Most Banks Expected to Weather Bond Yields’ Fall

Barring a recession, most U.S. banks should be able to maintain decent profit margins despite a sharp decline in bond yields, analysts said.

Money managers and investors plowed back into bank stocks Friday amid a bond rally sparked by weak May employment data. When bond prices go up, yields fall. The lower yields mean banks earn less on those kinds of investments, but they also give consumers and businesses incentives to borrow.

The employment data so emboldened Southwest Bank of St. Louis that it cut its prime rate to 8.5% from 9% on the belief that economic growth had slowed substantially. The prime rate is a benchmark for consumer loans for items such as automobiles and home improvement. Other banks are not expected to follow Southwest’s move, however.

For years, banks maintained a two-point spread between prime and federal funds, a rate the Federal Reserve Board says banks must charge each other to borrow money overnight. When the Fed started nudging federal funds up in early 1994, banks widened their spread to a healthy three points.

Analysts doubt the banks will rush to dismantle the healthy margin between fed funds and prime. For one thing, loans pegged to the prime rate is an attractive place to invest proceeds from maturing bonds, instead of reinvesting in a bond market with deflated yields, analysts said.

“The reality is that most banks have good loan demand, and if they reinvest funds into loans, that’s a plus,” said David Berry, senior analyst for Keefe Bruyette & Woods Inc.

Falling bond yields could spur a boon in mortgage originations as people rush to refinance loans at lower rates, other market observers said.

But not everyone is confident that a slowing economy and weak employment figures will be good for bank stocks.

“If the economy is slowing, it says that loan volume will slow down and loan losses will go up,” PaineWebber Inc. analyst Lawrence Cohn said.

“There has never been a business cycle where the improvement in margins has offset the deterioration in asset quality,” he said.