized gain in its bond portfolio. If I had tremendous loan demand, I would sell some bonds and make some loans. As interest rates fall, bonds that carry higher rates rise in value.


In Spokane, where banks have had record earnings the last two years and have lots of liquidity, theres fierce competition for loans, giving borrowers new-found power at the negotiating table, Fewel says. Both Fewel and Wes Colley, CEO of AmericanWest Bank, of Spokane, say that business borrowers, as well as homeowers, are using that power to refinance their loans.


You have what you think are fixed-rate loans, but the borrower has so much leverage any more that you have to rewrite the loans to keep them, Fewel says. Otherwise, he says, another bank will refinance the loan.


Right now, Colley says, business borrowers who have taken out loans to buy equipment or to meet other expenses are saying to themselves, Ive got two or three years to go on my loan. If I could drop it a percent or 2, it would really help. Theres a tremendous pressure to bring these rates down. Last year, businesses really woke up to the fact that rates are really low.


Colley adds that while business borrowers are in the market to refinance their loans, they are not trying to expand. Theyre trying to shore up their operations.


Fewel says that the unusual low-rate environment is causing banks to launch short-term promotions to attract certain types of loans or deposits when they need to shore up the asset or liability sides of their balance sheets.


We ran a home-equity line of credit last year at prime, Fewel says. We booked $7 million or $8 milion in home-equity loans at 4 3/4 percent. The bank protected itself by offering the loans at variable rates, which will rise as interest rates go up, Fewel says.


Meanwhile, Heath says, the lower interest-rate climate has ignited a wave of trust-preferred securities issues by banks looking to add to their capital structure, to make acquisitions, or to finance stock buybacks.


To take part in a trust-preferred issue, a bank-holding company forms a trust subsidiary to issue the securities, says Bob Davidson, managing director of the Seattle-based investment-banking arm of Wells Fargo Securities LLC. The trust-preferred securities are sold to a pool assembled by a Wall Street firm.


The securities pay interest rates indexed to the three-month London Interbank Offered Rate, or LIBOR, which is offered by a group of London banks for U.S. dollar deposits of a stated maturity. That rate, which is used as a base to set the rates of adjustable-rate mortgages and other adjustable financial instruments, fell below 2 percent in 2001 and since has dipped to just under 1.35 percent.


Bear Stearns, a longtime Wall Street giant that has handled several trust-preferred offerings, says the securities typically pay 3.25 to 3.3 percentage points more than the three-month LIBOR, so banks would pay less than 5 percent for money they would receive if they participated in an offering now.


Even small banks can raise trust-preferred (capital) at rates that are just phenomenal, Davidson says. So, theres been a boom in these things.


Trust-preferred securities have great advantages for banks because even though a bank is borrowing money through such issues, theyre accounted for as capital, which helps banks meet regulatory capital requirements, Davidson says. Yet, he says, for tax purposes, the securities are treated as debt, which makes the interest that banks pay on them a tax-deductible expense.


Its the best of both worlds, Davidson says.


Last September, AmericanWest last year took part in a trust-preferred offering for the first time, Colley says.


We used it to boost our capital, he says. We took on $10 million of trust-preferred. We did that so we could grow more. He says that for banks to raise money by using the alternative of offering their own stock is very expensive.