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Bank Shots Will Be Trickier

Where to Invest in 1998 -- Strategies for Stocks: FINANCIAL SERVICES


More merger mania in '98? Yes, but as stock prices soar, investing will get tougher

Rumors perhaps more than anything else propelled bank stocks forward in 1997, and there should be more of them in '98. "Rumors and whispers about bank stocks are pushing these stocks around every day," says Keefe, Bruyette & Wood Inc. banking analyst Hal Schroeder. Much of the talk turned out to be true, however. As of mid-December, more than 370 bank and thrift deals had been announced, with a total price tag of $93 billion. The average bank stock was up 50% in 1997, says Donaldson, Lufkin & Jenrette Inc. analyst Thomas K. Brown.

But while the consolidation will continue in 1998, investing in banks may get trickier for investors. Share buybacks, which reached record highs in 1997, are destined to drop back as bank stock prices escalate, says Schroeder. And as a result, the industry's 12% earnings-per-share growth rate will be a bit more difficult to repeat.

POTENTIAL GLITCHES. Adding to the uncertainty: probable losses associated with emerging-market exposure. Experts say the likeliest candidates for write-offs will be Citicorp, Chase Manhattan, and Bank of America. Other potential hazards could be the year 2000 computer issue, which could hurt banks that are lagging in fixing their systems.

Analysts, though, see plenty of investment opportunities. A top pick of Merrill Lynch & Co. analyst Sandra L. Flannigan is Norwest Corp., a diversified financial-services bank that among other things is the dominant originator of mortgages in the U.S. Norwest's earnings mix provides superior growth potential, says Flannigan. Goldman, Sachs & Co. analyst Robert B. Albertson has a buy on Banc One Corp., which acquired First USA Inc. last year. He expects lots of new growth from First USA's credit-card business: "First USA has the best revenue-generating history probably of any major sales culture."

Schroeder has picks in three regions. There's Washington Mutual in the West. "It has a combination of being in a very attractive market on the West Coast as well as an attractive takeover candidate," he says. For the same reason, Schroeder also likes Wells Fargo & Co., with $29 billion in market cap. CEO Paul Hazen said on Dec. 8 that he would consider a buyout. That caused a big runup, but the stock is still not overvalued, Schroeder says.

In the Southeast, Schroeder likes Richmond-based Crestar Financial Corp. It's the largest independent bank in the fourth-biggest population center and one of the last large Virginia banks not taken over by out-of-staters. He also likes Pittsburgh-based PNC Bank Corp., a takeover candidate in the Midwest.

The merger wave that drove life and property/casualty stock prices in 1997 should also persist. But Ernest Jacob, insurance analyst for Furman Selz LLC, warns that "earnings are likely to fall short of expectations," mainly because the dearth of catastrophic losses in 1997 is unlikely to persist.

Still, Gary Ransom of Conning & Co. in Hartford likes Allstate Corp. "They are changing the way the auto-insurance industry functions, such as the ways claims are settled and cars are fixed." In life insurance, Jacobs offers Conseco Inc., an industry consolidator.

The toughest sector of financial services in 1998 will be the subprime home equity group. Currently it's down 40% from its 52-week high this year. Skeptics have long been concerned by aggressive accounting and questionable loan practices in the industry. "A lot of pain still lies ahead for high-risk equity lenders. It's based on the age-old problem of too much capital chasing too few good loans," according to Lehman Brothers Inc. analyst Tom Facciola.

Perhaps it's best to avoid the whole sector. Or maybe it's a good place to find some short ideas. Facciola's take: The whole sector is a potential short. Nobody would make that judgment for all financial stocks, of course. But a dose of serious skepticism makes sense.By Debra Sparks in New YorkReturn to top

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