A Healthy Balance at FleetBoston?


By Margaret Popper With the equity markets' disintegration, a lot of commercial banks are now having to mop up after their aggressive fee-chasing strategies of the past couple years. Witness Wells Fargo's (WFC) recent write-off in its venture-capital portfolio. But that doesn't mean commercial banks are going to completely forsake fee-generating activities like investment banking and asset management. For one thing, the Federal Reserve can't keep easing forever, so the lending, or "spread" business as it's known among bankers, may enjoy its current popularity for only a few more quarters.

Sure, lending is a stable business, but it never grows much faster than the economy. And the equity markets don't have to return to their glory days of late 1999 and early 2000 for the fee business to deliver handsome profits.

The ideal strategy for commercial banks these days is probably one that includes a good mix of both fee and spread businesses -- fee for its growth potential, spread for its stability. And that's just the strategy FleetBoston Financial (FBF) is pursuing with its recent acquisitions of traditional commercial bank, Summit Bank in New Jersey, and fee-generator Liberty Asset Management in the Boston area.

A 60/40 MIX. Analysts like Fleet's business mix -- as long as it can execute on its cost-control campaign. At around $40 a share, they say the stock is cheap compared to its peers. For investors who can sit tight through the next quarter or two until the stock market and the fee business it drives pick up in earnest, this could be an opportunity to buy Fleet.

Currently about a third of the bank's earnings come from consumer banking, another third from commercial banking, while the remainder comes from three businesses -- capital markets, wealth management, and international banking. These latter three, which are largely fee-oriented, will offer the highest growth and could represent about 40% of earnings in five years' time, according to Eugene McQuade, Fleet's vice-chairman and chief financial officer.

The bank's goal is to achieve a fee/spread business mix of 60/40 by 2006 from its current balance of 52/48. And no wonder -- fee income grew an average 13.1% a year for the past five years, vs. 5.7% average annual growth for net interest income, according to Henry Dickson, financial-services analyst at Lehman Brothers.

Ironically, the fee business that helped the bank increase its operating earnings 16% in 2000 is going to hold back income in 2001. "Fee revenues are attractive but more volatile," says McQuade. "The good news was that we identified the potential weakness in those businesses in 2000, the bad news is they have proven to be as volatile as we thought they might be."

TAKING CHARGES. Fleet's three biggest disappointments in 2001 are likely to be investment bank Robertson Stephens, which it acquired in May, 1998; discount broker and market maker Quick & Reilly, acquired in September, 1997; and Fleet's $4.4 billion venture-capital portfolio, one of the biggest of any U.S. bank. How disappointing can they be? In the first quarter of 2000, the venture-capital portfolio earned more than $300 million and a total of $373 million for the year. In the first quarter of 2001, it lost $57 million.

Not that Fleet's management is sitting back and letting these market-sensitive businesses strangle earnings. "We have recognized the slower revenue opportunities and are trying to better align the cost side with the revenue side," says McQuade. In the first quarter, Fleet took a charge of $50 million to cut 750 jobs at Quick & Reilly and Robertson Stephens, either through layoffs or not filling empty slots. Plans are to reduce the bank's total expense base of $10 billion by 5% to 7%, says McQuade. About $500 million to $700 million of the cost-cutting will occur in businesses that Fleet already owned last year. An additional $300 million can be wrung out of its recent Summit Bank acquisition.

On the revenue side, the Summit deal is an effort to buy a more stable earnings stream and increase the client base in one of the bank's key growth areas -- financial services to high net-worth individuals. "New Jersey is a great market," says Matt Snowling, analyst at Rosslyn (Va.)-based investment bank Friedman, Billings, Ramsey. "It has one of the highest concentrations of high-net-worth individuals in the U.S., and it has a growing population." Fleet is the dominant player in New England, where plenty of wealthy individuals reside, but its population growth is much slower.

KEY HIRE. To date, commercial banks' infiltration of the high-net-worth customer base hasn't been too successful, but Fleet plans to change all that. "[Commercial banks in general] don't have the right products, which in general means the right customer service," says Lehman's Dickson. "Fleet now has an excellent base to build from."

Having bought the customer base, Fleet now plans to invest $50 million in the people, technology, and products that best serve that base, where clients tend to need fee-generating services like asset management. One of Fleet's key investments to date has been to bring in Keith Banks from Morgan Stanley Dean Witter to head the asset-management division. He'll be in charge of integrating the Liberty acquisition, which is an additional step in improving Fleet's offerings to the wealthy. The deal increased the fund sales force from 30 to 250 people and gave them new products to distribute as well. With a price tag of around $1.1 billion, analysts figure that Fleet got a bargain in Liberty.

With all the building blocks in place, the key now is execution, say analysts. The consensus is that Fleet's management is good at that. "Historically, Fleet has underpromised and overperformed," says Sharada Vibhakar, analyst at Pittsburgh investment bank Parker/Hunter. Fleet's financial management gets kudos from the analyst community for conservatism in a worsening credit market. "Fleet has a loan-loss reserve of 209 basis points [2.09% of its loan portfolio] while the industry average for the superregional banks averages 150 basis points [1.5% of the loan portfolio]" says Keefe, Bruyette & Woods analyst Thomas Theurkauf.

LONG-TERM BET. Despite their faith in management, analysts aren't predicting any great earnings news for 2001. Consensus estimates are 80 cents earnings per share in the second quarter of 2001, vs. 79 cents in the first quarter, and full-year 2001 earnings of $3.36 per share, vs. $3.37 last year, according to First Call data. In 2002 the picture looks brighter, with estimated earnings per share up 12%, to $3.76. Analysts project that revenues will grow 6%, from $14.9 billion in 2001 to $15.8 billion in 2002. Perhaps the lackluster short-term outlook accounts for the wide range of 12-month target prices -- from $34 to $52 a share, according to First Call.

Still, that's a potential upside of 30%. When you consider that Fleet is trading at 12.3 times this year's earnings while its peer group on average is changing hands at 13.7 times, the stock starts to sound like a pretty good deal. "As a trader, not an investor, do I need to buy Fleet today? No," says Keefe Bruyette's Theurkauf. "But the longer-term prognosis is good." And that's what investors should be focusing on in these days of sluggish and unpredictable equity markets. Popper covers the markets for BW Online in our daily Street Wise column


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