Fed Brightens Bank Picture, May Help Deal Makers

Source : The Straits Times, Sep 19, 2007

NEW YORK - The Federal Reserve came to the aid of US banks on Tuesday when it cut rates in a move that should improve their lending margins and give them breathing space to deal with the fallout from the subprime mortgage crisis.

The Fed's half percentage point cut in the federal funds rate to 4.75 per cent cuts the short-term cost of money that banks lend for longer periods, boosting their bottom line.

Lower rates could also revive some of the mergers and acquisitions idled by a global credit squeeze if investor confidence gets a sufficient boost.

'It's an old adage, that when the Fed start cutting, it's good for banks. Their cost of funds goes down, and their net interest margin usually rises,' said Ralph Cole, portfolio manager at Ferguson Wellman Capital Management in Portland, Oregon.

Bank stocks surged on the rate cut, with Bank of America Corp and Citigroup closing up 3.5 per cent and 5.2 per cent, respectively. Mortgage lenders and home builders also got a boost. Shares of No 1 US mortgage lender Countrywide Financial Corp rose 3 per cent and luxury home builder Toll Brothers climbed 8.7 per cent.

But Toll Brothers Chief Executive Robert Toll said he does not believe it is time to call the bottom of the housing market and worried about the magnitude of the cut.

'I would have done a quarter instead of a half because it signals we're in deep doodoo,' said Mr Toll, speaking at the Credit Suisse Homebuilder Conference.

Private equity firms and investment bankers who handle their deals were keeping a close eye on the Fed's decision. The credit squeeze has left investment banks with more than US$300 billion (S$459 billion) of leveraged buyout debt stuck on their balance sheets, as debt investors have largely steered clear of the loans.

The debt load has caused some banks to take losses on the loans and kept them from earning lucrative fees through lending to corporate and private equity deal makers.

The Fed rate cut could help entice hedge funds and other debt investors to take some, or a large chunk, of that debt off the banks' balance sheets. The rate cut, if nothing else, may help restore confidence in the leveraged loan market that banks have been hoping for.

'Lowering rates for someone like Lehman Brothers , I would imagine they can be more aggressive at funding some deals they were looking at,' said Jim Huguet, co-chief executive of Great Companies LLC, which has US$400 million in assets under management.

But the rate cut won't ease all of the pain being felt in the US housing market. And it won't bail out borrowers who stretched to buy homes they thought would skyrocket in value over the short term, analysts said.

'Banks are on the hook, too, if they lent money to people with poor credit,' said Ken Crawford, a portfolio manager at Argent Capital in St. Louis.

Mr Huguet was also concerned by the steepness of the rate cut.

'It makes me concerned about how bad things could get,' he said. 'There is a lot of risk lurking under the surface, or they would not have made that kind of move.' An escalating number of families are losing their homes because their mortgages are resetting at higher interest rates.

In August, there were nearly a quarter of a million foreclosure filings, according to data research firm RealtyTrac.

That is nearly one foreclosure filing for every 500 US households. In California, the rate was one per 224 households.

Meg McMullen, president of Boston's New England Research & Management, said the Fed move bails out bad behaviour by Wall Street, which funded many subprime lenders.

'Main Street needs the help, not Wall Street,' she said. -- REUTERS