Fed cut helps beleaguered U.S. banks, shares

By Jonathan Stempel -Analysis

NEW YORK (Reuters) - U.S. bank shares were among beneficiaries of the U.S. 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."

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.

Shares of most major banks rose, including gains of 2.6 percent at Citigroup Inc., 3.8 percent at Bank of America Corp., 3.4 percent at JPMorgan Chase & Co., 3 percent at Wachovia Corp., 5.2 percent at Wells Fargo & Co. and 7.8 percent at Washington Mutual Inc..

The Philadelphia KBW Bank Index of large banks rose 3.5 percent, while the KBW Regional Bank Index rose 3.8 percent. Those indexes remain down a respective 6.3 percent and 7.6 percent this year.

Shares of Wall Street banks also rose, gaining 3 percent at Goldman Sachs Group Inc., 5.5 percent at Morgan Stanley, 6.9 percent at Merrill Lynch & Co., 6.1 percent at Lehman Brothers Holdings Inc. and 1.5 percent at Bear Stearns Cos.. The Amex Securities Broker-Dealer Index closed up 4 percent. It is down 8.2 percent this year.

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.

As part of its changes, the Fed will now 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."

The Clearing House Association, a group of major banks, said the Fed move will encourage market participants "to take steps that would improve conditions in funding and credit markets."

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.