Analysts at Lehman Brothers raised investment ratings on three major Midwest banks on Tuesday, saying their stocks had become cheap in the wake of the recent sharp selloff in bank equities.
NBD Bancorp, Detroit, was elevated to "buy" status from "outperform" while Boatmen's Bancshares and Comerica Inc. were lifted to "outperform" from "hold."
Lehman Brothers analysts Mark T. Lynch and Michael L. Mayo said they are "increasingly bullish" on regional bank stocks after the thrashing they suffered in September, as investors gave in to their fears about rising interest rates.
"The sky is not falling. The selling in these stocks has been overdone," Mr. Lynch said on Tuesday.
The firm's regional bank composite index dropped 7.4% during September.
That was more than twice as bad as the 3% fall in the Standard & Poor's 500 stock index, the most common yard-stick of the overall market.
Mr. Lynch and Mr. Mayo pointed out that bank stocks now trade at only 55% to 60% of the S&P 500 on a price-to-earnings basis. Meanwhile, bank dividend yields are 30% to 35% higher than the yield on the S&P index.
"Over the past 25 years, when either measure was in this range, bank stocks outperformed [the market] 75% of the time," they said.
From this point, they said, banks' shares "should either act defensively in a down market or snap back if the market moves back to its highs."
NBD's relative valuation is currently even lower, at 52% of the S&P versus a 10-year average of 58% on a price-earnings basis, noted Mr. Mayo.
"NBD and Comerica sum up the inconsistency of the bank stock selloff" during the past five weeks, Mr. Mayo said.
"If the economy is going to be as strong as implied by higher interest rates, then loan growth, especially at the Detroit-based banks, will be stronger than expected," he said.
"Over the past year, Michigan has had some of the best loan growth of any state in the country," according to regulatory data, Mr. Mayo said.
"We are in a manufacturingled [economic] recovery," Mr. Mayo said.
The Michigan banks are benefiting from the boom in automobile industry production, with both NBD and Comerica now enjoying double-digit loan growth.
The analyst advised customers to "move out" of shares of National City Corp., Cleveland, which he recently downgraded, and into NBD.
Mr. Mayo's 12-month price target for NBD is $35, while his target for National City is close to its current stock price.
On Tuesday, NBD shares closed at $29.25, up 50 cents, while National City was up 25 cents to $27.50.
Shares of Comerica were ahead 25 cents to $27.50, while Boatmen's shares were up $1 to $30.875.
Besides the positive technical signs for the stocks, Mr. Lynch and Mr. Mayo cited a positive outlook for the banking business.
Loan growth is "much better than people think," they said. They expect net interest margins to be flat on average despite higher rates and note that industry expense control has been good.
Credit costs at banks are "unsustainably low" right now, but at the same time do not seem headed sharply higher, they said.
"Investors vigilantly monitor the banking industry for early-warning signs of the next lemming-like boom-and-bust cycle," the analysts said.
"We don't see any signs of a meltdown in credit quality."
Meanwhile, they feel banks have operating leverage powerful enough to produce 10% growth in earnings per share next year.
The biggest possible negative factor for the stocks feared by Mr. Lynch and Mr. Mayo is "dumb mergers."
But they "take solace in the fact that mergers hit one bank at a time rather than the whole industry."