Banks Bruised by Trend in Rates

The nation’s two biggest banks said Monday that their bottom lines were being squeezed as short-term interest rates rise while long-term rates hold near historically low levels -- a phenomenon that has caught much of Wall Street by surprise.

Citigroup Inc., the largest U.S. financial services company, reported second-quarter earnings below expectations, in part because of the unusual trend in interest rates, it said. The company’s shares slumped 3%, losing $1.42 to $45.

Bank of America Corp. reported earnings that beat analysts’ estimates, but its stock dropped 90 cents to $45.08 as some analysts pointed to shrinking profit in the bank’s core lending business.

The Federal Reserve has raised its benchmark short-term interest rate nine times over the last year, to 3.25%. Banks, in turn, have boosted the rates they pay on deposits.

But long-term interest rates, such as on 10-year Treasury notes, are lower now than they were a year ago, although they have been creeping up in recent weeks.

The trend in long-term rates -- which Fed Chairman Alan Greenspan has described as a “conundrum” -- is hurting banks’ net interest margin, the difference between their cost of money and what they can earn on loans and investments.

Citigroup Chief Financial Officer Sallie L. Krawcheck told analysts Monday that “we weren’t positioned for the decline in long-term rates” in the second quarter.

Besides squeezing the bank’s interest margin, the fall in long-term Treasury bond yields wreaked havoc with Citigroup’s capital-markets trading unit.

Trading woes drove down capital markets and investment banking profit 31% from a year earlier, the company said.

“The capital markets environment was one of the worst we have seen in years,” said Citigroup Chief Executive Charles Prince.

The New York-based company said net income in the quarter totaled $5.07 billion, or 97 cents a share, compared with analysts’ consensus forecast of $1.02 a share.

A year earlier, in a quarter that included a nearly $5-billion charge to settle lawsuits over the collapse of WorldCom Inc., Citigroup earned $1.14 billion, or 22 cents a share.

Revenue fell to $20.17 billion in the recent quarter from $20.86 billion a year earlier.

All three core Citigroup businesses -- credit cards, capital markets and retail banking -- saw results decline from first-quarter levels, said analyst Richard Bove of Punk, Ziegel & Co.

Citigroup said its card business was hurt by a “short-term spike” in U.S. consumer bankruptcy filings before a tougher federal bankruptcy law takes effect this fall.

The company fared better overseas: Revenue rose 10% in Citigroup’s international consumer business unit.

At Charlotte, N.C.-based Bank of America, California’s and the nation’s largest retail bank, second-quarter net income was $4.3 billion, or $1.06 a share, up from $3.85 billion, or 93 cents, a year earlier.

Revenue rose 7% to $14.21 billion.

Profit exceeded Wall Street expectations of $1.01 a share, according to earnings-tracker Thomson First Call.

But Bank of America’s net interest yield declined to 2.81% from 3.31% a year earlier. That helped to limit net interest income to $7.84 billion in the quarter, up 1% from a year earlier.

The company also recorded a $875-million provision for credit losses, up from $789 million a year earlier. And revenue in its capital-markets group fell 19% from a year earlier.

Bank of America was able to offset weakness in its lending results by making sizable profit in venture capital, increasing its fee-based income and “controlling its expenses incredibly well,” Bove said.

Non-interest income, including fees, totaled $6.37 billion in the quarter, up 16% from a year earlier.

Bank of America Chief Executive Kenneth Lewis said he was “very pleased” with the bank’s results amid a “challenging interest rate environment.”

The company recently struck a deal to buy credit card company MBNA Corp. for $35 billion.

MBNA, reporting its quarterly results Monday, said it earned $632.1 million in the three months ended June 30, or 50 cents a share. Profit was down 4% from a year earlier but beat expectations before a restructuring charge.

Separately Monday, Citigroup denied a CNBC report that Chairman Sanford Weill, who built the bank into an international giant, would step down early.

Weill has said he planned to retire next year. He handed the CEO reins to Prince in 2003.