Bank stocks outpace market despite threat of rate rise.

Bank stocks continue to trade a notch above the rest of the market, despite speculation that the Federal Reserve will soon increase short-term interest rates for a fifth time this year.

Banks again edged out the blue chips last week. In the five trading days that ended Thursday, the American Banker index improved 0.67% while the Dow Jones increased by a smaller 0.58%.

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Money managers and analysts attribute the banks' staying power to strong earnings over the past few quarters as well as the industry's consolidation trend, which continues to whet investors' interest.

The banks opened lower on Firday after a stronger-than-expected employment report for June unsettled the bond market, but quickly stabilized after doubts were cast on the new-job figures in the government's monthly survey.

"In the midst of confusion, you have to fall back on fundamentals. In our opinion, the banks have a strong foundation," said Robert A. Bonelli, manager of the Ernst Bank Equity Fund at Ernst & Co., New York.

The confusion in Friday's market was centered on the carefully watched business payroll figures.

Data in Doubt

Initially, the government reported that new jobs totaled 379,000 during June, exceeding the 284,000 expected by Wall Street. But several hours later, federal officials said the June payroll rise might be overstated by as much as 100,000 because of a "difference in survey periods."

Stocks, including banks, gained strength on the second announcement, but the bond market remained in the doldrums. The U.S. 30-year Treasury bond was off nearly a full point most of day, yielding 7.7% in late afternoon action.

Mr. Bonelli expects to see "continued earnings growth" when banks begin announcing second quarter results this week. The key factor, he said, "is going to be the reversal in the slide in their net interest margins."

Help Seen from Rate Rise

While their stocks have often slipped recently on bond price weakness as rates have risen, banks are reaping big benefits from higher rates, the money manager believes.

In response to rising shortterm rates this year, banks have raised the prime rate to 7.25% from 6%, but they have not been under pressure to raise deposit rates, he noted.

"Basically it has all been coming back to them in terms of enhanced spread, and that's translating to enhanced margins," Mr. Bonelli said.

Double-Digit Loan Growth

Moreover, the Fed's most recent Beige Book on the economy revealed double-digit loan growth in some areas of the country, he pointed out. "So you've got volume on top of rate increases. That makes for a pretty strong industry going forward."

Mr. Bonelli's $7 million bank stock fund, with holdings in 23 banks, tallied a net gain in value of 12% for the first six months of the year. By comparison, the Dow industrials were off 3.44% and the Standard & Poor's 500 stock index was down 4.76% in the first half.

Another industry watcher offered a note of caution. Frank J. Barkocy, senior bank analyst for Advest Inc., said that while he is optimistic about banks' earnings, he thinks it would be "more difficult" for banks to match another rate increase by the Fed.

Deposit Rates at Issue

"I think there might be more pressure to boost deposit rates," he said. "We've seen pressure from consumer groups already, and we may get jawboning from the regulators, but I think there are enough offsetting advantages for banks' earnings to hold up reasonably well."

Banks quickly matched the previous four Fed rate increases, preserving the highly favorable asset-liability structure they have enjoyed over the past several years.

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