Bank stocks face tough sledding no matter how the current business cycle ends, according to a veteran Wall Street analyst.
But the worst scenario would be a "soft landing" in which a recession is postponed, said Lawrence W. Cohn of PaineWebber Inc.
In a soft landing, the Federal Reserve throttles back the economy just enough to quiet inflation without disrupting expansionary business conditions.
Many in business would hail such an outcome since it would mean no shrinkage of economic output. But Mr. Cohn said he regards the prospect as akin to a mine field for bank stock buyers.
"It would be a very frustrating environment for people investing in banks," he said last week. "It would amount to constantly being on the knife's edge."
"With the economy brought down to a walking pace, you could never be sure it wouldn't slide into recession," he pointed out. "On the other hand, if the pace picked up, there would suddenly be the prospect of accelerating price pressures and higher interest rates."
Much less in doubt, Mr. Cohn said, is that "the closer we get to the end of the economic cycle, the less attractive bank stocks become."
As a result, the analyst described himself as "largely on the sidelines, recommending a few stocks as special situations but not playing actively, since we don't see any ways to make significant money."
The typical postwar U.S. business cycle ends in a recession, which usually means more problem loans for banks. The moment when the recession gives way to renewed economic expansion is the beginning of the next cycle.
Mr. Cohn currently recommends just five banks - "a short list that could well be shorter six months from now," as he described it.
In fact, it was shortened by one this week when Shawmut National Corp., Hartford, Conn., agreed to be acquired by Fleet Financial Group, Providence, R.I. Shawmut had been on the analyst's recommended list as a takeover play.
The analyst endorses J.P. Morgan & Co. and Bankers Trust New York Corp. He also likes Bank of New York Co., Bank of Boston Corp., and Midlantic Corp., Edison, N.J.
Morgan and Bankers Trust are "capital markets banks," he said, not money-center institutions, as they were once universally labeled.
"They are our stocks for all seasons," he said. "If we get a hard landing, meaning a recession, the rally in the bond market would be impressive, and we would expect these stocks to do exceptionally well.
"But even in a soft landing, if that should happen, the bond market would fare substantially better than it did last year, and these stocks should still do well," he said.
By contrast, "the money-center banks are the wrong place to be no matter what happens," Mr. Cohn said.
He tagged six banking companies as money-centers and has "neutral" investment ratings on them all. They are: BankAmerica Corp., Chase Manhattan Corp., Chemical Banking Corp., Citicorp, First Chicago Corp., and NationsBank Corp., Charlotte, N.C.
"The money-centers' biggest problem is inadequate revenue growth, and a soft landing really wouldn't help that much," he said. "On the other hand, a hard landing could bring major asset-quality problems."
Mr. Cohn said he could not pinpoint potential asset-quality problems but said, "One single area of possible concern is credit losses on derivatives instruments.
"We got our first little taste of this last quarter at Chase Manhattan and Bankers Trust," he said. "And I suspect there may be more of that to come."
The analyst also expressed a further concern about this group of banks.
"There is with the money-centers," he said, "a real fatigue with the process of reducing expenses. Their emphasis is much more on generating revenues than cutting costs, but that is much more difficult to do in a weaker (business) environment."
Regional banks would fare relatively better in a soft-landing environment, he said, "and to the extent we are recommending many banks right now, we are focusing mostly on regionals."
In this category, Mr. Cohn thinks Bank of Boston, Midlantic, and Bank of New York have exceptionally good fundamental earning strength that should set them apart in the harder climate ahead.
Additionally, PaineWebber regional bank analyst Thomas D. McCandless recommends Barnett Banks Inc., Jacksonville, Fla.; Signet Banking Corp. and Capital One Financial Corp., both of Richmond, Va.; Republic New York Corp.; and CoreStates Financial Corp., Philadelphia.
Despite the pending Shawmut acquisition, Mr. Cohn said, he feels few major combinations are likely among banks this year.
"It may well be that we have seen the peak in acquisition activity for this cycle," he said.
"The big buyers' stock prices are still down quite a bit. Their capacity to pay is really reduced, and at the same time, most sellers have not lowered their asking price," he said.
"We may see a lot of smaller and medium-sized deals for cash, but big blockbuster deals done for stock don't look to be in the cards for another year or more," the analyst said.
But Mr. Cohn had been recommending Shawmut primarily as a takeover candidate, and he feels that any merger activity in the industry will probably be focused in New England.
The Fleet-Shawmut deal "sharply alters the competitive balance in the region," he said. "Fleet and Shawmut have put a lot of time and effort into competing against each other. Now they will be turning their attention to the others."
The deal could be a catalyst for other transactions in New England, Mr. Cohn suggested. "This has really got to be a wakeup call for those institutions in New England who felt they would sell out at 2.5 times book value."
Shawmut agreed to sell to Fleet for $3.7 billion, or about 1.8 times its book value per share. Mr. Cohn described that price as "very definitely at or below the bottom range of what has recently been acceptable" in the banking industry.