Institutions Dumped Big Banks After Fed Rate Hike

Banks may have insulated their earnings against rising interest rates, but the latest data suggest rates still weigh heavily on the minds of long- term investors.

A new report by CDA Spectrum - an affiliate of American Banker in Rockville, Md.-shows a dramatic reduction in institutional holdings in some of the biggest banks after the Federal Reserve boosted rates by 25 basis points in March.

CDA reports the investors-including investment firms, insurance companies, and banks themselves-shaved 9.1% off their holdings in Wells Fargo & Co., 3.9% off holdings in Mellon Bank Corp., 3.8% off holdings in First Chicago NBD Corp., 3.7% off holdings in PNC Bank Corp., 3.6% off holdings in NationsBank Corp.

While some firms purchased banks selectively, some big players-including Janus Capital Corp., Fund Asset Management Inc., Wellington Management Co., Chancellor LGT Asset Management, Lazard Freres & Co., and American Century Cos.-slashed holdings in banks across the board.

Historically, higher interest rates have hurt banks by driving up their cost of funds and hammering the yields on long-term assets-primarily loans. Banks and bank analysts increasingly argue, however, that banks have learned to hedge risk and have emphasized fee businesses to reduce their rate sensitivity.

"To a certain extent, higher interest rates still hurt bank stocks," said economist Scott J. Brown of Raymond James & Associates, St. Petersburg, Fla. "But they shouldn't move in lockstep."

Still, bank stocks almost invariably fall on economic data that hint at inflation, as investors flee interest-rate sensitive stocks. Accordingly, the data show that many investors in the second quarter reacted to the hike in the federal funds rate by selling bank stocks.

Janus cut its bank holdings 33.25% and reduced the number of bank names in its portfolio to six from 13. Fund Asset Management Inc. slashed its bank holdings 21.14% and cut the banks in its portfolio to 12 from 32. Lazard Freres & Co. reduced its bank holdings 16.63% and its banks to eight from 25.

The value of bank stocks held by Chancellor LGT Asset Management was down 14.04% and the number of banks in its portfolio fell to six from 33. And for American Century Cos., the value of bank holdings was down 13.4% and the number of banks fell to nine from 19.

To be sure, there were factors other than interest rates at play.

Veteran analyst Richard X. Bove, also of Raymond James, pointed out that loan-loss provisions are no longer going down and margins across the banking spectrum continue to decline. Buybacks, which helped bolster bank stock prices, are also on the wane, he said.

"Institutional investors are not momentum players," said Mr. Bove. "They are people who know these companies inside and out. If they are selling, they see fundamental issues that are disturbing."

Credit-quality concerns, mostly caused by eroding credit card portfolios, also caused investors to sell early in the year, said one portfolio manager at a major institutional firm.

Still, "There is a certain amount of trading that is driven by the rule of thumb that bank stocks are interest-rate sensitive," said one portfolio manager at a major institutional investor.

And he said a healthy respect for rising rates is justified.

"On a very long-term basis, higher long-term rates are associated with higher inflation, which banks are structurally less capable of dealing with than manufacturers," he said.

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