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Bank Stocks to Avoid as Credit Worries Mount

Like a pinstripe-clad Roger Daltrey, bank investors were wondering who's next Wednesday after two big banks reported a troubling spike in shaky loans.

  • Junk-Bond Funds Face Growing Risk of Telecom, Tech Defaults
  • Credit Quality Issues Rear Their Ugly Heads Again

    First Union (FTU) and Bank of America (BAC - Get Report) shook up the financial sector with cautionary words Tuesday evening about their exposure to risky loans. Given that worries about deteriorating credit quality have hamstrung bank stocks for months, it didn't take long for the sector to wince. First Union shed more than 8% Tuesday; Wednesday, Bank of America dropped 9%, leading a 4% slide in the S&P Bank Index.

    The bad news sent investors scouring their portfolios for lenders whose loan-loss and nonperforming-asset trends could point to emerging problems. Using those and other guidelines, three analysts shared their thoughts on which bank stocks might be vulnerable.

    Pressure

    Bank One (ONE), still plodding through a major restructuring, leads the list of credit-risk-exposed stocks compiled by analyst Jennifer Thompson of Putnam Lovell. "Bank One is not only seeing pressure on the commercial side, but has indicated that consumer loss rates are trending up," says Thompson, whose firm rates Bank One a hold and hasn't done any underwriting. "They also have a fairly large auto-lease portfolio, which could continue to feel pressure as well." Bank One stock fell 5% Wednesday.

    Huntington Bancshares (HBAN) is another bank to avoid, Thompson says, noting an auto lease portfolio that could spur a second consecutive writedown in the fourth quarter. (She rates Huntington a hold, and her firm hasn't done any underwriting for the bank.) Huntington dropped 1.4% Wednesday.

    SunTrust (STI) and Wachovia (WB), both of which "have seen an increase in problem assets," are also stocks to keep an eye on, says Thompson. (Both stocks get the hold rating at Putnam, and the firm hasn't underwritten for either bank.) "In general, the areas that a lot of these banks are feeling pressure in are [exposures to] health care, textiles, the theater industry and agribusiness," adds Thompson. SunTrust dropped 4.2% and Wachovia 6.8% Wednesday as regional bank stocks took a heavy drubbing.

    Anxiety

    Though credit quality issues have loomed over bank stocks since as least mid-June, when historically conservative Wachovia roiled the sector with a profit warning, investors' anxiety over loan defaults has only risen as evidence of a nationwide economic slowdown continues to filter in.

    Kathy Shanley, fixed-income analyst with Gimme Credit in Willamette, Ill., says she'd avoid Comerica (CMA), whose stock fell two weeks ago on the announcement of its plan to buy California-based Imperial Bancorp (IMP), whose credit-quality track record is mixed. Shanley thinks Imperial's exposure to residential tract construction could be worth watching, as could the bank's $400 million emerging growth portfolio.

    Brock Vandervliet, banks analyst at Lehman Brothers, has assessed exposure to syndicated loans, which is particularly timely considering the big hit First Union and Bank of America will take on their syndicated deal with troubled Sunbeam (SOC). (A syndicated loan is one shared by three or more institutions.)

    Vandervliet said the risks of exposure to syndicated credits are well established, and recent events "are just confirmation that investor sensitivity should remain pretty high." Accordingly, he says Hibernia (HIB), Pacific Century (BOH - Get Report) and UnionBanCal (UB) will all have "some rough sledding in the near term." Of those names, UnionBanCal's exposure to syndicated credits is greatest. The banks' shares all fell fractionally Wednesday.

    Disclosure

    Still, Vandervliet thinks the bank sector as a whole is being taken down for "problems that are concentrated" at a smaller group of banks.

    On that note, some analysts are pointing to banks with what they see as a better grip on credit issues. Even as influential Merrill Lynch analyst Judah Kraushaar cut earnings estimates on Bank of America Wednesday and noted "credit erosion taking place," he made some top recommendations for investors eager to stay invested in financials, including Citigroup (C - Get Report), Chase (CMB), Mellon (MEL) and Wells Fargo (WFC). Those stocks dropped between 1% and 4% Wednesday.

    And perhaps even credit worries can have a silver lining. With all the recent hand-wringing over telecom debt, Vandervliet says Hibernia, for one, has taken the rare step of laying out its telecom exposure, which appears to be minor.

    "Banks have historically been reticent to provide that kind of detail," the analyst says. "Now that the market is throwing the baby out with the bath water, this should prompt banks to give us more details about the industries they play in."

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