Stocks: Bank Stocks Seem to Be Breaking Free of Link To Interest Rate

Have banks shed the rate-sensitivity label?

Bullish economic news has triggered the predictable setbacks for bank stocks, as investors worried that rates would have to be raised to cool the economy.

But banks have recovered strongly from each setback. And this year's 118-basis-point rise in the the 30-year Treasury bond yield, to 7.13% through Thursday, has been accompanied by a 12% gain in the Standard & Poor's index of major bank stocks.

Against that backdrop, the Federal Reserve's next meeting to weigh a rate change, scheduled for July 2-3, isn't seen by some investors as a particularly momentous occasion for bank stocks.

"In the short term, traders clearly believe that banks are rate- sensitive, and that becomes a self-fulfilling prophesy," said James Schmidt, who manages four bank funds and more than $3 billion of assets at John Hancock Investment Management in Boston.

But, he added, he has "never believed changing interest rates have a great effect on banks."

Mr. Schmidt and other observers said that new asset and liability management techniques have helped banks to offset the effects of interest rates.

Banks have been viewed as interest-rate sensitive because as rates rise, deposit rates must rise faster than loan rates, presumably cutting into bank profit margins. What's more, many banks own large bond portfolios, which can decline in value when rates rise.

Money-center banks - whose stocks have soared 18% this year - were seen as especially sensitive, because their large trading operations can be hard-hit when interest rates move sharply.

In late 1994, banks with large bond portfolios, such as PNC Bank Corp. and Banc One Corp., were exposed to a sharp downturn in bond prices, and their stocks were hammered.

But in the last few years, companies such as these have aggressively remade their balance sheets in an effort to be interest-rate neutral. So this year's sharp run-up in rates has not had a deleterious effect.

"Despite higher long-term rates, banks have outperformed the market year to date," said Michael Mayo, a bank analyst at Lehman Brothers. "It shows that investors may be finally starting to focus on something other than interest rates, like the industry's improving efficiency and the ability to use share buybacks to generate earnings."

Soon after the Fed's Open Market Committee meets, banks will begin to report first-half earnings results. Mr. Mayo predicted the results would be sound.

That news will more than offset any action by the Fed, which some expect will raise short-term rates 25 basis points to head off higher inflation, he said.

Not all observers agree banks have jettisoned the interest-sensitivity tag. Fred Cummings, an analyst with McDonald & Co., in Cleveland, predicted the sector will trade in a narrow range until the Fed decides whether to raise rates. Mr. Cummings does not expect that to occur in July, but he does expect the FOMC to raise rates at its next meeting, in three months. And a decline in bank stocks will follow, he said.

In trading Friday, the markets had little reaction to the Fed's report that industrial production rose higher than expected. While interest rates rose initially, the long bond was unchanged in midday trading.

The S&P bank index fell 0.26%, while the overall S&P fell 0.31% for the day.

Shares of Regions Financial Corp. fell 75 cents to $47 after it announced an acquisition of Allied Bankshares (see page 1). Shares of Allied fell $1.75 to $10.25.

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