The Best Bank Buys Bank megamergers may be grabbing the headlines. But these regional banks may help you grab a higher return
(MONEY Magazine) – In the wake of the blockbuster merger announcement from J.P. Morgan Chase and Bank One, Wall Street has been buzzing about which banks are next on the acquisition hit list. But merger targets won't be the only winners in the consolidation game. The real story is about business fundamentals: While Jamie Dimon and company are busy trying to make their megadeal work, smart regional bankers can pull in new customers and deliver solid growth and fat dividends to boot.
J.P. Morgan/Bank One and the other financial giants can offer investors a nice combination of lending, brokerage and investment banking businesses. But their street-level retail operations won't pose a big threat to regionals. "Bigger banks have not been the better-performing companies historically," says David Ellison, manager of the FBR Small Cap Financial fund. "They have higher cost structures, and they are more complicated businesses to run."
As a result, Ellison argues, bigger banks often have to charge retail customers higher fees--especially after mergers, when they are under pressure to deliver strong numbers to Wall Street. So local players can still attract deposits, the lifeblood of a lending operation, by offering better deals. That's exactly how New England regionals Sovereign and Banknorth gained market share even as local powerhouse FleetBoston grew on a steady diet of acquisitions (before being swallowed by Bank of America last fall). Smaller banks may also benefit from their focus on small business loans, a sector that is picking up fast.
Here's the risk for investors: Banks big and small have outperformed the market for four years in a row. A fifth year would be unprecedented. There's also the matter of interest rates, which many analysts expect will rise this year. That's generally bad for banks, which after all are in the business of borrowing money as well as lending it. But rates rise because the economy is heating up, so the impact of an increase may be offset by improvement in the quantity and quality of business loans. That's especially true considering that even with a hike, rates will still be very low.
So regional banks still look like long-term buys, especially when you factor in an average dividend yield of 2.4% vs. 1.5% for the S&P 500. If prices dip on interest-rate fears, regard it as an opportunity to add to your position. Some names we especially like:
--SOUTHTRUST (SOTR) This bank has posted 52 consecutive quarters of earnings improvement and has increased its dividend annually for 30 years. (Its yield is 2.7%.) It trades at 16 times 2004 earnings and should benefit from its southeastern location. In the 1990s, 40% of U.S. population growth occurred within SouthTrust's nine-state region.
--BANKNORTH (BNK) Based in Portland, Maine, it is the largest bank still based in New England. It has branches in Connecticut, Boston and low-tax New Hampshire, where many small businesses have moved in recent years. It has a 2.4% dividend yield and a P/E of 15.
--NATIONAL CITY (NCC) The Cleveland bank restated 2001 to 2003 earnings because of questions about hedging activity related to its mortgage business. But S&P equity analyst Evan Momios says investors overreacted to the restatement, which actually boosted 2003 earnings. He likes NCC's Midwest network, 3.9% yield and reasonable 2004 P/E of 11. --DONNA ROSATO