Placing Careful Bets on Financial Stocks

They're particularly susceptible to investor concern about interest rates, but money-center banks are holding up

In the world of bank stocks, the money for investors at the moment is in money-center banks and companies in investment management and consumer finance, according to Stephen R. Biggar, Standard & Poor's analyst of financial stocks -- in particular, money-center and major regional banks.

For the financial stocks overall, S&P and Biggar recommend a market-weighting -- holding such names in proportion to their status in the S&P 500, in this case about 15%. And among the stocks Biggar covers, the buy list includes Bank of New York, Citigroup, FleetBoston Financial, J.P. Morgan Chase, and PNC Financial. At the other extreme, he has a sell ranking on Bank One.

Biggar sees both the broad market and the financial sector as vulnerable to interest rates -- and, of course, to the seriousness of the economic slowdown. He thinks the market will continue to be volatile, moving up or down with each new burst of economic news.

These comments from Biggar came in a chat presented Feb. 27 by BusinessWeek Online and Standard & Poor's on America Online. He was responding to questions from the audience and from Jack Dierdorff of BW Online. Edited excerpts from the chat follow. A complete transcript of this chat is available from BW Online on AOL, keyword: BW Talk.

Q: Steve, watching this market is like being a spectator at a hot tennis match. Up very, very nicely yesterday, and today, for the Nasdaq at least, down again. What's the S&P view?


We think today's weakness reflected a few weak economic reports, including a lower consumer confidence index, lower new home sales, and weak durable goods orders. These have investors concerned that the Fed may be behind the curve on lowering interest rates. I agree with how you've characterized the volatility lately and suspect the market will continue to be volatile.

Q: What's your outlook for the sector you cover?

A: In general, financials are more susceptible to concerns over interest rates, and the group has had a mixed performance so far this year, with major regionals down abut 5% and money-center banks up about 9%, compared to about a 6% drop in the S&P 500.

We continue to recommend a market-weighting on financials. This means that with financials representing about 15% of the S&P 500, we recommend that investors have a similar weighting in their portfolios. Among the segments we'd be modestly overweighted in are money-center banks, investment management companies, and consumer finance firms.

Q: How about Synovus (SNV )?

A: Synovus Financial I have a hold on. It has benefited recently from a more favorable interest-rate picture, and I like the long-term fundamentals of the company because it has a higher-than-normal proportion of profits from noninterest income sources.

Q: What about the outlook for WFC [Wells Fargo] and FBF [FleetBoston Financial] in the near term?


I have a buy recommendation on Fleet. It has been one of the better performers recently. In particular, I like the business mix, which I see as more dynamic than most of the company's peers, with business lines that include discount brokerages and private equity (see BW Online, 2/27/01, "A Swift Move Up for FleetBoston?"). Although I like the longer-term view of Wells, I think optimism following the merger with Norwest has been priced in, and I see the shares fairly valued.

Q: What is your long-term view on JPM [J.P. Morgan Chase] and C [Citicorp]?


I have a buy recommendation on J.P. Morgan Chase. I think investors will become more comfortable with the combined company, and that revenue and cost synergies could be better than the company originally estimated.

Citigroup I also have a buy rating on. This is a company that has been able to keep earnings momentum going because of its global diversification.... Citigroup has also made a few recent smart acquisitions, including Associates First Capital, which solidifies leadership in the credit-card business.

Q: With J.P. Morgan and Chase consolidated, do you see any other big mergers coming?

A: Although mergers are difficult to predict, I think we'll continue to see modest merger activity in 2001 as banks continue to look for revenue growth opportunities and business-line diversification. Modestly weaker share prices in 2000 did not provide a strong currency to do many deals, but I think banks will continue to face pressure to grow their revenue base through outside sources.

Q: What about PNC [PNC Financial Services]?


This is a company that has dramatically altered its business mix in the last two years, thanks mostly to its acquisition of First Data Investor, which provides processing services for mutual funds. The new business mix is substantially less affected by interest-rate changes.

Q: Opinion of Mellon [MEL ]?


It's now called Mellon Financial, and I have an accumulate on this bank. I like its long-term prospects. With about 70% of revenues coming from noninterest income sources, we expect investors will continue to pay a premium for the shares. Earnings drivers continue to include trust and investment management, new business, and equity inflows at the company's mutual-fund units.

Q: Steve, with the economy slowing and consumer confidence down, are you worried about bank earnings?


Somewhat worried. We have been modestly lowering earnings expectations for banks since late last year. I think the wild card now is credit quality and how much deterioration there will be through the first half of this year.... Banks in general are well-reserved for some additional credit-quality weakness based on past cycles.

Q: You've mentioned two or three stocks on your buy list. Can you review the list for us?


Sure. I have buy recommendations on Citigroup, J.P. Morgan Chase, Bank of New York (BK ), FleetBoston Financial, and PNC Financial.

Q: Suntrust Banks (STI ) owns about $10 a share worth of KO [Coca-Cola]. Why is the stock not reflecting this added value? Do you like STI?


SunTrust does have a 48 million-share KO position and historically did trade at a premium to regional banks because of that stake. It offers dividend income. However, more recently investors have become more concerned about SunTrust's earnings growth prospects and its credit quality. I do like the shares longer term -- not for the big KO holding but for the bank's ability to generate better-than-average earnings from traditional lending businesses.

Q: You've told us about your bank buys -- how about the next layer down, accumulate?


I have accumulates on Comerica, Mellon Financial, and SunTrust Banks.

Q: And on the bottom rungs, any to sell or avoid?


I do have a sell on Bank One (ONE ), which I put on the shares after they rallied.... I don't think the premium valuation was justified, based on where the company is in its earnings turnaround. I think they would be more fairly valued in the low-$30 range.

Q: What do you think of First Union (FTU )?


I currently have a hold on the stock, but I'll admit it has been one of the better performers year-to-date. The company continues to have execution problems in many of its business lines, although I continue to like the company's service territory and think that the bank has a broad enough product set to generate good revenue momentum when execution problems are resolved.

Q: Hold is the one ranking category we haven't asked you specifically about. What do you have there besides FTU?


Oh, brother! That is a laundry list. But it includes Bank of America (BAC ), KeyCorp (KEY ), National City (NCBM ), Northern Trust (NTRS ), Regions Financial (RGBK ), State Street Corp., Wachovia (WB ), and Wells Fargo.

Q: In other words, that sort of sums up where bank stocks are these days -- something to hang on to but not to get too excited about?


Yes, I agree with that assessment. We think investors should continue to have exposure to financial stocks but need to stay with companies that continue to have good revenue momentum in a slowing economy.

Edited by Jack Dierdorff

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