What are your thoughts on the First Union meeting this morning -- Aug. 4 -- in New York, where the bank's management met with you and other analysts to highlight the Future Bank initiative, capital markets, and capital management businesses?

RONALD MANDLE: Management didn't give a lot of incremental guidance about where the company is going compared to what they had said in the past. They made it clearer as to how the two major segments are going to contribute to earnings growth, meaning the traditional banking part will contribute relatively little and the new part, First Union Securities, will be the major contributor to growth. With their Internet strategy, I doubt that it will be that differentiated from what's out there already. So I didn't really take away anything from the meeting that would make me change my thinking about the earnings outlook or my opinion on the stock.

KATRINA BLECHER: They made it very clear that they were not giving earnings guidance for the future. I was disappointed a bit in their outlook for the retail sector. The attrition rates were greater than I had anticipated. The outlook calls for only modest growth from their traditional branch network, even combined with the Future Bank initiative.

SEAN RYAN: There really wasn't much new in terms of what they were saying. They reiterated a lot of the same rosy projections and long-term estimates that they've given us before, and the gulf between what I hear from senior management and what I hear when I talk to their line employees, even in the newly renamed First Union Securities, particularly there, that gulf is as wide as ever.

THOMAS FINUCANE: I thought that the projections they made for the capital markets and asset management businesses of First Union Securities have some fairly rosy assumptions -- 15%, 17% pretax income growth out to 2002. The presentation was kind of self-serving, with (CEO Edward E.) Crutchfield's comment about how he felt it was the bottom. What else was he going to say? If he's right, then you have to look at the stock. It's very, very inexpensive, if he's right. If there's more floundering, then we'll see.

Do you think all these strategies to turn bankers into salespeople -- as at First Union and Citigroup -- can work?

MANDLE: First Union is doing it in a way that can succeed because they're focusing. They're managing the people like a sales force, which means you give them quotas and you reward the people who meet or exceed the quotas. Citigroup brought somebody to run the branches who's a proven sales manager, Joe Plumeri, who ran a brokerage firm and a large insurance company sales force. BLECHER: I disagree with Ron. It's very difficult to change consumer behavior. When a consumer's walking into a bank to get a product, they want to talk to someone. To suddenly shift them to a phone bank, they could've made the phone call from home. A change in consumer behavior is going to be something that occurs over a couple of years, as opposed to changing the branch network, putting in kiosks, and six months down the road expecting a difference in the P&L.

RYAN: There's a small group of banks that have been relatively successful compared to their peers: BB&T, Centura, First Tennessee, Firstar. They tend not to be among the very largest banks, with the exception of Wells.

But there's some real problems in the execution at most places. Too many managements get caught up in admiring the technology and what their data warehouses can potentially do. They lose sight of the fact that everybody has access to the same sets of consultants, and they bring them all in so they each get the same strategy on how to differentiate themselves in the exact same way.

FINUCANE: You raise an interesting point, though, that the jury's still out on whether a bank culture and structure can peacefully coexist with a brokerage. A very flat, hierarchical structure with a very entrepreneurial structure -- I don't know.

One recent report said credit quality deteriorated a little bit but not enough for red flags and for people to get alarmed. When do we have to start worrying about it?

BLECHER: I've seen credit-quality deterioration in virtually all the banks I follow, but it's been small and limited to the commercial portfolios. The consumer stays strong, which is a delight. But we're going to continue to see a continued deterioration. It's a good question: When does it become something that we really have to lose sleep at night over?

MANDLE: Right now there are not major signs of credit-quality deterioration. Nonperforming assets didn't change very much in the second quarter compared to the first. Of course, on the consumer side, credit quality is improving, and bankruptcy filings actually are down 10% year-over-year. A couple of years ago they were rising 20% year-over-year. So a huge change has occurred.

FINUCANE: The one-off corporate blow-ups that we saw the first and second quarters, though, is that indicative of future problems when the economy slows? That's the big question, that these guys could have been maybe a little smarter in underwriting some of these credits that went when times are very good. So how many more poorly structured, poorly underwritten loans are lurking in primarily large corporate businesses?

With all the loan growth out there, are you concerned with a lot of these portfolios being unseasoned?

MANDLE: Underwriting standards actually tightened last year after the financial market turmoil. If we had a recession starting right now, more loans from two to four years ago would be problems than would loans that have been written since the turmoil of last summer.

RYAN: Yeah, the deterioration we've been seeing this year is really more a reversion to the mean from unsustainably low loan-loss levels than the signs of getting a protracted cyclical downturn. The disparity and ability to measure and price for risk is playing out on a larger basis throughout loan portfolios. So it might not take much of a shock to really undo some banks, while some others might be able to swim through even a pretty severe recession without too much pain.

We've seen mortgage interest rates go up past 8% now. Is that a sign of trouble?

BLECHER: I see it as a potential positive. On the negative side of the equation, you don't get the origination fees, but on the positive side, if you've got a mortgage servicing portfolio, then it allows you to change your assumptions for the refis, and that value goes up. There is also new-home building, which provides growth. If it's just simply robbing Peter to pay Paul to refinance a loan to put it on someone else's books, that's neutral for the industry. So if that slows down, I don't view that as a negative.

Which banks should we look at?

MANDLE: I like some of the merger banks, like Bank of America and Bank One and the more traditional money-center banks like Chase and Citigroup.

Bank of America and Bank One both should have a pretty good ramp-up in earnings this year that should also set the stage for strong earnings growth next year.

Citigroup so far this year has really started to show the strength of their franchise. Chase is benefiting from their continuing market-share growth in investment banking, good growth in consumer earnings, although it's very much the smaller part of the business, and extremely disciplined capital management. First Union is too cheap to be negative on at this point.

BLECHER: The companies I like fall into two categories. One is with successful mergers, which includes Wells Fargo and SunTrust. The other is companies that I have a lot of comfort with, which includes Bank of New York and Mellon.

FINUCANE: One is SunTrust. But a stock that absolutely perplexes me is Comerica. Very solid balance sheet, very clean on the credit side, and the stock has been pummeled. And I don't know exactly why. We hear that they're mentioned as a potential bidder on the Fleet Bank of Boston divestiture.

RYAN: On the large-cap side, I like Wells Fargo still. That remains the one favorable large merger stock. You have too much skepticism about the ability of those two cultures to peacefully coexist. It's certainly a legitimate concern but one that has been overblown.

On the mid-cap side, I like First Tennessee, which is a stock that perpetually overreacts to interest rate concerns. They have a large bond underwriting division, a large mortgage operation, and at first glance (that) would imply a widely rate-sensitive company, but the rate sensitivity is really a lot less than meets the eye. And so the stock's recent decline presents a buying opportunity. And then also Centura Bank, that has one of the worst charts that I've seen for a bank this year to date -- for really no discernible reason.

Other than First Union, is there an M&A deal that's been done in the last 12 months where the integration has had some problems?

BLECHER: It's very easy to look at other mergers and say they're doing well because management will say that they're meeting their forecasts for expense saves and for revenue enhancement. But as analysts on the outside, we really have no way of knowing.

RYAN: Yeah, well the trouble is, when you have banks that have made this long string of acquisitions, is that it's so muddy. If something's gone awry, you can never parse it out.

What would be something to ask Union Planters on their acquisitions?

FINUCANE: You could ask the bank what its strategy was, exactly what was it was trying to build. You set the clock back three years and say, "You were this little bank in Tennessee and Mississippi, I guess, at the time. How will this strategy build shareholder value?"

What happened to the flow of sizable mergers?

FINUCANE: Well, it's a lot better than it was. The first quarter was weak -- I'll tell you the BankBoston deal was pretty slim pickings -- at least the deal flow has picked up.

MANDLE: Some of the second-quarter mergers were actually part of a two-act play. The first act was to do deals now and get them integrated so that you could do one more round of pooling before the pooling rules went away. So there will be a rush in midyear next year to get more done so they come in under the wire. After that I expect a hiatus.

BLECHER: With the share prices down, dealmaking is just not as attractive. That always kind of puts a damper on activity. But the elimination of pooling is going to be a major motivator for banks to make acquisitions.

Sovereign Bank recently announced its consideration of creating a tracking stock. Do you think banks will create more tracking stocks?

FINUCANE: Won't the investment bankers be busy enough with the merger transactions? If those dry up, then, yeah, we'll see a lot.

RYAN: Tracking stocks are totally bogus but, I suppose, a fad that may last as long as the rest of the Internet will. You know, you kind of are playing the shell game. That doesn't really create value. Basically, in this Internet game, it allows you to have your own brand of Confederate money to go out and swap for other people's Confederate money to do deals that look like they're accretive. But there have to be earnings before you can be accretive.

FINUCANE: If you look at the companies that are talking about it or have talked about it, it's companies that tend to have p/e multiples that they want to prod upward. PNC makes a lot of noise about these embedded businesses that they've got and may be spinning them out some day, to do deals, because they need a higher-value currency, to unlock the value. Sovereign, same way, these are guys that don't have the multiple, and they want some type of a fix.

BLECHER: Tracking stocks aren't a valid argument. I don't think any company can say, "If you attribute market multiples to our four different divisions, our stock should be higher." This argument doesn't work because market multiples are there because of take-out potential. Captive-subs don't have that. And they're never going to.

Do you think that banks will continue their double-digit earnings growth in the third quarter and beyond? Or is this as good as it gets?

MANDLE: If the economy continues to be pretty stable, then bank earnings growth should also be pretty stable. The one factor that might affect earnings in the second half of the year will be in Y2K, especially for capital markets-related companies.

We'll probably see some jamming of business into the third quarter and maybe early fourth quarter. After the calendar turns, I don't think very much is going to happen economically compared to what we see right now, and there will be a pretty sharp snap-back in earnings for the capital markets companies early next year.

BLECHER: And as securitizations dry up in the fourth quarter, it could benefit some of the banks. Corporations that rely on securitizations will have to turn to the regionals for credit. We're already seeing corporations increase their credit lines.

When does the bull market end?

FINUCANE: Well, it ended with bank stocks

MANDLE: There doesn't seem to be a compelling reason to think there's going to be a dramatic change, which probably means I'll be eating these words in three months.

Then has the economic cycle been suspended?

MANDLE: I'm glad you said "suspended," not "eliminated." Yes, we are on the verge of the longest peacetime expansion in U.S. history, but it's hard to imagine (the business cycle has) been repealed.

BLECHER: It's just been managed beautifully.

And there isn't a fear that there's going to be some kind of international market explosion that in some way is going to affect the U.S. economy?

MANDLE: No, we blew up all the emerging markets last year. There are none left to go up. I'm saying that somewhat facetiously because -- the questions about Argentina or Korea, or is China going to devalue -- they'll always have something come out that you don't see right now.

Where do bank stocks go from here? They have not responded well to the positive earnings reports.

BLECHER: Banks trade at a 42% discount to the S & P on a p/e basis, way below the historical average discount of 33%. I would think that over time the banks should perform in line or slightly exceed the market.

It seems like the momentum investors have left the group.

BLECHER: The momentum people left when the M&A activity stopped. And then they came back in slightly in the beginning of this year at the end of the first quarter, when the activity in the stocks did well. And until we start to see a little pickup in mergers, they're going to stay on the sidelines.

MANDLE: There's good value in a number of companies within the group. The concerns investors have right now are Y2K. And then also how aggressively the Fed is going to push up interest rates, and I guess the thinking about that changes day-to-day, based on whatever the economic report du jour is.

Any chance that Y2K anxiety is way overblown?

MANDLE: Well that's my expectation. The honest answer is, we really don't know for sure.

RYAN: From an internal compliance perspective, the banks are probably as prepared as anybody. The extent to which they're going to be infected by customers or counterparties is inherently unknowable. If the pessimists are right and we're going to revert to a hunter-gatherer society living in bunkers, then people are going to be not too concerned about their equity portfolios. So there's nothing to be done about it.

Is there anybody you'd like to see team up at this juncture?

MANDLE: We're going to see 10% companies created, meaning companies with 10% of U.S. deposits, and that's going to mean a lot further consolidation of the industry.

BLECHER: And there's a good chance that 10% will be repealed. It should be repealed. Eliminated. Raised. Whatever. When it was put in, it was assumed it would not be reached.

It also goes back to the international discussion -- it is a structural disadvantage because of the cap. You can't have a real nationwide bank with a 10% cap.

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