Financial stocks opened higher Thursday, but the rally that started the day before quickly died as the Philadelphia

Federal Reserve

Bank unexpectedly reported the biggest contraction in the region's manufacturing sector in seven years.

The Philly Fed report lends credence to those who believe the economy is in danger of falling into recession. While this bolsters the market's expectation of rate cuts from the central bank, stocks did not respond favorably. The

NYSE

Financial Sector Index, which spent most of the day in negative territory, more recently was losing 78.67 to 7,432.02.

Private banking and investment management firm

Boston Private Financial Holdings

(BPFH) - Get Report

was down 26.4% on the announcement that its affiliate, First Private Bank & Trust, increased its loan-loss reserves between $16 million and $19 million for the quarter ending Dec. 31. The increased reserves are due to potential losses in First Private's portfolio of residential construction and land loans in Southern California, The increased provision is expected to cut the company's earnings by between 27 cents and 31 cents per share.

Good news also didn't prevent

First Mercury Financial

( FMR) from falling 12.5% to $17.56. The company was downgraded by Ferris Watts from a buy to a neutral today, even though the property and casualty insurer more than doubled its fourth-quarter profit to $10.2 million, as it reported after Wednesday's close.

Increases in derivative losses and loan-loss provisions created a no-win scenario for

Capital Source

(CSE)

, which was down 4.5% on Thursday. The company reported a $15 million loss in the fourth quarter. Earlier this week, Capital Source announced that it is continuing to evaluate its merger agreement with TierOne, which it will either renegotiate or terminate.

SunTrust Banks

(STI) - Get Report

was downgraded at Oppenheimer from perform to underperform, sending it down 5.1% to $60.73. An analyst wrote that the stock "does not deserve its premium P/E multiple, and is not a likely an acquisition target."

MBIA

(MBI) - Get Report

fell 23 cents to $11.95 after panning activist shareholder William Ackman's proposed plan for struggling bond insurers be split into two. After the close, the company reiterated its argument that Ackman, a hedge fund manager, stood to benefit from negative bets on the stock.

On the bright side, property and casualty insurer

ProCentury

(PROS) - Get Report

climbed 21.4% after

Meadowbrook Insurance Group

(MIG)

said late on Wednesday it agreed to buy Westerville, Ohio-based company for roughly $272.6 million in cash and stock.

American Equity Investment Life

(AEL) - Get Report

saw shares shoot up 6.3% to $8.97, after the company released its fourth quarter earnings. The stock has lost 38% of its value over the last year, but could benefit from the recent struggles of its European competitor

Allianz

, which reported a 52% drop in profits on Thursday.