For the first time, equity analysts are questioning banks' spending on technology.

Analysts at the quarterly American Banker roundtable weren't sure whether banks were allocating the appropriate amount of money and using the technology efficiently.

Participants in the quarterly session included Robert Albertson of Goldman Sachs & Co., Tom Brown of Donaldson, Lufkin & Jenrette, Felice Gelman of Keefe Managers Inc., and roundtable newcomer Judah Kraushaar of Merrill Lynch & Co.

Another highlight of the discussion was Mr. Albertson and Mr. Kraushaar's defense of their switches to a less bullish position on bank stocks in the first quarter.

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Do you think the overcapitalization of the banking industry can lead to problems?

ALBERTSON: This is a permanent condition because we have an industry reinvestment rate so substantially higher than asset growth. But it's going to be an issue every quarter every year. And I don't care what level of discipline is in place now and how good or bad we may think it is, we as analysts are going to have to keep watching because the temptation is going to continue to increase - to do something with this extra cash spinoff.

The second observation I'd make is we tend to always look for how much banks pay for other banks as a sign of sinning. Or what they do in the corporate credit markets to reach too far as a sign of sinning. I suspect the area we're not looking close enough at is the one we like so much, which is technology spending.

Are some banks going to take the lid off that too much and wind up with cost numbers that don't have rewards as soon as they'd like?

BROWN: I worry about that a lot more, frankly, than I worry about credit risk, though I worry about credit risk.

But we don't know how to evaluate the investment decisions. At least I don't. When Wachovia says that they are spending $30 million to $40 million to build a customer information file, is that a good investment decision? Well, I think building your data base is a great investment decision. But could it be $10 million? Should it be $60 million? You know, I don't think those things we're used to evaluating. And there are some big investments that are being made on the part of a lot of companies where the payoff is still uncertain.

ALBERTSON: And it's particularly frightening now because we are going through this new era of electronic banking, and every CEO is focused on it, interested in it, doesn't quite understand it, and is quite prone to say yes to a project that on second look by some hard accountants and hard business people would make no sense at all. We can't tell what those are.

Is there any sort of baseline to go by on this sort of thing?

GELMAN: There is a baseline to go by, but we don't have the information for that baseline. The baseline is unit costs. Unit costs are just dramatically different at banks, and most banks don't try to project their unit costs beyond a year or so.

That is the next step in integrating management techniques and technological expertise. Because we're at the point where for the first time the use of technology is actually changing the way that work is done. Banks spent millions and millions and millions of dollars on technology in the 1980s and early 1990s and they got a lot of computers and they ended up with a lot of automated processes, but they did not change the way that work was done. And now that's really what reengineering effectively means. It means using that technology to change the way the work is done, and a reflection of this in unit costs.

KRAUSHAAR: I don't think the risk is so much, per se, the direct investment in technology. I think the cost of a lot of technology has come down to where the direct investment really isn't that burdensome.

The bigger issue is when you can talk about how work methods are changing, namely whether risk management and customer management practices are really keeping up with the technology. It's disconcerting to some degree that you now hear so many banks bragging about their prowess in data mining, micro segmentation, segment profit management, etc. I simply wonder whether the buzzwords are running ahead of reality at many companies. In other words, many banks know how to talk the talk, but they may be less adept in their wherewithal to walk the walk.

It seems to me that a lot these models aren't that exclusive, increasingly they can be replicated at fairly low cost. The bigger issue is whether you have management oversight of the models and a high degree of judgment over the whole process, kind of a commonsense test.

BROWN: I don't think the data bases are at all similar. I think that one of the things that we have underappreciated as investors is the great difference that exists in how difficult it is to build a data base.

I find that when you really get into the details, you find that the data, the warehouse of these companies, is tremendously different.

GELMAN: The other side of this, though, is using this stuff. You can have all the data in the world. We all actually have all the data in world because you just sign in - log yourself onto the Internet and you can find out anything you want. But that's not the issue. It strikes me that probably 10% of banks are actually in a position to use it, to use it consistently, to have a process that integrates the people who are in contact with the customers with the data base in a way that actually generates value.

Two of you made calls in January on the sector? Are you still comfortable with those calls?

ALBERTSON: We made a call basically to neutral. Banks are cyclical, and their primary product seems to be dying on the vine. We're now seeing declines in the consumer sector, and since the last time we talked we've gone from 10 down to 6% in the commercial sector, and I think that puts the kibosh on any group index outperformance from this point on.

We're still very strong on certain names. We are absolutely off the charts still on Citicorp. We're convinced that that stock has no cyclical limits ... for the next several years. It has no meaningful market share in any market except the domestic credit card. We really like the banks that have been marketing successfully for a long time. Frankly the one that has done that the longest is Banc One. That's very high on our list.

Norwest is a great story at this moment. It's producing substantially better profitability in its bank, and people are now paying attention to it.

Bank of America and NationsBank are similar kinds of things. The cycle is slowing. These banks don't seem to notice it. They know how to market through it.

Finally, to get outside the cycle, the merger stories remain powerful, particularly the new Chase. ... (So do those of) the nonlenders, where we emphasize Bankers Trust as a turnaround and Northern Trust as providing exceptional value.

KRAUSHAAR: We actually did two things at the start of the year. We reiterated our money-center bank call, which has really been our emphasis in our view of the bank stocks since late '94. And at the same time, we went to a modest underweight on regional banks.

Our view at Merrill Lynch is that the latter part of the year is going to be slower than the consensus expects. And we thought this would be an environment where particularly disciplined companies that are changing their stripes in certain respects - both in terms of focusing their strategies and in showing an outsized degree of financial discipline could be recognized more than in the past.

The names we've been especially recommending have been the new Chase and Republic New York. Chase, I think, is one of the preeminent restructuring stories in the industry. While Republic New York, we believe, is an under- followed company, but I think it's the epitome of a company that's refocusing around a much narrower product mix, namely private banking.

Our secondary recommendations have included a number of other restructuring stories. We like BankAmerica. We think management is really shifting gears in terms of its restructuring plans. I think the stock buyback authorization they recently announced is just a forerunner of a much more substantial business restructuring that might actually reverse some of the last decade's expansion.

NationsBank has been a company that finally and after many years is really driving its cost structure down in its regional bank. We like that. We like Citicorp both for its emerging markets franchise and also because of the broader specialization of the company toward global consumer banking. We still think there's a restructuring story there in terms of cost-cutting in branch and wholesale banking in Europe and North America.

Beyond these two restructuring stories we also like a few other companies that are becoming increasingly specialized in their skill sets. For instance, my colleague, Sandra Flannigan, has actively recommended Norwest. We think it's one of the preeminent marketing companies in the industry, with an exceptionally strong sales culture. I think once you get past the next couple of years and the current focus on downsizing and cost- cutting, they've got the revenue story all locked up for themselves.

Moreover, we like Wells Fargo, which is exceptional at distributing product and is driving down its cost structure in the short term. Longer term, Wells Fargo has an emerging cost advantage in originating new relationships.

And finally, we've also recommended Northern Trust and Mellon.

GELMAN: We've got a more bullish perspective, I would say. First of all - I'm not interested in drawing a distinction between money-center and regional banks. I think that larger banks, the banks that are $20 billion or more in assets, have the ability to outperform.

The two that I would cite are Bank of Boston and Bank of New York, both of which have become highly focused companies with exceptional returns. They both have a very good degree of operating efficiency and sustainable revenue growth.

I like Chase and Citicorp as well.

Citi just has enormous potential across a number of lines of business and Chase, I think, has tremendous restructuring opportunities. But I think if you were to look down the list of large banks that - if you were to look at the top 25, you would see probably 70% of those have something going on internally that makes them extremely attractive in terms of their business mix. Then you just have to take the ones that are the cheapest among them from a valuation standpoint.

The other area where I think there is enormous potential is specialty finance companies. Some have the ability to blow the roof off their earnings. The credit card companies are one sector, but you also have the home equity lenders, who I think have tremendous, tremendous potential.

I'm not terribly worried about credit card companies having huge loan- loss problems. I think they're going to manage that well. But if anybody's concerned about rising levels of consumer debt, they'd better invest in home equity lenders. Because the natural consequence of consumers feeling overburdened with installment debt is that they begin to consolidate their debt in debt consolidation loans. The size of the home equity lending market is going to rise dramatically, plus the specialized lenders are going to take significant market share.

The company you can see it most readily in is Cityscape (Financial Corp.). It's about every three weeks that earnings estimates go up for the company. Earnings are strong across the board; for Ames, for the Money Store, for Contifinancial.

BROWN: I continue to say - I don't care what the group does. I think we make a mistake every time that we try to talk about the (bank stock) group as a group, because there is no more group. We're really talking about a much more diversified universe of financial services.

Going forward I don't see that making a group call is going to be gainful. Last time I said there were two types of winners, this time I'll say three types.

I said there were the category killers, which I like - all the credit card companies and the automobile financing, some of the automobile finance companies. But there's going to be this minority of banks. I don't think it's the majority, but I think it's a minority of banks that know how to change the business dramatically and execute.

And then there's the vendors to this industry. I think we're going to look back on 1996 as the year that a number of vendors to the financial services industry either came public or became better known among investors.

Specifically though, in the cards, my two favorites would be Capital One, which is my retirement fund, and MBNA. And then among the banks Wells Fargo, KeyCorp, and Signet.

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