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Major Banks Are Slow to Lower Prime Rates

Financial institutions wait to act on the Fed's interest cut as their profits are bound to take a hit.

June 27, 2003|E. Scott Reckard | Times Staff Writer

A dozen times since January 2001, the Federal Reserve lowered its key interest rate. A dozen times, banks rushed in lock-step to cut their prime rates as well, providing ever-cheaper funds to steady a stumbling economy.

But after Fed Chairman Alan Greenspan engineered a 13th cut in the benchmark federal funds rate Wednesday, major banks held back for more than a day before following suit. This time, the cuts that help consumers could cut into the banks' bottom lines.

"There definitely was a little game of chicken going on," said analyst Joseph K. Morford of RBC Capital Markets in San Francisco. "The banks held out as long as they could, to see if they could get away with it.

"But Greenspan wanted to provide some more stimulus to the economy, and they finally caved."

The Fed announced a quarter-point cut in the funds rate at midday Wednesday, lowering it to a 45-year low of 1%. But it wasn't until after the financial markets closed Thursday that Charlotte, N.C.-based Bank of America Corp., the third-largest U.S. bank, cut its prime rate from 4.25% to 4%, followed quickly by Chicago's Bank One Corp.

Citigroup Inc. and J.P. Morgan Chase & Co. in New York, the two largest banks, followed suit late in the day. Some banks however, including City National Corp. in Beverly Hills and San Francisco-based Wells Fargo & Co., were still holding out on a cut at late afternoon.

The major banks didn't elaborate on why they decided to lower their prime rates, or why they waited to do so.

The prime is the interest rate paid by banks' best customers on short-term loans. Rates on home equity credit lines and other consumer loans often are tied to the prime.

Fixed-rate mortgages and other longer-term loans tend to reflect changes in the yield on the 10-year Treasury note, which hit bottom at 3.11% on June 13 and has since rebounded to 3.54% as of Thursday.

Even before the latest cut, rock-bottom interest rates were cutting into bank profits. That's because some banks have been reluctant to reduce rates much further on short-term deposits, while the interest they earn on loans has continued to fall.

Low rates have made it more difficult for some banks to attract and retain deposits, especially since the recent rise in stocks has provided an attractive alternative for investors.

Whatever the effect of the lower prime on borrowers, it clearly will "diminish bank earnings, which already have been squeezed quite strongly," said Henry Walker, executive vice president of Farmers & Merchants Bank in Long Beach.

Until recently, falling rates had boosted bank profits. Despite rising loan delinquencies and the generally sluggish economy, commercial banks and savings institutions earned a combined $105.4 billion during 2002, topping $100 billion for the first time, according to the Federal Deposit Insurance Corp.

Many banks have profited as long-term bond yields have plunged since 2000, boosting the value of banks' bond holdings. But those gains may be history.

Bond traders had thought the Fed would cut rates by a half-point after central bankers warned in May about the danger of possible deflation. Yields on Treasury bonds sank on that expectation, then reversed course after the Fed's quarter-point cut was announced.

"If you disappoint market expectations, you run the risk of inducing market reactions that undo what you want, and that's what happened to the Fed" this week, said Jan Hatzius, an economist with Goldman Sachs & Co. in New York.

But Fed watchers cautioned against a rush to call the central bank's latest policy move a mistake. "This is a work in progress," said Denver economic consultant David M. Jones. "Let's see where rates are a few weeks or a month from now."

*

Times staff writer Peter G. Gosselin in Washington contributed to this report.

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