M&I's policy: Just say `no' to derivatives

It's not your usual derivative surprise.

At a time when these complex financial instruments are turning up as nasty news in headlines everywhere, one large Wisconsin bank, Marshall & Ilsley Corp., is refusing to use them at all.

"M&I has zero derivatives in its portfolio," according to Kay C. Lister, banking analyst with the New York City investment firm of Keefe, Bruyette & Woods.

And that's unusual for a bank that size, she said.

"It's just their conservative style," Lister said.

Firstar Corp., the largest bank holding company headquartered in Wisconsin, does use derivatives, according to another analyst. Derivatives are financial products based on, or derived from, the underlying price movements of stocks, bonds, currencies or interest rates.

"They have some," according to L. G. "Mike" Milunovich, banking analyst for Robert W. Baird & Co. Inc., "But it's not extensive. It's strictly hedging, from what I can tell."

Both banks acknowledged their differing philosophies with little elaboration.

"It is a conscious policy," said Michael A. Hatfield, senior vice president and secretary of Marshall & Ilsley.

"We don't hedge our portfolio," said Anne Curley, a Firstar spokeswoman. "We hedge our interest-rate risk."

The difference is crucial. Banks use complicated derivatives, but the purpose is fairly simple. They are employed as a tool to make the maturities of assets and liabilities match up, according to Milunovich.

For example, without hedging, a bank could be squeezed if it suddenly had to pay higher short-term interest rates to savers, while its income was coming from long-term mortgages at fixed rates.

"Since you can't predict where interest rates are going," Milunovich said, "you use them to try to avoid interest rate risk."

Problems in derivatives elsewhere have occurred from speculation in these instruments. Borrowing money to bet on interest rate movements created huge losses for investors such as Gibson Greetings and Orange County, Calif.

Gordon H. Gunnlaugsson, vice president and chief financial officer of M&I, said the bank tried derivatives five to 10 years ago and decided to try to achieve the same results naturally through its business.

"We didn't have to do them," he said. "So we've had none on the books for the last three years." While possibly reassuring to stockholders, the absence of derivatives is not unqualified good news in a bank portfolio. Lister said that when interest rates were falling, M&I could have made more money if it had hedged its portfolio.

"On the flip side, they weren't hurt when interest rates started to rise," she said. "M&I is still situated well. If rates continue to rise, they tend to benefit a little bit."

Because of derivatives' hedging value, the fortunes of banks do not automatically rise as interest rate fall or decline as interest rates rise, as they once did. It goes bank by bank," Lister said.

Commenting on other aspects of Marshall & Ilsley's annual report, issued last week, Lister said the company appeared to have prospects for good revenue growth, particularly in its data-processing division.

"Their business outlook is very strong," she said. "Their deposit franchise has the greatest breadth and depth in the state."

The bank's 1994 merger with Valley Bancorporation, she said, "was an excellent fit."

Copyright 1995
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