Staying focused on carefully chosen lines of business is the formula for success among banks, according to Henry C. "Chip" Dickson, the regionalbank analyst for Smith Barney Shearson Inc., New York.
As the country's best institutions zero in on their selected paths in the future, banks will probably tend to look less like each other, he believes.
Among other things, some banks will operate broad geographic franchises, while others may build their franchises successfully in quite limited markets.
Mergers and acquisitions among banks will certainly go on, but Mr. Dickson cautions that much of the easy consolidation in the banking industry may have already been accomplished.
Future transactions will have to overcome the growing skepticism of stock market inventors about high acquisition prices and the prospects for revenue growth of the combined companies.
Q.: Where do the bank stocks stand right now?
DICKSON: I follow regional banks. In the past two months they have given back all their gains for the year. Partly it has been because of profit taking activity after so much money was made in these stocks over the past three years.
We have had two bull markets in banks since 1980. The longest was from 1981-1986, but the one of greatest magnitude, from trough to peak, was from late 1990 until 1993.
There is also a fair amount of sector rotation going on right now in the market as investors look for other places where values perhaps look more attractive to them because of the economic outlook.
That leaves us at this point in a classic stock picker's market for banks where selectivity is very important going forward.
Q.: Besides investment cycles, are their other reasons for the selloff we've seen?
DICKSON: We have also been in a situation where investors were looking at the franchise values in the banking industry. The financial condition of banks had improved a great deal since 1990, helped by falling interest rates, which was good for the stocks.
But we then reached a point where investors were asking whether the profit performance of the industry would compare well [to other stocks] going forward.
There have been people asking what the growth prospects are for the industry, given that the nation's population is getting older. The baby boomers are no longer in their peak borrowing years, as they were in the 1980s.
We are also no longer encouraging borrowing as much as we did after tax law changes that don't allow as much interest to be deducted.
The concerns are there because, according to FDIC data, 65% of the banking industry's income on average is in the form of spread income [from lending]. For regional banks the figure is a lot more like 70%. In short, it is still the largest part of the pie for the banks.
In the past three years the banking industry's profitability has been better because net interest margins were wider and credit costs were lower, but the industry is very not much more efficient, if at all. And that is a surprise, given all the consolidation that has taken place.
Q.: So do the banking industry fundamentals call for more consolidation?
DICKSON: The industry's fundamentals certainly call for rationalization, which implies consolidation. However, much of the easy consolidating has already been done, particularly the government-assisted kind.
There are concerns now about the pricing of [merger and acquisition] deals in the industry, and the format of some of the transactions is not as compelling as some earlier deals. Also, it is not apparent that bigger is better. Some of the best-performing banks are midsize regional banks.
Q.: How about two big banks that are combining now, Keycorp and Society Corp.?
DICKSON: Investors were disappointed that Keycorp did not sell out at a premium and since the two stocks are now linked, both of them have been depressed. The market has also become increasingly skeptical about mergers of equals like this.
But the market may be suprised by Society/Keycorp. I think they are going to deliver some pretty good numbers next year. Basically, the deal benefits both companies and extends the earnings growth curve into 1995.
It provides diversification that Society needed and it enhances the Keycorp franchise. Besides the geographic expansion, Society gets greater mortgage banking operations and a stronger retail focus.
For Keycorp, the deal takes care of some management succession issues. I also think pretty fair expense savings are going to fall out of this deal.
Q.: Why is the market skeptical these days of mergers among banks?
DICKSON: One thing is the riskiness in maintaining revenues and growing them. You can get all the expense savings out and that's great. But if you don't make any more revenues, then those expense savings don't create the earnings growth that was was being sought to begin with.
Q.: If consolidation is not the key for most banks, what is?
DICKSON: It's focus. The key is understanding your business, being focused, having the systems to measure this, and continuing to build the franchise from that basis.
As a rule, when a company is well focused it tends to be pretty successful in growing their business. When you are growing your business base it is a more enjoyable environment to work in. You can focus more on your customers. It's really a self-reinforcing scenario.
Q.: Which of the banking companies you follow are best focused, as you describe it?
DICKSON: First and foremost, Fifth Third Bancorp. They are very focused on delivering products to customers and expanding the business. They are also very focused on the bottom fine and on the strength of their balance sheet.
They have sustained a very strong earnings growth record over quite a period of time. Their average 10-year compound growth rate since 1971 is 15.4%. Their nonperforming asset ratio is under 30 basis points right now and they have a 10% equity to asset ratio.
Q.: How do you measure "focus" at a bank, going beyond the financials?
DICKSON: You get a sense of the business, how many lines of business they have and what their revenue mix is. It's significant if a piece of business is a major part of their loan portfolio or revenue mix and yet they don't talk about that much at all, or if money is being invested in areas that are not going to add a lot incrementally to the company.
Q.: Besides Fifth Third, what other banks you follow are well focused?
DICKSON: Northern Trust Corp. is certainly well along, with trust-related activities as its major focus. Firstar Corp. is very focused in the trust area as well. It is doing 1.5% on assets with very strong fee income.
Banc One Corp. has evolved into a well-focused small business and retail bank. its management information control system is a model for the industry.
Norwest Corp. is also far along in becoming a top retail financial institution. Just look at the structure they have built around the consumer with Norwest Financial Corp., the mortgage company, which is huge and makes a tremendous contribution to the company's [stock price] valuation, and, of course, their banking group.
Barnett Banks is also evolving into a major consumer organization with a lot of focus. They recently sold their indenture trustee business to Bank of New York, because they didn't feel it added value for them.
First Chicago Corp. is also becoming very focused. Their credit card business is one of the top operations among banks and it is a big contributor to their earnings.
Q.: On the subject of Chicago banks, how about Continental Bank Corp.?
DICKSON: Continental is evolving into a corporate bank, also with a strong focus.
But they are still going through the process of cleaning up their balance sheet.
The success of their business efforts is not yet being reflectcd very well in its revenue stream. That could well change a couple of quarters from now.
Q.: What do these various strategies mean overall for the industry?
DICKSON: Banks are going to look less like each other than they have in the past. The way the industry is going, it could diverge more, if you will, rather than converge.
You can see some companies becoming more retail oriented and some focusing more on the large corporate marketplace. At some companies, certain product lines are taking levels of significance that could affect valuation - Northern Trust is an example, and so is First Chicago, with its credit card.
Q.: What is the outlook for the stocks next year?
DICKSON: It depends on the rate scenario, but most of the banks next year are probably market performers.
It is a situation where investors need to look for quality names.
On the positive side for the banks, there are pretty good prospects for dividend increases, and [dividend-to-earnings] payout ratios could go up a bit. Also, the banks are more willing to buy their stock back regardless of whether it might taint a pooling.
