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Updated from 6:55 a.m.

It looks like smooth sailing for most bank stocks in 2004, as long as the

Federal Reserve

doesn't rock the boat.

After a rocky start, 2003 ended well for the nation's banks, and that trend is expected to continue through much of this year. Industry analysts and bank investors are looking for most banks to post double-digit earnings growth, and for bank stocks to rise another 10% to 15% on average in 2004.

A 15% gain is only half as good as the 30% jump recorded by most bank stocks last year. But it's better than the 10% rise many are looking for in the

S&P 500

in 2004.

The consensus is that barring a sharp spike in interest rates, a severe drop in the dollar or an unforeseen fiscal crisis, the nation's banks stand to benefit from a strengthening economy. That's especially so since the level of bad telecom, energy and manufacturing loans on the books of the nation's banks is on the decline.

Fears of a spike in interest rates also may receded following the release of the December employment report, which said the economy added an anemic 1,000 new jobs during the month. The weak figure will likely prompt the Fed to hold off on pushing up rates, until there's an indication that the economic recovery is both sustainable and capable of producing sufficient jobs on a regular basis.

In the past few years, a sharp rise in corporate loan defaults at banks such as

J.P. Morgan Chase



FleetBoston Financial


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Bank of New York



PNC Bank


have been the main drag on earnings. But bank balance sheets are looking a lot healthier these days.

"Banks should see revenue growth of high single digits, and that should lead to double-digit earnings growth," said Michael Stead, a Wells Capital Management portfolio manager who invests mainly in financialstocks. "And if earnings growth really drives stock prices, then banks that have a proven track record should benefit."

Stead said an improving economy not only means banks can lend more money in 2004; it also means that banks don't need to hold as much money in reserve to cover the cost of businesses defaulting on those loans.

Investors, meanwhile, won't have to wait long to see signs of that economic revival at banks. Most fourth-quarter earnings reports are now expected to come in either in line with or ahead of Wall Street expectations.

Optimists note that with Atlanta-based



set to report Monday, the sector has seen only a smattering of warnings. In fact, some banks, such as Puerto Rico-based

Doral Financial


, have been issuing press releases talking up their numbers. In a recent filing, Doral said it expects fourth-quarter earnings to "meet or surpass published market expectations."

David Hendler, a financial services analyst with CreditSights, an independent ratings firm, said in a research note that the good news for financial stocks "should continue into 2004 as low interest rates, good economics and a steep yield curve are the foundations for growth."

A steep yield curve is often seen as a leading indicator of an economic revival. That's because interest rates tend to rise as economic growth accelerates, and investors look to buy protection against a rise ininflation.

Of course, the big fear for bank investors is that the Federal Reserve will begin pushing up interest rates this year, after slashing them for nearly two years. The Wall Street conventional wisdom is to sell bank stocks -- or at least stop adding to your position -- when interest rates rise. A rapid increase in interest rates can raise a bank's borrowing costs, wreak havoc on its investment portfolio and cause a slowdown in consumer borrowing.

But few see the Fed moving in that direction, especially in a presidential election year.

"It's going to be a function of how anxious the Fed becomes over the next couple of quarters," said Sean Egan, president of Egan Jones Ratings, a small debt-rating agency. "So far it's been fairly relaxed. It's almostas if all parts of Washington are working together to make sure the economy performs as well as possible in advance of the election."

In fact, a gradual and modest uptick in interest rates would help many banks, which were hurt last year by historically low interest rates. When interest rates are too low, this can compress a bank's net interest margin, aratio that measures the difference between a bank's own borrowing costs and the interest it receives from borrowers. Last year, many banks, especially regional lenders, found that low interest rates were reducing theprofitability of their lending operations.

"In the past we were concerned about sustained low interest rates, because it would impact the banks' margins," said Sean Jones, a Moody's Investors Service bank analyst. "We believe rising rates would be beneficial for banks."

But there are some banks that investors may want to avoid in the coming year, and those are ones heavily dependent on revenue from underwriting mortgages and refinancing old ones. Last year the mortgage refinancing business was on fire and fueled powerful earnings gains at thrifts such as

Washington Mutual



But all it took was a small rise in interest rates last year for the refinance market to come to a crashing thud. And the slowdown in the home-lending market is causing severe pain for mortgage-revenue-dependent lenders like Washington Mutual. Last month the Seattle-based thrift slashed its earnings outlook for the fourth quarter and for this year. It also said 900 of its current workers would join 4,500 others who have been shown the doorsince August. Most startling was news that the volume of mortgages it originated fell by half from the third quarter to the fourth.

To some degree, the bad news at Washington Mutual stemmed from its failure to hedge itself properly for the upswing in interest rates and problems associated with the bank's rapid growth. But some also see it as a harbinger of things to come for other thrifts and mortgage banks if the Fed begins to tighten the money supply.