Bank stock investors historically have dumped their holdings at the slightest hint of a downturn, but with a growing number of bank analysts arguing that banks have changed, many are sticking with the sector.
When the U.S. economy was neck-deep in recession in the early 1990s, investors drove the share prices of some the biggest U.S. banking companies to single-digit levels. Today, investors seem much less bearish about the banking sector in spite of a growing consensus that the economy will soften.
One obvious reason is that the U.S. economy today is slowing but in the late 1980s and 1990, it was reeling. In the late '80s many banks' asset quality was deteriorating badly, but today it is relatively solid.
In a recent report, bank analyst Joseph Duwan of Keefe, Bruyette & Woods Inc. said key financial measurements of bank strength are much more favorable today than in the late 1980s when the nation's economy was slouching toward recession.
Such performance ratios as return on equity, equity to assets, efficiency, and nonperforming assets are at healthier levels for banks with more than $25 billion of assets in 1998 than they were in the late 1980s, reported Mr. Duwan.
From 1985 to 1998, the average re-turn on equity rose to almost 19% from more than 15%, and the average equity to assets ratio rose to 8% from 5.5%.
Average efficiency ratio improved to 59% from 62%, Mr. Duwan said. And average nonperforming assets fell to 0.5% of loans and foreclosed properties, from around 2.50%.
Banking companies today are not the same as they were more than 10 years ago, said Mr. Duwan. Many have more diversified streams of revenue and are less reliant on spread income, which is the first to suffer in an economic slowdown, he said.
Mr. Duwan added that bank managements are much more efficient because consolidation has driven many of the weaker managements into the arms of stronger ones. Management compensation packages are more attractive, and managers' interests are more aligned with those of shareholders.
Banks also have benefited from technology and improved alternative delivery systems that have sharpened their efficiency, said bank analyst Frank Barkocy of Josephthal & Co.
Still it remains to be seen whether banks can wade through a torpid U.S. economy without slowing down themselves.
Bank bond analyst Katharine Rossow of Chase Securities Inc. acknowledged that banks are healthier now than in the late 1980s. They are less exposed to cyclical industries in their loan portfolios and better capitalized now than they were back in 1990.
"There is no question that they are better prepared," said Ms. Rossow. "But I don't think they are that much better prepared."
Provisioning for nonperforming loans at the top 50 banking companies averages about twice the level of nonperforming loans in their portfolios, which means banks are well-reserved, said Ms. Rossow. But from a historical point of view, the 1% of loans that are nonperforming "is abnormally low," said the analyst, "meaning that if this country goes into a recession, nonperforming loans will skyrocket and that cushion will disappear very quickly."
There is also a problem with consumer loans, added Ms. Rossow.
"The U.S. consumers are much more indebted than they were before, and net chargeoff ratios are going up," she said. "It is not a major problem now because we are still in a good economy. But what will it be like three quarters from now?"