Stocks: Solid Earnings Help Banks to Shed Image As Cyclical Stocks

In a fundamental change, investors and analysts are beginning to look at bank stocks as growth stocks rather than cyclicals.

Some say this new focus is behind the surprising strength of bank stocks this month, when many investment pros expected banks to give back some of their stunning first-half gains.

Instead of falling, bank stocks have slightly outpaced the overall markets so far in September, after outperforming the Standard & Poor's 500 by a significant margin in the first half of the year.

Though bank mergers drove much of the rise, the persistent strength of bank stocks signals there may be more to the sector's strength than just takeover plays.

On Wednesday the American Banker index gained 0.55%, while the S&P 500 fell 0.06%. The bank rally was led by the large capitalization banks and money centers, not seen as takeover plays. On Thursday, the S&P index of major banks rose tktk%, while the S&P 500 rose tktk%.

"There is a lot of reason to be in banks because of pure fundamentals," said Robert Bonelli, who manages a bank fund at Ernst & Young, a New York broker dealer where he is also chief financial officer.

"Acquisitions aside, there is every reason to look at bank valuations and say they are still not near historical highs. We could see sustainable earnings growth of 15% per year for the next three years."

Among these strong fundamentals are high reserve coverage, strong loan- to-deposit ratios, and low levels of nonperforming assets, he said.

Perhaps most important, earnings look to be strong in the third quarter yet again, Mr. Bonelli said. This year banks should earn $47 billion, he said, and next year, with a full year of Federal Deposit Insurance Corp. premium cuts in effect, banks could earn more than $50 billion.

Before 1990, the industry's annual earnings were in the $20 billion range, he said.

Another bank booster is David Sloan, a fund manager with SIFE Trust Fund in Walnut Creek, Calif.

Banks have a good dividend yield, the cash flows are strong, and in light of low interest rates, there should be few earnings surprises, he said.

Inflation looks tame and there is a good prospect of sustainable moderate growth, he said. "In other words, we are looking at a great environment for banks," he said. "As a result, money managers are holding onto their bank stocks, and not selling them."

Indeed, all evidence seems to suggest they are still buying. The American Banker index is up 39% for the year, indicating this could be one of the rare years in which the second-half performance of bank stocks does not pale in comparison to the first half.

However, there are some storm clouds on the horizon.

If the yield curve flattens, net interest margins could compress and banks could get hurt, said Anthony Davis, a bank analyst with Dean Witter Reynolds Inc. Also, with 10 of the 25 largest banks in the country busy with pending mergers, additional activity seems likely to taper off.

Others have said bank stocks have risen too far and too fast, so they are no longer selling at a significant discount.

Heine Securities investment pro Michael Price has all but abandoned the sector except for a handful of large holdings. And John Neff, the fabled fund manager at Wellington Management, earlier this year cut his bank holdings to 30% from 37%.

Nonetheless, even Mr. Davis, despite his hesitations, said it is important now to distinguish between bank stocks, and not just tag them all as cyclicals tied to the direction of interest rates.

***

In trading Thursday, shares of Union Bank, San Francisco, fell tktk to tktk after it announced it would acquire Bank of California. Bank of California shares rose tktk to tktk.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER