The capital gains tax changes being hammered out in Washington may give investors a reason to think twice about investing in bank stocks.
"Obviously it's a plus for all equities, no matter what sector," said Blaine Rollins, portfolio manager, Janus Balance Fund. But the changes, which would cut the capital gains tax rate from 28%, to 20% for equities held at least 18 months, "doesn't benefit bank stock investors as much as others," he noted.
Mr. Rollins explained that dividends, which are taxed just like a paycheck, are generally higher in banking than in other sectors. That means investors may instead favor higher growth issues like biotechnology stocks, which pay meager dividends but - unlike banks - can triple their earnings in a year.
He said the new law could force bank management to cut dividends in favor of stock buybacks, which enhance earnings. Also, the changes may benefit banks that sell mutual funds, because customers could be encouraged to switch from certificates of deposit, on which banks pay interest, to equity funds, which provide banks with fee income, he said.
Ken Feinberg, co-portfolio manager of Davis Selected Advisors, said banks, which have historically been good long-term investments, will benefit from the lowered capital gains tax rate along with the market. But, he added, there could be profit taking in the near term, because bank stocks have been "phenomenally good" performers.
However, Charles H. Blood Jr., director of market and economic analysis at Brown Brothers, Harriman & Co., said the capital gains tax changes are not dramatic enough to have any major impact on the markets.
And Nancy A. Bush, associate research director and regional bank analyst at Brown Brothers, pointed out that banking stocks are largely owned by mutual fund companies, which makes the dividend yield less of a factor.
Meanwhile, as investors continue to seek value stocks, "banks are one of the few left on a relative valuation basis," she said.
Ms. Bush said the new law may serve to "tone down the class rhetoric around the stock market. There is the realization that stock ownership through mutual funds and other avenues is something even the common man can do."
Meanwhile, the market treaded water on Tuesday with the Standard & Poor's bank index gaining a scant 1.03 points to 596.23, while the S&P 500 broad market index rose 3.16 to 950.30. The Dow Jones industrial average struggled much of the day, but closed up 4.41 to 8,198.45.
U.S. Bancorp, freshly merged with First Bank System Inc., got a boost from upgrades by Goldman, Sachs & Co., Credit Suisse First Boston, and Merrill Lynch. Shares rose $3.06 to $90.00.
Sally Pope Davis, a Goldman Sachs banking analyst, said U.S. Bancorp "is a compelling value." She raised the bank to the firm's "recommended list" from a "market perform" rating. She said the company's management is "among the best in the industry," and "we think they'll do good job assimilating the merger."
The Goldman Sachs analyst's target price for U.S. Bancorp is $116 in 12 months.
Michael L. Mayo, banking analyst at CS First Boston, rated the company a "strong buy," up from "hold." In the third quarter, before the merger, First Bank lagged its peers by 11%, he said.
But post-merger it is trading around 14 times next year's earnings-"in line with the average bank"-while showing "above average return on equity, efficiency, business mix, and earnings per share growth," he said. Mr. Mayo said he expects the stock to hit $110 within 12 months.
Meanwhile, Texarkana First Financial Corp. said it would repurchase 89,515 shares, or 5%, of its outstanding common stock, over the next 12 months. Shares gained 75 cents to $22 on Tuesday.