Jittery investors in bank stocks are laboring under misperceptions about net-interest margins, loan growth, and productivity, according to Robert Albertson, an analyst with Goldman, Sachs & Co.
If investors had a fuller understanding, they'd be bullish, said Mr. Albertson, who has been an analyst for 20 years and one of the biggest bulls on the sector since early 1991.
He likes turn-around stories, where earnings are not linked to the economy. His two top picks: Citicorp and Wells Fargo & Co. Shares of these banks have soared this year, and Mr. Albertson said there is at least another 25% rise left in each before yearend.
And he likes banks that are showing early loan growth, particularly NationsBank Corp.
Q.: You're still bullish on bank slocks, but every quarter investors appear skittish. What's going on?
ALBERTSON: The earnings keep going up. The profitability of the banking system is at a 60-year record. The capital ratios are at a 30-year record.
Loan-loss reserves are wildly in excess of need. And investors can't believe this train will take them any farther down the track of invesment return.
Q.: So what's holding people back?
ALBERTSON: There's are several misperceptions people hold about this industry. First, that the interest-rate environment is unique and has produced a super-normal opportunity for net-interest margins.
People expect that the peak rate environment will die out shortly and that bank earnings gains have pretty much run their course. That's wrong.
People associate the fact that margins were going up for the last couple of years with the fact that interest rates were going down and the vield curve was getting steeper. I'm afraid that's more coincidence than reality.
Higher margins have to do with asset mix. If you look at the mix of earnig assets and liabilities, you will see a steady increase in weighting in consumer loans and consumer deposits. which have a higher elemental spread than wholesale loans.
They don't have a higher return to the bottom line. But they make the margin look higher.
Take an unpleasant rate environment such as we had in 1988, with rising rates and a lousy yield curve. Apply that rate environment to the current asset mix for banks, and the damage to the margin is minuscule. The average margin drops 10 basis points.
Q: What are the other misperceptions?
ALBERTSON: People deny there is a loan cycle, but there is one and it is in the process of rebuilding.
If you look at the actual earnings statements of banks quarter by quarter, there is ample evidence that loan growth is already in the single-digit range. In the second quarter of this year, over half the banks showed annualized growth in excess of high single digits.
We saw a turnaround in loan demand in the fourth quarter, particularly in some southeastern banks. We shouldn't sit and deny that the loan cycle will come back when it already has.
Q.: What's the other misperception?
ALBERTSON: It's productivity. The banking system is more productive now than it has ever been. The cost structure of banking has been markedly changed.
The trajectory of cost growth is lower than it has been in decades. So a 5% or 6% loan growth today will produce the same kind of bottom-line growth that a 15% to - 2O% loan growth did in previous cycles.
Q.: It' you look efficiency ratios over the past several years, there doesn't seem to be much of a drop.
ALBERTSON: When you examine the efficiency ratio, it requires a cyclical adjustment, the way loan growth requires a seasonal adjustment. In the revenue-sparse days of the recovery, you are looking at that ratio in its cyclically weakest point.
The 63% expense ratio for the banking system on average is equivalent to a 59% ratio in a normal revenue environment. Maybe better.
The innate profitability of banking has been in a multiyear up-trend. And that can be explained by productivity improvements, not interest rates.
Q.: Given all that, which stocks do you like?
ALBERTSON: In the forefront are turnaround stories. We believe these have a lot left in them, since earnings aren't a function of the economy. We particularly like Citicorp and Wells.
Our price target on Citicorp is $42 by yearend. Wells' yearend target is $144. [Citicorp traded at $32.875, unchanged Wednesday afternoon: Wells Fargo traded at $116.875, up 25 cents.]
Conversely, there are banks that are showing the cyclical side of the business. We are picking the ones at the front of the pack on the loan cycle. NationsBank is one.
Q.: What makes you still enthusistic about Wells?
ALBERTSON: We have contended for some time that the loan problem was exaggerated by regulators. I think the second-quarter earnings delivered a body blow to the people who still thought that the credit issue at Wells was a problem. Wells dropped the loan-loss provision far faster than I expected.
The whole reason to like bank stocks is not bccause they are going to recover again but because they have a good business that you respect.
Wells Fargo has that. They are on the leading edge of productivity improvement because they are taking out of branches what most banks still have. which is the deposit structure. They don't need all the people currently associated with gathering deposits in the branches.
They are going for the gold in productivity and they will probably achieve it.
Q.: Why is NationsBank among your cyclical plays and not another aggressive lender?
ALBERTSON: NationsBank has double-digit loan growth. Then there is the misperception about the bank's interest-rate play that makes the stock so cheap.
Everyone is convinced that Nationsbank does dastardly deeds in investment securities to make interest-rate bets.
Everyone knows they are huge in the five-vear Treasury market. but they don't understand why. In fact, the reason they are is to match that fact that they have a huge deposit base in Texas, which is also somewhat fixed in rate.
What they are doing is natural, but everyone is watching the hedge they are using as if it is a bet in isolation.
I think this should be a $66 stock by yearend.[NationsBank traded at $$51, down 50 cents Wednesday afternoon.]
Q.: What happened to BankAmerica's shares, of which Goldman was a fan?
ALBERTSON: BankAmerica-Security Pacific has been considered a brilliant merger that went wrong, but it wasn't. The $1.19 in per-share earnings that BankAmerica reportcd in the second quarter wouldn't have been anywhere near that high had they not had Security Pacific.
What we didn't expect at the time the merger was announced was an ongoing recession and the damage in California.
There is going to be one heck of an earnings upside, once we get some revenue movement again. But there are people who believe there isn't going to be a loan cycle, much less one in California. So you understand why the stock is still in the $40s.