Fourth-quarter earnings reports prompted participants in American Banker's latest Analyst Roundtable to worry about expense controls and credit quality. Still, they were more eager to recommend stocks than at the end of last summer.

The participants were Nancy A. Bush of Ryan, Beck & Co.; Ron Mandle of Sanford C. Bernstein & Co.; Sean Ryan of Bear, Stearns & Co.; and James Schmidt of John Hancock Advisers Inc.

How did the latest earnings reports look?

NANCY BUSH: The special charges and loaded expense lines were overwhelming and expense growth was quite robust. What we don't know is how much of that was fourth-quarter loading, and how much was real core expense growth.

JAMES SCHMIDT: We are up 12% year-over-year among all the bank stocks we follow. After stripping all the extraneous items out, the core number is more like 10%. On the positive side, loan growth seems very good, especially at the larger banks. At the smaller banks, there's still high- single-digit growth.

Net interest margins seem to be down some, and a lot of banks complained to us that they are having trouble passing on the lower interest rates across the spectrum of deposit products.

SEAN RYAN: We're seeing the continued bifurcation of the bank stock group. One by one you have banks beginning to stumble, and not able to make their numbers on an operating basis. They're resorting to more and more accounting gimmickry to make the 10% to 12% profit growth rate they've set for themselves. This is something we are going to see much more of against a backdrop of slower economic growth and continued disinflationary pressure.

RON MANDLE: We were generally pleased with the overall quarterly results. The 11% growth that we see in median bank earnings in 1999 will probably be twice the growth that we see in the overall stock market. We're emphasizing median rather than average because the average is distorted by the companies that have had big swings in their trading profits between quarters or between years.

Any surprises in the latest reports?

MANDLE: Chase Manhattan Corp. had a considerably better quarter than we were looking for. Their strategy of building up their capital markets activity internally seems to be working. They also had good results in some of their consumer businesses and in their processing business.

BankAmerica Corp. didn't have a great quarter. However, the underlying trends were a little better than I expected, and I raised my estimate by 10 cents, to $4.80 per share.

Republic New York Corp. had a weaker quarter than expected, raising the issue of what is the real earning power of the company going forward after the losses in the third quarter and the restructuring that they are going through.

RYAN: We saw an upside surprise in First Tennessee National Corp., where they had a record quarter in both their mortgage and capital markets operations.

We saw a disappointing quarter from SunTrust Banks where they seemed to be, if not choking on the Crestar acquisition, having some trouble getting it down in one piece.

BUSH: Fleet Financial Group had a very strong quarter, with their acquisitions performing quite well. They were also strong enough on the personal trust side to overcome net asset value problems.

I was a little bit disappointed in BankBoston Corp.'s quarter, from the standpoint of their trading operation in Boston.

I disagree with Sean on SunTrust. They haven't had time to either swallow or choke down the Crestar merger.

My biggest question mark in the quarter was Wells Fargo & Co. What are the underlying trends there.

Do you see the consolidation trend continuing?

MANDLE: In the very near term you're not going to see a lot of big deals because of year-2000 systems conversions. Also some of the banks that might be buyers or candidates to merge are still involved in their current mergers.

In 2000 and beyond we're going to see the industry consolidate further. We'll end up with maybe half a dozen really big companies that approach the congressionally imposed 10% domestic deposit cap. We're going to have to have a lot of mergers to get from here to there.

SCHMIDT: Banks that are interested in selling have to adjust to lower prices. They're not going to be able to get the 23 or 24 times earnings that might have been available early last year. Thousands of community banks and good-sized banks will largely be amalgamated into megabanks.

BUSH: There has been no impetus for the midsize banks to do anything. Revenue growth has been just strong enough to keep everybody going in this mindset of being in the best of all possible worlds. We need to see a more clear-cut sign of slowed earnings growth.

RYAN: I'm a little more optimistic about the prospects for continued consolidation, even in the short term.

Year 2000 is a lot less of an issue than is widely perceived. Every bank you talk to says they are compliant and in the testing phase. If that's true, we don't have a problem.

You still have banks-Fleet Financial Group and BB&T Corp. are good examples-that have stood up and said, "We're going to do deals where we find them and find a way to get around the systems issue."

I think for every bank that's bold enough to stand up and say that out loud, there are 20 who are thinking it but they don't want to come out and seem any more aggressive than they absolutely have to.

Banks like First Union or Wachovia are trading toward the high end of their ranges relative to the group, whereas some of the most attractive trophy franchises remaining in the industry-Summit Bancorp in New Jersey or Mercantile in St. Louis-are still toward the low end of their ranges. I think the stage could really be set.

What about pooling-of-interest mergers?

RYAN: Our accounting group expects that pooling-of-interests will basically go away by the third quarter of this year. After that, anyone that does a pooling will be doing it at their own peril and will in all likelihood be forced to restate. There may be a rush to get under the wire because of that.

Banks need to think about what's the last pooling they ever want to do. So that is an incentive to do a deal as soon as you can, bigger rather than smaller, sooner rather than later.

BUSH: The distortions wrought by pooling accounting have just been monstrous. Now we're beginning to see some of these companies were serial diluters.

How are the recent problems in Brazil affecting banks?

BUSH: There is an issue of financial fragility where you have a greater sense that the system is more interwoven. You are not able to defend from something that is going on completely beyond your control on another continent.

RYAN: Exposure to Brazil is limited to a very small number of banks, so most of the industry is exposed only to the extent to which problems there filter back into the broader U.S. economy.

MANDLE: Banks have substantially cut their Brazilian exposure over the past year. Also, they have started to provide more transparency as to what the actual exposure is. When you include things like trade finance and loans to foreign multinationals, or even trading assets that are marked to market, the likelihood that there will be the huge writeoffs that we saw from the crisis in the 1980s just does not seem to be there.

SCHMIDT: The problems are heavily concentrated among the largest banks, and yet if you look at the stock price performance, it's been inversely related to the size of the bank.

The poorer performing stocks are the smallest ones. If you sort by market cap, the lowest have done the worst the last 12 months, and then the highest market caps have had the best market performance. Something isn't quite squaring. The market is concerned about emerging markets, but the stocks that have been hurt the most are actually the smallest banks and also the savings and loans.

BUSH: There has been clearly a liquidity premium in large- cap stocks and it's overwhelmed everything.

How is the euro going to impact U.S. banking?

BUSH: It will have impact only to the degree that foreign exchange trading has been based on volatility. The bigger issue is, does the euro become competition for the dollar, and how does that impact funds flows.

MANDLE: The euro has interesting implications for investors in European banks that are analogous to interstate banking in the United States. You used to have banks segregated by state, and when the laws changed, we saw consolidation across state lines.

In Europe you have banks separated by nation, and we now not only have a common currency, but a general philosophy of economic cooperation. It might precipitate consolidation in Europe among the banks, like we saw in the U.S.

How are banks digesting their nonbank acquisitions?

BUSH: We find that company goals seem to be much more aligned in the acquisitions of smaller retail brokerage firms. But they're all tough.

The big question is who owns the relationship.

RYAN: You have very few bank managements out there that have shown any skill at managing businesses with disparate cultures. Banks just seem driven to try to impose a bank template on all these nonbank businesses, and then be shocked when things go horribly wrong. Probably far fewer will do it right than do it wrong.

What about bank stock values?

BUSH: The bank group has tended over the last couple of years to be an event-driven group. The events are either positive, like somebody paying four times growth. Or they were negative, like Brazil is out there falling apart. I don't see anything that's going to change that.

We need an event like the rate environment improving or some indication that the economy is going to continue to be better than everybody expects, or a great deal. That probably would do more than anything to bring attention back to the group.

What are the biggest challenges facing banks?

BUSH: The most vexing question is deposit growth. Core deposit growth continues to be slim-to-none for most of these companies.

SCHMIDT: The total number of banks in the country is shrinking, but you're seeing a couple hundred new charters each year. A lot of community bankers are finding they can exploit this dislocation because they do offer service. There is a niche there for a bank that doesn't have as much breadth of product or as much sophistication, but offers familiarity through needs and service. That's why many community banks are thriving, even as the large banks get bigger.

In the fourth quarter, bank buyback activities increased. Will this continue?

SCHMIDT: The industry is in a position of having too much capital. The choice is to obtain a good return on equity by reducing capital through a share buyback or by making dumb loans. I would opt for the first one.

What stocks are you recommending?

MANDLE: I like BankAmerica Corp., Wells Fargo, and Citigroup. In 1999 these banks won't fully have reflected all of their merger benefits. As a result, we give them additional benefit beyond what they are likely to report.

BankAmerica operates in the best growth regions in the country. It's a consumer and middle-market bank primarily, and it is currently selling well below the overall industry multiple for a company with strong earnings momentum and a very good service territory.

Some of that also applies to Wells Fargo. The cultures of Norwest and Wells Fargo were quite different, but they are blending in a way that's probably better than we anticipated nine months ago when the deal was announced. The Norwest culture, which is prevailing internally in terms of dealing with employees, should enable stronger revenue and earnings growth than anticipated.

In Citigroup the focus has been on the most controversial part, which is merging Citibank's corporate operations with Solomon Smith Barney's. That is still a work in progress. But there is still the rest of the company.

There are still vast opportunities in the rest of the company to run the businesses more efficiently using the Travelers' sharper pencil. There are also opportunities to cross-sell on the consumer side. They've already started doing some of these things, like referring some of the rejected credit card applicants from Citibank to Commercial Credit for secured loans.

RYAN: Among the larger banks, I really like Wells Fargo. The market, in a lot of cases, really underestimated the cultural risk in some of the megamergers we saw in 1998. Wells is the exception to that. This is the one case where certainly there are real risks, but the market is really overestimating them.

In the old Norwest, you had one rare bank that was actually capable of managing businesses with distinct disparate cultures. The consumer finance business is a great example of that. It should be a layup for most banks, and they screw it up largely because of culture. Norwest is able to manage that well.

Looking at the some smaller names, we really like Centura Banks, First Tennessee, and BB&T Corp. These are three of the best- managed banks in the industry.

SCHMIDT: Comerica and First American of Tennessee. These are banks that you could consider trophy franchises. The real strong price performance is in the very largest banks, so these stocks, to some extent, have been left behind in the last year.

In the case of Comerica, this bank has improved its image over the last decade as much as any regional I can think of. It used to have the image of a sort of stodgy, lower-multiple kind of bank, and it was prone to making ill-advised acquisitions. The bank has had a lot more discipline in recent years and worked hard to maximize shareholder value.

Among smaller-cap names I choose Bank of the Ozarks in Arkansas. Cascade Bank Corp. in Oregon is another pick. It's just a real solid community bank in a sparsely populated part of Oregon.

Also, FirstMerit in Ohio. I like the chief executive, John Cochran. He's done a lot to try to change the culture of that bank. It's another institution that maybe a few years ago was considered sort of sleepy and he's brought in a much more shareholder-oriented and marketing-oriented culture.

BUSH: This year we are not putting our strongest ratings on the money- center banks. We feel the climate and the volatility and whatever may happen this year make these institutions somewhat less attractive. We do have soft "buy" ratings on Bank of America, BankBoston, and Chase Manhattan.

We reserved our stronger ratings for the pure regionals. If Bank One can sort out the noise, I think people will start to focus on the revenue possibilities in the company. First Union is another pick; I like their new resolve to do a merger of equals, rather than another dilutive deal.

Fleet Financial Group just had the best quarter I've ever seen. They have the ability to take controversial properties like Advanta and Quick & Reilly and really capitalize on them. The stock is very, very cheap.

I regard National City along with SunTrust, which is also one of our stronger-rated stocks. National City is one of the most underestimated, highest-quality regionals out there.

Also, Bank of New York. The stock is still undervalued.

On the smaller-cap side we like Northern Trust, Wilmington Trust, Commerce Bancorp (in New Jersey), Mercantile in Baltimore, and People's Bank of Connecticut. These are high-quality companies that, with the exception of Northern Trust, are not yet fully getting their due.

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