Banks will be able to feed a bit longer off the fat spread between deposit and lending rates.

The Federal Reserve's easing and the cut in the prime rate July 2 set off widespread fears that banks would be unable to reduce already anemic deposit interest rates enough to maintain their spreads.

This concern was cited as one cause of the recent selloff if bank stocks. Investors, believing that interest rate spreads had peaked, have dumped shared even in the face of glowing second-quarter earnings reports.

However, analysts said that most banks so far have been able to cut deposit rates enough to maintain their spreads, as measured by net interest margin. "Thus far, we've been pleasantly surprise" by the strength of bank margins, said Sandra Flannigan, banking analyst at Merrill Lynch & Co.

On July 2 the Fed cut the discount rate and its target for the federal funds rate by 50 basis points, to 3% and 3.25%, respectively. In response, banks cut their prime rate by 50 basis points, to 6%. Banks then faced the task of pushing down retail deposit interest rates enough to make up for the loss of income from the cut in the prime rate.

Passbook Rates Under 3%

For some liquid savings accounts, this meant reducing deposit interest below 3%.

Fortunately, banks did not have to cut the full 50 basis point from deposit rates, because the total of deposits dwarfs the amount of prime-based loans.

Although some banks have taken the full half percentage point off savings rates most have settled for smaller cuts.

The average interest rate on money market deposit accounts July 22 was 3.08%, 26 basis points lower than on July 1, according to a national to a survey by Bank Rate Monitor. The average rate for six-month certificates of deposit fell to 3.34% July 22, 34 basis points lower than on July 1.

View at Wells, First Union

Well Fargo & Co. and First Union Corp. have told analysts they expect to be able to push down retail deposit rates sufficiently to make up for lost interest income due to the cut in the prime rate.

Wide net interest margins, spurred by the wide spread between short-term and long-term interest rates, have been a major factor supporting bank earnings this year.

The wide spread has enabled banks to invest low-cost, short-term deposits in higher-yielding, intermediate-term government securities.

Last week, for instance, the difference in yield between six-month CDs and five-year Treasury securities was nearly 3 percentage points.

Net interest margins at regional banks followed by Merrill have risen steadily, from 4.37% in last year's first quarter to 4.59% in the 1992 first quarter, said Ms. Flannigan.

She added that this year's second quarter looks even stronger.

Good Thing Must End

However, analysts are more cautious in predicting beyond the third quarter. "We don't see these historically wide spreads being maintained indefinitely," Ms. Flannigan said.

If the yield curve flattens this year, as many economists expect, bank margins may be squeezed.

In addition, continued weak loan demand means that many banks will have to continue investing in lower-yielding government securities.

Trend for Year's 2d Half

Peter Tobin, Chemical Banking Corp.'s chief financial officer, told analysts Friday that the bank expects its margin to be "stable to down slightly" this quarter, from the 3.69% reported for the second quarter.

First Interstate Bancorp in its second-quarter earnings report said it expects its margin to decline in the second half of the year as it turns to higher-quality, lower-yielding assets.

Troubled by Excess Liquidity

John Leonard, banking analyst at Salomon Brothers Inc., said First Interstate's margin would suffer because it would be reinvesting proceeds from higher-yielding loans into lower-yielding securities.

"I think the problem of excess liquidity they're having is common in the industry," said Mr. Leonard, who is projecting the industry's margins to be flat or slightly lower this quarter.

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