Banks Break The Mold - bank stocks that are good investments

Kiplinger's Personal Finance Magazine, July, 2000 by Beth Giese

STOCKS | These SUPERREGIONALS grow through fees, not loans.

ON A MUCH-traveled section of New York City's Seventh Avenue between the Garment District and the new, tourist-friendly Times Square, a strange storefront displays wedding gowns alongside video monitors showing New York street scenes, breaking news and stock quotes. Is it a bridal boutique? A television studio? A travel agency?

Actually, it's a bank--but not your father's bank. "The bank business is changing," says Duncan Richardson, who runs Eaton Vance Tax-Managed Growth fund. The emphasis now is for banks to get fees for any number of nonlending services.

Investors have been slow to recognize the sea change in banking. In the past, bank profits often slipped when the Federal Reserve Board hiked short-term interest rates, as it has six times in the past year. After all, higher rates translate into lower demand--for mortgages, credit cards and other loans that are considered the bread and butter of banking.

But few banks now depend on lending for most of their revenues and profits. So some are posting strong revenue and earnings growth even as the Fed tightens credit. That stock prices do not yet reflect that growth means there are bargains to be had, particularly as some of the ardor for technology stocks cools.

Of course, it's important to buy growing companies, and not just because they're inexpensive. The wonderful thing about investing in banks now is that you can find both growth and good value in the same stock, thanks to the slow but steady transformation of banks into fee machines.

Indeed, that odd bank on Seventh Avenue is a branch of FleetBoston, one of the best fee generators in the banking business. Having blanketed New England with branches, Fleet is expanding southward, in a push to become one of the nation's dominant superregional banks.

Big but still growing. Superregionals are those banks that have expanded beyond one city or state to offer financial products and services across an entire region. One, Bank of America, has built a coast-to-coast franchise, while others such as Wells Fargo, Mellon Financial and First Union are steadily expanding their reach beyond their original locales.

But it's not just geographic expansion that defines the superregionals. They also cross-sell more products and services to their customers than could be imagined ten years ago. Banks aren't just interested in taking deposits and giving out loans. They also sell mutual funds, insurance and estate-planning services. "I can't emphasize enough the importance of identifying customer needs and adding the services they say they want," says Rocco Maggiotto, head of global financial-services consulting at PricewaterhouseCoopers. "If Americans want stocks, give them brokerage services. If they want mutual funds, give them mutual funds. The banks that do that are going to be the winners."

To facilitate that change, bank branches no longer look like armed fortresses. You'll see branches that invite you inside--just like the FleetBoston branch on the edge of Times Square. By encouraging you to enter, Fleet has a good chance of capturing some business. You would discover that Fleet (symbol FBF, New York Stock Exchange, recent price $37) has a discount-brokerage desk, through its Quick & Reilly subsidiary. And its investment specialist might offer shares in an initial public offering underwritten by Fleet's Robertson Stephens investment-banking unit.

At the very least, you might use a Fleet ATM machine, for which the bank collects a $1.50 fee from non-customers. Considering that processing a cash withdrawal costs the bank mere pennies, that fee is almost pure profit. A $1.50 here and a $1.50 there, and pretty soon you're talking about the more than $2.3 billion that Fleet took in last year for all banking services. In the first quarter of 2000, interest income rose a mere 2%, but fee income jumped 51% from year-ago levels. Explains James Catudal, manager of Fidelity Select Financial Services fund: "There are a number of ways to boost fee income--by adding investment banking and brokerage services, or asset management or trust services, or securities processing for mutual funds, or mortgage servicing, or by charging ATM fees." Analysts surveyed by First Call/Thomson Financial expect Fleet to earn $3.38 per share this year, up from $2.91 in 1999. Its price-earnings ratio is only 11.

More than half of U.S. households own mutual funds, and the bank that nabs the most recognition for expanding into the mutual fund business is Mellon Financial (MEL, NYSE, $35), which owns both the Dreyfus and Founders families of funds. Mellon, says T. Rowe Price's Rob Sharps, also processes securities transactions, "so its income isn't really derived from loans at all, but from fees." The consensus of analysts, says First Call, is for Mellon to increase its earnings by 11% this year, to $2.03 per share, giving it a P/E of 17. "Its peers are selling at 20 or 30 times earnings," says Eaton Vance's Richardson, who thinks Mellon's valuation gap is undeserved.