Third Fed Rate Cut Seen Reviving Bank Stock Prices, Deal Momentum

Bank share prices have bounced back so sharply on the expectation that the Federal Reserve's rate cutting campaign will boost profit margins that some see another wave of consolidation shaping up.

After the Fed announced its third rate cut in two months Tuesday afternoon, investors snapped up bank stocks, driving them higher even as blue chip stocks fell.

In a report issued Wednesday, veteran bank analyst Thomas Hanley of Warburg Dillon Read declared Federal Reserve Chairman Alan Greenspan "man of the year" because his policymaking has created "an economic environment within which bank stocks have flourished."

Mr. Hanley said the Fed's focus on restoring the yield curve "should bode well for net interest revenue growth and, consequently, bank stocks."

Lower short term rates are seen as a boon because they enable banks to make money on long-term loans. Lower interest rates also prompt borrowing and add liquidity to a market that was atrophying because of the financial turmoil in the international markets.

Portfolio manager James Ellman at the GT Global Financial Services Fund said the series of rate cuts so far is sufficient to alleviate the credit crunch that many market watchers feared was coming.

"There still may be pockets or situations where banks are pulling in their horns to the riskier borrowers but creditworthy borrowers are able to secure borrowing now," said Mr. Ellman.

Mr. Ellman added that some banks will eventually be able to make money off the marginal borrower because as the competition for borrowers dries up, those few bankers will be able to charge high rates.

The higher bank stock prices that have resulted from the rosier expectations mean stronger currency for acquirers, who typically pay for deals with stock, Mr. Ellman added.

Still, though bank shares have rebounded, the S&P bank index remained 17% below its July peak at the close of trading Wednesday.

Michael E. Martin, head of the financial institutions group at Credit Suisse First Boston, said at a New York mergers and acquisition conference Wednesday that dealmaking probably won't resume right away.

"Until we get some stability in the market, deals will be slow," said Mr. Martin. But he added, "stability may be coming back sooner than expected because of the recent cuts in interest rates."

Some remained skeptical that the Fed's latest action will have much effect.

"I don't think that this action is going to make a real difference," said A. Gary Shilling, economist and president of his own Springfield, N.J. investment management firm.

The spreads between Treasuries and junk bonds and other securities continue to be wide, suggesting that there "is still a reluctance to lend to lesser credits," said Mr. Shilling.

"Banks are still scared, and on Wall Street greed is tempered with fear and fear has come back into the pictures," added Mr. Shilling also author of the book "Deflation."

Mr. Shilling said that he still believes the U.S. economy is heading toward a recession in spite of the Fed's recent action.

"We've got global deflation," or a decline in the general level of prices, "in the offing and a U.S. recession next year. We also could be in store for another crisis in which the troubles with Brazil worsen or China devalues its currency."

Michael Hamilton, portfolio manager at the Princor Fund, said that consumers may not necessarily increase their borrowing because of the decline in interest rates.

"You can lower interest rates, but you can't make consumers borrow money," said Mr. Hamilton. "Consumers already have a tremendous burden of debt on them and increased borrowing could become precarious."

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