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Finding the Money in Financial Stocks

Financial stocks have done slightly better than the overall market so far this year, but their prospects for 2002 are only average. So says banking and financial-services stocks analyst Stephen R. Biggar of Standard & Poor's.

Biggar explains his prediction by saying there will be crosscurrents between a moderate economic recovery on the one hand and weaker credit quality and an expected end to interest-rate cuts on the other. Regarding credit quality, Biggar doesn't see a major impact on the industry from the Enron disaster, but he does have some concern that rising unemployment could depress consumer spending and, in turn, the banks' consumer-financing business.

However, among the stocks Biggar covers for S&P, he lists three buy recommendations: J.P. Morgan Chase, FleetBoston Financial, and PNC Financial. And he is positive enough on Bank of America, BB&T, Bank of New York, SouthTrust, and U.S. Bancorp to rate them accumulate.

Biggar made his comments in a Jan. 22 chat presented by BusinessWeek Online and Standard & Poor's on America Online, during which he responded to questions from the audience and from Jack Dierdorff of BW Online. Edited excerpts from the chat follow. A complete transcript is available from BW Online on AOL at keyword: BW Talk.

Q: Steve, the overall market is still edging downward -- will it start climbing again soon, in S&P's view?

A: Stocks did move lower today, hurt by concerns [that there will be] limited semiconductor growth and weakness among the wireless telecoms. The news from Kmart (KM) [announcing bankruptcy] didn't help either. However, we think that the lower interest-rate environment and a slowly recovering economy will set the stage for a better 2002 stock market performance.

Q: Broadly, how are the financial stocks doing? Have they been hurt at all by Enron (ENRNQ)?

A: Financial stocks have been hurt recently by weaker credit quality. That's partly related to Enron's bankruptcy. Several large banks that I follow have had or have significant exposure to Enron, and this led to a rise in nonperforming assets in the fourth quarter. However, I don't believe that the failure of one large credit is an indication of more widespread deterioration of credit quality.

Year-to-date, financial stocks have slightly outperformed the broader market. But given the crosscurrents of weaker credit quality and the end of interest-rate cuts -- but with a moderately recovering economy -- we think that bank stocks will be average performers in the year ahead.

Q: What is your outlook on C [Citigroup]?

A: I kept my hold opinion on Citigroup following their fourth-quarter earnings. I thought that the results were impressive, given the inclusion of $700 million in charges for exposure to Enron and Argentina. Citigroup is likely to spin off its property/casualty unit and is rethinking its long-term strategy around growth and higher-margin areas of consumer finance and asset management and brokerage businesses. But I think that the shares will stay in a range.

Q: What's your view on J.P. Morgan Chase (JPM) and FleetBoston Financial (FBF) over the next 12 months?

A: I have buy recommendations on both JPM and FBF. I think that both are uniquely positioned to have substantial earnings leverage as the economy recovers. Both have significant exposure to capital markets, including investment banking and venture capital. And I think that we could see large increases in earnings estimates as these businesses rebound.

Q: A few minutes ago you spoke of interest-rate cuts coming to an end -- do you think they're over? And do you see any signs of the Fed's rate cuts starting to help the economy? In what areas?

A: It is possible that we could be in store for one more rate decrease, but what I said earlier is that the rate-cut story is largely over -- meaning that banks will not get much additional benefit from lower rates by the Fed. I do think that the rate cuts are beginning to work their way into the economy, especially the added spending power that consumers have been able to take advantage of through lower mortgage rates and refinancings....

Q: Where is Bank of America (BAC) stock heading?

A:I am moderately positive on Bank of America. And I have an accumulate recommendation on it. In today's conference call, management guided revenue growth estimates in the 3% to 5% range for 2002 and expects minimal expense growth to lead to about a 6% rise in earnings.... I would be more aggressive on Bank of America if it reached the mid-50s. Right now, it's trading in the low 60s.

Q: What do you think of WB [Wachovia]?

A: I currently rank Wachovia as hold, or 3-STARS [in the Standard & Poor's Stock Appreciation Ranking System]. I think that the company is well-positioned in its target markets, by geography and product set. However, it is too early after the merger with First Union to have confidence for a recommendation.

Q: What about USB [U.S. Bancorp] and NCC [National City] for the next 12 months?

A: I recently upgraded U.S. Bancorp to an accumulate. I think that it is a unique turnaround situation in 2002. They have lowered their risk profile and begun to focus on growth opportunities after completing the merger integration with FirstStar. With operational improvements expected and the fact that it's trading at a discount to regional bank peers, I believe that the shares can outperform in the year ahead.

I have a hold on National City. I think that they do have good expansion plans in several areas, and they released a fairly clean quarter of earnings. But I don't see a catalyst to move the shares materially higher in the next 6 to 12 months.

Q: What about credit quality? With Enron and Kmart as horrible examples at one extreme, and lots of layoffs for consumers at the other, is this a worry?

A: As I said earlier, I don't think that the failure of a few large commercial credits is an indication of widespread deterioration in credit underwriting standards. I do think that the rising unemployment rate will, at some point, lead to weaker consumer spending. And this will have a negative impact on consumer borrowing.

Q: Another question on regional banks -- SunTrust (STI)?

A: SunTrust's valuation was clearly hurt by its attempt to merge with Wachovia. Average loans in the fourth quarter were up only 1%, which I attribute to the slower economy, but also from a loss of focus as they were preoccupied with the merger attempt. Previously, it was a company with very high or very strong credit quality, but charge-offs jumped in the fourth quarter.

That's troubling, given expectations of a weakening credit-quality environment. I don't think that the valuation was permanently impaired, but I do think it will be some time before investors regain confidence in the company. We currently rank SunTrust as a hold.

Q: Would you recommend MBNA at this time?

A: I don't cover MBNA, but our credit-card analyst currently has it ranked as a buy, or 5-STARS. It has terrific net interest margins, very healthy credit quality, and trades at a discount to S&P's expected long-term growth rate for the company.

Q: Do you follow SouthTrust Bank (SOTR) and, if so, what is your recommendation?

A: I do like SouthTrust Bank and have an accumulate recommendation on them. A well-positioned balance sheet led to significant margin improvement in 2001, and the company is now working to increase its asset sensitivity to position for higher interest rates. They are expanding externally in high-growth areas, recently entering Virginia. As for valuation, they have a p-e/growth [PEG] ratio that's favorable vs. its peers.

Q: How does Bank of New York (BK) look to S&P now?

A: I have Bank of New York as an accumulate, or 4-STARS. I expect the company to focus on higher-grade credits and to become even more focused on fee-based businesses. Its processing units have stabilized after the World Trade Center attack caused disruption. I think that a return to its historical mid- to upper teens earnings-growth rate will move the shares higher.

Q: What are the chances of Commerce Bancorp (CBH) succeeding in entering the New York market?

A: CBH is a very service-oriented retail bank that has Sunday hours. It opened its first four branches in Manhattan in 2001 and expects to open 31 more in the New York area during 2002. We think that the bank will continue to grow deposits and earnings well above the industry average, and with the shares priced at a discount to its peers, we rate the shares as a buy.

Q: KeyCorp (KEY)?

A: KeyCorp, despite multiple restructurings, has been unable to generate much earnings growth. Credit quality deteriorated noticeably in the fourth quarter. Although it has made progress on some expense-saving measures, it hasn't been able to deliver on an earlier strategic plan to accelerate revenue growth after downsizing certain loan portfolios and exiting nonrelationship corporate lending. Although the shares trade at a discount to peers, I do not believe that it has much upside potential.

Q: Do you know anything about ACF [AmeriCredit Financial]?

A: I don't cover AmeriCredit Financial, but our consumer finance analyst has an accumulate recommendation on it. Despite the current recession, he believes that new- and used-car financing demand will remain robust for ACF. And the shares are trading at only seven times the 2002 earnings estimate. That's well below a 25% long-term growth rate forecast.

Q: Steve, how about refreshing us (especially for the late arrivals) on your buy and accumulate list?

A: I have buy recommendations on: J.P. Morgan Chase, FleetBoston Financial, and PNC Financial. I have accumulate recommendations on: Bank of America, BB&T (BBT), Bank of New York, SouthTrust, and U.S. Bancorp.

Q: Didn't you also list CBH as a buy?

A: Yes, I did. CBH, however, wasn't under my coverage.

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