An analysts roundtable in Atlanta last week failed to produce a clear consensus on the prospects for Southern bank stocks.
The first installment of what is planned as an regular American Banker event, the roundtable attracted three of the best-known Atlanta-based analysts.
John Mason, a veteran Interstate/Johnson Lane analyst who is known as a sharp stock picker, argued that historic buying opportunity is at hand, and that NationsBank Corp. is a best buy.
Kathryn H. Bissette of Sterne, Agee & Leach Inc. took a more pessimistic view, saying the buying opportunities won't come until interest rates peak.
Jon B. Burke of the Robinson Humphrey Co. also noted the unfavorable rate environment, but recommended stock in finance companies that have already marked their portfolios to market and shares of Barnett Banks Inc., which thrives in a strong Florida retail deposit market.
The discussion took place at Robinson Humphrey's offices. Representing American Banker were Atlanta bureau chief Kenneth Cline, senior editor John Racine, and finance editor Stephen Kleege.
Q.: - What factors will affect bank earnings in general for 1995, and specifically what factors will be important in the Southeast?
BISSETTE: I think '95 is going to be an O.K. year for bank earnings but definitely see a slowing in the growth rate. On average, earnings will be up around 8%. The main factor causing the earnings to slow down would be the higher interest rate environment.
We see rates peaking in the next few months, but still causing margin pressure to continue.
The offset will be the continuation of pretty good loan growth. We still think there's a chance some of the smaller banks might still need to address their interest rate sensitivity and maybe to take writedowns or reposition their balance sheet, maybe in the first quarter.
MASON: In the last 40 years, there have been at least five or six good times to get in - and they have not all been when interest rates were about to go down. Perhaps the most interesting major movement in bank stock in my lifetime lasted for about two years - not six months but two years - between late 1971 and late 1973. You go back and see what interest rates were then. It wasn't so important.
What was important what was Citicorp got up and made a speech about how they were going to grow 15% a year. What happened at that time is we differentiated among banks - and that's what we've got to do now. We've got to differentiate between the dogs and mediocrities.
I think certain verities are still with us. Territory is still important. NationsBank has the best territory in the Southeast and it also has the best in the Southwest. Not only territory, but commercial lending experience in addition to retail lending experience, is important. We're in the early-to-mid(dle) phase of an economic recovery. We've already got the retail rush. Now were beginning to get the commercial lending rush. This is one of the reasons why interest rates are rising.
There is a second reason interest rates rose. It had nothing to do with the economy as a macro thing. It had a lot to do with the economy's specific weaknesses right now: the fear of a meltdown in interest rates; a fear of a meltdown in derivatives. I think that had a lot more to do with the Fed pushing up interest rates very rapidly. I think that fear is now abating. I think that sets the stage for some interesting things. It's a question of who's got the best position.
BURKE: For a while, we've been negative on the banks as a group, and I would say that the fundamental basis for our position is that the industry is extraordinarily profitable today. As an industry it earns about one and a quarter on assets. Historically the industry has earned about half that. And essentially the same guys that earned half that are running these companies.
The industry has earned about 1.25% on assets for all of about 24 months, and maybe for 24 years before that it's earned about half that. So has something changed? Our thinking is, not really.
This extraordinary profitability is coming from two things.
(It's) Primarily the leftover of (Fed Chairman Alan) Greenspan's need to bail the industry out in 1989 and '90. He did it with the yield curve. And until very recently the extraordinarily steep yield curve permitted the industry to own bonds and make a huge spread on the bond portfolio.
The other part that has created the profitability in our view has been deposit pricing. Historically certificate of deposit pricing has been substantially above where it currently is. The mix of deposit base has also been substantially more expensive. The pricing leaders - the deposit leaders - tend to be the NationsBanks and the Barnetts and First Unions of the world; they basically have been funding their growth either out of running down liquidity or by not rolling bonds, or bank notes or some form of wholesale funds. It's been our belief that as the economy expands and liquidity becomes an issue, deposit pricing is going to have to change - will change - back to historical standards.
Q.: Who has the best franchises in the region - is that a point of differentiation among banks?
MASON: Absolutely. Who is the strongest bank in Texas, in North Carolina, and South Carolina? Then you've got Georgia. I don't think there's too much debate over who's the strongest; the bank is NationsBank. It has a tremendous retail presence, but it also has this commercial presence that I don't see as strong at First Union, another bank that has the second-best general franchise, but they're exclusively in the Southeast, whereas NationsBank is in the Southeast and the Southwest. You've got excellent individual locations, like Barnett in Florida - great location, great franchise down there.
BURKE: As far as the importance of individual markets is concerned, if we are correct and deposit pricing and margins is going to be an issue, then a way of insuring against that is to go to the market when funds are plentiful and costs low. Within the Southeast there are markets that have been more or less competitive, Virginia has been an irrational market. going back to the days of the early 1980s when Virginia banks' deposits were deregulated, the explicit costs have been 50 to 75 points higher than other markets in the Southeast.
The other side of that coin is Florida, which has historically been a low-cost market. It's been a low-cost market because essentially the two sides of the balance sheet don't add up. There have been more funds available on the liability side of banks than loan opportunities, so the cost of funds has historically been low - 50 points below what you see in other markets. The demographics create that, the retirement community creates that. We think that provides some cover, if you will, for investing in this group. And for that reason, among others, we think Barnett is an interesting stock to invest in.
BISSETTE: I don't know if the market is really going to distinguish between stocks because of geographic location. I think the bank stock market overall is going to be more a trading market on a near-term to intermediate-term basis where you can make money on a name by name basis if you get in at advantageous prices. Overall, I don't know that the market is going to distinguish all that much, particularly among banks within the Southeast.
Before we would become more excited about banks stocks generally we would want a clearer indication that interest rates have peaked. We think there is room, with higher rates, for dividend rates on average to move up 5%. We think there is going to be plenty of time to buy banks stocks later on, but overall, we're pretty cautious on the group.
Q: What about consolidation? Are there any takeover plays in the South?
BISSETTE: I think part of the reason why we haven't seen a pickup in acquisition activity as a result of interstate branching legislation is because it came just as the banks were about to figure out they had some earnings problems and that they were vulnerable to higher rates. But I wouldn't be surprised if some of the superregional banks take First Union's lead and look to make in-market acquisitions and strengthen their franchises in the Southeast - maybe in a state where you haven't seen much activity yet. Alabama is possible, particularly the banks that have banking assets outside Alabama - like AmSouth or South Trust.
You could see a pickup in acquisition activity in '95 in the Southeast. But the prices will need to be adjusted downward. In a super-bullish market you could see banks in very attractive markets getting buyout prices at 15- 18 times earnings. Now that will return to its historical range of 13 to 15 times earnings.
BURKE: On consolidation, in a nutshell, there's no currency unless you're speaking at the receiving end, unless you're very far down the food chain. I think it's very difficult to make a premium that is consistent with the perception of value. I don't think we're going to see a lot of consolidation right away. I think by the end of '95, if you want to make money in takeover names, it would be a list of nonperformers. Good franchises, bad management. Good franchises that aren't putting up the numbers.
Q.: What are your favorite stocks?
BISSETTE: Crestar Financial Corp., Barnett, and on a pullback, something like AmSouth Bancorp.
MASON: NationsBank is number one, because it has already completed its franchise. I'm not saying it's finished. It doesn't have Wachovia's or SunTrust's need to add to its franchise. It's in great locations. I'd move on to the new Southern National after its merger with Branch Bank and Trust. I think there are some real economies to be made in that merger. Beyond that I also like Barnett, because as John pointed out, Florida's fast growing and they're the king of the hill down there.
Some people think Barnett will be taken out. I think they'll fight like hell, and they'll buy other people before they sell out themselves. But the mere fact that it's possible turns me on. And the fact that a bank like Citicorp has a market value so incredible they could think of solving their core deposit needs by going all the way south - that would not make very many people happy in Florida, except maybe Barnett shareholders - but, you see, that possibility didn't exist two or three years ago.
BURKE: Obviously we like Barnett. We like the earning asset mix. We like the character of their earnings. At some point down the road, some years from now, Barnett's Florida-only strategy might create a situation where there are a lot of buyers.
One of the observations that we've made over the last few years is, as the banking industry has become more profitable and the franchise has eroded, there have been companies that do what banks do but aren't banks - securitizers of banklike assets. Securitizers basically mark their balance sheets to market every time they securitize, there's no lead and lag, their earnings already reflect the yield curve, already reflect the big increase in interest rates. A stock that we like a lot is United Companies (Financial), a securitizer in Baton Rouge.
Q.: What stocks could disappoint?
BURKE: Crestar. The trends in the fourth quarter are not good.
MASON: Crestar comes to mind in a roundabout way. It might be one of those stocks that have disappointing earnings but people are excited about. Riggs National Corp: near term, the earnings don't look so bad, but there is major room for downside there.
BISSETTE: I don't think we have any stocks we would single out. We're starting out with the premise that there aren't going to be many winners. As for Crestar, yes, we reduced our '95 estimate based on fourth-quarter numbers. But I think money could be made on Crestar on a pullback. That is part of the reason we upgraded AmSouth. Now the analysts and investors and are mad at AmSouth, and that is often a good time to jump in on a bank stock.