Is This Beginning or End of Party for Bank Stocks?
Some of the sharpest people on Wall Street were buying bank stocks late last year, when nobody else wanted them. Now, with many of the stocks up 40% or more in five months, the industry’s fans are multiplying faster than empty office buildings in downtown Los Angeles.
It makes you wonder: Is it smarter to bail from the banks at this point, or join the crowd?
Most Wells Fargo & Co. shareholders probably don’t want to leave the party. Their stock hit an all-time high of $95.625 in trading on Thursday, and closed up 62.5 cents to $94.125--more than double the low of $41.25 last fall.
Wells, California’s third-largest banking company, has confounded the legion of short sellers who bet heavily against the firm in 1990. The shorts, who sell borrowed stock betting that the market price will plummet, figured Wells would get murdered this year by its extensive commercial real estate loan portfolio and by its large collection of loans to deep-in-debt corporate borrowers. The recession seemed to guarantee that Wells’ loan losses would overwhelm profits.
Instead, Wells managed to earn $152 million in the first quarter, off just 5% from a year earlier. The prophets of gloom had to reconsult their crystal balls. Meantime, Omaha investor Warren Buffett--one of the most respected stock-pickers of this age--announced on May 14 that he plans to raise his 9.7% stake in Wells to as much as 22%.
That vote of confidence has helped tack $10 onto Wells’ stock in just 10 days. Joe Feshbach, whose Feshbach Bros. investment firm of Palo Alto was one of the loudest doomsayers on Wells last year, now admits that “they’ve got the upper hand.”
In New York, Prudential Securities bank analyst George Salem changed his longstanding “sell” rating on Wells stock to “hold” on May 15, saying there was no use fighting the trend.
That trend also has pulled shares of Los Angeles-based First Interstate Bancorp., the state’s fourth-largest banking firm, up to $39.25 now from $20 earlier this year. And as a group, 14 major bank stocks tracked by Standard & Poor’s Corp. rose 41% from Jan. 1 through mid-May, while the average industrial stock rose just 14%.
Obviously, a lot of investors are betting that the worst is over for the banks. But history suggests otherwise. The elation that bank stock investors feel, says analyst James McDermott at research firm Keefe, Bruyette & Woods Inc. in New York, is just part of the mood shift “from dire and bleak to decidedly mixed” about the industry’s future.
Investors were terrified in 1990 over projections of huge loan losses over the next few years. The debt excesses of the 1980s were expected to return to haunt the banks in spades.
Then came the first quarter, and with it reports from some major banks of a slowdown or drop in loan chargeoffs. Result: The bulls went wild.
Yet history shows that bank loan losses continue to grow for at least a year after a recession ends, notes Arthur Soter, bank analyst at Morgan Stanley Group in New York. He doubts that things will be different this time around, one quarter notwithstanding.
More worrisome, analysts point out that throughout the 1980s, banks’ non-performing loans (those no longer earning interest) and actual loan chargeoffs (when a bank finally admits a loan is hopeless) continued to rise--even as the economy boomed. Non-performers and chargeoffs are measured as a percentage of total bank loans, to show how much of the portfolio is rotten. As the go-go ‘80s wore on, the rot increased.
Makes a stockholder wonder how well the banks can fare in a slower-growth era, especially when the big loan fees and asset inflation that covered up many bank mistakes in the ‘80s won’t be part of the equation in the ‘90s.
Indeed, Soter looks around to see where the engine for bank earnings growth will be in the ‘90s, and finds “not much.” Consumers are forsaking debt, many companies have found better financing with commercial paper or stock than with bank loans, and commercial real estate lending (bankers’ favorite big-buck loan from 1985 to 1989) is all but finished for years to come.
Where does that leave the banks today? In their favor, the Federal Reserve has lowered short-term interest rates substantially in recent months, allowing the banks to cut deposit rates while keeping loan rates high. That helps profits. And Congress seems intent on passing a banking reform bill that will create true nationwide banking, thus hastening the consolidation of the industry. The strong will get stronger, the weak will disappear.
But to buy the big-bank stocks today, you really have to focus on the next six to 12 months, and believe two things: that there aren’t too many more bad-loan time bombs waiting to go off, and that earnings are going to recover nicely in 1992.
On either count, the bulls appear to be asking way too much. Bank stocks may still look cheap at 10 times projected 1991 earnings or less, but investors need to remember that they’ve always been cheap in that respect. After their big run-up this year, the party looks like it’s winding down. As McDermott gently puts it, “For the banks, this is still a healing time.”
The State of Banking
Bank stocks have rocketed so far this year on the assumption that the industry’s long slide has stopped. But the sharp rise in loan chargeoffs and non-performing assets during the 1980s--even during good years--leaves many analysts worried about further fallout.
