Big Banks Overvalued, Boston Analyst Says

One would think that the numbers on the banking industry-77% of its companies reporting peak earnings and shares trading at all-time highs- speak for themselves.

But Richard Lodewick, who follows banks for Boston Partners, doesn't.

"The market is misvaluing the companies," said the analyst, who argued that banks' shares already trade at the highest earnings multiples since the 1960s, and may be due for a slip.

Though Boston Partners has much of its $8 billion in assets in bank stocks, Mr. Lodewick is turning a bearish eye to the sector-especially the big banks. He is concerned that the quality of earnings may be deteriorating.

"We've stayed out of the major players," the analyst said."They're generating abnormally high returns, and should return to normal levels." To award a high multiple to bank stocks at this point is a mistake, he said.

Mr. Lodewick dismissed the argument that banking is no longer a commodity business, and that banks have erected sufficient barriers to entry to the business in order to sustain their high returns.

Hefty gains from trading, securitization, venture capital investments, and other market-sensitive lines of business may have misled bank investors about the prospects for growth, Mr. Lodewick said.

"I question the sustainability of these earnings streams of the last few quarters over a long period of time," he said. "The earnings are high because the stock markets are high."

Mr. Lodewick noted that some superregional and money-center banks reported increased noninterest income from the previous year. While some of this income came from deposit-related fees, credit card membership fees, and trust fees, the income stream also depended on market-related trading income and venture capital gains.

Gains on trading and related types of income "may be recurring, but not to the extent that they were helped out by the market this quarter," Mr. Lodewick said.

Analyst Joseph Morford of Alex. Brown & Sons maintained that the earnings growth at a company like BankAmerica Corp. is very real.

"The growth is coming from a combination of disciplined cost control, modest revenue growth, and aggressive share buybacks," Mr. Morford said. "Though they did have gains from asset sales in 1996, we expect to see additional gains in 1997 as part of ongoing restructuring efforts."

Economist David Kelly of Primark Decision Economics, an economic consulting firm, argued that it's too early to say that earnings have peaked.

"We're still seeing some growth in earnings," Mr. Kelly said. "The real question is whether the market has gotten ahead of itself in terms of value of the market relative to earnings; in general, current valuations are very high relative to prospective earnings."

Analyst Gerard Cronin of John Hancock Funds shared Mr. Lodewick's concerns.

"You can't rely on securities gains quarter to quarter," Mr. Cronin said. "Banks throw in venture capital and try to hide it in other noninterest income figures, but when you see this it puts a red flag up and says that the company is having trouble meeting earnings estimates."

Mr. Cronin added that if loan growth continues to slow and credit costs continue to rise, earnings growth is going to be tough for companies that rely on traditional banking business.

"A lot of investors are valuing companies based on what they're earning today, but once earnings growth slows, stocks of banks that aren't diversified are going to be crushed," Mr. Cronin said.

"The larger companies that rely on the traditional business of banking are hitting a revenue wall," he added.

"The bulls could claim that things have changed because of capital securitization and loan syndication and that the risks are not as highly concentrated as they were," Mr. Lodewick said. But he argued that the new disciplines will only reduce the number of big catastrophes, and will not eliminate risks altogether.

Mr. Lodewick said that he picks less-widely traded banks such as First American Corp., Nashville, and First Virginia Banks Inc., Falls Church, Va., because they are well-reserved against losses, enjoy good loan growth and have minimal levels of nonperforming assets.

The California thrifts, such as Glendale Federal Bank, Glendale, Calif., and Coast Bancorp, Santa Cruz, Calif., are also among this analyst's top picks, due to renewed signs of loan growth in California and the prospect of big awards in their lawsuits against the Federal government over accounting for the purchase of troubled thrifts.

Sovereign Bancorp, Wyomissing, Pa., given its significant market share, also wins an endorsement from Mr. Lodewick. He also notes Sovereign's entry into consumer and small business lending to increase yields on the asset side of the balance sheet.

Queens County Bancorp, Flushing, N.Y., also wins a place on Mr. Lodewick's list of top picks for its efficiency, strong net interest income growth, and conservative underwriting standards.

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