Banks and S&Ls; have been Wall Street's guaranteed-good-time stocks for nearly 2 1/2 years, a period in which they've risen three times as fast as the average industrial stock.
But two events last week caused some analysts to question this party's longevity.
First, the Clinton Camp announced plans to make it "easier" for bankers to make loans, especially to small businesses.
The Administration's goal is to get the economy moving again. But given Uncle Sam's history of misguided meddling in the banking system, the Clinton plan struck some investors as just another version of the Big Lie: "We're from the federal government and we're here to help."
Second, inflation concerns were revived with Friday's report of a jump in February wholesale prices. That caused interest rates to surge, and raised new fears that the next sustained move in rates will be up, which could squeeze the wide profits margins that banks now enjoy.
Even with Friday's rate rise, however, bank and S&L; stocks lost relatively little ground. Most remain near their all-time highs. And many pros who own these issues say that while the story isn't as great as it used to be, this still is a very good group in which to be invested in 1993.
Partly, the banks win by default, says James McDermott, analyst at bank specialist Keefe, Bruyette & Woods in New York: "There aren't a lot of places to run and hide in this stock market."
Even after their gains of recent years, many big bank stocks sell for prices that are just 10 to 13 times their estimated 1993 earnings per share. In contrast, the average industrial stock sells for 17 times '93 expectations.
While bank stock price-to-earnings multiples usually are below the market average, there is a strong argument that they're inordinately low now--especially given the industry's healthy near-term earnings outlook and ongoing takeover activity.
What's more, if the market ever pays a premium for financial strength, it ought to pay it now for the banks. "Bank capital ratios are at a 30-year high," McDermott notes. In plain English, that means that banks' net worth--the capital that funds their expansion and cushions against loan losses--is extraordinarily high.
David Ellison, manager of the Fidelity Select Savings & Loan stock mutual fund in Boston, offers another reason why these stocks should continue to shine: Despite their run-up since 1990, stocks of many banks and S&Ls; still don't reflect the earnings leverage they'll realize from an improving real estate market, he says.
"People have given up on real estate as an investment," especially commercial real estate, says Ellison. "Yet buyers' (interest) is picking up, and prices are starting to rise in many markets. And who owns these real estate assets? It's primarily the banks and thrifts."
In that respect, at least, the Clinton banking proposals would be a plus for many institutions. One directive in the plan would instruct federal bank examiners to stop valuing real estate at ridiculously low prices that don't reflect the properties' future potential worth.
James Schmidt, manager of the John Hancock Freedom Regional Bank stock fund in Boston, says the net effect of that change "would be to make some banks' published asset quality look a little better."
That would be of greatest significance to the real-estate-heavy lenders, such as Wells Fargo. Wall Street, anticipating the Clinton shift, drove Wells' shares from $100.875 to $107.25 last week.
But the bigger issue is whether the full Clinton program, and the outlook for the economy and interest rates, are on balance positive or negative for most banks and S&Ls.;
Many analysts figure it this way: Though it's rarely a good thing when the government tries to skew bank lending--especially to high-risk areas such as small business--that part of the Clinton program won't have much effect on bank loan portfolios for a long time.
And in the interim, the industry seems virtually assured of posting average earnings gains of 15% this year, given current business and interest-rate conditions.
"Bankers who I talk to have a pretty good feel for this quarter and next, and they're saying the first quarter already looks like another good one," says Schmidt.
Because the Federal Reserve is keeping short-term interest rates at 30-year lows, banks and S&Ls; continue to pay about 3% for short-term deposits. But the prime lending rate is 6%, and most bank loans are well above that.
Result: Banks' "net interest margin," the spread between interest income and interest expense, remains near record levels. Last year, the spread averaged a whopping 4.6 percentage points for the 140 banks in Keefe's data base.
Thus, the more pressing issue for banks isn't the Clinton program by itself, but whether a rise in market interest rates could squeeze the net interest margin. That's typically what happens as the economy gains speed. As demand for money rises, deposit rates usually rise faster than loan rates. Bank profit growth then slows.
This time? Friday's jump in interest rates on inflation worries may signal a temporary run-up in long-term interest rates, bank analysts concede. But that isn't likely to change the Federal Reserve's keep-'em-low stance on short-term rates--particularly in light of the Clinton economic plan (read: tax hikes), which is expected to cause growth to slow this year.
Overall, the recipe for 1993 looks like more of the same--a stop-and-go economy, with a gradual rise in loan demand as business confidence returns. And that's fine for most bankers.
"What you want in banking is slow growth," says Schmidt. "Banks don't make that much money in a booming economy."
One caveat for investors, however: After the latest inflation scare abates, don't be surprised to see the prime lending rate fall, even if other rates don't. If the Clinton Administration gives the industry some balance sheet relief, the quid pro quo could be a prime cut, to help business borrowers.
That could cause a temporary bout of profit-taking in bank and S&L; stocks this spring. But many analysts believe that banks can easily afford an ease in the prime without undue harm to earnings.
Once over their knee-jerk reaction to a prime cut, investors are likely to focus on the banking industry's inherent attractiveness--the cheap stocks, extremely healthy balance sheets, and long-term trend toward consolidation that rewards both the acquirers and their smaller target banks.
A Bank Stock Sampler Many major bank stocks have soared 50% to 200% over the past year, but still are priced relatively cheap compared to expected 1993 earnings per share (EPS). A sampling of major banks from different regions, with their 1993 EPS estimates and the stocks' price-to-earnings (P-E) ratios based on those estimates:
52-week Fri. Est. '93 '93 Stock (region) high/low close EPS P-E Banc One (Midwest) $54 7/8-$42 1/8 $53 7/8 $3.86 14 BankAmerica (West) 55 1/2-38 1/8 53 3/4 5.48 10 Chase Manhattan (East) 35-20 3/8 34 7/8 3.66 10 Citicorp (East) 28 7/8-14 3/8 28 3/8 2.04 14 Midlantic Corp. (East) 22 3/8-5 7/8 21 1/2 1.52 14 NationsBank (South) 58-41 5/8 56 1/2 5.00 11 PNC Financial (East) 33 3/8-23 1/2 33 2.65 13 Society Corp. (Midwest) 71 1/2-50 5/8 69 1/2 6.44 11 Wells Fargo (West) 111 1/4-61 1/4 107 1/4 7.00 15 S&P; 500 index 456-395 449.83 26.11 17
All stocks trade on NYSE except Midlantic (NASDAQ). Source: Zacks Investment Research (for analysts' consensus earnings estimates)
Financial Stocks: Still On a Roll Financial stocks such as banks, brokerages and insurance firms have dramatically outpaced the stock market overall since 1991, and many analysts expect that trend to continue at least through 1993. How the Standard & Poor's index of 40 financial stocks has fared versus the broad S&P; 500 index since 1986. S&P; Financial 1987: -19.7% 1990: -25.1% 1991: +45.5% S&P; 500 1990: -6.6% Source: Standard & Poor's Corp.