A wide performance gap between stocks of larger- and smaller-capitalization banks has Wall Street analysts searching for answers and looking for opportunities.
The disparity cannot be laid to fundamentals. Smaller banks are as good as or better than larger banks in terms of credit quality, efficiency, net interest margin and earnings.
"Large-cap liquidity premiums and declining acquisition activity" provide some of the explanation, but the discount for smaller banks still "seems excessive," according to Jeffrey D. Bittner and Joseph Roberto of Keefe, Bruyette & Woods Inc. in New York, who have studied the matter.
Through the end of last month, shares of Citigroup Inc. were up 62.6% for the year, while J.P. Morgan & Co. was up 25.2% and Chase Manhattan Corp. 9.4%, according to figures from Keefe. Banks specializing in trust and custody services, including Bank of New York Co., Mellon Financial Corp., and State Street Corp., were up 6.6% on average.
But among smaller and medium-caps tracked by Keefe, those in East were down 6.9% on average, in the Midwest down 8.1% and in the South down 12%. Those in the West were up 3.4%, with much help from Silicon Valley Bancshares, which had a 115% gain.
"Many of the smaller ones have been in hibernation recently," said Joseph A. Stieven of Stifel, Nicolaus & Co. in St. Louis. "I think investors are trading the large banks while trying to decide if momentum in the sector is going to pick up.
"The large banks have the liquidity, while the small-caps have gone dormant. It's as if their shareholders have said, 'I own this and I'm not going to sell, but I'm also not going to buy more'," Mr. Stieven said.
At the same time, smaller banks' values have not been helped this year by the well-known earnings travails of some large banks that are major acquirers, notably First Union Corp., Bank One Corp., and most recently U.S. Bancorp. An important part of smaller-cap banks' franchise value and stock price is their potential acquisition premium.
Indeed, shares of superregional banks tracked by Keefe were down 15% for the year as of Nov. 29. paced by a 36% decline for First Union. That was before the startling announcement by U.S. Bancorp that fourth-quarter 1999 and full-year 2000 results would be lower than analysts expected.
"Except for Firstar Corp. and Fifth Third Corp., it seems as if every major buyer has stubbed its toe," said Mr. Stieven.
The Keefe analysts and Mr. Stieven expect a pickup in acquisition activity next year, as concerns about Y2K problems for computers fade and the countdown to merger-related accounting changes takes center stage.
"Fading concerns regarding the millennium date change and the pending prohibition of pooling accounting treatment" should stir increased merger activity, Mr. Bittner and Mr. Roberto said.
Further, they see small-bank acquisition as the least risky and most financially attractive kind of transaction available. These line-of-business deals are "an area were bank managers have proven themselves capable of creating economically attractive combinations and meeting financial targets, and which pose less risk than large-bank acquisitions at premium prices," Mr. Bittner and Mr. Roberto said.
Mr. Stieven pointed out that expensive problems linked to large bank deals are a big reason major acquirers have stumbled so badly.
"A lot of the major acquirers have gone out and acquired the No. 1, 2, or 3 market-share position in a lot of markets, but you look again a few years later and they're all down," he said.
"Frankly, these companies are going to spend an eternity defending those positions, which have cost them so much money," Mr. Stieven said.
"Meanwhile the smaller and middle-sized companies in market positions four through 10 are busy picking up a tremendous amount of business," he noted. "The result is that internal [revenue] growth is very good, and their fundamentals are strong."