While Tuesdays 50-basis point rate cut the third in as many months delivers needed relief for stressed borrowers, credit quality will remain a concern all year, bankers and other experts say.
The problem is that this is happening in an economy where downside risks are building, said Jim Glassman, senior U.S. economist for J.P. Morgan Chase & Co. Lenders are saying, Great, the cost of lending is falling. The problem is lenders are being cautious, because they have to worry about credit risk.
Every time you get comfortable, there are new threats, such as the stock markets decline and the deterioration of the global economy, particularly in Asia and Europe, he said. Asked what it would take to ease lenders worries, Mr. Glassman said, a change in the economic environment; signs that things are beginning to stabilize.
Robert S. McCoy Jr., chief financial officer at Wachovia Corp. in Winston-Salem, N.C., said he expects the economy to pick up in the second half, but not sharply.
Mr. McCoy differed with pundits who say a lower interest rate environment benefits banks. I would rather interest rates were slowly moving up, because that means youre in a growing economy, he said. Banks actually do a lot better in an up-rate environment.
Al Sanborn, president of RMA, the trade association of bank loan and credit officers, concurred. Lower interest rates give borrowers needed relief, but they also underscore the economys problems, he said.
Its good news and bad news, he said. The good news is that borrowers that are highly leveraged and use variable rate debt, their borrowing costs are coming down. But the bad news is this continues to signal that the economy has weakened and is likely to continue that way for some period of time. I would suspect that problem loans would continue to increase, probably throughout 2001.
Financial stocks fell with the broader market Tuesday after the Federal Open Market Committees 50-basis point cut of the federal funds rate to 5%. Investment banking firms in particular gained ground during morning and early-afternoon trading, but were pulled down as the market retreated in disappointment that the cut wasnt larger.
The American Banker index of 225 banks fell 3.9%, while the Dow Jones industrial average dropped 2.4%. The Standard & Poors 500 index and the Nasdaq fell 2.41% and 4.8%, respectively, after the announcement. Many banks, including Bank of America, First Union, Citibank, and Bank One, cut their prime lending rates by half a percentage point, to 8%.
The real cloud hanging over the industry is loan quality, said Bert Ely, an independent consultant in Alexandria, Va. If we slide into a recession, a lot of ugly loans will float to the surface. That is why these rate cuts are so important. Will it be enough to keep us out of a recession? If it is enough to steer the economy away from a recession, that will be more beneficial to the banking industry than any immediate effects such as wider interest rate spreads.
Sung Won Sohn, chief economist at Wells Fargo & Co. in San Francisco, agreed that the biggest threat to bank earnings is asset quality, but said the danger will diminish with every rate cut, moving the economy further away from recession. He predicted that spread income will increase and fee income will hold up.
Jim Chessen, chief economist at the American Bankers Association, said margins may fall as loan rates decline in line with the Feds cuts, but banks are also more likely to be repaid, and revenue should climb as loan volume increases.
From a credit quality standpoint, the rate cuts are very good for banks, he said. Were already starting to get reports that it has improved cash flows among business borrowers.
Mr. Chessen predicted the Fed will continue its aggressive cutting at its next meeting in May.
The Fed is actually leaping in 50-basis-point increments, and I think theyve got one leap left, he said. I would bet theres another 50 at the May meeting.
This story was reported by Rob Blackwell, David Boraks, Michele Heller, Barbara A. Rehm, and Matthias Riecker and written by Ms. Rehm.