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Banks Benefiting From Low Rates

Finance: A surge in deposits is providing cheap funds to fuel the home loan market.


If your banker seems irrationally exuberant these days, blame Alan Greenspan.

Since the Federal Reserve cut its benchmark short-term interest rate last year to a 40-year low of 1.75%, stock indexes have tumbled while the economy's performance has been mixed, with weakness persisting in some key sectors.

But through it all, many banking institutions might as well have been printing money.

Despite a 55% increase in losses on loans industry-wide last year, to levels higher than in the savings and loan crisis year of 1991, bank profits overall set records that have continued this year--as second-quarter reports from many institutions have demonstrated.

The chief reason: a highly favorable interest rate environment, with a surge in low-cost bank deposits providing cheap funds to fuel the booming mortgage refinance and home-equity loan markets.

Because the next move in interest rates probably is up, banks may be nearing the end of this particular chapter, analysts say. But for the near term, the banks' financial health is a pillar of strength for an economy now threatened by the stock market's ongoing woes.

Second-quarter financial results released last week by major banks and thrifts showed strong earnings growth. Washington Mutual Inc. in Seattle said earnings rose 23% from a year earlier, to $984 million; Wells Fargo & Co. in San Francisco said profit was up 17% to $1.4 billion; New York-based Citigroup Inc., the nation's largest bank, earned $4.1 billion, up 15%; City National Corp. in Beverly Hills posted earnings up 16%, to $45.8 million.

Many banks have cited a continuing tidal wave of money flowing into basic savings accounts and money market deposit accounts, even as average interest rates paid on those accounts have fallen below 2%. Some of that money has come from investors who have fled the stock market, experts say.

Data from the Federal Reserve Bank of St. Louis show that, from May 2001 through June 2002, money in bank and S&L savings accounts rose from just over $2 trillion to more than $2.5 trillion--an increase of more than $500 billion in a little over a year.

Some of the money that has moved into short-term bank accounts has come out of bank certificates of deposit.

Executives at Newport Beach-based Downey Financial Corp. say many of the thrift's savers decided the small additional interest to be earned on, say, one-year CDs, wasn't worth tying up the funds for that long a period.

"They'd rather have the liquidity, so when rates start back up they'll be able to move right back" into higher-paying CDs, said Downey Chief Financial Officer Thomas E. Price.

Nationwide, the amount in CDs of $100,000 or less fell from about $1.05 trillion in May 2001 to $924 billion as of July 8, according to the St. Louis Fed.

Though rates on basic savings accounts and money market deposit accounts might appear paltry, at many banks the returns are better than the record-low 1.3% average yield on taxable money market mutual funds.

What's more, because bank savings and money market accounts are federally insured and absolutely liquid, they have provided peace of mind for many investors amid the stock market's plunge and fears of new terrorist attacks.

Meanwhile, on the lending side, rates on mortgages and other loans also have fallen over the last year, but they haven't dropped as much as rates on bank deposits, which are more sensitive to changes in the Fed's short-term rate.

At Downey, deposits in passbook and money market accounts more than tripled, from $986 million on June 30, 2001, to $3.08 billion at the end of last month. During that 12-month period, Downey's average interest rate on such accounts fell a full percentage point, from 3.4% to 2.4%.

By contrast, the average rate on 30-year conventional mortgages nationwide fell less than a point, from 7.11% to 6.55%, in the same period.

Wells Fargo said its average interest rate "spread" in the second quarter--the difference between its average cost of money and its average loan rate--was 5.66 percentage points, up from 5.31 points a year earlier. The bank's net interest income jumped 21% in the quarter from a year earlier.

At City National, net interest income rose 24% in the second quarter.

At Wells Fargo and other lenders, profits also have been bolstered by heavy demand for consumer loans.

Wells Fargo said commercial loan demand was essentially flat in the second quarter compared with a year earlier. But demand for consumer loans, including mortgages, grew by more than 20%.

City National's total loans were up 21% in the quarter, with strong growth in commercial and construction lending as well as mortgages, the bank said.

That reflects City National's emphasis on business lending and its location in Southern California, which Chief Executive Russell Goldsmith said remains one of the best-performing regional economies in the nation.

But even as banks revel in the current success, some analysts warn that profits could face a squeeze soon.

Analyst Michael Mayo, who follows large banks for brokerage Prudential Securities Inc. in New York, wrote recently that interest rate spreads are no longer widening for many banks.

"We believe banks have reaped nearly all of the benefits of the low-interest-rate environment," he said.

If the economy continues to recover, and the Fed begins to raise short-term rates later this year, worries about a bank profit squeeze could accelerate.

Investors in general seem more concerned. Bank stocks held up well in April and May, even as the broad market declined. But since early June many bank shares have fallen sharply along with the rest of the market.

An index of 24 major bank shares has tumbled 19% since May 31. The blue-chip Standard & Poor's 500 index is down 20.6% in the same period.

Year to date the bank stock index is down 17%, and the S&P 500 is down 26.2%.

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