NEW YORK -- U.S. bank shares were among beneficiaries of the Federal Reserve's surprise decision Friday to cut what it charges them to borrow.
Investors said the lower borrowing costs would help ease fears of illiquidity, and perhaps help banks shore up lending margins and profitability.
"Can banks make more money when the Fed lowers rates?" said Adam Compton, co-head of global financials research at RCM Global Investors in San Francisco, which invests $150 billion. "Very large banks have been having flat to lower net interest income, because you can't really make a good spread. That will change."
In early trading, the Philadelphia KBW Bank Index was up 2.4 percent, the KBW Regional Bank Index rose 3.4 percent, and the Amex Securities Broker-Dealer Index gained 2.8 percent. Through Thursday, the indexes were down, respectively, 9.5 percent, 11 percent and 11.8 percent this year.
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Among larger banks and thrifts, shares rose 2.2 percent at Citigroup Inc., 3.2 percent at Bank of America Corp. , 2.2 percent at JPMorgan Chase & Co., 3.2 percent at Wachovia Corp., 3.4 percent at Wells Fargo & Co. and 4 percent at Washington Mutual Inc.
Financial companies have been battered by worry over credit deterioration, losses in mortgage securities and hedge funds, and banks getting stuck — or "hung" — with loans intended to fund leveraged buyouts that investors don't want.
The Fed cut the primary discount rate it charges commercial banks to borrow to 5.75 percent from 6.25 percent, hoping to calm investors worried about a global credit squeeze.
It will now also let banks borrow for as long as 30 days, and renew such borrowings. The Fed said the changes will remain until market liquidity improves "materially." Its benchmark federal funds rate stayed at 5.25 percent.
"Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward," the central bank said. "These changes are designed to provide depositories with greater assurance about the cost and availability of funding."
DEEP PROBLEMS?
The Fed rarely changes a key rate between regular meetings. Its move suggests that even some corporate issuers once thought healthy were having too much trouble raising cash.
"This will help the credit problem in the short end, such as (asset-backed commercial paper), but it doesn't address the long end, such as mortgage lending," said David Wyss, chief economist at Standard & Poor's.
On Thursday, Countrywide Financial Corp., the largest U.S. mortgage lender, drew down $11.5 billion of credit lines intended to back up its commercial paper borrowings after short-term borrowing became too difficult.
"You've got to wonder how deep these problems are," said Jim Huguet, co-chief executive of money manager Great Companies LLC in Tampa, Florida.
Among Wall Street investment banks, Goldman Sachs Group Inc. rose 2.6 percent in morning trading, Morgan Stanley was up 6 percent, Merrill Lynch & Co. rose 4.7 percent, Lehman Brothers Holdings Inc. gained 5.2 percent, and Bear Stearns Cos. was up 0.7 percent.
The Fed restructured the discount window in 2003 to improve its use as a policy tool and backup source of bank funding.
"Liquidity problems should be manageable for a majority of banks, especially larger banks," said Chris Hagedorn, who helps invest $21.6 billion at Fifth Third Investment Management in Cincinnati.
Lower borrowing costs may help ease a year and a half of pressure on banks' lending margins.
Banks hope to maintain high net interest margins, the gap between what they earn from making loans, and pay to borrow and pay out on deposits.
For much of 2006 and 2007, short-term interest rates topped long-term rates, causing margin problems industrywide. Longer rates are now higher. But banks still face higher loan losses, which a tight credit environment exacerbates.
"It makes things better for banks but you don't tend to see huge absolute upside for their shares," Compton said. "They just tend to go down less than the rest of the market, because it all leads into a slowing economy."
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