Having gotten through the Y2K rollover with hardly a scratch, bank stocks might have been expected to do well Monday, but instead took their worst battering since the Russian bond default in August 1998.
Ironically, analysts actually blamed much of the carnage on the banks' success in avoiding serious computer problems as the new millennium began.
The American Banker index of 225 U.S. banks plunged 6.4%, and at many banks the damage was greater. Chase Manhattan Corp. shares plunged $4.6875, or 6%, to $73, while Bank of New York dropped $3, or 7.5%, to $37.
Regional banks fared poorly as well. Fifth Third Bancorp. shares fell $3.50, or 4.8%, to $69.82; Wachovia Bank slipped $3.25, or 4.8%, to $64.75, and KeyCorp. dropped $1.375, or 6.2%, to $20.75.
Among the worst performers were those based in the Midwest. First Financial Bancorp of Hamilton, Ohio, and Republic Bancorp of Owosso, Mich., both dropped about 11%.
Analysts linked the drop to the fact that foreigners, who had stored their money in U.S. Treasuries because they thought the United States was best prepared to avoid year-2000 computer problems, began dumping the Treasuries and repatriating their money. This caused the price of Treasuries to plummet, causing their yields to surge. The benchmark 30-year Treasury bond yield soared to 6.61%.
Apart from sales of Treasury securities by foreigners, investors feared that with Y2K problems behind it, the Federal Reserve would be free to raise interest rates. In fact, at its Dec. 21 meeting, the Fed indicated that it would have raised rates if it had not been worried about year 2000 glitches.
Prospects of rising interest rates made the stock market particularly jittery, and financial stocks were among the most badly hurt, as usual. The Dow Jones Industrial average fell 1.2%, and the Standard & Poor's 500 was down 1.0%. Only Nasdaq, brimming with technology stocks, continued its upward trend, climbing 1.5%.
Some analysts attributed the extra weakness in Chase Manhattan stock to the bank's removal from PaineWebber Inc.'s "focus list" of 30 stocks. Edward M. Kerschner, the firm's chief strategist, eliminated Chase from the list because he expects more interest rate hikes by the Fed.
Bank of New York was among the biggest losers. Michael Mayo of Credit Suisse First Boston said Bank of New York, which many funds like to show on their year-end balance sheets, may have been hurt by being sold off as these funds took profits on them.
Aside from raising banks' funding costs, some analysts worried that the rising rates will make it more difficult for marginal borrowers to pay their debts as scheduled.
"As you start to project whether the Fed is going to go up 50 or 75 or 100 basis points, then clearly you have to ask when the credit cycle kicks in. At what point does the marginal credit start to crack?," said analyst Nancy A. Bush, an analyst with Ryan, Beck & Co. in Livingston, N.J.
At the same time, she attributed some of Monday's huge selloff to the predictable shocked realization within the market that the Fed will now have to remove from the markets much of the excess liquidity it supplied to the economy to ease any year 2000-related problems.
Many economists now expect the central bank to raise rates again at its meeting on Feb. 2 and again in the spring if the economy continues to grow at a pace faster than Fed policymakers believe is safe from inflation.
Monday's slide in bank equities came on the first trading day after the books were closed on a dismal 1999. While bad loans were not a problem, Ms. Bush said lowered expectations were.
"I think we are seeing disappointment about the outcome of the bank merger wave of the past decade, with some people asking how much better off we are now than where we started," she said.
"The substantial question we have to deal with in this industry is: what is the inherent annual earnings growth rate?," she said. "And we don't know. We know it isn't 15% and probably not 12%. But is it 10% or 8% or even 6%?"
Industry analyst Anthony J. Polini of Advest Inc. outlined the difficult environment banks now find themselves in, with investors aggressively looking elsewhere.
"We're are in a very competitive top-of-the-cycle environment where pricing competition for loans and even deposits is incredibly fierce. It provides very little comfort or sex appeal for investors," he said.
As Mr. Polini sees it, "the industry has emerged from a period of rapid consolidation and record profits, only to find its investment appeal lacking and overall fundamentals ready to give way to normal cyclical pressures. Loan growth will slow and credit quality will weaken. These are facts of life. The question are when and how much."
The analyst thinks bank takeover activity and bank stock prices may never again reach the heights of early 1998. Indeed, he said, "we see no reason why these stocks can't go down to single-digit [price-to-earnings] multiples, even with fundamentals remaining good."
Longer term, when the stock market is again dominated by more value-oriented investors, banks can recover, he said. But in the shorter run, "it's one day at a time."
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