With the exception of Chase Manhattan Corp., stocks of the nation's largest banks dropped yesterday despite good news on the inflation front.

Citigroup Inc. dropped 0.98%, to $44.125; J.P. Morgan & Co. 1.08%, to $126.50; and Bank of America Corp. 1.22%, to $65.5625. Chase rose on the day, closing up 1.30%, to $78.0625.

Most large regionals showed gains, reflecting a bigger-than-expected dip in the National Association of Purchasing Management factory index. The July index dropped to 53.4, from 57 in June, indicating that the economy is slowing. A slower economy means the Federal Reserve is less likely to raise interest rates, and traders-rightly or wrongly-equate higher interest rates with lower bank earnings.

By 11 a.m., stocks of even the biggest banks were higher and the Standard & Poor's bank stock index was up 1.7%. But later in the day the gains of the big banks turned into losses, and the regionals' gains were mitigated.

The Standard & Poor's bank index closed up only 0.17%, to 653.69, while the Dow Jones industrial average fell 0.09%, to 10,646.

Many traders were stymied by the sudden reversal of bank stocks during the afternoon.

"The market is tired, valuations are still high and interest rates are going up," said Phil Cuthbertson, head trader at Keefe, Bruyette & Woods Inc.

But most regionals ended the day higher. They included Winston-Salem, N.C.-based Wachovia Corp., which gained 1.76%, to $79.4375; Pittsburgh- based PNC Bank Corp. 1.77%, to $53.1875; and Charlotte, N.C.-based First Union Corp. 1.63%, to $46.75.

Among the biggest gainers of the day was Huntington Bancshares of Columbus, Ohio, which rose 4.56%, to $31.50. Market observers attributed some of the gain to the company's announcement of plans to launch an Internet-only bank in the next six months.

They pointed out that shares of Sovereign Bancorp of Wyomissing, Pa., and North Fork Bancorp of Melville, N.Y., also surged when each announced on April 14 that they planned to form a separate Internet bank.

Christopher A. Bamman, a bank analyst at Advest Inc., said investors bought regional bank stocks on Monday because their valuations were compelling after being "beaten down unjustifiably last week."

"This is a perception issue," said Frederick A. Cummings, a bank analyst at McDonald Investments of Cleveland. "When interest rates rise, many portfolio managers believe that banks will have an earnings problem, but that is not reality."

There is a difference in this bank stock correction then the one last year," said Nancy Bush, a bank analyst at Ryan, Beck & Co. of Livingston, N.J. "We had international defaults and Long-Term Capital. There was a lot of scary financial system issues. But this year it's interest rates, so the damage to bank stocks will not be that bad."

Banks have been able to manage interest rate risk better than they did seven years ago, Mr. Cummings said. Banks also generate a growing portion of their revenue from fee income, which is less vulnerable to rising rates, he said.

Noninterest income, or fee income, makes up more of banks' revenue stream now than in the past.

Noninterest income made up 45% of the revenue stream of the top 50 banks in 1998, up from 34% in 1987, according to statistics compiled by Keefe Bruyette.

David Berry, director of research at Keefe Bruyette said fee income has helped safeguard some banks' earnings against higher interest rates.

However, he warns that not all fee income is the same.

"Fees from processing corporate trusts, global custody, or stock transfers are fees that last forever, because those activities need to be done regardless," Mr. Berry said. "But the least valuable fee income is that which comes from selling a building, or from trading income, or from investment banking."

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