Merger activity in the banking sector has cooled, but takeover appeal is becoming a more important factor in bond analysts' recommendations.
During a conference call Monday, bank bond analyst Eric J. Grubelich of Keefe, Bruyette & Woods Inc. listed several banks he recommends that have takeover appeal as well as robust business operations, including Mercantile Bankshares of Baltimore, Susquehanna Bank Shares of Lititz, Pa., Mellon Bancorp, and Dime Bancorp.
"These banks can acquire or they can be acquired," Mr. Grubelich said. "They have the right characteristics for consolidation."
Mr. Grubelich acknowledged that merger activity has slowed considerably, but said he expects the trend to pick up again.
"Some middle-tier players are going to realize that they need to get bigger to compete," said Mr. Grubelich, referring to banks that have between $2 billion and $10 billion of assets.
Usually, recommending takeout targets is the bailiwick of equity analysts. But after a year of megamergers. bank bond investors have been clamoring for picks, and bond analysts have obliged.
Investors can pick up yield when a bank merges with a higher-rated institution, noted Mr. Grubelich. When a larger bank acquires a smaller bank the merged company takes on the higher rating.
Bank bond analyst Scott O'Donnell of J.P. Morgan & Co. said merger potential is a growing part of bank bond analysis following the activity last year.
"It is my view that there will be a lot fewer large bank mergers this year" as banks focus on the year-2000 issue, said Mr. O'Donnell. But he added, "I expect consolidation to pick up in 2000.
"We don't make recommendations on consolidation alone," Mr. O'Donnell said. "Mergers and acquisitions can be a wild card. But because there is a possibility of it happening, you cannot keep it completely out of the picture."
Bank bond analyst Van Hesser of Goldman Sachs & Co. said that consolidation could take off any day.
"These smaller banks are going to have to compete with the new BankAmerica, the new Wells Fargo and the new Bank One," said Mr. Hesser. "All three of those deals set a considerably higher competitive bar in the sector."
Regional banks' spreads-the difference between their bond yields and those on Treasuries-trade tightly together, indicating that a takeover premium has already been factored into the bonds, Mr. Hesser said.
Because the bonds trade so tightly, it is doubtful that many investors will pick up substantial yield, the analyst said.