Mr. Cassidy: The banking industry has performed admirably over the last six to 12 months in an environment of declining interest rates and slow economic growth. The banks can be broken down into two groups. The first group, the troubled banks, has worked very diligently in reducing their nonperforming assets and lowering their credit costs over the last six to 12 months. The second group, the smaller regional and community banks, has not had to deal with credit problems and have performed well during the last 12 months. Going forward, however, the interest rate environment is changing on a daily basis, and it's affecting the banks in a meaningful way. The November 2002 fed funds rate cut inflicted a considerable amount of pressure on the industry's net interest margin. This became evident with the fourth-quarter and first-quarter results as well as the second-quarter results just reported. The companies have used balance-sheet leverage to offset that net interest margin pressure. In the last 45 days, however, the steepening of the yield curve has made many banks reconsider the leveraging strategy. If the industry continues with leveraging balance sheets in a rising-interest-rate environment, it becomes vulnerable to the mark-to-market accounting issue that is required for their investment portfolios. Some companies are reconfiguring their balance sheets in anticipation of rising interest rates and a stronger economy to which will enable them to avoid a negative mark-to-market to the investment portfolio. Overall, we feel selected banks are well positioned to benefit from an acceleration in economic growth. Furthermore, the traditional commercial bank that has a very large commercial book of business will benefit more than the consumer or mortgage banks that have benefited quite nicely over the last two or three years.
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