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If you're interested in bank stocks, keep your eye on the Federal Reserve. The time to jump into this interest-rate-sensitive sector will be when Chairman Alan Greenspan seems to be "nearly done" with raising rates.
That's the advice of Stephen R. Biggar, Standard & Poor's analyst of banking and financial-services stocks. However, there are a few banks on his "buy" list now, including Bank of New York, Chase Manhattan, and Fleet Boston, and others worth accumulating.
Biggar thinks the repeal of the Glass-Steagall Act, freeing banks to move into other businesses, has had less impact than expected, because the act itself had been weakened in recent years and also because the most obvious area for expansion -- insurance -- is not that attractive right now.
These comments came in a May 30 chat with Biggar on America Online, presented jointly by Business Week Online and S&P Personal Wealth. Here are edited excerpts of Biggar's answers to questions from the online audience and from BW Online's Jack Dierdorff, the moderator. For a full transcript on AOL, go to keyword: BW Talk.
Q: The market scored big gains today, but the financial sector still seems to be marking time. What's the outlook for that arena? A: We're still carrying a market-weight recommendation on the financial sector. Although valuations are low relative to historic averages, there are real concerns about the growth rate of traditional banking businesses, given the rising-interest-rate environment. So while we're not overly negative on the sector, I don't feel it's a particularly good time to buy without being selective.
Q: Regarding this need to be selective, do you have any selections? A: We currently carry recommendations to buy Bank of New York [BK], Fleet Boston Financial [FBF], PNC Financial Services [PNC], and Chase Manhattan [CMB] -- all of which should be able to maintain earnings-growth momentum regardless of the high-rate environment.
Q: What are your thoughts on WFC [Wells Fargo & Co.]? A: We have a "hold" recommendation on Wells. The company is actually one of a few major banks that continue to show good long-term growth, a stable margin, and lower credit costs. The merger with Norwest is on track, and the company should continue to see the benefits of revenue and cross-selling synergies....
Q: What do you think of Citicorp, now Citigroup [C]? A: We have an "accumulate" on Citigroup. Recent results have shown upside surprises in the areas of global consumer and investment-banking businesses. The company is still realizing benefits...since the merger with Travelers. We also see Citigroup as being in a unique position to take advantage of European merger activity, given the upcoming acquisition of Schroders' investment-banking business.
Q: What's behind your "buy" rating for Fleet Boston?
A: Earnings in the first quarter were well ahead of expectations, led by strength in capital-market activities and cost-savings from the BankBoston merger. I see many of the underlying businesses, including the Quick & Reilly brokerage unit and Robertson Stephens investment-banking unit, not getting their reward in the marketplace. So I see considerable expansion in the price-earnings multiple possible, given the faster growth of these units and the diversification that they provide.
Q: I would like an opinion on WB [Wachovia], please.
A: Wachovia continues to benefit from being in a regional territory where they are able to post above-average loan growth. They have also been rapidly expanding their wealth-management and capital-markets businesses.... But still, their p-e to growth ratio is on a par with peers, and we therefore see the shares as fairly valued currently.
Q: What's your opinion on FTU [First Union]?
A: We currently have First Union ranked as a "hold." Although it trades at a discount to its peers, we continue to see the shares as only a market performer this year. Growth from traditional lending businesses has been offset by flat income from capital-markets activities and higher incentive compensation...[although] the company appears to have put troubles related to the CoreStates merger behind it....
Q: In an era when so many fundamental market rules are broken, does the relationship still hold between interest rates and the prices of bank and financial stocks?
A: To some extent, that rule still holds true. Interestingly, banks were the third-best performers for the month of May, and despite a dramatic rise in short-term interest rates so far this year, major regional banks have beaten the market with an increase of 4.9% year-to-date, compared to a 6.2% decline in the S&P 500.
The normal rule of thumb is to begin buying financial stocks when you think the Fed is nearly done with tightening, so I think the psychology is that investors are increasingly convinced, at least by the performance of financial stocks, that the Fed is nearly through raising interest rates. However, it can be a very dangerous game to assume Fed policy over the near to intermediate term.
Q: Do you think JPM [J.P. Morgan] will be acquired this year? And what about the bank-merger movement in general?
A: I think that's highly unlikely, with size being the principal obstacle.... Merger activity has certainly slowed down, given depressed bank-stock prices and the negative stigma associated with a few large botched mergers.... But I don't see a lack of merger activity as being unhealthy for the sector.
Q: What banks do you see as taking best advantage of the repeal of Glass-Steagall, freeing them to go into more lines of business?
A: Clearly, banks such as Citigroup, Chase Manhattan, and Bank of America would have the best opportunities to take advantage of the repeal of Glass-Steagall, but the lack of merger activity by these banks is probably due to the fact that many of the Glass-Steagall provisions were weakened in the last 20 years. Also, the most likely area that they could expand into -- insurance businesses -- is not viewed as fast-growing....
Q: Consumer credit is piled high -- will that be a problem for banks if there's a market dive or a real economic slowdown? A: I think the rapid increase in consumer credit could certainly have a negative impact on credit quality if the economy turns down. Fortunately, consumer lending is, by itself, naturally diversified, since consumers are generally well diversified by region and employment....
Q: How much further can banks push the fee-income generator? How big a share of revenue is that source?
A: I think most banks have hit the ceiling on the basic consumer fees that they can charge without losing customers.... Fee income at major banks ranges anywhere from 30% to 70% of total revenues. Banks with a higher percentage of fee-based revenues are seen as less susceptible to rising interest rates and generally have faster earnings-growth rates. They also don't have the credit-quality concerns, since fee-based businesses are not lending-related.
Q: Do banks see online banking as a competitive threat? Are they getting into that act themselves with any success?
A: All of the major banks have some type of online service, but most see it simply as another form of distribution of customer service.... I think consumers, however, are still grappling with the decision to bank completely online without having a local branch to transact and buy certain products. Until all forms of payment can be accepted online, I think retail-branch banking will be alive and well.
Q: So, to sum up, Steve, the smart investor in financial stocks will pounce when it looks as if Alan Greenspan has finished tightening. Or preferably, just before everyone gets that idea. A: Right. Typically, that does represent a good buying opportunity for financial stocks. However, we always have to be aware that if the Fed tightens too much and there is a significant downturn in the economy, then credit quality will likely be a problem for banks.
Q: And now, remind us of the stocks on your own "buy" and "accumulate" lists. A: We currently have "buy" recommendations on Chase Manhattan, Bank of New York, Fleet Boston Financial, and PNC Bank, and "accumulate" recommendations on Citigroup, Mellon Financial [MEL], SouthTrust [SOTR], and SunTrust Banks [STI].
EDITED BY JACK DIERDORFF
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