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Bank Stocks Rally, but Appear Vulnerable

September 09, 1998|WALTER HAMILTON

When a group of stocks has been massacred for almost two months, does a one-day rally spell the end of the bad times?

That was the question flying around bank stocks Tuesday as the sector surged 7% following Alan Greenspan's hint late last week that the Federal Reserve Board might cut interest rates.

Banks enjoyed one of their few genuine rallies since dropping into a tailspin seven weeks ago. The only major group with a bigger percentage gain Tuesday was technology at 8.6%.

Nevertheless, many Wall Streeters doubt the coast is clear for investors to rush back into banks, especially large money-center banks.

Their reasoning goes like this: A Federal Reserve cut in rates--and that's far from a certainty--would help banks by signaling the central bank's willingness to act to prevent a recession.

However, with the world economy still a shambles, larger banks are vulnerable not only to further trading losses but to as-yet incalculable loan losses from Asia, Russia and Latin America.

"I'm reluctant to take a lot from [the rally] at all," said David Berry, research director at Keefe, Bruyette & Woods Inc., a bank research firm in New York. "It's not a straight line down every single day. There are a number of relief rallies."

If there are good buying opportunities to be had, experts say, they're popping up among regional banks with little or no overseas exposure. Among the banks favored by several analysts and mutual fund managers: National City (ticker symbol: NCC), Star Banc (STB) and First Tennessee (FTEN).

In an indication of how frustrated smaller banks are by the sell-off in their stocks, National City took the unusual step last week of issuing a news release stating that it has "little or no direct loans or investments" overseas.

"As soon as the market sniffs a hint of any problems, it overreacts and takes [stocks] out and shoots them," said Tom Goggins, co-manager of the John Hancock Financial Industries fund. "That's what's happened with some of the regional bank stocks."

The depth of bank stocks' problems since has surprised some observers. Even with Tuesday's surge, the Philadelphia Stock Exchange/Keefe Bruyette & Woods bank index is down 28% since mid-July.

Individual stocks have been hit far more. Citicorp (CCI) is still off its July peak by more than 45%, despite a 6.7% jump Tuesday.

"This isn't a little finance company," Berry said. "This is one of the largest financial companies in the world. It's breathtaking."

BankAmerica (BAC) is down 36% in the same period, and Chase Manhattan (CMB) has fallen 39%.

Historically, banks have been a forward-looking stock group. That is, they often rally first out of a downturn and break down first when the broad market is still strong.

Banks have sold off because investors fear that a potential recession both overseas and in the U.S. would boost loan losses and jar bank earnings.

Few Wall Streeters predict a repeat of the early 1990s, when a faltering economy and souring real estate loans caused bank stocks to collapse. Most analysts say banks' underwriting standards are tighter now than they were then.

Nevertheless, bank stocks are likely to be under pressure in coming months. Wall Street will pick apart third-quarter earnings numbers, which come out next month, for signs of weakness. They're also likely to pull the trigger quickly if economic data point to U.S. slowing.

Investor doubts are greatest over money-center banks, which face trouble on two fronts: losses from their securities-trading operations and potential emerging-market loan losses.

Banks "already were facing higher credit losses" in Asia as a result of that region's financial turbulence, but "it was not out of control," Berry said.

As for Russia, banks' initial estimates of their losses are modest. BankAmerica, for example, put its third-quarter trading loss at about $220 million pretax, almost entirely because of Russia. That's only about three weeks' worth of earnings, one analyst noted.

But as Russia shows, trading losses can hit with lightning speed. And unlike trading losses, which can be calculated and revealed fairly quickly, the potential extent of loan losses may not be known for some time, analysts said.

"It's not exactly easy to get your arms around what their exposure is," said Jeff Morris, lead manager of the Invesco Strategic Financial Services fund.

At the least, many analysts say, banks' overseas businesses will slow noticeably. With countries propping up interest rates to protect their currencies, their economies--and their borrowing--will slow.

If a rate cut materializes, it would help bank stocks primarily by boosting badly damaged investor psychology. But because banks have diversified their businesses in recent years to make themselves less sensitive to interest rate shifts, a one-quarter of a percentage point rate cut, for example, would have only a minimal direct impact on their bottom line, experts say.

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