Banking Analyst Scans Horizon for Signs of Rough Waters Ahead
A string of bad-loan warnings this summer from banks such as Union Bank of California, Imperial Bancorp and Wachovia Corp. sent Wall Street investors running for cover.
Those concerns helped drive the Standard & Poor’s bank stock composite index down more than 20% from its early-June high.
But by the time second-quarter earnings were all announced, fears that other major banks would suffer similar credit problems failed to materialize. The S&P; bank index has regained its footing and is up more than 13% for the year. Several leading bank stocks, including Mellon Financial and Citigroup, are up more than 30% this year.
Was this summer’s credit scare a false alarm, or a red flag?
Prudential Securities’ bank analyst Nancy Bush discussed her views on the industry in a recent interview with Times staff writer Edmund Sanders.
Question: How worried should investors be today about credit quality at banks?
Answer: We clearly are coming to the end of a very long, beneficent period in credit quality in the banking industry. If you look back, you see that we have not had a credit cycle since the onerous cycle of the late 1980s and early 1990s, which was driven by real estate. It’s been a remarkably benign environment.
As we get further into this remarkable expansion, the prospect of a credit cycle gets that much closer, particularly given the high levels of corporate and consumer debt. Both consumers and businesses are probably skating on the edge. Any kind of prolonged or severe downturn in the economy will give us some real problems.
Banks have drawn down loan-loss reserves to about half the level that they were in the early ‘90s, and that’s a real concern.
Q: Have banks been lulled into a false sense of security by the strong economy?
A: They did get lazy in terms of underwriting in the 1996-98 time frame. But that came to an end with the capital markets meltdown in the summer of 1998. Banks significantly tightened their credit standards after that.
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Q: Is there any risk that the industry will repeat its mistakes of the late 1980s, and suffer drastic loan losses?
A: There is not the huge pool of risk that there was in the late ‘80s with regard to commercial real estate. We were dramatically overbuilt at the time, particularly in California and New England. That’s not the case this time around. There isn’t an industry sector that we can point to as the problem. It’s a more diffuse problem this time around and harder to put a finger on.
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Q: Many of the credit problems are occurring with syndicated loans, in which banks join forces to spread the risk of lending to a highly leveraged firm. Why is that?
A: Syndication was one of the areas where underwriting standards got fairly lazy in the 1996-98 time frame. So many of these syndicated loans were to companies that were expanding. The companies themselves had good prospects, but they simply got involved in deals that took them over the line in terms of debt. [Bankrupt funeral home operator] Loewen Group is an example. So was Conseco Finance Corp.’s buying Green Tree Financial Corp.
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Q: So should investors be watching out for banks that do a lot of syndicated loans, such as Bank of America?
A: Not necessarily. The Shared National Credit exams, which are the regulatory exams of syndicated portfolios, have come to an end and we should get the full results in October. Unless somebody is blatantly lying, there does not seem to be a large bank out there that is going to experience problems as a result of its syndicated loan portfolio.
From what we know, it does not seem to be a widespread problem capable of bringing the whole industry to its knees.
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Q: Even so, is there a risk to investors that the Shared National Credit results might jolt bank stocks again?
A: No. I think the anxiety peaked in the late second quarter.
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Q: Did Wall Street overreact?
A: I think we did overreact. I was around in the 1988-91 time frame. I know how bad it can get. But in banking and other industries, you have many young portfolio managers and young analysts who have not been through one of those cycles. They got a little jarred by an outlook that was less than perfect. I chalk this up to part of the aging process for the next generation on Wall Street.
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Q: What are your top bank stock picks?
A: My two strongest-rated bank stocks are Fleet Boston and Bank One.
Fleet Boston is remarkably undervalued. It is very well diversified in terms of earnings and strongly devoted to keeping loan-loss reserves strong. It also has some nifty businesses, such as its Latin American business and the Quick & Reilly brokerage. The newly merged Bank Boston and Fleet is really coming together much better than I anticipated.
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Q: Bank One has certainly had its share of problems lately.
A: You still have a very viable franchise. [Newly appointed Bank One Chief Executive] Jamie Dimon is a young manager who has captured the imagination of The Street and is pulling off the most rational restructuring I’ve seen in my career. I think they will get [credit card unit] First USA turned around.
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Q: Bank of America and Wachovia both announced big layoffs recently to cut costs. Should we expect more of this as banks seek to boost profits?
A: There are cuts and then there are cuts. I’m not a fan of what we heard from either BofA or Wachovia. Those kinds of programs, where they say they need to lay off X number of people, have proven to be counterproductive. The law of unintended consequences always sets in. When you cut people and disrupt your organization in this sort of dramatic and visible way, revenue almost always falls, as people worry about their jobs.
Expenses at banks need to be looked at, but in a quiet, less intrusive way. For these two companies particularly, I look at it as a sign, not of strength, but that they are concerned about near-term earnings and feel some need to make an impact on Wall Street.
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Q: For much of the 1990s, big banks relied on mergers for growth. But last year, bank mergers dropped about 25% from 1998. Now that the consolidation craze has cooled, where will growth come from for banks?
A: Well, sooner of later, there will be more consolidation, but it’s not imminent. The reality of the industry is that we have a number of mid-sized, regional banks out there whose prospects are quite limited.
The future of this industry is in diversifying earnings and proving that it is relevant in a number of areas--not just retail banking and commercial banking, but also in capital markets activities. The industry needs to prove it can function more effectively in the “new economy” than it did in the “old economy.”
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Edmund Sanders can be reached at edmund.sanders@latimes.com.
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Under Pressure: Wary Wall St. Keeps Lid on Bank Stocks Overall
The Standard & Poor’s composite index of 29 major bank stocks, including regional and money-center banks, has rebounded 26% from its midyear low, but is still trading about 14% below its 1998 record high. Although the stocks sell for relatively low price-to-earnings ratios, some analysts are concerned that credit quality could become more of an issue should the U.S. economy falter.
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Standard & Poor’s bank stock index (SPBNKC), monthly closes and latest
Monday: 640.02
Source: Bloomberg News
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A Sampling of Major Bank Shares
Concerns about potential bad loans haven’t stopped several bank stocks from posting strong returns this year, many of them soundly beating the anemic Standard & Poor’s 500 index.
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Ticker Monday YTD Est. Bank symbol close change P/E* Mellon Financial MEL $46.69 +37.1% 23 Citigroup C 56.75 +35.9 21 Fleet Boston FBF 42.63 +22.4 13 Bank One ONE 37.94 +18.6 17 Wells Fargo WFC 46.25 +14.4 18 Bank of America BAC 56.56 +12.7 11 Chase Manhattan CMB 57.50 +11.0 14 US Bancorp USB 22.31 --6.3 10 First Union FTU 30.25 --8.2 10 Wachovia WB 59.50 --12.5 13 S&P; 500 1,489.26 +1.3 27
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*Price-to-earnings ratio based on estimated fiscal year 2000 earnings per share (consensus estimates from IBES International)
Source: Bloomberg News
