Fed's cut to add pressure on banks margins

By Juan Lagorio - Analysis

NEW YORK (Reuters) - The U.S. Federal Reserve's latest rate cut may be the cruelest yet for banks.

The Fed lowered rates by at least three quarters of a percentage point on Tuesday, one of its most dramatic moves yet in a bid to jumpstart a recession-bound economy.

But the Fed easing means that, while the rates at which banks lend will decline, the rates at which they fund themselves cannot fall much further. That, in turn, means any decreases in lending rates -- including the latest -- only squeeze margins.

But stock investors did not seem too alarmed on Tuesday as they sent bank shares up 10 percent, as measured by the KBW Banks index, on optimism the move would help banks by boosting the economy.

But some investors wonder if the markets are taking into account how painful this move could be for banks.

"Banks are going to see a significant drop in their current earnings power and there is no way around that. That's definitely a negative point," said James Ellman, president of hedge fund Seacliff Capital, who said he was "bearish" on many U.S. banks.

UBS analysts estimated on Monday that declining lending margins could cost the U.S. industry upward of $10 billion.

Regional banks BB&T Corp, Comerica Inc, Regions Financial Corp and SunTrust Banks Inc would suffer the largest declines in margins, they said.

"This is a challenge for any bank. We are aggressively managing our liability cost and there are many thing we can do to mitigate the impact of the declining rates," a BB&T's spokeswoman said.

SunTrust declined to comment, while Comerica and Regions Financial did not return calls seeking comment.

'MORE HOPE THAN REALITY'

Those pressures come after financial institutions globally have written down around $1 trillion of assets.

With most U.S. banks trading below their book value, or the accounting value of their net assets, the market seems to have priced in the possibility that banks could write off and mark down more loans.

But investors may not be paying enough attention to the problems banks face even after writeoffs and credit losses have slowed, said Matt McCormick, portfolio manager and banking analyst at Bahl & Gaynor Investment Counsel in Cincinnati.

The slowing economy could tamp down demand for loans. And even if loan demand rises, shrinking margins will hurt results.