Though they came out of 1999 the worse for the wear, there’s still gold to be found in many bank stocks as the new millennium — and a new era of banking-begins. The sector has been clobbered by rising interest rates, concerns about Y2K events and a slowdown in mega-bank deals, but 1999′s Financial Services Modernization Act opens the door to big business among banking, insurance, and securities divisions-and big potential profits for investors.
“There are a few [banks] out there that the Street feels will outperform their peers,” says Diana Yates of A.G. Edwards in St. Louis. “But the market became very skeptical the past couple of years, after the big wave of consolidation, as many acquirers didn’t deliver what they promised.”
Fred Cummings, a managing director at McDonald Investments in Cleveland, agrees. He cites the performance of Standard & Poor’s regional bank index of 25 companies, including giants such as Bank One Corp., Wells Fargo Corp. and U.S. Bancorp, which was down 7.4% year-to-date versus a 13% gain for the S&P 500.
But it’s not all lions, tigers and bears. A select few banks with strong fundamentals, well-chosen geographic expansions and basic blocking-and-tackling strategies will reward investors with returns above the industry average. Yates’ favorite picks, both rated “buys,” are Wells Fargo Corp. (NYSE: WFC) and U.S. Bancorp (NYSE: USB). Yates says that Wells Fargo, a diversified financial services company focused on balancing diversification across business and product lines, operates in nine out of 10 of the nation’s fastest-growing states and is focused on growing revenues internally and through disciplined acquisition. She also likes U.S. Bancorp. The Minneapolis-based bank is an industry leader at cutting costs, is among the industry’s best at integrating banks it purchases and then delivering on targeted goals and is expanding its West Coast operations.
Cummings-like many Wall Streeters and economists-believes the Federal Reserve won’t raise interest rates again until next spring. The fact that the Fed raised rates a total of 0.75% since June has been a major factor in banks’ poor stock performance. Rising interest rates increase banks’ borrowing costs, scare away potential customers who fear higher rates on loans and create more problem loans for customers already struggling to pay existing debt. A rein on additional rate hikes could contribute to a bank-stock rally, particularly for those with budding franchises.
Cummings’ top picks, rated “aggressive buy,” are Fifth Third Bancorp (Nasdaq: FITB) and Firstar (NYSE: FSR). He says good expense control, double-digit revenue growth from all four of its lines of businesses and low credit costs could help Cincinnati’s Fifth Third net year 2000 share earnings of $2.80, up from estimated earnings of $2.38 in 1999. Cummings figures most of those same factors will help Milwaukee-based Firstar, a Wall Street darling, post share earnings of $1.55 next year, up from $1.24 this year. Firstar was trading at 17 times its 2000 estimated earnings versus 13.5 for its peer group.