The Stocks Soar Again, but Risks Loom Large
The euphoria over the wedding of BankAmerica Corp. and Security Pacific Corp. continued to build on Tuesday, as BankAmerica stock hit an all-time high and Security’s shares rose in tandem.
* BankAmerica shares rocketed $3.375 to a record $43.375, after rising $2.625 on Monday. The stock now has gained 16% since the deal was announced Monday.
* Security’s shares jumped $3.50 to $35.625, on top of a $9.125 gain on Monday. The two-day gain: 55%.
The stocks’ action shows just how enthusiastic Wall Street is waxing about this deal. Already, analysts are tossing around extraordinarily optimistic earnings projections for the combined bank, extrapolating from BankAmerica’s promise to slash operating expenses and purge bad loans after swallowing Security.
Bank stock specialists Keefe, Bruyette & Woods Inc. in New York said on Tuesday that the new BankAmerica could earn about $5.50 a share next year, $6 to $7.50 in 1993 and $7 to $10 in 1994. That begins to sound like a growth company, not a boring old bank.
Indeed, BankAmerica has now become a “story” stock, some thing that Wall Street can sell to investors merely on the promise of tantalizing earnings potential a few years out.
The problem with story stocks, however, is that the stories often get way ahead of themselves. Remember Wall Street’s line when Time Inc. and Warner Communications agreed to merge in 1989? They said Time Warner would be a $200 stock in a matter of years. You can have it today for $87.
By most accounts, BankAmerica has struck itself a sweet deal for the sickly Security. Even with the latter’s stock surge, Security’s share price has barely moved above its book value, or theoretical net worth, of $32.40 a share. A better bank would fetch far more than book value in a takeover.
But just how substantial a bargain BankAmerica is getting depends on the very big “if” involving the California economy: If the state’s recession turns out to be a lot worse than expected, the loan losses at both Security and BankAmerica could swamp even BankAmerica’s seemingly sober projections. “If you think California is going into the tank a la New England, that’s going to create a new wave of problems that no one can yet foresee,” admits James McDermott, analyst at Keefe.
The uncertainty leaves Security shareholders in a tough position. If you bought the stock in the $40s or $50s in recent years, you want a better price than the current $35.625. But will you get it?
There’s only one reason to hold onto Security shares, which is that you’ve got to believe that Wall Street will keep pushing BankAmerica stock higher. Because BankAmerica will exchange 0.88 of a share for each Security share when the deal closes in six to nine months, Security stock will closely track BankAmerica’s stock from now on--up or down.
Tuesday, for example, BankAmerica shares rose 8%, and Security rose 11%.
Can BankAmerica stock zoom a lot higher than the current $43.375? Let’s say the transaction closes sometime early in 1992, and the new BankAmerica can indeed be expected to earn $5.50 a share next year. The stock therefore trades at eight times 1992 earnings.
Historically, big bank stocks trade for relatively low price-to-earnings multiples, so a figure of eight times 1992 earnings may be all BankAmerica is really worth for now. That’s how Phil Dubuque, manager of the $63-million Financial Programs Financial Services stock mutual fund in Denver, looks at it. He can’t persuade himself that BankAmerica is a bargain at the current price, so he refuses to buy.
“I’m scared to death of the commercial real estate market in California,” Dubuque says, noting the huge real estate exposure that Security and BankAmerica face. Besides, he adds, “The euphoria (over bank mergers) usually ends after two days.” He figures the stock will drift from here.
Another wary analyst is Campbell Chaney of Sutro & Co. He notes that BankAmerica appears to be giving itself a lot of leeway on loan writeoffs that it may yet find in Security’s ailing portfolio. BankAmerica expects to set aside a total $1 billion more for bad loans at both banks before the deal is done (the two have $5.7 billion in bad loans now, out of an asset total of $190 billion).
Wall Street heard that Monday and decided that there was beauty in such honesty. Yet Chaney figures there’s no way BankAmerica could have done more than cursorily look at Security’s loan portfolio in recent weeks.
“If you find $1 billion on a cursory (look), what will you find on a real due-diligence review” of the loans? Chaney asks. He also worries that neither bank has begun to write off much in California loans yet; both banks’ problems to date have largely been with borrowers outside the state.
So the risk is that the two banks will shock investors at some point in the next couple of quarters by announcing much greater loan losses than expected. That could reduce the earnings power of the new BankAmerica over the next few years and deflate the stock in the process. Even with the much-ballyhooed costs savings expected in the merger, huge loan writeoffs could quickly lower investors’ expectations from the bank.
Are Chaney and Dubuque right to worry? Definitely. But there’s a timing issue here, and it’s a big one. Loan troubles will take months to be revealed. And BankAmerica may be able to temporarily block out investors’ loan worries with its exploration of the “bad-bank spinoff” idea, which would put Security’s bad loans into a separate bank, to be jettisoned.
In the interim, chances are Wall Street won’t shake its excitement about the earnings leverage and dominant Western market position that the new bank promises in the ‘90s. Momentum favors BankAmerica stock now, and a lot of Wall Streeters see this as much more than a $43 stock.
Indeed, many far weaker banks than the new BankAmerica trade for more than eight times 1992 earnings estimates. For example, Fleet/Norstar Financial, which is to New England what the new BankAmerica will be to the West, closed at $25.375 Tuesday, or 13 times the $2 a share that Keefe analysts expect the bank to earn next year.
If BankAmerica even trades at 10 times next year’s estimates, the stock is good for $50 or $60, perhaps very soon. Whether it can stay there into 1992 depends on California’s quick recovery from this deep recession, however--and that is anything but certain.
What’s a Bank Worth?
Investors express optimism or pessimism about a bank based on where they price the bank’s stock relative to its book value, or net worth per share. Banks that trade well above book value are viewed as stronger prospects than banks that sell for less than book value.
Tues. close Book Stock vs. Stock and change value book value Santa Monica Bank $21 1/2, -- $11.00 +95% City National 15, + 1/2 9.90 +51% BankAmerica 43 3/8, +3 3/8 29.04 +49% Wells Fargo 76 1/2, +1 58.59 +31% Security Pacific 35 5/8, +3 1/2 32.40 +10% Riverside Natl. 8 3/4, - 1/4 8.94 -2% First Interstate 35 1/8, +1 1/4 37.53 -6% Union Bank 23, +1 28.74 -20% Cal. State Bank 10, - 3/4 13.24 -20% Imperial Bancorp 10 1/8, + 3/8 17.29 -41%
Santa Monica Bank trades on Amex. Riverside, Union, Cal. State and Imperial trade on NASDAQ.
All others on NYSE.
Source: Keefe, Bruyette & Woods
