Demand for business loans is the key to the attractiveness of the banking sector -- and of many stocks in that arena, says Evan Momios, equity analyst for Standard & Poor's. Momios covers banking and financial-services stocks for S&P. For now, S&P is neutral on the sector as a whole.
Nevertheless, Momios points out that stocks in his area have outperformed the S&P 500-stock index for the last three years. Until recently, that was due to a favorable interest-rate environment, he says, but he attributes the recent results to the improving economy. There are 18 names on S&P's current buy list in that sector, including Bank of America (BAC ), Citigroup (C ), and Washington Mutual (WM ). Another buy on the list is Commerce Bancorp (CBH ), which he points out scores 20% annual growth in earnings in an industry where 8% is acceptable.
Momios notes that acquisition activity could well resume in banking, especially if some valuations come down and larger banks become interested in smaller regional institutions.
These were among the comments Momios made in an investing chat presented Aug. 26 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A full transcript is available on AOL at keyword: BW Talk.
Evan Momios is an analyst with Standard & Poor's Investment Advisory Services. He has no affiliation with or ownership interest in any companies under discussion. Other S&P affiliates may provide services to the companies under discussion.
Q: Evan, the market managed a bit of a gain late in the day. What's the outlook from S&P?
A:The market stayed under water for most of the day. Although we had some positive economic releases early in the morning, which attracted buyers' interest toward the end of the day, we believe that the summer months are usually slow, and for the next few weeks we would expect the market to move sideways. In the longer term, we think that with improving economic conditions, equity market performance should be better than it has been in recent years.
Q: How have banking and financial-services stocks been doing? What do you think of the banking sector, long-term?
A:For the last three years banks and thrifts have outperformed the S&P 500. As a matter of fact, year-to-date, they have continued to outperform. Over the last three years the outperformance was possible in a favorable interest-rate environment.
For the year-to-date period, we think the outperformance should be attributed to the improving economy. But we remain neutral on the banking sector. The reason is that although interest rates remain favorable, we have not yet seen an improvement in business loan demand.
Q: If interest rates continue to rise, will it hurt the banking sector? And if interest rates do hurt, by how much?
A:In recent months, we have seen long-term rates going up. However, short-term interest rates that are determined by the Federal Reserve have been low and should remain low for the foreseeable future. Higher long-term interest rates should have a negative impact on demand for residential mortgages. However, the favorable difference between long-term interest rates and short-term interest rates should favorably affect banks' margin income, particularly if economic conditions improve and demand for business loans accelerates.
Q: Are you familiar with KeyCorp (KEY )? What are its future prospects?
A:We have a hold recommendation on the shares. We expect the company to remain focused on expense control and on asset-quality improvement for the next few quarters. We're encouraged by recent results. However, in the absence of demand for corporate lending, we don't think revenue acceleration is likely.
Q: Opinion on Staten Island Bancorp (SIB )?
A:We remain cautious on the shares. We have regulatory concerns resulting from an ongoing SEC inquiry. We would advise that investors remain cautious, and we believe these concerns are likely to affect the performance of the stock in the near future. We have a hold recommendation.
Q: What do you think about Citigroup (C )? Do you think it will be influenced by the change in CEOs?
A:We have a buy recommendation on the shares of Citigroup. We are not happy to see Mr. Prince leaving, which will be effective in early 2004, but we don't think this change of guard is likely to derail the company from its successful path. Our strong buy recommendation on Citigroup shares is based on the company's ability to maintain earnings momentum in a variety of operating environments and its diversified product mix and geographic markets.
Q: Would you continue to hold Wachovia (WB )? I have a profit.
A:That's a good question. We have an accumulate recommendation. The shares have performed very well in recent months. We believe this is the result of improving operating performance. We think that with the economy improving, Wachovia's results are likely to improve.
Q: Commerce Bancorp (CBH ) shares have fallen -- is it a good buy?
A:We think it's a great buy. In recent weeks the stock has been upgraded by three other analysts, but that's not the reason we like it. Our 12-month price target for the shares is $56. The reason we are so bullish is because in our view CBH is likely to continue to grow earnings at rates in excess of 20% annually in an industry where 8% growth is considered acceptable.
We believe that concerns over the effect of interest rates on the company's profitability are unjustified. Over the last approximately 26 quarters, CBH has either met or exceeded analysts' EPS estimates. We think this is a sign of a successful high-growth business model.
Q: Would you recommend Washington Mutual (WM )?
A:WM is on our buy list. We believe it's an above-average franchise. Its deposit base lacks commodity-like time deposits, which we think is positive. The shares were recently trading at about eight times our 2004 EPS estimate of $4.67 and are offering a 4.1% dividend yield, which in our opinion makes them an attractive investment. We would recommend that investors buy the shares of this highly profitable market leader.
Q: What are your other favorite buys at this point in time?
A:The financial-services buy recommendations consist of 18 names right now. Banks and thrifts include: AmSouth Bancorp (ASO ), Bank of America (BAC ), BankNorth Group (BNK ), Citigroup (C ), Commerce Bancorp (CBH), Compass Bancshares (CBSS ), IndyMac Bancorp (NDE ), Mellon Financial (MEL ), National Commerce Financial (NCF ), Sovereign Bancorp (SOV ), and finally Washington Mutual (WM ). In addition, there are names from the insurance, asset management, and REIT industries. And one that I forgot to mention above, Lehman Brothers Holdings (LEH ).
Q: Are larger banks with their constant fees going to take the average person to a smaller city bank?
A:That would be great for Commerce or BankNorth or Sovereign. We believe that there is some dissatisfaction from retail depositors when it comes to services provided and fees charged by larger institutions. This has helped new competitors in markets such as New York City, and we believe smaller banks have an advantage when it comes to customer service in the retail market.
Q: What about Dime Community Bancshares (DCOM )?
A:It's one of the few New York area thrifts that we follow. They focus on lending for multifamily housing. Shares of similar thrifts generally command a premium valuation to the industry because they offer higher dividend yield and have lower underwriting risk, in our opinion. We believe Dime's performance and outlook are comparable to those of its local peers, and we think the stock is fairly valued, which is why we have a hold recommendation.
Q: Have you talked about J.P. Morgan Chase (JPM )?
A:We have an avoid recommendation on the shares of JPM. Although the stock is trading at a discount to its peers, we believe this is well-deserved, since JPM has a more volatile revenue mix than those peers. We don't expect the shares to match the performance of peers until there is clear evidence of an improved outlook for both asset quality and capital markets.
Q: How do you rate FleetBoston Financial (FBF )?
A:We rate FBF as a hold. There's a lot of speculation about Fleet being acquired by a larger bank. However, there aren't that many banks that are a lot larger than Fleet. Excluding the acquisition rumors, we believe the shares at 12 times our 2004 EPS estimate of $2.60 are fairly valued, and they offer an above-peer-average dividend yield. So, in short, we would maintain positions, but we would not add at this time.
Q: Your long and short opinion of Huntington Bancshares (HBAN )?
A:Standard & Poor's Equity Research has a sell recommendation on the shares of HBAN. Although HBAN has had some success in deposit growth, their consumer loan portfolio, and fee income growth, we think this is because of the bad results of previous years that make comparisons look more favorable than they really are.
S&P is also concerned about what an ongoing formal SEC investigation may uncover. Based on these concerns, and the stock's valuation of 13 times our 2004 EPS estimate of $1.59, which is above peers, we think the p-e multiple is likely to contract, and we therefore recommend that investors sell the stock.
Q: Do you like Union Planters Bank (UPC )? Buy, sell, hold?
A:We have an accumulate recommendation on the shares of UPC. The shares have performed very well since the first half of 2000, when they came under pressure due to some acquisition-related costs and net interest margin contraction. Recently, the shares were traded at what we think is a low valuation for regional banks. We believe the shares are undervalued. The company seems to have become less acquisitive, focusing on expense control and reducing its interest-rate sensitivity.
Q: Will takeovers in the financial arena gain momentum again?
A:We think that's a likely development. We believe we're more likely to see acquisitions of smaller regional banks by larger institutions that want to quickly add branches or deposits and enhance revenue by trimming the expenses of acquired institutions. However, in recent years targeted companies have demanded prices that we consider very high. We think that if valuations of those targets come down a little, activity is likely to pick up.
Edited by Jack Dierdorff