Bank of America Corp. and Citigroup Inc. are among lenders thatmay find it more difficult to boost profits and capital after theFederal Reserve pledged to keep its benchmark interest rate lowuntil at least late 2014.

“This hurts the banks, I don't think there's any question aboutthat,” said Ralph Cole, a senior vice president of research atFerguson Wellman Inc. in Portland, Oregon, which manages $2.9billion. “Their cost of funds stays low but it makes it harder toearn a return.”

The Federal Open Market Committee said yesterday that economicconditions are likely to warrant “exceptionally low levels for thefederal funds rate at least through late 2014.” The policy may hurtlenders' profits as they struggle to find loans or securities withyields high enough to support their net interest margins, a gaugeof profitability that measures the difference between the cost offunds and what they earn on assets.

The KBW Bank Index of 24 U.S. lenders advanced 0.1 percent, ledby a 2.2 percent gain at Salt Lake City-based Zions Bancorp. Sharesof U.S. insurers, including Radnor, Pennsylvania-based LincolnNational Corp., slid as investors bet lower yields will crimpincome from corporate debt, municipal securities andmortgage-linked assets used by the companies to cover policyholderobligations and generate profits.

The average net interest margin at the four largest U.S. banks —JPMorgan Chase & Co., Bank of America, Citigroup and WellsFargo & Co. — dropped to 2.99 percent in the fourth quarterfrom 3.17 percent a year earlier. The margin at U.S. banks withmore than $15 billion in assets fell to 3.44 percent in the thirdquarter of 2011, from 3.85 percent in the first quarter of 2010,according to Fed data.

“As a bank investor, this is not a welcome response” from theFed, said Peter Kovalski, a money manager at Alpine Woods CapitalInvestors LLC in Purchase, New York, which manages about $6billion. Bank stocks “have had a good run here, but they could giveback some of the gains in the next few weeks,” he said. The KBWBank Index is up 11 percent this year.

Executives at New York-based JPMorgan expect low rates and theresulting margin compression to cause a $400 million decline inconsumer and business banking net income this year, BarclaysCapital analyst Jason Goldberg wrote in a report yesterday aftermeeting with bank management.

U.S. Unemployment

The Fed extended its previous pledge to keep rates low at leastuntil the middle of 2013 as inflation remains tame and more thantwo years of economic growth failed to push unemployment below 8.5percent. Some Fed officials have said further easing might beneeded to put more Americans back to work and revive the housingmarket.

The Fed's earlier pledge led San Francisco-based Wells Fargo topurchase more securities for its investment portfolio, ChiefFinancial Officer Timothy J. Sloan said in a Jan. 17 phoneinterview. Wells Fargo's securities available for sale climbed to$222.6 billion as of Dec. 31 from $186.3 billion at the end ofJune.

“If the Fed had not said we are going to keep rates low, maybewe wouldn't have invested as much, but they are the driver here,”Sloan said. “It's silly not to take some of our liquidity,particularly because we've had good deposit growth, and investit.”

The average yield on that portfolio fell to 4.46 percent in thefourth quarter from 4.92 percent in the third, the bank said lastweek in its earnings statement.

Banks may be able to cushion some of the negative impact of lowrates if the Fed's policy fuels economic growth and lending picksup, said Richard Staite, a London-based analyst with AtlanticEquities LLC. The yield on Wells Fargo's loan portfolio was 4.81percent in the fourth quarter.

“The best thing the Fed can do is promote economic growth, evenif that requires a sustained period of low interest rates,” Staitesaid in a phone interview. “Loan growth will be the most importantfactor to helping banks offset the negative impact of lowrates.”

Ferguson Wellman's Cole said he's worried about the potentialfor banks to make riskier loans if they grow desperate forincome.

“At some point they won't be able to make a return on theirmoney so they will have to lend more,” said Cole, whose firm ownsshares in Citigroup, JPMorgan and Wells Fargo. “Hopefully thatdoesn't mean the loan quality goes down. They start reaching foryield, and that's when they get hurt.”

Mortgage Rates

The Fed's pledge is likely to further trim mortgage rates, whichare linked to long-term government bond yields, said Greg McBride,the senior financial analyst at Bankrate.com, a unit of BankrateInc. Credit-card lenders, betting that their funding costs willremain low, also may boost or extend offers for zero-interestbalance transfers, he said.

The national average rate on deposits, which includes checking,savings and money-market accounts, and certificates of deposit upto five years, is 0.59 percent, according to Dan Geller, executivevice president of Market Rates Insight in San Anselmo, California.That's the lowest since he started tracking the data in January1990. Interest rates on deposits may reach zero within the next 12months to 18 months if lending continues to be soft, he said.

Custody Banks

Low interest rates also hurt custody banks by reducing thereturns they make on investments and from lending cash andsecurities to institutional investors such as mutual funds andhedge funds. Bank of New York Mellon Corp., Boston-based StateStreet Corp. and Chicago-based Northern Trust Corp., the threelargest independent custody banks, have made or planned 4,450 jobcuts since November 2010.

The Fed's announcement signals more difficulty for U.S.money-market mutual funds, which have waived some of their fees tokeep customers' returns above zero. The average annual fee chargedby the largest 100 money funds fell to 0.17 percent in December,from 0.37 percent in August 2008, according to Crane Data LLC inWestborough, Massachusetts. Money fund assets had declined 31percent in the past two years to $2.66 trillion as of Jan. 17.

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