Bank bonds finished September on an upbeat note, as investors registered their high expectations for third-quarter earnings.

Those upbeat views, as well as a growing perception that banks are a safe haven in a sluggish economy, led to as much as a 7-basis-point narrowing of the yield spreads of bank bonds in late September. The spreads had widened in early September when the yields on government bonds fell.

"Coming into the third quarter earnings season, people are viewing banks as a very safe sector, even as a defensive sector," said John Works, an analyst with J.P. Morgan & Co.

|A Sea Change'

Earnings are expected to be strong, with improvements in asset quality and capital levels.

"Banks are hardly a controversial sector to be owning right now, which is quite a sea change from where we were two or three years ago," Mr. Works said.

As the bond market rallied in early September, the yield spread of corporate bonds widened with bank bonds showing an increase of three to seven basis points.

"Because corporate and bank bonds are less liquid, the trading in those securities couldn't keep pace with the rally in government issues. The yield spread is the premium corporate bonds carry over U.S. Treasuries.

On Sept. 15, for instance, the 10-year Treasury note, the typical benchmark used for bank subordinated debt, traded in a 20-basis-point range, according to Salomon Brothers Inc.

Regaining Ground

But bank bonds generally regained most of the lost ground by the end of last week. Corporate bonds, by comparison, did not have a similar tightening of spreads.

"By and large bank bonds are back where they were at the beginning of September," said Ann Robinson, bond analyst with Donaldson, Lufkin & Jenrette Securities Corp.

Among the subordinated debt whose spreads widened in the middle of the month and then recovered the lost ground were: NationsBank Corp., quoted on Sept. 30 at a bid of 78 basis points over Treasuries for 10-year debt; Citicorp, quoted at 95 basis points; Fleet Financial Group, at 85 basis points; and PNC Bank Corp, quoted at 72 basis points.

Almost No Downgrades

Ms. Robinson noted that investors are more wary of tobacco and health care corporate bonds due to uncertainties over future business conditions or government regulatory actions. The bank sector, by contrast, continues to enjoy a steady stream of rising credit ratings, and almost no downgrades.

"To me, the slow-growing economy is pushing back the point at which the bank bonds will have problems," she said. "I'm not interested in big loan demand growth or big earnings-per-share growth. Banks are generating capital, but they are not generating risky assets," she said.

|By Appointment Only'

The recovery of bank bond prices in the secondary market masks the fact that many holders of higher-yielding bonds are simply not offering them for sale in any volume, said William King, bond analyst with Merrill Lynch & Co.

"Bonds are trading by appointment only' for some of the smaller to midsize regional banks where there may be just one or two outstanding issues," he said.

For instance, there are strong bids for subordinated debt of Midlantic Corp. and UJB Financial but none was being offered, said Mr. King.

Market sources said Midlantic was being bid at around 150 basis points over Treasuries, and UJB at around 100 basis points above.

Higher Yields a Factor

One reason trading activity has slowed down is bank bonds still generally carry higher yields than comparably rated industrials, said Mr. King.

"There's not been a lot of trading of bank bonds because the question is, if I sell my bond where am I going to reinvest my money?," he said.

The news of Banc One Corp. being put on review for upgrade by Moody's Investor Service is another bright spot for the industry, Allerton Smith, analyst with CS First Boston Corp., said in a recent report.

Banc One's senior debt is currently rated A1, and a one-notch upgrade would push it into the double-A category. Among all banks only Republic New York Corp. has been upgraded to this vaunted level in the last 15 years. he wrote.

Mr. Smith predicted that upgrades over the next year could potentially put subordinated debt of Banc One and four other banks into double-A territory: NBD Bancorp. Norwest Corp., Republic New York Corp. and Sun Trust Banks Inc. This would provide further strength for the sector's bonds.10-Year Subordinated Debt Trading Levels September 1 September 13 September 30J.P. Morgan & Co 50 53 50NationsBank Corp. 80(*) 85 78Banc One Corp. 63 67 63PNC Bank Corp. 73 78 72Boatmen's Bancshares 80 80 78CoreStates Financial 78 80 85Chase Manhattan 93 98 94Chemical Bank 82 88 85Bank America Corp. 88 90 90Citicorp 95 100 95First Union Corp. -- 85 78First Chicago 87 95 90(*) 9-year

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