Depository Institutions
Today's uncertain stock market and paltry money fund yields aid banks and thrifts, says Bernard Horn, manager of Polaris Global Value Fund and Quant Foreign Value Fund. Lending activity is up with equity-timid investors buying real estate, and cash is moving from money market funds to higher-yielding bank products, he observes.
Banks are generating near-record profits despite being dealt problem loans by the sour economy, says Mike Rosinus, general partner in the Tiedemann Investment Group, a private hedge fund manager that focuses on bank stocks. Banks have not experienced much commercial loan growth in the last two years, as businesses have reined in capital spending and inventory. "So [if] commercial loan demand picks up and losses on nonperforming loans fall, the table is set for a ramping-up of earnings," Rosinus says, adding that the group is trading at the lower end of its historical P/E range.
Besides coveting institutions that buy back their stock to boost per-share earnings, seek ones that are diversified beyond mortgage origination to avoid exposure to a rise in interest rates. "If the refi (refinancing) wave ends, that business goes away," says Burnham's Schutz. "The pure S&Ls that fund off of CDs also benefited when rates fell, so they've had two good things going for them that would make it hard" to grow earnings if rates trend north.
Another reason for pursuing multi-faceted organizations is that you can't see inside loan or investment portfolios reported on a balance sheet. There is little reliable means of assessing the creditworthiness of loan customers or the investment risks of securities and derivatives held, says Eck. Service revenues, therefore, are attractive. Bank of New York is a significant holding in Cooke & Bieler's Tax-Managed Value Fund because it derives earnings from being a custodian and processor for mutual funds. "We view (it) as a non-bank bank," Eck says.
When it comes to size, the pros disagree on its importance. Eck, for one, likes J.P. Morgan Chase. "We think scale is going to matter and that the few really large banks may have an advantage for a while," he says.
Others, such as Rosinus, are shying away from the mega-companies and buying regional ones. A top position in the local market is one characteristic Rosinus looks for in a regional institution. "We like strong market share on the deposit side," he says, citing M&T Bank Corp. of Buffalo, N.Y., as an example. Rosinus also wants well-capitalized companies, with common equity at 8% of assets (or at least more than 6%) and a loan-loss reserve of more than 1.5% of loans outstanding.
Horn likes small California banks that are filling gaps created by consolidation. "As big California banks have merged and changed, a lot of the customers are fed up. They're finding better service and more attention at the smaller banks," Horn says. Unlike other parts of the country, the economy in southern California is percolating. Horn's picks include Pacific Crest Capital, a maker of Small Business Administration loans, and Hawthorne Financial Corp., which lends against commercial property. A 2002 acquisition by Hawthorne grew its assets and should reduce costs after the organizations are fully integrated, Horn says.
Schutz looks for newly public regional thrifts. "There's usually a three-year period before they can sell (to an acquiring institution)," he says, noting that Connecticut Bancshares and the Boston area's Port Financial Corp. recently turned three. Schutz also likes Brookline Bancorp, which has beaucoup capital and is thus potentially a large buyer of its own shares. Brookline finalized its public offering last summer, so it's not an immediate takeover candidate. "But I view them as on the path," Schutz says. "The chairman is 67. You've got to wonder what's the next step."
Securities
The securities business is unquestionably at low tide. Brokers have been hurt by a drop in trading volume, while asset managers have helplessly watched revenues drop in lock step with stock valuations. But even when things turn around, damaged psyches may prevent the arena from growing quickly.
"I don't think investors are going to steamroll back into the market" for several reasons, says Rich Meagley, a vice president at SAFECO Asset Management and manager of the Seattle-area firm's Equity Fund. "The first is that investors have lost confidence in themselves. People are beating themselves up, going, 'I never should have believed that 25% a year was right. I should have realized that 40 times earnings was too high.' No. 2 is the bear market. We've had three years in a row, so even after one or two good years, you're probably going to be looking at negative five-year performance numbers," Meagley says.