Banks again favored for long-term growth

June 29, 1994|By Andrew Leckey | Andrew Leckey,Tribune Media Services

Put them away and forget about them.

That's how investors used to view bank stocks, a reliable core holding in conservative portfolios and trust funds back in "the good old days."

Nothing lasts forever, however, and the banking industry was subsequently hit with:

* Real estate and interest rate woes in the 1970s.

* Disastrous loans to developing countries and a commercial real estate decline in the 1980s.

* Slow economic revival, competition from nonbank financial-service companies such as mutual funds and brokers, and continuing controversy over use of derivative securities in the 1990s.

Volatility and surprises became characteristics of this once-staid industry. Yet among some experts, there's a growing belief banks now have a better handle on their future and can again offer safe and sound performance for long-term stock investors.

New earnings records will be set this year and next, as loan growth expands and credit card businesses prosper. Dividends, averaging around 3 percent, are expected to grow. Likely passage of nationwide interstate banking legislation later this year opens the door to takeover activity.

Such positives had been reflected in this year's stock prices, though recent declines make shares more affordable.

"Bank stocks remain undervalued and should outperform the overall market with 14 percent earnings growth and 15 percent dividend growth," predicted Ron Mandel, analyst with Sanford C. Bernstein. "There will be more stable earnings due to higher credit standards."

It still takes a while for a leopard to change its spots.

"Momentum of bank stocks extends too far one way and then too far another way, affected by factors such as the economy and interest rates," warned Lawrence Vitale, analyst with Bear Stearns. "So buy stocks of banks with the best strategies for coping with nonbank competitors and avoid the rest, for their business will shrink."

Bank stocks usually do well in the third and fourth years of economic recovery when interest rates are rising, according to Stephen Berman, analyst with NatWest Securities. "Banks are at the right time in the cycle to outperform," he added. "I expect 20 percent earnings per share growth this year, 14 percent next year and 10 percent in 1996."

There are concerns. Critics say derivative securities, instruments that derive their value from changes in prices of other financial instruments, inject gambling into banking. It is possible to get burned. Yet Berman contends use of derivatives linked to changes in interest rates, currency, commodities and stocks can be a useful tool to reduce overall banking risk, so long as the more complex, exotic examples are avoided.

It will take another credit cycle before volatility is out of the market, said Joel Gomberg, analyst with Duff & Phelps. He suggests buying bank stocks for the added kick from federal interstate banking legislation. "Expect consolidation, and opportunities for the individual," he said.

There are plenty of stock selections for investors among the biggest banks and the potential takeover candidates.

Citicorp, with strong earnings and global presence, is a Berman and Mandel recommendation. It restored its dividend and will likely raise it. BankAmerica Corp., which should benefit as the California economy revives, is suggested by Berman and Mandel. Its new emphasis is earnings, not acquisitions.

Chase Manhattan, driven by credit quality this year and earnings growth next year, is a Berman choice. Bankers Trust New York Corp., a wholesale bank whose stock suffered from its image as a derivatives player, is favored by Mandel, who feels the market overreacted. Banc One Corp., which improves profitability of banks it acquires, is a Mandel selection.

J. P. Morgan, able to finance a global economy despite "hitting a speed bump now and then," is a Vitale pick. So is Wells Fargo, with financial flexibility to battle nonbank competitors.

First Chicago Corp., excelling in credit cards and improving its asset quality, is a Gomberg selection. Takeover speculation is a factor.

Among smaller banks with takeover potential, Vitale suggests Michigan National, whose management is being pressured by shareholders to sell; West One Bancorp, with a big market share in Idaho; and First Security, a Utah institution that's one of the few independents left in the West.

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