As investors fret about credit quality in a slowing economy, analysts are counseling thrifts.
Thrifts and consumer-focused banks should excel as economic growth slows, analysts say, because they typically boast solid asset quality and scant exposure to increasingly volatile capital markets. With commercial and syndicated lending increasingly pressured by bad loans, reasonably priced smaller bank stocks should outperform richly valued big ones in coming months.
"Thrifts are attractive because they offer a lot of what banks don't," says Stephen J. Gresdo, manager of a hedge fund and co-founder of
. One of his current favorites is
, which he owns.
Improving margins, solid credit quality and an expanding product line have boosted Washington Mutual's profile, says Gresdo. "These once 'single product' institutions are giving the old-line commercial banks a run for their money."
A series of interest-rate hikes the past two years squeezed margins at thrifts, battering their stocks, says Gresdo. Now that the rate-hike pig has worked its way through the snake, he says, "These companies are benefiting as their assets are repricing." At Washington Mutual, Gresdo expects margin improvement in the fourth quarter: "Assuming rates go unchanged, margin should rise every quarter through 2001."
Valuation is also an important factor, say the analysts. Washington Mutual currently trades at about 11 times earnings, which is roughly in line with bank stocks. Gresdo says thrifts on average trade around eight times earnings and tend to be cheaper than a number of large banks in the sector, based on their growth prospects. "Earnings per share are growing at a decent clip, between 10% and 15%," says Gresdo.
Thomas Theurkauf, banks analyst at
Keefe Bruyette & Woods
, sees a few thrifts as "bumpy landing plays":
Charter One Financial
. (He rates all the stocks buy and his firm hasn't underwritten for the companies.)
Theurkauf says those thrifts would benefit from slower economic growth because, among other things, thrifts tend to respond more quickly to lower rates than do commercial banks. The
signaled Tuesday that it has abandoned its inclination to raise rates for the time being, which many investors are taking as a sign of rate cuts to come.
One of Theurkauf's top picks, Astoria Financial, is a "distinct beneficiary of lower interest rates should they occur," he says. KBW estimates 2001 earnings at $4.90 a share, a figure it says may prove conservative if short-term rates decline. Based on that earnings expectation, Astoria currently trades at 9.7 times earnings, which is below the current valuation of the
Philadelphia Stock Exchange/KBW Bank Index
, which is at 11.1 times estimated 2001 earnings.
Astoria has been on the rise in recent weeks, tacking on more than 20% since the beginning of November. The stock is currently around $47; Theurkauf's one-year target price is $51.50.
Credit quality is also a major sticking point now that bad loans are battering the balance sheet at some
large banks. Those that have exercised caution in lending, even at the expense of profits, are now getting their due. "Thrifts, whose assets consist almost entirely of high-quality residential mortgages and home equity loans, have steered clear of the earnings abyss that is created by loan defaults," says Gresdo.
Brock Vandervliet, banks analyst at
, still likes some commercial banks, but prefers those that have lent carefully. These include
, which he says have "less or no exposure to syndicated lending and are willing to stick to the markets they know best, particularly in commercial markets." (He rates Commerce Bancshares a buy and WestAmerica neutral.)
And for banks involved in the syndicated market, the market for large loans shared by three or more institutions, Vandervliet says average loan size is important. He points out
, a Honolulu-based bank that has been active in the syndicated market. "More important is that the average loan size is only $3 million. When one loan goes bad, it's not the disaster you'd see if it was $15 million," he says, adding that, "Heavy concentration in anything would be red flags" in the current environment. (He rates BancWest buy.)